Why does it matter if the UK and the U.S. had difficulty selling their bonds at auction yesterday? This report explains:

The plans of these governments to stabilize their economies depend on the ability to borrow money through these bond auctions. Now, there are signs that investors are balking. The fear is an “inability to control interest rates by governments, which is the next unintended consequence of the huge printing, and is coming earlier than expected,” said Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund. “It means people don’t buy government bonds … as a result, they have to do it at higher rates.”

Recently, the Chinese government signaled worries about the U.S. dollar and Treasury bonds because of the financial crisis, and the response of government spending. The Treasury Department and Federal Reserve argue that hundreds of billions of dollars of expenditure on economic stimulus and bank stabilization is the only way to get the U.S. economy back on an even keel.

Put differently: Obama is fixated on spending tons of money we don’t have and is spinning the line that our recovery depends on passage of his huge budget. That requires that we sell tons of Treasury paper to raise the cash. But there is only so much that individuals and other nations, including China, will buy — especially if they suspect we are flooding the market with debt and are on a glide path toward inflation (e.g. printing more and more money, making each dollar worth less).

And if we can’t sell all those bonds? Well, we have to raise rates to try to lure buyers. And higher interest rates in the midst of a recession sounds a lot like the recipe for 1970s-style stagflation. (Plus, the cost of servicing the debt financed by higher interest rates chews up an even higher proportion of our budget.) But this wasn’t supposed to happen for a while — it was a long term problem, we were told.  Well, like Rick who came to Casablanca for the waters, we were misinformed.