Think isolation.
Think monetization. Think trapped. Think Catch-22, no remotely viable option.
Think end of the road in a gigantic USTreasury bubble, in the process of
discredit. Think last resort of monetization, due to the absence of bidders
at USTreasury auctions. Think pressure like a vise. The USGovt is in a great
big bind and chooses not to discuss it. As European nations ponder the plight
of sovereign debt default, the United States compares an order of magnitude
worse from deeper insolvency. A default closer to home is considered
unthinkable. So was a broad mortgage market breakdown. So was an endless
housing decline. So was an insolvent broken banking system. So were
consecutive $1 trillion federal deficits. All were forecasted here.
BOND BOYCOTT LED BY CHINA
The Chinese, trade
partner turned adversary, have been in boycott of USTreasury Bonds for a
year, if truth be told. While still a significant creditor for USGovt debt,
it also stands as the primary adversary in the movement to displace the
USDollar from its global reserve currency. Arabs and Chinese are mentioned consistently
as the most important creditors for official USGovt debt. Something of note
happened in 2006 and 2007. The Japanese stopped adding to their USTreasury
Bond holdings. The slack was taken by China. Now something has happened
again. China has stopped purchasing the USTreasury debt securities. The United States has been set up for acute risk in funding its debt. The response is clearly
to be a greater dependence upon the printing press, as the USGovt will be
forced to finance its debt through monetization, perhaps almost exclusively. This
is the closest one might ever see of a major industrialized nation engaging
in behavior best described as Weimar-like. And US economists reward its chief
monetary mechanic with a national award! We witness the ultimate in moral
hazard, even its celebration.
The war of words
continues with China. The leaders and officials in Beijing have delivered
salvo after salvo against the weakened US fortress for months. They direct
volleys the deficit flank, the currency flank, the tariff flank, the reform
flank, and others. They have led the rebellion to remove the USDollar from
exclusive usage in international trade settlements. They have endorsed the
phase-out demise of the Petro-Dollar. The deputy governor of the Peoples Bank
of China had some stern words recently. Zhu Min from the PBOC said, "The United States cannot force foreign
governments to increase their holdings of Treasuries. Double the holdings? It
is definitely impossible. The US current account deficit is falling as
resident savings increase. So its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world. The world does not have so much money to buy
more US Treasuries. [It is] getting harder for governments to buy United States
Treasuries because the US's shrinking Current Account gap is reducing the
supply of dollars overseas."
This is a double
whammy. Foreigners have less US$
funds to buy when USTreasury supply is exploding, due to smaller US trade
gaps and smaller foreign trade surpluses. The outlet is USFed
monetization to purchase the official bond supply using printing press funds,
a last resort source of money. Asian economies have their own challenges.
Gone is the Japanese trade surplus. China, on the other hand, is openly sick
& tired of financing a government debt when the direction has not been
set toward progress or reform. Improvement of the USGovt finances seems NOT a
priority in the eyes of foreign creditors. Zhu was as plain as possible, that
the USGovt should no longer rely on China for funding its bottomless
deficits. Conditions are extremely likely to grow worse, with more
desperation to finance deficits that in no way are reduced. The Fed has no choice but to turn the
monetization machine on hyper-drive. A chart accentuates the
problem and exposes the risk, thanks to RBS bank.
China has made two important changes
in their USTreasury management. They have converted much long-term debt
securities into short-term debt securities. They have also stopped buying
short-term USTreasury Bills almost completely. See how China has sharply
reduced their short-term USTBill support (US S/T in brown), which fell off a
cliff since summer 2009, when it was an annual outlay of almost $200 billion
worth, but now is next to zero. Shown are rolling 12-month sums, meaning
around May 2009 the previous 12 months totaled around $190 to $200 billion. As
of October 2009, their assembly of USTBills has been nil for a year!! Their
long-term USTreasury purchases remain steady (in light blue) in the $90 to
$100 billion range, again summed over the last 12 months.
Look more closely at
the complex chart above. Notice the very serious dumping of USAgency Mortgage
Bond, from a level with running 12-month total near $75 billion in the early
summer 2009 to minus $25-35 billion in the last 12 months. Clearly, Beijing leaders have ordered a halt of USTBond
purchases. Major entities are selling huge amounts of
USAgency Bonds. The Chinese Govt has been selling mortgage backed securities
almost as fast as PIMCO. However, they have halted the purchase of
USTreasurys. Since May 2009,
Chinese USTBond holdings have been flat at $790 billion. The
USGovt is more isolated nowadays, left to its printing press device to handle
the avalanche of debt.
Imagine, the US recession does not produce enough trade deficits for foreign sources to recycle,
perversely. It sounds crazy. A recession will do that, like one that
stubbornly refused to end. Going hand in hand with stronger and more robust
economic activity inside the US fenceposts is huge trade deficits, no longer
seen. This is yet another ongoing
recession signal, since the October trade gap was ONLY $32.94 billion,
grossly inadequate for foreigners to purchase USTreasurys. Foreigners
have less US$ funds from trade to devote to USTreasury conversion, thereby
avoiding the currency lift at home. The experts call the process
sterlization, since the new US$ money does not convert, does not push the
local currency higher, does not interrupt via a feedback loop the export
trade that produced the surplus in the first place. Export of USTreasurys is
the nastiest, most sinister, most effective device in creating gigantic
unresolvable global financial imbalances.
A TEST TO EXIT FROM
0% RATE POLICY
The USFed decided to
keep the official interest rate at 0%. My forecast is either no rate hike for
12 to 18 months, or else a gambit of a 25 basis point hike, but with further
hikes halted. A series of rate hikes would cause far more havoc and
disruption than the so-called experts anticipate. The chronic 0% rate offered at the US bond ring assures a resumed Dollar Carry Trade, and USDollar decline. This
is simple speculation mathematics. The result will continue to maintain the
gold bull market. As universally expected, the USFed kept its overnight
target at 0-0.25% and pledged to keep rates low for an extended period in its
words, again. Their statement contained some rubbish about expressed growing
optimism for the USEconomy. They cited an abatement in the labor market
deterioration and hope of improvement in the housing market, pure fantasy. Neither
has remotely occurred.
More important than
such nonsense, the USFed underscored confidence in credit markets. It stands
by USFed plans to end most of its emergency lending facilities on February
1st. Removal of the primary true source of liquidity will be a dangerous
proposition, but they must fake the billboard messages and give it a trial. It
is my belief that the USFed will remove the flow of easy money, aka
Quantitative Easing, but only on the fringe. They will cut back on some
highly visible monetization of USTreasury and USAgency Mortgage Bonds. But they will not reduce any hidden monetization
of the same bonds, a powerful enterprise with magnificent unspoken volume
that prevents auction failures.
The USFed is actively
running a trial balloon. They are permitting the slow motion rise in the
10-year and 30-year USTBonds. If the 10-year TNX yield rises above 4.0%,
which could happen easily, a test will be given. Borrowing costs on car loans
and commercial loans would rise in step. But the main event would be the test to the housing market from the
mortgage rates sure to rise in step. In parallel, the mortgage bond market
would undergo a test. The USFed in my opinion wishes to test its urgently
needed but impossible exit strategy. My bet is the test
fails. My other bet is they lie about its failure. In time, they will halt
the test and admit the USEconomy and US credit market remain too weak to
begin a rate hike cycle. In order to prevent a future disaster, they must end
the current easing cycle. THE USFED WANTS THE TEST FAILURE TO PROVIDE
POLITICAL COVER FOR REMAINING IN A RIDICULOUSLY LOW INTEREST RATE
ENVIRONMENT. They might wish to kick the Dollar Carry Trade off its path
periodically. They know the extended risks. They know much higher price
inflation awaits on the other side of Easy Street. The veto vote goes to the
short-term USTreasury Bill market. If conditions were ready for a rate hike,
the USTreasury Bills would confirm it across the lower maturities. Notice the
3-month USTBill yield. It cannot
even rise to reach the 0.18% plateau seen for the entire spring and summer
months. This means no return to normalcy anytime soon. A
point of history is worth mentioning. The US Federal Reserve almost never
breaks away from the path set by the short-term USTreasury Bill market.
To further point out
the futility of policy and the lack of viable options, last week former USFed
Greenspan actually claimed the United States was on the path toward a 'formidable
fiscal crisis' unless its deficit situation is tackled shortly. He should
know since it bears his signature. Next turn to comedy. A recent report prepared
for the National Bureau of Economic Research suggested the monster USGovt
debt be reduced by allowing inflation to rise. The real value of the debt
would suffer erosion, the victims being the creditors. The NBER contains some
of the best misguided economists on the planet. Let us not even delve into
the risks of price hyper-inflation, which would serve as the greatest shock
of reality to these charlatans in residence. Fast rising prices would be like
a large bowl of cold liquidity splashed onto their faces. Laurence Meyer, the
fixture in the banker elite circles, actually said last week during an
interview that no connection exists between USGovt deficits, USTBond
issuance, and price inflation. Why do people listen to these guys? They are
inflation apologists and high priests.
USDOLLAR LEAST UGLY
FOR NOW
The 0% rate continues
to undermine the USDollar, an unchanging situation. The 0% rate continues to
feed the gold bull, whose trough was pushed aside but will soon be placed to
feed its appetite. The world requires an occasional US$ Index (DX) rally so
as to avoid having it march directly into oblivion. The USGovt deficits are
the ball & chain attached to the embattled USDollar. The onliest thing
making the buck look good is the ugliness of the other major currencies. The
fully engineered, entirely contrived USDollar rally began with the November
Jobs Report, a work of fiction. It continued with the very real troubles
facing European and London banks, from debt based both in Dubai and Southern Europe. The horrendous fundamentals for the beaten down buck had attention drawn
away, by the wretched situation facing banks that underwrote massive debt to
these two new centers of indebted attention. The Euro and British Pound gave way and buckled.
The last gold rally
was led by the United States. The gold price in Euro terms has hardly
corrected or budged. Attention is centered upon the European Union, certain
to fracture from Parliamentary disappointment, as its monetary foundation
suffers a grand erosion in its coastline to the South. Attention is centered
upon the European Monetary Union, whose Euro currency will soon be denied
usage across Southern Europe. The
next round of the gold rally will be led by Europe. The
broad advantages of a grand currency devaluation will soon come front and
center. Greece, Spain, and other nations will realize the benefits of debt
conversion and reduction on the back of returned currencies in the Drachma
and Peseta. Then comes steady currency devaluation to enable a competitive
position. The common Euro serves as a straitjacket for the distressed nations
in the South of Europe. They are stuck, and will surely default one by one. The
sequence of events is complicated. A heavy weight will sit atop the Euro
currency from European credit failures until important significant events are
unfolded and a new Core Euro is launched. At first the core version might
simply be the old version with carved off burdensome Southern gristle and
fat. These currency matters are analyzed in the December Hat Trick Letter.
MOTIVE TO MAINTAIN 0%
RATES
An ultimate factor of
practicality is often overlooked. Cheap
interest rates to service USGovt debt is a huge reason why the official 0%
interest rate policy continues. The USFed claims to want to
end its ultra-easy monetary policy, but it must resort to words more than
action. A higher USFed rate would not only deliver a heavy hindrance to the
USEconomy, but a great aggravation to the federal deficit. The USGovt
revenues are down sharply. Notice the Receipts have fallen from $2600 billion
to almost $2000 billion in the last two plus years. They have fallen and
cannot get up. In fact they contradict any lunatic notion of a jobs picture
improvement. The November Jobs Report was a pure fiction. Thanks to the Casey
Research folks for a great chart.
The White House staff
estimates the current fiscal year debt service to be $202 billion. That
amount is actually less than the 2008 debt service cost, even though the
official 2009 federal deficit shot into low stratospheric orbit at $1420
billion. Despite much higher debt
in 2009, the service cost to the USGovt debt went down, something of an
advantage. In fiscal 2009, the average USGovt interest rate
on new borrowings was under 1.0%, the lowest ever recorded. It is highly
doubtful they wish for borrowing costs to shoot up. TRowe Price estimated
that if USGovt debt service costs remained constant into year 2009, the cost
would have been $423 billion, higher by $221 billion, or almost 110%. Bill
Buckler of the Privateer calls 2009 the 'Interest Free Year' very
appropriately. The USFed cannot cut rates any lower, unless they go negative.
Furthermore, the USFed has used its mouths to make words to the effect that
it will stop adding toxic bonds to its balance sheet by March 2010. The
USGovt and USFed have enormous motive to keep their borrowing costs down, and
to continue the discount to borrowing costs.
My doubts are very
high for any end to monetization of USTreasury and USAgency Bonds or for any
halt to USFed massive expansions to its balance sheet.If the USGovt and USFed
stop buying US$-based official bonds, these debt securities must fight on
their own in the bond market for proper valuation.That means higher yields
and lower price, since supply is bloated and it shows no signs of stopping.
FINAL NOTE ON DEBT
DOWNGRADES
The debt ratings
agencies have been busy in the last few weeks. They do NOT wish for a
repeated episode to demonstrate on a global scale another example of sleeping
on the job. Their opponents, the many corporate bond losers in the wake of
2008, have begun lawsuits. The
prospects of sovereign debt downgrades have led to wide debate about the
likelihood of a string of sovereign debt defaults. Such
defaults are written in stone, in my view. The main question is whether the Big
Three ratings agencies will be ahead of the process and actually do
responsible work.
Mere discussion by
Moodys in recent weeks of a USTreasury debt default is indicative of the lack
of creditworthiness. They said a USGovt debt downgrade and a UKGovt debt
downgrade are unlikely. Between the
lines they declare a debt downgrade is deserved. The USGovt
debt burden will climb to 97.5% of GDP next year from 87.4% this year,
according to the Organization of Economic Cooperation & Devmt forecast in
June. The UKGovt public debt will swell to 89.3% of the economy in 2010 from
75.3% this year, a bigger percentage jump, according to the OECD. Moodys
mentioned that all Aaa rated governments are affected by the global financial
crisis, with differences in their impact and ability to respond. They must
refer to the ability to print money and monetize debt, perhaps even pressure
other nations to purchase the debt via their obedient central banks. David
Keeble is head of fixed income strategy in London at Calyon, the investment
banking unit of the French Credit Agricole. He said, "There has been a huge increase in
debt-to-gross-domestic-product ratios as a result of the crisis. It is right
that there should be a lot of attention and pressure on these numbers. It is
difficult to drive a big wedge between the US and UK in terms of their fiscal
outlook. The flexibility that Moodys spoke about is not obvious. It is all a
matter of political willpower."
My interpretation is to question their internal processes that failed to forewarn
of Wall Street bank implosions in the autumn months of 2008. The
debt rating agencies must operate with more independence and less pressure
seen as collusion.
THE HAT TRICK LETTER PROFITS IN THE
CURRENT CRISIS.
Jim Willie
CB
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