Is The Fed Enabling Foreign Central Banks To Swap Out Their Agency Debt Into Treasuries?

Tyler Durden's picture

Another quite intriguing piece by Chris Martenson "The Shell Game - How The Federal Reserve Is Monetizing Debt" reveals some of the intricacies of the Fed's monetization game and, by digging deeper into the Fed's Custody Account, demonstrates not just how the Federal Reserve is enabling foreigners to swap out of Agencies into Treasuries, but how it is implicitly monetizing a markedly larger portion of debt than is assumed.

For the full details of the article we eagerly refer readers to the original Martenson piece, but in a nutshell here are the components of what Martenson coins "The Fed's Shell Game":

It is no secret that capital flows into the US have declined precipitously, a fact that can be substantiated by TIC flows and by the St. Louis Fed:

Comparing this data with TIC releases, indicates that from January to May the total capital outflows from the U.S. amount to ($314) billion in assets, consisting of central bank purchases of $50 billion, however, matched with private investor dispositions of $364 billion.

Ignoring the implications of what this decline would mean for an economy that relies exclusively on credit growth in order to perpetuate the monetary Ponzi scheme that the US economy has been for years, the simple conclusion here is that a combination of declining consumer credit and foreign interest for US debt purchases has very negative implications for the credit bubble the Federal Reserve is trying to reflate. As for the consequences for the U.S. Dollar as a result of this activity, these have recently become all too clear.

All well and good up to here.

However, what is very troubling is what Martenson points out is the cumulative change in the Fed's Custody Account, which at last check was roughly $2.8 trillion, and represented by Martenson's chart below:

Martenson provides a good explanation of what the function of the Custody Account is:

The Federal Reserve actually holds the bonds (or rather an electronic entry representing the bonds) in a special account for these various central banks.  This is called the "Custody Account" and it holds US debt 'in custody' for various central banks. Think of it as a magnificently vast brokerage/checking account, run by the Federal Reserve for central banks, and you'll have the right image.

Indeed, while TIC may indicate one thing, an observation of the CA indicates that foreigned have in fact been accumulating substantial amounts of US debt since the crisis began in earnest, at a rate that has not budged from its long-term average.

Yet the concerning conclusion by observing the above chart is the dramatic divergence in the CA of Treasury versus Agency holdings. Says Martenson:

Here we note that agency bonds peaked in October of 2008 at nearly a trillion dollars but have declined by $178 billion since then.  Treasuries, on the other hand, have increased by over $500 billion over that same span of time.  A half a trillion dollars!  If you were wondering how the US bond auctions have managed to go so smoothly, here's part of your answer.

At this point it bears pointing out the Fed's balance sheet, where the Fed's large appetite for agencies (including MBS for the purposes of this analysis) is evident. I present the most recent Federal Balance sheet as presented on Zero Hedge a week ago:

May this be an explanation of what is happening:

It would appear that foreign central banks have been swapping agency bonds for Treasury bonds, but that's not how the markets work.  First, they would have to sell those bonds, before they could use the proceeds to buy government debt. So to whom did they sell those Agency bonds in order to afford the Treasury bonds?

And here is where the concept of the appropriately coined Shell Game comes into play:

These are the three critical points to remember as you read further:

  1. The US government has record amounts of Treasuries to sell.
  2. Foreign central banks, which have a big pile of agency bonds in their custody account, would like to help but want to keep things somewhat under the radar to avoid scaring the debt markets.
  3. The Federal Reserve does not want to be seen directly buying US government debt at auctions (and in fact is not permitted to, but many rules have been 'bent' worse during this crisis), because that could upset the whole illusion that there is unlimited demand for US government paper, but it also desperately wants to avoid a failed auction.

For various reasons, the Federal Reserve cannot just up and start buying all the Treasury paper that becomes available in record amounts, week after week, month after month.

Instead, it uses this three-step shell game to hide what it is doing under a layer of complexity:

Shell #1:  Foreign central banks sell agency debt out of the custody account.

Shell #2:  The Federal Reserve buys those agency bonds with money created out of thin air.

Shell #3:  Foreign central banks use that very same money to buy Treasuries at the next government auction.

The question arises, where are the agencies that the Fed is purchasing at such as gluttonous pace coming from? Absent an audit of the Fed, one can merely speculate, but likely is one of the primary motivations for the Federal Reserve Chairman and the Secretary of the Treasury to claim that any additional openness into the activities of the Fed would be "problematic to the country."

Would this "behind the scenes" rotation endorsed by the Fed, whereby the Custody Account is the middleman for Foreign-Fed transactions, be the primary reason for an apparently unwavering indirect interest in US Treasuries?

As Martenson concludes:

The Federal Reserve has effectively been monetizing far more US government debt than has openly been revealed, by cleverly enabling foreign central banks to swap their agency debt for Treasury debt.  This is not a sign of strength and reveals a pattern of trading temporary relief for future difficulties.

This is very nearly the same path that Zimbabwe took, resulting in the complete abandonment of the Zimbabwe dollar as a unit of currency.  The difference is in the complexity of the game being played, not the substance of the actions themselves.

The shell game that the Fed is currently playing does not change the basic equation: Money is being printed out of thin air so that it can be used to buy US government debt.

When the full scope of this program is more widely recognized, ever more pressure will fall upon the dollar, as more and more private investors shun the dollar and all dollar-denominated instruments as stores of value and wealth. This will further burden the efforts of the various central banks around the world as they endeavor to meet the vast borrowing desires of the US government.

One possible result of the abandonment of these efforts is a wholesale flight out of the dollar and into other assets.  To US residents, this will be experienced as rapidly rising import costs and increasing costs for all internationally-traded basic commodities, especially food items.  For the rest of the world, the results will range from discomforting to disastrous, depending on their degree of dollar linkage.

As more and more people dig behind the Fed lustrous facade, increasingly more troubling discoveries are made. On one hand you see POMO auctions that repurchase recently auctioned off securities; on the other - potential capital rotation via custodial accounts of which there is no mention in mainstream media venues. If this analysis is in fact correct, the Fed is monetizing not only the Treasuries it purchases via POMO, but effectively also the indirect bidders' treasury interest, which is represented by their rolling out of agencies purchased by the Fed, and the newly raised cash used for UST purchases. Has the Fed essentially monopolized the entire Treasury Auction process?

Whether this speculation of dollar abusive policies by the Federal Reserve, which will stop at nothing, to reinflate the credit bubble and debase dollar-based debt, is in fact true, is questionable. However, definitive answers from Chariman Ben will not be forthcoming until he is forced to show his hand, whether via a legal order such as the recently won Bloomberg lawsuit, or through political means, such as HR 1207 and S 604. In the meantime, it appears the Federal Reserve, whose accountability should be to the entire US population, not just to a select crowd of Wall Street oligarchs, continues to pursue activities that facilitiate at any and all cost the stratification of US society into that minority that will benefit vastly from the Fed's ongoing actions and the significant majority who will see the purchasing power of the paper in their wallets gradually disappear, and effectively put the entire concept of the "American Middle Class" at risk.

For the full link to Chris Martenson's article, please click here.

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Sancho Ponzi's picture

OT: I KNEW this was coming, but couldn't they have the courtesy to wait until his body is cold?   ARRRRGGGGHHHHH! Bastards, all of 'em!

Dodd: "Maybe Teddy's Passing" Will Spur GOP To Act On Health Care

Anonymous's picture

as Rush aptly pointed out "let's honor Teddy by giving every American the same Health Care Teddy himself had"

Anonymous's picture

as Rush aptly pointed out "let's honor Teddy by giving every American the same Health Care Teddy himself had"

Anonymous's picture

Ted was a good catholic. He rubbed his beads while he lay dying hoping God would forget the murders and the rapes. But He won't. This man was about as worthless a individual that ever lived and now he is held up as some kind of hero. God help us.

Project Mayhem's picture

Is The Fed Enabling Foreign Central Banks To Swap Out Their Agency Debt Into Treasuries?:  


Crystal ball says "yup"

defender's picture

Could you guys help me with this, wasn't the first week that the Fed bought agencies one week after the surge in treasury demand?

ToNYC's picture

Man in the Mirror too. Ben is channeling Michael Jackson. El-Erian's sugar high? ...more like crack and a course of propofol..the new FED speedball for the 21st Century deconomy. The public isn't spending because it doesn't believe there is an economy to replace their assets and they need to learn how to invest in their survival AIDS. That disease is now being spread by the FED at their crack house at 33 Liberty.


deadhead's picture

It's shit like this that is sending the usa into the crapper (well, bidet I guess for the ZH crowd, lol!).  the only good news is these phucks can't sneak it by anymore due to the new media.  I hope this pushes H.R. 1207 forward.

Project Mayhem's picture

Hey CNN, why don't you steal this article too.  Doubt they'd let you print it!


Anonymous's picture

Ponzi, Ponzi, Ponzi, Ponzi!

zenith1's picture

Standards Board decided to eliminate a concept known as the  special purpose entity"

Anonymous's picture

thanks for posting this!

Anonymous's picture

ok, then the question begs to be asked. how does this affect the velocity of money? and then my statement would be in this case. can this create the hyperinflationary collapse that many have been talking about?

Anonymous's picture

there are two sets of funds to consider when
thinking inflation....there is tarp, talf, etc
money which is largely on deposit at the fed...
there is about 700-800b usd which is sitting there
but has not entered the economy.....if it does its
expansion coefficient is at the least 10x...and
could be as high as 50-100x according to numbers
i have recently read....

the 2d set of money (1.25t usd) is the money discussed here...
much of that money as we just read is going overseas
and as such ben thinks he is so clever because
he thinks he is keeping the inflationary effect
out of the usa while at the same time stabilizing
foreign banks and economies....

however there is still some good sized portion
of the 1.25t usd which is staying stateside
and will feed directly inflation....that money
will not stay in fed unless the pd are buying
massive amounts of citi and other zombie banks...
but they in fact may be doing so as evidence
here recently suggests....

these dollars are fueling the rise in
the markets and as such is not entirely
irrational - there
is indeed money behind the rise just as there
was in the early 1930s when the market bounced
50% on its way to its nadir in 1932 at -90%....

so part of the 2d set of money is contributing
to inflation and yes the money expanded will
result in hyperinflation....but it takes time...
there are still counterveiling forces but expand
even .5t usd by 10-50 and you can see it
overwhelming deflation....

Anonymous's picture

actually i erred...i do not think any of the
fiat money is going overseas....i overlooked a
step in the shell transfer...

Anonymous's picture

People who don't understand what the phrase "begs the question" means should not use it.

Sancho Ponzi's picture

I assume lots of these Agency bonds were sold to fund FAN, FRE, etc. 

Would you not be delighted to trade FAN and FRE agency bonds for Treasuries?

Anonymous's picture

buy gold. buy silver. and put your head between your knees and pray.

Sqworl's picture

How do you convince the world that your credit worthy???

Anonymous's picture

pay your debts - principal and interest...and
do so in currency which is not tanking.

Anonymous's picture

yeh but rememeber paulson told the congress that unless they got their money there would be hell to pay.

Anonymous's picture

does this put the torch to the mish shedlock theoretical exposition? me thinks it does. oh wise mish, what say ye? i know it pisses him off. he said a couple of years ago, he never trusted anyone that posted on seeking alpha and never wanted to hear from them....ha ha ha

Project Mayhem's picture

Mish still thinks the Fed is incompetent rather than a criminal operation

Anonymous's picture

mish will hit that deflation drum until the time when he must take a wheel barrow full of money down the store to buy a loaf of bread....

Gordon_Gekko's picture

Which will be his undoing. You bring up an excellent point, PM. In fact, this type of thinking is common to many deflationists that have interacted with. They generally believe that there is no significant government manipulation occurring in various markets - that they are generally free and fair; believe that government is more stupid than criminal when in fact the opposite is the truth; think that government is incapable of spending enough to overcome "deflation" (whatever they fantasize it to be); vehemently deny the existence of precious metals price rigging scheme even when faced with mountains of incontrovertible evidence; believe that people will mostly "struggle" to pay their debts thus increasing demand for the dollar/cash instead of defaulting on  them (IMNSHO, the majority of us - i.e. those with a brain and survival instinct - won't give two shits about defaulting on an underwater house); usually live in a US Dollar centric world where they are are totally, madly IN LOVE with the USD and cannot explain what will happen in other countries which are basically on a similar fiat regime; think that the USD today is same as the Gold backed USD of the 1930's when in fact due to removal of Gold backing we are talking about two entirely different monetary regimes; totally ignore the possibility of hyperinflation due loss of confidence in the currency.

Anonymous's picture

mish thinks he is always right and everyone else is always wrong. denniger is the same way. also throw in that pinhead on kitco that goes by the name of jon nadler.

Project Mayhem's picture

haha Nadler sucks so hard

Anonymous's picture

nadler is a douche bag's douche bag.....

SteveNYC's picture

Good post. What I don't get then, is if they are more "criminal" than stupid, and if they are in this to benefit their buddies and cronies etc, under the scenario we are in two things may happen:


1) Hyperinflationary spiral, in which people's cash becomes worthless, and we riot and lynch politicians, Bernanke etc. the lot of them. BUT, their buddies, who are loaded up with cash (yes, foreign currency and precious metals, which are easily stolen and looted from them in such civil unrest) also become poorer via the value of their dollars being destroyed.


2) Massive deflation, in which a country with no savings and loads of debt is effectively crushed by this deflationary force, we lynch politicians, Bernanke etc. BUT their buddies, who have loads of cash, no debt, and some forex and commodities, literally get to own the place and buy the country for pennies on the dollar.


Hyperthetically, it would seem to me that if pure "crime" was behind their motives, the secondary outcome would be better for their cronies. Thoughts?


Disclaimer: The "lynching" comments were merely used for "effect"!

Gilgamesh's picture

2, then 1.  They have backups standing by.

Anonymous's picture

Anyone with lots of money and at least a little brains, whoc is in on this scheme at any level, will leverage themselves so that they gain at some multiple of the rate of hyperinflation. That's what most deflationists dont get about these schemes. The GD's of the world will not lose any money even if money is debased by 50 or 99%. Because they are the ones who will be getting all the new money.

btw appears to be down

ED's picture

Re the $700B Bank reserves held on the Feds books - If such funds could experience a multiplier of up to 100x when relased into the economy, when does the point arrive when people start not accepting paper in exchange for goods? It's a lever primed 'pull for hyperinflation' isnt it?

And does this make sense - could the Fed be trying to shake foreigners out of their long USD (savings) positions before smackin the deflation button? The Fed wouldnt want a severe deflationary episode to occur whilst foreigners hold all the cash would it?


Anonymous's picture

The "buddies" in group two are already hedged out of the dollar. They will buy things with gold silver and commodities, not with appreciated dollars. How can the dollar gain value. It's dilution is the mechanism of all of the theft. If I have a $1,000 and you steal $500, how can I be left with $1,500? Dilution and inflation are the tool of the theft. People that hoard an increasingly diluted asset because they believe the asset will appreciate in value are a counterfeiter's dream.

Anonymous's picture

If there are a million tons of corn in the world, and all of which is hoarded (ie the velocity is almost zero), and I am the only seller (say three tons) I am going to love the price I get and I'm going to encourage the hoarders. This is why the govenment loves the deflation myth. It can keep selling dollars while everyone else is hoarding.

whacked's picture

PM and GG

Interesting that you can lay so much crap on a bloggist that is yet to be proven wrong. A recent report showed that out of the 15,000 economists, only about 120 predicted accurately. Neo classical economists missed the boat. The classical ones did not.

As for deflation, history will be the judge. Quite frankly though, do you not think it is a tad deflationary when capital goods and rent are reducing? With the unemployment one would expect as much. Then again, the both of you know what you are talking about don't you?? And before any snide remarks read up on the definition of deflation, so you both know what you are talking about.

Same to with homebuyers underwater... you two should go read his blog instead of forming preconceived ideas that have no relevance to his comments. Then again it is easy to bad mouth and trash people isn't it .. the anonymity of the internet... I appreciate TD's anonymity but seriously your personalities and sometimes sanctimonious comments are making it tuff to really appreciate the site.

I forgot GG has a brain and makes this comment without reading the Blog!

As regards the currencies I think that you fall far short of expectations when addressing the USD. When markets collapse the money will still flow through to the USD. All CB's have done worse than the Fed and all CB's attempted to deflate their currencies. It is mind boggling. And on the Euro I will follow Keynes idea of the road bump. The individual States unemployment and various other problems will no doubt see to that.

For the hyper-inflation angle ... again history will decide who is right and who is wrong .. but why dont you go buy some Real estate or shares if you feel that the inflation is going north .. is that not the cure?

So instead of being right proper wankers just concentrate on the big gorillas, the Fed and the people in charge of the US (whoever they may be) ...

Arm's picture

Time to sell your gold holdings.

Paulson is talking his book (obviously to unload)

Arm's picture

Lack of confidence in a currency does not lead to hyperinflation in that currency - it leads to no currency.

That is precisely the point where new currencies are introduced.  (Think Brazil, Rome, Mexico, Argentina, etc)

In Zimbabwe most transactions are not paid with wheelbarrows of money; they are paid with dollars and euros on the blackmarket.  The Zimi is the currency that is used only when forced to.


Anonymous's picture

"In fact, this type of thinking is common to many deflationists that have interacted with. They generally believe that there is no significant government manipulation occurring in various markets - that they are generally free and fair"

Fair enough!

"believe that government is more stupid than criminal when in fact the opposite is the truth;"

OK ! So, the goverment is more criminal than stupid, big deal !
THAT DOESN'T MEAN THEY'RE INTELLIGENT : you can be criminal and stupid too !
At least not enough intelligent nor ALLMIGHTY to manipulate everything.

Here is your implicit fallacy : assuming they can do anything, it's like if the universe was still and they were ultimate masterpuppets. But hey , they're humans they FAIL time and time again. And we're speaking about a SYSTEM and systems FAIL too, especially human hysterical finance ponzi systems.
Your theories evolve around your adoration for them, their money and supposed unlimited power :just look at your nickname and avatar:)
This combination of hyper-inflation scare and power fascination brings mainly more submission : you're preaching the same market cult of the greespan era, same hubris "don't fight the fed! they want inflation they'll get inflation. Don't ask questions!". Only this time, instead of Y2K euphoria, you have post-crunch ben and statist-finance fascism. The neo-cons in pure old fashioned fascist theory wanted to force the creation of a new reality in geopolitics, now the world powers want to revert to a situation where everybody believes everything is ok.

zenith1's picture

pd are buying
massive amounts of citi and other zombie banks...
but they in fact

Gordon_Gekko's picture

Mish is FINISHED. Put a fork in him.

Project Mayhem's picture

Well I still read Mish in hopes some day he'll come around...  yeah we are in deflation sort of , M3 might roll over.  But M0 and M1 will not.   What's it matter what the net 'difference' between the two (printing vs credit destruction) if there is currency crisis?


As some people have mentioned before, prices of everything you don't want will go down.  Prices of everything you need will go up.


Assetman's picture

Exactly, PM.

Economists will call it stagflation.

The rest of us will call it Major Pain.

If this hypothesis has truth behind it, prision may well be the safest place for Bernanke, Geithner and Summers.

Arm's picture

Stagflation?  Would we be so lucky

darkness's picture
darkness (not verified) Gordon_Gekko Aug 27, 2009 1:13 PM

boycott just like hole foods

good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions

max2205's picture

Knew it, Ben says sorry bout them agencies. please don't dump'em I buy 'em back with Treasy's.  Oppps, but when those turn into poop, what will he use to make them whole?


Again, why are we making everyone whole except the freaking citizens of this f'd up country....never mind, back to my charts.

Humm, wonder why AIG FRE FRM ect are running....who had this inside info?  f'king sick of these inside trades

agrotera's picture

Some suggest ( i think probably bank agents) that there were private threats from around the world, and that the "giving" of money to AIG, and probably many programs by the Fed are like ransom money.

Even if this is true, it is exponentially worse that no clear statement against the operations, laws, and the people who pushed the laws and operations to bring us this mess has been made by either of our governments administrations.  Furthermore, on the day of the big announcement (Feb 09) when Obama reported that he and Geithner would be backing the Paulson/Bernake plan, some reporter asked when the people responsible for this mess would be prosecuted, and Obama's response was that we can't look back, we have to look forward--effectively letting everyone responsible for the crimes that brought us this mess, off of the hook.


Anonymous's picture

very good speculation....are any of these swaps part of the 1.25t usd announced purchases by the fed or are they in addition to?....

when the dollar goes into the crapper there will be the benefit of more expensive imports which may encourage more domestic production....although i am sure that the oligarchs would have a shit fit over that and stop it cold in its tracks....