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Guest Post: Here's The Setup For The Con Of The Decade
Submitted by Charles Hugh Smith from Of Two Minds
Here's the Setup for the Con of the Decade
The Con of the Decade, which I described last July, is being set up nicely.
I described The Con of the Decade last July (2010). The Con makes me a heretic in the cult religion of Hyperinflation. I consider myself an agnostic about the destruction of the U.S. dollar and hyperinflation (basically the same thing), but my idea that hyperinflation is fundamantally a political process makes me a heretic. I skimmed a few of the dozens of comments posted on Rick's Picks and Zero Hedge after they posted one of my expositions on this dynamic, and didn't see even one comment in favor of this perspective.
The Con is being set up right now, and the outlines are clearly visible. The Con works like this:
1. The Financial Elites/Oligarchy raked in billions in private profit from the orgy of leverage, credit expansion, fraud, embezzlement and misrepresentation of risk that resulted in the Housing Bubble.
2. The losses were transferred to the public (Federal government, i.e. The central State) or its proxy, the Federal Reserve (i.e. the central bank), via bailouts, backstops, guarantees, the Fed's purchase of taxic assets, and an open window for the financiers to borrow billions at zero interest (ZIRP) for further speculations.
3. The Treasury now borrows $1.6 trillion every year, fully 11% of the nation's GDP, as the Central State has replaced private demand and credit expansion with its own borrowing and spending.
4. Non-U.S. central banks have largely ceased to support this unprecedented scale of borrowing, so the Federal Reserve now buys most of the Treasury's issuance of debt via QE2 (quantitative easing, the direct purchase of $600 billion in Treasury bonds).
5. Unlike Japan, the U.S. cannot self-fund its own government borrowing: while U.S. investors, banks and insurance companies do own a significant chunk of Treasuries, the U.S. savings rate (capital accumulation) is still abysmally low, around 4%, which is half the historical average savings rate.
This is the result of the Keynesian Cult's One Big Idea, which is to pull demand forward and encourage borrowing and spending now by any means necessary, and thus sacrifice capital formation/saving.
So the basic outline of the Con is that private losses from the financialization of the U.S. economy were shifted to the public. Now to keep the Status Quo and Financial Plutocracy from imploding, the public is on the hook for $1.6 trillion in additional borrowing every year until Doomsday (around 2021 or so).
Having secured the backing of the Central Bank and Central State, the Plutocracy's only problem now is that it needs a risk-free source of high-yield income. Yes, it has a trillion dollars or so sitting in bank reserves, collecting interest from the Federal Reserve; this is certainly risk-free, but the Fed's Zero Interest Rate Policy (ZIRP) keeps the rate of return absurdly low.
Here's where we see the Con taking shape. The ideal setup for risk-free returns is to own Treasurys that pay a high yield. The way to get higher interest rates is to first make the Treasury market supremely dependent on a central bank or single buyer: Done. That buyer is the Federal Reserve.
Next, have that buyer stop buying. Suddenly, interest rates start moving up. If you don't believe this is possible, or part of a larger project, then please explain why PIMCO sold all its Treasuries. Duh--because interest rates are set to rise, and not by a little bit or for a brief span, but by a lot and for years.
That means holders of long-term Treasuries (and other debt) will be cremated as rates rise. (Holders of TIPS will do OK, unless the government fraudulently sets the rate of inflation well below reality. Hmm, isn't that exactly what's it's already doing?)
Once long-term rates have leaped up, then start accumulating the high-yield bonds. Why would rates jump? Supply and demand: as the demand for low-yield Treasuries dries up, the supply keeps rising: every month, the Treasury has to auction tens of billions of dollars of bonds, or even hundreds of billions of dollars. There is no Plan B, the bonds must be sold, and if there are no buyers, then the yield has to rise.
Once rates have been engineered much higher, the Financial Oligarchy accumulates the high yielding bonds.
Here's where "austerity" comes in. Once rates are so high that they're choking the real economy, then voices arise demanding the Federal government stop borrowing and spending so much. Austerity (forced or otherwise) soon reduces the supply of bonds hitting the market and so rates decline, boosting the value of the high-yield debt.
To service the cost of all this Federal borrowing, taxes are raised on what's left of the productive members of society.
To add insult to injury, it will become "patriotic" to "buy bonds."
OK, let's check the setup:
1. Treasury market now dependent on one buyer: check.
2. That buyer stops buying, pushing rates higher: no QE3. Check.
3. "Austerity" is now seen as inevitable--but not just yet: check.
What the true believers of hyperinflation and the destruction of the dollar cannot accept is that debt is an asset to the owner of that debt. In focusing solely on the advantages of inflation to borrowers, they ignore the critical fact that inflation quickly destroys the value of the asset that debt represents to the owner. And debt is a primary asset to pension funds, insurance companies, banks, and indeed the entire financial sector.
So in claiming high inflation is guaranteed, adherents are claiming that the entire financial sector will accept being wiped out, just so Mr. and Mrs. Taxpayer won't have to pay interest on the ballooning government debt.
That's exactly backward: the entire point is for Mr. and Mrs. Taxpayer to pay high yields on Treasury debt, owned by the Financial sector's Oligarchs. The Con is to stripmine the public coffers, then impose higher rates and "austerity", buy the debt with the cash plundered from the public, and then sit back and enjoy risk-free returns as taxes are raised on the remaining tax donkeys. Inexpensive Bread and Circuses (SNAP food stamps and the political theater of the two parties staging a partisan "fight to the death") will keep the peasantry entertained and complicit.
As I concluded in the first foray into the Con:
In essence, the financial Elites would own the revenue stream of the Federal government and its taxpayers. Neat con, and the marks will never understand how "saving our financial system" led to their servitude to the very interests they bailed out.
The circle is now complete: in "saving our financial system," the public borrowed trillions and transferred the money to private Power Elites, who then buy the public debt with the money swindled out of the taxpayer. Then the taxpayers transfer more wealth every year to the Power Elites/Plutocracy in the form of interest on the Treasury debt. The Power Elites will own the debt that was taken on to bail them out of bad private bets: this is the culmination of privatized gains, socialized risk.
In effect, it's a Third World/colonial scam on a gigantic scale: plunder the public treasury, then buy the debt which was borrowed and transferred to your pockets. You are buying the country with money you borrowed from its taxpayers. No despot could do better.
This is the ultimate endgame of the financialization of the U.S. economy and the concentration of wealth and thus political power in the hands of those who skimmed the immense gains from that financialization.
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Con of the decade? I beg to differ. A con is a swindle. It leaves you poorer, a bit chagrined perhaps. But once the con has run its course, victims are free to seek renewal. No, this is not a con, it is a coup. It is changing the nature of governance from democracy to oligopoly. But yes, the coup, while harming the average citizen, will be embraced because the oligarchs control the media - or at least most of it.
With the success seen thus far, the coup is likely to work hardest toward solidifying its power. It will seek a stranglehold on media - including the internet and sites like ZH. A strong sense of moral outrage toward government - as hindering rather than guiding economic growth has already been sowed and has taken root. In the end, the victims of the coup will become its most virulent defenders. For many of you, finding this malevolent army of true believers will be easy. Look in the mirror.
I like Charles and the way he thinks, but consider this. If gold doesn't respond to the rate hike, then what we're witnessing is a decoupling of economics from politics. If we see that, then which one wins out, the banks or the military. Hmmm?
I believe Charles view is very much based on conventional dichotomies which is essentially the way everything has been viewed for quite some time. Dichotomies are always needed when the plan is to divide and conquer. That's why Mervyn King is proposing a new "divorced" currency system (http://tradewithdave.com/?p=5310) that decouples transactional money from systemic risk through a gold component. We live in a Republican/Democrat ATT/Verizon Fedex/UPS Coke/Pepsi world.
The logic that gold will fall when rates rise makes perfect sense... as long as it happens. If it doesn't, then what? I believe we are already seeing a decoupling between precious metal paper and precious metal physical. Who's to say we couldn't see the same thing with rising rates and gold? Am I correct in assuming that such an outcome as simultaneously rising rates and rising gold may be just the thing to resolve the China yuan revaluation issue and lead to the SDR basket that is the plan anyway?
This is why I've been saying for the past few months that Ron Paul may not realize that he's a tool for this agenda for End the Fed. The only sovereign solution would be to Seize the Fed, not end it. The people who control the Fed and central banks are the very ones who plan to end them (aka the reset switch). Whose gold is it exactly in the basement of the New York Fed?
Dave Harrison
www.tradewithdave.com
this incessant reference to 'sheep' and 'sheeple' on ZH cracks me. never have i seen such a coherent bunch of sheep all bleating the same thing, without the slightest attempt at proper analysis, as on ZH. it really is too funny.
I prostrate myself on the altar of your insightful and masterful analysis of our current conundrum. Wait, thats right, you said nothing just another asshole with an opinion of course..
"Next, have that buyer stop buying. Suddenly, interest rates start moving up. If you don't believe this is possible, or part of a larger project, then please explain why PIMCO sold all its Treasuries."
Another scenario:
> Fed stops buying
> Stock market tumbles (same as last year after QE1)
> People exit stocks, $ goes into bonds.
Result: Bond market rally, lower yields.
Further supporting this scenario, economy slows due to higher fuel costs. Slower economic growth would also tend to suppress interest rates.
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Another scenario: unannounced QE - swap arrangements with other Central banks, etc.
or a more "limited" QE3 - e.g., the QE 'detox' wagon; slower removal of support from the markets. The Fed could use this to try and prevent large market moves that might be counter productive to its objectives.
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Gross is a smart guy. However because he manages such huge bond resources, could a small 'short' position be a 'pied piper' - trying to lead people into the 'con' scenario while knowing $ will flow into bonds with a QE2 exit? (Hence improving his returns?).
Or does he know QE3xxx will be required because he's far more in tune with the funding requirements of the US, appetite for US debt globally, Japan selling its debt to raise $ for rebuilding... etc.?
In either case, I don't think the 'con' scenario is a foregone conclusion. Slowing economy may force the Fed to stay dovish on monetary policy.
Yet again we seem to be faced with the five pounds of shit and only a three pound bag. A bit like a colostomy rodeo. It gets messy and someone always ends up wearing it.
I thought this was a possibility too. My fear is that only the friends of the government will be able to benefit from this. I remember commenting on a post of Bruce Krasting where I suggested "they" will bend the rules and call treasury bonds when it suits "their" needs. Bruce pointed out that treasury bonds are non-callable, but when you consider the precedent set when Chrysler bond holders got screwed I wouldn't count on this technicality being honored for you and I. Sure the tranches held by GS etc will never be called, but you and I will only have the opportunity to purchase tranches that will be called as interest rates begin to go back down.
Kudos on your recognition of the two-tiered legal system. What happened to the Indiana pension fund should have dropped the stock market 50%...but it didn't. The rich learned to rent politicians, and the middle-class investor missed the canary in the coal mine. Must've been watching American Idol.
GM, too. prez milk dud gave their legal interest in what was left of GM to the union, and screwed them. the courts will not uphold the bond-holders contractual rights to the property, under the very real terms of these LOANS, before the unions, and their income from the "jobs" in the company. bullshit! that company, like all the insolvent zombies should have been liquidated. jeeeez! it would be in pieces, people would be working with the pieces, and the world be be different, not over!
Tyler,
Since inflation is a monetary phenomenon (thank you Milton Friedman) what else could cause it other than politics?
But what is the big picture? Why? Just ask George Soros (and his man in the White House). The big guys want to take down the US a peg or thirty.
And why is that? The people of the US are too damned independent.
Does anyone here understand that it is the market that sets rate, not Ben?
Just asking...
I don't get it Tyler.
Your scenario was baked in when they announced the bank bail-out. It guaranteed the take-over by the banks of the income stream of the American government given deficit spending and positive discount window returns on zero rate money.
That makes it the worst legislation ever passed; a direct and inevitable transfer of wealth and ownership of real assets to the banks. US citizens are bankrolling their masters not just through manipulation of CPI and interest rates, but more importantly by guaranteeing the value of their bad debt.
Your scenario above only affects how fast it will happen. Letting the banks fail was our only chance to reprice all their debt that is still strangling the economy.
Won't work...Austerity and higher taxes won't work. The citizens have come accustom of walking away from debt and that will be the wrench thrown into the gears. Unlike Europe, the voters will demand a default.
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The author must have better info on the bond market than Pimco. Isn't Pimco in cash and zero Treasury?
Put " Con Of The Decade" and "Federal Reserve" together and OF COURSE you'll get more than 400+ responses - this is not the con of the decade, this is the con of the century.
Laws and Taxes are for Peons and Peasants.
Well, it worked in the Vietnam inflation and the Reagan deflation...why not again?
This all goes to the danger of political control of the economy. I believe hyperinflation will occur, due to a loss of control of the situation, particularly driven by a lack of confidence in the dollar world-wide. Smith's theory implies a level of control that doesn't exist in the real world.
And I will admit it is an intriguing idea. Problem is, when market direction is driven by political factors, it could go either way. Assuming they had the control, they could move it up or down. Rates up or down. Inflation up or down. And it could turn on a dime. How can you possibly invest in that sort of market?
The free market may be volatile, but in the long run it is rational. Bubbles burst.
This political manipulation sucks the blood out of the market and harms (virtually) everyone both short-term an dlong-term