Foreign Central Banks

With the physical gold market remaining very small when compared to the futures and paper gold market (futures, CFDs etc) there are increasing concerns of illiquidity due to the scale of demand and lack of supply. Pertinently, the size of the physical gold and silver bullion markets is tiny compared to the size of international equity, bond and currency markets. Not to mention the hard to fathom humongous international derivatives market (see chart below). The gold market remains one of the most liquid markets in the world. The market is more liquid than many government bond markets in Europe, with daily trading volumes normally exceeding $100 billion. UBS wrote about “illiquid conditions” in the gold market this morning. They did not clarify but they may have meant illiquidity in the physical gold bullion market.

Lately there has been a lot of chatter among the supposedly smarter-than-mainstream media that even should the debt ceiling not be raised, it would not mean the bankruptcy of America as interest payments would still be satisfied. While that technicality is absolutely true, it is even more absolutely irrelevant. What propagators of such theories forget is that lately there are just two exponential curve trendlines that are worth noting: that of the cumulative debt issuance, and of the US cumulative deficit (see chart below). Each month, the US issues around $50 billion more debt than is needed to just fund the deficit. This is debt that is on top of the debt that is needed to plug the different between revenues and expenditures. As Zero Hedge has pointed out repeatedly before, that ratio is already roughly 1 to 2, meaning for every dollar in revenue the US government issues more than one dollar of debt just to fund the deficit. And then some. As the chart below shows, in December alone the government issued $84.4 billion on top of the budget funding shortfall ($80 billion deficit and $164.4 billion in debt issuance)! So yes, while the Treasury can fund interest expense at record low interest levels, that is completely irrelevant. Unable to fund incremental expenses to the tune of hundreds of billions per month, the US government will shut down (a point when nobody will accept US government IOUs, not Social Security which passed the point of being self sustaining last year, and certainly not Medicare and Medicaid, and most certainly not private sector Defense Vendors) just like it did in 1995. Below, we present the key charts and the full report from a must read SocGen report on the sovereign debt crisis, titled Can It Happen Here? We urge all those who pretend to have an educated opinion on the US funding crisis to read this report before they open their mouths in public and once again validate their critics.

Think gold is a bubble driven only by animal spirits and speculation? We think not and have consistently maintained the fundamental driver of gold has been the massive accumulation of foreign reserves by global central banks and their need for diversification. Nothing illustrates this better than the chart below. We have included the table to illustrate how much gold China and Brazil would have to buy to get to the same proportional gold position as their fellow BRICs, India and Russia.

Instead of wasting time with Byron Wien's Top 10 "predictions for 2011" we have decided to skip this latest and greatest worthless charade in prognostication, and instead we believe that presenting the list of what the man whose retirement age has come and gone, thought would happen in the past year, is a great example of why all these so called institutional Wall Street experts are nothing but two bit hacks. As may be expected, somehow Wien got exactly zero out of ten correct! The man is the contrarian indicator on Wall Street. Also keep in mind: it takes a lot of skill to be this bad.

Our esteemed Fed Chairman Ben Bernanke is about to find his policies running face first into a BRIC wall. He’s been exporting inflation abroad to the emerging markets all the while claiming it doesn’t exist. With growing civil unrest due to soaring food and energy prices the emerging markets are now fighting back.

Two days ago, in a surprisingly vocal announcement to make sure everyone heard it, the Fed extended the duration of its USD FX swap lines with foreign central banks from January (when they were due to expire) to August. One may ask: why the extension when Europe continues to lie that all is good, and when America has made it clear that it is not China, but the US, which will suddenly lead the next global growth spurt (ignore for a second that the recent jump in crude to just under $91 has wiped out virtually the entire benefit from the just passed payroll tax "stimulus"). One may also not get an answer. So while the announcement is nothing but the latest salvo in what is now merely a policy approach to risk asset pricing, the question of what is being achieved from a purely fundamental standpoint is likely somewhat relevant in our brave new centrally planned world. Bank of America provides the explanation to all those for whom the Fed's continuing backstop of Europe is a novel topic.

Tonight's must read piece of introspection comes from the keyboard of Russ Certo over at Gleacher, who has compiled a fantastic look back at the key events that transpired and shaped 2010, and summarizes the key market themes that prevailed in the now past year. In summary: "the answer to the question of what were the main themes in the market
is ...............valuations in equities, credit spreads, sovereign
spreads, exchange rates, mortgage interest costs, bank earnings, net
interest margin, accounting schemes, tax code, debt ceiling and more are
all related.  Related to the ebb and flow of monetary and fiscal policy
aspiring to make adjustments to imbalances caused by earlier failed
fiscal and monetary policies.  How, circular indeed." In other words, not only does history not only rhyme, but chases its tail, and the more things change, the more absolutely nothing has changed. We are where we started, and in fact are in a far worse position, as increasingly fewer last resort levers to push and pull are available to the fiscal and monetary authorities. We jest when we suggest that a Martian bail out of plant Earth will soon be required, but pretty soon, in our Onion (or is that Douglas Adams?) reality, NASA may find itself with the prerogative to rapidly find semi-intelligent and very wealthy life on other located within a few parsecs. We can only hope that the restaurant at the edge of the universe is an In and Out Burger.

In what is increasingly shaping up to be a showdown of epic proportions, the brand new chair of the Monetary Policy Subcommittee, Ron Paul, whose sole purpose in life for the past 20 years has been putting the Federal Reserve out to pasture, and returning to the gold standard, will soon spar with none other, than his, and every middle-class American's nemesis, the Chairman. And it could soon get even messier. In an interview with Fortune magazine's Nin-Hai Tseng, not only does the Texas doctor make it all too clear that he once again has presidential ambitions, but when asked whether he wants to end the Fed, gives the following brilliant reply: "Well, I don't expect to. The Fed's going to end itself when they destroy the system. So yes I would end the Fed but I would do it gradually and have a transition." Good luck Ron. However, there will be no gradual transition. If anything, it will be protracted, very much involuntary, and quite likely violent, as it would mark the end of a century-long scheme to transfer countless ounces (no pun intended) of tangible wealth to the ruling oligarchy in exchange for worthless and infinitely dilutable linen.

I feel quite a bit of empathy and maybe even a little remorse for those who blindly believed the mainstream nonsense of the past few years. I can’t imagine being so lost and so utterly disappointed on such a regular basis. The only good to come out of this dashing of false hopes is that it has caused many to begin questioning what the hell is really happening. Why have things only become worse? What about all the government legislation and stimulus? When is it finally going to produce the effects that were once guaranteed? In fact, what are the benefits of ANY action the government or the private Federal Reserve has taken so far? Let’s look at financial conditions across the globe and here at home, and perhaps we can gain a true understanding of the situation before us, and find answers for some of these questions…

One may be forgiven to believe that via its FX liquidity swap lines the Fed only bailed out foreign Central Banks, which in turn took the money and funded their own banks. It turns out that is only half the story: we now know the Fed also acted in a secondary bail out capacity, providing over $350 billion in short term funding exclusively to 35 foreign banks, of which the biggest beneficiaries were UBS, Dexia and BNP. Since the funding provided was in the form of ultra-short maturity commercial paper it was essentially equivalent to cash funding. In other words, between October 27, 2008 and August 6, 2009, the Fed spent $350 billion in taxpayer funds to save 35 foreign banks. And here people are wondering if the Fed will ever allow stocks to drop: it is now more than obvious that with all banks leveraging the equity exposure to the point where a market decline would likely start a Lehman-type domino, there is no way that the Brian Sack-led team of traders will allow stocks to drop ever... Until such time nature reasserts itself, the market collapses without GETCO or the PPT being able to catch it, and the Fed is finally wiped out in one way or another.

A roundup of reports from around the Web ...

...Going through it right now

The person who is almost singlehandedly responsible for the complete disaster that are today's bankrupt GSEs, somehow succeeds in making America hate him even more, when he notes that the global response of condemnation to the Fed's actions, and the subsequent enjoinder by Republicans who wish nothing less than to save the dollar, instead of allowing hyperinflation to deal with the consequences of the idiotic actions by the MA congressman, is "extreme hypocrisy." How this excuse for a representative (of anything more than a few well-rounded bankers) gets any air time is beyond us. Until then, we will make sure the collective blood pressure of our readership remains elevated thanks to such unprecedented examples of the supreme corruption in D.C. as Barney Frank. And unrelated, but even more disturbing, is Frank's statement that he doesn't mind that there haven't been prosecutions of financial crisis players. Don't worry Barney, prosecutions will come... Luckily these will happen once your immunity lapses.

Much has been said about how the PPI and the CPI are stuck in deflation mode (despite what everyone is seeing when buying groceries or filling up empty gas tanks). Much less has been discussed about how Bernanke's blunt policy tool of unlimited liquidity is leading to an inflation-driven bubble in Asia (and all Emerging Markets). Luckily, Macro Man Simon Black provides a first person perspective of how this bubble is developing, and how it will soon pop. In some ways this is empirical evidence of what Knight Research said previously: namely that the days of an EM push-pull mechanism are coming to an end. Here is why Knight's conclusion is spot on, paraphrased half way around the world: "when central banks start ratcheting up interest rates (like the Fed did in 2004 and what China is doing now...), buyers and developers no longer have access to cheap credit. Demand drops, and prices fall. When this finally happens, I think the subsequent fallout will serve as another strong argument to abandon the dollar and reset the financial system, especially in the developing world. All they need is a reasonable alternative. China is already allowing its currency to be used for cross-border settlement and limited reserve status, and as this function grows for the renminbi, you can bet that Asian nations will stop importing American monetary inflation and start exporting those dollars back home." A must read note for all those who base their investment decisions based on theoretical musings and thought experiment speculation.

While we await for the Treasury Department to actually update its complete September TIC LT flow data tables, here is some of the data we can compile with what has been released so far. China is now once again solidly ahead of the Fed in terms of total Treasury holdings, owning $883.5 billion USTs in September, a $15 billion increase from August, of which $10 billion came from an increase in non-Bill holdings, and the balance from Short Term, which at $21 billion have risen to the highest since... April 2010. This is peanuts. The Fed will surpass this total by Thursday. The bigger surprise came from Japan, which added $28.4 billion in Treasury debt to a total of $865 billion, of which just $3.5 billion was from ST holdings. The broke UK moderated its torrid pace of gobbling up US debt and added just $10.7 billion in US paper to bring its new total to $459 billion. Notably, in September hedge funds (Carribean Banking Centers) sold $14 billion of Treasuries as they took the proceeds and invested it all in Apple to force the biggest short squeeze in history (note the number of HF adding Apple as of Sept. 30, shares which they have almost certainly disposed of since). The biggest surprise by far in today's TIC update had little to do with Treasury holdings but instead had everything to do with Agencies, the security most in peril courtesy of the massive fraud perpetuated by MERS and the robosigners. To wit: foreign official institutions (primary central banks) dumped a massive $31.4 billion in Agencies: a record number since the TIC data has been reported in 1978. This was offset marginally by Agency purchases by other foreigners of $23 billion, although the dump by central bankers what everyone will be focused on. This is certainly news that PIMCO and all the other RMBS investment funds did not need to see today.