The Fed is Playing a Very Dangerous Game

Phoenix Capital Research's picture


The US Fed is committed to keeping interest rates low for the simple fact that if interest rates were to rise then the payments on the debt would send the US into an EU-syle debt crisis along with the commensurate intense austerity measures being implemented.


Unfortunately for the Fed, the bond markets may indeed force this in spite of the Fed’s efforts.


Weimar Germany, like most historic episodes of hyperinflation, occurred when Germany’s Central Bank began monetizing its debts. This worked until the country lost credibility in the international bond markets at which point the Central Bank was forced to monetize everything resulting in a currency collapse and one of the worst episodes of hyperinflation in history.


The US has been moving increasingly down this path which each new QE program. The two reasons the US has not yet entered an inflationary death spiral are:


  1. The fact that the US continues to maintain its credibility in the bond markets (at least compared to Europe and Japan).
  2. Large financial institutions’ needs for high-grade sovereign bond collateral.


Regarding #1, the US has never defaulted on its debt. Compared to Germany (another safe haven), which has defaulted on its debts twice in the last 100 years, the US remains one of the most credible governments in the world, regardless of how bad the country’s finances are becoming (for now at least).


Regarding the collateral situation, as I’ve explained in recent issues (see the “C” Word) one of the most critical issues in the financial system is the shortage of high grade collateral to backstop the $700 trillion derivatives market.


With France and the ESM bailout fund recently losing their AAA status, there is already a scramble for high grade collateral in the system. The US, despite losing its AAA rated status is still consider high grade due to its having never defaulted on its debt. With that in mind, the Fed decision to take US Treasuries at a time when more and more countries are losing their AAA rated status means that even less high grade collateral will be in the system.


Indeed, as I’ve noted before, because so much of the US debt market is already held by government controlled entities, the Treasuries shortage is even worse than the below article indicates.


Clearinghouses, run by firms such as Chicago-based CME Group (CME) and London-based LCH.Clearnet Group, make traders provide collateral, including government bonds, that can be seized and easily converted into cash to cover defaults. Traders may need from $2 trillion to $4 trillion in extra collateral to meet the new requirements, according to Timothy Keaney, chief executive officer of BNY Mellon Asset Servicing.


The trouble is finding all that high-grade debt. The U.S. had $10.8 trillion in Treasuries outstanding at the end of August. Other countries, including Japan and European nations rated AAA or AA, had about $24 trillion of debt in the second quarter of 2011, according to an April report by the International Monetary Fund. Those government securities are already in heavy demand from central banks and investors.


The solution: At least seven banks plan to let customers swap lower-rated securities that don’t meet standards, in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed “collateral transformation.” The maneuver allows investors who don’t have assets that meet a clearinghouse’s standards to pledge corporate bonds or mortgage-linked securities to a bank in exchange for a loan of Treasuries. The investor then posts the Treasuries—the transformed collateral—to the clearinghouse. The bank earns fees plus interest, and the investor is obliged at some point to return the Treasuries. In effect, the collateral is being rented…


JPMorgan Chase (JPM) and Bank of America (BAC) are already marketing their new collateral-transformation desks, executives at the companies say. Other banks confirmed they’re planning to offer the service too, including Bank of New York Mellon (BK), Barclays (BCS), Deutsche Bank (DB), and State Street (STT).


Here’s the actual amount of Treasuries available to the banks:


Total US Sovereign Debt

$16 trillion

Foreign Nation holdings

$5.4 trillion

Intergovernmental holdings

$4.8 trillion

US Federal Reserve

$1.5 trillion


$4.3 trillion


Indeed, as the below article reveals, the search for high quality collateral is one of the primary items holding up the Treasury market. The Treasury’s latest information reveals that:


Foreign ownership of U.S. Treasury securities rose to a record level in October, a sign that overseas investors remain confident in U.S. debt despite a potential budget crisis.


Total foreign holdings of U.S. Treasurys rose to $5.48 trillion in October, the Treasury Department said Monday. That was up 0.1 percent from September. Still, the increase of $6 billion was the weakest since total holdings fell in December 2011.


China, the largest holder of U.S. government debt, increased its holdings slightly to $1.16 trillion. Japan, the second-largest holder, boosted its holdings by a smaller amount to $1.13 trillion. Brazil, the country with the third-largest holdings, increased its total to $255.2 billion.


My point with all of this is that the search for collateral will drive yields lower… until the bond markets truly begin to spin out of control. In the meantime, the US Fed is playing a very dangerous game by purchasing as many Treasuries as it is. But that game can last much longer than anticipated.


How precisely these issues will finally play out is a mystery. But the consequences will be tremendous. And enormous fortunes will be made by those who get it right. The first key clues will be when Bunds and Treasuries begin to nose dive in a big way.


On that note, we’ve recently prepared a Free Special Report outlining how to prepare for this as well as the ongoing currency debasement that is pushing inflation higher. It’s called Protect Yourself From Inflation and it outlines how inflation has already developed in the financial system as well as which investments will profit from it most.


You can pick up your FREE copy here:


Best Regards


Graham Summers

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All Out Of Bubblegum's picture

Having the world's largest military means that you can print toilet paper and force a lot of people to pretend it's money.

Grand Supercycle's picture

Wile E. Coyote...

Reminder ~ the Wile E. Coyote scenario awaits – no matter what eventuates with the fiscal cliff.

dunce's picture

I do not believe that debt can really be collateral even though the rest of the world seems to accept that kind of accounting. Yes accounts receivable are counted as assets but the debtor has to actually make good on the account and many are going to be demanding to settle as Greece has done for 35 % on the notes. The only good paper in my view is not sovereign debt.

andrewp111's picture

The Weimar Republic owed war reparations in gold. They could not print gold, so their attempt to print their way out resulted in hyperinflation. The USA does not owe anything in foreign currency or gold. We can do outright monetization and get away with it.

Room 101's picture

We can monetize to a point.  Once that point is passed, things get interesting.  Money only has the value people ascribe to it, and if Y numbers of people stop accepting X currency as a mode of payment, that's where you can no longer monetize if you wish to preserve the currency. 

I view what the Fed is doing to the dollar as being similar to what theowner of a great retail brand does when they cheapen the underlying product. For awhile, people will continue to buy it.  They'll bitch and moan about it, but they'll buy.  There is a tipping point, though, when they simply stop buying your product and instead buy something else. 

tony bonn's picture

the huge demand for treasuries is generated by interest rate swaps; all else are secondary....once that complex of horse manure fails - as it already is doing at jp morgan chase - the end will light up like a supernova...

Downtoolong's picture

How can it really be collateral if a third party bank who isn’t posting it has the ultimate claim on it? This is the fraud in such schemes which, unbeknown to most investors, is making all markets riskier every day than ever before. And, it’s no surprise to me that it’s the TBTF banks who are ultimately behind the schemes, quietly pushing them as hard as they can for an easy risk free profit.

MrTouchdown's picture

The two reasons the US has not yet entered an inflationary death spiral are:


  1. Red Herring
  2. Red Herring


The real reason? The Fed and the banks are doing a marvelous circle-jerk and only a little bit of that money is sloshing out onto main street. When the pols force the "bail-out for mainstreet" - that's when things will start to get exciting.

andrewp111's picture

Yeah. It doesn't matter if they print zillions if that money never leaves the banking system.

OldE_Ant's picture

Agreed with respect to comments regarding trade moving away from USD.  It is already occurring.  I'm not so content with thinking China would ever be trust worthy to pay anyone back.  Frankly I'm thinking some move to hard backed currencies in multiple jurisdictions to be the only way to work things.

China simply isn't trustworthy at this point given all the IP theiving they are doing.  But hey they learned from the best.   Really we are screwed here because the US was supposed to be Gold/Silver backed, with solid dependable enforcable laws, backed by a strong military TO back it up, and a strong healthy economy.

We tossed gold/silver backed long ago, we recently booted enforcing laws, the strong economy going to crap and all the US has left is the military.   hell even if we declared war on China, Japan this only wipes 2.2T worth of debt.   War doesn't even get anyone out of the financial debt loads they are under.

Frankly the US had a very sweet spot and all it had to do, was what it said it would do.  Too bad no one on this planet can do what they say anymore, and no one will call anyone else a liar for fear of being called out themselves.   This is one of many reasons why we all will face hard times ahead and wars, rioting, sickness, starvation will be the likely outcomes for many.

Buying USTs, and 'quality collateral'.  Yeah right, sure, keep dreaming the dream because no one should ever have to face reality.  As to stability of US , see default date list and judge for yourself.

MeelionDollerBogus's picture


"China simply isn't trustworthy at this point given all the IP theiving they are doing"

Intellectual Property IS thieving - it's government-guns against the free-market of innovation, ideas, rapidly evolving information. You can't own other people's memories, you can't own all the sounds or sights they might ever hear & you CAN NOT own information spread publicly. It isn't yours to begin with.

You can at best keep trade-secrets, any secrets, until you can't, then you're fucked there too.

As it should be.

MFLTucson's picture

How can you default when you can print money and buy your own debt?

spinone's picture

Indeed, our debt is dollar denominated, and we can print dollars at will for no cost. 

The question is, what will the value of those dollars be?

dumpster's picture

bull manure graham

never defalted LOLLOLLOLLOL

do some simple research .  

technicalanarchy's picture

I'm probably way out in left field here but I think the real inflation will start if or when the banks start loaning the 40 billion a month they are getting from the Fed on the mortgage buy back. If they can loan it out at 10 or 20 to 1. 

spinone's picture

Thats why they will never loan it out, while they can get 2% from the fed as "excess reserves"

technicalanarchy's picture

Right, I guess what Im wondering is all this pump getting shuffled.between a few players. i don.t expect huge inflation unti it gets released to the genral public so to speak. 

If citi and jp are just back and forthing with ben then thats one thing but quite another if they release it to the masses and multiply it. They could quickly cause a huge boom letting loose with loans again and it could quickly result in massive inflation. 

What we have now is scary enough, but I think happy days again (banks opening to loans again) will signal get to a fox hole.

honestann's picture

The US never defaulted on its debt.

Are you fracking serious, man?

So if I borrow, say, 1000 pounds of gold from you... and when it comes time to pay you back, I give you a few slips of paper that say "debt notes" on them (which are only claims on other paper debt notes), what?

You are saying that is not a default?

Are you serious, man?

Give us a break.

The current game/system will end when foreigners refuse to accept dollars.  At that time the world will return to gold, because it can no longer afford to pretend that fiat currency is anything other than a fiat, fake, fraud, fiction, fantasy, fractional-reserve SCAM.

DanDaley's picture

You look at that schedule and things seem to just get curiouser and curiouser

nofluer's picture

"The US has never defaulted on its debt."


Bullfrogs! Ever heard the phrase "not worth a Continental"? The US has been down this inflation/hyperinflation road before, and the ONLY reason that it can be "truthfully" said that we "haven't defaulted" is that the honorable members of congress went around buying up the US script for peanuts so they stood to make a huge amount of money if the US Govt redeemed the worthless script instead of stiffing the people to whom it was issued. (IIRC most of the script was issued to the war veterans and to the citizens for things "purchased" by the Continental Army.)

Snakeeyes's picture

Don't worry about it. Ben will just pop one his little blue pills (Easeagra) to stimulate the economy.

I am on to you's picture

What a lovely word:Easeagra ,never will i forget that word,one word say a million things!

WhiteNight123129's picture

The crux is the following. The Fed buys treasuries but inexorably the new currency unit have the same effect of a double Cargo of Gold coming from South America into spain, it has impact on prices. Inflation expectation rise and the spread between treasuries yields and inflation expectation shrink and shrink and shrink until the pressure cooker gets to maximum pressure.


Spigot's picture

Every dollar monetized into existence is a default.

WhiteNight123129's picture

US defaulted on its Gold obligation to Panama in the 1930s.

Come on, US treasuries are junk debt, everyone knows it, the Fed, the Congress and the foreign country. The process is to drop slowly those (not in one shot) and to make excuse to Uncle Sam everytime the emerging market central banks buy Gold.

The reversal of selling into buying Gold from central banks is eerily similar what happened post the 1931 UK devaluation and the ensuing liquidaition of foreign exchange reserves for Gold by central banks explained by Eichengreen. The linked to gold has been cut but the fear of mutual devaluation is the same.   (page 6)

Seasmoke's picture

700 TRILLION !!!!!!!!!

steelhead23's picture

Relax, its just 0.7 quadrillion, a mere pittance.

auric1234's picture

Regarding #1, the US has never defaulted on its debt.

WRONG. Last time was in 1971, when their debt was in gold and Nixon declared it wouldn't be repaid.


zerozulu's picture

"Nixon declared it wouldn't be repaid"

So what can stop them doing the same this time?

Spigot's picture

The deal was that US$s held by foreign CBs and institutions could be redeemed for gold bullion.

Once Britian and Europe had returned all the gold tonnage that the Treasury had collected from it during WWII then Nixon closed the redemption window.

Britian and Europe had repatriated their gold holdings and the US did not wish to have its 8,000 tonnes remaining removed.

auric1234's picture

Prior to Nixon shock, all FRN in circulation was gold-backed debt.

After Nixon shock, the US defaulted on its debt, turning FRN into worthless paper.


markettime's picture

I didn't hear any mention of the US being the reserve currency via the petro dollar. If the dollar loses that advantage it will fall dramatically. Having status as the reserve currency (Petro-dollar) allows us to print and buy our own debt because there is always a constant demand for dollars. What happens if OPEC boots the USA out? I am guessing nationalization of US oil reserves to keep the dollar floating. We are so screwed. 

cranky-old-geezer's picture



When Russia & China (mainly Russia) extend (thermonuclear) military protection to OPEC nations they'll kick American bases out and dump the rapidly debasing USD in a heartbeat, moving to Euros or Yuan, whichever is stronger by that time (Yuan likely).

The thermonuclear card will be played before much longer, and that's when America tucks tail & leaves the ME.

You heard it here first.

andrewp111's picture

Why would Russia do that? Russia is a BIG oil exporter, and a high cost one at that. Russia would love nothing more than to have a proxy nuclear war in the ME that wipes out the export capacity of its competitors, particularly those with cheap oil. Then Russia would really clean up.

China, on the other hand, is a big oil importer. They want captive suppliers, but no war. Sanctions against Iran are very very good for China (and India). If Iran efectively takes over Iraq, that is also very very good for China.

spinone's picture

Then its the corn and wheat dollar.  The US feeds the world.

ultraticum's picture

Yes we are #1 in Ag.  But your "The US feeds the world." comment is a little much.  Are you a Kalifornian by any chance?  Reminds me of the insularity and arrogance nearly always exhibited by them - until recently.

Shell Game's picture

"I didn't hear any mention of the US being the reserve currency via the petro dollar."   "We are screwed."


Indeed.  The ultimate fiscal cliff is also the ultimate taboo.  Not only would oil be nationalized, but likely all commodity producers....and real money miners.


Fun times await!


auric1234's picture

It's already happening. Emerging countries are cutting deals to buy oil using gold as payment.


Room 101's picture

Source? I believe you but want to read more about it. All I can find is articles about countries paying Iran for oil using gold.  The impetus there is the trade sanctions. 

auric1234's picture

Sorry, can't recall. I read that China wants to avoid the USD not just for economic reasons but also for intel reasons. They don't want the Fed to be notified of each and every of the transactions with their neighbours.


markettime's picture

Yes you are right, China set up an alternative to the Bretton Woods system last November. It will be a race to debase currency on a global scale until someone refuses the monopoly money that we keep printing. Then we will see who's currency will remain.

max2205's picture

The US Fed is playing a very dangerous game by purchasing as many Treasuries as it is."

Your grammar sucks Graham

hoos bin pharteen's picture

Anyone care to comment on whether the Fed would lend out batches of USTs for collateral transformation in the same scheme as the other big banks?

Vooter's picture

"Your grammar sucks Graham"

Before you go calling the kettle black, Mr. Pot, perhaps you'd like to put a comma after "sucks" and a period after "Graham."

falak pema's picture

hey Summers you have woken up in deep winter! 

"after Euro Armageddon we talk FED hitting the iceberg! Summers waking up !

newworldorder's picture

The "elephant in the room" RE US government debt is that it is the ultimate firewall. lender/swaper of last resort/guarantor of stability for the world wide financial system. Along with the US military the FED is needed to stabilise the entire banking system. The US cannot be allowed to fail. Other than the US - Who you going to trust? China, Japan, Russia, Europe, India?


Tompooz's picture

"Who you going to trust? China, Japan, Russia, Europe, India?"

Europe. Cleanest shirt, biggest economy, gold reserves, still has a core remnant of fiscal sanity.

Vooter's picture


Which means it's going to be so much more fun when it finallly and inevitably BECOMES an option!

cranky-old-geezer's picture



Just as the British Pound gave way to the US Dollar, so will the US Dollar give way to something else. 

With USD being rapidly debased by the Fed, it's just a matter of time.

US govt debt is no "firewall" when the dollar collapses and all those US govt bonds are worthless toilet paper.