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The Fed is Playing a Very Dangerous Game
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:
- The fact that the US continues to maintain its credibility in the bond markets (at least compared to Europe and Japan).
- 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).
http://www.businessweek.com/articles/2012-09-20/a-shortage-of-bonds-to-back-derivatives-bets
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 |
|
Remaining |
$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:
http://gainspainscapital.com/gpc-inflation/
Best Regards
Graham Summers
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So was the BoE at one time.
No one could imagine a situation where it wasn't.Normalcy bias in action.
Seems quaint ,and so will be the dollar as a reserve currency.
Oh sure,this time is different.
Weimar on one hand, Japan on the other. Pick your poison. I couldn't honestly tell you which way it's going to go, but if I was forced to guess, I'd say Japan is more likely than Weimar.
"More than any time in history mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray that we have the wisdom to choose correctly." - W. Allen
Re US Treasury Bonds, the great Jim Willie has just published his latest, regarding the coming collapse of the UST (US Treasury) 'bond tower', and how the world is already quite more than half ready for the death of the dollar and liberation from it and from the US-Fed poisoning of the global economy.
Willie marks the absolutely stupid sanctions to try to exclude Iran from the global banking system, as the key American stupidity that vastly accelerated Asia's concrete programme to dump the US dollar entirely.
Jim Willie writes:
« ... a new trade foundation will be the complete arena of Asian trade being conducted in Yuan transactions. They have no need for USDollars in trade. They see their USTBonds held in reserves under management as vulnerable to serious loss. They see their USTBonds held as subject to grand debasement from USFed central bank monetary policy itself. They see their USTBonds held as supported by Weimar machinery in hyper-drive. They see their USTBonds held as part of a corrupted Wall Street arena and its vast trappings. They see their USTBonds held as prisoner to the USGovt debt battles and a potential crush victim on a fall from the fiscal cliff ... »
Always great reading on gold, the global collusion by the American-Western banksters, and much more:
'The Coming Isolation of US Dollar'
http://news.goldseek.com/GoldenJackass/1356642000.php
I knew Obam was Mugabe 2 back in 2008, but I hoped I was wrong.
a new trade foundation will be the complete arena of Asian trade being conducted in Yuan transactions. They have no need for USDollars in trade.
I've been saying this over a year now. Maybe I should start a blog.
Willie has hit the nail on the head.
I also thought using SWIFT against Iran would be pivotal in the dollars demise.
it will also be Them vs. US and its poodle(UK).
Interesting times to live indeed.
Gold.
"Regarding #1, the US has never defaulted on its debt."
We have defaulted in 1779, 1862, 1934, 1979 and 2014?
http://mises.org/daily/5463
I know, I know. When we default this time it will be our last trust me.
And 1971.
And 1965 (LBJ's Coinage Act)
Yes, Bretton Woods.