The Great Dollar Short-Squeeze Is Coming

In Part III of MacroVoices’s conversation about the twilight of the dollar’s dominance over the global financial system, Jeff Snider elaborates on a theory we initially referenced in our writeup on Pt. II: The notion that, as the supply of dollars to certain economies contracts, the greenback could see its relative value climb, even as it cedes its dominance over the financial system to the Chinese yuan, or a consortium of rival currencies.

Snider describes this phenomenon as a short squeeze: Because so many central banks predicate their monetary policy on the dollar, and because so many foreign governments and corporations need dollars to finance trade and pay down debts, the global economy is effectively net short dollars.

 

Macrovoices

So, when the Federal Reserve stops the money presses and the supply of greenbacks becomes less pliable, certain parts of the financial system – Snider points to BRICS countries like Brazil and Russia as examples – will begin finding it increasingly expensive to roll over their funding, pushing the greenback higher, as Snider explains.

Yeah, I think a better terminology would be short squeeze. It’s sort of a dollar short squeeze. And, again, if we think about the Eurodollar development from things all the way back as – some things like banker’s acceptances – it’s essentially a short dollar system, where every participant in it is short the dollar.

They roll over funding every day, whether it be in repo or unsecured or in FX – or however it’s done – essentially everybody around the world needs dollars and therefore they’re short of them. So when the dollar supply becomes less malleable, less pliable, less dynamic, it becomes a problem for certain parts of the system being able to roll over their commitments.

And what happens when you have to roll over your commitment and it’s not as easy to do so, the price of it goes up. And, in terms of currencies, a short squeeze in the dollar means a rising dollar or a falling counterpart currency.

Some signs of this squeeze have already started to emerge, Snider argues. Back in 2014, the Russian Central Bank started auctioning Eurodollars and euros after the annexation of Crimea, when sanctions from both the European Union and US made it more difficult for Russian banks to obtain foreign currency. The RCB was effectively repositioning itself as the central distribution point for dollars in the Russian economy. Snider argues this is a symptom of being squeezed out of the dollar market.

 

Russia

Furthermore, while this phenomenon helped push the dollar higher, the Russian ruble devalued, eventually reaching an all-time low around 80 to the dollar in late 2014.

So I think a good place to start, to really kind of describe and put some real-world examples to this process, is Russia. One of the things about central banks going back for the last couple of years – and this was Ben Bernanke’s (supposed to be) his great legacy – was opening up central banks to be more transparent in how they conducted monetary policy.

And some central banks take that to heart. Some central banks don’t. In 2014, the Russians, for example – the central bank of the Russian Federation very explicitly and very publically started auctioning off Eurodollars and euros – which in this case would be euro-euros. The reason they did so was because Russian banks were having trouble securing dollar funding, primarily in the second half of 2014.

So, essentially, what the Russian central bank was doing was becoming a redistribution point for local Russian banks that were being shut out or couldn’t afford the terms of Eurodollar financing.

They were, in essence, being squeezed out of the dollar market. And as that was happening, of course, the Russian ruble started to devalue. Because, again, the price of participating in a short squeeze is you have to pay up for it. So the Russian ruble in the second half of 2014 and throughout 2015 and 2016 underwent severe crisis. The devaluation was severe because the dollar shortage had become severe for them.

And the Russians were not alone in this. Brazil’s central bank also had to resort to creative derivative strategies to help create a large enough supply of dollars for its domestic economy.

However, these strategies are unsustainable, as Brazil demonstrated. Almost immediately, the program was threatening to consume nearly all of Brazil’s foreign currency reserves.

They were not alone in that position. In fact, it became a widespread thing. You go to Brazil, for example. The Brazilian real (R$) had started devaluating all the way back in the 2011 dollar crisis. But that really came to a head in 2013. The Banco do Brazil, the Brazilian central bank, chose to deal with their dollar squeeze a little bit differently. Or a lot differently, really, than the central bank of Russia.

Rather than deplete their reserves, they decided they would go into, essentially, a dollar subsidy. They’re technically not swaps, but a lot of people think of them as dollar swaps.

Without really getting into too much of the details, what the central bank essentially had to do was to subsidize Brazilian banks borrowing in the Eurodollar markets to make it cheaper so that they could borrow more on the Eurodollar market to bring dollars into Brazil.

And what happened was, in 2013 and especially 2014, they did so many of these swaps, or these synthetic swaps, that it threatened to use up all of Brazil’s reserves. I think at the worst part it was about $120 billion in non-deliverable swaps – compared to about, I think it was $380 billion in Brazilian reserves.

So as soon as they cut off the subsidy in late 2014, the Brazilian real, the bottom essentially fell out from it. Without the subsidy, there was no way for Brazilian banks to easily obtain dollars on the dollar market. And, of course, the short squeeze hit Brazil.

Still, central banks looking for an alternative to the dollar are bound to be disappointed, as the Chinese undoubtedly were, Snider said, when they tried to liquidate some of their dollar-denominated foreign reserves.

As Yusko pointed out in Pt. II – an analysis of the Eurodollar market’s role in supporting US dollar hegemony – shifts in international currency regimes happen gradually. By the time Nixon killed Bretton Woods, the infrastructure for the Eurodollar system and floating interest rates was already in place.

 

China

The Chinese are grappling with this problem. The dollar system isn’t working to  their benefit, but any attempts to ditch the dollar inadvertently trigger an uncomfortable tightening in Chinese monetary conditions.

You know, the dollar is the basis of so many central banks. The monetary system in China is predicated on the dollar. And so selling down US Treasuries or US dollar balances has the effect of tightening Chinese money.

And that’s exactly what happened. Bank reserves in 2015 declined by some 3 trillion RMB, which is an enormous decline. So there was direct economic and financial consequences to that happening. Which is essentially the point. These countries are almost in the position of mutually-assured destruction here. They can’t just sell off their own dollar holdings, because that would undermine their own currency. It would undermine their own monetary system.

So I think that’s why we’re getting into Luke’s point, and to Mark’s point as well – the geopolitical concerns here is that, okay, the dollar system doesn’t work, but we’re stuck with it. So what the hell do we do? You kind of sympathize with their position, because it’s between a rock and a hard place.

My sympathy kind of ends, because they were certainly on board with all this while it seemed to be working. Up until August of 2007. So they kind of made a deal with the devil. And eventually the devil gets paid. And so the question is, how does the devil get paid? And in what form?

And so, from my perspective here, especially when we go through the Chinese stuff, is – what is their choice? They have to work almost behind the scenes to try to get something of a workable alternative. Because they don’t have an alternative today. They cannot go with today getting rid of the dollar. Can’t ditch the dollar today. I think they would want to.

After years of resisting a shift away from the dollar for fear of the consequences, how long until the Chinese just saw ‘screw it?’

Luke: Doesn’t that speak to the binary nature, in your opinion? Like, if there’s going to be a change, it’s going to have to be – just by virtue of the fact that how much this is not working and how far away we still appear to be from a solution, right? Like I think of those things and it’s like, we’re running out of gas in the plane and we’re nowhere near a landing strip, right?

So that doesn’t imply that we’re going to get to the landing strip. It implies that we’re going to fall straight down. No?

Jeff: Yeah, I agree. And I think that’s what scares me the most. Maybe the analogy’s a little different. To me the Chinese are increasingly desperate. You look at what they’ve done in ‘14–‘15–‘16–’17. They do increasingly desperate things. And it’s possible – to get to your point about a binary option here – they get to the point where they say screw it. You know what?

We’ve resisted de-dollarizing as best we can because we don’t think there’s an alternative. Let’s just do it.

Let’s just say tomorrow – I mean, because this isn’t working. We’re in a high-risk position. So why don’t we just say screw it. We’ve been waiting patiently for those idiots in America to get their house in order, for somebody to take control of the Eurodollar system and do something about it. It’s been ten years already, it’s clear that’s not going to happen, So let’s just start reevaluating everything we do in RMB.

As global banks’ dollar lending business has declined in Europe, it has grown in the emerging markets in Asia, based partly on the assumption that these economies would continue to grow at a rapid clip, and therefore, would maintain a high demand for dollars.

But banks are quickly realizing that they can’t take this for granted.

Comments

Precious Hawk Mementoil Tue, 01/02/2018 - 06:21 Permalink

Yes, group-think versus unintended consequences.

Just suppose the debt-holders don't want to take a depreciating asset!

With the US$ collapsing, they don't want to be the billion dollar bag-holder.

They might just turn to barter; exchanging their debts for Gold, bonds or something we don't even know about, like SDRs.

"I'm rich because Jimmy owes me a million bucks!"  Yep, that's one way of thinking about it.

Or, "I'm rich because I've got a million bucks in the bank!" Oh yes! Tell that to the Cypriots.

Or, "I'm rich because I have some high-yield (Junk) bonds.  They have to pay me back in US$"

Great, they get 1,300 of them for an ounce of Gold - today.

How many will they get when the dollar starts its descent?

PH

 

In reply to by Mementoil

Albertarocks wisehiney Mon, 01/01/2018 - 22:20 Permalink

You're right, a dollar shortage would definitely be highly deflationary.  The problem is that a quick glance of any chart of the dollar shows quite clearly that the short squeeze they discuss just isn't in the cards right now.  The dollar has clearly broken down and it looks like it will be dropping for at least another month before we see any bounce at all.  More than likely it keeps heading down until closer to the end of March or April before we see a bounce.  And it would only be a bounce, not the start of any new bullish phase.

In reply to by wisehiney

Albertarocks wisehiney Mon, 01/01/2018 - 23:28 Permalink

I never lose sight of the fact that currencies are always compared "against each other".  But all of them are battling inside a basket, and that basket has been thrown out of a plane from 40,000 feet.  So as that battle rages on, and the media focuses on the dollar index as if it's no big deal that it might be rising or falling a little bit against the Euro for example... it's a huge deal that the entire basket hurtles towards its inevitable end.  But they never talk about that part. 

If gold was allowed to do what it should have been doing for the past 40 years (exactly what Bitcoin is doing these days... soaring), then the media would have no choice, they would have to acknowledge it.  So I think the days of stacking cheap gold and silver are now behind us. The next bullish phase for precious metals should last at least 3 years before it even takes a rest.  Best of luck and Happy New Year.

In reply to by wisehiney

directaction Mon, 01/01/2018 - 21:50 Permalink

Fluctuations aside, no way.

The USD's going to be dropping in value from now on due to wildly insane deficit spending, wars, welfare and related printing.

Inflation is the only possible outcome. 

Hubbs Mon, 01/01/2018 - 21:52 Permalink

Got to hand it to Louis Cammarasano over at www.smaulgld.com

He has repeatedly focused all this BS attention to the "dollar demise.

"The fact is, the yuan and or ruble comprise only a very small percentage of the transactions in the world, and that the Saudis, Russians, and Chinese have recently increased their purchases of US Treasuries (interest rate hike helpful, dollar least dirty shirt?)

Like it or not, the US dollar corncob is stuck way up the rest of the world's ass, and it is going to be a long, painful  process of extrication.

Hubbs 3LockBox Mon, 01/01/2018 - 22:21 Permalink

You are absolutely correct 3locks, and Louis is very aware of this, especially when valued against gold. He is not wrong. He just points out that things are not what they seem. That is the problem. The dollar has dropped in value vis a vis the dollar index, but the fact is, the rest of the world is still stuck with it as the reserve currency, to the point that purchases of Treasuries increased last year. How can this be explained? Everyone has been saying that the world is abandoning the dollar and selling treasuries. Louis points out that this is not the case.

In reply to by 3LockBox

Harry Lightning Mon, 01/01/2018 - 22:15 Permalink

The entire dollar shortage outside the US is a result of Eurodollars being subject to reserve costs by the Federal Reserve to the American banks that hold them anywhere in the world. What that means is that for every $100 Eurodollars that an American bank anywhere in the world is holding as a Eurodollar deposit, it can only use $90 of those dollars for lending activity The other $10 has to be held in reserve and the bank reserve fund does not make any money for the bank unless lent to another bank in the Federal Funds market or lent directly to the Federal Reserve. At very low interest rates such have been seen during the last 9 years, the interest that can be accrued by lending the 90% of a Eurodollar deposit that a bank is allowed to use does not generate enough of a profit margin to account for the interest expense that was paid for the 10% of the deposit that had to be reserved, plus the profit margin required by the Return on Capital ratio that the bank seeks to earn to fulfill guidelines from the Bank for International Settlements, the Basle III Accords, and the stock markets's expectation of earnings for the bank.

The bottom line is that during periods of very low interest rates, it behooves American banks to hold deposits as domestic reserves that can be lent inside America rather than to hold them as international Eurodollars that have to have reserves placed against them The effect of this deliberate guiding of liabilities is to reduce the available dollar liquidity around the world while increasing reserve balances of American banks with the Fed. That is what has been seen during the last 9 years. 

The answer to solving this problem is for the Federal Reserve to lower Reserve requirements and to raise short term interest rates. They are well-along the latter process but have done nothing to effect the former process. The Fed should reduce reserve requirements and then Eurodollars will be available for use around the world. 

As a final footnote, the negative spreads of interest rate dollar swaps relative to US Treasury yields has nothing to do with dollar shortages in Eurodollar accounts of American banks. It has everything to do with aberationally low short term interest rates. In an interest rate swap, the payer of the swap is paying a fixed yield or a long term period in exchange for receiving three month libor payments every three or six months for that long period, depending on how the swap is structured at origination. Because short term interest rates have been so abnormally low for the last nine years, payers of the swap have reason to believe they are being cheated from the interest they should be receiving if short term interest rates were at more normalized levels. As such, they want the perceived shortfall they will be taking in the three or six month libor payments they will be receiving from the swap to be offset by a lower long term fixed interest rate they will be paying during the life of the swap. As such, this offset pushes the rate of interest they pay on the fixed leg of the swap to levels below the corresponding Treasury yield for the same maturity of the swap. The consideration is solely one of what is versus what should be, and has nothing to do with creditworthiness, reserve requirements, or Eurodollar Deposits. As short term rates move back to more normal relationships with longer term rates and economic activity, the swap spread should once again return to a premium above like-maturity term Treasury security yields. Interestingly, this perceived distortion in the yoield curve from shortest to longest maturity structures also is playing a large part in the flattening of the US yield curve that has been seen during the last year.

Essentially, investors are saying that if abnormally low short term rates are the new normal, which after 9 years of such its easy to think is so, then the long end of the yield curve must adjust to this new normal, which is the natural rejoinder in the cash markets to swap spreads staying negative for so long. My own feeling is that at some point, bond investors will start screwing their heads on correctly and see that the linkage between short and long term yields is what is forever broken, and that long term yields have to be determined not by short term yields of Fed policy, but rather on the classic formulae that considers how likely it is that the issuer of the debt will repay it, and how much inflation will erode the interest that the borrower pays during the life of the security Once that type of calculation is employed to etermine where long term US interest rates should be, then the US yield curve will stand on its head as long term US Treasury yields move significantly higher to price in the terrible fiscal condition of the US balance sheet along with the growing inflationary pressures that have been building recently in the US.

 

 

Harry Lightning AC_Doctor Tue, 01/02/2018 - 01:03 Permalink

I a hoping the Chinese start paying for their global purchases in Yuan so that there is plenty of it to go around to banks around the world. I want to get some from my bank and see if the Chinese restaurant I go to will let me pay for my meal there in Yuan. That would be pretty rotten if the Chinks do not take Chink currency at a Chink restaurant !

If you want to have a good laugh, go to a Middle Eastern restaurant where the waiters all speak Arabic to each other after getting some Israeli shekels from an international bank near where you live. When one of the customers is leaving, you get up to go to the bathroom and pass by the table where the people just left. Place the Israeli shekels on the table as a tip, removing any other tip the customer may have left there. Then go to the bathroom but just go in and come out to return as fast as possible to your seat. 

Sit back and watch the waiter's head explode when he realizes he was given Jewish money for his tip ! hahahahaha, Muslim's probably have some kind of law against it !!!

In reply to by AC_Doctor

Hubbs Harry Lightning Mon, 01/01/2018 - 22:55 Permalink

Whew, what a post. Took me 5 times to read it as I am not financially literate. In other words, at some point, holders of long term 30 year Treasuries  will abandon the assumption that the 2-30 spreads will ever return to their traditional range, and that inflation and inability of borrowers to pay will destroy the value of the 30 year treasuries, not simply because the yield curve is flattening. The interest rate on the 30 will suddenly have to climb with this new realization, and then it will be hello inflation. In the meantime, the only cure for this spread is to paradoxically raise the STM rates?

In reply to by Harry Lightning

Harry Lightning Hubbs Mon, 01/01/2018 - 23:24 Permalink

Okay, let me simplify. The yield curve has been flattening because after 9 years of really low short term interest rates, bond investors are starting to believe that short term rates will never go up again. So they are thinking that if short term rates are never going up again, its best to invest in the longest term rates as they will be the best bargains as far as the eye can see.

My feeling is that this change of thought about long term yields is a mistake. Because long term yields fundamentally are much more about creditworthiness and inflation rather than what rate of interest the Federal Reserve is charging banks to lend to one another on on overnight basis. 

Accordingly, I think that once investors realize that inflation will continue to rise - 2017 was the first year since 2011 when the year-over-year US Consumer Price Index exceeded 2% - they will come to the realization that long ter yields are not paying enough to compensate for the risks of future inflation. That's when long term yields will move back to the 4-5% range at least, and the US yield curve will steepen. Which will cause some huge losses for the people who thought the wheel was being re-invented and had joined in on the flattening trade by buying long term US bonds below 3% yields..

In reply to by Hubbs

atomp Harry Lightning Tue, 01/02/2018 - 00:07 Permalink

Not trying to be rude, but some dick in a Jeep in the middle of the road with poor spatial relations couldn't realize that I was waiting for him to proceed with plenty of room, and finally figured it out and passed me but stopped next to me to give me what for (really?), but it put me in a bad mood, so maybe my brain is not working, but... since when has any one of consequence bought bonds to "compensate for the risks of future inflation"?

In reply to by Harry Lightning

Harry Lightning atomp Tue, 01/02/2018 - 00:44 Permalink

Whether you realize it or not, until the Fed started this QE nonsense, the aggregate market perception of where inflation was headed is what drove long term interest rates. Fundamentally, a long term interest rate by definition has only two components :

a) the credit premium, which is the part of the interest rate that compensates the lender for taking the risk that the borrower may not be able to pay back the principal of the loan. This is also known as the real rate of return, the yield you receive less the cumulative average rate of inflation during the time you lent the capital;

b) the inflation premium, which compensates the lender for the deleterious effect that inflation will have on the lender's capital while it is being lent.

The credit premium for sovereign debt does not change much or often, so in reality most of the movement in a long term security's market-traded yield is the inflation premium being adjusted for perceived changes in future inflation.

For the past 20 years, US Treasury 30 Year bonds have traded at an average real rate of return of 2.30%, meaning that long bond yields averaged 230 basis points higher than the year-over-year Consumer Price Index. However, during the last several years that spread has shrunk significantly due to the purchases of the Fed in Quantitative Easing programs. Today, the long bond trades at about 2.75% with the year-over-year Consumer Price Index last measured at 2.50%. That means the real rate of return now for a 30 year US Treasury Bond is only 0.25%, absurdly low for a country that owes $20 trillion !

So right now we can say that the Credit Premium of the US Treasury 30 Year bond is 0.25% and the Inflation premium is at 2.50%, meaning the marketplace is saying they expect the present year-over-year Consumer Price Index to stay where it is now for the foreseeable future. Now going forward, we can expect to see the Credit Premium start to widen very slowly again as the QE programs slowly are unwound. Which further means that most f the ensuing moves in the yield of 30 Year US Treasuries will be changes in market sentiment towards the Inflation premium.

In reply to by atomp

MK ULTRA Alpha Harry Lightning Tue, 01/02/2018 - 00:58 Permalink

Because of the huge amount of global liquidity, CB interest rates can't do anything to impact a currency. In the past, interest rates determined everything from a projects viability to the value of a currency. I had a theory once, don't know if it's a valid theory. The higher an interest rate, the more valuable a currency. The return on a higher interest rate causes buying of the nations currency to participate in the higher rate of return, thereby forcing a supply and demand equation for a nations currency.

Zero interest rates weren't the end of this theory, it was the massive amount of liquidity which caused a currency to lose value because there wasn't a productive profit generating interest rate. Excess capital wasn't held because it can't generate a rate of return.

The Russia story is inaccurate, it was the same as the run on South Korea. It was Soros and his wolf pack of currency speculators which hit South Korea. The South Koreans tried to defend their currency from devaluation, the more they tried, the more the devaluation because they ran out of dollars to buy their currency. It was the same as Russia devalue, but the Russians didn't try to defend their currency, they let it devalue. It didn't hurt the Russian economy like what happened in South Korea. And Russia could have sold off gold to protect their currency, it wasn't like the Russians didn't have the resources.

I don't see a short squeeze of the dollar with the amount of dollar liquidity pumped by the Fed during the quantitative easing era. I see a stronger dollar because demand caused by a robust growing US economy and the Fed selling off it's balance sheet to remove some of the quantitative easing. The Fed can't raise interest rates to the level needed to increase the value of the dollar because this strategy would damage the Federal governments ability to repay national debt of over $20 trillion. A 3% interest rate on the repayment of US debt would hurt and might cause a federal default. Thus, political consideration is also a part of Fed decision process.

The other point on interest rates determining bond value. If the Fed raises rates too rapidly, the bond markets could be flushed, meaning a massive sell off in bond markets would cause a financial crisis because the biggest borrower wouldn't be able to utilize the bond markets to fiance debt and that borrower is the US government.

In reply to by Harry Lightning

Harry Lightning MK ULTRA Alpha Tue, 01/02/2018 - 01:17 Permalink

1) The higher an interest rate the stronger the currency. Its true, but not the be all and end all. It depends why the interest rate s rising. Is it because the country has totally messed up its finances and now investors are wary of the government being able to pay off its longer term debts ? Or is it because the Central Bank of the country is buying in currency at the same time it is raising interest rates ? In the former case, the currency would be getting pounded while its interest rates rose, while in the latter case, the country's currency would rise as the economy works to control inflationary forces.

2) To some degree the present strength of the US economy, the attractiveness of the US stock market, and the belief that both will continue to exert positive influence on investment capital is enticing people around the globe to buy dollars that they then can invest in the US. But considering how many dollars the Fed threw into the world economy with the QE purchases, there should be more than enough dollars to meet any dollar demand scenario. But as we know empirically, there is more than enough dollar liquidity, and unfortunately for the world economy, this liquidity is being parked at the Federal Reserve in trillion dollar reserve accounts rather than being lent in interbank Eurodollar markets. And the reason these dollars are finding a home in those reserve accounts is as I explained, the combination of abnormally low rates with the costs associated with reserve requirements on US banks around the world as set by the Fed. 

In reply to by MK ULTRA Alpha

MK ULTRA Alpha MK ULTRA Alpha Tue, 01/02/2018 - 01:26 Permalink

And the point I forgot, been up to late tonight, for many years now, the mantra was deflation. Over and over we were told the danger was a deflationary spiral, not inflation. Deflation was supposedly caused by China's ability to throw massive amounts of labor at production to lower prices. We haven't heard of deflation in a long time and now, a small percentage move of inflation has everyone jumping around. Is it a signal for Fed tightening? Because the deflation mantra was the reason to increase the monetary base. And what was Greenspan freaking out about when he warned the bond markets were on the edge of collapse. Recall Yellen wasn't just jelling when she went to London, she had long meetings with Greenspan.

In reply to by MK ULTRA Alpha

Nomad Trader Harry Lightning Mon, 01/01/2018 - 23:05 Permalink

Thank you Harry. Some people see low bond yields as proof that inflation will never exist again. And though I generally believe in the power of markets to get it right, I just can't swallow the argument in this case. Inflation is not a fairytale. As sure as shit, bonds are going lower. And that will probably cause the next crisis. As a reminder - crises are those things that central planners can't stop no matter how powerful they appear to be at the present time.

In reply to by Harry Lightning

GittyUP Harry Lightning Mon, 01/01/2018 - 23:30 Permalink

I couldn’t agree more that the yield curve will disconnect from the fed and ECB’s short term rates. I think it’ll be credit risk as opposed to inflationthat will finically force investors to abandon the will of the fed and start to worry about their return of capital.  

it’s all very connected as companies can roll their liabilities very easy now and with low rates.  When credit risk rears it’s head it’ll snowball as rates go up, cash flow down.  It’ll be a Euro crisis all over again but this time the ECB or FED will be all stuffed to the gills with corporate and sovereign debt.   

In reply to by Harry Lightning

Harry Lightning GittyUP Tue, 01/02/2018 - 00:54 Permalink

I believe that you will be proven to be absolutely correct in your evaluation. Credit Risk of the US is the main risk to lending to the US today. 

Keep in mind, however, that Credit Risk can be transferred to Inflation Risk. Suppose private investors finally say that they no longer will underwrite the debt of the US, and thus the Federal Reserve would have to buy the notes and bonds issued by the Treasury to pay for the US deficits and debt. And let's say that finally, the Fed goes too far and prints enough money that the world finally realizes the money is really not worth what it thought, and everyone who sells anything to Americans in dollars jacks up their prices to account for the new worthlessness of the dollar. In that case, inflation measures would register the increasing inflationary pressures, which would cause inflation premiums to rise due to credit circumstances. The result is that both private and public bond markets for all debt securities denominated in US dollars would experience catastrophic increases in yields which would ripple over to the equities markets and wreak likewise destruction. 

This is what happened several times to Argentina since 1947, and is probably how the collapse of the US bond market will play out. This is what happened to US bonds when the moved up to 14+% during the period from 1978 through 1981. Credit Risk originally engendered by the US coming off the gold standard and also printing money to pay for the Vietnam War and the Great Society programs of Lyndon Johnson translated into higher inflation that jacked up the yields of long term bonds. 

The bottom line is that sharp increases in one component of a bond's yield can lead to subsequent sharp increases in the other component of a bond's yield, and that self-reinforcing mechanism causes disaster in bond markets. 

In reply to by GittyUP

class of 68 Harry Lightning Tue, 01/02/2018 - 01:27 Permalink

Harry,

Good post. 

The (so called) young "experts" who have been buying every dip will be devastated. Every earnings estimate based on operating vs reported earnings will finally come into play. As a futures trader I see first hand the relationship between stock and bond futures and options. Where we used to sell "dimes and 15c " pieces to book premium,now most times Cabs are being sold. Razor thin margins for huge risk. When long rates head up in earnest, the put option premiums will explode first on the S&P options. Normally one would think the bonds would then get a bid as a safety net. But if bonds (10 and 30's) sell off and do not recover, with stocks falling, this could get nasty very quickly. 

 

The crypto buyers distrust the banks Centrals and money center, but they have no clue on the coming bond/stock problems. I see not only Australia but other soverigns are moving to restrict crytpos. Even some US banks are bringing in restrictions. You can believe in any sort of crash .gov will decimate all cryptos. 

 

In my area the Marcellus is strong. how strong will it be with double short and long term rates? massive bankruptcies on the horizon. 

 

I continue to believe Au and Ag will benefit in a big way. even Cu and other raw commodities should do well. 

rwz

In reply to by Harry Lightning

52821740 Harry Lightning Tue, 01/02/2018 - 08:39 Permalink

Thanks Harry.

 Nice to have an intelligent post on ZH for a change. I've been a ZH member for around 10 years and been  disillusioned with the site due to its overt bias and what appears to be dominance of state sponsored trolls supporting the political agenda that sledges anybody that is not conspiracy theorist and pro Trump,  pro Russia and anti US/West ( No.  I'm Australian and not a particular fan of the US ) but your post reminds me of how ZH used to be.  Well at least in my decrepid memory anyway..

In reply to by Harry Lightning

SeuMadruga Harry Lightning Tue, 01/02/2018 - 10:22 Permalink

Great post ! But it left me scratching my head, so any clarification would be very appreciated...

"The entire dollar shortage outside the US is a result of Eurodollars being subject to reserve costs by the Federal Reserve to the American banks that hold them anywhere in the world."

What I had (maybe incorrectly) grasped/inferred from Jeff Snyder's "Eurodollar University" presentation (available @ https://www.macrovoices.com/macro-voices-research/guest-publications/13…) is that the USD monetary authority is unaware of how many off-shore dollars are deposited at banks that don't have a direct reserve account in the Fed, as though these so-called "eurodollars" comprised a kind of a fractional reserve's second layer with no (american) CB oversight.

"What that means is that for every $100 Eurodollars that an American bank anywhere in the world is holding as a Eurodollar deposit, it can only use $90 of those dollars for lending activity The other $10 has to be held in reserve and the bank reserve fund does not make any money for the bank unless lent to another bank in the Federal Funds market or lent directly to the Federal Reserve. At very low interest rates such have been seen during the last 9 years, the interest that can be accrued by lending the 90% of a Eurodollar deposit that a bank is allowed to use does not generate enough of a profit margin to account for the interest expense that was paid for the 10% of the deposit that had to be reserved, plus the profit margin required by the Return on Capital ratio that the bank seeks to earn to fulfill guidelines from the Bank for International Settlements, the Basle III Accords, and the stock markets's expectation of earnings for the bank."

I guess what you actually meant is that for every $100 dollars an american bank has on its reserve account (asset) at the Fed, this same (commercial) bank can simultaneously maintain $1,000 dollars on its deposit/client accounts (liability). And since the QE program started, any bank reserve (excess or otherwise) is accruing interest to goad banks on avoiding excessive monetary multiples (M1, M2, etc) multiplication through typical lending, especially when considering their newly, Fed-created, huge reserves ! And if this is the case, then I think it'd be much easier for any bank to offset caption costs of reserves (when lent from other banks), as it can profit over a much wider base even at lower interest rates charged for the newly created deposit/credit.

In reply to by Harry Lightning

Global Douche Mon, 01/01/2018 - 22:42 Permalink

My biggest question is "How will this affect America domestically?" If this contagion manifests itself here, NOW may be the time to start withdrawing some fiat and hiding it under the mattress or take that wonderful class on midnight gardening.

Maestro Maestro Tue, 01/02/2018 - 05:40 Permalink

Another CIA mindfuck psyop article on ZH to confuse and mislead you.

Shorting means borrowing something you don't have  only to be able to sell it hoping to be able to buy it back later at lower price in order to pocket a profit.

That's not what people and real businesses do when they borrow dollars: they buy actual things with them, they do not speculate with said dollars.

Yes, they have to service their dollar debts with dollars but (1) the price of the things they bought also go up at least in local currencies and (2) those things they bought are actual assets which can be sold to generate funds to pay back their debt. Furthermore (3) the ONLY things backing the dollar are violence, lies and ignorance on the part of most of humanity.  These do not constitute a sound foundation for any currency.

 

CIA = Zerohedge 

AyatollahOfRoc… Tue, 01/02/2018 - 11:37 Permalink

This article is complete, unmitigated, bullshit.  The dollar is never, ever, going up again.  The jig is up.  The printing press is all worn out, and no one wants US $ anymore.