One of THE BEST Articles that I Have EVER Read!

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  • Wed, Sep 01, 2010 - 06:30pm

    #11
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    Re: One of THE BEST Articles that I Have EVER Read!

For a debtor to obtain cheaper and cheaper borrowing rates, even as he piles on the supply, is contrary to the way real markets work.

As the old adage goes, banks are happy to lend when you’re flush and don’t want the money. But when you NEED the money, they call in your loans and cancel your credit lines. Every small business owner has seen this phenomenon.

Yet the US Treasury — an insolvent-but-liquid borrower which is totally dependent upon rolling over debt every Monday — sees its borrowing rates falling toward zero across the curve, as it issues record volumes. This is the financial equivalent of a river running uphill.

But Treasuries aren’t a normal market. They’re a managed market, with a monopoly supplier (exempt from SEC prospectus requirements), and both domestic (Federal Reserve) and foreign official buyers.

The ‘conveyor belt’ aspect of this market was established at the Bretton Woods conference in 1944. As Robert Triffin pointed out, the US would be obliged to run trade deficits to supply the world with enough dollar reserves — a fundamental imbalance. Excess dollars overseas would be recycled to the US. Until 1971, those dollars could be exchanged for gold. Treasury didn’t like this, because the gold supply was finite, and running out. Now overseas dollars are mostly exchanged for Treasuries, whose supply is infinite. Demand is strong, prices rise on; not a cloud mars the azure sky.

Well, except that excessive debt chokes economic growth (this has already happened). And futile attempts to monetize debt to stoke growth eventually will croak the dollar (the monetization has begun, but the dollar remains miraculously suspended in midair). Until the dollar takes to its sickbed, we can party on, lulled by the illusory price signals from bond yields:

Mirror, mirror, on the wall
Who’s the fairest borrower of all?

A managed market can stay elevated for years. But to believe that it’s sustainable is a lethal error. Every ‘fixed’ market eventually comes under attack, and crashes back to fair value, or even below. 

No one knows when. But the end result is certain.

  • Wed, Sep 01, 2010 - 08:46pm

    #12
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    Re: One of THE BEST Articles that I Have EVER Read!

As far as the inflation/deflation debate goes, I’m not on either side (I just want to protect my ASSets just like everyone else).  One thing that strikes me when I hear the deflationists speak, is they seem to conveniently ignore all the debt/dollars held by foreign nations and foreigners.  Its almost as if the world outside the US doesn’t exist and that bothers me a bit.

Please see the video “Japan: Americas lost decade” on the National Inflation association website.  http://inflation.us/videos.html  this video gives a nice comparison between the US and Japan. 

They mention in the video that Japan still owns $1 trillion of US debt, foreign nations combined hold $4 trillion of US debt, and total debt (foreign nations and citizens) hold $10 trillion.  (im not sure about the $10 trillion, but I know the other two numbers are just about correct).  What is going to prevent these foreigners from dumping their dollars and using them to bid up the price of important commodities such as food and fuel?  Am I missing something?  It make sense to me that once the first country dumps their treasuries, then all the other nations will quickly follow suite.  It seems to me that a lump of $ 4 Trillion dumped on the market (and especially into vital commodities) could cause hyperinflation.  Will the destruction of credit that Mish talks about matter in this case?  Please tell me where my logic is flawed.

Brian

  • Wed, Sep 01, 2010 - 08:53pm

    #13
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    Student Loans Surpasse Credit Card Debt

 

That is just scary how much debt young students are saddled with. It’s almost as if someone wants young healthy people to be in debt to them for life.

Poet

  • Wed, Sep 01, 2010 - 09:09pm

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    Re: One of THE BEST Articles that I Have EVER Read!

Thanks Davos. Very good article.

Coop

  • Wed, Sep 01, 2010 - 09:43pm

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    Re: One of THE BEST Articles that I Have EVER Read!

[quote=bluestone]

They mention in the video that Japan still owns $1 trillion of US debt, foreign nations combined hold $4 trillion of US debt, and total debt (foreign nations and citizens) hold $10 trillion.  (im not sure about the $10 trillion, but I know the other two numbers are just about correct).  What is going to prevent these foreigners from dumping their dollars and using them to bid up the price of important commodities such as food and fuel? 

[/quote]

Foreigners wouldn’t even have to dump Treasuries. A more likely scenario is a buyer’s strike — a glitch damages confidence, and foreigners withdraw from new auctions. But they are half of the buy-side market. Then, either yields must go up to attract more US domestic buyers (but this means prices are falling, which will scare those already on board) … OR, the Federal Reserve steps in to make up the difference, which will undermine confidence in the dollar as wholesale monetization starts.

The weak-dollar scenario would lead to sharp hikes in food and fuel prices, simply because of the exchange rate. But speculators would likely pile on too, as in crude oil’s apocalyptic run-up to $147 a barrel.

  • Wed, Sep 01, 2010 - 10:02pm

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    Re: One of THE BEST Articles that I Have EVER Read!

The debt is only monetized twice if it the debt asset ends up in the hands of the Fed, and then only the difference between the value given by the Fed and the fair value of the asset is monetized. This has certainly happened a lot in the past year and a half.

  • Wed, Sep 01, 2010 - 10:38pm

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    Re: One of THE BEST Articles that I Have EVER Read!

thanks Machinehead.  that sounds like the “bond vigilantes” that they describe on Financial Sense Newshour.  So let me get this correct.  You believe that the failed auction itself could lead to not only inflation, but even hyperinflation.  (maybe you discussed this in your article.  i’ll have to renew my membership to read it). 

btw – is that a picture of Hank Williams?

Brian

  • Wed, Sep 01, 2010 - 10:40pm

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    Re: One of THE BEST Articles that I Have EVER Read!

[quote=blue]when I hear the deflationists speak, they seem to conveniently ignore all the debt/dollars held by foreign nations and foreigners……What is going to prevent these foreigners from dumping their dollars and using them to bid up the price of important commodities[/quote]

I can’t speak for the others, but my deflation view is based precisely on the global situation.  China, Japan, and the private global banking institutions didn’t buy trillions in Treasuries to dump them.  They bought them because they expect to be paid.  The power they have now trumps all other forms of power in the world.  It’s a mega hammer being held over the US’ head.  If the US steps out of line from the capital holders’ perspective, it will be hammered into submission.  This is the threat that will probably keep it in line.  If it steps out of line and the hammer comes down, i.e. the global institutions run on Treasuries by not showing up at auctions, the US’ response to that is what will determine deflation vs. hyperinflation.  The Fed’s automatic response will be to jack up short rates to defend its balance sheet, i.e. please the capital holders, which will cause mega deflation and austerity (it’s our turn to experience what the IMF has enforced on the poor people in the South for decades).  If the US says no to the Fed and tries to cutoff the capital holders by printing actual dollars for its people without defending its financial borders first, that will be hyperinflation.

What these Treasury holders know (assuming countries don’t free themselves from the bond market, i.e. debt-based money) is that the 21st century will witness the epic decline of the West/North (deflation) and rise of the East/South with China emerging as the global leader of a more equalized planet by 2050.  China is all about long-term stability…it thinks in 50 year increments vs. the US quarterly mindset.  And Confucianism is all about discipline and obedience.  The Confucianists will attempt to transition the West into vassal states in an orderly fashion over the next 40 years.  But if it needs to play whac-a-mole, it has the hammer now thanks to the bond market, the global banking establishment, and the corporate system’s transfer of production assets to it.

  • Wed, Sep 01, 2010 - 11:06pm

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    Re: One of THE BEST Articles that I Have EVER Read!

[quote=strabes]

If it steps out of line and the hammer comes down, i.e. the global institutions run on Treasuries by not showing up at auctions, the US’ response to that is what will determine deflation vs. hyperinflation.  The Fed’s automatic response will be to jack up short rates to defend its balance sheet, i.e. please the capital holders, which will cause mega deflation and austerity (it’s our turn to experience what the IMF has enforced on the poor people in the South for decades).

[/quote]

I can see how raising rates could help future auctions be successful and may increase the currency’s value, but how would it defend the FED’s balance sheet?  If the FED already has loads of Treasuries and MBS on its balance sheet, wouldn’t raising rates damage the value of the existing “ASSETS” it already has on its balance sheet?  Wouldn’t the FED be commiting suicide?

Am I looking at this incorrectly?

[quote=strabes]

If the US says no to the Fed and tries to cutoff the capital holders by printing actual dollars for its people without defending its financial borders first, that will be hyperinflation.

[/quote]

I agree with this but that seem contradictory to what many of the sovereign money supporters believe.  How would you “defend the financial borders”?

  • Wed, Sep 01, 2010 - 11:21pm

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    Re: One of THE BEST Articles that I Have EVER Read!

[quote=bluestone]

thanks Machinehead.  that sounds like the “bond vigilantes” that they describe on Financial Sense Newshour.  So let me get this correct.  You believe that the failed auction itself could lead to not only inflation, but even hyperinflation.  (maybe you discussed this in your article.  i’ll have to renew my membership to read it). 

btw – is that a picture of Hank Williams?

Brian

[/quote]

A failed Treasury auction, even for technical reasons (for instance, 9/11 happened on a Tuesday, but if it had occurred the morning before, what then? — the stock market closed for the rest of the week), would be a serious event. The US government is highly dependent on these auctions going off smoothly. The Treasury doesn’t usually keep enough cash on hand to pay off maturing debt. It needs to roll over existing debt, and add more. This is the same sort of short-term financing risk which forced commercial paper issuers to scramble for backup bank credit lines during the Lehman crisis.

Statistically, hyperinflation is a long shot, just as a market crash is. Gonzalo Lira wrote a vivid scenario for a hyperinflation, but its probability remains low for now. The strange thing about markets is their tendency toward quantum shifts in sentiment, like an electron leaping from one orbit to another.

In 2009, southern European sovereign debt was popular, offering a slight yield pickup over northern Europe. Then in early 2010, it was revealed that Greece’s finances had been misstated. In a matter of weeks, all southern European debt was suspect. The euro weakened, but the larger countries (France, Germany) functioned as anchors.

Nobody can predict the timing of such events. But one distinction is that the euro currency area has a roughly neutral trade balance, whereas the US is in chronic deficit to the tune of $50 billion a month.

http://www.tradingeconomics.com/Economics/Balance-of-Trade.aspx?Symbol=EUR

The US is very dependent on a lifeline of foreign capital imports. This is an obvious risk factor. Markets, with their nose for vulnerability, will test it someday. Rising interest rates and a falling dollar don’t HAVE to blossom into hyperinflation — but they might.

As ol’ Hank said [that’s his picture]:

Now you’re lookin’ at a man that’s gettin’ kinda mad
I had lots of luck but it’s all been bad
No matter how I struggle and strive
I’ll never get out of this world alive

Nor will the US dollar, I assure you. Frown

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