Psycho Bearish on T-bones

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machinehead's picture
machinehead
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Psycho Bearish on T-bones

In the wake of the president's 'four percent [of GDP] forever' deficit forecast, the long knives are coming out for the 'market' most at risk, U.S. Treasurys. Consider this blast from Dr. Marc Faber:

In his latest GloomBoomDoom market commentary, the irrepressible pundit concludes that the US has basically two choices: default on obligations or massively monetize US debts and reduce the debt through inflation. “In my opinion,” he declares, “additional massive monetization of debts is the most likely outcome."

http://ftalphaville.ft.com/blog/2010/02/03/139991/faber-lashes-out-again/

Usgov's desperate dependence on weekly debt auctions is reminiscent of the way commercial paper stopped rolling over in 2008. When Wall Street smelled blood in the water, it immediately attacked the financially wounded, shorting their bonds (via credit default swaps) and cutting off their access to the commercial paper market. Nicholas Taleb, author of The Black Swan, draws a similar conclusion about U.S. Treasury bonds:

Feb. 4 (Bloomberg) -- Nassim Nicholas Taleb, author of The Black Swan, said “every single human being” should bet U.S. Treasury bonds will decline, citing the policies of Federal Reserve Chairman Ben S. Bernanke and the Obama administration. It’s “a no brainer” to sell short Treasuries, Taleb, a principal at Universa Investments LP in Santa Monica, California, said at a conference in Moscow today. “Every single human being should have that trade.”

http://www.bloomberg.com/apps/news?pid=20601087&sid=a3E4uC5VIFeo&pos=5

Whoa; lordy! Nick, dude, you sound psycho bearish on them T-bones! Yet, the great Greenspan conundrum -- the bizarre fact that Treasury bond prices hover and twinkle high in the sky with no visible means of support -- continues to haunt us. What explains it? One is official (that is, 'non-market') buying. Bloomberg's William Pesek, also using the B-word ['Bubble'], describes what's going on:

China sure has its share of bubbles. Oddly, little attention is paid to the biggest one of all. Its $2.4 trillion of reserves is a bubble all its own, one growing before our eyes with nary a peep out of those searching for the next big one.

The trouble is, China is trapped in an arrangement of its own making. As China and other Asian nations buy more and more U.S. Treasuries, it becomes harder to unload them without causing huge capital losses. And so they keep adding to them.

Like all pyramid schemes, there’s no easy end in sight and things could end badly. If the dollar collapses, panicked selling by central banks looking to limit losses would shake global markets more than the U.S. credit crisis has.

http://www.bloomberg.com/apps/news?pid=20601039&sid=a4mPCXeGTl4Y

'Pyramid scheme' -- oh my! Ground zero of the scheme is the Federal Reserve's custody account, now pushing $3 trillion. Yet, like the wounded mortgage giants Freddie and Fannie Fubar, the Federal Reserve has barely more than 1% capital supporting its gargantuan on and off-balance sheet liabilities. Dangerous? It's like giving glue-sniffing feral six-year-olds a live grenade launcher to play with.

But still -- with Uncle Sam treading water in a growing pool of deficit blood, why are Treasurys not under attack? Besides official buying, there's also a safe haven play. With economic growth weak and credit risk still elevated, Treasurys are a safer place to hide than other debt securities. Too, the southern underbelly of the euro is at risk, garnering the dollar a certain relative safe haven status.

Nevertheless, China is making rude noises about a variety of what it sees as U.S. provocations, ranging from Taiwan arms sales to the president meeting with the Dalai Lama. China doesn't need to outright sell Treasurys to shake Usgov's debt pyramid; it merely needs to stop accumulating them. To no country is global monetary reform -- that is, deleting the US dollar's vestigial central role -- more important than to China. We should not be surprised if China announces major plans along those lines this year. The strategic danger to China of continuing to accumulate US dollar reserves has become potentially life-threatening to its prosperity.

Since central bank reserves are inherently unredeemable (in no country can one exchange currency for the bonds which 'back' it), one wonders why central banks don't accumulate less-liquid income-earning reserves such as property, oil fields, and the like. It can be objected that these have equity-like price risk. But -- as will soon become apparent -- so do U.S. Treasury bonds. Raise the prevailing interest rate on 30-year Treasurys from 4% to 8%, and watch their price crash!

Over to you, Benny Bubbles! Did it ever occur to you that, like Freddie and Fannie, the Federal Reserve is a bizarre public-private hybrid, without explicit Treasury support? Your $3 trillion custody account -- the largest fund on the planet -- is not FDIC-insured, nor is it an obligation of the U.S. Treasury. Sounds like a recipe for trouble to me. When Ms. Market sees a developing hairline crack, her unerring instinct is to pound it with a sledgehammer while reciting Humpty Dumpty rhymes. As an old-school tycoon used to cry, 'Sell? TO WHOM?'

 

Johnny Oxygen's picture
Johnny Oxygen
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Re: Psycho Bearish on T-bones

Great post Machinehead!

Which merits 'the steps' list again.

 

The Nine Steps of Hyperinflation 

BOOM. Markets rise. Creation of asset bubbles.

BUST: Market Crash. Inflation goes negative. Central Banks overreact and cut interest rates. Money injections.

BOND BOOM: Government debt balloons. Debt issuance soars.

STABILIZATION: Stocks and commodities recover. Bonds stabilize. Volatility declines.

YOU ARE HERE

 

BOND BUST: Inflation goes positive. Bond buyers pull out. Central Banks step in and buy bonds (Quantative Easing). This gradually crowds out and scares off real buyers.

CURRENCY CRISIS: Money flees inflated currency, at first a trickle then a flood.

INFLATION SOARS: Quantitive Easing. Currency weakness pushes prices. Inflation accelerates. Commodities rise. Inflation reaches pre-bust highs.

POINT of NO RETURN: Central Banks are slow to contract money supply. Government continues to spend more. Deficits continue to grow. Real economy is still slow. Prices spiral.

CURRENCY DESTRUCTION: Double digit inflation. Currency devaluation. Bond market crash. Inflation goes logarithmic. Confidence in money is destroyed. Eventually even monetary contraction will not help as demand for cash evaporates.

 

 

machinehead's picture
machinehead
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Re: Psycho Bearish on T-bones

Nine steps, huh? Yep, looks like the end of the fourth inning to me, too.

Let's hope it don't turn into a traditional 12-step program, with the last three steps being FOOD SHORTAGE, CIVIL UNREST, and NORTHCOM MARTIAL LAW.

FrownYellCry

Johnny Oxygen's picture
Johnny Oxygen
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Re: Psycho Bearish on T-bones

I hear that. If it get violent there is no telling were it will go.

Whenever I post the list people frequently ask "What is the tenth step?" Surprised

I'm not sure if I want to know.

machinehead's picture
machinehead
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Re: Psycho Bearish on T-bones

This just in from the NY Times - article posted ten minutes ago:

BEIJING — A senior Chinese official said on Thursday that China not bow to pressure from the United States to revalue its currency, which President Obama says is kept at an artificially low level to give China an unfair advantage in selling its exports.

The official, Ma Zhaoxu, a Foreign Ministry spokesman, said at a regular news conference here that “wrongful accusations and pressure will not help solve this issue.”

On Wednesday, Xinhua, the official state news agency, the official state news agency, said Chinese economists were concerned that the American government, suffering from a record budget deficit, could print more dollars and issue more bonds, eroding the value of the dollar.

http://www.nytimes.com/2010/02/05/world/asia/05diplo.html?hp

Obama's contretemps with China is a classic example of 'be careful what you wish for.' A sudden revaluation of the yuan could well slide out of control, with speculators dumping dollars for yuan.

Remember how Oil Shock I juiced U.S. inflation in 1974, even in the midst of recession? A yuan revaluation would force WalMart and other retailers to hike prices on imported goods, even in the midst of wage slack. Oil is not the only commodity which can produce 'exogenous' inflation, as economists label events which they failed to predict.

My sense is that tensions are coming to a head with China. The ensuing currency turmoil will reveal many unanticipated consequences, which can be summarized in a simple aphorism: Debtors can't be choosers.

Johnny Oxygen's picture
Johnny Oxygen
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Re: Psycho Bearish on T-bones

I second that!

I sense that things have been unwinding a little faster the last month.

Davos's picture
Davos
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Re: Psycho Bearish on T-bones
machinehead wrote:

 Dangerous? It's like giving glue-sniffing feral six-year-olds a live grenade launcher to play with.

 

Hysterically put. So true!

SagerXX's picture
SagerXX
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Re: Psycho Bearish on T-bones

Dang, MachineHead...nobody cuts to the heart of things like you do -- and it's hard to believe you make it hilarious, considering the gravity of the discussion...but you do.  Thanks for your posts.

Viva -- Sager

cmartenson's picture
cmartenson
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Re: Psycho Bearish on T-bones

Oy.

4:15 p.m. House approves $1.9 trillion debt-limit increase

"It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations," Mr. Geithner said

Yes, nothing inspires confidence in a debtor nation quite like when it raises its own debt limit.  Good thinking there.

Davos's picture
Davos
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Re: Psycho Bearish on T-bones
cmartenson wrote:

Oy.


Kind of recall reading that they didn't raise the ceiling high enough - this will be gone in MARCH!

V's picture
V
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Re: Psycho Bearish on T-bones

Being a conspiracy wacko paranoid nut case , i though I would share this little quote.

' You are certainly right that there is much to be earned from a government which has no money. But you have to take risks"

James Rothschild to Nathan Rothschild

12/18/1815

V

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