Tuesday, August 24, 2010

The US Bonds Circle Jerk

"US Treasury data show that China has cut its holdings of Treasury debt by roughly $100bn over the past year to $844bn. ZeroHedge reports that net purchases by the big three of China, Japan, and the UK (Mid-East petro-dollars) have been sliding for two years. In August they bought the least amount of US debt this year"

During World War II, the US Government needed to borrow vast sums of money in order to wage war on two different fronts. The American people, then a frugal, hard working lot, lined up by the tens of millions to buy "War Bonds" with their paychecks and savings. We as a nation got no loans from abroad.. our own people were able to foot the bill thanks to a high savings and very low debt of the average American. Even into the 1980s, the United States was the world's largest creditor nation. Then Alan Greedspan become Fed Chairman.

Today, the US Government spends approximately three dollars for every two dollars it takes in. We need to borrow that extra dollar.. well, $1.5 trillion of them actually.. from somebody. For the last decade, the Chinese, Japanese and English (actually the wealthy Arab states invest thru the UK) have been funding us; the economy was good, deficits were a quarter of today's levels, and the overall US debt picture was fair. It was considered a safe, if boringly low yield, bet.

Today, however, the picture is drastically different for all of the participants. China, the largest buyer of bonds, is having a pretty difficult time with a real estate implosion that's much more serious than Beijing is letting on. They have entire cities that are empty. The mess is, according to Jim Chanos {former VP of DeutscheBank and a man who's made bazillions betting against Enron and other companies and nations that seemed too good to be true} approximately a trillion dollars.. about half the size of China's GDP. Speculators have bid up the price of housing to stratospheric levels.. and we here know the result of such policies. Of late, the Chinese have been buying Korean, Japanese and other Asian bonds.. as well as metals. They're buying gas reserves in Africa. It seems they're simply looking for something to do with the money other than pump it into US treasuries and their historic low rates. Soon enough, they'll be bailing out their banks from this speculator and liquidity induced catastrophe.

Japan is in a different pickle. Their government's debt is more than 200% of their GDP. Their currency is appreciating due to deflation; just today the Bank of Japan threatened to sell yen on the open market; the yen market today was a wild ride for sure. Worse.. and perhaps terminally.. their working age population is entering a terminal decline and the number of pensioners recieving government Social Security and Medicare is rocketing upwards. Simply put, those fewer and fewer working Japanese are simply unable to keep the US afloat. In my predictions for this year, I predicted the Japanese would become net sellers of US Bonds, and indeed they have become just this. This is more than a cyclical or temporary decline.

The Gulf Arabs have also been a reliable source of funds.. but they are also in a financial pickle thanks to declining oil revenues and an increasing youth population demanding jobs and a better life. US Treasuries and their 2.5% yield over ten years just isn't going to cut the mustard; they must develop their own economies. Iran is also a threat, and many have been beefing up their security forces. Abysmal returns have forced many to look elsewhere for better returns.

But.. US Bond yields are near historic lows; indeed the US 2 year bond today reached it's historic low. So.. just who is it that's buying up these Bonds ?? Some of it is foreigners in troubled nations who are abandoning their own sinking ships (fearful Europeans head this list). Some of it is American investors and their Mutual Fund managers, who are seeing the equities markets stall and increasingly are seeking the safety of Bonds. The Fed is also a buyer; just last week they agreed to purchase another $340 billion or so over the next year or so. But the biggest buyers of US treasuries is American banks, who can borrow at 0.5% from The Fed and get 2.5% on the ten year Bond. It's safe, easy and much, much safer than loaning to individuals or businesses. This lovely three legged animal has a problem.. it leaves Main Street with very little liquidity. Obama himself understands this, as does Bernanke; indeed Obama has chided banks several times on this very issue. But he's essentially helpless to change the current situation; he simply cannot order private banks to loan to people they don't want to. Part if it is also the lack of credit worthy applicants; many consumers have too much debt, bad credit, or a reduced income. Deflation is what it's called, and it's only going to get worse as confidence in the US "recovery" sinks on a daily basis. Today the US existing home sales came in at the worse level ever, spurring another "Hindenburg Omen". These are not the headlines that inspire confidence.. or bank lending.

In the short term, the Fed-US Banks-Treasuries circle jerk will hold water, each of them supporting the other, all at the expense of the value of the US currency. But in time, this cozy little arrangement will have to give way as the value of the US dollar begins to crater. Look for physical commodites to continue to appreciate vs the USD, despite the raging deflation all about us. One day this will end very badly, as all numbers games do.. and with it, our way of life. Keep an eye out on Japan; they are a few steps ahead of us in this Keynesian Death March. So goes Japan, so we go. It'll happen with startling speed.


  1. According to FRBNY website:
    What types of assets can I pledge to the Discount Window?

    The following types of assets are most commonly pledged to secure discount window advances:

    * Obligations of the United States Treasury
    * Obligations of U.S. government agencies and government sponsored enterprises
    * Obligations of states or political subdivisions of the U.S.
    * Collateralized mortgage obligations
    * Asset-backed securities
    * Corporate bonds
    * Money market instruments
    * Residential real estate loans
    * Commercial, industrial, or agricultural loans
    * Commercial real estate loans
    * Consumer loans
    * Check with your local Reserve Bank if you have questions about other types of collateral

  2. Mr K something is wrong with the most recent post Bernake's War.