Thursday, September 3, 2009

A Troubling Shift

As we have discussed here before, mortgage interest rates are set by the sale of US Treasuries.

And for the past 12 years, those rates have been kept artificially low as the US Federal Reserve 'stimulates' the economy.

The dot-com crisis, 9-11 and the 2008 financial crisis lead the Fed to supress rates.

[A by-product of this 'stimulation' was the creation of a massive world-wide housing bubble]

The Fed achieves this interest rate suppression by 'buying' their own Treasuries. A ready buyer eliminates the need to raise 'yields' (interest rates) in order to make the sales attractive. Of course they only way this is possible is if the United States 'creates' the money to make the purchase.

This is the infamous 'cranking up' of the printing presses we hear so much about.

And only a nation whose currency is used as the world's reserve currency could pull off this type of manipulation. If any other nation tried such a stunt, it, would trigger hyper-inflation.

The problem with all of this is that you can only maintain this shell game for so long before the rest of the world loses confidence in your currency as a reserve currency.

China, Brazil and Russia have been clamouring about US monetary policy for a good part of the year. In June, Russia and Brazil both announced they’d soon be selling $20 billion in U.S. Treasuries in exchange for a new type of International Monetary Fund (IMF) bond.

These new bonds would be denominated in Special Drawing Rights (SDR), a quasi-currency used by the IMF in its dealings with member governments. China has suggested using SDRs as a substitute for the dominant U.S. dollar as the world's reserve currency

It would be a smart move... each nation gets to diversify out of the dollar (the IMF will pay these bonds back with a basket of global monies) and they send a clear signal to the U.S. government.

At the same time China, Russia and Brazil can hide behind altruistic intentions: “This support is important to help end the international financial crisis," said Brazilian finance minister Guido Mantega. Since the money will go to the IMF’s emergency fund, these nations get to look like generous, globally cooperatave players... even if their only intention is to get the hell out of U.S. Treasuries.

Well, today it finally happened.

After clamoring for a reserve alternative all year, the Chinese government agreed to a $50 billion currency-diverse deal with the IMF.

In their deal with the IMF - the first of its kind for any nation, ever - China buys $50 billion worth of bonds denominated in Special Drawing Rights, which will represent a basket of global monies. (That basket will be a split between the dollar, euro, pound and yen… not exactly the gems of the global currency batch.)

Russia and Brazil have each promised to buy $10 billion of these bonds, as well.

The immediate reaction to this move was a sharp spike in the price of gold and silver today.

And it sends a signal.

The days of the US Federal Reserve keeping interest rates artificially low may be coming to an end sooner than we think.


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  1. I assume yesterdays talk of US $ rising by Prechter and Mish would be affected by this news?

  2. We shall see. Gold hit a 6-month high today as it neared $1,000 an ounce.