Tuesday, December 29, 2009

Whole lotta pain

Yesterday I talked about US debt and today the theme continues.

Specifically... US Treasuries and how few people acutally bought them in 2009.

Eric Sprott, the Toronto-based money manager whose Sprott Hedge Fund returned about 496% in the past nine years, has been trying to figure out that very question.

In a report entitled 'Is it all just a Ponzi scheme?', Sprott and David Franklin suggest that it's impossible to find who was the second largest buyer of Treasuries in 2009.

Of the $1.885 trillion dollars in public debt the US added in 2009, $704 billion (annualized) was bought by "Other Investors", a collection of buyers defined in the Federal Reserve Flow of Funds Report as the "Household Sector".

Interestingly, the $704 billion is 35 times more than this sector bought in the prior year, 2008.

Sprott and Franklin did some digging and here is what they found:

  • Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can't be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide,

    "For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector."

    So to answer the question - who is the Household Sector? They are a PHANTOM. They don't exist. They merely serve to balance the ledger in the Federal Reserve's Flow of Funds report.

    Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills... they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3.

    It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury's ability to attract outside capital. If our research proves anything, it's that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market.

As we discussed yesterday, the actual number of US Treasuries sold to foreigners was next to nothing. As the Sprott report points out, the US Treasury and/or the Fed has been buying US treasuries themselves, in much larger numbers than they acknowledge.

The coming year of 2010 will be known as the year of the Debt.

It will bury entire nations. Nations like Greece and Ukraine, and states like California, and it will threaten to topple scores more.

As was posted yesterday, the looming question is who is going to buy the $2.06 trillion worth of US Treasuries next year?

China, Japan and the UK have increasing doubts about amassing USD denominated paper including Treasuries, Japan also plans to be as aggressive a seller as the US when it comes to debt. And of course there are many other countries who desperately need to sell sovereign bonds in order to pay for their already accepted and implemented budgets - not the least of which is Canada.

And that's just the nation states.

Corporations and lower levels of governments, in every nook and cranny of the planet, want to sell you their debt. Badly.

So the story of 2010 is going to be all about debt and the rapid rise in interest rates to cover it.

It's impossible to foresee at this point how high the rates may rise, but it looks patently obvious that it is going to be a lot more than a few percentage points... and there will be a lot of pain involved when they do.

A whole lotta pain.


Email: village_whisperer@live.ca
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  1. 2010, the tipping point.
    Gold already is showing some contraction and the USD is looking ready to move up.
    Welcome to...
    Debt Unwind Part 2: This time it's personal.

  2. I only recently discovered your blog and just wanted to say thank you for writing such a well informed and thought out one. I look forward to your posts!

  3. Thanks for the comment Black Light. And welcome to the blog Anonymous.