Wednesday, January 20, 2010

To Infinity and Beyond?

Two days ago I made a comment that "if [interest] rates stay low we will remain protected and secure."

It was a bit of a sarcastic comment because long time readers of this blog know I don't think interest rates are going to stay low at all.

One reader (jungberg) asked, in the comments section, what the chances were that the government will raise rates?

Let's be clear. Rates are going up. The Bank of Canada has sounded enough warnings to Canadians about that very fact to leave not doubt. The only question is: how high will they go?

I think without US intervention (more on that in a bit) they will go far higher than Carney would like... and he won't be able to prevent it.

It all has to do with the cost of money.

All Western governments are in record states of deficit. The global competition for money is about to heat up the bond market.

What's keeping things down right now is Quantative Easing.

Your mortgage rates are directly tied to the yields of the sale of US Treasuries, and right now those yields are artificially low. Very low.

They have been manipulated that low by US Federal Reserve intervention throughout 2009.

Three weeks ago we talked about a report from Eric Sprott, the Toronto-based money manager, which pointed out that the actual number of US Treasuries being sold to foreigners in 2009 was next to nothing and that the purchase of those Treasuries by the Fed was far higher than originally acknowledged by the government.

Of the $1.75 trillion in 2009 US Treasuries sales, only $200 Billion was actually bought by entities besides the US government.

As Sprott pointed out, 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.

In 2009 we had a situtation where the US Federal Reserve was printing far more dollars to buy Treasuries than they 'officially' announced they had planned to do. This amounted to a means of faking the Treasury's ability to attract outside capital. Since the US bought the vast majority of it's own Treasuries, the yield (interest rate) was kept artificially low. Only $200 Billion was actually sold to investors.

In 2010, the United States needs to fund $2.21 Trillion worth of Treasuries sales. Since $200 Billion of those Treasuries will be absorbed in the 'official' conclusion of Quantative Easing, it means in the 2010 fiscal year (November 2009 to October 31, 2010) the US will have to sell $2.01 Trillion in debt to the rest of the world.

So who going to buy them if there weren't enough buyers in 2009?

Either interest rates are going to have to jump dramatically... or the US is going to have to embark on Quantative Easing to Infinity.

Since November 2009 marked the start of a new fiscal year, we can now start to answer that question.

And the first bits of evidence coming in are disturbing.

Yesterday the latest US Treasury International Capital Flows data covering November 2009 were released (the date is about two months behind the current month).

The data reveals a huge surge in capital flows predominantly as a result of a massive buying binge in US Treasuries. The implication is that there is, presumably, a strong market for the purchase of US Treasuries.

The surge in purchases is so strong that the November data is the largest amount of purchases for any month since 2005 (reference this analysis by Jim Sinclair's Mineset).

(Note: the previous high in purchases of US Treasury's occurred during the month of June 2009 when $100 billion worth of Treasuries were purchased on net)

November 2009 topped that by another $18 billion. So all is good, right?

Not so fast.

Dan Norcini, who did the above referenced analysis, had the following comments:

  • "Strangely enough, when you look into the breakdown of the Treasury buying by country, we see a decrease in the biggest buyer of US Treasuries, namely China. They sold about $9 billion worth. Japan compensated for that by buying another $11.4 billion. The biggest increase however came out of Great Britain where some $47 billion were added. Keep in mind that London is often the primary conduit through which foreign entities affect purchases of US Treasuries for the purpose of secrecy as that information generally does not get revealed until the Treasury revises the TIC data in June of each year.

    Call me cynical but we really have no idea who actually bought all those Treasuries through London offices.

    In times past the revisions have seen many of those purchases being credited to China but that does not guarantee anything of the sort this time around, especially with China being a net seller this month.

    We also have a decent sized increase in Treasury buying out of those Caribbean based banks.

    Were it not for the binge in Treasury buying, the Agency, Corporate Debt and Equity categories would not have been sufficient to fund the negative balance of trade. This of course will be spun as a vote of confidence for the US Dollar as the spinmeisters will step up and proclaim that the world still has a strong appetite for US debt. Personally I think the Fed is buying the Treasuries."

Norcini's suspicions can't be confirmed until the June numbers come out. Last year the US Federal Reserve wasn't forthcoming with the true extend of how widespread and extensive the purchasing of their own Treasuries was, so it's not that much of a stretch to imagine the same deceptions are playing out again this year.

And Sprott called what was going on in 2009 a virtual 'ponzi scheme'.

If the Fed has embarked on QE to infinity - look out. Spiking interest rates will be the least of our worries if that's the case.


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  1. Wow. Thanks again. Every week you seem to come up with info that is incredibly informative.

  2. Thank you for the good work! every day I get lots of great analysis and knowledge from your blog.

  3. Thank you for all the great articles.

    There is a divine providence that protected the U.S. dollar, but the beginning of this decade may signal its demise. As the dollar value tumbles, its status as world reserve currency is now in doubt. The Fed is operating a policy of benign neglect of the dollar, engineering an artificial demand of its own treasuries and keeps interest rate low. This strategy works as long as the world still believes in the supremacy of the dollar. However, this time it may not be the case. At the end of 2010 U.S debt will reach 100% GDP, but the total national debt including state, municipal, corporate and personal exceed 600% GDP according to some analysts. Bernanke, the man of the year, can monetized debt as long as he want, but it will not go unnoticed. Once the dollar lost its luster, there will be less demand for it and interest rate begin to rise. When that happens, America's interest burden will consume a large part of its tax revenue, which in turn incurred more debt. A vicious circle. All this stems from Washington misguided policies of borrowing like mad to bail out Wall Street instead of Main Street. The result, Wall Street given out huge bonuses while over 10% unemployment and foreclosure decimate the middle class. To rub more salt to the wound, the government raises their taxes, throwing the tax payer under the bus. With so much public discontent, 2010 will see a big change in the U.S. political landscape if Tuesday Massachusetts vote is any indication. Unfortunately, it does not matter which political power the American public chooses. In the end, The U.S can not spend itself out of a recession. It has to face the music. It can chose either to stop vilify deflation and let it purges all the mal-investment, to cut spending, to raise taxes, to pay down debt or to continue monetizing debts and face the risk of a currency crisis. Deflation and spending cut seem painful, but of all the calamities befalling U.S. economy, a currency crisis will be the end of a once mighty nation.

    As for Canada, we are different. We have a special providence with our real estate. Our housing asset defies gravity. Just like a bubble, it can only go up. The fundamental is irrelevant, with such a low interest rate and carrying cost who cares about prices. Buy now or be price out... It is deja vu. Plus c'est different, plus c'est la meme chose. We are not different, it is just that our providence last longer than our American counterpart.


  4. One of the very few very educated blogs on the present state of the North American economy.

  5. Thanks, Patrick - you anwered my next question after reading the Whisperer's pot - namely, what does happen if quantitative easing is attempted for infinity and beyond?
    Would anyone care to connect the does about what an American currency crisis would mean for Canada and our housing bubble?