Debtor's Prison

Greetings fellow inmates,

It's Thursday evening, time to check into Uncle Benny's Bizarre Mystery Science Theater of Black Money Magick, otherwise know as H4.1 release. 

This week, each side of the FedBS grew by close to $50bln, to a whopping $2.2tr.   On the asset side, this growth was primarily due to the asset purchase programs.   This week, Uncle Benny bought $46bln of MBS, $11bln of Treasuries and $2.4bln of Agency debt.   Liquidity swaps with other countries fell by $10bln, signalling a decreased demand for dollars worldwide, and the commercial paper funding facility fell by $6bln.    As usual, all these new purchases (ie, the growth in the assets of the FedBS) were financed by increasing Reserve Balances held by banks at the Fed, which grew rapidly this week, at $76bln.   For some of our new readers, Reserve Balances are deposit accounts all banks hold at the Fed.  In order to finance the asset purchases, the Fed must also increase the liability side of its balance sheet.  The easiest way to do this is by increasing Reserve Balances, effectively giving the banks free money, which they could turn and lend if they so pleased.   Quant easing has been "sold" to the public this time around as "credit easing", allegedly focusing on easing conditions in private credit market (ie, the asset side).  The liability side however is just as important, if not moreso, since it is this high-powered money that is supposedly meant to stimulate lending growth and lead an increase in the monetary aggregates, thus preventing deflation.  At least, this is the monetarist point of view to which Uncle Benny subscribes.   We, on the other hand, are quite concerned about the growth in the liability side since we believe it's the precursor to a severe USD-crisis which will eventually lead to superinflation in 1-2 years.

One very important detail we'd like to note, is that in their April meeting minutes, "some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery".   This comes as no surprise to us, and as somewhat of a vindication, as we have often prognosticated that QE will be increased beyond its current levels.  We have even forecast that by the end of 2009, Uncle Benny will have committed to buy as much as $1tr in Treasuries.

As usual, here is the chart of the asset purchases and the UST30 yields.   The beleaguered 30-Year US Treasury bond continues to get absolutely shellacked.   Yields widened out significantly today all across the curve, especially the long end, rising to 4.31, from last week's 4.05.   Making the news today was concern over the eventual loss of the US's AAA credit rating, after S&P said that the UK might lose its credit rating.   Meanwhile, Secretary Timmy, lying through his baby teeth, said that the rise in yields “is a sign that things are improving”.   To be frank, this type of statement is to be expected.  A rise in interest rates (ie, yields) has always historically lauded as signs of a recovery from recession.   Make no mistake about it however, this time around it is indicative of an endemic problem to over-leveraged governments and nations and spells trouble, not relief.     Since the annoucement of full-fledged QE in March, UST30 yields have risen 70bps, a huge amount.  While this does not guarantee that they will continue rising in the near term, we do expect them to rise much higher than this in the medium term as confidence continues to crack on this worthless piece of paper.

In the USD Broad Index (measured against a basket of currencies), we continue to see a significant and unwavering decline.   Today, in fact, the dollar reached a four-month low, according to Bloomberg.   As you well know, we expect that all the recent absorption of credit risk on central bank balance sheets, and their significant levering will lead to a fiat currency crisis.   Think about it, the monetary base has nearly tripled (increasing the amount of USD "available") while simulateously going from being backed by mostly government debt, to mostly private toxic assets, including MBS.  Is the dollar overvalued? You bet.   Let us reiterate one of our principal premises: the USD, through the actions of the FedBS, poses one of the largest, if not THE largest systemic risk for the next 1-3 years.

All in all, this marks the 6th straight week in which we have done our weekly updates.  As we expected, thanks in part to Laswyguy, the hidden costs of QE have shown up quite dramatically in the UST30 and the USD.  Of course, the data only implies correlation, not causation; in other words, we can't ascribe with certainty this deterioration in the UST30 and USD solely to QE.   However, our gut feeling is that they are intimately related.   Even if there is no direct causation now, there will be, and it will be fast and furious.   We will continue to track these two indicators, and a few others, to see if this thesis holds up.

Tune in next week!

May your capital be safe and your investments prosperous,

MAAA