Debtor's Prison

Greetings fellow inmates,

We apologize for the delay in getting out the weekly update on the FedBS QE programs, as released in Uncle Benny’s H4.1 release. This past week we saw a decrease in the size of the FedBS, notably through the decrease in some of the liquidity programs. In total, the asset side of the FedBS shrunk by about $90bln, a hefty amount. This was mostly due to a decrease in the Term Auction Credit, which fell by about $56bln. Central bank liquidity swaps also decreased markedly by close to $51bln, they are down to only $180bln. We find this very interesting since it indicates that demand for dollars all over the world has decreased. It’s important to remember how liquidity swaps work. Central banks all over the world got USD from Uncle Benny (and in exchange they gave their own currency) and then proceeded to lend those dollars to its liquidity-starved banks. This massive liquidity crunch was ostensibly caused by margin and collateral calls all over the world as confidence tanked. Presumably, this reduction in central bank liquidity swaps indicate improved funding conditions, where banks all over the world are able to obtain dollars from private markets. However, we advise caution when ascribing this rosy view to this phenomenon as it could also signal a structural contraction in USD demand. We don’t know how many of the previous USD-denominated debts were paid off and the level of retail or wholesale demand for new USD debt. For those reasons, we remain cautious on this indicator. As for the liability side of the FedBS, as usual, the decline was mostly due to a drop in the Treasury account, which dropped $23bln and a reduction in Reserve Balances, which shrunk by $68bln. The latter is only a temporary phenomenon, reserve balances will continue to increase markedly, thus increasing the monetary base, and fuelling the likelihood of superinflation in a couple of years’ time. Let us remind you, we believe superinflation will come about from a collapse of the USD, rather than through the monetary aggregates, but this wanton increase of the high-powered money certainly won’t help.

The asset purchase programs this week totaled $16bln for Treasuries, $5bln for Agency and $400mm for MBS. This week was a strong one for Treasury purchases, perhaps because the yields have climbed so much that Uncle Benny felt like he had to support the market. In usual fashion, MBS purchases took a breather following a period of strong purchases. Below is the chart of the 30-year US Treasury yield, which continues getting hammered. This past week, the yield rose another 28bps, to 4.51%. As reader PRG has reminded us, the mass media outlets have mostly been attributing this rise in yields to an incipient recovery; even Sec. Timmy got in on the lying last week. This weekly exercise has shown that this rise in yields corresponds nicely to the ramping up of QE. It has also coincided with increased rhethoric from official sources across the globe about the waning demand for long-term debt. Perhaps the strongest indicator that this rise in yields is mostly due to a secular downturn in demand (rather than optimism for a recovery) is that countries have been shortening their maturity distributions by buying short-dated debt and staying away from the long end. Eventually we will have a situation in which the economy is getting worse, talk of green shoots faded and yields still climbing. This will be a very strong indicator that QE is largely to blame for the rise in yields. Perhaps then will the media pay more attention to this brewing catastrophe. For now, opiates for everyone!

The dollar also continues its slide on the back of QE. Uncle Benny’s broad trade-weighted index declined to 105.5, a level it hasn’t seen since last October. It is down close to 9% since its high of 114.5 right before QE was announced. In our opinion, the synchronicity of the QE is even stronger with the USD than it is with the UST30, providing stronger evidence that QE is the culprit of the downturn. Our readers are well-familiar with our belief that QE will eventually lead to a USD crisis. This tenth week of pretty much unabated decline is certainly significant, but far from a crisis yet. The path to the crisis is, of course, not clear at the moment since QE has a couple/few more years to go. We believe the USD crisis will come within the next 1-2 years. A sustained decline until such a period might be unlikely, as retracements do tend to happen. Remember there are huge losses awaiting for banks, insurance companies, pension funds from the massive wave of Commercial Real Estate defaults, consumer credit delinquencies and retail bankruptcies. A new wave of fear/panic could instigate a new bout of USD and UST buying. That is of course, if confidence hasn’t been shaken enough to mitigate the flight-to-quality effect. This is still up in the air. What we are trying to say is that we don’t necessarily expect for the USD and the long bond to decline monotonically as QE increases during the next two years. In the end, however, it will be the deleterious effects of QE that will lead to the final crisis, much as it has been behind this weakening in the USD and UST30 at the inception of the infamous program.

Tune in next week for some more zany adventures in Bizarre Mystery Science Theater of Black Money Magick.

May your capital be safe and your investments prosperous,

MAAA