Debtor's Prison

Greetings fellow inmates,

A lot happened this week in Fed World Live! – or Bizarre Mystery Science Theater of Black Money Magick (BMSTBMM). For starters, German Chancellor Angela Merkel lambasted central bank policies and questioned the legality of certain actions taken by Uncle Benny and Uncle Merv. She’s completely right (oddly so). Remember that the Fed can only legally hold debt backed by the full faith and credit of the United States, a law that is currently being simply ignored. Merkel also pleaded with the banks to return to a “policy of reason”. Well said, reason is everything. Perhaps it might seem strange to hear such a frank statement from an important politician. As usual, we caution you to take all rhetoric with a grain of salt, aggregate all relevant pieces and then draw plausible conclusions. One of the hypothetical models for information dissemination we’ve discussed here in DP includes the media function of preparing the masses for what’s coming. We have seen this happen many times. Check out the Video Cart and download the “Inflation” video from 1933 as an example. We guarantee you that rhetoric about inflation will increase dramatically as it becomes an evident problem. Already, one can clearly distinguish in the proportion of deflation/inflation chatter that inflation expectations are increasing. This hypothetical model then takes the position that calculated statements such as Merkel’s or the multitude of Russian, Chinese and other complaints are partly with the aim of preparing the masses for what’s coming: a massive central bank failure as potentially demonstrated by a fiat currency collapse. We’ll even come out and say that major powerful people in the world know what is going to happen. In the same way that back in 2006, Uncle Benny clearly and must have known that such a huge systemic crisis lay in all the debt backed by mortgages in a climate of declining housing prices. Either that or he’s incompetent and he is not incompetent. But of course his job is to “hold the boat steady”, he must be conservative in his estimates and must avoid spooking markets. You might take this benign view or whatever degree worse, but the point is that we believe Uncle Benny knows he is fighting a losing battle, but he is obligated to fight it to the fruitless and destructive end.

Uncle Benny also made headlines himself by testifying before Congress. In terms of the economy, he had a number of interesting comments. He mentioned that sizable job losses and further increases in unemployment are likely over in the next few months. We’ve got $10 that says Uncle Benny is wrong on this one. He also mentioned the burdens that still exist for consumers and corporations, notably weak labor markets, declining property wealth, tight credit. He seemed quite excited when he mentioned the improvement in short-term funding markets, as evidenced in the reduction in some of its credit facilities, like the commercial paper one. We have no differing opinion on this, but remain extremely cautious of ascribing it a recovery. It’s certainly possible that so much short-term funding that has been pumped in has restored some degree of liquidity. The problem we see is that liquidity is not moving as much proportionally up the risk spectrum (ie: further out the curve). Also, many other credit transmission channels are still broken, so the liquidity is not flowing down to the economy, which is still massively deleveraging. We find it hypocritical and laughable that Uncle Benny warned of fiscal deficits and cited them as a concern for wider long-term Treasury yields. Quant easing has failed to bring down rates miserably, his “frankness” could be due to finding a scapegoat. Whatever his reason was, the widening in yields has been mostly due to his zany adventures with his BS. Come on Uncle, we know that you know what has to happen with your experiments, you know how it will end. Higher yields (rates) for everyone! – courtesy of your monetization. Geez Uncle, we thought you were better than that.

Otherwise, it was a week of relatively slow activity in the actual FedBS. Each side of the FedBS shrunk by $8bln. One the asset side, this was mostly due to a drop of $9bln in the Commercial Paper Funding Facility (CPFF) and a $9bln in central bank swap lines. The asset purchase programs also had a relatively slow weak. Treasury purchases were $7b (most of it in the belly of the curve 1-5 years). We find it interesting that Uncle Benny isn’t really touching the 30-year, he knows it’s crap! Agency purchases were $1bln and MBS actually registered net sales of $3bln. So far in Treasuries, we are about 46% done with the total $300bln program, which has until September; in Agencies 40% done and in MBS for which Uncle Benny has until the end of the year, we are 34%. That simple back of the envelope that Uncle Benny seems to be about on pace to complete the purchases. Remember that we have prognosticated that he will be forced to increase his quant easing purchase programs and will have committed to buying as much as $1tr of Treasuries.

30-year Treasury yields dropped only mildly this past weak by 1 bp. This data point certainly does not constitute a turn around whatsoever, it is effectively the same thing. As far as we are concerned, this widening trend has simply paused. We will see what happens in the short term, but over the long-term you are well aware that we believe that QE will lead to substantially higher yields at the long-end. This hypothesis has been somewhat corroborated with the coincident strong rise in yields throughout the duration of QE thus far.

The dollar continues to slide, for the eight week in a row. This decline has been formidable, but it certainly doesn’t mark the beginning of the end for the USD. At least not yet. As we have mentioned many-a-time, we believe that QE will have to accelerate as the economy continues to deteriorate and foreign creditors continually refuse to purchase long-term debt. This will eventually lead to the USD event horizon, which could result in a massive fiat currency crisis. This is not an imminent scenario, but certainly one whose likely begs that one begins to monitor from the onset. We’ll continue watching the dollar’s awesome downward streak. When will it stop?

As a new introduction this week to our weekly updates, we will begin tracking the Rogers International Commodity Index. This index measures a broad basket of 36 commodities, you can see the weightings here. This is a natural thing to look at when exploring hidden costs of QE. As yields rise and the dollar drops, commodities would be expected to rise, and indeed they have. Though they are still substantially below levels pre-GCC, they have risen substantially and constantly, also coincident with the onset of QE. Moreover, QE even compounds this natural mechanism since more nations such as China are now moving to acquire and stockpile natural resources rather than invest in pieces of paper. This will be another dramatic effect of the aftermath of QE and we will begin tracking it. Eventually, all the savers in the world might rush into the procurement of natural resources as the faith in paper begins to disintegrate.

Tune in next week for some more zany adventures in the BMSTBMM!

*We apologize for not having the chart of the Rogers Commodity Index initially - technical snafu.

MAAA