Wednesday, July 26, 2017

Why The Treasury Market - And Everything Else - Is No Longer a Free Market


In a "free market", when the majority of buyers cease buying and inventory continues to increase, prices typically fall (and in the case of bonds, yields rise).  However, this is not the case for the worlds largest and most liquid asset class, US Treasury debt.  Since the Fed completed the taper and ceased outright QE in October of 2014, neither the Fed nor foreigners have purchased a single net new US Treasury while issuance continued unabated, rising by an additional $1.6 trillion (although further issuance since Trump was inaugurated has ceased due to the absence of a debt ceiling resolution...(more on this later). 

The fact that up to 80% of marketable US Treasury buyers would cease buying with no negative impact on rates deserves a little deeper dive, particularly as the Fed now intends to begin allowing up to $30 billion/month in Treasury's (and $20 billion/month in MBS) to roll off it's balance sheet (anti-QE) until it's balance sheet is roughly halved.

The first chart below shows monthly 10yr Treasury rates versus the periods of Federal Reserve purchasing (QE, Twist, and Taper).  Interestingly, during periods of QE, rates generally rose and only fell once QE phase-outs were announced or during tapering.  Also interesting, the chart highlights when at the end of QE2 China ceased buying and began selling...and rates fell significantly further.  Likewise, when QE3 ended and nearly all sources of buying vanished aside from "domestic buyers", rates fell again confounding 100% of polled economists who unanimously expected rates would rise.
This should be raising all kinds of questions and alarm bells...but funny enough, all I hear are crickets.  To build some context for the accusation I'm about to level, I'm going to take a quick side trip into the Japanese bond market.

Those familiar with Japan's JGB (Japanese Government Bond) market are fully aware that it is in fact not a market in the least.  The chart below (from Bloomberg) shows Japanese government debt (in excess of $10 trillion) to Japanese GDP (just in excess of $4 trillion).

And a look at the annual issuance of new debt since 2007 (below)...broken out by type of bonds.  Those in blue and magenta (construction and deficit bonds) to fund new deficit spending but the vast majority or 2/3rds, in black, are "refunding bonds" used by the Japanese central bank (BoJ) to purchase and replace maturing bonds.  Again, chart from Bloomberg and article Quick Guide to Japan's Government Debt.  The primary and perhaps only buyer for Japan's $10+ trillion in government debt (10yr JGB presently yielding 0.07%) is the Japanese central bank buying these maturing bonds via "money" it creates out of thin air rather than via tax revenue.  Of course, the Central banks aims are politically driven economics and it need not concern itself with trivialities of profit or loss.

Of course, the reason this is beyond ludicrous and a bridge to nowhere is the chart below.

  • The purple line is the Japanese child bearing population from 1950 through 2015 versus the columns representing the number of births in Japan (per 5yr periods).
    • The Japanese childbearing population peaked about 1970 and has presently declined by 10 million (a whopping 22% decline and births have decided by 50%...perhaps good to remember here that a depression  results from a 10% decline in GDP). 
  • From 2015 through 2050, the chart shows the UN medium and low childbearing population estimates.
    • Best case, the childbearing population will fall by another 10 million and worst case by another 15 million (further 30% to 40% declines, respectively). 
  • In total, by 2050, the childbearing population will be somewhere between 55% and 65% smaller than the 1970 peak...and births are far likelier to hit the UN low estimate around 2.7 million per 5yrs...or nearly a 75% decline in births from the twin peaks of 1955 and 1970.


The idea that Japan can incessantly create and consume ever greater debt (only to service its ever greater debt load) against this magnitude of population collapse (and resultant collapsing consumption) to spur economic "growth" is somehow not seen as completely ludicrous.  There is little doubt Japan can find means to produce more via innovations of all sorts but a collapsing pool of potential consumers for that output (domestically and globally) makes greater production or more efficient production a moot topic.  Japan will not have anywhere near enough buyers for its existing stock of homes, used cars, and general economic output as its population is plunging.  I show all this to explain why Japan will never willingly return to a free market allowing prices to be set based on supply and demand...and that Japan's foundation is now built upon a set of "colossal untruths" so daunting that none (of import) are willing to even note that "the emperor" is standing buck naked.

So, this brings me back around to the US and it's supposed Treasury "market".  But before we look at the Treasury "market", we must again look at the shifting population trends (not the distraction that is the distribution among demographics but actual population changes among the young). 
  • US Births per 5 year periods peaked in the 1955-->1960 period and have never again seen that high water mark.
  • From 1960 to 1990, the child bearing population rose by 60% but total US births remained 12% below the 1960 peak.
  • From 1990 to 2015, the child bearing population has risen just 4% and births still remain 9% below the 1960 peak and continue falling since 2007.
  • The US child bearing population is estimated to peak in 2035 at some 8 million more persons than present (an 8% increase) before likely beginning to decline.
    • The projected growth in the child bearing population is premised on continuing levels of immigration (primarily illegal immigration).  For a multitude of reasons, illegal immigration has turned to net emigration.
    • Likewise, US birth rates are hitting new record lows and a wide variety of factors are pushing the number of births closer to the UN low estimate than the medium
    • All those experts, analysts, and projections showing the US would have positive population growth to foster economic growth are being proven completely, absolutely wrong.
So, what's all the population crap got to do with the Treasury market?  Population growth is essentially the only true means of consumptive growth (higher wages are generally met with higher inflation, and the only other means to get a population to consume more via lower interest rates to incent greater private indebtedness has run its course).  So now, lower rates are to incent corporations and federal governments to issue ever greater debt at ever lower rates of debt service.  And with all that as a preamble, here we go into the Treasury market...

The chart below shows US Treasury issuance ($'s per period) and breakdown of buying among the four buyer types (Intra-Governmental surplus primarily thanks to SS, the Federal Reserve, Foreigners, and lastly all remaining forms of domestic buying (banks, insurers, mutual funds, private citizens, etc.)). 
  • 1776-->2007:  What should be clear is that the primary buyer (certainly since 1970 through 2007) was the Intragovernmental surplus taking down nearly half of all US debt while simultaneously reducing the need for greater debt issuance.  This reduced the marketable debt issuance by half that Foreigners and the domestic public essentially split.  The Fed only held a relatively small portion of short term debt.
  • 2008-->2014:  The Treasury issued nearly as much debt from '08 through '14 as it did over the previous 231 years, but the sources of buying radically changed.  It was foreigners who purchased nearly half of all US Treasury's, the Fed and domestic public nearly a quarter each as IG buying plummeted due to declining revenues from SS.
  • 2015-->2017:  Since QE ended in October of 2014, the Fed has ceased outright buying and foreigners have been net sellers, leaving the buying to the domestic public with a small and declining assist from the IG fund.

And below, what this looks like on a % basis.
Since QE ended, here is a snapshot of who those domestic buyers are.  According to the Treasury, it's mostly "Other" with an assist from mutual funds?!?  So "other" and some mutual funds are America's sole creditors who in the absence of all other buyers suddenly find Treasury bonds (still yielding near record lows) irresistible.  And yet, the change in their buying is felt nowhere else as equity and real estate markets race to record valuations???
Some questions that might be worth asking as the US Federal government has issued about $20 trillion in Treasury debt and total global debt is somewhere around $220 trillion (the majority of the interest rates on this global debt are driven by the US Treasury rates).
  • Since the Fed and Foreigners (as a collective) aren't buying a single cent of net new Treasury debt since QE ended...who is "other"?
  • With 75% of historical buyers now only net selling, why haven't 10yr rates risen (rates were over 3% when the tapering began, over 2.5% when the taper ended, and sitting at 2.28% as I write this)?
  • Why did Foreigners cease buying and what is the linkage of the Foreign abandonment of accumulating Treasury's to the end of QE?
    • A sub question, from 2000 to July 2011, China recycled 50% of its dollar surplus into Treasury debt.  However, China's Treasury holdings peaked in July 2011 (coincident with the US debt ceiling debate) and have net declined by over $200 billion since (a 15% decrease).  This net selling in Treasury debt has happened while China's dollar trade surplus with America has reached record quantities......why was there no negative impact on rates and were have those record dollar surplus' been going?
  • Since the domestic public is left to shoulder nearly all the Treasury buying, why aren't other markets (equities, real estate, corporate bonds) suffering absent the huge quantities of dollars supposedly flowing into still near record low yielding Treasury's (and away from these other asset classes also at record highs)?
    • FYI - The collective Fed / Foreigners averaged nearly $70 billion in monthly Treasury purchases from '08-->14...and are have net sold an average of a billion plus monthly since QE ended.
    • The US Domestic public has purchased at a record pace since QE ended...nearly $50 billion monthly and double the pace from '08-->14.  This is presently more than 10x's it's long term average.
  • Later this year, the Fed intends it will begin "winding down its balance sheet" and progressively selling larger quantities of Treasury's (and MBS) while continuing to raise rates.  Simultaneously, the debt ceiling (which has meant no net new Treasury debt has been issued since Trump became President) must be raised.  The Treasury will subsequently flood the absence of Treasury buyers with something in the order of a half trillion + "catch up" issuance to pay back all the governmental funds it is presently raiding to fund federal spending.
    • Collectively between the debt ceiling resolution, the Fed BS wind down, and ongoing Treasury issuance...another surge in Treasury's will be coming to the "market" absent nearly all identifiable buyers...and I'll bet the "market" won't skip a beat and rates will not rise, equities will not decline, and this ridiculous fa├žade won't even be questioned.  Market technicians will point at lines, bullish analysts will say stuff, CFP's will tell their clients to invest for the long term.
I don't know if this began as a grand plot or simply as white lies that morphed into the current falsehood that has now metastasized throughout our economic, political, and social systems.  Regardless, our intellectuals, central bankers, and politicians are by and large liars and the electorate chooses the liar that tells the lies they most prefer to believe.  Regardless, everything we collectively stand upon is built on a system of lies or more correctly, a web of "colossal untruths".  And here I must quote Adolf Hitler, for his words written in 1925's Mein Kampf are every bit as powerful today as then:

"...in the big lie there is always a certain force of credibility; because the broad masses of a nation are always more easily corrupted in the deeper strata of their emotional nature than consciously or voluntarily; and thus in the primitive simplicity of their minds they more readily fall victims to the big lie than the small lie, since they themselves often tell small lies in little matters but would be ashamed to resort to large-scale falsehoods.

It would never come into their heads to fabricate colossal untruths, and they would not believe that others could have the impudence to distort the truth so infamously. Even though the facts which prove this to be so may be brought clearly to their minds, they will still doubt and waver and will continue to think that there may be some other explanation. For the grossly impudent lie always leaves traces behind it, even after it has been nailed down, a fact which is known to all expert liars in this world and to all who conspire together in the art of lying."
— Adolf Hitler, Mein Kampf, vol. I, ch. X

Lastly, the charts that show why markets are no longer markets...because we stopped growing from the bottom up long ago...
and below...the global 15-40yr/old child bearing population excluding Africa.

Finally, the chart below shows when each of the cadre of nations that consume 70% of global oil and 80% of all exports saw their 0-64yr/old annual population change turn negative (and the whole grouping goes negative as of 2018).Below, take a look at the largest central bank balance sheets vs. the same decelerating growth (and as of next year outright declining) population and I believe it really is that simple.

Regardless whatever the Fed says, they can never truly stop buying one way or another because we have crossed the Rubicon and there is no going back.