Sunday, March 22, 2015
Treasury Buying - Pyramid, Ponzi, or GDP Crushing Paradox???
If we believe the Federal Reserve's emergency policies of QE (quantitative easing...aka, printing money to buy select US debt) are finished nor is there an unannounced "shadow QE" taking place behind the scenes, then two of the four sources of US Treasury buying have dried up (Federal Reserve plus waning "intra-governmental" surplus trust fund purchases). Unless the third source (“foreign holdings”) is re-doubled (at continued record low yields) the last man standing is the "domestic public” (US domestic institutions like insurers, pensions, banks, plus retail buyers, etc.). Without the Fed and much larger "foreign" bid, the Domestic Public has only one choice available; the interest rates by which either the public goes bankrupt or the government goes bankrupt. Over the next four years (’15-’18...and beyond) the Domestic Public is left with buying 3.5x’s (corrected, 3/19) more Treasury debt than over the previous four (’11-’14)…effectively crashing US GDP and the US economy.
The Treasury puts all potential Treasury buyers into four distinct classifications:
The chart below outlines the changes in ownership since ’09…note that ’12 through ’14 nearly all buying is courtesy of Fed and “Foreign held”. As an aside, clearly whatever has intrigued the “foreign held” bid since 2011 has not intrigued US institutions to buy more record low yielding US Treasurys. Strange such different business models and yield expectations exist domestically vs. “foreign held”?!?
Source, TIC, Federal Reserve
We Are In BIG Trouble - Here and Now!
Intra-governmental net surplus’ and resultant buying has slowed (and will likely turn into outright selling over the next 4 years), the Federal Reserve’s QE has run its course, and “foreign holdings” abnormally high pace of purchasing is at best likely to maintain its pace…but not likely to increase their pace of buying. The kicker is that the Federal Reserve should begin a “normalization” of its balance sheet concurrently or some time shortly after its much discussed interest rate hikes begin. This puts the US domestic public as last man standing and a lot of issuance (new and rollover) coming our way.
The US has two choices – either the public maintains the buying at near record low yields and the public slowly goes bankrupt due to loading up on low yielding debt instruments (far below their plan returns and payout schedules)…or the yields rise to something like the 50 year average around 7%...bankrupting the Federal Government with interest payments of $1.25 trillion annually based on 7% blended interest rates (and a third of all interest payments will be paid to “foreign holders”, providing little to no velocity for the US economy).
Further, the impact on GDP of the US public buying a total of about $600 billion Treasury debt annually and another couple hundred in MBS effectively would remove about $800 billion from the US economy (let alone diminishing bids for stocks or real estate). This alone would represent a -5% headwind annually to GDP...worse than any seen in the '08-'09 crisis.
Of course, the above makes some assumptions, 1) Federal Reserve won’t initiate another round of QE and the Federal Reserve will move to “normalize” it’s balance sheet, and 2) “foreign held” Treasury buyers will maintain their general current pace.
Let’s review each:
1) No further Federal Reserve QE is planned as the Fed states near full employment has been reached...hard to believe given this http://econimica.blogspot.com/2015/03/amazing-math-from-bureau-of-labor.html. Regardless, the Fed states interest rate raises will commence as early as June, however balance sheet normalization –the idea that the Federal Reserve would “normalize” over some period from the $4.5 trillion current balance sheet back to perhaps $1.5 trillion (still double the amount the Fed held prior to ’08) would require a sustained multi-year (6yrs up, 6 yrs down?) plan of selling and/or rolling off assets. Given the balance sheet composition of MBS ($1.74 T) and Treasury ($2.46 T), the Fed leaked rumors have state the goal of primarily reducing Treasurys. This would reduce Treasury holdings to about $500 billion and reduce MBS to $1 trillion. The Fed’s reduction means someone else (Domestic Public) needs to buy this $333 billion of Treasury debt and about $115 billion of MBS…of course while simultaneously purchasing all new issuance. Again, this totals about an $800 billion annual increase in low yielding debt by the Domestic Public.
2) Another option certainly could be that “foreign holdings” in BLIC (Belgium, Luxembourg, Ireland, Cayman Islands), and Japan effectively re-double their holdings, as they did from July ’11 through ’14. Or perhaps the ECB or BOJ or other central banks could step in to buy US Treasury’s via dollar swaps with the Fed? But the Fed loaning, swapping (giving away?) money so it can reduce its balance sheet is again kicking the can or playing a silly shell game.
Still, that appears what has happened since July 2011, as China has been a net seller since then and off shore financial centers have quadrupled their holdings (below).
Source, TIC, Federal Reserve
Note that China, although running record trade surplus’ with the US over this period in excess of $1 trillion has been a net seller of US Treasury debt (quite a change from the previous decade long pattern of recycling 50% of their trade surplus into US Treasury debt). BLIC and Japan (despite running record trade and budget deficits) buy record quantities at record low yields. My point with China is the big change in trend…3.5 years (Dec ’08 to July ’11), China purchased $588 billion in Treasury debt. Over the next 3.5 years (July ’11 til Dec ’14), despite a larger dollar surplus, China net sold -$71 billion. Something significant changed.
The reason I picked July ’11 was due to the failed debt ceiling debate concluded in July ’11. At that point the US Congress determined to neither cut spending nor raise taxes in any significant manner. The change in trend from China (transitioning from Treasury debt to gold), change in trend for gold prices (peaking in August ’11), the unbelievable change in Treasury buying from Belgium, Luxembourg, Ireland, Cayman Islands (picking up for China’s absence) – all these changed on a dime as of July ’11.
Note in the below chart that BLIC has purchased nearly equivalent Treasury debt to that of the Federal Reserve since July ‘11. Perhaps these nations will entirely take over purchasing in the post QE period???
Source, TIC, Federal Reserve
And since the “taper” announcement in Dec ‘13…BLIC and Japan keep on keeping on…and BRICS opt out.
Close up on the BRICS since the taper announcement (below).
So, we have two scenarios:
1) Get Ponzi'er with the Fed-directed scheme of more QE or Fed sponsored Treasury buying in BLIC nations (with no dollar surplus’) used to mop up the selling in BRICS nations (with dollar surplus’) and mask the lack of domestic buying. All this to maintain even lower rates to facilitate even more debt.
2) A no-win scenario of the domestic public buying the majority of Treasury debt at low rates (bankrupting the public due to the extremely low yields) or buying Treasurys at high rates (bankrupting the federal government in interest payments). The retraction of domestically available cash to purchase Treasury's would detract 5% from GDP and crush economic activity.
I know it seems ludicrous and yet those are the choices before us after the Fed's temporary(?) quantitative easing synthetically created demand for a real, permanent supply of debt. Ramp up the Fed's Ponzi / Pyramid (and crash) or leave it up to the public (and crash). Unfortunately, the Federal Reserve directed pyramid or ponzi scheme seems to be the only politically viable option (at least by this means, the Fed can help select winners and losers)…but even with this, time is rapidly running out due to collapsing global credit and debt creation (see http://econimica.blogspot.com/2015/03/are-seeds-of-depression-sprouting.html). The much feared printing leading to hypermonetization or hyperinflation followed by depression is now in the batters box…