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Monday, December 12, 2016

A Case for Financial Armageddon Or Trump's First of Many Bailouts, & Implications on Democracy...

US institutional buyers like pensions, insurers, banks, etc. have mandates and obligations to ensure they don't get too far out over their skis with risky assets.  However, I don't think these mandates or obligations are significantly greater now than the '01-->'07 period when these US institutions net purchased just $200 billion in Treasury's or '11-->'14 when they net purchased $900 billion. The $1.5 trillion (& growing) unprecedented surge by US institutions in US treasury bond buying from year end 2014 is something else.

For perspective, the 10yr Treasury bond has risen from the 2016 low of 1.36% to 2.48% presently, an 85% increase.  However, the much greater quantity of 2yr Treasury's have risen from a 2013 low of 0.2% to 1.15% presently, or a 475% increase.  The huge rise in the 2yr yield better signifies the moves happening among the much larger quantities of shorter duration T-bills and notes for those holding them plus the rising Federal Government interest payments.

Financial Armageddon or Another Bailout Coming?
Noteworthy should be the obvious...if US institutions traded $1.5 trillion in liquid cash to the Treasury for bonds, that would represent a large tightening in the money supply....unless they use those record setting purchases of bonds for collateral to leverage up into equities or higher risk assets moving upward, presently at break neck speed. But what happens when the price of your leveraged (or highly leveraged?) collateral collapses in price like treasury's have over the past couple of months???   Just saying...this doesn't usually end well (particularly for tax payers if it results in another "systemically necessary" bailout to save "us" from the economic boogeyman, "a depression").

For those curious where this is coming from, in my previous article, I outlined the shifts in US treasury buying away from foreigners, the Fed, and the Intra-governmental trust funds leaving only one source of buying left, the US Public (primarily US institutional buyers like pensions, insurers, banks, etc.).

What Does Record US Treasury Demand Signify?

Now, there is another more cynical or tin-foil hat wearing option...that US institutions (like foreigners) did not buy any more bonds than previous periods and some other "buyer" did.  A buyer who doesn't have a profit or loss motive but instead a political motive.  A buyer who can sustain infinite losses because it can create infinite new "money".  I have no proof or evidence of this, but simply noting the possibility exists.

Implications for a Republican Democracy
While we are discussing the financial and economic impacts of this potential for the Fed to officially (QE) or unofficially buy up some, much, or all the Treasury debt...the discussion of what QE or unofficial Fed buying really represents should be broadened.  In 1981, the Fed set off on a 35 year course of continually cheapening credit to encourage it's use...initially in capital formation but eventual abuse by government and consumers.  In '08, when private parties could take and service no more debt, QE was implemented and the federal government became almost the sole creator of new debt...and thanks to ZIRP, the total cost of servicing all the debt actually fell.

The Federal Reserve holds $2.5 trillion of the $20 trillion in Treasury debt (12%), though primarily longer duration bonds. This is up from about $800 billion of primarily short duration notes and T-bills as of 2008...and the Fed's publicly stated but somewhat laughable goal is to reduce it's balance sheet (reducing or rolling off both Treasury's and Mortgage backed securities) back to something like $1 trillion or so in Treasury debt and maybe the same in MBS?  But many economists, politicians, Wall Street types, postulate why should the Fed not continue to maintain it's massive balance sheet (as it is doing) or go further and buy more or all the Treasury debt???

The idea that the Fed should digitally create new money to purchase Treasury debt so we can perpetually spend as much as we like without taxing ourselves for it (let alone consider how we would ever pay it back) or make congressional compromises of our wants vs. our means is the end of our democratic republic. It breaks the compact that de Tocqueville noted...that the American people could determine they need no longer compromise on their wants and needs via taxation.

Congress, realizing true compromise is no longer necessary or politically acceptable, would simply meet everyone's needs, wants, and desires (ok, everyone that matters, politically) by unrestrained money creation...that would be the end of a functioning democratic republic.  If the Congress knows that it need not compromise, it's ok to perpetually spend more and tax less (hello Reagan through Obama, and get ready for the Donald show)...they will certainly do so and to great excess. This signals the loss of virtue and a childish belief that we can have everything we want without paying for it.

What many (consciously or unconsciously) are promoting is formalizing the end of our democratic republic and a spiral into another type of governance where a fourth branch of government is now the dominant branch, the Federal Reserve.

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