Saturday, July 17, 2010

Who is buying US Treasuries?
The reason: in it we read that in May 2010, China dumped $33 billion in Treasuries, bringing its total to the lowest since June 2009. Furthermore, Japan also offloaded $8.8 billion in bonds, as did the Oil Exporters. Yet total foreign Treasury holdings increased from $3,957 billion to $3,964 billion almost exclusively as a result of ongoing exponential UK accumulation. It is time someone in the mainstream media asked just who is doing all this "UK-based" buying? It is not hedge funds, which operate out of Caribbean Banking Centers,...

Yet in what is (and continues to be) the most perverse observation, that proceeds without any questions from the mainstream media, the otherwise broke UK, once "bought: a stunning amount of Bonds, or just over $28 billion in the month of May, consisting of $27 billion in Bonds, and $1.3 billion in Bills. The "UK" accumulation patterns continues growing in an exponential pattern, and the country which owned "just" $180 billion in USTs in December, has doubled its holdings to $350 billion in less than half a year.

This is increasingly appearing as shadow Fed debt monetization operation, operating out of the United Kingdom.

Let me break down Bond Markets 101. The Fed and US Treasury have to issue a lot of debt in the form of US Treasury bonds (long expiry) and US Tresury bills (expirations of less than a year). They are basically IOU's with a coupon promise to pay a certain interest rate to the lender (i.e. bond investor). They have to issue trillions in debt to fund our overspending government. As long as demand is there for this debt (i.e. buyers), the yields or interest rates buyers demand will remain relatively low.

However, if supply exceeds demand, yields must increase in order to attract buyers. Hence, interest rates rise. Higher interest rates are problematic for the economy, because loans of all types are indexed to said bond yields. For instance, 30-year mortgage rates may be indexed to 10-year US Treasury yields. If interest rates rise, fewer homes and cars are purchased, and fewer businesses borrow money to fund their operations. That's why sharply rising interest rates are detrimental to economic growth.

Now, the Fed and US Treasury know this, and they know that foreign appetite for US Treasury bonds is waning--and for good reason. The US government is broke, and will never be able to pay back their debt obligations. But in order to maintain a semblance of the status quo (i.e., the US government is the borrower of last resort, the borrower with the highest credit rating), the Fed must artificially create demand and thus, prop up bond prices, while simultaneously suppress yields and interest rates (remember: when bond prices increase, yields decrease, and vica versa, by definition).

In other words, the Fed is buying its own US Treasury bonds, in order to keep interest rates low--and they're doing it surreptitiously through banking affiliates in the UK, in order to not spook the bond markets (which are several orders of magnitude larger than equities markets). But with this so-called debt monetization (which is really acceleration of the printing of currency), the Fed is flooding the market with USDollars, which ultimately devalues the currency. Once the bond market vigilantes wake up to this, they will drive the USDollar down even further, much like a predator senses weakness in its prey.

George Soros did exactly this in 1992 to the British Pound Sterling, driving rates up and bankrupting the UK. Remember: when a sovereign nation's currency is devalued, bond investors demand higher yields in order to compensate for the extra devaluation risk. Combine that with high sovereign debt levels, and bond prices plummet in a self-fulfilling death spiral. This, of course, devalues the currency even further, into a debt spiral with no escape. This also happened to Greece, Portugal and Spain recently, which had to issue bonds at much higher interest rates when high sovereign debt levels spooked the bond markets. In a nutshell, due to high debt levels, their creditworthiness was downgraded, causing their borrowing costs to soar.

The US, of course, has a huge advantage because the USDollar is the world's reserve currency, and that it can issue debt in USDollars, while the 16 Euro zone countries can only raise debt through Euros. Hence, the Fed can hide our Federal government's insolvency by issuing even more debt to pay off previous debts. But as any sane person knows, no household can solve their debt problems with more debt. It's the same for corporations, states, municipalities, and yes, sovereign nations like the US Federal government. Eventually, the creditors go into collection mode. And apparently, our biggest creditors in China and Japan have told the US government "enough is enough."

So the Fed is forced to go offshore with our allies in the UK to hide their purchases of its own US Treasury debt, because the American public has bailout fatigue--we now understand digging a deeper debt hole has bad consequences. This signals desperation on the government's part, and the gargantuan US Treasury bond market may be on its last legs. The shell game can be extended as long as confidence in the USDollar is intact. But when the "con" is up, the bursting of the bubble in the US Treasury bond market will be cataclysmic--much larger than the subprime mortgage bond market bubble.

Many entities may hold US mortgage-backed securities, but every sovereign entity holds USDollars and/or US Treasuries in their foreign reserves. When that bubble bursts, the global financial system itself would collapse.

Gold and silver may be the last currencies standing. Which is another reason why central bankers abhor increasing prices in precious metals, as it signals a crisis in confidence of paper currencies.

See disclaimers in the side bar.

Disclosure: long TBT, long gold, long silver.

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