Funding Concerns

Discussion in 'Economy' started by gonegolfin, Nov 19, 2008.

  1. gonegolfin
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    gonegolfin Member

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    The US Treasury, Federal Reserve, and Federal Government have some interesting decisions to make concerning how the various bailout packages and fiscal stimulus programs will be funded in the coming months (and years), especially since the Treasury Supplemental Financing Program (TSFP) is being disbanded (HP-1275: Treasury Issues Debt Management Guidance on the Temporary Supplementary Financing Program). Tax revenues will not fund the massive spending that is in process. Tax revenues are set to take a serious fall in 2009 from current levels and the last thing you want to do in the current economic climate is raise tax rates. Having the Fed monetize debt is a last resort option. There is no doubt that the Treasury will attempt to float this debt, expecting that foreign investors will pick up most of it. But will they?

    Despite the short term strength of the US Dollar, foreign investors are very wary of taking on more US Dollar denominated debt. It is obvious to the currency experts that the recent strength in the US Dollar is primarily due to massive deleveraging. This deleveraging is the unwinding of dollar based loans (many the result of margin calls) where the loaned dollars were used to invest overseas (equities, currencies, foreign debt) or in commodity based investments. This will run its course in due time and the US Dollar will resume its slide amidst the horrid fundamentals for the currency (provided we do not slip into a deflationary depression, in which case the money supply would contract and the currency would strengthen - the exact scenario the Central Banks of the world are trying desperately to avoid). Meanwhile, China is not only refraining from new purchases of Agency debt (Fannie/Freddie/etc.) and US corporate bonds, they are divesting themselves from these positions (either allowing them to mature without rollover or outright selling their positions). This accounts for the substantial rise in foreign investment of treasuries as the dollars are moved to what is considered to be a safe haven. But a safe haven for how long? Foreign Central Banks, notably Japan (but we also know how China feels), are now expressing deep concern about the amount of debt soon to be issued by the US Treasury. They are obviously concerned about anticipated weakness in the US Dollar as it adds significant risk to their existing dollar based holdings. But also, investing additional funds in foreign debt instruments that pay little yield and are denominated in a currency that is likely to decline is not very attractive. So, what to do?

    Japanese economists are calling for the issuance of foreign currency denominated debt by the US (with China assuredly lurking in the background in full agreement), in lieu of US Dollar denominated treasuries. For example, US Treasury debt denominated in Japanese Yen. This would provide currency protection for foreign investors. But it would also require proper stewardship of the US Dollar by our leaders, as a declining dollar could potentially make the loan repayments quite expensive.

    Asia Times Online :: Japan News and Japanese Business and Economy

    China has introduced its own economic stimulus plan, which will cost roughly $586 billion. It will be interesting to see how this is funded. China could easily issue debt to fund the mostly infrastructure related projects in the plan (some say part of this funding would be for past expenses incurred for the Olympic Games buildup). But it could also elect to spend from its foreign reserves piggy bank, most of which is US Dollar based. This simply means that someone else will hold the debt after the sale, although there would be additional pressure on the US Dollar as there would be additional supply in the market. But if that someone else decides to redeem those dollars for US goods and services and/or real estate, domestic price inflation will be the result as the dollars are sent back to our shores to compete for these items.

    If the result of all of this is a glut of US treasuries for sale (due to waning foreign demand), the funding gap will need to come from either domestic investors (institutional investors - mostly banks, individual investors) or an increase in interest rates to attract investors of all kinds (notably foreign investors). Alternatively, foreign currency denominated treasury debt must be issued or the Fed would need to monetize any remaining debt portions by purchasing treasury securities on the open market, resulting in an increase in bank reserves and thus the monetary base. This would be a serious situation as it would threaten existing US Dollar based foreign reserves. The Fed has executed various unsterilized liquidity injections on a temporary basis recently via its lending programs (swapping newly created money for various types of collateral, without the offsetting sterilized treasury sales that were conducted before September of this year) ... but not yet on a permanent basis as the treasuries entry on its balance sheet has held firm. Will that soon change? Stay tuned.

    Brian
     
  2. dilloduck
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    dilloduck Diamond Member

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    I wonder how much we could sell an average sized state for on e-bay ?
     
  3. gonegolfin
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    gonegolfin Member

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    Another funding possibility that is taking shape is the execution of a carry trade that has banks borrowing cheap short term funds from the Federal Reserve (rates are especially cheap now) and using those funds to purchase treasury debt. The Fed has been attempting to steepen the yield curve. A large enough spread between short term loan interest rates offered by the Fed and interest rates paid by longer term treasuries allows the banks to engage in a profitable carry trade (at the expense of dollar holders). From the point of view of the banks, this beats lending to the private sector as risk is greatly reduced. Also recall that these short term funds borrowed from the Fed have turned into infinite term loans as the Fed continues to roll them over. This is essentially handing the banks a pile of money.

    If all of the hoop jumping seems to be convoluted and confusing, it is. It is supposed to be. Else more people would figure it out and would be really mad at what is taking place.

    Brian
     
  4. Toro
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    Toro Diamond Member

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    Brian

    A couple of things.

    1-month T-bills were yielding 0.02% today.
    3-month bills were yielding 0.02% today.
    The 2-year Treasury bond went below 1% today for the first time ever, I believe.
    10-year bonds were yielding 2.995% today when I last checked, the lowest since God knows when.

    Treasuries have been in a massive bull market and have outperformed gold over the past two months. It has become very apparent that the Treasury bond is the instrument to hold in a panic. The Treasury should issue massive amounts of it right now and buy back risky assets, given that CMBS spreads have blown out to 1000 bps over Treasuries, that junk is yielding 20% and that corporate bonds are at multi-decade highs. What a great carry trade!

    I would argue that to those who are bullish on gold - and I will admit this has not ended, so who knows the ultimate denouement - the uber-bears have so far been right about the collapse in credit. But gold is 25% off its highs and is just sitting there. Maybe its about to go up but gold is lower than it was two months ago when the market started to collapse. The market is scared out of its mind over deflation. Inflation will only come about when the deflation panic ends and all the monetary aggregates return to previous levels and higher.

    Plus, when people say that the dollar is going to fall or collapse, my question is, against what? Against the euro? Against the pound? Against the commodity currencies? The dollar is crushing all those currencies. People making this argument never tell us the other side of the trade. The dollar hit at least 40 year lows against all these currencies last year. It is unlikely the dollar will go lower than it did, at least against those currencies. All of those countries are dependent upon global growth. If the US is collapsing, so will they. Fiat currencies have natural bounds to which they can not trade beyond without significant economic structural changes. So to say that the dollar is going to collapse, my question is, against what? BTW, did you see that Japan has been running a trade deficit as of late?
     
  5. gonegolfin
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    gonegolfin Member

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    Yes, with 1-month and 3-month T-bills this low, this may become an effective cap for the federal funds rate, despite the 1% interest paid on excess reserves.

    The 10-year closed at 3.03%, a five decade low. My data only goes back to the late 40's (maybe this was when the 10-year was first issued), but it is the lowest yield recorded during this time span.

    With treasury yields taking a dive across the yield curve in this climate of fear, the Treasury should sell as many bills and bonds as the market can absorb. This is the cheapest financing our government will ever see.

    For now it is. But this market now feels bubbly to me. I certainly would not be holding a 10-year note or bond at 3.0%. Credit default rates on treasuries are at an all-time high.

    But make no mistake, there has been a lot of physical Gold buying. Buying that is not reflected in the COMEX paper price. I would rather hold treasuries than COMEX paper as well. But not rather than the physical metal.

    Of course, China has been making sizeable moves into treasuries from their Agency debt positions.

    Corporate credit default swaps are at an all-time high.

    The recent Fed program of quantitative easing (begun in early September) only affects the monetary base. We are still not seeing increases in the money supply (M1 as well as M2) because the new money is simply piling up as bank reserves and credit has obviously contracted. All other things being equal, I do not expect Gold to move significantly higher until this money begins making its way into the economy (lent by the banks). This could take a long time (more than a year). But I think it will eventually happen. And the Fed will be late once again draining reserves from the system.

    That said, the physical price of Gold (and especially Silver) has been considerably higher than the paper price (futures market). The open interest (very low) and trader positions on the COMEX are also very bullish again. I am very interested to see if there is any real effect (COMEX inventory levels) from speculators demanding delivery of the metal instead of cash settlements for their December contracts. This is already being done in record numbers on some foreign exchanges and I know a couple of US fund managers that are executing such a strategy for the first time.

    Finally, with respect to the Gold price you mention over the last couple of months ... the price really took a hit (along with Silver) in the August time frame. This was the time when some very large short positions showed up on the Bank Participation reports owned by at most three banks (Gold) and two banks (Silver).

    Agreed. Although we are not seeing monetary deflation. The monetary aggregates are treading water, but they are at their all-time highs (very modest increases this year).

    A substantial portion of the US Dollar rise over the last couple of months has been due to the deleveraging I mentioned (dollars had to be purchased to repay the loans). This is short term and not any indication of the dollar's fundamental strength (as oil was not worth $150). The fundamentals of the dollar are horrible. Once the leveraged positions are mostly liquidated, I think you will see a correction back to approximately previous levels in the index.

    I think that if all of this worldwide credit makes it into the system (money supply), I think that you will see all currencies lose value against commodity currencies. But that could take some time and it is certainly possible that a deflationary depression is in the cards. In which case, Gold will hold its purchasing value, but may fall some against currencies.

    I do think the selling of the Australian Dollar was overdone. They certainly have their problems as they have a nice real estate bubble and some economic problems. But I think the currency drop was overdone. I also think the Yuan has a lot of pent up strength that has been suppressed due to the basket peg. This is more of a longer term play as the Chinese wean themselves from the US consumer. But if the Yuan were to free float, it would move considerably higher versus the dollar. The Yen has also been strong.

    I did not see the trade deficit, but it is not surprising considering the impressive recent strength of the Yen.

    Brian
     
    Last edited: Nov 21, 2008
  6. Zoomie1980
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    Zoomie1980 Senior Member

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    I wouldn't mind selling San Francisco to the Chinese....
     
  7. Zoomie1980
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    Zoomie1980 Senior Member

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    Meanwhile I will simply continue buying what most investors seem to detest today....quality stock equities.....and now....some real-estate.... Just got a 1800sq ft 3BR 2BTH 70 year old house on a 1/4th acre plot.....for $67,000!!! Getting $850 rent for it, but it's a steal even if I had no tenant....

    And yes, I had no problem getting a loan for the place at 6.35%....

    Things are simply cheaper than I've seen in 20 years compared to their value...stock, houses, commercial....
     
  8. Paulie
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    Paulie Platinum Member

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    Unfortunately, those deals can only be taken advantage of by people with extra money to spend/risk.

    And @ Toro:

    I'm not sure if you've seen what the premiums for physical metals are right now, but the few places I buy from are asking for almost a 50% premium on SAE's, and around 15% on GAE's. Much higher then the COMEX price. You can't manipulate the physical market with shorts like you can on the COMEX. The market is too smart to be tricked in that regard.

    You must be able to at least IMAGINE how much higher metals could go if and when this new money hits the streets.
     
  9. gonegolfin
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    Mint suspends orders amid rush to buy bullion | The Australian

    Brian
     
  10. Toro
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    The problem with this assumption, re: weakening against the commodity currencies, is that there are many other more powerful factors in the setting of currency prices other than commodities, at least in the long run.

    For example, in Canada, productivity growth has been substantially lower than it has in the US. Also, the rate of population growth is lower. Thus, the Canadian economy is structurally a slower growing economy than the US. Canada has run its affairs better, i.e. it balances its budget, but higher structural growth is a stronger determinant of currency values over time than the price of commodities. Plus, the term "productivity" in Canada is often seen as a dirty word since it implies job losses, which the Canadian electorate is far more willing to resist than the American electorate.

    There are natural bounds to which fiat currencies cannot go beyond without doing structural damage to those economies. The Canadian economy cannot see the loonie rise much above $1.10 without doing serious damage. The purchasing power parity of the loonie is about $0.80. Its past rise was deep-sixing firms in the industrial base in Ontario and Quebec. So it is hard to see the loonie rising much beyond $0.80-$0.90 over the long-term. I suspect the Aussie dollar is the same.

    As for gold, it did not go unnoticed that it was up $50 on Friday on the same day the market was up 500 points. I have traded gold off and on for several years, and I am very interested in the basing action that has been occurring over the past few months. It very well may be headed higher. But it also may be presaging a move in all asset markets higher (apart from Treasuries), for the reasons you gave above. If and when credit starts flowing again, stock prices are going to explode up and rip the faces off the shorts, perhaps in a violent move that has never been seen before.
     

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