The Market Ticker - Monetary

So It's Official: IMF / Carry Trades

nospam@example.com (Karl Denninger) — Mon, 09 Nov 2009 07:46:00 -0500

You can put a fork in us down the road....

The U.S. currency dropped against 12 of its 16 major counterparts as the International Monetary Fund said traders are probably using the dollar to fund so-called carry trades around the world and it may still be overvalued.

I hope everyone here in The United States takes a moment to understand what this means. Let me lay it out for you:

When the global economy truly recovers oil will skyrocket up to or beyond the $150 where it was in late 2008. If the dollar is indeed still "overvalued" and going to 40 as many technicians predict, oil will likely reach $300 a barrel. This will in turn drive gasoline prices north of $6, heating oil will reach $7-8/gallon, and diesel will be commensurate with heating oil.
This will in turn decimate the trucking industry. Now you know why Buffett bought BNI. Many things he may be, but dumb isn't one of them. Trucks will of course remain for terminal-to-door deliveries but for long-haul they will simply be uneconomic. Those who currently are employed in this business will lose their jobs. All of them.
The middle class will be decimated. Those who live in suburbia, who are primarily middle-class Americans, will find themselves faced with commute costs that are double or more what they pay now. Those in the middle class who live in the Northeast where heating oil is the primary fuel for winter, where natural gas infrastructure does not exist to replace heating oil, will find themselves choosing between heat and food in large numbers.

What's far worse is that all carry trades eventually unwind and in the history of the markets I have never seen it happen in an "orderly" fashion. Japan witnessed the destruction of the Yen Carry last year and it was horrific. We will see it in the future - exactly when cannot be predicted with certainty, but that it will happen in an uncontrolled fashion will be. While this "unwind" will bring relief from sky-high commodity prices it will do so at the expense of asset prices, which will collapse.

Our government has, quite simply, refused to take the steps necessary to stem this ridiculous and self-destructive course of action. Part of the problem does indeed lie with the yuan and China's mercantilist policies, but this is similar to blaming the drug dealer in the entirety for one's addiction. Without the user the dealer has no customer and makes no money. We have become addicted to cheap Chinese crap, even when it is poisonous (e.g. lead-painted toys or adulterated toothpaste) while refusing to address our own debt imbalances by either government or private interests.

The rest of the issue is ours, and ours alone - Bernanke could end this tomorrow by draining the liquidity necessary to cause short term interest rates to rise to 2% - still a very "accommodative" rate, yet one that would make carry trades unprofitable. He and the rest of the FOMC have refused, even though they're aware of the extreme distortions this creates in the foreign exchange markets and the draining of productive capital from the "funding" currency source nation that always accompanies carry trades.

The only remaining question is whether these "carry trades" and the dollar depreciation that they cause will continue to levitate the equity markets. Friday morning there was a stunning correlation between the moves in the dollar and the S&P 500 - but then suddenly about 11:00 AM Central time, it broke down. Many equity and index futures traders have been essentially using the dollar as their "roadmap" for the last several months - but this is a correlation that only works so long as the decline is both orderly and perceived to continue to be so. If and when that perception changes the correlation will break with extremely violent results.

We certainly do and will live in interesting times, but thus much I am certain of - the Average Joe will neither understand why oil skyrockets the next time it does, nor will he properly place the blame where it belongs: squarely on Ben Bernanke, President Obama and our Congress.

And So It Begins (Dollar Warnings)

nospam@example.com (Karl Denninger) — Fri, 23 Oct 2009 08:47:00 -0400

I have been on a potential dollar dislocation - or collapse - for more than two years. Indeed, back in the fall of 2007, it was one of the themes of petitions to Congress and letters I sent under personal cover to all 535 members.

The debt liquidation cycle of 2008/early-09 appeared to stop the deterioration. Unfortunately that cycle was interrupted - intentionally - by enabling a continuing pattern of lies and fraud within our government.

This has reversed all of the gains that the dollar had made last fall and winter, despite the stock market and other asset prices being materially lower - by a lot - than when those warnings were issued.

Treasury is always "for a strong dollar" in word, but their view when it comes to deeds is another matter. This is most unfortunate, as this, like Treasury's and The Fed's view when it comes to sweeping trouble under the rug and lying about asset quality has been proved wrong through time not only here in America but worldwide.

Japan is a prime example. They adopted the same sort of "programs" we did when they ran into debt-based trouble in their economy two decades ago. Instead of forcing those who had made bad loans and by doing so blown asset bubbles to eat them - even if it blew them up - they instead played extend and pretend - that the loans were good, that the asset quality was fine, that the banks had plenty of reserves.

The Japanese economy never recovered. Instead it scraped along a deflationary bottom for a literal two decades, sustained only by the Yen Carry Trade.

But carry trades don't deploy the borrowed funds in the "host", or "funding" nation. Indeed, the entire point is to borrow there cheaply and then "invest" (or trade) somewhere that has a higher return. This drains the host just as does any parasite, and drain it did - for more than a decade, Japan's capital flows were turned inside-out.

Now it's our turn; the dollar has turned into the funding currency of choice, cutting off the last bit of Japan's bond appetite. The government is now threatening to issue as much as $50 trillion Yen of bonds in the next year of "new issue" in an attempt to keep the game going, flooding the market. This could in turn provoke a currency dislocation and drive the Yen/Dollar swap to 200, according to some observers.

There is a lesson there that is not lost on others; out of Australia we now have this:

In unusually pessimistic comments for a senior political figure, Senator Joyce said the US Government was running such large deficits and building up so much debt that it was in a similar position to Iceland or Germany before World War II.

In a Senate estimates hearing on Wednesday night, he asked Treasury secretary Ken Henry what would be the implications of an American debt default for the Australian economy.

....

''Far from turning around the [George] Bush legacy of deficits and debt, [US president Barack] Obama has made it worse. It has got all the hallmarks of a financial collapse about to happen in America.''

Senator Joyce said investor concerns about the American Government's ability to fund its deficits were already undermining the role of the US dollar in the international trading and financial system.

''The US dollar is almost becoming like junk bonds,'' he said.

Uhhhhhhh.... yeah.

Unfortunately.

America had a justified hubris for decades coming out of WWII in terms of our manufacturing base and intellectual capital, both of which led to the dollar's strength and a fully-reasonable view that the dollar was indeed the global currency - whether others liked it or not.

But today this has changed. The view that "deficits don't matter" and that The Dollar can be debased by outrageously ridiculous spending patterns in the Congress has undermined the foundation on which the dollar relies for that reserve status. Political promises have put into place a budgetary structure in our government that defines more than half of all the money spent every year as "mandatory", going to either Social Security and Medicare or debt interest, and another 1/4 being spent on defense. Of those four categories only two - interest and the military - are defined as enumerated and proper powers in The Constitution, yet the demographic and political realities turn the other two into "mandatory" categories that are impossible to challenge or modify. Those who have tried to do anything other than enlarge either have been swiftly booted from office.

Mathematics, however, trump politics. The mathematical reality is that you can only sustain deficit spending policies (whether by government or private debt acquisition) if GDP grows faster than debt and that growth has to come from the private sector, not government transfer payments, or the deficit percentage and impact will grow faster than GDP. This is, again, mathematics and cannot be avoided, since the government is only a fraction of the entire economy (and even in a command economy can't be more than 100% of it!)

Again I present the graph that I have shown before on what happens if you don't obey the realities of mathematics:

This isn't conjecture. It isn't politics. It is mathematical reality.

There has been NO - underline that - NO - recognition of the mathematical realities that underlie debt and GDP growth within our government, including Congress and regulators.

None.

This is precisely the same road that Japan went down after the Nikkei topped and then crashed when their debt bubble blew up.

A raw refusal to recognize the mathematical realities has led The Fed and Treasury to instead make legitimate outright fraudulent accounting, enabling banks and others to arbitrarily defer recognition of losses based on nothing more than a hope that through currency debasement popped bubbles can be re-inflated.

History tells us that such strategies never succeed, especially in an import-based economy, which we are, as input costs are tied directly to currency debasement and worse, those foreign interests that hold necessary imports also tend to hold significant currency reserves. As those reserves are debased the holders of these resources will raise prices and/or constrain supply so as to recover not only the current debasement but also the debasement of their reserves.

Congress may not like the facts, but that doesn't change them. Fraud never pays in the end, and despite all of the crooning and intentional diversion by people such as Bernanke, Summers and Geithner the above chart is a simple reflection of mathematical realities of compound growth - a reality that cannot be changed with "magic wand" waving or burying bad assets under a mountain of fraudulent accounting manipulation.

Is The Dollar Doomed?

nospam@example.com (Karl Denninger) — Mon, 12 Oct 2009 10:09:03 -0400

When Bloomberg runs articles like this, you have to wonder....

Oct. 12 (Bloomberg) -- Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two-quarter rout in almost two decades.

Flush with printed reserves, I might add.

World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors.

Tolerate? I'd argue that this is a formal policy of the administration (and the last one too), not a matter of "tolerance."

That Congress allows this is a raw dereliction of their duty as set forth in The Constitution; they seem to be entirely blind to the willful destruction of currency value that is taking place.

This is not the first time, I might add. Go look at what happened in the 80s with regard to our currency....

America’s currency has been under siege as the Treasury sells a record amount of debt to finance a budget deficit that totaled $1.4 trillion in fiscal 2009 ended Sept. 30.

Oh wait - maybe it is Congress. Hmmm.... who is it that passes revenue bills again? That would be Congress. Who passed the budget? That would be Congress. Who has control of the debt ceiling?

That would be Congress.

Oops.

This is just another example of "kick the can"; instead of facing our medicine and swallowing, instead of forcing those financial institutions who made bad bets to eat them, we are instead devaluing our currency as a means of trying to "print" our way out of this.

But that has never worked throughout history. Japan tried this in the 1990s and all they did was cause capital to flee; the capital that "came in" was all consumed in carry trades! They're not the first either; devaluations of this sort in other nations have all failed.

Bernanke, Geithner, Paulson and both administrations seem to believe that because The Dollar is the world's reserve and trading currency that they can ignore these lessons of history and get away with it.

I'm skeptical, for the simple reason that if you look at the issue in terms of what people are doing, as opposed to saying, they are all moving out of dollars and into other things. The dollar's reserve currency status isn't a function of The US "military might" (until and unless The US is willing to start flinging nuclear warheads around, which I more than somewhat doubt) it is a function of the US maintaining sustainable monetary and fiscal policies.

Again, for the mathematically-challenged, consider the following story.

Many years ago there lived a monarch in India who ruled that all of the people must store their 90% of their rice harvests with him for safekeeping, so in the event of famine there would be enough rice to eat.

One year a famine hit but he refused to release the stored rice, fearing that he would run out and starve himself.

After a couple of months a clever girl came to the monarch and asked for one grain of rice, and for the next month to double it each day.

The Raja agreed, and shortly discovered the magic of exponents, much to his chagrin.

On the first day, he gave 1 grain of rice.
On the second, two.
On the third, four.
On the fourth, eight.
On the fifth, sixteen.
On the sixth, thirty-two.
On the seventh, sixty-four.
On the eight, 128.
On the ninth, 256.
On the 10th, 512.
On the 11th, 1024.
On the 12th, 2048.
On the 13th, 4096 (it was now taking a while to count!)
On the 14th, 8192
On the 15th, 16,384 (The Raja now knew he was in trouble)
On the 16th, 32,768
On the 17th, 65,536
On the 18th, 131,072
On the 19th, 262,144
On the 20th, 524,288
On the 21st, 1,048,576
On the 22nd, 2,097,152
On the 23rd, 4,194,304
On the 24th, 8,388,608
On the 25th, 16,777,216
On the 26th, 33,554,432
On the 27th, 67,108,864
On the 28th, 134,217,728
On the 29th, 268,435,456
And on the 30th, 536,870,912

Needless to say before the 30th day the village was quite-well fed and the Raja was the one who went hungry.

But I want you to pay special attention to the above table, which is why I reproduced it all - most renditions of this story do not.

Notice that on the 29th day the girl was due more rice than had been paid to her in all of the previous 28 days. This is also true for each day in the series - a fact that you need to think about for however long it takes to sink in.

This is the fundamental truth of all exponential (or "power") functions. It is a mathematical truth, not a theory or possibility.

Now let's add another fact - if you take the growth rate of anything and divide 70 by it, you get the doubling - or halving - time. (Yes, I know this imprecise - but it's close enough to do with a paper and pencil or in your head, which is what counts here.)

So let's take the so-called "average" 3.5% inflation rate over the last couple of decades. If you're saving money, this is a problem. Why? Well, divide 70 by 3.5 and you get 20, which means that money stuffed in your safe loses half its purchasing power in 20 years. In another 20 it loses another half, and is now worth 25% of what it was in terms of what it will buy.

Now let's look at the debt growth percentage from 1990 onward. On an average annualized basis, it is 7.90% (this is from the Fed's Z1 table, by the way - go argue with them if you disagree. As an aside from 1953 to the present debt has grown at an annualized rate of 8.77%, and since 2000 onward at 8.495%, so I'm being nice here by using the 1990 forward numbers.)

This means that the total debt doubles every 8.86 years (or around 8-1/4 years if you use either of the other rates.)

Now go back to the above table again.

Notice that this table shows the unfortunate reality - every 8.86 years there is more NEW debt taken on than has been taken on in the entire history in The United States up to that point.

This cannot continue forever. The politicians do not want to talk about this, nor do the economists and central bankers, but it is a mathematical fact, and if we continue to ignore it we will suffer the loss of our currency and, in all probability, our form of government.

This, by the way, is why credit-led recessions cannot be "printed" or "eased" out of. Credit-led recessions occur because debt service cannot be met by the population any longer, and as a consequence they begin to go bankrupt, forcing credit contraction instead of expansion. Yet all modern monetary systems are debt-based, and as a consequence as this contraction occurs it begets more contraction.

Lowering the cost of borrowing money (making money/credit more available) is nothing more than an attempt to allow "one more doubling" to take place in avoidance of reality. But as you can see, had the Raja above not made a "forward promise" of allowing thirty doublings, he could have stopped before he was bankrupted.

Everyone in America wants "a pony" - the magical alchemy that will turn lead into gold, or return their stock market portfolio to its previous purchasing power.

It won't happen so long as our government and citizens spend more than they make.

There is one and only one way to make that happen: You must grow output faster than debt. When there is a credit overhang this means you must get rid of the debt at a faster rate than GDP declines.

There is only one way to achieve the necessary outcome - what is called "creative destruction", where those who made bad bets (both as lenders AND borrowers) go bankrupt, clearing the path for new lenders to spring up and take their place. Attempting to prop up GDP with government spending is exactly backward and in fact insanely destructive since to do so you must expand debt issued by the government dollar-for-dollar and due to inefficiency (which is very high in the government!) the debt taken on for each point in GDP created is ridiculous.

In the last quarter, for example, government handouts and spending added about four points to GDP. That works out to about $130 billion dollars (the math is ~$13 trillion X 4% / 4 quarters = $130 billion). But to generate that $130 billion government took on $435 billion in new debt (Source: Treasury Direct "debt to the penny"), or roughly $3.35 for each dollar of GDP boost.

There is no durable recovery that can come so long as debt expands faster than GDP does. The math simply does not permit it.

In 1930 there was a tremendous stock market bounce, and everyone and their brother thought that The Depression had been avoided as a consequence of looser money and recovery of asset values. Indeed, I am hearing echoes of President Hoover and James Davis in my head these days.....

May 1, 1930
“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States – that is, prosperity.” – President Hoover

June 29, 1930
“The worst is over without a doubt.” – James J. Davis, Secretary of Labor.

June 9, 1931
“The depression has ended.” – Dr. Julius Klein, Assistant Secretary of Commerce.

Uh huh. The government tried to shield borrowers and lenders from having to take their medicine in 1930 too.

The result was a Depression that lasted until we entered WWII in 1941. The Depression was not exited despite more than a decade of attempts from our government as the government never forced those who had gone bust to take their medicine and thus allow creative destruction to run its course - instead they interfered at every turn (even to the point of burning fields and shooting cattle!) and as a consequence until we were faced with a war that killed a large percentage of the workforce and destroyed massive amounts of material, thereby forcing full employment and realignment of industry, our economy languished.

If The Government comes to recognize the sixth-grade math and implements policy that comports with the immutable mathematical facts the dollar would strengthen significantly and, if maintained, such a policy would guarantee the preservation of reserve status.

However, such a set of policy actions would also prohibit the hiding of losses and force their recognition, thereby forcing the oligarchs and thieves out of business on Wall Street who are currently hiding defaulted paper in the hope that devaluation will allow them to abscond with all of their ill-gotten gains.

The choice is quite simply between economic and policy stability and the banksters on Wall Street along with their handmaidens in Congress.

That's the debate folks when it comes to the dollar and indeed the future of our nation, and the sooner we recognize it the sooner we can exit from this mess.

Until then the claims of "arriving dawn" are in fact incoming ordnance.

What Took You So Long?

nospam@example.com (Karl Denninger) — Tue, 15 Sep 2009 08:02:00 -0400

Gee, it took this long for someone over on the other side of the pond to figure it out?

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

You're the one who's mad.

The problem isn't lending capacity. Lord knows with a doubling of base bank reserves at The Fed there is plenty of "money" (credit or debt) available to be lent out.

The problem is that there are no qualified borrowers.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

It is unclear why the US Federal Reserve has allowed this to occur.

Bernanke has no choice.

He would (certainly) prefer this not occur. What would you call a zero percent Fed Funds rate and printing new bank reserves like a madman?

But just as occurred in the 1930s, Bernanke cannot change the dynamic because there are no willing and able borrowers left.

THAT is the dynamic that sets off deflation and makes it pervasive. This is the condition that Bernanke has ignored and claimed does not exist, but the fact remains that it does.

It is the dynamic that I identified more than two years ago in April of 2007 when I showed analysis right here on The Market Ticker talking about the "terminal shift" of consumer borrowing onto credit cards in a desperate attempt to keep the game going.

Bernanke, Geithner, Paulson, Bush, Obama.

All have gotten this mess dead flat wrong.

The debt collapse necessary to clear the system once you have hit the wall on borrowing capacity given your free cash flow cannot be avoided.

It can only be made worse - much worse - by trying to tamper with what is an essential corrective process that clears the system of unsupportable debt that must be defaulted.

We have spent two years trying to avoid the truth.

Trying to avoid taking the inevitable pain.

Trying to avoid the inevitable economic contraction.

We have only made the problem worse.

What sort of worse? Well, you could start here:

The running joke in Singapore, Hong Kong, Bangkok, and Kuala Lumpur is that the U.S. is the place where even your pet could get a credit card or a home mortgage.

So to Asians, the crisis we’re going through is our own fault. And although it was also caused by blunders in Western Europe and other regions, truth be told, they are mostly right.

The message is clear: We need to immediately stop living beyond our means.

That's not funny.

It is, however, true - and an exact copy of the path that I have been preaching since The Market Ticker began publication.

We have blown several trillion dollars in a futile attempt to stave off the contraction in debt outstanding and GDP that must come.

The contraction is still coming, but the several trillion we wasted in an ill-advised attempt to prevent the inevitable is all gone.

Make sure you thank Bernanke, Geithner, Obama, and of course Paulson and Bush.

Oh Oh.... Trouble Dead Ahead

nospam@example.com (Karl Denninger) — Fri, 21 Aug 2009 08:29:00 -0400

While I disagree with pretty much everything Jim Willie writes when it comes to metals and such, every squirrel finds a nut once in a while:

You can read the original article at the above link, or I'll just point out the important parts: foreigners are rejecting virtually all forms of US debt, most specifically corporate and agency (mortgages.)

The only place foreigners are "still buying" is in the Treasury market, and one wonders: for how much longer, and how much of that is really foreign buying?

Not that it matters. This debt is being rejected because foreigners have no faith in the future of its value. It is not just the risk of default any more - it is also the risk of currency translation going "the wrong way" to an extreme degree, potentially destroying the buyer's purchasing power even if a formal default does not occur.

This is the wall that I have written about for more than two years, and the risk of Bernanke's so-called "smarts" when it comes to "quantitative easing", otherwise known as "monetization" (which Bernanke said, under oath, he wouldn't do - but both was and is.)

Here's the issue, in a nutshell: Bernanke surmises that he wants long-term (and short-term) interest rates low to "spur borrowing" and thus attempt to kick the economy back into growth. This in turn "mandates" an extraordinarily loose monetary policy.

The math says this is idiotic: We are in this mess because of too loose a monetary policy for too long, which in turn engendered too much debt in the system for the economy's productive output. The economy got drunk on too much credit; you can't fix it with a bottle of whiskey.

In turn the market believes this policy is dangerous on two accounts: The debt itself needs to yield more as a consequence of actual default risk and the dollar has a risk of rapid, disorderly decline due to money printing which is exactly the same from a foreigner's point of view of purchasing power as a default.

The fallacy Bernanke (and other policy-makers, including Congressfolk) have is that "they're in control." In fact the market is in control; you can offer all the bonds you want, but you can't force anyone to buy them. What we're now seeing is outright rejection - it began slowly, but as it has become clear that The Fed was hellbent and determined to go to the wall, consequences be damned, that trickle of rejection has turned into a veritable flood.

There is no "solution" for this problem that maintains what Bernanke (and other policy-makers) want: rates must and will rise; we are now only left with the ability to choose the method by which they do.

Bernanke must withdraw the "loose money" policy now and allow lending rates to find their market equilibrium before the water flowing through the cracks of the dam washes away too much of its foundation and it collapses in an outright revulsion toward all dollar-denominated credit instruments.

That equilibrium, which will be reached one way or another, will be higher than today's rates, perhaps significantly so.

This may in turn force the bankruptcy of firms that have been artificially supported by these insanely low rates, as their borrowing costs will rise.

It will force the US Government to cut back its spending to a level it can actually afford.

It will keep the consumer from spending beyond his or her means not only now (as is already happening) but going forward as well.

If we do not withdraw the extraordinary actions and that revulsion breaks through we could easily see a technically-driven disorderly collapse in the dollar's value along with mass-selling of dollar-denominated securities.

If that occurs last fall will look like a Girl Scout picnic.

Let's not.

Welcome To Hell

nospam@example.com (Karl Denninger) — Thu, 23 Jul 2009 08:08:45 -0400

The last week or two I had noticed that the /DX (dollar index) had a somewhat-odd correlation to the stock market - one that had not been present to the same degree, if present at all, before.

Specifically, it would move just before the /ES - S&P futures - moved, and the correlation between the two was almost lock-step.

I had mentally blocked out the worst of the possibilities until last night, when it was said right up front by a user who had lunch with a banker in Australia: The dollar has become a carry-trade funding currency; he was executing an increasing number of these trades with the dollar.

We are following Japan's script almost exactly, but our trip down this road will be far worse than it was for them, because as a nation we are monstrous net importers and in tremendous debt, both as consumers and as a government, where Japan is a net exporter and their population is full of savers.

Tuesday I wrote about the dollar decline powering this latest ramp job in equities, but this development, if it has become or is widespread, is a major problem for The United States, and opens the yawning maw of a trap that we will find it tremendously difficult to escape from.

Japan has been essentially trapped at zero interest rates and moribund economic growth - essentially zero - for more than a decade. The Carry is a big part of that, as it depresses the currency, since the carry is essentially a short on the funding currency. As traders press those bets the currency comes under increasing pressure, which increases import prices (but makes exports more attractive), draining resources from the "host" country that has become the funding currency.

Putting a stop to it means raising interest rates even if the consequence would be a severe economic recession or worse, and the longer it goes on the worse the damage in the form of structural distortions in the economy is. But refusing to raise interest rates means that not only does the distortion continue but the damage from ZIRP continues as well - borrowing no longer becomes a function of interest cost .vs. marginal utility but rather simply a matter of whether you can find someone that will let you borrow at all.

Carry trades can also unwind due to exogenous (not interest-rate) pressures - should there be a sharp upward spike in the dollar these trades suddenly (and very painfully) go "underwater" as the currency translation is an integral part of the profit (or loss) in the transaction. This "unwind" feeds on itself as to liquidate the carry you must buy dollars, which in turn adds yet more upward pressure on the currency, which makes the spiral tighten even more. This is what happened to Japan over the last year as the crisis deepened, and it decimated their exporters (and stock market) last year.

The paradox is that you'd think this would create tremendous inflationary pressures. But that's not what has happened in Japan - they wound up with incredible deflationary pressures instead, because consumption became much less desirable than export! As such the policy "prescription" becomes yet more easing, but with interest rates at zero the policy folks are left scrambling for yet another knob to turn of some sort.

In the United States this will be ugly, because we're not an exporting nation. Instead of being able to "prefer" export we are instead likely to find quite-crazy ramps in certain import prices, specifically oil. That in turn makes economic recovery nearly impossible, as it sets up even more structural dollar flows out of the country.

Nor is this supportive of asset prices in the intermediate term. Sure, it looks good when you get a 7% stock market rally when this begins, but have a look at the Nikkei - their market topped at 40,000 and has never been anywhere near there since. Real estate prices have not recovered their previous highs and remain moribund, and the former "never get laid off" Japanese economic model has been laid waste, with generations-long policies abandoned as simply unworkable.

This is something we should not have allowed to happen but we now have, and it is now incumbent on The Administration and The Fed to put a stop to it before it becomes pervasive. Determining exactly how much "carry" is out there is difficult; if The Fed has a handle on this they sure aren't going to divulge it, just as Japan's Central Bank never has, but the impact, especially when you get forced unwinds, are vicious and impossible to ignore.

For those who said "we won't make the mistakes Japan did" let me point out that we have indeed made all of the same mistakes and now we're getting the same results.

Why is it that Einstein's exhortation continues to echo in my head?

Insanity is doing the same thing over and over but expecting a different result.

Liquidity Disappearing

nospam@example.com (Karl Denninger) — Mon, 22 Jun 2009 13:52:00 -0400

Bill auctions: 13 week bid-to-cover 2.79, 26 week 2.72.

Both the lowest btc in over three months.

Gee, on a day when the market is down 24 handles on the SPX there's no huge demand for Treasuries?

Hmmmm.... gee, let's see, we seem to be a bit short of money here.

Short on the Treasuries, short on equities, short on COMMODITIES.

Remember what I was talking about with liquidity drains a week and change ago? Two events detected a few days apart, with today being "T + 3" on the second one (yes I know that other markets don't settle like stocks, but there is USUALLY a 2-3 trading day delay between when these things are initiated and when they show up in the markets.)

The Fed is quickly proving that it is nothing more than this:

I bet that if the movie were shot today that guy would be standing there in a pair of boxers.

I hope you folks who got all giddy about the SPX in the 900s and the DOW up around 8,800 took the opportunity to either sell or hedge.

While there is no guarantee that this pattern will continue the fact remains that liquidity matters and there is little point in trying to argue that the primary fuel for the rally off the March lows has been unprecedented system liquidity provided by Sir Feds-a-lot.

The problem is that Treasury has been and continues to suck all the oxygen out of the room with their unprecedented issuance of debt to fund Obama's silliness in the form of his budget "priorities" and the raw handouts to banking interests, much of which is apparently going to show up in Goldman Sachs bonuses.

Again, to put this in perspective this 7-day window has $165 billion in issuance. The entire S&P 500 - all 500 stocks - has been trading in the $2-2.5 billion a day range for the last month or so. That's the capital flow that is represented by all trades in all 500 stocks.

There are of course lots of other stocks, but in aggregate the S&P 500 posts the largest dollar volume on a typical day by a significant margin.

You simply cannot issue $165 billion in Treasury Debt and expect it not to have a major impact on system liquidity. It is not possible. That which is spent on one thing (in this case Treasury bonds) cannot be spent on another (in this case stocks.)

The Fed cannot "monetize" this debt without creating an instant dislocation in the Treasury market - their games thus far have produced a SMALL rumbling of trouble there, but nothing like an outright monetization campaign would produce.

Bernanke and Obama are backed into a corner, exactly as I predicted would happen. In order to continue to issue like this in the Treasury market while not driving Treasury rates to the moon money will have to be "scared" into bonds - which means blowing up the stock market.

Sorry folks, but those "green shoots" are in fact marijuana plants and our President along with his economic advisers have been smoking 'em.

30y Bond Results: Beware

nospam@example.com (Karl Denninger) — Thu, 11 Jun 2009 14:05:00 -0400

The auction results make absolutely no sense under "conventional wisdom."

Median yield down, primary dealers took about half and indirect bidders took the other half, basically.

What? 50% take for foreign central banks on 30y debt at a 4.6ish coupon?

That makes no sense given what we're being told is coming: massive inflation, maybe even hyperinflation, commodities ramping to the moon, the stock market going to the moon in a hyper-inflationary printing explosion.

The stock market rocketed on the release. I couldn't make sense out of the initial FX moves, especially in the DX and Yen. Someone was front-running in the financials bigtime as well, with a big ramp for an hour or so prior to the results.

Folks, if you think hyperinflation is coming, or even serious inflation, you're going to get your head cut off on a 4.6% 30y bond. In fact you could easily lose half or more of your investment, should you need to sell, and your coupon will be half or less of what it should be.

So how does this make any sense?

There is only one reason for the FCBs to want this sort of exposure:

They expect a ramp in the dollar and crushing DEFLATION, as this is the only way that bet will pay off.

If you're on the other side of this trade in any way, I hope you are putting on some sort of hedge.

Remember, foreign central banks can FORCE a pull in liquidity and make their desires a self-fulfilling prophecy.

Care to bet against someone who can make their bet pay off?

That's what I thought.....

Oh guess what - the primary dealers would like this outcome too......

PS: If this analysis is correct then we're in for some really NASTY trouble, quite soon. If you're short Ts, short dollars or long equities, your neck is in the guillotine. Better move before the blade falls!

Short End Debt Offerings

nospam@example.com (Karl Denninger) — Mon, 01 Jun 2009 13:13:23 -0400

Hmmm... this is interesting.

91 day bill offering:

Bid-to-cover 3.69, Indirect was ~51% of the total (eek!)

182 day bill offering:

Bid to cover 3.22, Indirect was 46%.

This tells me the following:

The shorter the offering, the more interest. That's not so good.
The shorter the offering the more indirect (foreign) interest, and foreign interest is abnormally high.

Thus:

Foreigners (e.g. China) are shortening duration. This is very bad for the longer end of the curve. We could see DRAMATIC evidence of this next week, which would confirm the warning that the bond market has been flashing since Bernanke's QE announcement.
People are willing to take damn near nothing for 26 week (basically half year) bills - 0.29% and half that (0.15%) for the 13 week.

Short form: Don't fall in love with the idea that "everything is improving" aka "Green Shoots."

Foreign governments and general bond buyers aren't believing in it; they're willing to lend on very short terms for almost nothing, and foreign governments are piling into the short duration offerings.

Why should you believe it if the folks with inside information do not?

CBs And Other "Real Money" Had Enough?

nospam@example.com (Karl Denninger) — Thu, 21 May 2009 13:38:00 -0400

Oh oh......

From the forum, wire from Reuters claimed original source:

21. There apparently is a new wrinkle to the intermediation trade between buying from Treasury to sell to the Fed with real money, including central banks, now in on the act. Indeed, several Street sources relay central banks were aggressive offers into this morning's coupon pass, with one letting go of a large block of old 5-years. Other offers too are coming in from embedded Asian real money longs -- in the higher coupons -- also looking to sell size without unduly upsetting the market, and especially considering the illiquidity in off- the-run bids from the Street.

Whether influenced or not by the much higher tenders coming in on the Fed Passes ($45 bln tendered for $7.4 bln bought in today's pass for a 16.2% hit rate), fast money has been tattooing the bid and especially so in the belly with the 10-year most leaned on. Note as well, earlier this week the Bank of England (BoE) gilt pass too saw a need to offer paper at or below the market's bid side in order to get sales off.

So now what Ben?

If Foreign Central Banks are selling into Ben's bid then the game is literally weeks or even days away from being over.

I have written for over a year about the potential for a bond-market implosion and subsequent economic collapse.

Bernanke, if he continues to play his "QE" games into this, assuming it is real, must be immediately forced from office by President Obama and/or Congress.

In short we must choose the (much) higher interest rate path and choose it now, because that is now an assured outcome.

We can choose between significantly higher interest rates and an economic collapse along with significantly higher interest rates.

Avoiding the higher interest rate outcome no longer appears to be possible exactly as I have been talking about for more than a year.

And exactly as in the 1930s, we will wind up in the same place with "The Fed" being blamed for the "loss of liquidity" when in fact the truth is that it was the government attempting to spend more than it made, and finding the market unwilling to support insane deficit spending, that led to the bond market dislocation, much higher interest rates, and the second phase of the economic collapse.

We are following the precise same path we went down in the 1930s.

Hope you're ready, and say thanks to Ben, Hank, Geithner and of course Obama, all of whom think they can ignore the realities of the market.

Disclosure: The time to short the phone book is approaching.

Bond Market To Bernanke and Obama: F&$k You

nospam@example.com (Karl Denninger) — Wed, 25 Mar 2009 15:12:00 -0400

Good luck Ben:

NEW YORK (AP) -- Stocks lost ground after a weak auction of U.S. government debt stirred worries about how easily Washington will be able to raise money to fund its economic rescue program.

Investors gave an unexpectedly cool response to a $24 billion auction of 5-year Treasury notes Wednesday, which also sent prices for Treasurys lower.

You wouldn't think that would happen on the day that Ben came into the market to buy Treasuries, but it did. Ben had roughly three times the amount he took submitted to him: SOLD TO YOU BEN, and oh by the way, we're not interested in buying any more of this trash either!

Worse, indirect bidding (foreign interest) essentially collapsed, down by some 50% from last month.

As if that's not bad enough the BOE (England) actually had a failed Gilt auction, with insufficient bids for the amount pushed out.

That's coming to America and soon Ben.

I and a few other astute people who actually believe the market is bigger than any loudmouth with a title (like Bernanke) tried to warn both him and our President that neither of them are capable of forcing people to buy that which they do not wish to buy or fund.

Well Ben?

When I wrote my Ticker from this morning, which I actually penned last night, I had no clue that the first piece of this dislocation was going to happen today.

It did.

Ben came into the market and bought Treasuries today, and in response yields moved.... up?

Oh, and the stock market sold off hard too, down some three hundred DOW points from where it was before these bond "operations."

A blunt, clear warning was issued by the market today Mr. President and Mr. Fed:

Cut that crap about "borrow and spend", along with playing "circle jerk" and "I'm gonna threaten to print money!" out right here and now, or run the risk of the Treasury market imploding in your face, taking what is left of the American economy and our capital markets with it.

Are you listening to investors both here and abroad Mr. Obama and Mr. Bernanke?

You can't force China, Japan and Saudi Arabia to buy our debt. You can only ask, and the results of the bond auction today makes clear that their answer so far can best be described as "Bite Me!"

Actions Have Consequences

nospam@example.com (Karl Denninger) — Thu, 19 Mar 2009 15:31:59 -0400

So The Fed thinks it can print its way out of this eh?

MOSCOW, March 19 (Reuters) - China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.

Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decision-making globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.

Oops.

By the way, if you want to see lots of "fun" in our currency markets along with a near-immediate bond dislocation, get the oil producers along with China and Russia to agree on a new reserve currency and......

That'd be "goodnight Uncle Sam."

Congress might want to rethink their concept of spending more than they make, thereby effectively calling for "Quantitative Easing" and similar shenanigans.

Yes, I know that contracting spending to tax revenues would be extraordinarily painful and end the stupidity of doing things like granting unlimited "free" medical care in hospitals to illegal aliens.

But if you think an announced change in Social Security, Medicare and similar programs would be bad, how bad do you think one would be that occurs as the consequence of forced action if our bond market was to implode?

Welcome to crazy-town Mr. Bernanke!

Heh Ben: Is That Loan Good?

nospam@example.com (Karl Denninger) — Tue, 03 Feb 2009 14:27:11 -0500

From Bloomberg:

The Fed extended currency-swap programs with the central banks of Australia, Brazil, Canada, Denmark, the U.K., the euro region, South Korea, Mexico, New Zealand, Norway, Singapore, Sweden and Switzerland. The Bank of Japan will consider an extension when its policy makers next convene, the Fed said.

The dollar value of outstanding swaps has risen more than sevenfold since the Lehman Brothers Holdings Inc. bankruptcy in September, to $465.7 billion as of Jan. 28. "

$500 billion eh? How good is the collateral? Oh wait - these are swaps so there isn't any.

Uh.... just one question - what if one of these nations pulls an Iceland while the line is open? Canada, for example, doesn't bother me, but how about South Korea......

Just curious Ben. You know, last time I checked, given the sort of activity we're seeing in places like Japan, where their economy has contracted at rates worse than any economy has ever recorded, even in The Depression, the people gotta wonder - are these lines "safe"?

Don't you think that Congress and American People deserve some details? After all, is it not our tax dollars that are supporting your $500 billion in "temporary" help that now appears to be a lot more than temporary? After all, you did originally say that this was just for six months...... looks like you were wrong (again) eh?

Just curious.