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SQUINTING AT BONDS &
THE DOLLAR
When the US government
stops wasting our resources by trying to maintain the price of gold,
its price will sink to . . . $6 an ounce rather than the current $35
an ounce.”
-- Rep. Henry Reuss
-- Chairman of the Joint Economic Committee of Congress
-- November 25, 1967
Sometimes I feel like
Peter Falk, the stupid detective squinting cross-eyed at the facts
trying to make some sense out of them. Here’s one column of figures
that doesn’t add up.
ECB BAILS FREDDIE &
FANNIE
On July 10 in the
meeting of its constituent national banks, the European Central bank
(ECB) announced that on
account of credit risk it was cleaning out of its portfolio all
US agency debt issued by Freddie Mac & Fannie Mae. The bank
apparently also recommended that its member banks sell their Freddie
Mac & Fannie Mae holdings. (Where do they get these names?
I’ll bet you there is a hidden federal agency dedicated to nothing
but thinking up stupid acronyms, the Intergovernmental Denomination
Inventing Office for Terribly Stupid Names, better known by its
acronym, “IDIOTS Names.”)
Fannie & Freddie are the
two “government sponsored entities” (GSEs) established to keep real
estate churning with cheap mortgage money. They ought to be called
“Government Sponsored Engines-of-Inflation,” because that’s why they
are there. Although they are called “Government Sponsored Entities,”
the US federal government does not guarantee their obligations. And
they are exempt from the regulations the rest of American companies
suffer – such as SEC regulation.
Together they own or
guarantee about 42% of the $7 trillion US mortgage market. (42% of
$7 trillion is $2,940,000,000,000.) Remember that about 60 days ago
in the June Moneychanger I wrote that firing the top three
executives of Freddie Mac hit my ears like a firebell in the night.
For every bubble, one pinprick exists to bring it down. It may be
something small, just a whiff of trouble at a prestigious
institution, and it’s always unexpected. What could have been more
unexpected? Why would Freddie Mac, riding high, suddenly fire its
three chief officers for accounting improprieties.
What is more unexpected
than the ECB pulling the plug on US agency paper? After all,
central bankers are all happy members in one big country club.
Every month the really important ones meet for supper in Basel,
guests of the Bank for International Settlements. It’s nearly
inconceivable that the ECB would take this step without first
notifying Alan Greenspan. And it’s likewise inconceivable that
Greenspan wouldn’t take measures to contain the damage.
Odd that the ECB’s
decision did not spark a rush out of US agency paper. Odd, too,
that the Bloomberg report on the ECB’s action didn’t appear until
July 28, eighteen days after the announcement.
Federal Reserve Board of
Governors Release H.4.1,
www.federalreserve.gov/releases/h41 gives data on what US
government securities the Federal Reserve holds for foreigners,
mostly foreign central banks. H.4.1 breaks that total down into US
Treasury debt and US agency debt. The agency debt made an all-time
peak 5 June 2003 at $189,850 million. By 24 July it had sunk to
$183,250 million, a drop of only 3.48%. Hardly a panic out of US
government agency securities.
BONDS
But meanwhile bond
owners, who had been enjoying a great bubble thanks to Alan
Greenspan and his Disappearing Interest Rates, got creamed. In the
past month bonds sank 18%, their worst beating in US bond
market history. What started the flight from bonds? Again, just a
little pin prick. Bond holders thought Greenspan & Co. would line
their pockets with another half percent interest rate cut at the
last Fed meeting, but only cut it a quarter percent. Or perhaps it
was even something else, but once the bond bubble was pricked, it
collapsed. Probably it will make a secondary peak, a touchback to
where it broke down, but it certainly appears that the bond bubble
has burst.
Which gives the lie to
the Federal Reserve’s claim to control interest rates. Contrary to
its Blarney, the Fed does not set interest rates. It may be
able to influence interest rates, but it doesn’t control
them, other than its own discount window rate for lending to other
banks. Unless the Fed is willing to go into the longterm bond
market to buy bonds without end and tremendously balloon the money
supply, it can’t control long term interest rates.
DOMINOES & PUZZLE PIECES
Now I start trying to
fit the puzzle pieces together. Begin with the Presupposition of
Near Divinity. Having read a roach-gagging quantity of
Establishment material, from CFR journals to Federal Reserve
governor’s speeches, I know that they believe they are
Masters of the Universe (for proper effect, say that slowly through
an echo chamber). That is, they have successfully managed so many
crises that threatened to bring down the whole system in “cascading
cross defaults,” that they now believe no crisis can beat them.
But here’s the crisis
du jour. Greenspan wanted to contain the stock market carnage
and keep the economy from sinking into a depression, so he has kept
the money valve wide open. To keep the economy from freezing up
altogether, he had to keep the real estate industry humming. But
the only way to do that was to funnel them money (through Freddie
Mac & Fannie Mae) and make sure interest rates stayed low – which,
by the way, would help the stock market, too.
Uh-oh --
to keep real estate in the air, more and more
buyers and mortgage re-writers had to be sucked in. That meant not
only lowering interest rates, but also lowering standards of
creditworthiness. Like, lowering them to “zero down payment and
an eventual wish for gainful employment.” Whoops! An
uncontrollable side effect of this plan was a bubble in the bond
market as dropping rates raised bond prices.
WATCH THE DOLLAR!
WATCH THE DOLLAR!
Behold, Greenspan’s
whole game plan. But no plan is an island unto itself, so let us
turn to the Yankee dollar, the playing field for the game. As a sop
to Wall Street, Treasury Secretary Summers had let climb the dollar
index climb to 120. This squeezed the life out of US manufacturers
& farmers but filled Wall Street’s troughs with plenty of foreign
investment capital.
Ouch, another
backfire -- the high dollar also
attracted record imports, and with them, record current account
deficits nearing $500 billion a year. The countries choking
on big trade surpluses have to do something with their extra
dollars, so they must recycle them into US Treasury debt.
Look at Chart 1,
“Foreign Owned US Gov’t. Securities held by Fed, quarterly” from
July 1996 and Chart 2, the same thing in the weekly version from
October 2000. The holdings never rose over $650,000 million until
the end of 1999. Then they took off, flattened, and exploded.
Foreign holdings of US government securities rose from $683,000
million in Nov. 2000 to 945,600 in July 2003. That’s a 38.4% rise
in 32 months –staggering.
If we look at the rate
of change Oct. 2003 through July ’03 we get another picture still.
The absolute numbers chart shows us growth or decline, but the
year-to-year rate of change shows us which way it is trending.
Rate of change hints at the future, at whether growth will
increase, slow, or stop altogether and begin to shrink. That chart
shows a series of three upwaves. After the first wave, it grew
from a low rate of 2.2% in March 2002 to a peak of 23% in May 2003.
In June, however, the rate began to decline, speeding up sharply in
July to a low of 16.8% in July. That implies a top is in.
PUTTING THE PIECES
TOGETHER
For heaven’s sake,
Moneychanger, how does all this fit together?
Simple: Greenspan & the
US government have played themselves into a corner. This game is
far more complex than a two dimensional chessboard – imagine not
just three dimensions, but four or. That barely describes the
complexity of this game.
The only way to keep the
economy afloat is to engineer easy money and low interest rates
(inflation). But that
corrodes the dollar’s value, and with the dollar sinking who will
hold it if it only pays a tiny interest rate? Meanwhile the US must
somehow finance a current account deficit that requires attracting
$2.5 billion from foreigners every business day, and government
deficits to pay for the war and what not of – who knows how many
billion a day.
But if the recycling
inflow of dollars stops from overseas? What if foreigners become
unwilling to keep on sending their money to the US? What happens to
the dollar? It sinks, my friends, it sinks.
And what will be the
first sign of its sinking? Well, they say when a ship has trouble
at sea, you know it’s about to sink when the rats all jump off.
The monetary world is
about the same. Whenever a currency is about to sink, the central
bankers all disembark.
Now
do you understand why I am watching these Fed holdings of
foreign-owned US government securities? Because there’s a good
chance that’s where the panic out of the dollar will show up first.
That statistic is where credit risk and interest rates and trust in
the US dollar all meet.
And the rate of increase
in those holdings turned down in June. In the first week of August,
foreign holdings rate of increase rose from 16.8% to 18%.
Technically the US
dollar index line in a primary downtrend, and has fallen from 120
(June 2002) to 96 today. Right now the dollar is enjoying a
reprieve in the form of a countertrend rally that has carried it
from its 92 low to 97. However, that rally has almost ended.
Now we watch and wait.
ACTION
The most frightening
thing about writing a newsletter is not wondering whether you will
be right or wrong. In advance you know you’ll be right some of the
time and wrong some of the time. Scarier is knowing that you’ll be
right, but your readers will remain stuck in inertia.
For a long time I’ve
been repeating this recommendation: get out of stocks, get out of
dollar denominated assets, get out of real estate, get into gold and
silver. Thinking about it and understanding it are only the first
step, and they do you no good whatever if you never act.
-- Franklin Sanders
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