But the phonies over at the Fed Reserve might be a tougher nut to crack. Despite having created, administered and presided over a crumbling financial system, the market still hangs on their every word. Last night, the word from the Fed disappointed.
Rather than administer a fresh blast of money printing to boost risk assets around the world and reward speculators, the Fed meekly opted to do a little more of the same. That is, continue to buy long dated bonds and sell short dated bonds…an extension of Operation Twist. There was no mention of balance sheet expansion…of buying additional amounts of Treasuries or mortgage backed securities.
They did downgrade their economic growth forecasts though…and ratcheted up their unemployment forecast. Only two months ago they were far more bullish. What a bunch of phonies…
Given the month long hype we’ve had to endure about the likelihood of more QE, it was all a bit of an anti-climax. And the market didn’t really know what to think…it was all over the shop.
This fits into our theory that the Fed’s primary aim of money printing is to fund the government deficit. Propping up the stock market is just a by-product — albeit a beneficial and popular one.
Think about it. The US runs an annual budget deficit of $1 trillion plus. Given the debt deleveraging taking place in the private sector, it is likely the government will continue to run these massive deficits for years to come. $1 trillion — per annum — is a lot of money. Where is the US government going to get it all from?
In the good old days, the US government managed to fund their deficits (which were ‘only’ in the $200 billion range) via the trade deficit. That is, the US economy consumed more than it produced. It paid for the excess consumption with dollars. Its trading partners then recycled those funds back into the US economy by buying Treasury debt. It was the pre-credit bubble vendor financing system that everyone loved so much.
But now, the US government’s borrowing requirement is well in excess of the country’s trade deficit. Recycled trade deficits from trade partners only do half the job. If the market had to soak up the other half, yields would be much higher. So someone else needs to step in to do the buying. Enter the Fed.
But here’s an interesting point. The Fed hasn’t bought additional Treasuries since around September last year. This coincided with another flare up in the European debt debacle. Soon after, the European Central Bank performed its own version of QE, the ‘Long Term Refinancing Operation‘ (LTRO).
Clearly, this operation freed up capital to flow into the perceived safe-haven of US bonds. So it’s our guess that over the past 6 months or so, European capital financed the US deficit. That’s why yields are so low, despite borrowing requirements being so high.
How long this lasts is anyone’s guess. But you’ll know when it ends, because it will coincide with the Fed announcing another round of government bond purchases. The market will probably be much lower by then, so the printing can take place under the guise of propping up the market.
But it will really be about propping up government finances. Don’t tell anyone though. This phony system we operate in is all about maintaining confidence. Once that goes, it’s all over.
for Markets and Money
From the Archives…
The Problem With the Spanish Bailout
2012-06-15 – Keith Fitz-Gerald
Australian Housing – How to Avoid This Pauper’s Retirement Trap
2012-06-14 – Kris Sayce
Why Warren Buffett is Loading Up on Tungsten
2012-06-13 – Don Miller
China’s Economic Data Statistics: Just Add Salt
2012-06-12 – Dr. Alex Cowie
Why Graphite is One of the Few Places For Savvy Investors to Make Money
2012-06-11 – Dr. Alex Cowie