If you want any further evidence of a system in disrepair, look no further than last night’s market action. The much awaited US jobs report came in weaker than expected, sparking a rise in stock markets around the world. The Australian market should also have a good day too, piggybacking on the rise of global complacency towards all things risk-related. We are in melt-up mode.
For the uninitiated, stocks rose because the weak jobs report means the Fed will continue with its US$85 billion per month QE program until well into next year. And then when we get into next year, the goalposts will move again.
QE is not going anywhere, and it’s not because of a poor jobs market – although ‘jobs’ and the ‘economy’ provide great cover for what the Federal Reserve is actually doing.
What is the Fed doing? As we’ve written before, it’s effectively financing the US budget deficit. Actually, it’s financing the US current account deficit with the rest of the world. As you’ll see in a moment, that’s not good at all. It shows that the rest of the world has stopped supporting the ‘system’. That doesn’t mean it all goes pear-shaped from here, but it does mean the ‘system’ is hanging together by a thread. That thread is confidence, or more accurately, the wilful ignorance of the international investing/speculating community.
Here’s the stats…
Overnight, the US Treasury released its monthly ‘Treasury International Capital’ (TIC) data. The data shows foreign appetite for US assets. Why is this important? Well, the US runs a current account deficit of around US$400 billion per year. To keep things running smoothly, the US needs foreigners to finance this deficit.
The current account deficit is a combination of the US trade deficit and the net income the US earns from overseas investments. Taken together, it amounts to a financing gap of around US$400 billion per year.
To plug the gap, the US must sell assets, either Treasury bonds, corporate bonds, or equities etc. Historically, the US has financed its current account deficits by issuing Treasury securities and the rest of the world eagerly absorbed this issuance. After all, they were ‘risk-free’ and backed by the full faith and credit of blah blah…
But recently, the rest of the world has been reluctant buyers of Treasuries. And we got further evidence of this in last night’s TIC release. It showed that in the month of August, the rest of the world reduced its holdings of Treasury bonds by $11 billion.
Keep in mind the forecast for the US government deficit this year is around US$750 billion, which means on average it will need to issue new Treasury bonds of $60 billion per month. But foreigners aren’t absorbing this issuance any more.
Over the past year (12 months to August) they only accounted for $25.3 billion of Treasury purchases. Compare that to the 12 months to August 2013, where foreigners absorbed US$532 billion in Treasury notes and bonds. In other words, over the past 12 months demand for US government debt has fallen off a cliff.
Can you see what the Fed’s QE is all about now? They’re buying $45 billion per month in US government debt not to promote economic growth and support the jobs market, but to ensure the parasitic organism that is the US government gets its hands on the cash it needs one way or another…even if it risks crashing the system.
The limits to this dollar-based financial system have been apparent to many people for many years. But it’s persisted because of the support of foreigners in soaking up the US government debt issuance. And that went on for so long because of the mutual dependency of everyone on the ‘system’.
But this recent trend showing that foreigners are no longer prepared to finance US excess consumption means that the system is a lot closer to breaking up than many people think. Perhaps the melt-up in stocks is a sign of this. Nothing will make much sense when this 40-year monetary experiment comes to an end. Certainly, stocks rising in the face of such high risks certainly don’t make much sense.
Here’s some more interesting data from the TIC release…
As we just showed, on a net basis, foreigners reduced their holdings of Treasuries by US$11 billion in August. But what happened on an individual country basis?
China, the largest holder of Treasuries in the world, reduced their holdings by US$11.2 billion. This is very telling because we learned last week that China’s FX reserves increased by a whopping US$166 billion in the third quarter. China must be buying euros and yen instead, and their yen purchases are likely currency war related. They want to deny Japan a cheaper yen vis-à-vis the yuan to protect their export markets.
Amongst other major owners, Japan increased their Treasury holdings by US$13.7 billion. The ‘Caribbean banking sectors’ (hedge funds) increased their holdings by US$12.7 billion while the ‘Oil Exporters’ reduced theirs by US$11.3 billion.
Once again, it’s basket case Japan and hedge fund speculators providing just a skerrick of support to the US bond market. In Japan’s case, we’re assuming the Bank of Japan’s own gargantuan QE is providing some demand for Treasuries, as Japanese banks and pension funds sell JGB’s to the Bank of Japan and buy US bonds with the proceeds.
But as we pointed out yesterday, with Japan’s own current account surplus shrinking it has limited ability to continue buying US government debt.
Yes, the US is running out of friends. Even the oil exporters are dumping Treasuries. Since peaking in April, their Treasury holdings are down by $25.3 billion. We’re not sure whether this represents the need to spend more and more on welfare to keep restive populations in check (and thus dip in their reserves) or whether it’s a sign of Saudi displeasure at US policy in the Middle East.
Yesterday, the Wall Street Journal reported:
RIYADH, Saudi Arabia- Saudi Arabia’s intelligence chief told European diplomats this weekend that he plans to scale back cooperating with the U.S. to arm and train Syrian rebels in protest of Washington’s policy in the region, participants in the meeting said.
Prince Bandar Bin Sultan al-Saud’s move increases tensions in a growing dispute between the U.S. and one of its closest Arab allies over Syria, Iran and Egypt policies. It follows Saudi Arabia’s surprise decision on Friday to renounce a seat on the United Nations Security Council.
The Saudi government, after preparing and campaigning for the seat for a year, cited what it said was the council’s ineffectiveness in resolving the Israeli-Palestinian and Syrian conflicts.
Diplomats here said Prince Bandar, who is leading the kingdom’s efforts to fund, train and arm rebels fighting Syrian President Bashar al-Assad, invited a Western diplomat to the Saudi Red Sea city of Jeddah over the weekend to voice Riyadh’s frustration with the Obama administration and its regional policies, including the decision not to bomb Syria in response to its alleged use of chemical weapons in August.
Remember, the Saudis are the original supporters of the US dollar financial system, agreeing back in 1973 to support the dollar by pricing oil in dollars. Well, with the US outmanoeuvred on Syria and now talking again with Iran (traditionally an enemy of Saudi Arabia), the long term Saudi alliance is looking a little withered.
All this points to greater and greater volatility ahead. At the moment world markets are levitating on confidence, but it’s only a matter of time before the confidence morphs into a kind of incredulity as to what’s really going on.
That is, the world’s largest and most important economy is financing itself with newly created electronic money. This situation is laughable and absurd. But it’s also deadly serious. As always, the question remains…how long can this go on?
By the way, we said we’d look at how Australia would fare in all this but we got caught up in the Treasury data…more on Australia’s place in the ‘system’ tomorrow.
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