This makes sense if you think, as we do, that the Fed’s underlying motive is to monetise the government’s massive deficits whenever there is a funding shortfall. Right now, there is no shortfall. We’ll come back to that in a moment.
The far more interesting — and related — piece of news overnight was the action in the US Treasury market. $21 billion worth of 10-year Treasury notes were auctioned at a near record low yield of 1.45%. Normally, ‘primary dealers’ (the big Wall Street banks) conduct these auctions and distribute the bulk of the government bonds. Put another way, these banks collect money off their clients and give it to the government. In return their clients receive a paper promise from the government.
But last night’s auction was notable for the large proportion of ‘direct’ purchases. Over 40% of the auction came from ‘direct bids’, which refers to anonymous bidding…and bypassing of the primary dealers. According to the Financial Times, the recent average for direct bids at auctions is around the 17% mark.
It is usually foreign central banks who have the size to bid directly and anonymously. Who could it be? China is the usual suspect, but we’re not sure China is desperate for more Treasuries right now. What about Europe’s central banks? Could they be buying on behalf of their impaired domestic banks?
We don’t know of course. But the strong demand and ultra-low yields suggests someone is desperate for US Treasuries. Which brings us back to the Fed’s decision. The rest of the world seems to be financing the US government’s $1 trillion plus deficit with ease at the moment. There is no need for the Fed to step in with yields at these low levels.
Because US Treasuries are ‘risk-free’ and represent the world’s best collateral, in times of turmoil capital flows into the coffers of the US government. Just think about it. The US government absorbs more than US$1 trillion in global capital annually. It has been doing so since 2008 and will do so for many more years to come.
What does it do with that capital? Does it generate a decent rate of return? As far as we can tell it uses the funds to prop the economy up and stop it from crashing. The US economy rests on a foundation of around US$54 trillion of credit (debt). If the credit growth stops or even contracts by a minimal amount, the US economy and equity market fall into a hole. That’s why the Feds keep spending and that’s why the Fed Reserve is on standby to print what the government can’t get via the global capital markets.
The long-term implications of this insanity are mind-boggling. But no one’s mind seems to be boggling just yet. It’s all about short term preservation. After all, in the long run we are all dead. Anyone who knows how the financial system works knows that the US will eventually blow up, just like Europe…and Japan.
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From the Archives…
How to Survive Inside China’s Financial System
06-07-2012 – Greg Canavan
China’s Economic Policy of Denial
05-07-2012 – Greg Canavan
The Question China Has To Answer Fast to Save Its Economy
04-07-2012 – Callum Newman
How Investing in Commodities Can Prevent a Personal Financial Crisis
03-07-2012 – Dan Denning
Wouldn’t it Be Nice to Not Lose Money on the Australian Share Market?
02-07-2012 – Dan Denning