Financial topics

[Higgenbotham]

You seem to be thinking that the treasury bills denominated in dollars could in a panic be safer than dollars. This is an impossibility, as long as paper and electronic dollars are pegged 1:1. In the best case the treasury pays you back with dollars.

There are 3 different options for how t-bills are redeemed. One is electronic dollars (bank account), another is one day rollovers that are like t-bills, and the third is rollover into a t-bill. T-bill rates went slightly negative in 2008. My guess is in this round of panic, probably next year, the long bond will hit 8% at the same time the bills go to -8%. If what you are saying were true, then I would agree that by definition the t-bills can't say negative for any length of time. But the money doesn't necessarily have to come out; it has the option to stay in hiding.

[vincecate]

My guess is in this round of panic, probably next year, the long bond will hit 8% at the same time the bills go to -8%.

So imagine someone has $100,000 come due on a T-bill. If they put it in their bank account they get $100,000. If they buy a -8% bill they will get less after waiting. Why would they every take the -8%?

As everyone is fleeing long term debt into short term, I can imagine someone with $10,000 decided taking a slightly negative interest rate for a short period was better than the wire transfer fee to take the money out and then later send it back. So I can sort of see funny cases of slightly negative for a short time, like happened last time. But I can not imagine -8%.

[Higgenbotham]

My guess is in this round of panic, probably next year, the long bond will hit 8% at the same time the bills go to -8%.

So imagine someone has $100,000 come due on a T-bill. If they put it in their bank account they get $100,000. If they buy a -8% bill they will get less after waiting. Why would they every take the -8%?

It's because they want to keep the money out of the banking system and they think they will get less back from any other investment. At some point it is herd behavior taking over too. The reasoning given for t-bill rates going slightly negative in 2008 when things were a lot sounder than they are now was stuff like we want to show we have good collateral. If the banking system (including the Fed) were to get restructured in the intervening time, some of the money might be tied up and they may get less than 100 cents on the dollar. At least, that's the history. In a lot of ways, I'm keying off the 14th Century collapse and there the banks returned about 20-50% after having the money tied up for a long time. FDIC doesn't guarantee the large blocks of money. Most people think in terms of "the FDIC guarantees all the money" but they don't and maybe can't. If there's a run on the long bonds, the market is already turning the screws. I also see a lot of it as being based on the uncertainty of political outcomes.

A couple recent articles dealing with Fed insolvency that might be useful:

http://www.nakedcapitalism.com/2010/10/ ... orner.html

The second sighting is more amusing. The Fed is starting to think forward to the date when it has to realize losses on all that stuff it bought during the crisis and still has on its balance sheet. Losses were baked in from the beginning, yet people at the central bank appear, weirdly, to be focusing on that issue only now.

It may be that they really believed real estate prices would go back up and now that real estate prices are falling again, they are getting worried. This shows how stupid they are. It also shows that didn't see the risk in backing Federal Reserve Notes with the junk MBS collateral.

http://monetaryfreedom-billwoolsey.blog ... vency.html

The nature of academia is narrow and specialized, so these types of sources are good to fill in details. I wasn't previously aware at all of any discussion of this.

This goes back to something else that was brought up awhile back. Martin Armstrong said the currency would be replaced and people didn't understand why he would say that. I didn't either. It could be that if the Fed does end up needing a bailout that the public will stand firm against it. I believe the new Republican Congress is on that wavelength. In that situation, it is possible that the Fed could be shut down and the Treasury would take over that function. New money could be printed called "United States Notes" or something similar and it could be required that Federal Reserve Notes be exchanged one for one or in some other ratio. If someone has large amounts of notes to turn in, they may be subjected to registration in a database and questioning. There may be a limit on how many notes can be turned in without going through a formal process. Of course, they may just allow the notes to circulate side by side. How it sorts out is a political question as much as an economic one.

A point I should make that hasn't been explicitly summarized, but has only been stated in bits and pieces. The PhD economists will say that the theoretical lower limit on t-bill interest rates is zero because cash and t-bills are substitutes and cash can't pay negative interest, that the interest rate on cash is zero by definition. That's all well and good in theory but watch what happens if the market enters into a panic state and people have to get out the door "now". As mentioned a few days ago, there isn't a feasible way to get a large block of paper cash "now" to settle a transaction. In the event of a panic, you settle in what you can settle in. The PhD economists are not taking into account: panic states, time constraints, availability of paper cash, political risk, whether notes backed by junk collateral are true substitutes as they once were when they were backed by good collateral, and whether the market will desire to hold them over time. I've stated several times that hyperinflation is unlikely until the Fed mows through the entire debt market. The last wall is the very short end of the curve and they will have to completely bankrupt the US "now" to get through it. Probably the only way they can do that is to make physical gold available for immediate settlement of transactions and there's no way in hell that will happen. There's a shortage of physical gold anyway and paper substitutes don't cut it any more than junk MBS is a good substitute for cash. This is all my opinion and I've not seen any discussion that outlines these concepts. I am not a PhD economist nor would I be considered an expert by the establishment in these matters. I think I've clearly outlined that several times in several different ways. There would be a further argument that for every seller in a panic there is a buyer so the cash settlements move back and forth equally. Wrong. The buyers will readily give up their particular funds to buy while the sellers, being risk averse, will desire to move into funds that they deem safe.

The final area to cover would be non treasury money market funds that reside outside the banking system. Some of those are municipals and municipals have come under more stress in the past week. The main point would be that in order for there to be a panic into t-bills and for the rates to go negative, the money market funds would need to break the buck significantly across the gamut. When the Reserve Fund broke the buck, that was only one fund and it did not occur across the gamut of money markets, as the Treasury was able to do a quick rescue. As long as the non treasury money market fund door is open for the most part, then t-bill rates will not stay negative.

[Higgenbotham]

http://kingworldnews.com/kingworldnews/ ... andeo.html

This links to an interview with Victor Sperandeo, who worked with George Soros at the Quantum Hedge Fund.

He outlines 3 scenarios.

The first is that stocks go back to around 1500 on the S&P 500 and gold goes down to around 650. This would be an economic growth scenario. (This ties into the recent discussion here about the Dow/Gold ratio. If greater than about 3% real growth can be attained, then all bets would be off as far as the Dow/Gold ratio going any lower. In that case, stocks and real estate are the better investments).

The second is that there is a steady inflation like that of the 1970s. Under this scenario, there would be no deflation and no hyperinflation. Inflation would average in the high single digits for a long period of time, like a decade or two.

The third is deflation, followed by hyperinflation.

I got the idea that he presented the first scenario as an alternate and the second and third scenarios as the most likely scenarios. He stated that a determined Fed will eventually get inflation if they try long enough and hard enough.

[John]

Vince and Higgie -

Could you respond to this query from a web site reader?

> Your articles on why the electronically printing of money by the
> Federal Reserve is not adequate to generate hyper-inflation is
> heartening. The logic is clear.

> Have you addressed the possibility of stagflation? The
> anti-western oil cartel cuts back oil production, the Chinese
> corner energy resources from enemy countries.

> Have any position on the Federal Reserve's motivation to monetize
> the national debt?

Thanks.

John

[Higgenbotham]

Vince and Higgie -

Could you respond to this query from a web site reader?

> Your articles on why the electronically printing of money by the
> Federal Reserve is not adequate to generate hyper-inflation is
> heartening. The logic is clear.

> Have you addressed the possibility of stagflation? The
> anti-western oil cartel cuts back oil production, the Chinese
> corner energy resources from enemy countries.

> Have any position on the Federal Reserve's motivation to monetize
> the national debt?

Thanks.

John

I don't have an answer, but have an idea for a starting point.

I believe real growth rates in excess of 3 percent on average would result in a growth scenario (scenario one above). I give this scenario a probability of close to zero.

Real growth rates between about 0-3 percent on average could result in a stagflation scenario (scenario two above). The reason I say could is because there can't be too many things that go wrong to maintain things steady as she goes because there is so much debt. The controlled stagflation would gradually reduce the debt load. I give this scenario a probability of 10 percent.

Negative real growth rates would result in deflation followed by hyperinflation if the Fed stays on course (scenario 3 above).

This assumes the Fed stays in control. I have no idea what the chance of that would be.

It would probably be a good idea for several people to read this and comment on it. It's a good topic as far as trying to figure out what will determine whether these various scenarios unfold. People give their opinions but they don't too often say what would determine why or why not or quantify it. For example, Sperandeo says either stagflation or deflation followed by hyperinflation but doesn't say what would determine whether it's one or the other.

One recent data point is world oil production (liquid fuels technically) has recently risen to a new all time high. That argues for some kind of growth if it continues.

[vincecate]

Vince and Higgie -

Could you respond to this query from a web site reader?

> Have any position on the Federal Reserve's motivation to monetize
> the national debt?

I will take a stab at this part. The Fed serves two masters. There are 12 people on the Open Market Committee which decides Fed monetary policy. Private Member banks own shares in regional Fed banks which get to appoint 5 members on the Open Market Committee. The government appoints 7 Fed governors who are on the Open Market Committee.

Now both the Private member banks and the government like to see lower interest rates. Private banks like it because it means higher bond prices, stock prices, and real estate prices. If interest rates on 30 year loans are 4% people can buy a house about twice as expensive as if interest rates are 8%. Banks loan against assets and so rather see assets going up in value than down. When they go down too much they are no longer good collateral for the loans and they get more defaults and lose money.

The government can sort of manage their $14 trillion in debt as long as interest rates are near 0%. But if interest rates go up the government will be clearly bankrupt. Before interest rates got as high as they did in the 1970s the interest on the debt would be more than all the taxes. So they also want to see interest rates low.

So both the Fed's masters want low rates. The Fed thinks they can drive up bond prices by buying more bonds, which would drive down rates. However, since QE2 was announced bond prices have actually gone down and rates have gone up.

I think the problem is that short term the Fed can influence interest rates by making new dollar and buying up debt. But if they do it too long and too much the fact that they are making all the new dollars will eventually lower the value of the dollar. If the money is dropping in value people will need higher interest rates to get them to loan it for some length of time (by the time they get their money back the same amount would not be worth as much). Sometimes the market anticipates things before they happen. It may be that the market anticipates that QE2 is going to cause the dollar to drop in value (at least measured against real things like commodities, even if not against other paper currencies in the dollar index). It may be that measured against real things like commodities the dollar has already dropped in value. I know I anticipate that the dollar will keep going down in value when measured against real things.

http://en.wikipedia.org/wiki/Federal_Re ... #Structure
http://finance.yahoo.com/bonds/composite_bond_rates

[vincecate]

Negative real growth rates would result in deflation followed by hyperinflation if the Fed stays on course (scenario 3 above).

This assumes the Fed stays in control. I have no idea what the chance of that would be.

So I am this forums resident hyperinflationist. Every forum should have at least one.

In my view there will come a time when people stop wanting to buy US government debt at the artificially low interest rates the Fed is creating given the real level of inflation. When this happens (which might be starting) the Fed ends up making enough new money to buy so many government bonds that they can cover the total government deficit and also all the old government bonds coming due each month. They will feel they must do this because if they did not buy bonds and interest rates went up all government taxes might go toward paying off bonds coming due and paying interest on the national debt leaving no money for the government to spend. So the Fed will feel forced to keep buying, just for a little while longer. But this enormous amount of money creation will lead to hyperinflation. At that point the Fed really loses control.

http://pair.offshore.ai/38yearcycle/#hyperinflation

[John]

So I am this forum's resident hyperinflationist. Every forum should have at least one.

Is hyperinflationism a religion or a career choice?

John

[vincecate]

So I am this forum's resident hyperinflationist. Every forum should have at least one.

Is hyperinflationism a religion or a career choice?

John

Of course I think it is science, or at least good economics. But if I am wrong, it seems more likely to be a temporary cult than a lasting religion. If we get through 2012 and there is no hyperinflation it will probably lose followers.