The Federal Reserve will not monetize the debt - Economics -- Two Plus Two Poker Forums

J.R. · 08-06-2009, 09:20 PM

On June 3, 2009, Ben Bernanke testified before the House Budget Committee.

Quote:

Rep. Paul D. Ryan of Wisconsin, ranking committee Republican, said the rising bond yields were "telling us that there is no free lunch," and he cautioned that the combination of huge Treasury debt issuance and central bank purchases of Treasury bonds under a recently announced Fed program could be a dangerous mix.

"The Treasury is issuing debt and the central bank is buying it," Mr. Ryan said. "It gives the alarming impression that the U.S. one day might begin to meet its financial obligations by simply printing money."

But Mr. Bernanke adamantly denied that would happen. "The Federal Reserve will not monetize the debt,"he said. "Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation."

http://www.washingtontimes.com/news/...d-chief-warns/

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On Wednesday, July 29, 2009 the Treasury's auction of $39 billion in 5 year debt had very poor demand:

Reuters:

Quote:

NEW YORK, July 29 (Reuters) - The U.S. Treasury sold $39 billion in five-year debt on Wednesday in an auction that drew poor demand, raising worries over the cost of financing the government's burgeoning budget deficit.

Demand overall was below average, measured by the bid-to-cover ratio of 1.92, the weakest in almost a year.

In a further sign of weakness, yields at the auction were well above expectations, known as a "tail" by market participants.

A key proxy for foreign interest, the indirect bidder category, was slightly above the average of auctions over the past year at 36.6 percent but far below the most recent sale.

"It was just a horrendous result," William O'Donnell, head of U.S. Treasury strategy at RBS Securities in Greenwich Connecticut, said about the auction.

"It was the weakest bid-to-cover since September 2008, and by my numbers it was the biggest tail since February 1993. It was just a very, very weak result."

The tail indicates that dealers drove an unexpectedly hard bargain to raise yields, and lower prices, to buy the bonds, which spooked the bond market.

http://www.reuters.com/article/marke...49944020090729

Denninger was his usual in your face, over the top about this 5 year auction:

Quote:

US 5yr Bond Auction Effectively FAILS[/U]
..
And here's the math:

1.923 BTC X 61.59% Primary Dealer bid = 1.18 BTC (PD), greater than 1.0. Or to put it a different way, but for the primary dealers the bid-to-cover was less than one, meaning that some of the issue would have been left on the table.

Thats a fail; but for the primary dealers the issue would not have subscribed.

Primary dealers are required to bid. That's the deal in exchange for their being named as "primary dealers." For this reason short of thermonuclear war you will never see an actual (BTC < 1.0) "fail" on a US Treasury Auction - Treasury has rigged the process so as to insure that cannot be reported.

Therefore, the question is this: Less the primary dealer "bid" (forced by agreement) was there sufficient interest to subscribe the issue, and the answer is NO.

Those who think this is "no big deal" need to have their head examined. In general any BTC under 2.0 indicates a serious problem, and the perverse nature of the primary dealer system is the reason.

The United States' Credit Card (issued by China and Japan) is being slowly cut off. That the stock market "recovered" after this ridiculously bad auction (bow-wow is the best way to describe it) speaks to the vacuum between the ears of both the cheerleaders in the mainstream media and those in the equity markets.

There is only one other time in recent memory that we've had a bond market auction fail like this. You might want to go have a look at your charts - with dates - for what followed shortly thereafter.

They're going to try to sell 7yrs tomorrow, and then the real fun begins with the quarterly refunding.

http://market-ticker.org/archives/12...ely-FAILS.html

As Karl noted, the poor 5 year auction raised concerns about the 7 year auction the next day.

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What happened at the $28 billion 7 year auction the next day:

Quote:

Seven Year : Not an Itch But A Soothing Massage
July 30th, 2009 1:56 pm | by John Jansen |

The treasury successfully auctioned $ 28 billion 7 year notes at a yield of 3.369 percent.

http://acrossthecurve.com/?p=7460

WSJ:

Quote:

Longer-maturity Treasurys were boosted Thursday after a successful seven-year auction soothed investors and dealers burned by two disappointing Treasury note sales earlier in the week.

Treasurys seven-years and out were outperforming after the $28 billion sale, the final auction in a record $115 billion offering of Treasurys this week.

The auction drew the most interest from large institutional investors, including foreign central banks, of the three note sales this week. This demand, known as the "indirect bid", accounted for a robust 62.5% of the offering, compared with the 67.2% bid seen at the last $27 billion seven-year sale in June and an average bid in the low-to-mid 30% range.

The new notes were awarded at a yield of 3.369%, a bit below the 3.396% yield seen just before the sale, a sign of good demand. Bids totaled $78.59 billion, or 2.63 times the amount on offer, compared with 2.82 at the last sale and an average this year of 2.40.

Results came as welcome news for investors after the previous two- and five-year sales failed to attract much demand, raising the cost of borrowing for the U.S. government as it seeks to cover its rising budget shortfall.

http://online.wsj.com/article/BT-CO-...30-720829.html

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Inquiring minds are uncovering things were not as they perhaps seemed on the surface regarding the $28 billion 7 year auction on July 30:

From Chris Martenson

Quote:

Here's a recent example illustrating that the Fed's actions are more consistent with financial desperation than economic health.
...
Looking at the maturity range we can see that these are all long-dated bonds with the one today specifically offering us a tantalizing clue as to how the shell game is being played.

Here's the Treasury announcement for the 7-year auction that came out on July 30 (last Thursday). Please note the specific CUSIP number circled. Every bond in this auction carries this specific identifying number.
...

Good grief! Just last week, when the auction results were announced it was trumpeted to great fanfare that there was "more than sufficient" bid-to-cover, "strong demand" and all the rest.

And now it turns out that 47% (!) of the bonds that were taken by the primary dealers in that auction have been quietly bought by the Fed and permanently secreted to its balance sheet.

They didn't even wait a full week! A more honest and open approach would have been for the Fed to simply buy them outright at the auction but this way, using "primary dealers" and "POMOs" and all these other extra steps the basic fact that the Fed is openly monetizing US government debt is effectively hidden from a not-too-terribly inquisitive US press and public.

The speed of the shell game is accelerating.

This immediate repurchase of newly auction bonds by the Fed tells us that demand for these bonds is not nearly as high as advertised, and that things are not quite as strong as represented.

..........

Denninger picked up on Martenson's find and the hyperbole exploded: BLATANT Monetization Uncovered

Quote:

Remember the Dallas Fed's Fisher saying that "The Fed will not become the handmaiden of Treasury"?

He was lying (The Fed already has), and now there is proof.

Mad props to both Zerohedge and Chris Martenson for noticing this; I missed the facts buried in the CUSIP list.

The upshot: The Fed bought nearly half of LAST WEEK'S 7 year Treasury Issuance TODAY.

Huh? Remember, after the 5 year auction that went badly (and which I wrote about) the 7yr auction went "well." Rick Santelli (and a lot of other people) agreed - demand was strong. That made no sense to me at the time, coming one day after a near-failure in the 5 year.

Well now we know what happened: The Fed pretty clearly pre-arranged, either explicitly or by "suggestion", that the Primary Dealers take up the auction with the promise that The Fed would immediately monetize half the issue!

Folks, this is beyond bad - it is pernicious and outrageous conduct by The Federal Reserve in conspiracy with the Primary Dealers, both of which are now desperately trying to prop up the US Government Bond Market through subterfuge rather than just buying up the bond issue from Treasury when originally put to the market!

If you think the economy and credit markets are "on the mend" why would The Fed do something like this? It would not be necessary unless The Fed was told (by those very same Primary Dealers) that they were going to be unable or unwilling to take down any more Treasury Debt.

Folks, let me be clear: The United States HAS OFFICIALLY HIT THE TREASURY DEBT WALL and The Fed and Treasury are engaged in subterfuge and conspiracy in an attempt to hide this from the market.

There is no other explanation for what just happened.

None.

http://market-ticker.org/archives/13...Uncovered.html

.....

ZeroHedge picked up on it too: The Fed's UST-POMO Pyramid Scheme Exposed

Quote:

In a brilliant piece of investigative reporting, Chris Martenson (original article here) has uncovered that the Fed, merely a week after issuing $28 billion in 7 year bonds (which Zero Hedge discussed previously) via its puppet, the US Treasury, of which $10 billion ended up being purchased by primary dealers, has turned and bought 47% of the primary allocated bonds in Open Market Purchases. This is undisputed monetization removed simply via one primary dealer and less than 5 days of temporal separation in order to leave no easy trace. As Martenson points out:

"A more honest and open approach would have been for the Fed to simply buy them outright at the auction but this way, using "primary dealers" and "POMOs" and all these other extra steps the basic fact that the Fed is openly monetizing US government debt is effectively hidden from a not-too-terribly inquisitive US press and public."

The question is did the Fed implicitly tell the primary dealers they are merely holding the treasuries for a flip, and that it would acquire them immediately. Absent this $4.8 billion in effectively monetized bonds, what would the Bid To Cover have been for the primaries? Would this have been the second practically failed auction for USTs after the deplorable 5 year auction results a day prior? One wonders if there would have been 62% indirect interest in these bonds (which the day before had a measly 32.5% indirect bid) if the purchasers were aware of the Fed's immediate prompt monetization of a large part of the directs' balance.

It is truly a sad state of affairs when the Fed has to manipulate public and media perception in this way, and has to cover up for the complete lack of interest in US Treasuries.

http://www.zerohedge.com/article/fed...posed#comments
........

Golden Truth:

Quote:

As a former bond trader, it wouldn't bother me if just a small amount of paper with last week's 7-yr Treasury cusip showed up on today's POMO report. That could be attributed to coincidental bond trading flow. HOWEVER, the fact that Primary Dealers took down 36% of last week's 7-yr auction and then the Fed turned around and repurchased almost 48% of those exact bonds from the Primary Dealers suggests that some kind of arrangement beyond mere coincidence was in place between the Fed, the Treasury and the Primary Dealers.

In fact, between last Thursday's $28 Billion 7-yr Treasury auction and today's stunning find by Mr. Martenson, the Fed conducted FOUR POMO operations in which it swallowed up (i.e. directly monetized) $23.74 billion in Treasury bonds ranging in maturity from 4 yrs. to 17 yrs. This represents almost 85% of the total 7-yr. Treasury auction. IN FACT, the four POMO operations in the last week represents neearly 10% of the total number of POMO operations conducted by the FED in the last 12 months. Here is a link to the Fed's POMO operations:

http://www.newyorkfed.org/markets/po...play/index.cfm

Given that we know the Chinese did not participate in a meaningful way in the last week's Treasury auctions, many of us were wondering how the Treasury was able to auction off as much paper as it did without a significant back-up in yields or more overall volatility in the bond market. It looks like we have our answer and the answer is that the Federal Reserve has resorted to printing money in order to directly monetize the record Government spending deficits AND the Treasury auctions used to finance those deficits. Get ready for a big uptick in inflation.

http://truthingold.blogspot.com/2009...ast-weeks.html

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On June 24, the Fed commented the following in a Press Release:

Quote:

As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

http://www.federalreserve.gov/newsev.../20090624a.htm

Quote:

What happens when the $300 billion purchase program limit has been met? At the current rate of purchases, this will be sometime in early September. Will the Fed extend this program? A few possible outcomes ...

* The Fed does not extend the program and the Treasury continues its schedule of longer dated auctions (monthly and in consistent amounts for the 7-year, 10-year, and 30-year treasuries). Here, longer dated treasuries will fall and yields will rise, sans some unexpected reversal of investor sentiment with respect to these securities. The impact on the economy and particularly the housing market will be significant.

* The Fed does not extend the program and the Treasury cuts back on the volume of longer dated auctions, replacing them with securities of shorter duration. Here, the average maturity of outstanding Treasury debt will continue to decline, forcing the Treasury to roll over maturing debt more often. This is also much riskier for our economy in that investors will have more leverage over short term interest rates, which will also impact longer term interest rates over time.

* The Fed extends the program. Regardless of what the Treasury does, this additional debt monetization will result in more bank reserves created by the Fed and all other things being equal, an increased monetary base. Also, at some point, investors will shun these securities in larger numbers, driving longer term interest rates higher.

Revelation of the path chosen by the Federal Reserve and Treasury will not be long in coming.

http://www.financialsense.com/fsu/ed...2009/0804.html

J.R. · 08-06-2009, 09:54 PM

Oops, forgot to link the original C.Martenson article: http://www.chrismartenson.com/blog/f...-auction/23880

Zygote · 08-06-2009, 10:54 PM

i wrote about this on my blog. bernanke saying they have less treasuries now than they did before the crisis is so misleading its ridiculous. he ignores the changes in maturity and all the agency debt he's taken on plus all mortgages they bought which forsure have federal obligations stuck in a good chunk of them. plus aig credit etc. also if we count all federal debt they are holding as collateral compared to the past the changes are hugangous. this also ignores that everyone knows he'll monetize more push come to shove, despite what he says.

havent read all the pieces you posted yet but will. thanks again for your posts

mjkidd · 08-06-2009, 11:10 PM

I've been in the Austrian deflationist camp and even I'm getting a little worried about rising bond yields. If the dollar unravels (and it will) I think that it will happen shockingly quickly...I've recently said that it's extremely unlikely it will happen in the next two years, but I very well could be wrong. Luckily for me if it does happen no one is going to be posting on internet poker forums and I won't have to admit my mistake.

J.R. · 08-06-2009, 11:29 PM

Quote:

Originally Posted by mjkidd

I've been in the Austrian deflationist camp and even I'm getting a little worried about rising bond yields. If the dollar unravels (and it will) I think that it will happen shockingly quickly...I've recently said that it's extremely unlikely it will happen in the next two years, but I very well could be wrong. Luckily for me if it does happen no one is going to be posting on internet poker forums and I won't have to admit my mistake.

Many/most would argue it still depends on what the FED does, although the inflationistas think its obvious what the FED will do. In some respects its a poker game, because as Krugman and Bernanke have argued, perceptions and expectations matter. This is why people like Mish and Denninger think deflation - they think Ben is scared of a hyper/destroying the currency and recognizes he can't push too hard despite his puffery otherwise, and that he will relent and the debt must deflate.

If/when a hyper occurs is largely dependent on how hard they push against the massive deflationary forces. They have pushed a lot and aren't doing so well.

Most don't think they have pushed enough yet to cause a hyper, but its hard not to see how this ends if they keep it up, and there is loads more debt to deflate. CRE and Alt-A/option arm (much of it juicy prime) is/will get slaughtered, along with lots of regional banks failing and many companies (corporate debt) defaulting.

In a credit crisis economic downturn, unemployment is not a lagging indicator (because the underlying problem is too much debt, hence the answer is boosted wages/employment (i.e. economic production) to pay off the debt).

A credit crisis doesn't end while layoffs continue, the credit crisis gets worse as layoffs continue.

mjkidd · 08-06-2009, 11:54 PM

I agree with your post. Except I actually DON'T think that it matters what the fed does; inflation is inevitable, given the structural deficits that the US faces. Well, I guess it's not inevitable, since the Fed could refuse to monetize debt, but I doubt that they will refuse. I guess I'm a deflationist because I don't think that the dollar will crash anytime soon...it's more a market timing thing than anything else. Except I'm not actually trying to time any markets since most of my savings is in gold, because I'm a big big pussy.

J.R. · 08-07-2009, 12:52 AM

Quote:

Originally Posted by mjkidd

I agree with your post. Except I actually DON'T think that it matters what the fed does; inflation is inevitable, given the structural deficits that the US faces.

Hyperinflation and inflation are worlds apart. The new money (if its not a nutty amount that causes a hyper) will eventually lead to price inflation, we will also de-leverage (deflate/default on debt - foreclosures, bankruptcies (corporate and individual). Stagflation where the new money runs to good assets and the bad assets collapse in value (houses down, oil up!).

To the extent you mean they will keep engaging in monetary inflation, probably, but its arguable they could keep monetary inflation going slow enough to avoid a big collapse and slowly flatline it sorta like Japan (up to a point).

A hyper is a whole other story that follows from fighting the de-leveraging /deflation too hard (and/or too long).

J.R. · 08-07-2009, 01:09 AM

Currencies trade relative to one another. The US has been inflating/debasing relative to other currencies.

Quote:

07th August 2009

Hopes for a quick economic recovery were dashed yesterday when the Bank of England dramatically expanded its money-printing operation.

The Bank stunned the City by voting to pump an extra £50billion into the markets over three months - more than half a billion pounds a day.

And the official interest rate was kept at its all-time low of 0.5 per cent, as the Bank warned the recession was proving 'deeper than previously thought'.

The decision blindsided many in the City, because recent figures on housing and business activity pointed to a tentative recovery.

But while the Bank acknowledged there are signs the downturn may have bottomed out, there are no signs its drastic measures have yet brought an end to the credit drought.

A statement from the Bank blamed Britain's banks, criticising them for continuing to reduce the supply of credit to hard-pressed businesses.

This will suppress the economy's potential to grow, the Bank said. It added that financial conditions remain fragile and interest rates on loans are still high.

http://www.dailymail.co.uk/news/arti...-recovery.html

Wonder how this impacts the FOMC's looming decision on the future of its (so far) $300 billion QE experiment.

J.R. · 08-07-2009, 01:11 AM

Where is your blog?

Quote:

Originally Posted by Zygote

bernanke saying they have less treasuries now than they did before the crisis is so misleading its ridiculous. he ignores the changes in maturity and all the agency debt he's taken on plus all mortgages they bought which forsure have federal obligations stuck in a good chunk of them. plus aig credit etc. also if we count all federal debt they are holding as collateral compared to the past the changes are hugangous. this also ignores that everyone knows he'll monetize more push come to shove, despite what he says.

Dope.

Your Mom · 08-07-2009, 04:41 AM

Any thoughts on what will happen if the dollar collapses?

ianlippert · 08-07-2009, 07:39 AM

Quote:

Originally Posted by Zygote

i wrote about this on my blog.

Is your blog goldnews.com?

Zygote · 08-07-2009, 09:40 AM

Quote:

Originally Posted by ianlippert

Is your blog goldnews.com?

yes. i hope to post more frequently in the near future.

if you happen to read anything, please let me know your thoughts, comments and/or criticisms on content or writing style.

thanks

Zygote · 08-07-2009, 09:50 AM

Quote:

Originally Posted by J.R.

Where is your blog?

www.goldnews.com

please let me know your thoughts if you check out and have the time. thanks

mjkidd · 08-07-2009, 10:24 AM

Quote:

Originally Posted by J.R.

Hyperinflation and inflation are worlds apart. The new money (if its not a nutty amount that causes a hyper) will eventually lead to price inflation, we will also de-leverage (deflate/default on debt - foreclosures, bankruptcies (corporate and individual). Stagflation where the new money runs to good assets and the bad assets collapse in value (houses down, oil up!).

To the extent you mean they will keep engaging in monetary inflation, probably, but its arguable they could keep monetary inflation going slow enough to avoid a big collapse and slowly flatline it sorta like Japan (up to a point).

A hyper is a whole other story that follows from fighting the de-leveraging /deflation too hard (and/or too long).

I agree mostly but I don't think the line between significant inflation and hyperinflation is not under the control of the Fed. Obviously the Fed has some control, but given the status of the dollar as the world's reserve currency, the dollar's value is largely controlled by foreign holders of treasuries, rather than the central bank. The Fed actually has less control over the dollar than other central banks have over their currencies.

ianlippert · 08-07-2009, 02:39 PM

Thats cool Zygote, your one of the few poster who I wish posted more. Now I see where all your content has gone!