Bond Talk

There has been more bond talk[1] this weekend. The following rather cryptic (in my opinion) Reuters wire snippet has a lot of people worrying:

[11:41 US GOVTS: Real Money Using Coupon Passes To Exit; FM Blast]

Boston, May 21. There apparently is a new wrinkle to the intermediation trade between buying from Treasury to sell to the Fed with real money, including central banks, now in on the act. Indeed, several Street sources relay central banks were aggressive offers into this morning’s coupon pass, with one letting go of a large block of old 5-years. Other offers too are coming in from embedded Asian real money longs — in the higher coupons — also looking to sell size without unduly upsetting the market, and especially considering the illiquidity in off- the-run bids from the Street.

Which pretty much says that central banks (European and Asian) are using the US Treasury’s bond auctions to dump existing holdings. Meaning that they are getting creative at dumping long term treasuries, without unduly freaking the market.

Denninger comments:

So now what Ben?

If Foreign Central Banks are selling into Ben’s bid then the game is literally weeks or even days away from being over.

I have written for over a year about the potential for a bond-market implosion and subsequent economic collapse.

and i can see why he might think that… if the real money is looking for the exits, the Fed will be left holding all the long term (10 to 30 year?) debt, with the rest of the world closing out at short-end.

However, i don’t think this game is going to play out in the suddenly apocalyptic fashion that people like Denninger (and many like him) fear. The holders of these bonds (mostly China, Japan, and other asian central banks) know that if they crash the dollar, debt they hold is going to be worthless. My guess is that they are going to push this as far as they can without actually letting it break. Over time they’ll push the yield higher and higher, hoping that they can bleed America dry without actually sending it into cardiac arrest.

If you’ve been watching the yield on the ten and thirty year you’ll see that they are still heading up. And that has to be halted or it’ll set off a next wave of defaults in the housing market… certainly agree with the question, “So now what Ben?”

As an aside, there are a bunch of stories[2] out there about the rating agencies (S&P, Moodys, Fitch, etc) downgrading the national debts of the US, UK, and Japan. This looks like a side- show to me – these are the same clowns who stuck AAA ratings on MBSs, and obviously don’t understand that Japan doesn’t give a flying about it’s debt rating because it’s not borrowing externally… ignore it, and keep an eye on that bond yield!

[As always, Cynicus Economicus is worth a read.]

1. Bond market Week of Reckoning, Lighten upBond Market To Bernanke and Obama: F&$k You

2. UK credit rating under threat as debt hits £8.5bnWhy US Debt Rating Poses Such a Big Worry to InvestorsTreasurys fall further ahead of auctions

Reality Sucks

Imagine a group of 100 fisherman faced with declining stocks and worried about the sustainability of their resource and their livelihoods. One of them works out that the total sustainable catch is about 20% of what everyone is catching now (with some uncertainty of course) but that if current trends of increasing catches (about 2% a year) continue the resource would be depleted in short order.

The Tragedy of the Climate Commons, Realclimate

No need to imagine!

The Commission acknowledged years of policy failure in an unusually candid report last month, which concluded that too many subsidy-dependent fishing boats were chasing too few fish. “If nothing happens soon, we will soon end up with no fish to fish for,” said Joe Borg, the fisheries commissioner.

— Storm threatens as Brussels trawls for answer, FT.com

A Little Fun: Redux

Time to face the music.

On Sunday of this week i decided that it’d be fun to make a prediction. In my view it was going to be impossible to sustain the current rally in the US markets. Too much news was obviously negative, and all the attempts to put positive spins on it were getting out of control.

DJI-15-05-09The graph is nowhere near as dramatic as i predicted (or expected) it would be. Still, it was down 5% on the week, the biggest weekly fall for 2 months (back when this rally started in March ’09).

As usual my ability to relate to peoples desire to believe that things are always on the up and up, was my undoing. As far i can tell there is very little reason to optimistic given the fundamentals. No point in going over it all again. I’ll just say that it’s hard to see anything out there in the news that indicates much more than a world economy approaching terminal velocity. That’d be great news if we were talking about an ant falling out of a tree, but it’s not so hot with the full weight of capitalism there to drive us into the ground.

Interesting aside: what on earth is going on with the trading volume spiking at the end of each day? It appears that a lot of parties are closing / taking positions at the end of each day. Perhaps it’s related to trading systems trying to match outstanding orders before the market closes. Should look into it, must be explained somewhere… yes, people closing up positions.

Well, enough of that for a while. No idea what the market will do next week… but i maintain my opinion that we’ve seen the end of this (suckers) rally.

Defeat

Interesting things going on in the world of gloom, doom, and despair recently.

The FT is running an article where the US secretary of agriculture basically warns that there is food crunch ahead:

The US agriculture secretary has warned that unless countries take immediate steps to sharply boost agricultural productivity and food output and reduce hunger, the world risks fresh social instability.

“This is not just about food security, this is about national security, it is about environmental security,” he said on the sidelines of the first meeting of the Group of Eight ministers of agriculture.

Charming.

Lots of talk about the US Treasury ‘stress tests’ for the banks. The worst case scenario that they are using is predicated on the headline unemployment number hitting 10.4% by the end of next year (it’s currently 8.5%, and rising fast… it’ll probably hit 10% in a couple of month, maximum) and a decline in house prices of 29% from the start of this year, and over a similar period… they are currently down 22%, and, you guessed it, falling rapidly.

The other issue is that while stress tests might have seemed like a good idea at the time, now that the results have to be released, there are all sorts of dilemmas. If all the banks pass with flying colours were the tests rigged? If some of the banks fail, and are sent off to secure new capital over the next six months, what is going to happen to their shares? Will it provoke runs on the failing banks? Perhaps the results could be kept secret.. that always inspires confidence.

This is looking like a slightly different take on the old, ‘good bank / bad bank’ discussion. The outcome doesn’t stand much chance of being much different… the people will end up assuming the position (all of the risk) while the banks try to hide their losses. What a mess.

This piece by Cynicus Economicus is really worth reading (as are the comments). He makes a pretty good case for believing that the anglo-saxon system of capitalism has run it’s course, and that we are now going to live through a very different (and declining) part of the cycle. I’ve always been intrigued by the idea that societies develop in cycles, going from youthful exuberance, middle aged stability, to staid old age. There seem to be many examples of this… and i’m sure a lot has been written about it. I’m already reading too much.

The other aspect of that piece, that is far more worrying, is the idea that the Chinese have twigged to the idea that Fed printing money <cough> embarking on quantitative easing, is a de facto act of default on the debt. There is evidence out there that China is positioning itself to survive this figurative middle finger to the developing world. 

Graphs like that (from here) make it clear that the Chinese are very aware of the “dollar trap” and, if the reports of them moving to buying up natural resources, precious metals, etc. are to be believed, actively working to insulate themselves from the US attempting to inflate themselves out of debt.

It’s a disturbing prospect on many levels. Defaulting on debts denominated in the worlds reserve currency… seems like a road to terrible instability, economic warfare, and eventually, outright conflict. It’s always said that war is only way out of depression, and it’s easy to see why. Personally, i’m not convinced that it’s inevitable… an odd moment of optimism?

On another positive note, the sheer size of China’s dollar denominated reserves mean that they aren’t going to unduly rock the boat. They’ll be trying to beat an orderly retreat, reallocating into other currencies, and assets. This movement is going to take time. Meaning that those of us with exposure to the dollar might see a period of relative stability until the endgame (a new world reserve currency, that greatly reduces America’s influence) becomes obvious / inevitable.

It’s looks to me that China has their eyes on the prize and is very much playing to win… will be interesting to see if Japan choses to go ‘down with the ship’ or makes like a rat. There is a lot of historic baggage to be lugged around, but surely pragmatism will force Japan to reconsider it’s current position as the outsider in Asia.

The War on Iceland

Been slacking in my econo-doom reading recently – too busy with work. However, this article, by Michael Hudson, is too good to ignore. Class quote:

Bad real estate debts also are pulling down banks in the two leading creditor nations, Britain and the United States. Real estate prices, stock market prices and employment are going down in a straight line unprecedented even in the Great Depression of the 1930s. This has turned the neoliberal financial dream of “creating wealth” by inflating asset prices, by creating credit without actually increasing tangible capital formation (wages and living standards) into a nightmare. Just as individuals can’t live off a credit card forever, neither can nations. As any classical economist knows, societies that only manufacture debt are unsustainable. Casinos may be fun places to visit (customers pay by losing their money), but no place to live. The same is true of casino economies.

A long read, but worth it. Covers most of the issues that have been bothering me for the last couple of years. Looking at history older than the Great Depression is instructive. It would appear that the issues of debt are intrinsic to the system of capitalism and human nature:

The birth of international post-medieval banking proved disastrous for many family banks that foundered on what turned out to be bad loans to the leading powers of early Europe, from Spain to France and England. The historian Richard Ehrenberg notes that Spanish bankruptcies “occurred at intervals of about twenty years – 1557, 1575, 1596, 1607, 1627, 1647,” often being rationalized by pious allusions to Church prohibitions against usury. England declared bankruptcy under Edward III in 1339, and Charles II shut down the Exchequer in 1672 and suspended payment on its floating debt.Wiping out debts was the only way to retain basic economic and political relations and national independence. In view of this long experience, England’s advice to Iceland today is in the character of “Do as we say, not as we ourselves have done and are doing.”

All the ‘smoke and mirrors’ tricks of governments to shuffle debt around, tweak interest rates, fix / float exchange rates, end up being impacted by the usual human failings: clever in the short term, but catastrophic in long term. The imbalances are maintained until entropy can no longer be cheated, and the whole hideous edifice comes crashing down.

My favourite analogy for this are the forests of the Western US. By managing for decades to control the fires that would periodically rage there, the build up of undergrowth reached a point where control was impossible, and any fires became unnaturally large / fierce. Giant sequoia that can easily withstand the periodic small fires, don’t stand a chance in these raging infernos. 

Too big to fail? We shall see.

This seems to be one of the underlying messages of Straw Dogs – man’s presumed mastery of the world around him is largely an illusion. All our ‘progress’ comes at a price. And it’s not cheap.

Meanwhile, the stock market in the US has recently had it’s strongest five days since 1932. There are still a lot of people out there who want to believe

Bear Entrails

Can you tell i’m catching up with my reading?

four-bears-large

Over on dshort.com there are updates of the Four Bad Bears, and Mega-bear Quartet. The first of those links to some pretty interesting looking datasets / discussions. In essence this is now the 2nd worst S&P / DOW market in a hundred years… I’m guessing the Great Depression record is going to be hard to beat. Despite all my cynicism, it does appear that some lessons have been learned in the preceding years.

That being said, the Swiss have started trying to devalue of the swissy, that doesn’t bode well.

Anyway, it will be interesting to see how the S&P tracks the 30s collapse. My feeling is that we’ll see a similar pattern of long decline, punctuated by ‘Sucker Rallies’. The peaks and troughs in those graphs are really maps of human nature, and despite what history tells them, people just want to believe!

Hope. Hope has bought us this far – far enough to shred our hearts to pieces.