Thursday, August 26, 2010

Bond market: "Reports of my death have been greatly exaggerated"



If you're like me I'm sure you've been hearing a lot of talk about a bond bubble recently. It's everywhere--on TV, in the news, everywhere. You can't go five minutes without somebody talking about how the bond market is in a bubble and how it's going to burst. That's just for starters, because when they tell you it's going to burst they say that when it does it will make the housing and dot-com bubbles look tame by comparison.

Some of these Cassandras have been shouting their warnings for a long, long time. People like Peter Schiff, Jim Rogers and Marc Faber have been telling us that bonds have nowhere to go but down for years. Meanwhile, the bond market has done nothing but go up. I'm absolutely positive that Rogers, Schiff and Faber wouldn't have any money at all if they followed their own advice. That's why they don't. They've cleverly fashioned lucrative businesses for themselves that keep them far away from the dirty and distasteful chore of having to earn money off their own investment ideas. Rather, they earn money the modern American way: through clever marketing, celebrity, advisory fees, book sales and public appearances. Maybe this is a testament to their business savvy, I don't know, but one thing I do know for sure is that it's certainly a sign of their disingenuousness.

Their message has been finely honed: the United States government is borrowing its way into oblivion and pretty soon there won't be anyone around to buy our debt. We ought to get down on our knees and thank God that all those generous Chinese people buy our bonds because without that we'd be another Zimbabwe. The outrageously flawed analogy to Zimbabwe is one of their favorites and they invoke it often and with great flair! Sometimes they'll even display a real, 100 trillion Zimbabwe note and say that it wouldn't even buy you a 2 cent stick of gum. In the next sentence they'll confidently predict that the dollar is headed for the same fate if the U.S. keeps up this "profligate" spending. You have to admire their showmanship; it's just too bad the comparison to Zimbabwe, Wiemar Germany or Argentina is completely ridiculous.

When I hear people say that the U.S. is broke and that we only exist because of the kindness of the Chinese, I have to ask them a very simple question: What exactly is America borrowing? I mean, seriously, what are we borrowing? Let's be specific here! After all, if you want to solve a problem or understand something complicated you sometimes have to break it down.

So, let me repeat...what are we borrowing?

The answer is, if we're borrowing anything at all (and that's debatable), we're borrowing dollars. Not Chinese yuan or Japanese yen or Euros or Beanie Babies. We're borrowing dollars. Even the "Debt/Doomsday" crowd wouldn't disagree on this one.

Once you accept that dollars are being borrowed, not yuan or yen or Euro, then the next question has to be, where did those dollars come from? Yes, maybe some of those dollars came from China, but where did the Chinese get them from? Ultimately there is only one place where anyone can get dollars from and that is the U.S. Government. The United States is a sovereign currency issuing nation and the monopoly issuer of the dollar. Dollars cannot not be gotten anywhere else; if they are, they're counterfeit.

It follows that in order for anyone to have the dollars to lend us the government had to have spent those dollars into existence in the first place or nobody would have them--period! They can't come from any other place. Moreover, the government must spend more of its dollars than it collects in taxes and fees for the non-government (that's me, you, businesses, states and the rest of the world) to have a surplus of dollars to "lend." There's simply no other way.

It should now be obvious that the money that goes into Treasuries--whether that comes from American citizens or foreigners--is not really a loan at all. A bond is nothing more than a savings account that the government offers to people who hold dollars. That's it. And the money to buy bonds comes from government spending itself (more accurately, deficit spending).

I'd like to bring the Fed into the equation at this point because I started out talking about how this is not a bond bubble and I'll need the Fed to help explain this. (Short sellers, pay attention!)

The Fed's main policy tool is the setting of interest rates. The Fed does this by buying or selling government securities. Yes, those very same bonds, notes and bills that the public holds. When the Fed buys securities it credits the reserve accounts of banks. Reserves are added to the banking system and, voila!, the interest rate goes down. If the Fed wants to raise interest rates it does the opposite: it sells securities and that results in the debiting of reserve accounts and rates go higher.

Throughout this economic crisis the Fed has been bringing interest rates down, in fact, it has brought rates down a lot. The Fed funds rate is currently close to zero and it has been there for quite some time. In order to get the funds rate to zero it has had to be a buyer of securities as per my explanation. Moreover, the Fed recently said that it would start to target longer term rates, so it has begun buying bonds. Remember it is buying bonds from the public. I often hear people say that the Fed is buying bonds from the U.S. Treasury so that the government has the money to spend. That is completely wrong. I explained earlier that the government spends by issuing its own money, which gets spent into the private economy and some of it is held by the public in Treasuries.

The Fed will continue to buy until it reaches the rate of interest that it feels is appropriate and it will maintain that buying as needed to keep the rate there.

This is where the short sellers and bond bubbleheads need to pay very close attention.

The Fed's checkbook is unlimited and it will use that checkbook to any degree necessary to implement its policy. That is why talking about a bubble is simply ludicrous. Bonds are up for one reason: because the Fed continues to guide interest rates lower and it is telling us that they're likely to keep them low for an extended period of time. That means, a lot more bond buying. It also means that no matter how many short sellers there are in the Treasury market no one is going to "break" this market if the Fed does not want it to be broken. Moreover, it doesn't matter if China, Japan, the U.K. the Saudis or anyone else never buys a single bond again; it does not hinder the U.S. Government's ability to spend in its own currency.

In the meantime, interest and principle will be paid the same way it has always been paid, which is by crediting bank accounts electronically. Changing the numbers. Marking them up. That's how it's always been done and that's the way it will continue to be done.

In the end the "bubble" will burst when the Fed tells us it is going to reverse its policy. In other words, when it says it's going to start raising interest rates again. In the meantime, if you've been thinking about going short because of all this talk about a bubble, save yourself some money and go have a beer instead.

26 comments:

Anonymous said...

Moreover, it doesn't matter if China, Japan, the U.K. the Saudis or anyone else never buys a single bond again; it does not hinder the U.S. Government's ability to spend in its own currency.

But it does matter, you said it! What's the difference between Argentina and the US? Mike Norman: the US borrows in its own currency.
So, at that point there would be no difference between the US and any other country that issues its own currency. And then you can "print", "mark up" or "change accounts electronically" just like Zimbabwe.

googleheim said...

Add the Bizradio BOZOs : frischberg, lucia, phil grande

they are all saying that bonds are going to hurt you when interest rates go up

they now function interest rates with bonds

yesterday the function interest rates with debt

before that with oil prices

before that with wheat mold in a revival gospel tent making people shake like their speaking in tongues

WHEN WE KNOW THAT RATES ARE EXACTLY WHERE THE FED DECIDES TO PUT THEM

RATES ARE NOT CHANGED BY ANY FACTORS EXTERNAL

RATES ARE CHANGED BY HUMAN CHOICE TO "DO SOMETHING"

WHEN VOLCKER RAISED RATES IT WAS NOT, I REPEAT NOT BECAUSE SOMETHING EXTERNAL OR SOME MARKET OR SOME COMPUTER OR SOME LOGIC CHANGED THEM

THEY WERE CHANGED TO COMPENSATE FOR ALL THE TAX CUTS REAGAN MADE AND DONE SO BY CHOICE BY VOLCKER HIMSELF BECAUSE HE WANTED TO "DO SOMETHING"

BERNANKE IS FOLLOWING THE JAPANESE PATH AND SHALL NOT RAISE INTEREST RATES UNLESS HE IS BLUFFING THE GEISHE MOVE AND REALLY IS BEING PUPETEERED ALONG WITH OBAMA BY VOLCKER SITTING IN THE BACK PORCH HAVING COCKTAILS WITH PINOCHET AND KISSINGER

Anonymous said...

when you're ultimately proven wrong on this, as you were on the real estate bubble, are you finally going to retire and stop spouting your ponzi-nomics nonsense in public?

fantasy-nomics can only go on so long, before reality turns round bites your ass.

you can say youre not bankrupt all you like, because your debt is denominated in your own currency, but as soon as people finally wake up and want real things of value rather than your green toilet paper, the whole fantasy financial league will coming crashing down.

& whats the betting when it has youre still on here bitching about Schiff? :-/

Swifty said...

I just dont see how your theories are sustainable? This type of printing cant go on forever. The world will one day want a currency actually worth something. Your thoughts please?

Unknown said...

Yeah right, and house prices can only go up forever - as I recall that was your view in 2007 when Peter Schiff put you in your place. Why would anyone listen to your loser ass now, let alone pay for your advice. Ha

Anonymous said...

You should debate Schiff again, I want to see your girlish laughs commemorated for posterity on Youtube when you argue there is no bond bubble

Matt Franko said...

naysayers:

All you have to do to is go to the Feds z.1 report and go to Tables:
Household Sector B.100 Line 9 and Non Financial Corporate Sector B.102 Lines 8,9,10 these are the bank account balances of these two sectors.

These are the only two domestic sectors that could "lend" the US Government money. If they really do lend the govt money, then you should be able to show us here how the line item balances have gone down by over now $2T (govt deficits) since Spetember 2008, and now instead of over 2T balances in these sub-accounts, they should have over $2T of additional Treasury securities that they received in exchange for their cash balances...I'll save you some time, you will not find this in the actual accounting.

Since the end of Sept 2008, both of these sectors have increased the balances in their bank accounts. How could they lend the government over 2T and not have their bank account balances go down? Answer: the government spending provides the funds to both the household and corporate sectors that are then used to buy the Treasury bonds, no "lending" or "borrowing" occurs.

Check it out.

Matt Franko said...

PS naysayers:

If the Treasuries all go to 0%, then yes I'll agree with Rogers and Schiff that bonds are a 'sell'! LOL!

googleheim said...

The point is that primary rates are set by a choice inside the Fed&TSY , not by a market.

Markets determine bond rates.

TO BERNARDO: MIKE NORMAN HAS SUCCINCTLY DIFFERENTIATED USA AND ARGENTINA - ARGENTINA BORROWED IN DOLLARS AND PEGGED THEIR PESO TO THE DOLLAR 1 FOR 1.

THEN WHEN CLINTON BALANCED THE BUDGET, HE PULLED MONEY FROM THE REAL ECONOMY WHICH WAS THE RESULT OF GOV SPENDING, AND THEN RAISED RATES.

ARGENTINA DEFAULTED ON INTEREST ALONE DUE TO CLINTON, BUSH, AND THE AFTERMATH OF 911.

EVERYONE WILL STILL RUN TO THE USD NO MATTER.

GO AHEAD AND RUN TO THE RENMIBI YUAN IF YOU LIKE ... YOU PROBABLY THINK THAT THE CHINESE EXCHANGED THEIR PALTRY CURRENCY FOR USD TO BUY USD TREASURIES WHICH IS OUT OF PARADIGM AND INCORRECT.

FOR DOGGINGS : YOU ARE WRONG ALSO.

IS IT A FANTASY THAT THE USA IN THE 1940'S SPENT MORE THAN WE DID IN THE PAST 3 YEARS ? IS IT A FANTASY THAT REGAN SPENT MORE THAN ALL PREVIOUS GOVERNMENTS COMBINED ?

TAKE A HIKE AND PICK UP AFTER YOURSELF.

THE SCHIFF HIT THE FAN ...

Anonymous said...

googleheim,
The so called convertibility in Argentina (1991-2002) was just an experiment to control hyperinflation. Argentina is just an example, perhaps a better comparison to the US than Zimbabwe because it has plenty of natural resources. Now, that's not the point.
The point is that Norman said that it doesn't matter if the world stops buying bonds. And it does matter, because at that point there would be no difference between the US and the rest of the countries in the world (that is, those that issue their own currency). Do you think that Argentina wouldn't like to borrow in Pesos? Right now the US is in the enviable possition of being able to exchange paper (or electronic bits) for real goods, congrats. Will it last forever? And yes, you can always print money, just like Zimbabwe.

Unknown said...

Mike,

I don't disagree with your explanation on how money gets created. As you and others have pointed out here the US can print currency at will. My question is that despite the deficit hysteria, the masses maintain their faith in the dollar precisely because they believe the US is somehow constrained in the issuance of currency (that the Treasury has to borrow) which leads to the belief that there is a limit of dollars akin to faith in gold because there is a limited supply of that.

If tomorrow. everyone on the planet understood that the Treasury has no issuance limits whatsoever and that deficits can and will expand forever, isn't there a possibility that the US dollar could lose its psychological validity as a currency and masses turn to gold as the only "real" currency because the supply is limited and they perceive that as a good thing?

Note that I am not stating that the US will issue quadrillions in currency a la Weimar. I'm simply wondering what happens if people realize the dollar is no more limited in potential issuance than a coupon I can print up on my printer? Could this lead people to flee fiat currencies?

MortgageAngel said...

Naysayers: I want to address the point you are making about the Real Estate bubble. As far as I know, Mike didn't see it coming and so you are correct on that point. I didn't see it coming. Other mortgage industry experts like Barry Habib, Sue Woodard, Jim McMahon didn't see it coming. Also, I would bet no Realtor on the face of this planet believed there was any truth to the bubble theory.

In 2006 it was my own opinion that we'd hit a realistic top of the market at least in my corner of the state which is southern California. To my surprise values continued to climb but a bubble? I didn't think so. The reason why I didn't think so is this: I had a great deal of confidence in our banking system and in Wall Street too. I believed that there was enough goodwill in the hearts of men to counter attempts to corrupt. So naive and so ill placed were my confidences. Peter Schiff and only a few others correctly called the Real Estate bubble. I've noticed a common thread among those few and that is they are all very familiar with hedge funds.

MortgageAngel said...

PS. Knowing what we know now I'm wondering if it might be more appropriately referred to as the hedge fund bubble.

Unknown said...

" I didn't see it coming. Other mortgage industry experts like Barry Habib, Sue Woodard, Jim McMahon didn't see it coming."

You and other real estate "experts" didn't see it coming because you collectively have the iq of an amoeba.

MortgageAngel said...

Trader: "I'm simply wondering what happens if people realize the dollar is no more limited in potential issuance than a coupon I can print up on my printer? Could this lead people to flee fiat currencies?"

In my opinion, this is a thoughtful question and a fair one too. I'm going to take a stab at it.

The value of any fiat currency lies in the governments level of influence vis-a-vis it's ability to collect taxes. The perception around the world should have little influence over a leading economy such as we enjoy in the United States (at least for now that is still the case!) As far as Americans realizing this it no doubt would be the mark of a new age so long as our dollar has the ability to put food on our table and pay for shelter to live in, and realistically we can expect this to be the case, perception here at home will improve with time. Ultimately we will all be better off when common understanding shifts and is "in paradigm".

MortgageAngel said...

In the event my comments to this post qualify as "successful strike" I'll leave my mark :)
STORMY www.moslereconomics.com
Counter Insurgency, Deficit Terrorist Unit

MortgageAngel said...

I have just one more thing to share w/ everyone here - I had an epiphany yesterday - I am still in a state of ephoria from it! It's really simple and all of you will probably say "You're just NOW putting that together, Jill?" But that's okay. The important this is my understanding continues to grow!

Here's how it came about-

A mortgage/real estate video blog I frequent has posted what they are referring to as the $70 billion question which addresses the desparity between the amount of money approved to spend to help homeowners stay in their homes via mortgage modification. If it's not being used then where's all that money?

After months the answer finally came to me. My epiphany- The rest of the money isn't anywhere. If it hasn't been spent then it hasn't been created.

(BIG SMILE)

Ralph Musgrave said...

MortgageAngel wants to know what happens when people lose faith in a fiat currency. The answer is that there is unlikely to be much of a problem and for the following reasons.

First, money (whether fiat or in any other form) is such useful stuff that it takes an ASTRONOMIC degree of incompetence for people to totally lose faith in the dominant currency. Look at Mugabwe: a complete tosser. But it took YEARS of catastrophic incompetence for his population to lose faith in the currency and start using other currencies in serious volumes.

Second, if people DO start to lose faith, they’ll begin dumping the currency in exchange for other assets. But that equals a rise in aggregate demand, i.e. it equals stimulus, and that’s a way out of the recession.

Indeed, those who advocate that central banks should raise their target rate of inflation are advocating very much the latter policy. I.e. they’re trying (amongst other things) to induce a SMALL loss of faith, which in turn will result in a rise in AD.

googleheim said...

to bernardo : you flip flop with slop about argentina and zembobway. there is no comparison.

to others :

why does Germany not top the list as debt holders of treasuries in the USA ? Why UK, Japan, and CHina ?

Germany is the top exporter, and all that. Why do they not buy U$D denominated securities ?

Because they are only pro-Euro which is the Deutsch Mark dressed up and covered up with others

Matt Franko said...

MA,
Per your epiphany, I think youre correct...it seems that certain govt programs require some entity in the non-govt sector to often make a "claim" for the appropriation to actually effect the Treasury outlays. For instance a Medicaid recipient must get sick and receive treatment so a medical practice can submit a bill to Medicare that is then credited to the hospitals bank account.

With this mortgage assistance program, probably current mortgage holders have to make some form of application and then have it approved before any Treasury withdrwals take place by crediting either the lender or borrower or however it is constructed.

So yes is seems the "money" was never created as not many have applied or been accepted in those relief programs.

PS: Do you have that link to the latest FNMA bond quotes? I bet the yields are at recent lows...

Resp,

Anonymous said...

googleheim:
There are innumerable reasons why the US is a great country and innumerable are the advantages it has over any other country on earth. Being able to print money? No, that's not one of them.

Matt Franko said...

Bernardo,

The US doesnt 'print' money (except for small amounts of FR Notes for wallet convenience) anymore.

It's all done on computers now...in the banking system.

Resp,

MortgageAngel said...

Matt,
No prob! We started tracking 3.50% coupon 2 weeks ago. Here's a 3 month view from a few days ago - http://twitpic.com/2j48o9

Here are current yields, 30 day candlestick chart w/ slow stochastic as of close on Friday http://twitpic.com/2j48tv In my observation slow stochastic is not a good day to day indicator but week to week it seems to reinforce the trend up.

Here's the 30 day fast stochastic chart as of close on Friday. Negative cross over in neutral territory reassures the reverse on Friday was just "a breather" and trend higher will continue.

From reading the posts here, particularly the last 30 days or so, and everyone's comments too (THANK YOU, EVERYONE!!) I've pretty much concluded that with the Fed targeting 0% and in absence of stimulus, there's only one way rates can go. The only odds I see worth betting on are how long it will take for mortgages to hit 2%.

Finally - contrary to what I've believed my entire career until my paradigm shift began two years ago - Proof that the Fed's decisions does set the trend http://twitpic.com/2gco38

Thanks for confirming my epiphany - If it hasn't been spent then it hasn't been created.

Congress approved $75 billion for HAMP and only $5 Billion has been used - not for lack of people applying for it either! It's not like there's an account with $70 billion sitting waiting to be spent or perhaps embezzled? I'm not sure what people mean to imply when they ask what our government is doing with the money from anything. When you're in paradigm this question is obsolete!

Here's the link to the video blog asking the $70 billion question.
http://www.thinkbigworksmall.com/mypage/archive/1/52943

Toodles!
MA
Congress votes and approves budgets of all kinds and when

MortgageAngel said...

Whoops! I dropped the link to the fast stochastics - Here it is http://twitpic.com/2j48xo

Unknown said...

Musgrave said: "Second, if people DO start to lose faith, they’ll begin dumping the currency in exchange for other assets. But that equals a rise in aggregate demand, i.e. it equals stimulus, and that’s a way out of the recession."

Not necessarily so. The result may simply be a bidding up of assets considered inflation/currency hedges such as precious metals, vacant land, art, diamonds, baseball cards etc from people fleeing a currency they are losing faith in. This doesn't add any aggregate demand at all. A version of stagflation...

Adam2 said...

Hey Austrians. You were NOT the only ones calling the bubble. The debt-deflationists like Roubini did too.

Roubini has been more on target of what would happen after the bubble then you goldbug hyperinflationists.