Thursday, May 21, 2009

U.K. Downgrade makes U.S. downgrade almost a certainty now

The clueless idiots at the ratings agency simply don't understand that countries that spend in their own, non-convertible, free-floating currency can NEVER have a payments problem. Their ability to pay is, by definition, without question. While there may be exchange risk associate with this, their ability to meet all debts and obligations denominated in their currency is iron-clad. (Read Warren Mosler's excellent letter in the previous post.)

However, the clueless jerks at the ratings agencies will go with their inapplicable analysis. (Remember, these are the same guys that rated all the subprime junk, Triple-A!)

The U.K. downgrade now makes it almost a near-certainty that the U.S. will soon lose its AAA credit rating.

When this happens we will all get rich. This is the trade we can all retire from!

Here's how to play it:

When the ratings agencies downgrade the U.S. (it's coming, don't worry) there will be a knee-jerk and, likely, viscious selloff in the Treasury market. (You might even want to play that by buying some, TBT now. That's an inverse Treasury etf.)

However, when the selling subsides,

buy as many treasury futures and call options as you possibly can!

Because the downgrade will have zero impact on the America's ability to pay its debts, just like Japan's downgrade had no impact on Japan's ability to pay its debts. Treasuries will remain highly sought after savings accounts even after the loss of AAA status and they will rally right back to where they were prior to the downgrade.

We can all soon retire on your yachts! GET PREPARED NOW!!!!


STF said...

As long as the Fed doesn't raise rates between the selloff and the return to normal, should work.


mike norman said...

Yes, good point!

Anonymous said...

regarding what STF said - then it would be ideal if U.S. credit rating was downgraded before the next scheduled FOMC meeting coming up this time next month. On the odd chance (like really odd, would you agree, Mike?) the Fed raises their funds rate that is currently 0%-.25% range I can't imagine it would be set more than .25% higher absent of much better than expected employment and retail sales numbers.

I've got hold of your coat tails, Mike. (following you on this strategy) Derek and I are looking forward to meeting up with you in St Croix. Salt, shaker and lime!

googleheim said...

what is the mechanism by which Bernanke will "mop" up the credits in the future to fight inflation ?

high interest rates with volcker behind him with a thresher ????

please comment - tell me something

Anonymous said...

Raising the water level in the pool is one way of manuevering around the threat of inflation. Right? There's one other way though. I don't recall what it is though. I think there is another tool for this.

STF said...

The fears about the Fed's balance sheet and inflation are nonsense.

Reserves don't fund anything.

The Fed's assets were mostly lender of last resort activities.

At any rate, the Fed is an interest rate setter, not a quantity setter, even if it doesn't understand this itself. It would make much more sense to "worry" about the market rates the Fed is manipulating than to worry about its balance sheet. As it is, though, even the rates it is setting aren't much of a problem, as spreads are still well above normal.

What's going on in St. Croix?


googleheim said...

that does not answer my question

but reaffirms my surmise - the fed and tsy will raise interest rates to get the money back into the banks and then it will mop up the credits.

there has to be other ways to mop.

inflation will be real if the holes the banks created are plugged and the money starts flowing

STF said...

"the fed and tsy will raise interest rates to get the money back into the banks and then it will mop up the credits"

That makes no sense at all. What are you talking about?

"inflation will be real if the holes the banks created are plugged and the money starts flowing"

Inflation will occur if oil prices rise (quite possible) or if the govt deficit relative to net savings desires of the non-govt sector pushes the economy beyond its capacity to produce (highly unlikely).

Matt Franko said...

Mike & Scott,
Could I seek your comment here on 3-mo Libor lately? Do you think the Fed has engaged to reduce even these US$ interest rates in foreign jurisdictions (via forex swaplines/IMF and other measures)? If so, it has really done the job! (It's just taken about 6 months though) I'm reading the 3mo libor at around 0.6% (& falling), 90 day treasury at 0.18%.

googleheim said...

mr scott stf :

1. volcker is hovering behind obama like a reagan-era moth ball.

2. bernanke has issued the credits that Mike talks about nonstop, something effectively like $10 trillion or whatever

3. bernanke said that he will remove or what I call "mop up" this oversupply of money in the system - what other people misnomer as "printing money"

4. a possible means of acheiving this, in my opinion, is to raise interest rates and get regular ol' people to put their money in the banks just like volcker did in the 80's. my opinion is based on your first comment of this post.

5. after the money circulates and does it job, bernanke will siphon the credits/printed-money out of the system to reduce the heat / inflation.

there will be all sorts of places to make money supposedly.

STF said...


Seems to me that the swap lines were substantially about LIBOR, but LIBOR spread being high was about perceived counterparty risk, too. Haven't followed as closely as I should, so can't say much more than that. Also, as you allude to, Fed could have set term rates for US banks from the beginning.


1. Agree

2. Fed has expanded its balance sheet by about $1.5 trillion at the peak. Came down from that peak by a few hunder billion for a bit. Possibly to get higher as TALF and Tsy purchases get moving, though. Asside from TALF and Tsy purchases, yes, this was an extension of credit to banks, foreign central banks, primary dealers, and commercial paper issuers.

3. As #2 accelerated at almost hyperspeed after Lehman, Fed couldn't "sterilize" increase in reserve balances from its "credits" because it didn't have enough assets to sell anymore. So it just left reserves circulating and the overnight rate fell. As an aside, the Fed tried to pay interest to keep the overnight rate from falling, but only yesterday finally got that right (topic for another blogpost, perhaps). Agree that Bernanke and others think this increase in reserves (at one point, about $800 billion, up from about $15 billion) needs to be reversed at some point. Bernanke's wrong, though, since reserves don't finance any additional bank lending or spending . . . loans create deposits. With or without the additional reserves, the banking system can create whatever quantity of loans it desires.

4. Incorrect. Draining reserves has NOTHING to do with "regular people." Reserves in the aggregate only change when something on the Fed's balance sheet changes. The reserves thus can only be drained 2 ways . . . by the Fed's "credits" being paid back, or by the Fed selling assets (possibly issuing its own "debt" even) that are purchased ultimately by debiting the reserves. Raising interest rates also has nothing to do with it. In fact, the only way the Fed can actually raise its target rate is to first drain the reserves, not vice versa, unless it pays interest on reserves at the higher target. (As an aside, if the Fed issues its own debt at longer maturities, it CAN raise interest rates by declaring the rate it will pay, and also drain reserves at the same time. I doubt they know that, though.)

5. The "money circulating" (whatever that means) has nothing to do with inflation.


googleheim said...

back to # 4 -

I think of the credits to banks and then the banks to people as a linkage - such that you are correct in that the credits will be paid back by banks, however I was making a leap of faith that the people will be able to pay the banks back such that the banks will be positioned to repay the credits.

What does it have to do with the price of tea in china ? what about the price we pay due to illegal deforrestation in SE Asia which feeds the China furniture factories ? a lot of people here in the US are sitting on it ( the furniture ).

Just saw the news about a furniture mogul here in Houston whose entire warehouse went up in smoke. Nice chap, but it was a bonfire of the vanities.

mike norman said...


And we still have people saying "interest rates are set by the market."


Nobel economist, James Tobin quote:

"Interest rates are a parameter of the central bank. Period!"

STF said...

"I think of the credits to banks and then the banks to people as a linkage "

There is no such linkage. If there were, then the money multiplier model would be correct. It isn't; loans create deposits, no reserves or central bank credit necessary for that.

googleheim said...




STF said...

Googleheim . . .

There is no such linkage either in the real world or in Mike's post that you mentioned. If you think there is, then you have misinterpreted Mike's words. Mike is talking about government deficits, not Fed lending to banks.


STF said...

Googleheim . .

I think I see where this has gone astray. Please note--this isn't a criticism of you, it's just how this all works for me--when we are talking about this stuff, the taxonomy has to be precise or we end up talking past each other.

The Fed has loaned to banks, or created credit, which raises reserves and which the Fed has not yet drained. These will be drained if the Fed sells assets (which it does not have enough of to drain all of them), sells its own debt, or when the banks and others that have borrowed repay the loans. As I said before, raising interest rates doesn't help, because the Fed must either pay interest on reserves at the target rate to raise the interest rate target with so many excess balances circulating (which it appears will be at least part of its strategy to raise rates) or else it must drain the reserves BEFORE it can raise rates (via the above methods).

A government deficit creates a credit to a bank's reserve account and a credit to the deposit account of the recipent (of the net spending). This, however, DOES NOT help banks or others pay back these Fed loans for two reasons. First, the deficit just creates more reserves, so even if banks used these to pay back the credits, there would still be the same amount as previously. Second, the Treasury issues its own debt when it runs a deficit, so it drains the reserves it creates with its deficits.

Given that the Treasury sells bonds to offset any increase in reserves from the deficit, that the banks' depositors now have more deposits (as a result of the deficit) also does not help repay the loans from the Fed, because the loans can only be repaid with reserves (a liability on the Fed's balance sheet and an asset on a bank's balance sheet), not a deposit (a liability on a bank's balance sheet).

I hope this helps a bit. Let me know if I still haven't grasped the point you were making.


mike norman said...

Goog, the reserve bank credit merely replaced an asset that the bank (or one of the bank's customers) had. There has been no, "net" creation of anything. (Net worth remains unchanged.) It was all just an asset exchange. So the folks talking about this coming inflation are not understanding this.

Goog, I love ya! You are a faithful and regular contributor to this blog and I want you to know I appreciate it.