“Who are you going to believe, me or your own eyes?” – Harpo Marx
Last summer, I wrote a research brief on the US QE, titled Bernanke cannot take his foot off the gas pedal. You can read it here. The pithy summary is that I did not believe the Fed would be able to taper the QE program for the foreseeable future. The US economy continued to struggle, unemployment was persistent, official inflation was low, the velocity of the money supply was low — in essence, the Fed objectives were not being met. And like a junkie, the markets would likely tank without the electric kool-aid the Fed was juicing the markets with.
Well, here we are in June 2014. Much has changed. The US economy officially contracted by 1% in the first quarter. And since the beginning of the year, the Fed has been tapering QE and intends to continue to do so. I guess I was wrong …
… or have they?
Since 2008, QE officially totaled $85B / month, with the Fed buying $45 billion of U.S. government debt (US Treasury bonds, USTs) and $40 billion of mortgage securities (MBS). But, the actual average monthly purchase of bonds and MBSs in 2013 turned out to be $94B. So even an official initial taper of $10B would have put the monthly QE back where the Fed says it was in the first place.
What is even more interesting is the sleight of hand that has been occurring since the middle of 2013. Here is the US Treasury report of Major Holders of Treasury securities. Observe Belgium’s UST holdings from August 2013:
Aug = 166.8; Sept = 172.5; Oct = 180.3; Nov = 200.6; Dec = 256.8; Jan = 310.3; Feb = 341.2; Mar = 381.4
Monthly deltas from August: $6B, $8B, $20B, $56B, $54B, $30B, $40B. Curious, no?
Speculation is rampant that while the Fed is tapering its domestic bond purchases, it has ramped them up using intermediaries, in this case, likely the ECB through Belgium. Jim Rickards speculates that the Fed and the ECB are exchanging dollars for euros, and the ECB is then using the dollars to purchase and hold USTs through Euroclear (see the interview here, go to 20 minutes for this discussion. Paul Craig Roberts also has some interesting insights into this, listen here, read here).
According to Wikipedia, Euroclear is a Belgium based financial services company that specializes in the settlement of securities transactions as well as the safekeeping and asset servicing of these securities. It was founded in 1968 as part of JP Morgan to settle trades on the then developing eurobond market. Using Euroclear makes a lot of sense given the close relationship the Fed has with JPM.
For the Fed, this would be an off-balance sheet transaction, essentially invisible to external scrutiny. Despite the lack of transparency, it is clear that rather than a taper, the Fed is actually increasing its bond purchasing activity, with monthly purchases of somewhere between $55B and $85B, when you include the Belgium proxy purchases.
Why? You ask. Because the US economy sucks, the global economy sucks, and if the Fed was not buying USTs at 2.47% (today’s yield), rates would reset commensurate with risk. Would that be 3%, 5%, 7%? I don’t know, but it is certainly higher than 2.47%.
The system cannot tolerate higher interest rates. Some speculate that 3% causes hurt. Seems low, but perhaps. 5%, twice today’s rate and close to the long-term average, probably lots of pain. 7% strikes me as catastrophic. The global economy would blow up because of the astronomical debt sovereign states and corporations have accrued, and the $trillions of casino bets in interest rate derivatives the financial markets have struck. Stuck between a dog and a fire hydrant.
Here is where we at today (May 30):
- the US economy is contracting, Q1 saw an official contraction of 1%. I am certain it is much higher than that, likely in the range of 4-6%. Growth in GDP is certainly less than 2% annualized, and inflation is certainly greater than 6%. Net the two together and that is the real growth i.e. quite negative
- Official inflation, as measured by the the bogus CPI, remains below 2%, even though anyone can see energy and food prices are spiking. According to Shadowstats, consumer inflation, using what would have been the official methodology in 1980, is nearly 10% as of the end of April.
- UST yields have been dropping, now sitting at 2.475%, and slowly drifting downwards. The Fed is obviously intent on keeping money cheap in a desperate effort to juice the economy. So, as with Japan, the Fed buys its own bonds and manages the yield downward.
- US attempts at ostracizing Russia has encouraged Russia to dump its UST holdings. From the Treasury report, you can see Russian holdings dropping off steeply in 2014. Once April and May are reported, Russian holdings will certainly have dropped further. This, of course, puts upward pressure on the yields as more treasuries hit the market … unless someone is vacuuming them up. Thank you, Belgium … err ECB … err US Fed.
- Gold has been predictably slammed, sitting at $1,245, down about $60 over the last couple of weeks. The Fed does not want gold to be seen as a safe haven from the US$, so they slam paper gold down on the COMEX and the GLD
- The US$ index had recently slipped below $0.80, but now has recovered to above that psychologically important threshold. Yay for small graces
- The $US as a reserve currency is showing increasing vulnerability. The US misadventure in Ukraine has encouraged China and Russia, in particular, to establish a trade settlement mechanism outside of the petrodollar system. As bilateral trade relationships increase which bypass the US$, the demand for dollars will drop as supply of dollars increases, which will put pressure on the US$ and raise the specter of out-of-control inflation and even hyperinflation. The genie is out of the bottle. The petrodollar is history.
… and here we are at June 30:
- US economy shrunk in 1st quarter officially by 2.9%, though the reality is much worse if you consider the true rate of inflation. Pundits were projecting GROWTH of 2.6%. What a crock. Expect more of the same for 2014.