“Monetary Policy” Gone Berserk

One issue the financial media is willing to ignore, but has been foremost in my mind for many years is the utter recklessness of the Federal Reserve’s “monetary policy.”  Below is a chart the public will never see on CNBC, or anywhere else, but I believe is vital to understand the threat that Washington and Wall Street currently present to the world at large.  You’re looking at what academic-quack economists have done to the global reserve currency to save the hides of the banking elite, who for decades have acted as if Wall Street was their private fiefdom.  

The FOMC calls this “monetary policy” but for me something completely different comes to mind: legalized counterfeiting.  Unfortunately, for years the baby-boomer generation (and their children; the Gen-Xers) have sought pleasure in immediate consumption.  It’s hard to blame them since the Fed destroyed their incentive to save by lowering the Fed Funds Rate to nearly 0% in December 2008.  This rate can never be raised (despite the Fed rhetoric) without blowing up the budget deficit, sinking the economy in the process.  For decades American’s, (and just about everyone else) have taken full advantage of the debt generously provided by the banking system to leverage their income, and now far too many people are hooked on cheap credit and just one paycheck away from insolvency, as are their employers.

The financial markets currently find themselves in the same perilous situation as consumers, and for the same reason; their valuations are being supported by central bank “policy.”  Janet Yellen may intend to reduce QE to zero in the next few months, but when the stock and bond markets begin their long overdue corrections, she’ll be “monetizing” Treasury debt yet again to supporting financial “asset” valuations.  Yellen (an inflation dove) is a typical economist of her generation; she too, prefers pleasure to pain when it comes to matters of monetary policy.  I can’t see any way for the Fed to unwind (or stop expanding) their balance sheet without risking the wrath of an army of financially ruined voters in the next election cycle.

However, whether the voters are happy or not, the simple fact is that the Federal Reserve’s “monetary policy” is totally out of control.  The quantity of US Treasury Debt monetized by the Fed since Alan Greenspan became Fed Chairman in 1987 is enormous as evident in the table below.  Their portfolio of US T-Debt is now 77% larger than the entire US National Debt was in August 1987.

But monetizing US Treasury debt hasn’t been exclusively monopolized by Americans.  Barron’s also publishes the dollar value of US T-bonds held at the Federal Reserve by foreign central banks (Blue Plot below) which have been huge purchasers of Treasury debt for decades.  Once purchased, these central banks do what central banks always do, that is “inject” the resulting “liquidity” into their banking system, increasing its ability to create credit (debt).  However, foreign CBs apparently reached their limit in 2011 of how much US Treasury debt (the US National Debt) they were willing to monetize, and since then the Federal Reserve (Red Plot) has picked up the slack.  

Next is a Bear’s Eye View (Blue Plot / Left Scale) of the foreign central bank data above. In November 2012 there was a large (11.4%) reduction in US T-bonds held, but this decline didn’t make the news.  However the 15% decline in September 1998 (due to the sharp contraction in the “Asian Tiger Economies” known as the “Asian Contagion”) was big news at the time.  Alan Greenspan needed to reassure Congress and the public on TV that he had everything under control.  And during this mini-panic in Asia (March 1997- September 1998) Greenspan did maintain control over the market; 10Yr US T-Note yields declined from 6.70% to 4.90%, while the price of gold fell from $339 to $290.  But then no one could execute “monetary policy” like Alan Greenspan!

In this next table we see how much US Treasury debt different countries were holding as of June 2014.  Note: this data is from the US Treasury (not the Federal Reserve).  I included the Federal Reserve’s T-debt holdings for comparative purposes BUT the Fed’s T-debt is NOT included in the grand total.  I’m assuming that the Treasury’s data includes all holders of T-debt within a given country, not just their central banks.  Also the “Max Val” column gives the maximum holdings from 2008 to present, as the “Min Val” lists the minimum.  The Percentages columns give the percentage increases and declines as of June 2014.

China and Japan (#2&3) each hold more than a trillion dollars of T-debt, but combined hold only 60% of the Federal Reserve’s portfolio.  Out of curiosity I checked to see how many billions of dollars these CBs held in May of 2008, at the start of my data:

• China: $506
• Japan: $575
• The Fed: $478

What a difference six years and one credit crisis can make.

Germany (#21) holds only $68 billion dollars of Uncle Sams IOUs.  Germany is one of the world’s largest economies, yet countries like Ireland (#16) hold more US T-debt.

A frequent theme of the US Treasury market is that should a major holder of T-debt (such as China, #3 above) decides to sell, they could trigger an economic doom’s day.  So let’s have a look at this same data sorted by the Percent From / Max Val column (below).  The biggest seller to date (on a percentage basis) has been the UK (#1 below) which has liquidated just over half of their T-bond portfolio.  Russia (#3) has sold off 35% of their T-bonds.  But so far, none of the major holders of US Treasury debt have liquidated a significant percentage of their portfolio as of the latest data.  And note that the grand total (#36) is at a new all-time high.

China (#18) may sell a large percentage of their US T-bonds at some point in the future, but I don’t believe they would do so as retribution against Washington’s foreign policy.  A big sell off in US Treasury Bonds would hurt more than just the Federal government.  Creating a panic in the US Treasury market would greatly harm China’s trading partners as well, countries with which China wants to foster good relations.

But just because China isn’t willing to commit economic suicide doesn’t mean the US Treasury market is a healthy place to hold your wealth.  Currently banks hold 58% of the US national debt.  Should that be a source of comfort or concern for the owners of the other 42%?  These banks are definitely not intentionally going to start a panic in the T-bond market.  But the 58% of the Treasury market they currently own is also the size the entire US national debt when President Obama was first elected in 2008, and the remaining 42% was created during the first six years of the Obama Regime (chart below).  Does that comfort you?  It doesn’t me.

It wasn’t always like this.  In the table below we see that in May 1995 private holders held 83% of the Treasury market.

One thing we must keep in mind is that the so called “national debt” is only the fraction of the of the Federal Government’s liabilities that trades in the bond market.  It seems that no one really knows, but when one takes into consideration the future expenses for Social Security, Medicare, Federal pensions, and who know what else, I’ve seen estimates as high as of $150 trillion dollars of unfunded liabilities pending on the US Treasury in the coming decades.  There is coming a day of crisis that Washington will attempt to postpone by funding these unfunded liabilities with monetary inflation.

Taking this into consideration; is it possible that there are some in the Federal Reserve Board of Governors concerned of a future shortage of US Treasury debt?  I wouldn’t be surprised if there were.  After all, to create the required credit and currency necessary to re-inflate the financial markets after the 2007-09 credit crisis, the Federal Reserve has been grinding up T-debt like hamburger at a sausage factory.  Forget for a moment Uncle Sam’s unfunded liabilities, if Janet Yellen actually intends to taper QE to zero, and the financial markets once again begin to deflate as we saw in 2008-09, I expect that political pressure on the Federal Reserve would be impossible to resist after the a stock market decline of 30% or more.  And without direct Federal Reserve intervention in the stock and bond markets, stock and bond valuations would decline to incomprehensibly low levels.  To a Keynesian-macro economist, how many trillions of dollars of T-debt does the Federal Reserve require to move the economy safely into the mid-21^st century?

This is interesting: since May 1995, the US national debt has increased by $12.75 trillion dollars, yet T-bond yields have declined to levels not seen since the 1950s.

With growth in the US national debt this grotesque over the past twenty years, how could T- bond yields possibly decline to levels not seen since 1953?  It wasn’t hard, because the Federal Reserve has unlimited funds with which to execute their low interest rate policy.  So, they don’t care how much they have to pay for a US T-bond, or how many trillions of dollars of T-bonds they have to purchase if “policy” dictates that bond yields must decline. 

Keynesians economists still dominate the FOMC, and they believe that lower interest rates can cure all market ills, so the current absurdly low T-debt yields are to be expected.  But the Keynesians are fellow travelers with big-government nanny-statists, you know, President Obama’s crowd.  Since the Bolsheviks first nationalized the Soviet Union’s health care system, everything these left-wing progressives have touched eventually died, and I expect that will also prove to be the case with our current bull market in stocks and bonds.  And if these people hate gold and silver, maybe that is a good reason for you to like them.

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