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Sunday, August 7, 2011

The Fed faces a serious dilemma from summer 2011: an absolute necessity for QE3, an absolute impossibility of QE3

The Fed faces a serious dilemma from summer 2011: an absolute necessity for QE3, an absolute impossibility of QE3

(6) In this respect, the attitude of the three major Anglo-Saxon rating agencies is becoming a real travesty: downgrading Spain on the eve of the Euroland summit, refusing to touch Japan’s rating (in complete economic and financial chaos), but downgrading Portugal (for no other reason than a feeling over the country’s budgetary efforts). For that matter, market participants seem to have drawn the necessary consequences: the Euro didn’t even move one inch after the rating agency announcements. For our team, rather like the Financial Times a year ago with its manipulation around the Euro, these agencies have definitely lost all professional credibility to be nothing more than auxiliaries of Anglo-Saxon financial markets in full collapse. They will soon realize that nobody listens to them, which offers a vast market to new rating agencies wishing to work objectively ... a booming market for long term investors.

The Fed faces a serious dilemma from summer 2011: an absolute necessity for QE3, an absolute impossibility of QE3
As noted previously, with the Quantitative Easing 2, against a background of growing distrust vis-à-vis the Dollar and the US economy, the Fed has become virtually the only buyer of US Treasury Bonds. Officially it is already buying 70% of new issues. The use of “undercover agents”, via the City of London and offshore financial centres, more than likely brings this share above 90%. But the actual share of Treasury Bonds purchased by the Fed is not so important in itself because, according to LEAP/E2020 (1), it's been purchasing the majority of new US debt issues for years through its “primary dealers” and the numerous exotic channels offered by the financial world. What is important with the announcement of Quantitative Easing Policy since 2009 is the “unveiling” of a previously hidden reality... because it could be hidden.

Confidence in the US economy allowed the Fed to carry out “its little deals” with reality while no one cared or even (for most operators) imagined that such practices had been the norm for many years. The economy being, in the main, a matter of collective psychology, the importance now is that most players know that there is no one other than the Fed to purchase US Treasury Bonds.

The Japanese disaster greatly enhances this awareness because it will be impossible to convince anyone that Japan will continue buying US debt at a time when it must marshal all its financial resources to save the country. Therefore, the Fed arrives at the end of the “road to nowhere” otherwise to a financial disaster (2). In fact, in three months, when QE2 officially ends, it must both lie and tell the truth on the same subject: claim that QE2 has worked, that the U.S. economy has relaunched and that it therefore no longer needs to buy US Treasury Bonds, and simultaneously continue to buy 90% of these same Treasury Bonds since it is the only buyer in the market.

Yet in three years the psychology of financial markets has changed dramatically regarding sovereign debt in general and US debt in particular: the operators will carefully scrutinize the flow and draw their conclusions, as PIMCO has just done already by selling its Treasury Bond holdings.

The Fed faces a serious dilemma from summer 2011: an absolute necessity for QE3, an absolute impossibility of QE3
Let's summarize the situation in summer 2011 for US debt markets:

. Munis (local authority debt) will continue to deteriorate to literally melt down at the start of the new US fiscal year (which starts in July) (4)
. private operators (like PIMCO) are selling, or at least, not buying US debt any more
. Japan (the third largest holder of US Federal debt after the Fed and China) will have to sell its T-Bonds to finance its reconstruction (5)
. Euroland is quietly making its exit from Anglo-Saxon financial markets (6) (with, as expected, a Euroland summit on March 11 which confirmed the continuation of its financial stability fund (7) and the assertion of Euroland control (8) on general EU progress (9)) and will thereby further reduce its stock of US debt (10)
. China no longer wishes to increase its huge stock of US Federal debt
. the Gulf oil states, led by Saudi Arabia, whose regimes are struggling to survive and who no longer believe in US protection, now have other priorities than to support the US Treasury Bond market (and they may even make it a weapon against Israel and Washington (11)).

Finally, to top it all, the US economy continues to sink into “double-dip-flation”. No one now believes US unemployment data, supposed to show an improvement in the labour market. Even the “mainstream” US media now condemns the unreal nature of the statistics in question. CNBC headline on 14/02/2011 was even “Why the unemployment rate has become a bad joke” (12). Property prices continue to collapse. The trade deficit has swollen again (13). And actual inflation (in the price of goods actually consumed by people) is rising sharply. The least one can say is that this is a picture (14) that really is not conducive to “invest” in the debt of such an economy. And we remember that the rest of the world, having already rallied strongly to criticize the launch of QE2, just like, for that matter, a significant number of US policymakers (see GEAB N° 49, internal and external opposition to QE3 will extremely powerful.

Three US unemployment rates: two official (U-3 in red and U-6 in grey, and SGS alternate in blue (calculated according to official methodology of the 1990s) - Source: SGS, 04/02/2011
Three US unemployment rates: two official (U-3 in red and U-6 in grey, and SGS alternate in blue (calculated according to official methodology of the 1990s) - Source: SGS, 04/02/2011
Still, between the absolute need for QE3 and the absolute impossibility of QE3, reality will not be content with vacuum; something must happen in the second half of 2011 (15)! Our team is convinced that it’s the moment when the dominant view of recent years that no major holder of US Treasury Bonds has an interest in selling them for fear of devaluing its own stock of US debt will run up against the principle of reality. Japan in its disastrous situation probably constitutes a “principle of reality” even more powerful than that of the Arab regimes of the Gulf that we have already identified in the previous GEAB issue.

In any event, ”two principles of reality” pushing in the same direction (16) at a moment of historic weakness of the US economy, of the Fed and the US debt market, in our opinion represent the certainty of a sudden meltdown in the US debt bubble in the second half of 2011 (17).

We explained last January that 2011 would be the worst year since 2006, the year of the beginning of our anticipation work on the global systemic crisis, mainly because the international system is in such a state of weakness and decay that any major shock could sweep it away in a new turmoil. The US debt market is in the course of reaching this stage and, of course, the US Dollar as well.

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Notes:

(1) See the 2006 and 2007 GEAB issues on this subject

(2) February 2011 was the biggest ever monthly Federal deficit ever recorded at 223 billion USD. Source: Zerohedge, 03/07/2011

(3) Entitlement spending includes social spending such as Medicaid, Medicare, Social Security. This scenario takes for granted in particular a sustainable economic recovery in the US.

(4) 44 States are facing cumulative deficits of more than 100 billion USD in 2012. Source: CBPP, 03/09/2011

(5) This option is beginning to be clearly seen in the US. Source: Los Angeles Times, 03/14/2011

(6) In this respect, the attitude of the three major Anglo-Saxon rating agencies is becoming a real travesty: downgrading Spain on the eve of the Euroland summit, refusing to touch Japan’s rating (in complete economic and financial chaos), but downgrading Portugal (for no other reason than a feeling over the country’s budgetary efforts). For that matter, market participants seem to have drawn the necessary consequences: the Euro didn’t even move one inch after the rating agency announcements. For our team, rather like the Financial Times a year ago with its manipulation around the Euro, these agencies have definitely lost all professional credibility to be nothing more than auxiliaries of Anglo-Saxon financial markets in full collapse. They will soon realize that nobody listens to them, which offers a vast market to new rating agencies wishing to work objectively ... a booming market for long term investors.

(7) As explained in previous GEABs, in acquiring its own financial infrastructure (funds, rules, procedures ...), the Euroland countries have very sharply reduced their dependence on external financial markets.

(8) Read the interesting article on this subject in Corriere della Serra which illustrates the younger generations’ massive support for Euroland and the Euro, without any nostalgia for Marks, Francs, Lira or Pesetas. Source : Presseurop, 03/04/2011

(9) Sources: Yahoonews, 03/15/2011; Deutsche Welle, 03/12/2011

(10) Euroland will in fact focus on the purchase of its own debt! And we will not even dwell on the total divergence of the perspective on interest rates between the ECB and the Fed. Source: CNBC, 03/03/2011

(11) See GEAB N°52

(12) Far from falling to 8.9%, the unemployment rate is above 20%. See chart above and the very interesting ShadowStats website. Moreover, it is helpful to read the article by Richard Benson, published in Safehaven of 16/02/2011, which very clearly explains the collapse of the US workforce. In addition, evidence of the unreality of official statistics, the Fed requires US banks to prepare for a stress-test including an official unemployment rate of 11% for first quarter of 2012 (who, according to LEAP/E2020 should place the real rate at 25%).Source : Zerohedge, 17/02/2011

(13) Source : CNBC, 10/03/2011

(14) We encourage you to browse the excellent report by Mary Meeker, entitled USA Inc., which presents the fundamentals of the US economy as a financial report on a business. If the Federal debt is a share of USA Inc.., in other words investors will tend to sell rather than buy.Source : KPCB, 02/2011

(15) Ben Bernanke must face up to the impossibility that he himself has helped to create. Source : Financial Sense, 03/03/2011

(16) Source: Bloomberg, 03/16/2011

(17) Under the Obama administration the Federal debt has increased by 3.5 trillion USD. Source: CBS, 02/23/2011

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