HUGE Treasury issuance is Deflationary?

[Raz]

This article is by David Kotok of Cumberland Advisors. I try not to read this type of "research" from money managers who are essentially "talking their book", but occasionally the headline or subject is so interesting that I'm hooked and drawn in.

His description of the current situation is quite good; it's the conclusions he draws that I take issue with. Of course, if one believes that "Bubbles Ben" will not monetize the US Government's debt then Kotoc would likely be correct. The problem for me is that I don't believe anything Bernanke says, and history is on my side.

2010: The Year to Focus on Sovereign Debt December 23, 2009 David Kotok, Chairman & Chief Investment Officer

Abstract: Sovereign debt is likely to be the big headline issue for 2010. This commentary will look at some debt-related issues of Greece and California in their two respective currency zones and then discuss our view of sovereign debt markets for 2010, particularly with respect to the US dollar and euro currency zones. Some strategy guidance for portfolio management of debt will wrap things up. "Whatever it is, I fear the Greeks even when they bring gifts." This is one of the English translations of Virgil's Aeneid. It refers to the Trojan horse that Greece used to deceive Troy and gain entry into the city. "During the Depression about half the population of Oklahoma moved to California and the intelligence level in both states went up." Will Rogers, the great American commentator from Oklahoma, hatched this quip decades ago in his analysis of California's governmental policies and its finances. If we were writing a play on the theme of sovereign debt, we might use the following characterization. The US and the EU are the setting: two currency zones. The Fed and the ECB are the dominant members of the cast: two central banks responsible for the two currencies. Greece and California are in leading roles: two states within the two currency zones. In the United States, California constitutes about 13% of America's GDP. If CA were a standalone economy, it would be about the seventh largest in the world. The currency in use in California is the US dollar. The CA government determines its own budget, has its own constitution, operates an internal legal system, and decides its own state tax structure. It is also one of the 50 sovereign members of the USA and has legally bound itself to the rules promulgated in Washington, while attempting to preserve some state rights within our highly federalized legal system. CA and most other states have a requirement to balance an annual budget. There are provisions for emergencies in many of these states, and in the coming year we expect the concept of a financial emergency to be deployed and tested in various state courts. CA recently issued "scrip" during a short-lived budget crisis when it ran out of cash and until its legislature passed a revised budget. That was not the first time script has been used. We do not expect it will be the last. In the euro zone, Greece is about 3% of the GDP. It is a sovereign state (country), one of the 16 members of the euro monetary system, and one of the 27 members of the European Union. GR maintains its own budget, although it has pledged to adhere to EU budget rules, which it is currently violating along with most other members of the EU. Under present agreements, penalties will occur if GR is not making a sufficient effort to improve its fiscal situation within a year. We do not expect those penalties to be imposed on GR nor on the other EU states in difficulty. Greece has its own tax structure, constitution, and internal legal system. GR is also covered by the newly developed EU Lisbon Treaty and, like other EU member states, is gradually moving into a Europe-wide economic structure. California and Greece are both lowly rated by the agencies that appraise the creditworthiness of sovereign debt. CA and GR are also on the top of the list of possible default candidates in their respective currency zones. That list is prepared by CMA DataVision, a service that scrutinizes credit default swap pricing in order to determine market-based assessments of default probability over the next five years. CA and GR are both poorly rated, and their scores (default probabilities) are about the same. CA is a problem for the Federal Reserve because the state is a very large part of the US economy and because it is suffering from the financial crisis and the collapse of the housing bubble. If CA defaults, it will lose access to credit markets and contract a governmental economy that is 1/7 of the US. That would be a huge blow to the nascent American economic recovery. ... http://www.cumber.com/commentary.aspx?file=122309.asp

[LargoWinch]

Re: HUGE Treasury issuance is Deflationary?

I don't believe anything Bernanke says, and history is on my side.[/COLOR]

[COLOR="Blue"]
And who can blame you Raz? ;)

See the latest from Charles Hugh Smith and the "Ministry of Propaganda":

Survival+ Trends for 2010 (December 17, 2009)


Here are a few key trends which will gather momentum in 2010--trends drawn from the Survival+ analysis.
My purpose in writing Survival+ was to provide a coherent account (i.e. an integrated understanding) of the powerful trends which are working beneath the superficial surface of our economy and culture.

Survival+ explains why the status quo is doomed, and illuminates the mechanisms which doom it. It also describes "the way out"--we must each put our energy into constructing a parallel, transparent, self-organized, re-localized system which is entirely legal and entirely independent of the failing, doomed status quo which is stripmining the productive to enrich the public and private Elites (file under "Fall of the Empire, Roman and other").

Here are a few of the trends described in Survival+ which I anticipate will be gathering momentum in 2010.

...

From here.

[Rajiv]

Re: HUGE Treasury issuance is Deflationary?

The latest from CH Smith - The Transition to Risk (December 31, 2009)

The hidden transition to ever-higher systemic risk was the major story of 2009: nothing's been fixed, and the risks of systemic failure are rising every day.

On this last day of 2009, I want to address what I call the transition to risk.

One analogy is the way that the risks of suffering a fatal heart attack rise in a completely hidden way. The body doesn't signal the slow accumulation of fatty deposits in arteries; the process is silent. Nor is there any conscious awareness that arteries are hardening. The accretion of risk is slow, steady, invisible--until it's too late.

Some transitions to risk are highly visible. If you're driving on winding mountain roads and suddenly enter a thick fog bank which cuts your visibility to a few feet, the risks posed by continuing at high speed skyrocket.

The prudent person slows down or even pulls well off the road; the imprudent person ends up a statistic.

Then there are situations in which risk is building but someone with an asymmetric stake in the game convinces everyone the risk remains low to serve their own needs.

The boat is leaking, the winds are rising, but the skipper's profits require completion of the passage. So he reassures the nervous passengers that everything is fine, the weather is actually improving, and the ship's pumps can easily handle the leaks.

In an economy with a mainstream media controlled by a handful of corporations and a government financial policy in the hands of a few secretive manipulators, this "reassurance" comes in the form of blatant propaganda.
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Here's my disassembly of the bogus GDP "headline" number which (surprise) "proves" the economy is "recovering": How Misleading Economic Data Increase Investor Risks.

If the economy is "growing again," then why are sales and income taxes still falling? State, Local Tax Revenues Decline 7%

By borrowing trillions of dollars and using those taxpayer funds to prop up a failed banking/speculative finance sector, the Treasury and the Fed have greatly increased the risk of systemic failure.

Every day that the Federal government sells tens of billions of dollars in new debt-- and rolls over all the trillions of short-term bonds which are maturing--the risks of rapidly rising increases rates increases.

Rising rates would destroy the housing market by raising the costs of mortgages. They would undermine the entire shaky regime of "cheap easy credit" which props up not just the housing market but the entire economy.
Every day that the Federal, State and local government apparatchiks dissemble, obfuscate, and kick the can forward, their legitimacy declines and the concurrent risk of systemic failure increases.

Every day the mainstream media prints/speaks/distributes propaganda under the guise of "official statistics" and "news," it loses legitimacy and adds to the risk of public outrage when the constant reassurances are all revealed as false.

While the official line of propaganda is that the "recession ended in August or September," the reality is the systemic risk rubber band has simply been stretched to an unprecedented point of stress. In their supreme arrogance and hubris, Geithner, Bernanke and Co. are confident (or at least publicly so) that they can manipulate the smoke machines and the mirrors indefinitely.

2010 will be the year the rubber band snaps and their arrogant confidence will be revealed as the empty tricks of conjurers.

Beneath the superficial reassurances and the ginned up statistics, risk has been building, slowly but relentlessly. The transition from low to high risk has been visible to those who refuse to be lulled to sleep by the official assurances. While no one knows when the rubber band will snap, those who have watched the systemic risk rise are confident it will break. Will the smoke-and-mirrors work for another year? Perhaps. But the rubber band is already refusing to stretch any more, despite the stupendous pressure being applied by the Fed and Treasury.

Betting the rubber band will stretch another year is a very high-risk bet.

Also his Dec 24th article is relevant - Why Interest Rates Will Rise in 2010

[unlucky]

Re: HUGE Treasury issuance is Deflationary?

His description of the current situation is quite good; it's the conclusions he draws that I take issue with. Of course, if one believes that "Bubbles Ben" will not monetize the US Government's debt then Kotoc would likely be correct. The problem for me is that I don't believe anything Bernanke says, and history is on my side.

I find the analysis by Cumberland Advisors quite plausible. Bernanke, I think, is subject to a particular kind of regulatory capture - ideological capture. In other words, he is not venal but wants to do the right thing, however within a world view that has been decided by Wall Street. He is Wall Street's Boy Scout. There is a good chance he will not monetize until forced to do so by the House of Representin' (which is entirely venal), and even then there will need to be a fig-leaf of some kind, e.g. "we have to this or the whole friggin' economy will collapse!"

[Raz]

Re: HUGE Treasury issuance is Deflationary?

I find the analysis by Cumberland Advisors quite plausible. Bernanke, I think, is subject to a particular kind of regulatory capture - ideological capture. In other words, he is not venal but wants to do the right thing, however within a world view that has been decided by Wall Street. He is Wall Street's Boy Scout. There is a good chance he will not monetize until forced to do so by the House of Representin' (which is entirely venal), and even then there will need to be a fig-leaf of some kind, e.g. "we have to this or the whole friggin' economy will collapse!"

There is no chance, since he already has: the Fed has monetized over $300 Billion in Treasury securities, probably a lot more. They have purchased over a $Trillion Bonars worth of MBS crapola. Unless Eric Sprott and Charles Hugh Smith and Arthur Cutten and Marc Faber and others are grossly misinformed then Bernanke & company have probably monetized even more than this.

Bernanke can theorize and rationalize to his little heart's content, but he knows that what he's doing devalues every Dollar held by everyone - except his banker friends who first receive the money. In other words, he's a criminal, even if the U.S. government says he's not.

[jneal3]

Re: HUGE Treasury issuance is Deflationary?

From the Cumberland analysis:

Another aspect of this construction about sovereign debt is that it is deflationary. Rising debt burdens consume greater and greater portions of income. They restrain spending. That is why the assumption that the increasing debt will bring on a large inflation is not necessarily correct. Japan is testimony to this outcome.

Isn't the problem with this is that Japan's sovereign debt was internal? At the very least, the disproving of the 'starve the beast' theory of constraining federal spending here in the U.S. contradicts the above.

This is the quote that struck me as the proof that the Treasury issuance is inflationary, not deflationary:

History shows that most governments do not pay off their debts. They refinance them indefinitely, and their governing central bank applies its directives and mandates and accommodates its sovereign states within that context.