I read today that the purchasers of long term U.S. government debt are howling mad that the Federal Reserve is considering buying up treasuries of long term notes.
It made me nostalgic enough to post this diary to remind myself of who exactly runs this planet, who exactly has the power to squeeze the Fed despite being the all powerful agent it seems to be at the center of this financial predicament.
The investors of long-term bonds, specifically issued by the U.S. government, are all those entities who do have money around the planet, just sitting there waiting for the safe returns the humongous issuance the crisis demands. They are the powers and principalities that beyond the banking systems, beyond the shadow banking, sit and wait.
They are the ones that call the shots at the IMF and World banks. In fact they created the IMF and World Bank for just their purposes to restructure Latin American and Third World debt in the 1980's.
They,for the most part, hold a low profile and go about their business parking money as the world shatters knowing they are the last desperate chance for governments to float a cause for saving the system.
In one worldview we need them. In another more realistic view we are destined to be beholden to them.
But one consistent characteristic defines them:
Their incessant bitching.
Along with their bitching about any attempts to depress their entitled and inflated returns they have an effective track history at threatening governments and manipulating policy makers on up to Presidents when it comes to percentages.
Stock markets aren't about to disappear, but they'll retain relevance only to few. The financial fate of the masses will depend on another arena entirely - the bond market. It's no coincidence that James Carville, former economic adviser to Bill Clinton, said, "I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody."
Eytan Avriel at Hard Look
You might've come across that quote recently since it's been popping up of late everywhere.
There's a reason in the tremendous quantities the U.S. Treasury is going to auction off in 2009 to pay for stimulus, bank and foreclosure relief.
It would be wise to remind ourselves of the place, maybe more to the point, the utility of long-term bond investors in the pantheon finance. We should contrast their role to say the role of Keynesian spending regimes in a crucible of "purpose". They are bookends in all respects, even lashed to each other.
But there is an enlightening difference in application.
The Keynesian engines look to engage the economy by spurring on credit and its creation. The bond market looks to park money so it can beget more money in the form of returns. And this is fine if it fills the function needed to float the credit market. But the fundamental purposes are fundamentally counter to each other almost existentially.
"If the Fed commits itself to a policy of artificially depressing the returns on Treasury securities for an extended period, it will force investment committees around the world to reconsider their portfolio allocations to the U.S. Treasury market as an asset class," Crandall wrote recently. "There is no guarantee that the international investors who dominate the Treasury market will move into other dollar-denominated assets if the Fed manages to make Treasury securities unattractive to them.
Given the Treasury's massive borrowing needs, any attempt to rig the market in this environment could backfire -- with serious long-term consequences for the public finances of the United States," Crandall said.
And therein lies the evil if the equation goes out of balance between what kind of return on government debt is required and what kind of return is demanded.
The mechanics of the demanding along to the unambiguous threats made to governments to the point of vexing Fed policy to use a form of quantitative easing - buying up Treasuries to expand the money supply - as a tool to avert the worst of financial crisis should be seen as a threat.
But a government bond is a loan by you to the government. Where will governments find the money to repay everybody, given the sky-high amounts they're borrowing to rescue the financial system and jump-start the economies? Answer: They'll issue new bonds. Result: A glut of bonds and inflation, which will depress bond prices. Economists expect that in two years, the price of government bonds will reflect returns of 7%, which will also depress the price of Israeli government bonds.
Did you get that? 7% is a the depressed rate if government, U.S. specifically, gets its way. They expect 10% returns.
The maddening element, like most things meltdown these days, is the silly arrogance in the face of the fact that Treasuries, at least the short term ones, are considered sanctuary for the smart money. But if this is a planet wide disaster in the making and the bond market is indeed the last backstop for government policy since the central banks are left at a loss, where do the bond investors have to go when it all comes down? Put another way, if the whole world becomes one big Latin America Circa 1986, there are no IMF's or World Banks left to restructure their investments to date. They go down with the rest of us.
They must know this but still reflexively threaten not to buy and squeal like poked pigs if someone else does.
Ship of Fools. Mr. Gross and the rest.