When are rates really gonna go up?

[powayseller]

I already explained it. The effect was made when the money came here. By buying so many Treasuries, the yields went way down, and asset bubbles were created. There is a misunderstanding that the FCBs are just buying Treasuries. But in truth, their purchases of mortgages (Fannie Mae GSE kind of stuff and MBS) exceeds the Treasury purchases. The growth in the financial sector rose from 4% of GDP in 1980 to 71% by early 2002 (I don’t know what it is today). The Flow of Funds report shows all this. Federally related mortgage pools have grown from $114 bil in 1980 to $3 tril in 2002. In 2002, mortgage-related securities issurance totaled $1 trillion in just the first half of the year, an increase of over 50% from the same period in 2001.

So that money is hot, hot, hot, and it alone is responsible for our big stock market gains since early 1980, and the asset bubbles fueled since then. The bonds that were purchased are used by businesses and governments to provide services, and their purchase affects the interest rate of those bonds.

As of 2002, Treasuries were the 4th largest category of total credit market debt. The 3 bigger ones are financial sector, non-financial corporate business, and the household sector. The FCB dollars are going into about 26 categories of credit markets, working to make easy money for us to buy stuff, for corporations to buy each other out. Check Flow of Funds, Table L.1.

So the question remains what happens when the FCB divests its US assets. It will have the effect of credit contraction, and devaluing the dollar and US assets. Imagine the stock market really falling when those foreigners sell their US stocks.

So when we ask who is to blame for the housing bubble, don’t blame realtors or lenders. Blame the US consumer for spending more than producing, because the result is that a bunch of countries ended up with hundreds of billions of dollars that they needed to find a home for.

[powayseller]

As far as Treasury money, I’m by no means an expert but doesn’t the government spend all the money it gets from selling Treasury bills and bonds? I don’t understand how any money that goes somewhere just sits idle. Banks, governments, they all spend the money they get. Banks lend it, but governments use it to run their government and pay the interest on past debt.

[Anonymous]

ps, peruse any college textbook on “Money and Banking” and you’ll see that the Federal Reserve and U.S. Treasury control the number of dollars in circulation via two functions:
1. Adjusting bank reserve requirements (not applicable to this topic).
2. Buying and selling U.S. Treasuries.

The U.S. Treasury takes dollars from the Japanese or Chinese and gives the Japanese or Chinese U.S. Treasury securities in exchange. That is how the Treasury keeps excess dollars out of circulation.

Japanese purchases of MBS, stocks, and real estate are different. The Japanese or Chinese give an individual or corporation dollars, and the individual or corporation deposits those dollars in a bank. The bank then makes loans against those dollars. Thus, the originally-held-by-Japanese-or-Chinese dollars remain in circulation.

Dollars received by the U.S. Treasury (in exchange for U.S. Treasury securities) reduce dollars in circulation; dollars received by individuals (in exchange for MBS, stocks, real estate) have no effect on dollars in circulation.

[poorgradstudent]

Good idea or not, I agree that we’re not going to see an increase by the Fed until after the coming recession, whenever it hits.

[Wiley]

JG,

To be honest I don’t know enough about the mechanics of the Treasury but wouldn’t they be using those funds to pay for gov’t expenditures, war, etc. Otherwise why would a treasury agree to pay interest for dollars their not using?

Also, dollars recieved by individuals, companies, etc that get deposited would have an affect in that the banks don’t lend out the same as they have on deposit. We have a fractional reserve banking system so the amount lent is multiples of the deposit.

[powayseller]

jg, your college textbook would have told you that goverments actually spend the money they get when they issue bonds.

The U.S. Treasury does not put all those dollars it gets from selling Treasuries into a big vault, out of circulation, “on ice”. They spend it.

[Anonymous]

Wiley, I fully agree that, given our fractional reserve system, deposits into a bank have a multiplier effect.

Example for the U.S. Treasury:
The government wants to purchase radar technology from Japan in Nov.

In Nov., the Dept. of Defense receives the radar system and pays Mitsubishi $1B via check drawn on the U.S. Treasury.

Separately in Nov., the U.S. Treasury sells the Bank of Japan a $1B T-Bill. The BOJ receives a $1B T-Bill and the U.S. Treasury receives a $1B check drawn on the BOJ.

Net effect: the U.S. receives its $1B radar system and the BOJ holds a $1B T-Bill. Because the $1B checks originated from, and ended in, the U.S. Treasury, there is no increase in the money supply.

Repeat the above transaction in Dec., Jan., etc. and you soon have $2.1T in Treasury bills/notes/bonds outstanding.

Should the BOJ ever choose to liquidate its $1B T-Bill, it will receive $1B via check drawn on the U.S. Treasury and the U.S. Treasury will receive its $1B T-Bill.

Net effect: reduction in the U.S. debt of $1B and increase in the U.S. money supply of $1B.

Up to this point, the $1B is strictly accounting entries between the U.S. Treasury and the BOJ. The key is not what happens to the ‘dollars’ returned to the U.S. Treasury (the U.S. Treasury keeps the $1B ‘on hand’ via accounting entry to serve as a ‘reserve’ against the $1B outstanding T-Bill, as the Japanese will redeem the T-Bill sometime in the future, and the U.S. Treasury must have the $1B ‘on hand’ to fund such).

The real key is whether the U.S. Treasury is able to sell T-Bills to sop up the ‘printed’ money (the original $1B check issued by the Dept. of Defense and drawn on the U.S. Treasury). The biggest way the U.S. Treasury ‘prints money’ is to issue checks drawn on its own account.

If the U.S. Treasury can’t sell T-Bills, those $1B checks to Mitsubishi, General Dynamics, United Nations, etc. remain in circulation, get deposited in banks (and get multiplied, as you point out), and cause inflation. That’s why, to-date, inflation has been mild, as the U.S. Treasury has been able to continuously sell those $1B T-Bills, sopping up the money that it has ‘printed.’

Wiley, please tell me if I have been unclear on a point.

[powayseller]

I won’t interfere with your conversation with Wiley. But I’d like to elaborate on my points made earlier.

The Federal Flow of Funds Credit Market Debt chart shows that US Treasury debt has risen steadily, but it is not the largest source of credit market debt.

As of Q2 2006, Table L.1 shows these are the largest categories of debt outstanding.

Household sector $ 12,310 trillion
Non-fin. corporate 6,600 tril
Federal government $ 4,700 Trillion
mortgage pools 3,813 trillion
ABS issuers 3,228 trillion
GSE 2,686 tril

The household sector’s credit market debt is the 2nd heaviest borrower in the credit markets after the financial sector (which includes mortgage pools, ABS, GSEs, and other categories).

Mortgage pools are pools of mortgage securities issued by one of the GSEs, and have brought a lot of money into our housing market, thus pushing up prices. They’ve grown from 4% of GDP in 1980 to 29% of GDP in early 2002.

ABS issuers have seen the greatest explosion of debt. 12 years after their introduction, their debt is 4x greater than that of commercial banks. That category includes credit cards, auto loans, equipment leases, corporate loans, mortgages (esp. sub-prime home equity loans), and trade receivables.

Pension funds and retirement accounts, which hold a lot of the ABS debt, have taken on the risk of default by borrowers of this debt. Expect to see a lot of pension and retirement account mutual funds take big losses when this credit bubble implodes, further burdening corporations and governments, and reshaping retirements for millions of Americans.

If the US budget deficit or credit demand is reduced, where will the foreigners put their dollars? The foreigners need a sufficient amount of US debt issue to recycle their dollars.

[qcomer]

There is acually now dominating view that interest rates will be cut by March 2007 because the housing downturn is taking the whole conomy down with it. However, with the dollar decline, you have a corresponding increase in oil prices. And I think oil prices, not the housing market or recession, is what is going to drive the interest rate outlook for the US. It is simple that the Fed can afford to have a housing recession but it cannot afford $100 per barrel oil in this country. So my prediction for rates is that they will depend on oil prices.

[Wiley]

Ok I think I agree if the Treasury is able to sell its notes to someone else (in this case BOJ), and we we have no trade deficit, then its just a trading of assets and liabilities on eathothers books. However I think the chink in the armor here is your assuming the BOJ’s money was not created into existence and also that treasuries sold on the open market can and are purchased by our Fed (money creation).

Tell me if I’m wrong here (as per my initial disclosure that I’m no expert on this)

There is also this non-traditional method which has been reportedly used recently…

The following is what the Electronic Money Printing Press is:

Japan experiences a demand for the yen which is not welcomed by the Bank of Japan.
In order to stave off an appreciation in the yen, the Bank of Japan needs to create yen in order to sell it to buyers who offer US dollars in return.
The Bank of Japan borrows yen in the same manner as the example below, whereby the US or any other nation can create money in their insular systems.
The difference here is there is no time for a natural creation of money via the many steps. The Bank of Japan needs dollars and they need them now.
The Bank of Japan enters the yen/dollar 24 hour market selling the borrowed yen, receiving dollars in return.
The bank of Japan is now drowning in US dollars, but only for a very short time.
The Bank of Japan electronically transmits dollar money wires to the Federal Reserve Bank of New York.
The Federal Reserve Bank of New York many times with a 24 hour day receives these wires and deposits them in the Japanese Float Account at that bank.
The Federal Reserve Bank of New York is the investment manager of the Japanese Float Account.
With the knowledge of the Bank of Japan, the Federal Reserve Bank of New York utilizes 100% of each bank wire as it arrives to enter into the international market for US Treasury instruments, buying US Treasury bonds all across the maturity curve from the shortest out to 30 years.
This fuels a bull market in the US Treasury market.
This bloats the US TIC report on inflows of capital into the US.
The New York Federal Reserve Bank, by buying the bonds for the Japanese Float Account at that bank in the open market, places dollars in the hands of worldwide sellers of Treasury instruments.
Because the international US Treasury market is a private market the increase in liquidity is huge, quiet and everywhere.
The reason this transaction cannot be unwound is because the method would be selling all those bonds that have been accumulated for the Japanese Float Account at the Federal Reserve Bank of New York into the open market. That is a practical impossibility as even the huge international market in US Treasury items cannot absorb such a supply.

This transaction is totally different in its manner and impact than subscribing to an issue of US Treasuries at auction on behalf of a non US buyer, which is customary.

This is the non-traditional method Professor Bernanke utilized that liquefied the world in a short period of time. This attempt to support an international economic recovery is now hitting home with its inflationary impact. This is beyond huge and happened over a short period of time compared to traditional methods. The results cannot be stopped because the liquidity cannot be drained. Regardless of the games played to break the psychology of inflation, real inflation will be delivered in an unprecedented proportion and non traditional manner.

[powayseller]

jg, here’s a quote from The Dollar Crisis, which explains that all the money created by the FCBs entered the US as high powered money into our banking system, multiplying many times over, and creating the .com and housing bubbles.

“…regardless of what type of asset was initially purchased with these funds [inflows into the US], eventually, most of that capital worked its way into American banks. For example, if the capital inflows were used to buy government bonds, the government spent the proceeds on goods and services, and the providers of those services deposited the payments they received from the government into their bank accounts. The same is true regardless of whether the funds coming into the country were used to buy corporate bonds, stocks, or any other kind of asset. Unless the money was hidden under a mattress or destroyed, most of it would have entered the banking system as deposts; and deposits make up most of the money supply.

….When funds from abroad enter a banking system as deposts, they are not re-lent only once. The original amount that is lent will be redeposited and then re-lent and redeposited numerous times. …Therefore, the $3 tril in capital inflows after 1983 did much more than finance an additional $3 tril worth of debt. Those inflows were deposited, lent out, redeposited, and re-lent mulitple times. In that way, they caused the U.s. money supply to expand, fueling the bubble economy that emerged in the the U.S in the 2nd half of the 1990s’.”

That money created the Nasdaq bubble, too. What happened is that the gov’t ran a surplus, so the FCBs couldn’t buy enough Treasuries with their dollars, and had to buy other assets instead. In hindsight, we would not have had the .com or housing bubbles if the government would have continued running a deficit and issuing sufficient Treasuries to absorb all those dollars. Another solution would be to stop printing so goddamn much money!

Duncan continues, “The investments in corporate bonds facilitated the misallocation of capital that is now laying low the dot.coms and the telecommunication companies, among others. And the investments in agency debt have helped fuel the boom in U.S. property prices, that has allowed the U.S. consumer to extract additional equity through refinancing his home in order to keep spending more than he earns”.

French economist Jacques Rueff explained our dollar recycling program back in 1961, before it even existed, as he saw what would happen once we went off the gold standard:

” The functioning of the international monetary system was thus reduced to a childish game in which, after each round, the winners return their marbles to the losers”. – Rueff

In other words, the producer countries of Asia sell us their stuff, and then return to us the money we pay them. It’s a ridiculous sytem!

[Anonymous]

Wiley, I followed and agreed with your example down to near the end. If you say that the Fed Reserve Bank of NY buys bonds on behalf of the Japanese, I defer to you, because I don’t know of such a mechanism. Sounds interesting and scary!

I just know of the risk posed for huge inflation from sudden selling of Treasuries held by the Japanese, Chinese, et al.

[hipmatt]

I am not a financial or economic pro, but I just can’t understand how everything can keep going up in value, and how inflation isn’t a problem, when it seems like the only thing thats keeping our economy going is a crap load of loans and financing.

Everyone (wall street) acts like the economy is just fine, there will be a soft landing, and the fact that personal and national debts are at an all time high and growing is no big deal. Is anyone expected to pay off their debt, or is debt a new “concept” that goes like, “if you can afford it now, thats all that matters, perpetual debt is now OK”.

Incomes are not going up, but houses in socal are 3-4 times more expensive than they were just 10 years ago. Health care is up. Fuel is way up.(temporarily down, but you are kidding yourself if you believe the worst is over). Rents are going up. People are driving nicer cars, buying nicer LCD TV’s, and now we have cell phone bills/HDTV Sat bills, etc that we really didn’t have 10 years ago. Theres the illegal immigration costs. Where is this money coming from? How can we say inflation isn’t here?

How can the Jones’ buy a $600k home in Temecula(at 2%tax too), a new Suburban or two, commute to SD, furnish their home with granite, plasma, and stamped concrete, and actually pay off ANY debt? I know I currently make a lot less than you all, but who else plans on OWNING(not owing any $$ to anyone else) their car or home? How can all these mortgage brokers survive? There like a dime a dozen, how many are actually needed? I am confused.

I know a couple who makes what my wife and I do(just about $75k per year). They just bought a first home in Menifee for $385k. They feel like they got a steal because the price was reduced $20k. They did 100% financing. Now that they are struggling to make the payment, they have decided to move to Oregon. But their plan is to wait a year, so that they can make a $100k profit on their house, “like their neighbor did”. They said this so matter of fact, like everyone who owns a home just makes $100k per year, just like the past few years. They are not the only ones. There are tons of people doing this like its no big deal.

If they would make a 20% cash down mandatory, we wouldn’t have any of this bs. I am just confused, and disappointed in our countries lack of financial responsibility. I wonder when its all gonna hit the fan, and wonder what I can do to make it through. So far, I sold my home last summer, invested in some Gold, Oil, and CDs, thats about it. I haven’t made a whole lot yet, but I would have lost about $20k on the house if I stayed. I am happy with my decision, but I wonder whats best to do in the future.
Matt

[Anonymous]

Nice, clear read of the situation, Matt; I could not agree with you more.

Great job getting out of your house.

In my opinion, it's going to be an ugly run of years, and you're now in a better position to survive, then thrive.

I recommend gold, or better yet, gold mining mutual funds.

P.S. — some well-heeled folks are attuned to the devaluation of the dollar and the attractiveness of gold: a guy who lives in (per my wife) the best looking house in La Jolla and I were chatting on Saturday. He found the recent article in The Economist on the fall of the dollar convincing. For folks interested in a local source for gold, he recommends Joel Perlin:

http://www.goldendures.com/about_us.html

[powayseller]

If the Treasuries are sold off or not renewed when they expire, then the interest rates on Treasuries will go higher. What else? Where will all those dollars go? The export countries won’t convert them into their own currencies. They could buy other currencies or gold or hard assets. oil is sold in dollars, so they could buy lots of it. Unless of course they think the price will come down, or they lack a large storage facility.

Imagine the worse problem when we actually pay down our debt, and there aren’t enough treasuries to absorb all the dollars. Then the FCBs have to buy ever more MBS and equities, and create bigger and bigger bubble! Now, isn’t that a conundrum? Paying down the national debt creates asset bubbles!

My brother thinks that China has a long term plan to attain all the US manufacturing and high tech industry knowledge, so they can learn it and copy it. Once they have what they want, they’ll discard their dollars and use their money to buy natural resources.

[Author]

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