(by Chris Hamilton)
Once upon a time, there was a thing called a “free-market” and for a time nations strove toward this ideal. To wit, a free market economy was a market-based economy where prices for goods and services would be set freely by the forces of supply and demand and allowed to reach their point of equilibrium without intervention by government policy, and it typically entailed support for highly competitive markets and private ownership of productive enterprises.
But power and belief shifted and faith now resides in governmental fiscal policy (spend more, tax less) and central banker interest rate policy (make money ever cheaper) to avoid the free markets down-cycles and extend its up-cycles infinitely. The central bank high priests have determined free markets are better replaced by command economies and further the priests’ purport they know appropriate levels of demand and supply…and absent the achievement of these levels, they will enforce their will even if the Fed’s programs are the likely cause that retards the Fed’s from achieving their stated goals!
But this has gone so far that now all we have is fiscal imbalances (the true nature is hidden by accounting fraud) and central bank centralized command of financial valuations. And I’m not being dramatic…I truly mean the Fed and central bankers are controlling the pricing of nearly everything financial (including sovereign debt / bonds, stocks, real estate, commodity prices, etc.) via interest rate targets and bond purchasing programs. The politicization and centralized control has turned the economic indexes into the central banks gauges which they actively “manage”.
The typical response to my diatribe…”Bullshit!!!…If this is true, prove it!”
Ok, I’ll take that challenge…and I’ll start with the misadventures of 2011 and attempt to show how so many seemingly disparate parts make up an interacting, interwoven whole.
So Much Fraud, so Little Time…but 2011 was a Banner Year
1) In May – July of ’11, China began the process of disengaging from the dollar…and began with a nearly half trillion $ Treasury selloff coinciding with the May ’11 ramp up of their program of gold accumulation.
2) July ’11 to year end ’11, Treasuries were accumulated in Foreign nations, in lieu of China, which lack the dollar reserves to purchase the Treasuries themselves…These are false fronts for shadow buyer(s).
3) The trend of rising debt and falling interest on that debt was unaffected by China’s withdrawal…US Debt to GDP doubled while cost of financing the US debt fell 2/3rds (see #1, #2, #4).
4) Sovereign bond “markets” were disbanded in ’11 replaced by central bank policy and purchasing to “establish” the CB’s will…(QE, Operation Twist, LTRO)
5) The US shale oil revolution simultaneously blasted off in 2011 driven by massive accumulation of unrepayable debt and tax deferrals.
6) BRICS bonds yields were flat throughout ’11 (and have remained so since), BRICS equity markets have generally fallen since ’11…while PIIGS have been rewarded w/ 70%-90% sovereign bond yield collapses and flat indexes since ’11 despite continued depression.
7) Quantitative easing purchases and the Fed’s balance sheet expansion are a fraud that can never be undone (anyone have an extra $3+ trillion lying around looking for sub inflation yielding Treasury vehicles?)
2011 – China Opted Out and Central Bank Fraud Took Over
Sometimes only in retrospect can you appreciate the magnitude and significance of events…2011 was such a period. In this time, China’s decade long accumulation of US Treasury debt peaked (not to be matched since) and fell precipitously, and I believe China effectively dumped $450 b of US Treasury debt in a matter of a couple of months and clearly simultaneously began a massive gold purchase campaign. Amazingly (yes, sarcasm), the price of gold (and silver) collapsed on this large increase in demand in concert with the end of QE2.
But this wasn’t how a massive sell-off of Treasuries was supposed to look…particularly since rates collapsed during this period and the dollar strengthened. And after stocks initial 20% fall, equities rebounded, never to correct since…exactly the opposite of the narrative of what the world’s largest holder of dollars actively de-dollarizing would look like.
The Chinese Treasury selloff was more than offset by six nations with little to no available reserves (some with no history of significant purchases) dramatically and rapidly buying Treasury debt…and these massive purchases were immediately followed by the announcement of the Fed’s Operation Twist in September and LTRO by the ECB in December and February ‘12. It appears all of this was either a contingency plan in place for this scenario or this was a coordinated effort…either way, nothing has looked the same since!
But first, Here’s the Set-Up to ‘11…
Global ForEx Reserves rising but % of Reserves held in dollars falls and likewise for the % of global dollar reserves held in Treasuries.
Nations running balance of trade surplus’ hold US dollar reserves either in dollar denominated reserves (est. $7.1 trillion assuming 60% of total reserves are dollar denominated…this is IMF’s best guess) or in the form of foreign held Treasury bills, notes, bonds ($6 trillion) or foreign held physical dollars in excess of $2 trillion. It seems logical that the $6 trillion in foreign owned Treasuries are purchased primarily from the $7.1 trillion in dollar based foreign reserves given Treasuries can be purchased and sold solely in dollars.
Among those “allocating” the % of dollars held in Reserves (allocated reserves are from nations stating to the IMF in which currencies and forms they hold their foreign reserves along with gold, SDR’s, etc…while China, Taiwan, and others do not disclose this breakdown, aka, “unallocated”), the % held has been declining since early ’01 from near 72% to 62% and this same decline is assumed for the “unallocated” countries as well (chart #1). Likewise the % of foreign held Treasuries rapidly declined until ’07 (as the US trade deficit was peaking)…Since ’07 the % of dollar reserves have continued declining while interestingly the % of foreign held Treasuries have recovered to early ’00 levels.
As Risk (default/devaluation) Rises, Lenders ask for less Reward???
From 2000 ‘til present, debt to GDP* doubled while the rate of interest charged by US creditors fell 2/3rds (see chart #3). Much of the credit for this counter-intuitive movement of rates vs. risk is thanks to the Fed’s easing and eventual quantitative easing programs. But it wasn’t just the Fed’s purchases; growth in foreign held debt grew 6x’s in the same period while intra-governmental holdings grew 2x’s and Public held debt grew a little less than 3x’s (though this growth in Public debt is a little misleading as most of the growth was in short term T-bills, converse to the Fed’s growth in long notes/bonds).
Chart #2, *Debt /GDP shown as 5% to 10% instead of actual 50% to 100% allowing easy comparison w/ interest rates.
Of the 80% increase in Federal debt since ‘08 ($8.44 trillion in US Federal debt added), the ownership increase was led by “foreign” purchases 43.5%, then “public” 26%, “Fed” 19.5%, and “Intra-governmental” debt 11% (see chart #2).
And from ’00 to ’11, America’s top four foreign creditors grew their Treasury holdings…China’s 20x’s increase led the way, Belgium / Luxembourg’s 17x’s, Cayman Islands (aka, Carribean banking centers) 10x’s, and Japan 4x’s; all vs. the Fed’s 3x’s increase in the same period.
But Who’s Got the US dollars to Buy Treasuries?
One might assume a nations foreign reserves would be recycled into US Treasuries to earn a return on excess held trade surplus’ and that the forex Reserves would be the limiter to a nations ability to buy Treasuries…but alas, chart #4, showing a nation like Belgium with $20 billion in Foreign Exchange Reserves (presumably split between multiple currencies, likely 60% in dollars or $13 billion) yet holds $364 Billion in Treasury debt, shows this is false. Many nations show this same discrepancy…holding Treasury debt far in excess of US dollars with which to buy it!?!
BTW – On a relative basis, China’s est. Treasury holdings represent only 45%-50% of their dollar reserves…in line w/ Germany and Switzerland’s ratios and while China does not share the breakdown of foreign currency held, it likewise does not share its gold purchases held as portion of its reserves…officially China still maintains holdings of 1054.1 tons but a quick glance at chart #6 of monthly gold imports belies that claim.
So What Happened in 2011…by the numbers
• Commodities peaked and then were slaughtered…never to recover (at least so far)
o Commodity metal price index peak Feb ’11 256…currently 169
o Commodity Food index peaks 192 in Apr (post ’08 peak)…currently 172
o Energy index peaks 212 in Apr (post ’08 249 peak)…currently 190
o Copper $4.63 (Jan) $3.01 (Sept)…currently $3.21
o Silver peaked above $49 (March) and collapsed 45% to $26 (Aug)…currently $19.43
o Crude Oil hit $115 barrel (Apr…post ’08 $147 peak high) and fell 35% to $75 in 6 months…currently $93.87
o Gold peaked above $1900 (July) and fell 20% to 1560 (Aug)…currently $1283
• Currency trends reversed
o Dollar index hit 73…then rose 10% to 80 by August…currently 82.5
o USD/JPY bottomed @ 76 (July) after the March ’11 Tsunami…was range bound 6 months before hitting 84 in Feb ’12…but only after Abe’s arrows were unleashed in September of ‘12 did the BOJ realize it’s devaluation goals with a 40% drop…currently 104.
• S&P 500 peaked @ 1374 (Apr ‘11)
o June 31 QE2 completed
* S&P falls 22% to 1068 (Sep)…last 20%+ equity correction
• China Sold…
o Canada, UK, China hit sequential Treasury holding peaks and soldoff $451 b (1):
May ’11 – Canada peaks @ $93 b, sells 52% ($48 b) to $45 b in 2 months
June ’11 – UK peaks @ $347 b and sells 70% ($240 b) to $107 b in 3 months
July ’11 – China peaks @ $1315 b and sells 13% ($163 b) to $1152 in 4 months
• China, which traditionally utilized UK (and perhaps Canada) as fronts to buy Treasuries, likely ran up treasury holdings and then dumped them…this is pretty clear as both Canada and UK purchased 2x’s and 4x’s, respectively, in excess what their foreign exchange reserves would otherwise allow. None of these nations have since reclaimed the above peaks in Treasury ownership.
• China, w/ 35% of the world foreign exchange reserves, simultaneously began a massive gold purchase program in May ’11 carrying on to this day (see chart #1).
• Somebody Behind the Curtain Buys…
o Japan, Belgium, Luxembourg, Ireland, Norway, & Cayman Islands fill the Treasury breach with purchases of $527 b (July til years end) (1). Interestingly, none of these nations likely had the foreign exchange reserves to make these purchases (see table #7)?!? Seems fair to say these nations were used as fronts for some other entity doing the purchasing.
* Japan re-starts buying and adds 20% ($169 b) to $1058 b
* Belgium picks up 400% ($101 b) to $135 b
* Luxembourg adds 210% ($79 b) to $148 b
* Ireland adds 360% ($61 b) to $98 b
* Norway adds 280% ($37 b) to $57 b
* Caribbean banking centers add 55% ($80 b) to $227 b
• Fed & ECB to the Rescue
o Sept ’11, Operation Twist announced $400 b (eventually increased to $667 billion) selling all 3yr or less Fed held bills/notes…to purchase $667 b in longer term notes/bonds
o Dec ’11, ECB LTRO lending 489 billion Euro ($640 billon $’s) @ 1% to allow banks to buy PIIGS sovereign debt (325 billion Euro went to banks in Greece, Spain, Ireland, Italy) then yielding up to 20%
o Feb ’12, LTRO2 lending additional 529 billion Euro ($693 billion $’s) @ 0.5%…
o Sept ’12, QE 3 announced
(1) – http://www.treasury.gov/ticdata/Publish/mfhhis01.txt
How’d it all Work Out? Compare and Contrast US / EU vs. BRICS
• US, EU Bond markets rates were effectively dictated by central banks…
o During this massive rotation, US 10yr Treasury yield fell 55% from 3.67% in Jan to 1.67% in August ‘11 (currently 2.36%)
o June ’11 Irish 10yr peaked 14.5%…fell 87% til present (currently 1.78%)
o Oct ’11 Italian 10yr peaked @ 7.5%…fell 68% til present (currently 2.39%)
o Dec ’11 Greece 10yr debt peaked @ 42%…fell 86% til present (currently 5.62%)
o Dec ’11 Portugal 10yr peaked @ 17.5%…fell 83% til present (currently 3.02%)
o Jun ’12 Spanish 10yr peaked @ 7.75%…fell 71% (currently 2.14%)
• However, BRICS interest rates were generally unchanged Jan ’11 – present
o Brazil 12.4% to 11.6%
o Russia 7.8% to 9.3%
o India 8.15% to 8.5%
o China 3.9% to 4.26%
o S. Africa 8.6% to 7.8%
An Aside – ECB’s Overt Rate suppression via LTRO…Does the Federal Reserve Run a Covert QE?
o Given the US Treasury curve (yielding from 0.025% 1mo, 0.08% 1yr, 0.89% 3yr, 2% for 7yr, to 3.2% for a 30yr)…there would be no spread or profit in using commercially lent money to purchase Treasuries. I wrack my brain to come up with lenders willing to lend money below these Treasury rates? Who but the Fed could loan money @ 0%? Yet Treasuries are bought in nations with no reserves and those with Reserves show no interest in purchasing. By process of elimination, seems the Fed is the only one who has means, motive, and opportunity.
o In Europe the LTRO* was engaged in Dec ‘11 lending 489 billion (Euro’s…$640 billon $’s) @ 1% to allow banks to buy PIIGS sovereign debt (325 billion Euro went to banks in Greece, Spain, Ireland, Italy) then yielding up to 42% followed by LTRO2 lending 529 billion (Euro’s) @ 0.5%…pretty nice spread for those taking those loans. And yields of PIIGS debt have crashed 70% minimum up to almost 90% now, many lower than corresponding US yields. But I don’t recall the US implementing a similar program focusing lending @ 0% to foreign nations with which to buy US debt!?! (*LTRO – long term repurchase operations = refinancing high yielding sovereign debt to artificially low interest rates w/ no loss reserves necessary.)
• Select US, EU, Most Favored Nation Status Equity markets unleashed (’11 – present)
o S&P 500 1068 (Sept ’11) to 2000…+87%
o Nikkei Feb 8227 to 15521…+90%
o DAX Aug 4965 to 9588…+93%
o FTSE Jul 4791 to 6823…+42%
• BRICS equity markets Jan ’11 to present
o Brazil 66,600 to 59,900 -11%
o Russia 1723 to 1443 -19%
o China 2790 to 2207 -26%
o India 16,400 to 26,400 +60%
o S. Africa 32,000 to 52,000 +60%
Since June, ’11…
o Fed added almost $2 trillion of purchasing in 5yr+ Treasuries
o Treasuries Foreign held added $1.6 trillion…but the bulk of additions came from nations with no available foreign exchange $ reserves?!?
o China / Russia, representing 38.5% of global foreign exchange reserves $’s, since June ’11 have reduced their Treasury holdings by $45 billion.
* When China’s false front buying locations are included (offshore buying in UK, Canada), China and Russia combined have reduced Treasury holdings by $246 b since June ’11 but added untold quantities of gold to their holdings.
Noteworthy is the US currency devaluation of ’71 coupled with the initiation of the petro-dollar agreement in ’71 marked the beginning of the four decade long decline in US oil production. Likewise, a major uptrend in US oil production took place from 2011…as some sort of currency operation was once again was under way in ‘11…somehow I think this wasn’t coincidence…consider:
• World oil production remains flat for the last decade without US production gains
• US oil production rockets…as WTI oil prices range bound @ $95
o US oil production peaked in 1970 @ 9.640 mbpd, bottoms ’08 @ 5 mbpd but begins a rapid rise from mid-year ’11 @ 5.65 mbpd to 7.45 mbpd in ‘13 (30%) and still rising.
Or even more plain to see, take a look at the production of oil in the state of Texas…and note the massive leap in production beginning in…2011.
What spurred massive increases in the US oil production in ’11? Virtually the entire increase in US oil came from “tight” oil or Frac’ing as traditional sources of oil maintained their 4 decade production descent.
From SRSRocco Report… CONDITION RED: Fracking Shale Is Destroying The Balance Sheets Of Oil & Gas Companies
In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years (’11-’13), the gap was over $100 billion/yr. This is the chart of an industry with apparently steep and permanent negative free cash-flows: This is the huge problem with Fracking shale oil and gas. Due to the extremely high annual decline rates of the typical shale oil or gas well, companies must continue to spend a great deal of capital expenditures to replace what was lost. It’s known as the DRILLING TREADMILL…. once you start, you can’t get off.
In one year the top 127 oil and gas companies spent $110 billion more on capital expenditures than they received from operations. So, they acquired $106 billion in additional debt (a large percentage through the Junk Bond Market) and sold assets to make up the difference.
This is not a sustainable business model, just like the same nonsense taking place in the broader stock markets as corporations buy back massive amounts of their stock to give the ILLUSION that everything is fine and BAU- Business As Usual will continue.
Not only are many of these oil and gas companies hiding the fact that their balance sheets are hemorrhaging debt, they also have a cozy situation with the Federal Government. Basically, the Fed’s allowed them to defer more than half of their tax bill… and it’s a lot of money. In a nutshell, the top 20 oil and gas companies still owe $16.5 billion (more than 50%) to Uncle Sam in tax revenue.
Taper and Exit Talk
Now the Fed says it will likely taper QE to zero by October and eventually thereafter begin to normalize its balance sheet selling Treasury’s and MBS’s…but to whom? The Fed will have far more to sell ($3+ trillion from its current $4.41 trillion balance sheet) than there are available foreign held dollars to buy???
In the below estimate from ’15-’18 under the Fed’s suggested taper and balance sheet reduction, I estimate;
• Federal Reserve ceases QE by year end in ’14
• Fed begins selling or does not roll over 10% of Treasury holdings / MBS annually thereafter
• Foreigners and Intra-governmental purchasing remain stable
• Budget deficits maintain an average of $1 trillion
Under this fairly optimistic scenario (chart #11) the domestic “Public” is left to purchase $800 billion in Treasury debt annually vs. the $60 billion/yr actually purchased from ’11 –’14. To say the least, this would not be equity positive and I really can’t guess under what conditions the US domestic buyers needing 7-8% yields (ie, pensions, states, muni funds, insurers, etc.) would turn this heavily toward bonds yielding literally little more than zero!?! More likely, we should simply expect ever more massive Treasury holding increases through “foreign” false fronts who haven’t the dollars to buy them!?!
Central Banks have taken ownership of the sovereign bond markets. China and Russia (and BRICS in general) have and will continue to abandon the dollar-centric system and their lack of participation will be papered over by central bankers. Treasury buying through false front nations which themselves have no reserves with which to purchase the US Treasury debt will likely only accelerate. This centralized command of sovereign bond markets (and its yield mechanisms from which all other assets are derived) has mispriced all asset classes. The central bankers have created a hall of mirrors distorting all we see and the benefits of these distortions are flowing to an ever smaller minority at a growing cost for the vast majority.
Post Note –
BTW – I also gladly acknowledge the Foreign Exchange Reserves data from the IMF and TIC report from the Treasury, on which I base much of the above, is highly dubious and highlights some truck sized fundamental holes in the reporting of who owns Treasuries by the TIC and who holds currencies, gold, etc. by the IMF. Both organizations admit their reports are best guesses and only as accurate as the entities self-reporting the data. China does not make public the breakdown of its reserves nor does the TIC report state it knows the actual owners of Treasuries, only where they were purchased and held…To wit, directly from the TIC…”Since U.S. securities held in overseas custody accounts may not be attributed to the actual owners, the data may not provide a precise accounting of individual country ownership of Treasury”. Still, I have to start somewhere if not at least to show the consensus narrative is fatally flawed.
This article was written by Chris Hamilton, originally posted at CharlesBiderman.com.
Please check back for new updates and articles at the SRSrocco Report. You can also follow us at Twitter, Facebook and Youtube below: