Sunday, August 4, 2013

Why the US has enjoyed lower interest rate while printing vast amount of USD

Christopher Marlowe raised a timely issue/question in the comments to one of my recent posts:

why is the rising rate on the 10 year bond unavoidable?

Can't the Fed just buy a bunch of these? Andrew Gause says that the Fed will continue with QE when the interest rates get too high.

This is a very timely question because, as Zerohedge explains, yields on US government debt have recently started to climb.  And, the consequences of higher interest rates are dire.

Zerohedge asserts that if the Fed stops buying US treasuries or even slows their current pace of purchases, which is now commonly called tapering, interest rates will take off.  This is very logical because 1) interest rates started coming down several years ago when the Fed started purchasing treasuries and 2) the Fed is currently purchasing about $85B per month of US treasuries and without this demand yields would be higher in order to entice other buyers to purchase the US government's debt.  

If tapering would increase yields, the inverse must be true and increasing Fed purchases will lower yields.  Thus the Fed can keep a lid on rates by continuing with even more QE and increasing the rate of treasury bill purchases.  Zerohedge, CM, and Andrew Gause are all in agreement.

So why are debts and deficit spending a problem for the US?  Print more dollars to finance solar energy farms and create jobs.  Print more money to save Detroit and other US municipalities.  Print more money to finance wars and military occupations.  Print more money to subsidize big, profitable international agriculture, defense, oil and pharmaceutical corporations.  Keep printing by issuing more treasuries.  The US Fed will keep buying them and interest rates will stay low.  The US has been on this path and will continue on this path until something breaks.  Something will break eventually.  One cannot keep printing and expect a counter party to accept that currency in exchange for real goods, such as oil, food, gold, etc.  When and how will the printing path meet a cliff?

The Zerohedge article presents the quote "Obviously you can't print money forever or no emerging country would have gone broke".  However, the US is not an emerging country and therefore this fact does not help us forecast when and how.  The situation in the US is special because the USD is the world's reserve currency.  Argentina and Japan, to name a couple cannot just print their way to prosperity because no one would accept their currency in exchange for real goods if they printed too much too fast.  The Japanese Yen, for example has lost 25% of its values versus the USD since November when Japan hit the accelerator on their money printing machine.

The US has been able to get away with printing a lot of USD really fast and enjoy lower interest rates because others continue to accept the USD.  Why does Saudi Arabia still accept USD in return for oil?  Or why does China still accept USD in return for iPhones?  They accept USD because they can turn around and purchase jet fighters and oil, and even gold for USD.  There is still trust in the USD and therefore it is called the world's reserve currency.  Additionally, the current global financial system which was set up by the US after World War II is based on the USD.  And, perhaps most importantly there is no practical alternative to the USD.  Would you trust Euros or Yen or SDRs more than the USD?  

Trust fractures.  It does not erode slowly over time.  So it is very difficult to predict when trust in the USD will be lost.  Interest rates are the best early warning system available.  However, since interest rates are being depressed by all the Fed buying it is difficult to distinguish the warning from the manipulation.  So yes CM, the Fed will manage rates down by buying more and more US government debt until they cannot.  Then the system will fracture.

As a side note, one way to get more insight in to the rates on US government debt is to watch the Treasury's auctions.  Zerohedge does a nice job of regularly posting about Treasury auctions: the category of buyers and the bid/cover, for example.

And, one more thought: gold could be a practical alternative to the USD or any other fiat currency for that matter.  Gold has served in that capacity many times through history.  The central banks, led by the US Fed have been manipulating gold prices for exactly that reason - to eliminate an alternative to the USD.


  1. I just saw an interesting show where Max Kaiser was talking to Rob Kirby of about the 400 trillion dollar interest rate derivative market.
    beginning at around 13:00
    Kirby says that JPMorgan is doing FRAs with the US Treasury. Kirby says that long term rates being manipulated, and that they will be LOWER next year.
    Do you think this manipulation of the long-term interest rates will work?

    1. Yes, it will work. Take today's experience in the bond market. Rates jumped up to 2.86% and then before it could get more out of hand the rates were managed down to 2.83%.

      The bigger question that you are asking is if they can keep up with the suppression for another year. And, yes I think they can and will. The next presidential election is in 2016.

      As an experiment, imagine that the US Fed is purchasing 100% of the US Debt that comes to auction. This may be the case sooner rather than later given recent news that China and Japan have stopped buying US Treasuries. Then the Fed will simply purchase at their desired yield, which will be the rate commanded by the Treasury. So they can fix rates. And, they will fix them low.

      In the case of completely fixed (they are partially fixed today) rates, the US Dollar will depreciate. The price for everything that the US imports will inflate, such as oil, shoes, and many foods. Gold and silver prices will take off. This will hurt economic growth and stock market valuations will suffer. We saw these dynamics in play over the last 2 weeks.

      The beatings to the US middle class will continue until moral improves or they decide to elect some leadership and hold them accountable.

      Note that the USD will depreciate versus real goods such as commodities. The USD may continue to hold up versus Euro, Pound, and JPY as they race to the bottom.

      One more note: this highlights China's conundrum. If they don't support the USD by buying low interest rate US debt the Yuan will appreciate hurting China's exports.

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