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When The Bell Tolls

Question for CNBC's morning Bond Bell: when does a Surplus turn into a Deficit? The answer: when Monetary Policy no longer works. When we're through with monetary policy, we're going to show you how safe the Federal Budget Surplus is. This answer came to mind as I was trying to determine what it would take for bond traders to see how much meat was really behind the US Treasury Department's promise to buy up its 30-year bonds. Are investors just waiting for the announcement, or what?

But first, let's review the Law of Diminishing Returns

Greenspan might say, "of course it (monetary policy) still works. The inventory adjustment is well under way thanks to yours truly, and besides, we do not target the stock market." That's too bad though, because the stock market thinks he does. We, on the other hand, only think he "takes it into account" when deliberating on monetary policy. I mean, we should hope so, because the capitalization (market value) of the stock market had outgrown the size of the US economy some years back (1997). At any rate, it is widely regarded as a leading indicator, for consumption and investment.

Do I need to repeat that? For the outlook for either consumption or investment, by looking at any of our stock market charts, does not look good. Under such circumstances, we can assume nothing about the inventory cycle. Rises and declines in inventories can happen for many reasons, the most powerful of which are changes in confidence and market expectations. The inventory adjustment (decline), which Mr. Greenspan refers to, is easily the result of the deflation expectations that have been ingrained into our minds by the Federal Reserve System. How? Because chances are that if you expect the prices of various goods and services to decline, you aren't going to be holding the inventory.

Conversely, if you expect that prices will rise precipitously (we call this an inflation breakdown), not only will inventories be hoarded, but also monetary policy will simply not work. So it is important, no vital, that you believe that any financial crisis will immediately result in deflation and depression, and that the dollar is the soundest currency on this here earth. That is how you empower the Fed. Even the Bank of Japan recently bowed to what must have been intense moral suasion, or maybe even fear mongering, from any one of a handful of power brokers (read thugs) that work at institutions like Morgan, or Goldman Sachs, or Citigroup (isn't that where the venerable Mr. Reuben / Rubin works?).

There are an enormous amount of politics and political mechanisms engaged in managing foreign exchange markets, so you can feel free to use your own imagination as to who is really doing what. I've been asked recently, whether another yen carry trade is going to be put on. So I know that many of you already know that these games exist. They have to; else this currency regime would not have had half a chance to create the kinds of global economic imbalances, which it has over the decades. Of course, I don't know that the yen carry trade is anything other than a trade, which offers incentive to move capital from Yen to Dollars. One such trade that would qualify is for US corporations to issue Samurai bonds. These bonds are denominated in Yen and are usually bought in Japan. We first noted the rise in issuance in these bonds sometime in the fall, interestingly, by JP Morgan, Citibank, IBM, and a few other strategic allies or shareholders of the Federal Reserve System. And if you didn't already know, the FRB represents the private ownership of its District banks.

From a November 28th Bloomberg report:

IBM, one of the most active foreign sellers of yen bonds this year, paid fees less than half of the typical level for its biggest sale of yen debt, as arrangers cut prices to attract business. "Competition has increased as banks' securities units and foreign firms have come into the yen bond markets," said Junichirou Okura, deputy general manager of debt capital markets at Daiwa Securities, which ranks second in arranging domestic bond sales. While IBM has been completing fewer bond sales this year compared with last year, it's raising more money in yen. Yesterday's sale was its 10th this year. Last year the world's biggest computer maker sold bonds 46 times. Five of its 10 sales this year have been in yen, while last year 45 of its 46 sales were in U.S. dollars. The other one was in euros, according to Bloomberg Data.

Complete data on these kinds of bonds are nearly impossible to gather. Nobody seems to track the data publicly. At any rate, there are legitimate economic reasons (note that I did not say cogent) for issuing debt in Japanese capital markets. Their interest rates are much lower than ours. However, there are also legitimate strategic (political) reasons for issuing debt in Yen if the act of borrowing inflates the foreign exchange rate of the US dollar. We are going to talk about some of these reasons today… and please note that these kinds of flows are not confined to the Samurai bond market. There are hundreds of ways to make ephemerally profitable deals if you want to influence certain flows. At any rate, if you happen to be reading this and thinking that we're spinning a conspiracy theory here, I would suggest that you don't trade for your or anyone else's accounts. We do not have to label something a conspiracy in this world of managed interest rates, economies, and expectations. It is as if Keynes himself were laughing at all of us, for not seeing these financial machinations, from his grave.

Ok, so let's deal with some facts here, which almost everyone seems to be afraid to touch. We've all heard that the US Treasury, under Lawrence Summers mind you, was planning to buy up all (or most) of their long term - starting with the 30 year - maturities over the next decade because the Federal Government has finally learned how to manage its budget. This is a really important part of the entire game because it was the one event that turned the bond market around in the first quarter of 2000. Of course, the announcement did not come without controversy because Mr. Summers goofed. He didn't expect that it would invert the yield curve and cause the damage that he subsequently did, to the various yield plays that the hedge fund community had put on prior to the announcement. The honorable President Clinton also gave his word to the American public, all year (last year) long, that its debt was about to be paid off in its entirety. Mr. Greenspan said in the first of two congressional testimonies this year, with fists waving in mid air, that the problem is that the debt will be paid off too fast. These are all facts. And as a result, the mainstream media runs around talking about the surplus as if it is here to stay. Damn, the President said so!

This Week from Goldenbar:

  • How safe is the unified budget surplus from the inevitable forces of the slowing business cycle, when they arrive this year, if they haven't already...
  • How do you get deflation with a steepening yield curve, when the only difference between short-term interest rates and long-term interest rates is the inflation premium?
  • How the Fed targets the Dollar today, not the stock market, in order to hide its daily inflation and reckless abandon...
  • Goldenbar gets it right, again !! Almost within days of announcing a 2000-point sell off in the DJIA, it happened. Surprised? Stay tuned, because we see more surprises around the corner...

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