Gaming Imaginary Money

Tuesday the Fed auctioned off another $37 billion in 4-week T-bills. My first thought was that this is reminiscent of “payday loans” shops, except the rate of interest is far lower when the question is, “Buddy, can you spare $37 Bil’ until next month?” but the mechanics were very interesting again and echoed what happened in January.

There are two types of bids in these auctions: competitive and non-competitive. The non-competitive bidders agree to buy the bonds at whatever rate the Fed offers. The competitive bidders will buy the bonds only if they are paying some minimum interest rate. When the bonds are auctioned the non-competitive bids are accepted first at the lowest interest rate offered by the competitive bidders. Any bonds left after the non-competitive bids are sold to the competitive bidders in the order of increasing interest.

Last Tuesday, the lowest bid was 0.0% – no interest. The highest bid accepted was at 0.055%–almost nothing. Nearly 99% of the bids were competitive ones. This makes sense – who in their right mind would buy a bond that pays no interest? (And who DID buy a little over 1%’ worth?!) But almost 30% of the bonds went at the HIGHEST yield. This is quite unusual. How many bidders are going to guess the exact percentage down to the thousandth of a percent? This could signal the market is starting to demand higher interest rates to buy U.S. debt and we will likely have to pay more interest in the very near future, a nice traditional attitude, or at a rough cynical guess, at the very least somebody knew something ahead of time about just how high competitors were willing to go and how much money they were willing to spend. Let’s worry this one around a bit. Forget the interest, which is inconsequential. The first two questions that cross my Medieval mind are “Who was confident enough of prospective buyers’ interest in T-bills to hold off and demand ‘top’ dollar?” and “WHY did they want ten billion in short term bonds–four weeks being very short term–in the first place?” The interest isn’t even penny ante; there is almost certainly more money to be made in lightning trades.

The only answer that sprang to my mind immediately was that someone knew or had strong reason to suspect that it will be safer or more advantageous to hold one sort of government paper rather than the same government’s fiat currency very soon. On the surface, one would suppose the things are interchangeable, which only makes me wonder more what is lurking down in the murky depths. If I know that my competition is willing to buy two-thirds of what is available…and that all the bonds must be sold lest the foundation rock even more under the monetary world (and by the rules of the game)…why do I put in my top bid at 0.055%? Why not try for more, toss in .075%, perhaps, and see who blinks?

What do I really want, the interest, to keep up the sham of an auction, or to hold the T-bills for what they represent/may be worth at a later date?

Let’s let that percolate through the assorted facts and theories in our minds while we look at WHO was buying the bonds.

There are 3 types of bidders in the competitive bid world:

  1. Primary Dealers – The banks that are “part” of the Fed (J.P Morgan, Citi, e.g.).
  2. Direct Bidders – Groups that bid directly through the Treasury department. Direct bidders are usually other countries such as China and Japan. China, of course, just sold off about that much US paper, leaving Japan holding the biggest and ugliest of the Old Maids out there.
  3. Indirect Bidders – These have to bid for the T-bills through a Primary Dealer…but neither the Primary Dealer nor the Fed is required to report who they are. Hmmm. Now, why would anyone want to keep a thing like that secret, other than embezzlers or Congressmen who had kept the cash in their freezers, or possibly someone who wouldn’t want to be known for picking up such a position…Sometimes accounting for how one came by money can be quite embarrassing…

Historically, these are individuals or banks that are not members of the Federal Reserve System. In the last year the Fed has also bid on the T-bills it was issuing through the indirect bidder channels. This is one of the ploys that makes honest folks like us whimper, because it seems like money laundering or Dr. Seuss’ Star-Bellied Sneetches. After the money has been run through the machine several times it can be quite difficult to keep up with what is “real” and what is imaginary, even for fiat currency.

Swapping trading cards is one of the ways they have accumulated their $5.1 trillion balance sheet. Note: Indirect bidders are reported through the primary dealers. Whimper again. If the Primary Dealer doesn’t have to report that he bought, how does he explain reporting who he sold the T-bills to? “Oh, look, the cute wee elves drank the little bowls of milk we put out for them and left us certificates to sell!?”

It is…disturbing…that only 19% of the paper was bought by Direct Bidders, i.e., by foreign governments.

“Primary Dealers are required to buy whatever debt does not sell at auction. Thus it is possible, although unlikely, that the Fed just could not sell the full $37B and the Primary Dealers were forced to eat it. The reason I say this is unlikely is because $37B is a LOT of money even to organizations as big as the Primary Dealers. The Fed is NOT going to put their buddies (the Primary Dealers) in a cash flow bind if there is any way they can help it. But, if the primary dealers did get stuck with that big a chunk, it would mean that our debt is not even AA rated (as Moody’s has been reporting lately.)” comments my friend, Mike. Well…maybe. We were batting around the idea after a recent auction that there weren’t enough direct bids to cover most of the T-bills offered and speculating on the ramifications of that. It should be noted that the rules/definitions of what constitutes an “indirect bidder” have been loosened and fuzzied recently which hardens my suspicions that because our paper is being seen as less and less desirable new ways of disguising who is buying (or “buying”) are being sought. There have been rumors, let’s call them, of funds being transferred to other nations who use them to purchase/”purchase” our bonds. It could be that Citi has laid the groundwork to spring the “no withdrawals for 7 days” scheme to cover forced buys anticipated in an auction in March.

To digress only slightly into the banking situation, Citi is in bad odor this time for warning customers that effective 1 April it will “reserve” the right to deny withdrawals for seven days, almost certainly “banking days.” (See “New Meaning to Special Drawing Rights?”) Wells is in deep kimchee, WAMU and over a hundred other banks are pushing up daisies…banking in general is a pretty dicey business for anyone without a platinum parachute and/or the ability to pull strings…something like 700 banks are in the coronary ward…and FDIC is down another big hunk ($21 Bn) and gasping on the way to reaching into their $500 Bn from the Fed.

Last Tuesday, nearly 70% of the debt issued went through the Primary Dealers and will either be resold to indirect bidders or kept by the Primary Dealers. (In normal times the goal is for the Primary Dealers to be stuck with the debt to leave indirect buyers free to invest their money in the stock market and corporate bonds.) But, then again, in normal times the Treasury is not issuing debt at these levels. Or with this frequency.

The last time this much of the debt issued went through the Primary Dealers was in mid-January of this year. That did not alarm many at the time because the stock market was generally going down and it was easy to suppose Fed paper was picked up by folks selling their stocks and parking their money in T-bills for a month or two until the market returned. This time seems different-–or maybe we’re just being cautious or even paranoid.

Nearly a third of the bonds purchased by the Primary Dealers went at the highest rate (30% of $37B–the amount sold at the highest rate–about the same as 43% of $25.9B, a previous result that I discussed in an article the name of which escapes me. I write a lot of the things, you know!)

It appears that a gaudy chunk of the Primary Dealer purchase went to one person/organization. My friend, Mike, commented “That certainly could be a ‘whale’ like a George Soros or Warren Buffet sensing–or setting up–an imminent drop in the stock market and trying to protect his money – even though the stock market has been going up more or less again for the last month, but it could also be the Fed again buying through the Primary Dealer channel to hide just how bad the quality of our debt is.” It gets harder and harder to hold on to that triple-A rating. Moody’s is of the opinion that AA is pushing it. Spontaneous laughter…maybe Timmy needs to get one of those firms that run banners across the bottom of the screen offering to straighten out bad credit ratings.

Hmmm…Once may be an oddity or somebody’s accountant dropping a decimal, but we’re starting to develop a pattern that I would be inclined to label a trend if we get one more dot that belongs on the same plane. Three dots may show us who’s playin’ with the money. Recall that the Fed announced that it wouldn’t buy any more after 31 March, 2010, so in the next month Uncle Sam needs to come up with a new player in the game of “you buy mine and I’ll buy yours.”

Are you, too, starting to feel that all of this is meshing in ways investors aren’t going to like? The knowledgeable gentleman who brought these facts to my attention commented “at least a 60% chance that Direct Bidders (China, Japan, etc.) no longer want U.S. debt and we are going to start seeing bad inflation in the next few months and the ‘bad’ inflation will turn into ‘way bad’ inflation within a year because the Fed is just monetizing the debt through the Primary Dealer channel.” Optimists forecast hyperinflation no later than 2012, but only the green shoots crowd doesn’t expect it by then. That was my tentative conclusion in January, when we had an auction that looked like this. The banker boys are playing ring-around-the-rosy with electronic digits, or, to put it bluntly again, laundering fiat money.

Knowledge comes from tearing words and figures apart hunting for contradictions, nuances, and straws in the wind. We’re past the occasional straw and looking at what (honest!) is known as a “flake” of hay, a hunk ripped off for an individual animal. That’s useful terminology on more than one level: the well-positioned flakes are ripping us off, as usual, but it is also possible that some of them will be eaten in the process. If all the banks on the watch list fail the estimated bite for FDIC is something like $409 Bn, which, when added to how much it is in the red now, would wipe out c. 86% of the imaginary “special fund,” and another half a trillion dollars.

Analysts work with what we’ve got and keep dumping data in the hopper. Our..inner minds?…extrapolate from the handful of puzzle pieces we have and test hypotheses and conjectures, worrying bits of data that don’t appear to fit anywhere, and leaping blithely over several missing steps when necessary to form working hypotheses. If the picture appearing weren’t so unpleasant I would be enjoying myself because quite a few bits are slotting into my mental grid very neatly. A reader asked recently that I write an article on how I think and analyze, and the one- sentence answer is “Accumulate a lot of information and impose order on it.” In time we learn to deduce what the probable structure is and keep that hypothesis in mind until something disproves it. Not closing our minds in the process! We’re trying to discover the truth, not pushing global warming.

Facts that indicate we’re in for–at best–the Greater Depression with strong possibilities of civil unrest or even dictatorship have been accumulating for several years, now. All that has varied are the time table and speculation on which pillar will collapse first placing further stress upon the remaining supports. Every additional strain makes the aging system that much more rickety, and here in the Whiskey Bar we’ve been expecting the collapse of the commercial real estate bubble–and the collapse of the bond market. One odd recommendation I haven’t found a logical home for in the emerging picture is taking physical possession of stock certificates. Helpless gesture; I didn’t think anyone who dealt in round lots ever wanted to hold those things. Don’t we just leave them “in street name?” Ideas, anyone? A simple answer is a pitying, “You were a trader, so you never planned on holding anything you bought for more than a few months to a year or so. People who are in it for “growth” or “investment” should keep up with such papers in case the computers all go out.”

I expect the bond market to go first, and soon. As Abraham Lincoln asked, “How then will I fill my coffers?” If the Washington gang can’t sell paper to cover creating “money” out of thin air, where will they go for funds? My call is the GRA, a grab for the fifteen trillion held in private retirement accounts of one sort and another. I’m no Miss Cleo, but the sheer relief of “solving” the projected debt now and through perhaps 2020 will almost certainly set off an even bigger bender of government spending. Hurrah, hurrah, they don’t have to decide between shutting down a lot of useless, detrimental government programs and throwing Grandma out when she needs an MRI…can put off whether to make trial lawyers or union/government pensions take the next hit…can put off cutting welfare programs while inflating their way out…They think. Some day soon we’ll discuss Juan and Eva ruling Argentina.

Sorry, Charlie, as the old tuna commercial went. The only way from here is down, down, down.

The above was my first draft, which I sent to Pete (the Middle East expert), Mike (who sent me the basic figures, darling man that he is) and our own Tex Norton, before leaving the matter to bubble through my brains. Today is when things really started to pop. Tex wrote back thanking me for the “brilliant” thought that there may come a time when an instrument denominated in dollars may be worth more than the face value–and my mind bonged “Ka-ching! Like silver ‘dollars’ being worth more than FRN.” I thanked Tex prettily but started writing that I’m not fully responsible for what the gremlins in the gray matter do. Just as I prepared to write that I didn’t know why that such a disparity in relative value might be, my brain smacked me firmly. Of course I can account for how it might be that a short-term T-bill could suddenly be worth more than face value.

Two things were obvious instantly and my brain added, smugly, “And don’t forget Hugo Chavez.” Right. He devalued lately, but there is a tiered system; what your money is worth depends on where you are spending it. Brain also said, “GM, yoyo.” Right; what your stock was worth after the government takeover depended upon whether you were union, management, or Joe Nobody who owned 22 shares. The “obvious” reasons were what we know about legislation with short sections that exempt “certain corporations located in New Jersey” or American Samoa, and SPQ-USA, where Senators rail loftily over bonuses they had already approved in previous legislation. Ayn Rand, of course, and the “frozen” railway bonds which could be melted by those with pull and cash. Piece of cake.

The fix is in, and in time to come–perhaps very shortly–some bonds may be more valuable than other pigs. My advice is that we NOT buy T-bills because that’s bound to be a mug’s game; the rules will be written carefully to benefit only connected players, and not for the man in the street or even the Whiskey Bar.

Linda Brady Traynham

March 1, 2010

The Daily Reckoning