Friday, November 19, 2010

Armageddon Coming to a Bond Market near You

11/19/2010 Portland, Oregon – Pop in your mints…
Activity in the markets today almost appeared normal.  Stocks and Commodities up, the dollar and bonds slightly down.  It is like watching waves lap gently onto the shore while under the water a vicious whirlpool is gaining steam and angry clouds form overhead.  What is in store?  A hurricane? An earthquake followed by a Tsunami?  Or will it all disappear and turn into just a lazy day at the beach?
Personally we were hoping that the lazy days had returned.  But after what we heard this morning, we are certain that a magnificent storm is on the way and it is best to at a minimum get out of the water and perhaps move inland.
The forecast took shape this morning as we attended a breakfast where the speakers focused on Cash Management Strategies.  For the most part the presentation was a basic review of the use of credit lines, bank accounts, CDs, spreadsheets, etc.  At The Mint, we are too focused on secondary effects to get much out of obvious practical steps and generally tune this part out and enjoy the free coffee and rolls.  We do, however, have our radar out to detect seismic events that appear disguised as innocuous comments during otherwise innocent breakfast presentations.  Today, halfway through our apple turnover, two large blips appeared on our radar.
First, the speaker noted that there are $14 billion of dollars worth of letters of credit that are up for renewal in 2011 in their industry alone.  A year over year increase of 700%!  Most of these letters of credit must be rolled over (renewed) for the bonds that they back to be worth anything.  The speaker considered her organization lucky to have been able to renew their organization's letter with Banco Santander as many of the US Banks are simply not writing them anymore.  As an additional kick in the pants, the organization is being asked to have 250 days of cash on hand, a much stricter covenant, up from 200 previously.  The bank originally requested 300.  Blip 1 on the radar!  Incoming threat to bond market.  Could be a bird.
Second, and more significantly if you follow large cash movements, the FDIC is changing their rules as of January 1, 2011 to permanently raise the insured limit up to $250,000 and to cover non-interest bearing accounts without limit Blip 2 on the Mint's radar!  Definitely not a bird! Approximately two months to evacuate the bond market!  Up until now, anyone who has a ton of liquidity in the form of dollars that they need to access on short notice has been forced to either find feeble comfort that their bank will not fail or to find a work around the FDIC limit to assure that all of the funds are secure (in other words, they will get all of their money back if their bank fails).  The "work around" for most firms takes the form of investing excess funds in what are known as "Repo's" which pay literally pennies of interest on millions of dollars that buy bonds overnight, before the bank may fail, and then sell them in the morning, providing liquidity while the bank is safely open.  This arrangement is commonly known as a "Sweep" account.  That yields are non-existent speaks to the fact that everyone and their mother is now employing this strategy.
Sweep accounts are currently expensive relative to yields and the FDIC rules effective January 1 will give customers who simply want liquidity the option to leave the money in the bank, earn 20 to 60 basis points of "interest" via service fee credits (as opposed to 1 to 2 basis points in the Sweep accounts) and have those dollars fully insured.
So what happens when everybody and their mother decides to leave their tonnage of liquidity in the banking system overnight instead of purchasing "Repo's", which is just a fancy way of purchasing bonds? 
We must admit that we have absolutely no idea but that will not keep us from guessing!  Our current guess is that 1) The cash movements caused by this FDIC rule change will mean round two of Armageddon in the bond / fixed income markets and that 2) the FED's quantitative easing program is timed to fight Armageddon against what could be a wholesale collapse of world-wide fixed income markets that could play out in early 2011.  In more colorful terms, our guess is that the FDIC is unwittingly preparing to squeeze the mushroom shaped dollar debt sponge!!!
Will the FDIC Wring out the Debt Sponge?
A Caveat to this story:  The Municipal Bond market has depended upon government stimulus funds to leverage huge amounts of recent offerings to cover unsustainable spending at all levels of government.  These stimulus funds will phase out between January and June of 2011.  On cue, the FED is now on the verge of buying up Municipal Bonds.  Just think of it as Blip 3 on the Mint's radar.
It is all coming together, fellow taxpayer.  Now you know why the Irish are being forced to accept a bailout even though they don't intend to borrow until June 2011.  The government there has no idea that Armageddon is upon them and that the fixed income markets as we have come to know them may not exist in June 2011.  At least not one willing to accept 7% on Irish debt. 
No wonder Ben Bernanke and his fellow of Central Bankers of the world are throwing caution to the wind as they shamelessly print more money.
What else can they do?
Stay Fresh!
P.S.  If you enjoy or at least tolerate The Mint please share it with your family, friends, and colleagues!

*See FED Perceived Economic Effect Rate Chart at bottom of blog.  This rate is the FED Target rate with a 39 month lag, representing the time it takes for the FED Target rate changes to affect the real economy.  This is a 39 months head start that the FED member banks have on the rest of us on using the new money that is created.

Thursday, November 18, 2010

Look Out Below! Bond Markets Will Need Luck of the Irish to Survive

11/18/2010 Portland, Oregon – Pop in your mints…
The action today is in the Bond Markets so we must turn our attention away from our "Junk" to the Junk of the Irish.
Today from the Associated Press comes word that European officials are traveling to Ireland to "lift the lid" on Irish banks.  Apparently word is out that all is not well on the Emerald Isle.  A stench has been rising for some time and Bond Market participants have fled Irish paper in droves.  The stench has now gotten so bad that the EU feels compelled to take a whiff and to see these worthless bank assets first hand.  Again, we submit this as evidence of the wisdom of Government management in action on multiple levels.
The EU is lagging behind the United States on a crash course leading to currency and debt catastrophe. However, they both are heading in the same direction and will both meet with the same disastrous fate.  The EU, concretely Ireland, is still stuck on the mantra of curing bad debt problems by saying to the bond holders "Don't worry, we'll back the Irish bank paper (insert troubled asset) no matter what" and hoping that the bond holders don't call their bluff.  Unfortunately, as we have learned in a previous Mint, if you add a spoonful of sewage to a barrel of wine, you get sewage.

Wednesday, November 17, 2010

Don’t Touch My Junk

11/17/2010 Portland, Oregon – Pop in your mints…
In case anyone missed this on Monday, the now famous "Don't touch my junk" exchange seems to have struck a collective nerve across the land of the "Free".  For those of you who missed it, a software engineer was asked to submit to the Transportation Safety Authority's (TSA) new "enhanced security" screening while boarding a plane in San Diego.  The software engineer chose not to submit to the screening on the grounds that he would not be groped in the name of national security.  The software engineer unwittingly but perhaps providentially left his smart phone video recorder on which recorded a good portion of the incident.  You can see the entire clip, all 15 minutes which, if you embrace freedom, are worth hearing (if not watching the airport ceiling):

Now the person solely interested in safety might think that the software engineer seems to be unreasonably obstructing the "right" for everyone to fly "safely" and should be dealt with accordingly.  You may detect that most of the quotations used so far ring of sarcasm.  Your senses do not deceive you.  For a better understanding as to why this incident demands sarcasm and why it is important to see the cost of "security", we need a bit of history on the TSA and its latest screening spree.
The TSA was formed in response to the September 11, 2001 attacks on the World Trade Center in New York.  It operates under the cabinet level Department of Homeland Security.  All of this was authorized under what is known as the "Patriot Act" which betrays its name as it amounts to one of the most invasive pieces of legislation we have seen on these shores.  It removed any protections that the Citizens of the United States may have against the Government of the United States and has far reaching implications from travel restrictions to financial transaction and communication monitoring.  The TSA's job, apparently, is to make American's feel safe while travelling.  This new enhanced level of screening that our software engineer is currently concerned with was inspired by an alleged attempt by someone to board an airplane with a bomb in their underwear during the last Christmas travel season. 
Does this business of smuggling a bomb onto a plane in one's underwear seem farfetched?  Apparently not to the TSA, who in response dutifully stimulated the economy by ordering X-ray machines by the thousands and instituting "enhanced" screening which amounts to government endorsed voyeurism and groping, all in the name of passenger safety and National Security.  Do you feel safer, fellow taxpayer?  Apparently making millions of travelers walk barefoot and removing their belts before walking through a metal detector is not sufficiently humiliating.  The TSA now is going all the way.
How far will the Government go?  The Boston Tea Party was not inspired because the British were going to raise taxes, it happened because the British attempted to collect a tax at all.  In our day and age, with the Patriot Act, Big Bank Bailouts, Healthcare Reform, Financial Reform, and now "Enhanced Security Measures" threatening the very Freedoms we cherish, are we, as Americans, as principled as those brave souls who founded this nation?  There is no other nation in the world that embodies the ideals of Freedom on a large scale.  If Americans do not take a stand, who will?
So we leave today with a question:  How much Freedom must be sacrificed in the name of Security?  We would do well to understand the words of Benjamin Franklin on the subject:
"Those who desire to give up freedom for security will not have, nor do they deserve, either one."
Or as we might sum up today, "Don't touch my junk!"
Stay Fresh!

*See FED Perceived Economic Effect Rate Chart at bottom of blog.  This rate is the FED Target rate with a 39 month lag, representing the time it takes for the FED Target rate changes to affect the real economy.  This is a 39 months head start that the FED member banks have on the rest of us on using the new money that is created.

Tuesday, November 16, 2010

The Mushroom Shaped Dollar Debt Sponge

11/16/2010 Portland, Oregon – Pop in your mints…
So what is the point of all this speculation about the dollar no longer being widely accepted as a medium of exchange?  Why would this be important?
The point is that the worldwide real demand for dollars may have hit its high water mark, in the long historical sense, in 1971.  Since then, any increase in relative value has been mostly smoke and mirrors obscuring a long, winding road that the dollar has been following on its way to obsolescence.  As the wheels begin to fall off the "dollar mobile", the only thing that is holding it together is that its debt markets are the deepest that have ever existed.  If a large portion of the US denominated debt market were to be defaulted upon or forgiven (the portion owed by the government in Washington, D.C. comes to mind), inflation in domestic prices would shoot off like a rocket and the whole sorry episode would end in a spectacular, fantastic debacle played out in real life, a debacle the likes of which cannot yet be fathomed.

Monday, November 15, 2010

Anyone Want a Buck?

11/15/2010 Portland, Oregon – Pop in your mints…
The world left off Friday with gold taking a $38 drop and the world markets worried that China is worried about inflation.  At the Mint, however, we left off by coming to an even more astounding conclusion.  One that has far reaching implications not only for misguided Keynesian school economists but for every dollar denominated bond and bank account holder.  It also applies to those of us dinosaurs who still use dollars in its cash and coin form as much as possible.
The astounding conclusion is that the world, after nearly a century of increasing demand for dollars as a medium of exchange, is slowly turning towards other mediums of exchange to replace it.  For those of you who missed it Friday, we put it this way: