The recycling of the US dollars financing the US deficits ... · 3 unsecured transactions between...

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TherecyclingoftheUSdollarsfinancingtheUSdeficitsisgoingtoend(Part3)

ConclusionwhytheUSdollar’sreservestatusisatriskWhatisatstakeisthereservestatusofUSdollarfollowing:

1. LossofdependencyonSaudioilbecauseoftheUSbecominganoilnetimporterasearlyas2019makingthePetro-Dollarcontractlessofimportance.

2. TheintroductionofthePetro-Yuan-GoldcontractplannedforMarch26.3. TradetariffsthatwillreducetheflowofUSdollarsintoforeigncentral

banksandassuchtherecyclingofUSdollarsintofinancingUSdeficits.4. Theincreasingbudgetandtradedeficitsthatneedfinancingfromforeign

investors(goodfor48%oftreasuriesownership),becauseAmericansdon’tsavewithasavingsquoteof2.7%,anddemandinghigherinterestrates.AlsobecausetheincreasingUSdollarhedgingcosts.

5. TheblowingoutoftheLibor-OISspread,theglobalyardstickforcostofcreditanduncertainty,riskintheglobalcreditmarkets.

6. Acceleratinginflation,loominghigherinterestratesandtheexhaustion/taperingoftheQEmeasuresthatwillnotmisstheirimpactonthetighteningcreditconditionsresultinginthedebasementofthecurrenciesandespeciallythereservecurrency.

Ad5-Idiscussedpoints1to4andwilldiscusspoint5next.WhyarepeopleworriedwithrespecttotheincreasingLibor-OIS?TheLiborrateforthree-monthloansindollarshasclimbedto2.20%,alevelithasn’treachedsince2008.

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NexttothatthespreadovertheOISrateorOvernightIndexSwaprate(orFed’sFundRate),hasalsowidenedquitedramaticallyfollowingaCongressionaldealontheU.S.budgetanddebtceilingonFeb.8,oneofthemostcloselyfollowedleadingindicatorsofanimminentfundingcrisisandglobalcreditcrunch,brokeaboveits6yearrange,whentheUSDLibor-OISspreadonFridayMarch16,roseto51.4bps.Andinmypointofviewthistimeitisnotoffshorecauses,likeBrexitortheGreekBailout,thattriggeredthespreadtoblowoutbutonshorecausessuchastheincreasingdifficultytofinancetheUSdeficits.NexttothatIwanttoemphasizethatitisespeciallythespeedofthemovethatisgivingsomeinvestorspauseforthought.Rememberitisalwaystherateofchangethatworriesinvestorsbecauseoftheinabilitytoadapttothenewsituation.Definingthetworates,Libor(officiallyknownasICE(InterContinentalExchange)LiborsinceFebruary2014)istheaverageinterestratethatbankschargeeachotherforshortterm,unsecuredloans.Theratefordifferentlendingdurations–fromovernighttoone-year–arepublisheddaily.Theinterestchargesonmanymortgages,studentloans,creditcardsandotherfinancialproductsaretiedtooneoftheseLiborrates.Infact,over$350trilliondollars'worthoffinancialderivativecontracts,mortgages,bondsandretailandcommercialloanshavetheirinterestratestiedtoLibor.Liborisdesignedtoprovidebanksaroundtheworldwithanaccuratepictureofhowmuchitcoststoborrowshortterm.Eachday,severaloftheworld’sleadingbanks(thusnotonlyUSbanks!!!)reportwhatitwouldcostthemtoborrowfromotherlendersontheLondoninterbankmarket.Liboristheaverageoftheseresponses.Liboralsoindicateshowmuchtrustthereisinthebankingsystem,betweentheUSandRow,becausetheseLiborrateswillrisewhenbanksdon’ttrustthecreditworthinessoftheircounter-partybanksanymore.ThoughitshouldbenotedthattherehasbeenaninitiativetoreplaceLiborwiththereporates.Iwonderwhy?Iamfacetiousofcoursebecauseitisallaboutcontrol!Anindustrybody,theAlternativeReferenceRatesCommitteeorARRC,convenedbytheUSgovernment,haschosenanewbenchmarkinterestratetoreplacethescandal-riddenLiborgaugeasareferencefortrillionsofdollarsoffinancialinstruments.ThedecisionbringstoaheadeffortstoestablishanewreferenceinterestrateafterLiborbecametarnishedbyrevelationsofwidespreadriggingbythebanksthatsetit,astraderssoughttomanipulateittotheirbenefit.Andwheredoyouthinkmostofthatriggingtookplaceandwhatmakesyouthinkthatwon’thappenwiththereporate?DespitereformstoLibor,theARRCtookthedecisiontomoveawayfromtherate,asthemarketfor

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unsecuredtransactionsbetweenbankshasdwindled,recommendingabrand-new,broadTreasuries“repo”rate,whichwillreflectthecostofborrowingcashsecuredagainstUSgovernmentdebt,asareplacementfortheUSdollarLiborrate.Thenewratewillbebasedonlive,actualtransactionsandpublishedbytheFederalReserveBankofNewYorkinco-ordinationwiththeOfficeofFinancialResearch,inanattempttoreducetheriskofmanipulation.ThisisinmypointofviewpurelydoneinordertobringthesebenchmarksforcreditpurelyundercontroloftheAmericanstherebyreducingtheinfluenceofforeignbanks.Itisonebigscam!Rememberthemoreyoucontrolthelessyouareincontrol!TheOIS,meanwhile,representsagivencountry’scentralbankrateoverthecourseofcertainperiod;intheU.S.,that'stheFedFundsrate–thekeyinterestratecontrolledandfixedbytheFederalReservecurrentlyrangingbetween1.25%to1.5%andmostlikelytobeincreasedby0.25%onWednesday.TheOISisderivedfromtheovernightrate,whichistypicallyafixedratebycentralbanks.Asaresult,theOISletsLIBORbanksborrowatafixedrateoveraspecifiedtime.Ifacommercialbankoracorporationwantstoconvertfromvariableinteresttofixedinterestpayments–orviceversa–itcould“swap”interestobligationswithacounterparty.Forexample,aU.S.entitymaydecidetoexchangeafloatingrate,theFedFundsEffectiveRate,forafixedone,theOISrate.Itshouldbeemphasizedthatinthelast10years,withinterestratesathistoricallows,there'sbeenamarkedshifttowardOISfixedratesforcertainderivativetransactions.Becausethepartiesinabasicinterestrateswapdon’texchangeprincipal,butratherthedifferenceofthetwointereststreams,creditriskisn’tamajorfactorindeterminingtheOISrate.Duringnormaleconomictimes,it’snotamajorinfluenceonLIBOR,either.Butweknowthatthisdynamicchangesduringtimesofturmoil,whendifferentlendersbegintoworryabouteachother’ssolvency.Intheenditbecomesaboutthereturnofyourmoneyandnotthereturnonyourmoney!Priortothesubprimemortgagecrisisin2007and2008,thespreadbetweenthetworateswasaslittleas0.01%points.Attheheightofthecrisis,thegapjumpedashighas3.65%.

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SowhydoesitmatterthattheLibor-OISspreadiswidening!Short-termborrowingcostsintheU.S.haverisentolevelsunseensincethe2008financialcrisis,andrecentmovesintwocloselywatchedindicators--theLondoninterbankofferedrateanditsspreadwiththeOvernightIndexSwap(OIS)rate--arecausingsomeconsternation.Thespreadhasexpandedtoitswidestlevelinmorethanayear,raisingquestionsaboutwhetherrisksmightbebrewingwithincreditmarkets.The51.4bpsspreadsurpassingthe2011/2012highs(andthewidestlevelsinceMay2009),whenthelatestEuropeansovereigndebtcrisiswasroilingthemarketsandforcedtheFedtoopenunlimitedswaplineswiththerestoftheworldtoavoidaglobaldollarfundingcrisisandeffectivelybailouttheworld,whichaccordingtotheBISissyntheticallyshorttheUSDtothetuneofover$10trillion-forthesecondtimein4years. WhateverthecauseoftheongoingblowoutinLibor-OIS,thismoveishavingdefined,andadverse,consequencesonbothdollarfundingandhedgingcosts.Thisalonewillhaveasevereimpactonforeignbanks,becauseasDeutscheBankwroterecently,"theriseindollarfundingcostswilldamagetheprofitabilityofhedgedinvestingandlendingby[foreign]financialinstitutions.Forexample,oneofthemostimmediateconsequencesisthatitisnowmoreeconomicalforJapaneseinvestorstobuy30YJGBs,withtheirpaltrynominalyields,thantopurchaseFX-hedged30YUSTreasurieswhichasofthismomentyieldlessthanmatchedJapanesesecurities.ThesamelogiccanbeappliedtoGermanBunds,asthecalculushasmadeitincreasinglyunattractiveforEuropeaninvestorstobuyFXhedgedTreasuries.InotherwordsthehedgingcostsfortheUSdollararesohighthatithasbecomeadeterrenttoinvestintreasuriesandthuskissevenmoregoodbyetofinancingtheUSbudgetdeficits.Seebelowthechartsofthe10yTreasuryyieldscomparedtothe10yJapaneseandBundyields.

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ForcompletionpurposesIwillalsobrieflyrefertotheTEDspread.TheTEDspreadmeasuresthedifferenceinyieldbetweentheU.S.3-monthTreasurycurrentlyat1.76%and3-monthLiborat2.15%or39bp.SinceSeptember2009,theTEDSpreadhastypicallyrangedbetween10and20basispoints.Duringeconomiccrisisitgetsmuchhigher.Itspikedashighas457basispointsinthefallof2008,whenLehmanandBearStearnswerecollapsing.

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Asmentionedthe3MonthLIBOR-OISspreadisthedifferencebetweenLibor,nowat2.15%,andtheovernightindexedswap(OIS)reflectingtheFedFundsRate,whichis1.42%,or73bp.AsfortheLibor-OISspread,ittypicallyrangesplusorminus10basispoints.Asmentionedduringthefallof2008,itgotupto365basispointsor3.65%.Importantly,theLIBOR-OISspread,liketheTEDspread,tellsinvestorshownervousbanksabouteachother’scredibility.IfLIBORheadshigher,wideningthespreadtotheFedFundsRate,it’sasignalofshrinkingliquidityandbanksbackofffromcredittransactions.Ad6–Thefearofacceleratinginflation(especiallyfollowingtheimplementationoftradetariffs)andthusevenmorepressuretowardshigherinterestratesandtheexhaustion(readlossofeffectiveness)oftheQEmeasureswillnotmissitsimpactoncontractingcreditconditionsandthedebasementofthecurrenciesbutespeciallythereservecurrency.AsIalreadyindicatedinthepreviouspointthereisanupwardpressureontheLiborandTEDratessignifyingincreasinguneasinesswiththecreditconditionsinthemarkets.TheexhaustionoftheefficiencyoftheQEmeasuresandtheirtaperingintheUSandinJapanandEuropewillnotmisstheirimpactoninterestratescurrenciesandespeciallythereservecurrencyandthusalsohaveaverypositiveeffectongoldandsilver.SinceIhaven’treallyreferredtosilverIjustwouldliketocommentonsilver.Everythingthatappliestogoldalsoappliestosilverexceptthatsilverisextremelycheapatslightlyabove$16/oz.andunlikeforgoldsilverhasalotofindustrialapplicationsrepresentingabout60%oftotaldemandin2017orabout520moz.TheSilverInstituteprojectscontinuedgrowthin2018andnottheleastbecauseofsilver’suniquequalitiesthatseemtoimproveandenablenewinventionsandthusincreaseitsdemand.Forexamplebecauseofsilver’sexcellentelectricalconductivity,strongdemandisforecastfromtheautomotivesegmentasvehiclesbecomemoreelectrifiedandcomputerized.Strongdemandisalsoexpectedfromphotovoltaicapplications.Large-scalesolarcapacityadditionsanduptakefromindividualhouseholds,particularlyinChina,shouldalsoboostsilverdemand.IthinkthatsilverisoneofthemostundervaluedassetsthereareatthemomenthencealsowhyIshowthechartherebelowwhichshowsatechnicallyveryattractivepicture.Andasalastremarkonsilver,itisingeneralgoldthatisconfiscatedandnotsilvernexttothatsilverwillmost

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likelyrisequickerto$160/oz.(10x)thanthatgoldwillrisefrom$1,310/oz.to$13,100/oz.

Whileeveryonestillbelievesthatstockswillholdup,thebondmarketisconstantlyhoveringbetween2.80%to2.90%.Whenwebreakthe3%levelthewayisopentoitsnextmajorresistancelevelof4.25%(IrefertoMSA’sexcellentmomentumresearchbyMichaelOliver)resultinginallmarketsundergoingaseverepricereadjustment.

Thereasonthatallmarketswillbeaffectedisthatbonds,notstocks,representthebedrock,thefoundationofthefinancialsystem.Bondbearmarketsareconsideredtobemuchworseandlastmuchlongerthanbearmarketsforstocksbecauseeverythingisbenchmarked/valuedagainstinterestrates:bonds,mortgages,stocks,currencies,commoditiesetc.etc.Bondmarketshaveamuchdeepermoreprofoundimpactontheeconomyandpeoplesfinancesthanstockmarkets.Andtheotherimportantfactorthatwillworsentheimpactisthatthe

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breakoutofyieldsoutoftheirlong-standingmulti-decenniatradingrangesisnotjusthappeningintheUSbutisalsohappeninginGermany,Japan,andothercountries,seechartsbelow.

Thebreakingoutoftheinterestratesoutoftheirlong-termtradingrangesisaglobalphenomenon,asisthecasewiththeglobalcorruptionofthepoliticianswhichoftenisasignoftheendofacycle.Justreadthe“Thedeclineandfalloftheromanempire”byGibbon.ThereasonIalludetothecorruptionofthemajorityofthepoliticiansisthattheyseemtobesolelyconcernedaboutthenumerousbenefitstheycanacquirebeingapoliticianlikeexpensereimbursements,fullpensions(Congressionalpaywas$174,000peryearin2016,forjust133daysof“work”,which,atan80%rate,equatestoalifelongpensionbenefitof$139,200!!)andalightworkload,ratherthanlookingaftertheinterestofthepeoplethathaveelectedthemtofulfilltheirelectionpromises.YoujusthavetolookattheCongressandtheEuroParliament.EspeciallythefringebenefitsandthelaxrulesoftheEuropeanParliamentaredisgustingandcanbasicallybedefinedaspurethievery.Andhowcanoneexpectfromthesepeoplethatfirstlookafterthemselvesthattheyhavethebestinterestatheartofthesocietiestheyareso-calledrepresentinginparliament.Everythingistunedtotheirowninterest.WeseethesameintheUSAwiththeDeepStateandmoreunambiguouslytheClintonFoundationthathasonlyponiedouthalfapercentofallthefundstheyhavereceivedandboughtsocalled(verycheap)HIVdrugssourcedfromaboguscompanyinIndiathatwereuselesstosolvetheHIVprobleminHaiti.TheClintonFoundationissolelyacharityfortheClintons

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andnobodyelse.“WewerebrokewhenwelefttheWhiteHouse”remembertheinterviewwithHillaryClinton!Asifwehaven’tlearntanythingglobaldebthasincreasedfrom$150trnin2008to$230trnin2018aCAGRof4.37%whilstoverthesameperiodglobalGDPhasgrownfrom$63.5trnto$79.6trnoraCAGRof2.29%.

Andthisiswithhistoriclowinterestrates!Justimagineworldwideinterestratesincreasingonaveragebyonly1%.Thatwouldmeanthatglobalinterestcharges,theUSingeneralsetsthetoneininterestrates,willriseby1%over$230trnor$2.3trn($2300bn),thatisanamountthattheworldcan’tstomach.$2.3trnoverglobalGDPof$80trnis2.9%thatisequaltoroughlytheprojectedglobalGDPgrowthpercentagefor2018;theWorldBankisforecastingGDPgrowthof3.1%fortheworldin2018!Inotherwordstheworldwidedebtscanneverbepaidbackandthuswewillfaceeitheradebtimplosionorthedebtwillbeinflatedawayorwewillgetadebtjubileewherebyalotofdebtwillbeforgiven.Inanycasesomeone(afewmorepeople)willincurlossesanditwillnotbeprettyhencewhytheauthoritiesaredoingeverythingtokeepthegravytraingoingtilltheycan’tanymore.Thereisnopainlesssolution.Youhavetoaskyourselfwhatyouneedtopreserveyourwealthwhenthepapermoneywillloseallitscredibility.AsIhavereferredtomanytimesgoldstandsfordisciplineandhasvalueofitsown,notdependentonthecorruptionandincapabilitiesofthepoliticiansandmonetaryauthorities,whilstpaperoffiatmoneydoesn’trepresentdiscipline(canbeprintedatwill)anddoesn’thavevalueofitsown(paperdoesn’thaveanyvalueitisavailableinabundance)andwhosevalueispurelyrelyingonthecounterpartypromiseoftheFedtoensurethatthenominalvaluementionedonthegreenpaperkeepitspurchasingpower.

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ThoughaswehaveseeninearlierchartsthepurchasingpoweroftheUSdollarhasfallenbyanastounding84%followingincreasingdeficitssinceweabandonedthegoldstandardin1971.Rememberpoliticiansdon’thaveanydisciplinewhentheycansolvetheshortageproblembyprintingafewmoredollars!Infiscalyear2000,TreasuryreceiptsintheOct-Febperiodwere$741.8bn,nearlymatchingoutlaysof$741.6bnthoughinfiscal2018receiptsintheOct-Febperiodwere$1.286trnwhilstoutlayshadrisento$1.677trn.Receiptsaregrowinganaverage4%peryear,whilstoutlaysarerisinganaverage7%.

Source: ReutersHencewhywewitnessedamosttroublingdouble-digitjumpininterestexpensesonthepublicdebt,whichinthemonthofFebruaryjumpedto$28.4billion,up10.6%fromlastFebruaryandthemostforanyFebruaryonrecord.Inthefirstfivemonthsofthisfiscalyear,October1,2017toSeptember30,2018,interestexpenseshavealreadyaccruedto$203.2bn,up8.0%y.o.yandthemostonrecordforanyOct-Febperiod.

Source: Reuters

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ThoughitshouldbestatedthatFebruaryistraditionallynotagoodmonthfortheUSgovernment,that'swhenitusuallyrunsasteepmonthlydeficitastaxreturnsdraintheTreasury'scoffers.However,thisFebruarywasworsethanusual,becauseasspendingroseandtaxreceiptsslumped,theUSdeficitjumpedto$215billion,thebiggestFebruarydeficitsince2012.Forfiscal2018(4Q17-3Q18)theUSfiscalorbudgetdeficitisforecasttoincreasetoapprox.$800bn-$1trnor5.1%of2018GDP(was $666 billion, or 3.5% of GDP).ThesharpincreasecomesastheUSpublicdebtrapidlyapproaches$21trillion.Andwiththeeffectiveinterestratenowrisingwitheverypassingmonth,itisvirtuallyassuredthatthisnumberwillkeeprisingforthemonthsahead.Waittillwebreakthe3%yieldonthe10yTreasuryandwegotoitsnexttechnicalresistancelevelof4.25%.Itwilldefyallthosepeoplethatalwayssay“ohbutinterestratesarestillrelativelyverylow”.Whatisn’tunderstoodinmypointofviewisthatasaresultofthesehistoricallylowinterestratesdebtlevelshaverisenastronomicallyendingintheendresultinginahugeabsoluteinterestamountonahugedebt,lowinterestratesornot.Anddon’tunderestimatethatgoingfrom3%to4.25%,isequaltoa42%increase.Ibelievethatthe2018tradedeficit(exports–Imports)willremainequalorwillbelowerthanthe2017deficit.In2017thetradegapingoodsandservicesroseto$566billion,thehighestlevelsince$708.7billionin2008.Importssetarecord$2.9trillion,swampingexportsof$2.3trillion.ThegoodsdeficitwithChinahitarecord$375.2billionin2017,andthegoodsgapwithMexicoroseto$71.1billion.And thus, most likely to still incur a half trillion trade deficit, theUSAwillneedstrongcapitalinflowstocompensatefortheseshortfallsordeficits,becauseAmericanshaveaverylowsavingsrate(2.7%),inordertopreventthefree-falloftheUSdollar,becausethealternativeismonetizingthedeficits,whichwillalsoresultinmuchhigherinterestrates.Ontopofthedeficitswehavetheotherfactorsthatarehavingatighteningeffectonthedollarliquidityleadingtohigherrates:thelaunchofthePetro-Yuan-Goldcontract,thetradetariffsandinflationthatseemstobeawakening.NonethelessIstronglybelievethatitiscounterproductivetopenalizealliestowards‘supportingandunderwritingthedollarsystem’ashistoryhastaught

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us.ItismystrongconvictionisthatitisjustamatteroftimebeforetheincreasedriskintheUSmarketsandthedryingupofdebtfundingfromrecycledUSdollarswillpushUSinterestratesuporforcetheUStomonetizetheincreasingandoutofcontroldebtlevels.WellbothsituationsarenotanexpressionoffundamentalstrengthhencewhyIbelievethatthedownsideontheUSdollarwillmuchhigherthantheupside.IhopethattheabovementionedhasillustratedwhytheUSdollarandthustheUS,whowasamajorbeneficiaryoftheglobaltradeandFXregime,couldbemorethaneverbeforeonthebrinkoflosingitsreservestatus.What'scomingwillbemuchworsethan2008,everythingisconvergingandiscomingtoahead.Allthetoolsinthetoolboxareexhausted! March19,2018©GijsbertGroenewegenSilverarrowpartnersg.groenewegen@silverarrowpartners.com