Pay No Attention to That Man Behind the Curtain

August 9, 2007

Lee Adler puts together a Fed and Treasury update that paints the current picture of Fed and US Treasury activities to a tee. This is really first class institutional quality work by the way, and should be picked up by the clerks, (I mean money managers, banks, hedge funds, etc) who “invest” other people’s money . I think because of Lee’s (and mine as well) tin foil hat, satirical “behind the paper curtain” reputations/styles, quality work like this gets get overlooked and ignored, and once again that’s a damn shame. Still for those who recognize fine art when they see it (after all Van Gogh cut his own ear off, and it didn’t detract from his appeal), Lee has made this report available for a free read this morning, and also for my comments.

If you look at Lee’s SOMA (Fed system open market account) chart and the orange line, you will see that it is completely or indeed slightly down since March. As I’ve mentioned, the Fed has NOT conducted a permanent coupon pass since May 3rd. Finally with a big blow out this morning in Libor rates in Europe from 5.35 to 5.89%, the Fed did an aggressive repo adding $24.0 billion against $13.25 expiring. I don’t believe this is at all recognized by the cognoscenti, who believe that the Fed has been providing liquidity and “printing money”. However I don’t think there is much doubt that the Fed itself has been tight or more accurately an insignificant player.

So what’s going on here? Several theories can be advanced, but the most likely bet to me holds that the Fed is acting in this manner as a decoy because the real monetary power over the United States is held by creditors like China, Japan, Wildcat Financiers (see primer on Winterisms for definitions of my terms) and Kimono women (Yen carry traders). Lately China in particular has been sounding off on this score on what is being called the “nuclear option”.

Of course the primary indicator I use for determining liquidity and interest rates in the US are foreign central bank (FCB) purchases, most of which shows up in the Thursday afternoon Fed release of H4.1. Total FCB custodial holdings of US securities now totals $2.011 TRILLION, of which 37.63% or $756.7 billion is housing agency paper. $574 billion of this housing agency debt has been bought in indiscriminate fashion over the last four years. Little wonder there was a housing Bubble! The total holdings (now a factor of 2.66 FCB holdings / Fed holdings) completely dwarfs the $790.8 billion in securities held in the Fed’s portfolio. In fact as of last week FCBs held almost as much in GSE’s housing agency securities alone as the Fed held in it’s entire portfolio, the former which has taken 94 years to accumulate. Actually this $2 trillion figure is low, as some reporting (particularly China) is less than complete and is not transparent.

Just four years ago this number was $937.8 billion in FCB custodial holdings and $715.4 billion in the Fed’s portfolio, a factor of 1.31 times. The math suggests that FCB now have twice the impact of the Fed from four years ago, and the effect is expanding exponentially. Figure that over $100 billion in interest alone is being paid out annually to FCBs at today’s interest rates. However, in terms of present day market operations the effect is 13.7 times to one, as FCBs in the last year purchased $355.6 billion in custodial securities, compared to the Fed who in the last year purchased or monetized a mere $26.0 billion. In reality the Fed is now really functioning as a defacto minion of China and other FCBs, better get used to it.

Finally the Fed (and other central banks) may also be quite aware of the out of control speculative forces at loose throughout the world, and is simply showing solidarity with foreign central banks and creditors to try and curtail this. The Fed has to at least provide lip service and a semblance of a defense for the USD. Mostly this is done by exaggerating US economic strength, talking authoritatively and lying about inflation. Then every six weeks the Almighty Wizard of Oz issues the FOMC statement and the “experts” and traders dissect and parse every single word, much like Stone Age medicine men examining animal entrails.

Despite working with one shot derringers as monetary firearms, and having about as much actual credibility as Winston working the rectification machine in the bowels of George Orwell’s Ministry of Truth, the Fed’s smoke and mirrors myth lives on. Really instead of calling together talking heads at every FOMC meeting, CNBC and the WSJ should be waiting with baited breath for the Thursday release of H4.1 FCB custodial holdings. But then that’s the job of tin foil hat renegade financial web sites apparently?



The other big actor who is increasingly rendering the power of the Fed moot is the US Treasury (UST). The UST runs a Treasury Investment Opportunity (TIO) program whereby extra unneeded funds from tax collections are offered temporarily (a day to two weeks) to broker-dealers. For instance right now there are $30.5 billion in TIOs outstanding at rates of around 5.25-5.35%. The amounts in the TIO program seem to get larger and larger, and of course work to provide extra liquidity and funds to bankers in addition to the Fed’s TOMO system offerings.

The UST can also influence the yield curve. For instance as Lee mentions, $40 billion in 30 year bonds are being paid off, with $27 billion going into T-bills. Additionally the Treasury Borrowing Advisory Committee (TBAC) report in May estimated that the UST would have needed only $2 billion in new money in the 4 week bill. Instead they are now looking to raise $17 billion new. As long as One Trick Pony tax receipts and Alternative Minimum Tax creep is at work, the UST can have extra and pronounced influence on monetary conditions in the US.

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