A few days ago I mentioned that Bill Gross, the world’s largest bond fund manager with over $1 trillion AUM, called US finances a Ponzi scheme. I also said that I reprint part of it for you, which follows.
You can find the entire article here…
You can find the entire article here…
"The End of QEII: It’s Time to Make the Donuts"
- With quantitative easing the Federal Reserve has in essence picked the pockets of Treasury bond investors throughout the world.
- Ultimately, the U.S. must own up to its past sins and let the deleveraging process play itself out.
- The U.S. must invest in its people, its land, and its infrastructure, as well as promote free trade, to achieve economic growth rates fast enough to justify consumption levels previously supported by debt.
In 1920 the Boston Post contacted Clarence Barron, the founder of Barron’s, to investigate a man who claimed to be racking up remarkable gains for investors in an arbitrage involving the purchase and sale of postal-reply coupons. Charles Ponzi, the developer of the scheme, sought to convince investors that differentials in inflation rates between countries had created an opportunity for investors to purchase the postal-reply coupons on the cheap in one country and redeem them in the United States, an arbitrage that Ponzi said would enable investors to grow their money by several fold if they invested with him…
From Donuts to QEI and QEII: The New Profit Illusion
Just as Charles Ponzi needed donuts to turn back a suspicious crowd of investors, the Fed needs “donuts” in order to fill the bellies of the literally millions of investors worldwide who worry about the alarmingly large U.S. budget deficit and the impact that the U.S. debt dilemma could have on their Treasury holdings. Investors are no doubt worried they may have bought into an unsustainable scheme: the creation of a scourge of debt so large that the Fed itself has had to purchase the debt to keep the game going.
All that the Fed has had to do thus far to keep the game going is press the “on” button to its virtual printing press, crediting the account of the U.S. Treasury. In the process, the Fed has kept the demand for U.S. Treasuries high, perhaps deceptively so, attracting with its redolence many classes of buyers, including households, banks, pension funds, insurance companies and foreign investors. Their collective buying has created what we believe to be a profit illusion with many investors mistakenly believing they can continuously reap profits from perpetually falling bond yields and rising bond prices, just as they have had opportunity to do over the past 30 years, amid the great secular bull market for Treasuries and the bond market more generally.
For many reasons, this “duration tailwind” for Treasuries can’t last, particularly because the United States has reached the Keynesian Endpoint, where the last balance sheet has been tapped. In addition, with inflation expectations rising in the context of low levels of initial jobless claims, and with Federal Reserve officials themselves expressing reluctance to go beyond Quantitative Easing (QE) II, the Fed’s Treasury buying is expected to end in June, leaving others to carry the Treasury’s heavy load.
The Federal Reserve’s colossal bond purchases therefore will likely, to the chagrin of millions of unsuspecting Treasury bond investors, be one of the markers for the latter stages of the bull market for Treasuries. For now, however, the Fed’s purchases have the sweet aroma of freshly baked jelly donuts and many a Treasury bond investor has been drawn to their savory, sugary, scrumptious taste.
What they should instead smell is the whiff of rotten eggs. But this is easily hidden with a nose pin, which the Fed through QEII places on the noses of each investor, with the goal of creating perpetual serendipitous moments that in the eyes of investors transform the rotten stench into something far more delectable. Ultimately, however, the stench of the Federal Reserve’s bond purchases will seep into the nostrils of investors all around the world when it becomes glaringly obvious to them that the Fed can’t possibly continue as the Treasury’s main source of demand.
Treasury investors will also realize that not only has QE suppressed the rates they earn on their Treasury holdings, QE promotes financial and economic conditions that hurt Treasury bond holders, primarily because it boosts economic growth and inflation, resulting in confiscation of the skimpy Treasury yields they earn. Foreign investors have the added discomfort of a decline in the foreign-exchange value of the U.S. dollar. To top it off, Treasury investors face the potential for capital losses for having bought into the Fed’s scheme at prices inflated by QE, sort of like playing a game of hot potato and getting stuck with the potato when the Fed abruptly leaves the game.
…Ultimately, the U.S. must own up to its past sins and let the deleveraging process play itself out. It can’t pretend that previous levels of demand for goods and services can be restored simply by turning on the Fed’s printing press.
The United States instead must recognize that only by increasing investment in its people, its land, and its infrastructure, as well as promoting free trade, can it achieve economic growth rates fast enough to justify consumption levels previously supported by a wing and a prayer – by debt.
For the Federal Reserve and the U.S. Treasury, it is time to make the donuts. There is a crowd standing outside and, although there is no wrongdoing to make them as angry as the crowd that stood outside of Charles Ponzi’s office before he was busted, they are just as anxious, and it is going to take a lot of convincing to get them to show up at the next Treasury auction and the one after that, and the one after that, and….
With this morning’s horrible weekly jobless claims data there were economists and professors already clamoring for QE3. The debt ceiling and monetization-of-debt cans will both be eagerly kicked down what some believe to be a road that never ends.
Trade Date: 5/12/11
E-Mini S&P Trades*
(before fees and commissions):
E-Mini S&P Trades*
(before fees and commissions):
- VA sell @ 1:03pm at 1346.75 = b/e & -0.25 (2 lot)
- Algorithm positions (4)
- “Reading the Tape” positions (8) …combined Secret’s, Algo, & “Reading the Tape” total… +7.25
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