Friday, March 18, 2011

Is This Why Bill Gross Dumped Treasuries?

By Global Macro Monitor

A couple of revealing charts from the Fed’s Flow of Funds data.   Both show net flows into Treasuries by creditor type and the Federal Government’s borrowing during each quarter.   Note, the quarterly data is annualized.

The first chart illustrates how QE2 flushed domestics out of Treasuries and effectively funded 63 percent of the budget deficit in Q4.  The Treasury is prohibited from directly selling bonds to the central bank, but effectively finances the government through POMO.

Given that a large portion of the Rest of World category are central banks recycling BOP surpluses,  it’s likely that 90 percent of the U.S. budget deficit in Q4 was funded by central banks.    You think this may have anything to do with what’s happening in the commodity markets?   That is, the central banks’ printing presses providing the fuel for speculators?

Furthermore, we ask: who is going to finance the U.S. budget deficit when QE2 ends, especially at a sub 3.50 percent 10-year Treasury rate?  Bill Gross knows!

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Japanese Fallout May Hit U.S. Treasury Bonds

Japan is facing two meltdowns in the wake of its devastating earthquake. The first, and more critical, is the meltdown at the Fukushima I Nuclear Plant, 150 miles north of Tokyo. Surely, this is the greater near-term threat. But long-term, another threat looms, having to do with the Japanese government's response to the former.

As the fourth largest economy in the world, behind the EU, US, and China, any major setback in Japan likely will have widespread repercussions. Japan is also the third largest holder of US Treasuries, behind the United States and China. While it is too early even to assess the Japanese damage accurately - let alone to forecast the full implications - it is possible to see the potential for a meltdown of the US Treasury market and international monetary system.

Current estimates hold that the Japanese disaster has already lowered world economic growth by a full percentage point for the year.

Leaving aside massive international aid, a complete nuclear meltdown, or other escalations, Japan already will have to spend a massive amount of money to cope with the current disaster. This raises the question: from where will such an enormous amount of money come?

Japan could borrow. However, with a debt-to-GDP ratio of some 200 percent, or twice as bad as that of the United States, and with the main credit rating agencies exercising more scrutiny than before the Credit Crunch, raising funds will be difficult at an economic rate of interest. Moreover, Japan will likely be spending a large chunk of its foreign exchange reserves to buy oil to replace its lost nuclear power generating capacity - diminishing its collateral in the eyes of creditors.

Japan could follow the US example and "paper over" its problems. But without the benefits of being the international reserve currency, the Japanese would immediately feel the effects of domestic inflation. The Bank of Japan has already pumped out ¥8 trillion ($98 billion) in the wake of the earthquake, but it is unlikely to try to match the Fed's $600 billion printing spree this quarter.

So, if Japan is limited in its ability to borrow or print money, it may have to sell part of its vast holdings of US Treasuries.

At the end of last month, the US Treasury had outstanding debt worth some $14.19 trillion. This represents 96.8 percent of the total $14.66 trillion value of business generated within the United States for the entire year of 2010. It is just short of the $14.294 trillion debt limit set in 2010 by a profligate Democrat Congress. To put it in perspective, the US government now owes $91,400 for every working American. However, this represents only some 22 percent of Washington's $62 trillion of unfunded obligations, which include Social Security, Medicare, housing, and other guarantees.

Japan is the third largest holder of US Treasuries ($877 billion), behind China ($896 billion) and the Fed ($1.108 trillion). Should Japan start selling Treasuries in large amounts to fund the repair of its economy, it could have a serious effect on US interest rates and the market value of Treasuries the world over. US bonds are widely held by central banks, international banks, and insurance companies, which already are concerned about their funding of loss claims arising from the damage in Japan.

Thus, a Japanese selloff could trigger a liquidity crisis like the one following the collapse of Lehman Bros. and AIG. Large institutions may not be willing or able to bear with US bonds through a steep correction.
Western economies are on thin ice as it is, even without a shock in their presumed "safe" asset.

Stock markets in the EU and US are weakening, destroying large amounts of private wealth and potential consumer confidence.

Further, the EU is facing the reality that the financial rescue programs it organized to save some of its members are not working. China and Japan offered to help. Now Japan may not be able to fulfill its promises. This could reignite further speculative downward pressure on the euro.

It seems that while we are all concerned about the effects of nuclear meltdown on the residents of Japan, we should also be aware that the fallout could spread further in the financial markets than it does in the atmosphere. Just as Californians are stocking up on iodide pills as a precautionary measure, investors should be stocking up on hard assets. After health, it's vital to guard your wealth - especially in emergency times like these.

Coffee squeeze may yet drive prices to record high


The rally in coffee prices could last for at least another season, and take out records set in the 1970s, driven by a market squeeze that will drive supplies to their tightest in 50 years, Rabobank said.
The tightness in the market for arabica coffee, traded in New York, which has already driven prices to 34-year highs looks set to increase further in 2011-12, as robust demand encounters a falling supply of the beans.
That will be an off-year in the two-year production cycle in Brazil, the top grower, leaving world output of arabica beans – generally considered the better quality coffee type – down 7.4% at just under 78m bags.
Although stocks are set to rebuild somewhat in the current season, "the surplus built up is not expected to be sufficient to counter the lower production expected in 2011-12", the bank said a report.
'Significant upside risk' 
"As demand growth will continue, we expect the stocks-to-use ratio for 2011-12 to be the lowest for the last half a century, resulting in high prices and continued competition for beans."
The report added that "significant upside risk" remained for prices, even after a doubling in the past year.
"If production is threatened by weather, prices could take out the record set in the 1970s."
Changing tastes 
The market tightness has been spurred by years of modest growth in arabica output, and little prospect of a significant uptick given the time needed for coffee trees to establish.
Meanwhile, demand for the beans has shown a significant increase, in line with a taste for upmarket coffee, such that even a 25% rise in prices of some US brands over the last nine months is not expected to dent consumption much.
Indeed, US demand is expected to remain flat in 2011-12 and grow by 2.0% in the European Union, while hitting 2.8% in Brazil, which is closing in on America as the top consumer of the beans.
"The growing demand comes despite the higher price tags," Rabobank said.
"The consumption of coffee was very resilient during the financial crisis, and we believe it will continue."

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I Hate Corn

By Barry Ritholtz

So on a lark today, I grabbed a new URL:
I was thinking that with all this newfound talk about fiscal responsibility, perhaps it might be time to put an end to one of the dumbest Energy/Ag subsidies in the history of the US: Burning food (corn) for fuel.
I do not have any issue with alt.fuels — but they have to make sense. Ethanol does not.

I am thinking of some interesting ideas to use this with in the coming 2012 Electoral season:

Get candidates to sign a pledge to do away with Corn Ethanol Subsidies
• Clearing house for all corn ethanol related research, news, data.
• Community / Message board for ethanol related haters
Any ideas? What should be done of value with this web site?

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