Jim Willie: Dead Wrong on a 2014 T-Bond Collapse
It is important that analysts who say that something huge is coming provide coherent evidence for such an event. Let me offer a recent example of an analyst who failed to do this.
In an article by Jim Willie, whose subscription-based newsletter is the improbably titled Golden Jackass, we learn that the Treasury bond market is now a huge carry trade market. A carry trade exists when a lot of investors have borrowed short-term at low interest rates and have lent long-term at high interest rates. If you borrow at 1/10th of 1 percent and lend at 1.6%, you make 16 to one. That's a very nice rate of return.
Banks can borrow overnight money at 1/10th of 1%. They were able to buy 10-year T-bonds last May at 1.6%. (Today, it's 2.7%). Jim Willie warns that this is a carry trade market. He does not say that it is a possible carry trade market. He says that it is one. For this, he needs to offer evidence.
Rates on 10-year T-bonds have climbed by about 65% since May: from 1.6% to 2.7%. This is well known. He concludes that this T-bond carry trade is unwinding. The investors are trapped. Rising rates have knocked down the market price of all the low-rate bonds held by banks. The holders must now sell to avoid huge capital losses.
Really? Why? Commercial banks are allowed to maintain their investments on their books at the prices which they paid, not what the bond market says they are worth today. They need not report any losses on their T-bonds until they sell the bonds. My conclusion: bankers will not sell their banks' bonds. Keeping the bonds in their portfolios lets them conceal their losses. The higher the banks' real-world losses, the less willing bankers will be to sell.
But if the bond owners will not sell, then this market, while analytically speaking is a carry trade market, and may possibly be one in operation, is not in imminent danger of collapsing. To the extent that banks hold T-bonds, it will not collapse.
Mr. Willie says otherwise. He bases his argument on the ownership of T-bonds by banks: commercial and Federal Reserve.
He says that regional Federal Reserve Banks have begun panic selling. He offers the following evidence. I reproduce the actual page, so that you can see the bold facing, the italics, and the exclamation points. No one in the hard-money camp uses more of these than Jim Willie.
All of the regional Federal Reserve Banks were ordered to unload as many USTreasurys and Mortgage Backed Securities as they could, even though they are selling at a loss, to provide immediate liquidity even at the expense of capital!
When a central bank sells any asset on its balance sheet, this reduces liquidity. The digital money used by the buyer to purchase the asset is taken out of the economy. The sale of the asset shrinks its balance sheet. Willie is talking about regional Federal Reserve banks here. This is the bottom of the inverted pyramid of bank assets.
The sale of assets by a Federal Reserve Bank is deflationary. Anyone who has read even the most elementary materials on how central banking works should know this. An article by Murray Rothbard describes the process in detail. He concludes:
If the Fed purchases any asset, therefore, it will increase the nation's money supply immediately by that amount; and, in a few weeks, by whatever multiple of that amount the banks are allowed to pyramid on top of their new reserves. If it sells any asset (again, generally U.S. government bonds), the sale will have the symmetrically reverse effect. At first, the nation's money supply will decrease by the precise amount of the sale of bonds; and in a few weeks, it will decline by a multiple, say ten times, that amount.
If you sell an asset, this tends to reduce its price: greater supply, same demand ===> reduced price (to get someone to buy). This is economics 1. In bonds, the lower the price, the higher the yield. They are inverse relationships. Here is a summary by Investopedia, a conventional site on basic investing.
The relationship of yield to price can be summarized as follows: when price goes up, yield goes down and vice versa. Technically, you'd say the bond's price and its yield are inversely related.
The sale of bonds by the Federal Reserve banks would therefore have driven up the yield. But not according to the economics of Jim Willie.
Eventually, late Friday night a tranche of Treasurys was sold above market price to several Federal Reserve Member banks in order to drive down the yield!
First, why would member banks pay the FED an above-market price? This is "buy high." This deserves an explanation. He offers none.
Second, the effect of such a sale would be to reduce the monetary base, which is a deflationary policy. What authority did these regional FED bankers possess that authorized them to counteract the FOMC's policy of QE3? When did they receive this authority?
In short, Jim Willie doesn't know what he is talking about at this most basic level. He has the economics of the bond market upside-down. He has the economics of the Federal Reserve literally upside-down: regional FED banks making national monetary policy. Then he adds exclamation points to prove all this.
A "WOW!" STORY
This is a "wow!" story that rests on supposed inside information from a secret informant. The informant also has cause and effect backwards. The supposed fact -- the order to sell T-bonds -- is proven by a chart that proves the opposite. Why should anyone believe this story? It's preposterous.
First, the story sounds fishy. Regional FED banks, other than the New York FED, have never had any power. They were deliberate scams to fool Congress in 1913, which they did. They were set up to fool Congress into believing that the FED was not a national central bank. There is no way that regional FED banks would scheme to do this apart from a meeting of the FOMC.
Second, he takes his 100% dead wrong bond analysis and draws a conclusion: an impending crisis of monumental importance.
More important, WE HAVE NOW SEEN THE BEGINNING OF FLASH TRADING ON USTREASURY BONDS!! A grand round robin closed circle selling program will be relied upon in desperation to maintain price, just like with NYSE stocks in Algorithm Trading. The internal trading volume will grow and dominate the system, just like with the stock market where 80% of NYSE volume is from the perverse Algo Trading. No computer based trading like with Algo Trading is regulated, as the computers run wild. The dangerous times and the instability of bond markets will become major spectacles and news items. The risk will be transferred to stocks, which rise in value from more QE volume flowing into asset purchases, but which fall in value from creeping bond yields. Great instability will be a regular fixture in the US Stock market, and possibly many other national bourses around the world. The next several months will see some important bond market events and likely outsized derivative losses, complete with revelation of USTBond market rigging devices.
Here, he attacks the free market. Algorithm trading is legal, and should be. Entrepreneurs put their money on the line. They try to forecast future prices. They use programs to do this. What is wrong with this? Ethically, nothing. Technically, nothing. No prices are rigged. If anything, algorithm trading undermines price-rigging. The various programs seek out tiny price disparities. An entrepreneur finds a price he thinks is too low in one market. He buys. He finds a price he thinks is too high in another market. He sells. He does this simultaneously. This is called arbitrage trading. It is called "buy low, sell high." Algorithms find these opportunities and execute trades in millionths of a second. So what?
He uses his utterly inaccurate understanding of the bond market, plus some highly improbable inside information, to draw this conclusion:
In fact, QE to Infinity will be ramped up, with double the volume of USTBond purchases in the next several months. The foreign nations will diversify out of their USTBonds held in reserve, and foreign corporations will dump outright USTBonds, in what will become the grandest vote of no confidence toward US-UK bankers in modern history. The USFed must sop up the supply. The alternatives are truly horrendous.
My prediction: None of this will happen in the next 12 months.
CONCLUSION
My advice is this: ignore his italics, his bold facing, his capitalized words, and his exclamation points. Their only function is to emphasize hype-driven conclusions that are drawn from analytical and conceptual mistakes.
Economically unsophisticated readers love bold facing, italics, and exclamation points. "This must be important," they think. "I mean, the type face looks really scary." What is scary is that Jim Willie is taken seriously.
Ignore him. He doesn't know what he is talking about.
He may decide to respond to my article. I welcome the opportunity to reply. This is like shooting fish in a barrel.
His subscribers will send him links to my article. They will beg him to respond, to show I've got it all wrong. I recommend the following to him: "When you're in a deep hole, stop digging." The wise strategy would be to pretend I never wrote it. He can hope that most of his subscribers don't see it, or else they forget about it.