Where the Money Is...And Isn't

I'm in the process of composing my annual predictions for 2010, and as those of you who were around for my last set will know, let's just say that my number of hits won't be as high as the previous year (the previous year was weirdly correct, this one more normally imperfect). This is not a serious problem for me, since every year I include the basic disclaimer that there's absolutely no reason why you should believe that my predictions are worth anything, but I do like to be right better than being wrong ;-).

The major thing I screwed up was underestimating how successfully the US government would be at propping up the economy and painting lipstick on the pig. I admit, I'm still pretty surprised that they succeeded as well as they did - in part, of course, because they were able to throw a truly astonishing amount of money at it, in part because they jerk the statistics, partly with a remarkable amount of straight-out lying but it is still an impressive accomplishment, in a horrible, disheartening way.

Why horrible and disheartening? Well, because we're going to have to pay the money back - and so a short term bump in stocks and the illusion of a stable economy was bought at a very, very high price. Being able to do something doesn't necessarily translate to being able to do it indefinitely - and I think the second cycle of balls falling out of the air will probably happen sooner rather than later. But then again, the problem is that the application of reason to the economy doesn't work - the game is rigged, and even though the juggler's hands have stopped moving, the balls don't fall if you hook wires onto them.

Ilargi at The Automatic Earth has been doing what he does best - bringing together disparate sources to consider why it is that the balls haven't begun to fall. His latest documents the degree to which a. we have no idea what is actually happening (ie, the 704 billion in unaccounted Treasury Purchases Eric Sprott finds) and the bizarre expectations (that US denominated fixed income issuance is expected to rise to 2.22 trillion dollars in 2010 to keep pace with interest payments) to the malfeasant - which Ilargi suggests could look like this:

Now, let's be clear: it's entirely unclear who the buyer of the $2.06 trillion will be. Not only do the usual suspects, China, Japan, have increasing doubts about amassing USD denominated paper including Treasuries, Japan also plans to be as aggressive a seller as the US. And of course there are many other countries who desperately need to sell sovereign bonds in order to pay for get their often already accepted and implemented budgets. And that's just the nation states. Corporations and lower levels of governments, in every nook and cranny of the planet, wants to sell you their debt. Badly.

Obviously, this will drive up interest rates on all this debt. It's impossible to foresee at this point how high the rates my rise, but it looks to be painfully obvious that there will be a lot of pain involved. You can bet that many if not most of the managers and budgeteers involved have done their clever calculations based on low interest rates. And they won't get those. Which will lead to new deficits, new budget cuts, new job losses etc.

But in case you were starting to think that we bring only sorrowful tidings, here's a ray of light for you. For Wall Street, things may not be all that bad. Not at all. The major US banks, as their European counterparts, have access to enormous amounts of funds (yours) at ultralow interest rates. All they need to do is borrow at one of the Fed windows, walk across the street (I know they don't have to do that, but I'm going for the George Bailey era image here) and buy themselves some Treasuries.

In practical terms, say Bank (of) A borrows $1 billion at 0.25% from the Fed, and buys Treasuries that pay 5.25% (oh yes, we'll get there, and beyond). All a banker needs to do is sit back, or play golf, and make 5%, or $50 million, on that $1 billion. Since it's that easy, why not borrow, say, $200 billion, leverage that 10-fold, buy the $2 trillion in Treasuries, and make $100 billion just for sitting still?

Would work like a charm. The debt gets sold, the White House and the media can convince everybody this means that the economy is doing great, and the only sucker in all of it is the taxpayer who's losing $100 billion a year while the principal of his debt keeps growing, sort of like in a non-amortization loan. Or if the banker doesn't like the sitting still part, (s)he can use the Treasuries as collateral for more loans (covered by the full faith and credit of the American taxpayer), and go play in the derivatives casino down the street.

Now all we need to do is find a buyer for the trillions in mortgage backed securities the country's choking on.

I'm going to write my piece and take my fair hits for my screw ups last year. Although, I admit, I'm tempted to weasel out of it just a little - because who the hell could have predicted that?

Sharon