Inverted Yield on Long and Short Term Debt
Nathan-Kaufman said in my comments section
“What do you think of the inverted yield curve in the U.S.?
11:26 PM, July 06, 2005”
I have the same opinion as Jim Puplava from Financial Sense Online. In his broadcast show this week he goes into this phenomenon. First we need to answer a few questions.
Why are mortgage rates so low anyway?
Who wants to buy United States Treasuries and Mortgage Backed Securities?
What is the current driver that makes foreign banks want to buy US securities?
What does it mean to be the world’s reserve currency?
What does “Inverting the Yield Curve” accomplish?
The US dollar is the world’s reserve currency. That means that the US dollar and US paper is held in foreign banks as part of their core assets. Core assets are the base to which banks are allowed to lend against (reference the fractional reserve system). The US dollar is used as a hedge against fluxuations in their own currencies.
The US has a negative trade balance, and the US dollar is the world’s reserve currency. These two facts make foreign banks to want to obtain US paper. As countries sell goods to the US they end up collecting the US dollar. Even without a negative trade balance other countries wanted to collect the US dollar as a hedge.
As countries increased the size of their debts, they decided to finance this through borrowing. In order to expand the money supply countries securitized debt. This makes it possible to sell mortgages and other hard handle financial arrangements as bonds to an international market. Using this method, other countries are essentially expanding your “leveraged” money supply for you.
With a negative US trade balance, countries start to collect far more dollars than they can use. You see, most of these dollars are “leveraged”. This means that this is money in a quickly expanding money supply. Countries on the other side of our trade balance cannot get rid of the dollars they are collecting.
Why, how can that be?
They have collected so many dollars that if they were to trade them for, let’s say other currencies; the value of the dollar would drop. So the countries make money when they sell the US goods. These countries receive “leveraged” US dollars in payment. So at this moment these countries are making money by selling, and losing some of that profit on the decline of the value of the US dollar.
Now the situation gets interesting. The only thing these countries can buy with these US dollars is US debt, because to do anything else would devalue the dollar. If the dollar were to devalue they would be sacrificing value of the past gains they made through selling the US goods.
So, now these countries must buy US assets in order to maintain the value of the dollar. In fact so many dollars have been sent oversees that the US doesn’t produce enough debt (even though our debt is rising to biblical proportions).to offset this arrangements. So these countries are forced to buy mortgages or anything else they can get their hands on.
Even if Greenspan were to “invert the yield” on short and long term treasury debt, this may not change anything. These countries have nothing else to do with our currency. They have already run out of options for our dollar, which is why mortgages rates are so low. Counties keep on buying our mortgage debt because they are running out of things to do with our dollar.
Here is the sticky point. If the dollar devalues than these countries banks core assets devalue at the same time. This shall send them into a banking crisis. It is coming to the point were these countries will not be able to make “real” money from selling to the US. At this point they won’t care if the dollar devalues because they cannot do anything with it anyway.
Just like in the 17th century with John Law, the first to cash in will do the best. When foreign banks stop buying US debt we shall enter a housing crash that will destroy the US dollar. If the housing market gets too high, and it really already is, than no one can afford a loan, the housing market will crash under its own weight.
If any member of the G-8 has a housing crash, and they are all in trouble like we are, than through the derivatives market, we shall also be put into a banking crisis which will lead to a housing crash.
If we get into a trade war with China, they can devalue the dollar, sending us into a housing crash.
These other countries see the writing on the wall, they are just doing what they can. After almost all banking crisis there is a “revolution”. They are just trying to stay in power.
This situation has a time limit, and that time limit is quickly coming to pass.
“What do you think of the inverted yield curve in the U.S.?
11:26 PM, July 06, 2005”
I have the same opinion as Jim Puplava from Financial Sense Online. In his broadcast show this week he goes into this phenomenon. First we need to answer a few questions.
Why are mortgage rates so low anyway?
Who wants to buy United States Treasuries and Mortgage Backed Securities?
What is the current driver that makes foreign banks want to buy US securities?
What does it mean to be the world’s reserve currency?
What does “Inverting the Yield Curve” accomplish?
The US dollar is the world’s reserve currency. That means that the US dollar and US paper is held in foreign banks as part of their core assets. Core assets are the base to which banks are allowed to lend against (reference the fractional reserve system). The US dollar is used as a hedge against fluxuations in their own currencies.
The US has a negative trade balance, and the US dollar is the world’s reserve currency. These two facts make foreign banks to want to obtain US paper. As countries sell goods to the US they end up collecting the US dollar. Even without a negative trade balance other countries wanted to collect the US dollar as a hedge.
As countries increased the size of their debts, they decided to finance this through borrowing. In order to expand the money supply countries securitized debt. This makes it possible to sell mortgages and other hard handle financial arrangements as bonds to an international market. Using this method, other countries are essentially expanding your “leveraged” money supply for you.
With a negative US trade balance, countries start to collect far more dollars than they can use. You see, most of these dollars are “leveraged”. This means that this is money in a quickly expanding money supply. Countries on the other side of our trade balance cannot get rid of the dollars they are collecting.
Why, how can that be?
They have collected so many dollars that if they were to trade them for, let’s say other currencies; the value of the dollar would drop. So the countries make money when they sell the US goods. These countries receive “leveraged” US dollars in payment. So at this moment these countries are making money by selling, and losing some of that profit on the decline of the value of the US dollar.
Now the situation gets interesting. The only thing these countries can buy with these US dollars is US debt, because to do anything else would devalue the dollar. If the dollar were to devalue they would be sacrificing value of the past gains they made through selling the US goods.
So, now these countries must buy US assets in order to maintain the value of the dollar. In fact so many dollars have been sent oversees that the US doesn’t produce enough debt (even though our debt is rising to biblical proportions).to offset this arrangements. So these countries are forced to buy mortgages or anything else they can get their hands on.
Even if Greenspan were to “invert the yield” on short and long term treasury debt, this may not change anything. These countries have nothing else to do with our currency. They have already run out of options for our dollar, which is why mortgages rates are so low. Counties keep on buying our mortgage debt because they are running out of things to do with our dollar.
Here is the sticky point. If the dollar devalues than these countries banks core assets devalue at the same time. This shall send them into a banking crisis. It is coming to the point were these countries will not be able to make “real” money from selling to the US. At this point they won’t care if the dollar devalues because they cannot do anything with it anyway.
Just like in the 17th century with John Law, the first to cash in will do the best. When foreign banks stop buying US debt we shall enter a housing crash that will destroy the US dollar. If the housing market gets too high, and it really already is, than no one can afford a loan, the housing market will crash under its own weight.
If any member of the G-8 has a housing crash, and they are all in trouble like we are, than through the derivatives market, we shall also be put into a banking crisis which will lead to a housing crash.
If we get into a trade war with China, they can devalue the dollar, sending us into a housing crash.
These other countries see the writing on the wall, they are just doing what they can. After almost all banking crisis there is a “revolution”. They are just trying to stay in power.
This situation has a time limit, and that time limit is quickly coming to pass.
posted by Chromatic Dispersion at 7/07/2005 04:56:00 PM
6 Comments:
www.nationalreview.com/kudlow/kudlow200505110857
Great piece. I didn't realize how "unintentionally" leveraged our currency gets outside of the USA.
This is pretty bleak...I honestly DO NOT SEE any sort of easy way out "rate cut by the FED" remedy if the USD crashes and drags down the Real estate market with it. This would take more than 20 yrs to fix.
My arguments had been the re-valuation of the Yuan and the Real Estate markets own frothy weight.
Japan style collapse?
May 11, 2005
National Review
Larry Kudlow
The Economy in the Fed's Hands?
* even if you are not conservative or do not like National Review, you may find the article to be interesting.
Isn't a housing crash deflationary? A credit crunch, a lot of defaulted debtors and
underwater debtors and out of work RE people certainly would reduce spending.
I shall post an answer to the delfation question on my blog. The answer is not so simple as it may appear.
I have been following a site now for almost 2 years and I have found it to be both reliable and profitable. They post daily and their stock trades have been beating
the indexes easily.
Take a look at Wallstreetwinnersonline.com
RickJ
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