I heard a quote yesterday that is better than anything I’ve ever heard regarding finance before. I do not know who came up with it and wish I could credit someone because it says it all in one sentence that is simpler than 2+2. The quote, “You cannot ever taper a Ponzi scheme” goes to the heart of the entire global financial system. Think about it, A Ponzi scheme by definition must continually attract “new suckers” to stay alive. The only way to continue “paying” is by attracting new investors in order to pay earlier ones.
Before talking about the Fed possibly “tapering” it is important to understand that a “taper” has already started. Namely the fact that China “unofficially” stopped purchasing Treasury bonds a year ago and has now “officially” announced that they will no longer accumulate dollar reserves. The “slack” in demand created by the Chinese stepping away from this market has been taken up by the Fed. They now own 1/3 of the all 10yr equivalent Treasury securities. At the current rate, they will have ownership of 1/2 of the Treasury market by the end of next year as Zero Hedge explained.
I will get to China in a moment but think about what a Federal Reserve that owns 1/2 of the Treasury market really means. Is this what the old saying “it’s no big deal because we owe it to ourselves” means? Yes I know, the Fed is a private institution and without a doubt in no way shape or form “ourselves.” But think about it, if the time ever came (it can’t) that the Fed needed to actually sell part of their holdings…WHO would they sell to? It’s like the old story of an investor who buys some stock at $1 and sees it move up a little and decides to buy more. The stock goes a little higher and he decides again to buy more. This keeps going until the stock hits $10, he calls his broker and says to sell everything, his broker then tells him “to who, you were the ONLY buyer.” This right here is the position the Fed has put them in. Treasury bonds are only “priced” at current levels because of the Federal Reserve buying, without it interest rates might be double or more where they are now…and bond prices FAR FAR lower!
As for China, how foolish do we have to be to keep peeing on their boots? We have made so many “missteps” over the years and now the latest being flying our B-52 bombers over the islands that are disputed between them and Japan. Vice President Biden is in Asia presumably holding Japan’s hand and telling them there is nothing to worry about because “we have their back.” Really? Let me ask a couple of simple questions here. What would be our response to China selling $25 or $50 billion worth of treasuries in one shot? What if they did this and at the same time told us to mind our own business and stay out of the disagreement between them and Japan…or the next sale will be $1 trillion with a capital “T?” How long do you think we would “support” Japan and our nearly 70 year old treaty with them?
I have written before regarding China and their ability to basically shut us down just as any lender could who “calls in their loan.” The fact now is that China could make it impossible for us to protect Japan by making it “unaffordable” to do so. We cannot move forward one single day without borrowing more “to pay our bills,” as foolish as this sounds we already saw it back in October with the government shutdown. But, but, the Fed will buy Treasuries and we’ll always be able to borrow…well yes this is true but then the small detail of what a “dollar is worth” comes into play. Will dollars even be accepted for trade is another small quirk? The answer of course is that Walmart would no longer be able to offer trinkets on the cheap and the inflation that we created for years upon years and “exported” would finally come home to roost.
As far as the quote about “tapering a Ponzi scheme” is concerned, a tapering is not even necessary for collapse. A simple “leveling off” of inflows will collapse any and all Ponzi schemes. This goes back to Richard Russell’s “inflate or die” slogan. In order for the U.S. to “keep the doors open,” MORE not less capital must continue to flow inward. Yes the Fed can take up the slack but they can only do this for so long before they become “too big of a player” which they already are. Technically the U.S. cannot default because we have the ability to print whatever amount that we owe…but this does not matter. It doesn’t matter because we don’t “produce” much of anything anymore and must import most goods…goods even as simple as your underwear! Once foreigners decide to no longer accept dollars it will be game over…life changed. Whether this happens slowly as so far has been the case or rapidly because we ticked off the Chinese or someone else remains to be seen. It does seem though that nations are beginning to “choose sides” as illustrated by the South Koreans moving business toward China and away from the U.S. Benign? Maybe but there are still many veterans alive today who can remember fighting FOR the South Koreans and against N. Korea who was supported by China. Simplistic I know but this is very similar to when you were in grade school and alliances were formed or dissolved based on perceived strength, or lack of.