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Back in the fall of 2008 I wrote that this entire financial episode would end up in the “lap of the U.S. Treasury.”  It has but I did not think it all the way through back then (or I was naïve in how far they would go).  Yes, the Treasury has in fact blown out their balance sheet through outright borrowing, loan guarantees and other promises but…the game goes on.  It is now apparent to me that the game won’t end until the Fed’s itself is questioned.  The loss of credibility (there’s that word again) caused by last Wednesday’s non taper “bagging” of the financial markets will probably commence the “interrogation process.”

What I am getting at here is that the finances, balance sheet and solvency of the Fed will now come under scrutiny.  Needless to say, they will be found wanting.  From a balance sheet of under $800 million in 2008 when the financial fiasco began, they will top $4 trillion by the end of this year.  Foreigners are left scratching their heads as Thursday and Friday saw Fed governors speak of “taper” by December while already this morning 2 other Fed governors have spoken of easier policy for longer and even larger QE…so which is it?  Like I wrote yesterday, “Where is the credibility in this?”  Now that the Fed’s balance sheet has gotten so large I suspect that the time for speculators to trade AGAINST the Fed rather than with them cannot be too far off.  In other words, large holders (they will be explained away as “evil speculators”) of Treasuries may not even need to hear the word “taper” to push the sell button as it becomes apparent that the Fed is the first, last, only and best bid out there to sell into.

Last week Warren Buffett describes the Fed as the world’s “greatest” hedge fund in the world.  In a nutshell, if you can print unlimited amounts of money then you never have to worry about “losing.”  It’s like going to a casino and doubling down on each and every hand…surely you will win one hand right”?  THIS is what the Fed is doing with each successive and larger QE and what they are doing with their balance sheet.  In theory they have no limitation whatsoever as to how much it can monetize, in practicality they have limits because of the amounts of collateral they are pulling from the system.  They do know this and is the reason they are testing a “reverse repo” system to drain reserves while adding collateral.  In one of THE best posts ever by Zero Hedge, the complicated process is explained and debated here.

I titled this piece “The Buck Will Stop at the Fed” because as with any nation that deficit spends or prints (monetizes) to better their standard of living; it all will inevitably show up in the currency, “the Buck.” Up until now whenever the Fed spoke…markets and literally the entire world would dance to their tune.  Now the “tune” is confusing.  We hear taper and more QE from different governors on the same day and the message is unclear.  It is unclear because there IS NO ANSWER.  It’s merely a matter of time before dollars from all different directions are returned to the U.S. in “return to sender” fashion.  The massive inflation that we have exported all of these years will come back, all at once and be presented to the only buyer…The Fed.

I must chuckle because years ago in college finance classes I can remember the Fed being described as “the lender of last resort.”  Yes they were back in 2008-09 but they have now set themselves up as THE only buyer.  Yes I know, they are “lending” technically but in reality it is FORCED buying.  If they don’t buy, no one else will and the “value” of their $4 trillion balance sheet?  Well, maybe “still” $4 trillion but certainly less in terms of eggs, potatoes, barrels of oil or …gold ounces.  Think back to your schoolyard days and the big bully who ran the show.  Little by little, people would “turn” on him until he had no friends (through coercion or not) left.   Then would come payback as 4 or 5 kids would join up and whip the snot out of him after school.  This is where we are now with the Fed.  The world collectively understands that we bullied them and took advantage of our “right” to (over)issue the reserve currency.  They are joining together (Russia, China, Africa, Brazil, India etc.) and doing deals exclusive of the U.S. and without the use of dollars.  Treasuries are already coming back home…and now that the Fed has publicly told the world that there will be no end to the printing…they will come home even faster.

The selloff in Treasuries started because of “taper talk” back in April but will now continue because “he who sells first, sells best” when it comes to a bubble.  And yes, the Fed, the Treasury, the dollar…IS the bubble.  We know it, they know it, and everyone knows it and the focal point will be testing the Fed’s strength and ability to take back what we pawned off on foreigners in the first place.  John Connally said to the world in the early 1970’s that “the dollar is our currency but it’s your problem.” He was correct then because we still had the ability to provide and manufacture for ourselves…and a lower dollar actually helped our competitiveness short term.  Now however it is OUR problem because the dollars (Treasuries) will be sent back home to us as we are the only buyers left.  From a financial standpoint there is no worse than a position to be in than over indebted and having a currency that no one wants.  On the bright side…we can always pay the Treasuries off with freely printed dollars so we won’t “really” be broke after all…technically!