Who Will Buy Our Treasuries?

I believe zerohedge was the first to report that PIMCO's Bill Gross, the Bond King, recently dumped his U.S. treasuries holdings—all of them.

And many thought Bill Gross was only posturing when he said he is getting the hell out of dodge. Based on still to be publicly reported data by Pimco's flagship Total Return Fund, the world's largest bond fund, in the month of January, has taken its bond holdings to zero...

The offset, not surprisingly, is cash. After sporting $28.6 billion in "government related" securities, TRF dropped to $0.0, while its cash holdings surged from $11.9 billion to a whopping $54.5 billion...

In his most recent newsletter, Gross describes who holds our bonds.

What an unbiased observer must admit is that most of the publically issued $9 trillion of Treasury notes and bonds are now in the hands of foreign sovereigns and the Fed (60%) while private market investors such as bond funds, insurance companies and banks are in the (40%) minority. More striking, however, is the evidence in Chart 2 which points out that nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns.

Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?

Here's an alternative view of the Fed's Z1 Flow of Funds data from Global Macro Monitor's Is this Why Bill Gross Dumped Treasuries?

The chart [below] illustrates how QE2 flushed domestics out of Treasuries and effectively funded 63 percent of the budget deficit in Q4. The Treasury is prohibited from directly selling bonds to the central bank, but effectively finances the government through POMO.

Given that a large portion of the Rest of World category are central banks recycling balance of payment [trade] surpluses, it’s likely that 90 percent of the U.S. budget deficit in Q4 was funded by central banks.

You think this may have anything to do with what’s happening in the commodity markets? That is, the central banks’ printing presses providing the fuel for speculators?

This chart was re-formatted by Tim Iacono.

I think this situation, even if it is temporary and ends with QE II, should be taken at face value. The Federal government issues debt, and the Federal Reserve buys 70% of it. The other 30% is purchased by the central banks of the trade surplus countries. These countries are "recycling" excess dollars.

Future historians, discerning the causes of future calamities, will note that by the 4^th quarter of 2010, and during the 1^st quarter of 2011, the United States was printing money to cover its debts. I first covered these issues in The Biggest Ponzi Scheme Ever Conceived. Gross would like to know who will buy Treasuries after the latest round of quantitative easing ends. Who will it be?

I don’t know. Reserve surplus sovereigns are likely good for their standard $500 billion annually but the banks are now making loans instead of buying Treasuries, and bond funds are not receiving generous inflows like they were as late as November of 2010. Who’s left? Well, let me not go too far. Temporary voids in demand are not exactly a buyers’ strike. Someone will buy them, and we at PIMCO may even be among them. The question really is at what yield and what are the price repercussions if the adjustments are significant...

What I would point out is that Treasury yields are perhaps 150 basis points or 1½% too low when viewed on a historical context and when compared with expected nominal GDP growth of 5%. This conclusion can be validated with numerous examples: (1) 10-year Treasury yields, while volatile, typically mimic nominal GDP growth and by that standard are 150 basis points too low, (2) real 5-year Treasury interest rates over a century’s time have averaged 1½% and now rest at a negative 0.15%! (3) Fed funds policy rates for the past 40 years have averaged 75 basis points less than nominal GDP and now rest at 475 basis points under that historical waterline.

I don't know how events will unfold in the bond market over the next year or two. After the recent disaster in Japan, there was another "flight to quality" (or "flight to safety") as investors once again bought up Treasuries.

Events related to the devastating earthquake in Japan superseded all else in the capital and currency markets last week, even sectors with no discernible connection to the disaster, as investors fled anything hinting of risk for the safest harbors.

One of those was the U.S. Treasury market, where prices rallied and yields slid sharply in the classic "flight to quality" trade. Ironically, that was the reverse of the initial reaction right after the Sendai disaster on Friday, March 11, when the fear was that Japan—the second-largest overseas holder of U.S. government securities—could liquidate a significant portion of its $886 billion cache of Treasuries to pay to rebuild.

Seriously, one must ask at this point what the words "safety" and "quality" mean in the year 2011. Does it strike you that debt which is mostly covered by money printing is particularly safe? Or that it's a quality investment? As opposed, let's say, to hard assets. T-bills are safe in the very short term, which is what most people think about, but certainly not over the longer haul, as we watch the dollar turn into toilet paper.

In this fiat money world of ours, a world of abject economic and monetary policy failure, the safest bet is the Biggest Loser. Where did Keynesian counter-cyclical spending get us? Nowhere! — the Bernank merely blew some new bubbles. Big shocks are coming. Nobody in their right mind could possibly think this bond market nonsense can go on for much longer.

Comments

[Gail]

This is obviously a promotional video but has a few moments of levity (harhar):

http://www.stansberryresearch.com/pro/1011PSISBBVD/PPSIM309/PR

[Gail]

I forgot to add, he brings up the concept of "normalcy bias" which is something I hadn't heard of before, and, along with the notion of shifting baselines, explains quite a bit:

http://en.wikipedia.org/wiki/Normalcy_bias

[Snow Pea]

Bill Gross suddenly noticed are our biggest bond holders are China et al and expects to be taken seriously? Since this fact has never been a secret, I think he's full of it

[Morocco Bama]

I'm betting it won't be the guy in Libya.

[Morocco Bama]

Gail, that video was such disinformation, meaning truths mixed with half-truths mixed with misdirecting statements, it made my head swim. I had to shut it off when he started saying the U.S. was hostile to corporations and it had one of the highest tax rates.....then he went on to cite Japan as having a more business-friendly environment. Yeah, Japan's positively aglow to businesses right now.

[Gail]

Well, when he starts quoting Ron Paul you have to wonder...I think his approach is that the bad bad US is unfriendly to business because we restrict things that are so convenient to business, like, unregulated pollution, slavery and child labor - at least, more than some other countries.

[Morocco Bama]

I agree, Gail, and, of course, he's attempting to scare the hell out of potential clients in order to sell them safety.....as if there is any safety from what's to come. The most any of the scum at the top, and most likely they are not his clients, or his firm's clients, is a can hope to gain is a little more time....but a little more time for what? To watch the anguish a little longer and relish the masterpiece they have created? Sick.

[Kostas Kalevras]

Fed has a zero interest rate policy right now and is engaged in QE versioning. That means that it can add excess reserves to the banks balance sheets which, by definition, has to happen by bond purchases. The bonds are already there, they are just being replaced with zero maturity reserve accounts. How is that money printing?

Bonds will be bought by exporting countries because that is basically the only real thing they can do with their dollars.
Bonds will be bought by US banks because otherwise they will end up with excess reserves not earning any interest.

USA is not Greece. It does not face any threat on it's debt, just like Japan (with a 200% of GDP public debt) does not face any dangers.

[Dave Cohen]

Quantitative easing (QE) defined:

QE is an unconventional monetary policy used by some central banks to stimulate their economy. The central bank creates money which it uses to buy government bonds and other financial assets, in order to increase the money supply and the excess reserves of the banking system; this also raises the prices of the financial assets bought (which lowers their yield).

Technical note: the Fed buys the Treasuries via POMO, since they are forbidden by law to make purchases directly from the Treasury. Thus, the banks buy the T-bills, and sell them to the Fed, which has CREATED MONEY to buy them. This also allows the banks to front-run the Fed on the purchase price.

For all the details, see How Quantitative Easing Really Works by Ed Harrison

http://www.creditwritedowns.com/2011/03/how-quantitative-easing-really-works.html

[Morocco Bama]

You have to love Disaster Capitalism. As the world disintegrates before our very eyes, the Mullahs of High Finance continually trumpet that with calamity, there is growth and opportunity, all one needs to do is change their perspective, and filter out the bevy of disconfirming information. There's a new religion in town....it's called Cognitive Dissonance.

http://finance.yahoo.com/news/Buffett-Keen-on-tsmf-2736972723.html?x=0&sec=topStories&pos=3&asset=&ccode=

*******

Buffet Keen On Japan

Japan continues to be closely watched as the media and individuals around the globe struggle to sort out and gain a better understanding of the immediate and lasting impact of the devastating earthquake and tsunami which struck the nation earlier this month.

At the start of this week, famed investor, Warren Buffett weighed in on the situation. Speaking from South Korea, the Oracle of Omaha offered promising words for the nation's future. Rather than seeing the current disaster as a death knell for the nation, he insisted the subsequent drop in the Japanese stock market offered a great opportunity to gain exposure to the nation's marketplace.

This is not the first time that the head of Berkshire Hathaway has taken on a reassuring tone during tumultuous times. Rather, this is another example of Buffett standing by one of his most memorable quips: "Be fearful when others are greedy, and be greedy when others are fearful." Living by this credo, the investor has been able to profit even in the most dire of times.*******