Wednesday, April 20, 2016

The Citi-Fed-Barry-Arab-China Cycle Begins

Say that I am shamelessly speculating. Fine! Yet, like passers by who can't help but to stare at a car crash, let's take a look. 
Janet Yellen
On Monday April 11, The Federal Reserve called for an unusual meeting. Both President and Vice President of the United States were requested; thus increasing the odd nature of the meeting. After said meeting, all we heard was cheers for a job well done. Obama couldn't stop the accolade shower over Fed Chairman Yellen's job on the economy. So, aside from the love fest, what was all the fuzz? Why a meeting with so many important people?
Then, more internal Fed meetings took place. Again, it is unusual to have so many top level meetings during such a short time. Even the Europeans' central bank participated. It all had the feeling of a war game session.
King Salman
And now, the President traveled to visit his least favorite king. "Obama will meet King Salman and will attend a summit on Thursday with leaders of six Gulf Cooperation Council (GCC) countries, at which he will be joined by US Defense Secretary Ashton Carter and Secretary of State John Kerry." wrote Aljazeera, who described the meeting as a "potentially tense visit". Could Barry's visit to Saudi Arabia have anything to do with the Fed's meeting? If so, what's the connection?
Despite the unusual nature of a Presidential visit of the Fed, we are still left without any sense of direction over what could be happening.
We know that this is an election year and that any economic issues would most certainly affect the results coming November. Still, not much to go on other than the fact that things are probably serious enough. But what could be so serious as to demand the President's involvement?
Well, how about things being in such dire straits that Barry, our fearless leader, has to make an unpleasant house call. We know he hates to share smiles with those he dislikes, which is pretty much anyone who wouldn't vote in favor of his Nobel Prize.We also know that the Saudi royal family has previously skipped a meeting with our President as a sign of their discontent with his footsie sessions with the Iranians.
Michael Corbat
So let's try to see what could be at the core of this soap opera.
What if the Saudi's sent an important message to say Citi's CEO. We all can remember that the Saudi's bought large positions in the bank and that they were responsible for its rescue during the 2008 liquidity crisis. Surely Mr. Corbat, Citigroup's CEO, would have an open door policy for such important stakeholders. Then, as a 'too big to fail' institution, any message from Citi would find no resistance on its way to Fed Chairman Janet Yellen's desk.
And what exactly could the message be? Well, how about one that would make Citi, the Fed and Obama jump off their seats. How about a suggestion that perhaps the Saudi's will dump their fat collection of US bonds? Can you imagine? What would you do if your credit card company calls and says that they are ending your loans. What if your loans are so big that finding willing lenders may be  near to impossible?
Xi Jinping
Then let's throw in another interested party. What if the Arabs, who are selling lots of oil to China, commented in passing to Xi Jinping that the country's extensive national reserves will probably shrink in value over night? If the Saudi's sell even a portion of their US bonds, sellers will probably pile on trying to make a move before the Chinese do. The profits for any fast moving trader awake at just the right night could be in the billions of dollars. The losses for those caught sleeping could be disastrous. Threatened by a sell off of their reserves,. the Chinese would probably join the selling frenzy hoping that many bottom feeders show up to the carnage. It could all turn nasty very quickly.
To clarify, if large lots of US bonds suddenly come onto the market for sale, it would be a very bad thing for all of us Americans. The Treasury would have to print large amounts of money in a swift and uber-inflationary move. The Federal Reserve would then take the newly printed money and would have to use it to lend money back to the institution that just printed it. Crazy!
Barry Obama
Buying US bonds in this way would certainly start a vicious cycle. After the selloff begins, existing bonds would lose value every minute of the day. As the Fed buys a bunch of bonds, their money will literally evaporate faster than premium spirits after a truck full of Dom Perignon bottles with their corks popped sits idle right in the middle of a summer day. The faster they lose value, the lower the chance that others will jump in to buy them, thus leaving the Fed as the only loser. As the Fed's balance sheet collapses, the need for their participation as buyers of last resort will only increase. Meanwhile, the Treasury will face having to pay much higher interests for any new bonds issued. To prevent hurting the Fed, the treasury may have to call back the bonds sold by the Arabs and China in an attempt to try to reissue them at a higher interest rate to potential market buyers. Unfortunately, these sort of events may push interest rates to unreasonable levels over just a couple of days.
And what do you think could happen if Barry gets an interest bill much higher than he has been accustomed to? Well, Barry will probably have to announce that we are broke. That we can't spend on the kinds of goodies he likes to dish out. Things like food stamps may become a luxury.
And if this was not enough, most of the 'too large to fail' institutions like Citi will also fail. You see, the Fed has been forcing bank owners and savers to carry the risk of an out-sized investment in US bonds. In essence, the government used their mighty power to force its citizens to lend it money. So when the Arabs and Chinese stop lending to our government, we are all sure to lose our shirts and our beloved food stamps.
Christine Lagarde
Now that there may be an alternative to all this mayhem. Christine Lagarde of International Monetary Fund fame may come to the rescue. By deploying trillions of dollars in SDR's they may create the illusion of bond buyers. This may explain why she participated in the Fed talks. But don't be mislead, the IMF's SDR's are no more than paper funds. The reason why they may be useful in our situation is because there is no real balance sheet to worry about. Since there are no assets backing this funny money nor any ability to collect taxes from anyone, they are a dream come true for lovers of fake accounting. The problem will then be that we would be in essence exporting inflation at a massive level. We would therefore finally see all commodities spike in price after the US economic borders are bridged. No more internal deflationary pressures as the dominant force over our economy.
The SDR vs. the Dollar
In any case, inflation is just as vicious on people as a balance sheet collapse. These are both ways to force pain on citizens.
But wait a minute. All these thoughts are sure to be no more than fear-mongering on my side, right? Well, perhaps.
But even if I am wrong, it is still worth considering how close we are to a scenario similar to my fictitious narrative. Our debt is out of control. Our international presence has also deteriorated at the exact time we need our former partners to hang on. Our future is at stake like never before. Moreover, the pain during the process may be unbearable. The question is not whether this will happen but when. Let's hope I am wrong on timing and that we will have a second chance to correct our spending addiction.

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