James West writes:
Is 2009 the year that the United States formally defaults? And with that, will the dollar collapse be rolled back ten FOR one or more?
There are a lot of reasons to support that theory. To Wall Street economists, such an event is heresy and therefore unthinkable. Yet Wall Street is the very La-la-land that bred the idea of a perpetually indebted nation in the first place.
Number one among the indicators favoring this scenario is what is happening in the U.S. Treasuries auction market.
Last Thursday, an $30 billion auction in five-year notes failed to stir the interest of traditional primary dealers. The auction itself was saved by an anonymous “indirect” bid.
Buyers are discouraged by the prospect of what is expected to amount to $2 trillion total issuance for the full year of 2009. The further out the maturities on notes, the more bearish the sentiment towards them. The only way to entice buyers is through the increase in yields.
But with yields at 1.82 per cent, five-year notes were met with a demand for 1.98 times the amount offered - the lowest bid-to-cover ratio since September. A sell-off in treasuries began in earnest upon the conclusion of that auction.
Ok. What is the "U.S. Treasuries auction market"?
Again, thanks to mike762, who said this: "...when the Treasury gets a budget or spending request from Congress,
they hold an auction to sell bonds and bills to finance whatever portion is not covered by current receipts-taxes, tariffs etc.
Investors buy these bonds/bills at a coupon rate (interest rate) that is dependent upon the level of risk associated with these bonds/bills.
When there are not enough buyers at the auction to cover the amounts required,
the Fed or it's proxies buy the bonds/bills.
This is what is meant by monetization, and it is highly inflationary.
Credit is then placed on the books at the Fed for the Treasury to draw on
to turn into checks and cash to pay for the programs in the budget.
It is a circular process that will continue until the currency and the bond market collapses."
Source - "The biggest reasons that T-Bills are so popular is that they are one of the few money market instruments that are affordable to the individual investors. T-bills are usually issued in denominations of $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1 million. Other positives are that T-bills (and all Treasuries) are considered to be the safest investments in the world because the U.S. government backs them. In fact, they are considered risk-free. Furthermore, they are exempt from state and local taxes."
Off on a tangent.
I found this while I was digging. It's just a Yahoo Answers thing, but I want to keep it: Where does the government get money from to keep paying treasury bond interest? One of the answers included this: : "...In order to establish this, we look at the National Debt relative to the GDP(adjusted for Purchasing Power Parity)...."
I don't understand what this part of the answer meant, but it's the first time I've seen "GDP". GDP stands for Gross Domestic Product.
Who are the "traditional primary dealers"?
According to Wikipedia: A primary dealer is a bank or securities broker-dealer that may trade directly with the Federal Reserve System of the United States. They are required to make bids or offers when the Fed conducts open market operations, ..., and to participate actively in U.S. Treasury securities auctions.
The current list of primary dealers:
As of October 1, 2008 according to the Federal Reserve Bank of New York the list includes:
BNP Paribas Securities Corp.
Bank of America Securities LLC
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Dresdner Kleinwort Securities LLC.
Goldman, Sachs & Co.
Greenwich Capital Markets Inc.
HSBC Securities (USA) Inc.
J. P. Morgan Securities Inc.
Merrill Lynch Government Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
UBS Securities LLC.
Three notable changes to the list have occurred in 2008. Countrywide Securities Corporation was removed on July 15 due to its acquisition by Bank of America. Lehman Brothers Inc. was removed on September 22 due to bankruptcy. Bear Stearns & Co. Inc. was removed from the list on October 1 due to its acquisition by J.P. Morgan Chase.
What does "bid-to-cover ratio" mean?
Wikipedia: "Bid-To-Cover Ratio is a ratio used to express the demand for a particular security during offerings and auctions. In general, it is used for shares, bonds, and other securities. It is computed in two ways: the number of bids received divided by the number of bids accepted, or the total amount of the bids is used instead.
The higher the ratio, the higher the demand. A ratio above 2.0 indicates a successful auction comprised of aggressive bids. A low ratio is an indication of a disappointing auction, marked by a wide bid-ask spread.
For example, suppose debt managers are seeking to raise $10 billion in ten-year notes with a 5.125% coupon, and in aggregate the bids are as follows:
$1.00 billion at 5.115%
$2.50 billion at 5.120%
$3.50 billion at 5.125%
$4.50 billion at 5.130%
$3.75 billion at 5.135%
$2.75 billion at 5.140%
$1.50 billion at 5.145%
The total of all bids is $19.5 billion and the number of bids accepted would be $10 billion, therefore leading to a bid-to-cover ratio of 1.95."
Thanks to chuck_tree: "The bid-to-cover ratio shows demand versus supply. That is how many bonds were wanted versus the number of bonds (or notes or bills) that are available."
So what West is really saying is (30 x 1.98) = 59.4 billion was offered for 30 billion in 5yr notes that pay 1.82%.
Mike once more: The higher the demand the lower the rate, the lower the demand the higher the rate. When the Treasury held the auction and didn't have enough demand (bids) to cover the offer, then they had to raise the rate to entice people to purchase. In this case there were no takers, so the Fed bought them at the offer rate, or par. ... It expands the money supply and keeps interest rates artificially low. This helps when servicing the interest on the debt, which is the fourth highest item on the annual budget. ... Investors are looking at our debt level, and the addition of $3T over the last 6 months, and are not willing to buy, because they know they will lose due to devaluation.
What's devaluation again? From Investopedia:
"What Does Devaluation Mean?
A deliberate downward adjustment to a country's official exchange rate relative to other currencies. In a fixed exchange rate regime, only a decision by a country's government (i.e central bank) can alter the official value of the currency. Contrast to "revaluation".
Investopedia explains Devaluation
There are two implications for a currency devaluation. First, devaluation makes a country's exports relatively less expensive for foreigners and second, it makes foreign products relatively more expensive for domestic consumers, discouraging imports. As a result, this may help to reduce a country's trade deficit."
