first majestic silver

A Look at Debt

July 21, 2013

The US national debt is approaching seventeen trillion dollars.  That’s an awful lot of money to have to pay back.  Decades ago, it was widely acknowledged that while America’s debt was huge, it was manageable as US Treasury debt was an economic asset in high demand.  As was once believed back when the letter Q was always followed with the letter U, and never an E, the Federal government could always roll over their debt in the market place as Treasury debt would always be in demand by financial institutions.  But that was many years and trillions of dollars of debt ago.  This assumption of eternal demand for Uncle Sam’s IOUs no matter how irresponsible Washington wastes vast sums of money, is beginning to sound more ridiculous as time passes.

However, this huge sum is dwarfed by the total future liabilities, promises made and pending on the Federal government since the beginning of FDR’s New Deal to past, current and yet unborn generations of Americans.  Here is a bar chart I borrowed from Andy Hoffman of Miles Franklin.  In it, we see the total future liabilities of the Federal Government is 120 trillion dollars, a sum I suspect will prove to be insufficient when needed in the decades to come.  Not that it matters how large this sum is, as the US economy doesn’t have the means to make good on these obligations in real terms of goods and services, even if “the means of production” were “nationalized” by the Democratic Party, a scheme they will no doubt propose sometime in the coming economic crash as to their cure for the intractable problems of big government.

This 120 trillion is the Congressional Budget Office’s (CBO) best guess of how much money will be needed to make good the promises made over the past decades for Social Security, Medicare and who knows what else?  Well, no one spends money like a politician running for office, especially when the money is the public's and the promises made don’t have to be honored in full until the members of Congress, (presidents too) have safely escaped to their graves.  But they don’t see it that way, as they have academics providing cover for their squandering the prospects of future generations for their political necessities of today.

"If current trends continue, the typical U.S. worker will be considerably more productive several decades from now. Thus, one might argue that letting future generations bear the burden of population aging is appropriate, as they will likely be richer than we are, even taking that burden into account.”

- Doctor Bernanke, Federal Reserve Chairman / 04 October 2006

Do you understand this?  Congress and the president don’t have to worry about the national debt and social security as babies not yet issued their social security numbers will do the bidding of long-gone generations.  Doctor Bernanke believes tax payers not yet born will take his advice and work two jobs to make good on promises Washington made long ago.  But I think these babies, when they are finally born and learn to talk, will most likely respond with a “to hell with the old people” and go on strike. 

But what I really want to focus on is who owns the US national debt traded daily in the US Treasury bond market.  Half of it is owned by the global banking system.  And banks today purchased Uncle Sam’s IOUs with inflationary funding (Green Box below).  And the more US Treasury debt they buy, the more money they have to purchase more US Treasury debt.  Global Banks now own 100% of the US national debt as it stood in August 2006, but 50% of the US national debt as it stands today.  This could be a big problem as Doctor Bernanke sees “monetary policy”; central banks are running out of Uncle Sam’s IOUs to monetize for “stimulating” and “stabilizing” their economies.



Every week for many decades, Barron’s faithfully published data the Federal government and Federal Reserve reported to the public.  In their latest issue, we see that the Free Reserves for the American banking system is now at $1.983 trillion dollars.  In the chart above (Blue Box) we see that means that the American banking system has monetized the entire US national debt as it stood in March 1986. Today this is only 11% of the current national debt. 

The American banking system’s current huge holdings in the Treasury debt market is only a recent development, as we see in the chart below.  Since the 2008 mortgage debacle, American banks have become huge buyers of the American national debt, or so I’m assuming.  After all, the money needed to increase these free reserves isn’t coming from savings deposits, but from Doctor Bernanke “injecting liquidity” into the banking system.  As Doctor Bernanke wants lower bond yields, as do the banks themselves, this expansion in the free reserves in the banking system he regulates would do much to keep Uncle Sam’s IOU fully priced, and market yields low.  I’m making a very safe assumption that the US banking system’s Free Reserves is mostly in US Treasury debt.


And the Federal Reserve’s own purchases of US Treasury bonds since the 2008 mortgage debacle (Treasury bonds / Blue Plot below) has increased momentously too.  The astonishing growth in US bank reserves since October 2008 seen in these two charts is an excellent metric to understand exactly how devastating the aftermath of Congress’s mortgage bubble has been on the financial system.  The Federal Reserve’s purpose in all this is to paper over the huge losses its banking system sustained in the housing bust with monetary inflation.  But in doing so, they have created an even larger bubble in the bond market that will one day to go bust.


Today we hear much of the need to “maintain market stability” from the “policy makers.”  But if “stability” can only be purchased by having the American banking system monetizing 31% of the US national debt (and increasing), as we see in the chart above with Lord Keynes Time magazine cover on it, the “stability” the banking system is purchasing is only an illusion.  This voracious monetary consumption of the national debt is a huge development that began with the 2008 mortgage debacle as we see in the table below.  There’s more than just a whiff of desperation in this.


When asked directly during a congressional hearing if the Federal Reserve would monetize U.S. government debt, Doctor Bernanke replied:

"The Federal Reserve will not monetize the debt."

- Doctor Bernanke, Chairman of the Federal Reserve / June 2009

Well, the good doctor lied.  Between the Federal Reserve and the banking system it manages, the portion of the US national debt they have monetized has increased to 31% from 7% in only five years.  But congressional testimony is only a dog & pony show Washington puts on for the benefit of the financial media and the public.  House and Senate public hearings are staged productions with predictable questions and answers that do little to inform anyone not important within the system.  Important communications between the American political establishment and their central bank, where lying by either side is discouraged if not completely eliminated, is over an encrypted phone system or at a table in a local bar far from the public’s ear.  I agree with what Bill Holter said about Doctor Bernanke below.

“So, everyone in the financial industry just "hangs" on every word that comes from this idiot’s mouth.  This guy is the head of and running THE biggest Ponzi/Pyramid/never pay scheme in the history of history, raises his right hand and places his left hand on the bible and outright lies...and everyone just can't wait to hear what he has to say!  Is everyone stupid?”

-Bill Holter, July 2013


Yes they are Bill, and they have been for decades when it comes to these congressional hearings.

However, it’s not just American banks monetizing the US national debt.  Foreign central banks also have significant positions in the T-debt market.  Below I have a chart plotting foreign central bank holdings of US Treasury debt in my Bear’s Eye View format (BEV format Blue Plot / Left Scale) and in dollars (Red Plot / Right Scale).  With the exemption of the 1998 “Asian Contagion”, where the inflationary wind blowing from the Greenspan Fed inflated the Asian “Tiger Economies", stock markets suddenly reversed direction, forcing their central banks to sell their holdings of US Treasury debt to “re-liquefy” their banking systems; these central banks have been big buyers of Uncle Sam’s IOUs, until November 2012.  



Unlike the 1998 “AsianContagion's” 18% reduction, the November 2012’s 11% decline occurred on no news, nor was it noted in the financial media.  But even if this was not “news”, I believe it’s important to realize that these foreign central banks can sell US T-debt as well as buy it.  And resentment of Washington’s spendthrift ways is developing.

“We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”  - Luo Ping, a director-general at the China Banking Regulatory Commission , 11 Feb 2009

So, the theory that US Treasury bonds will always have market demand may not be as plausible as it once was believed.  Let’s face it, at the heart of the QE program is the Federal Reserve’s recognition that if they don’t buy US Treasury debt and abandoned US mortgage, no one else will.  The natural lack of demand for these “financial assets” would cause bond yields and interest rates to rise significantly, thus lighting the fuse to a multi-hundred trillion dollar powder keg of OTC derivatives in the heart of Wall Street.  The financial system’s abuses of former good banking practices since August 1971 (when gold was booted out of the monetary system) have been so huge, that today should any honesty be applied to the banking system as it now stands, would prove to be fatal to it.

I’d love to know what was said over the phone at the Federal Reserve when they first learned this November 2012 decline was going to happen.  You can be sure of two things this 11% decline resulted in:

  • Key members in the House and Senate as well as the President were notified shortly after the Fed learnt it was going to happen.
  • No member of Congress will ever ask the Fed Chairman about this on live televised congressional testimony because they already know.

Detroit, Michigan has declared bankruptcy.  Zerohedge reports this will most likely mean a 90% cut in pension benefits for retired Detroit employees and an over 70% cut in principal to holders of Detroit muni bonds.  Ouch!  I’m not surprised as Detroit is a city that has been dominated by the Democratic Party and labor unions since before World War Two, and now the muni bond market is finally getting this news?  How much sympathy can we have for anyone who invested in Detroit’s muni bonds?  Maybe a little bit more than for someone who is investing in US Treasury bonds.

The Detroit muni bond default will be the largest since the Great Depression, maybe in muni-bond history.  Many local governments had problems paying their bills during the great depression, resulting in delayed payments to bond holders.  However in time, most local government from that depressing era made good on their commitment to their bond holders, but I don’t think that will happen here in the 21st century.  President Obama’s treatment of General Motors and Chrysler’s corporate bond holders is a third-world lesson in money management Democratic office holders will take to heart.  Tell the bond holders to; “sit down and shut up you greedy bastards, you’ll take what we give you or you will get nothing!”  Obama learnt this technique at Harvard Law School.  Funny; the politicians were so nice to their creditors when they took their money.

No one should be surprised by any of this.  Since November 2010 the tax-free yield on good grade muni bonds have been above the taxable-yield on Barron’s Best Grade Corporate bonds.  As we see below, nothing similar to this has happened since 1937.  What does this mean?  That not everyone is stupid!  

You don’t need to be a Wall Street insider to know that government at all levels in the United States is ethically challenged.  Their understanding of contract law is much like Fidel Castro’s.  There are exceptions to that, but not many.  Also, after decades of artificial and imprudent low interest rates and rivers of “liquidity” flowing from the Federal Reserve, there are many cities and local counties whose financial situation is as bad or worse than many of their property tax payers who also took advantage of low interest rates in the mortgage market not all that many years ago. 

We should expect many more major defaults in the muni-bond market before we get out of this inflationary mess, and the same will prove to be true for many good grade corporate bonds too.  But where do people go to for safe income?  Well, you can forget about that.  The very dollars used to measure income are at risk when Washington’s political establishment selects people like Alan Greenspan and Doctor Bernanke to manage the money supply.  Bernanke says the damnest things on TV.

"Gold is an unusual asset. It's an asset that people hold as a sort of disaster insurance.  --- Nobody really understands gold prices and I don't pretend to understand them either."

- Doctor Ben Bernanke testifying before the US Senate Banking Committee; July 2013

Doctor Bernanke fears gold like Dracula fears garlic because he fully understands that rising gold prices are a vote of no confidence by the market in his monetary malfeasance.  As the US dollar is now only backed by the full faith and credit of the United States government, he must be very concerned anytime prices in gold and silver are rising.

And as far as him not understanding gold prices; what he doesn’t understand is that since October of last year, after whacking the price of gold by $500, why is global demand for gold draining Western central bank gold reserves?  He thought this price decline would have forced Asia to sell back their gold at a loss to

Wall Street, allowing the big NY banks to return the gold they leased from Fort Knox and Germany.  

Let’s take a quick look at Barron’s Confidence Index (CI).  The CI is the credit spread between Barron’s best and intermediate grade corporate bond yields, or the gap seen between the plots in the chart below.  Look at the yield spike in the lower quality intermediate grade bonds during the 2008 credit crisis.  These are not junk bonds.  Still from November 2007 to November of 2008 their yields spiked from below 8% to above 15%.  Lower grade investment bonds are not supposed to do that.  Since 1934, the only credit event similar to this was seen during the late 1930s in the Great Depression.  But eight decades ago it took ten years before the yields in Barron’s intermediate grade bond average to return to normal.  This was not the case at all for the credit crisis, where the yield for Barron’s intermediate grade bonds came down as fast as they went up.


This rushing back into a disastrous market situation just isn’t a natural market reaction for bond holders after seeing their capital cut in half in a financial panic.  The Dow Jones saw a 53% credit crisis decline, something similar to the losses in Barron’s intermediate grade bonds, but didn’t return to its November 2007’s price levels until March 2013.  But Barron’s intermediate grade bond prices returned to their November 2007’s levels in March 2010, three years before the Dow Jones.  Something is not right here. The most likely explanation to this collapse in bond yield is that the Federal Reserve was active in the corporate bond market to restore confidence and market “stability.”

Next is the chart for Barron’s Confidence Index itself.  The CI * is not * a technical tool for timing the bond market.  Anyone who used it for that would have lost big money from World War Two to 1982.  I dare anyone to make any kind of connection between the rising CI below and the bond bear market very much in evidence above from 1946 to 1982, ditto for the down trending CI from 1999 to 2012, which occurred during a bond-bull market.

So what good is the CI?  Well the CI provides us with the bond market’s best guess of how likely lower grade bond issuers will be able to pay back the money they owe to their bond holders with interest.  Whether or not their bond holders will make or lose money in the bond market is something the CI doesn’t measure.  So, the bond market’s expectation of future business conditions is the only thing CI tells us.  And right now, as was the case in the late 1930s, Barron’s CI is now telling anyone who listens that the bond market is anticipating future bankruptcies for companies whose financial situations are not best grade.  If the CI is correct, it’s expecting rising unemployment, contractions in government tax revenues and lower financial asset valuations as corporate American is forced to lower its debt levels via bankruptcy, as was the case during the Great Depression.

It’s a real mess bankers, politicians and academics have placed the world in.  Everyone is going to be hurt by what is coming because part of the process of a massive bear market is to force everyone to understand that something is terribly wrong.  Like a broken leg, a big bear market won’t let you move on until you actually fix what is wrong.  Do you want to know what the real problem is in the markets and economy?  Everyone forgot that honesty, fair dealing and keeping your word in contract agreements is the best policy government, business and the average citizen can have.  This will be a very hard lesson for a corrupt world such as ours to relearn.  


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