Give Treasury-Bond Holders a Haircut

Donald Trump says a lot of whacko things and his recent wild pitches about defaulting on the national debt and replacing Yellen because she is not a Republican sound as if they were coming right out of his wild man wheelhouse. Certainly these statements have gotten mainstream financial journalists and editorial writers in high dudgeon.

Said the NYT editorial page about Trump’s observation that if things got bad enough he’d seek to negotiate “discounts” on Uncle Sam’s towering debt,

Such remarks by a major presidential candidate have no modern precedent. The United States government is able to borrow money at very low interest rates because Treasury securities are regarded as a safe investment, and any cracks in investor confidence have a long history of costing American taxpayers a lot of money.

Well, now. These “very low rates” could not have anything to do with the fact that the Fed has vacuumed up $3.5 trillion of Treasury debt and its close substitute in GSE securities since September 2008. Apparently, the law of supply and demand has been suspended until further notice—-except for the fact that when Bernanke even hinted that the Fed might sell down some of its grossly bloated balance sheet in April 2013 treasury yields erupted higher in the infamous taper tantrum.

The fact is ultra low rates on Uncle Sam’s mountainous debt have everything to do with central bank manipulation of interest rates. There has been a central bank Big Fat Thumb on the scales for nearly two decades, and it now includes the $1.7 trillion of treasury debt owned by the People’s Bank of China (including its off-shore accounts), the $1.2 trillion owned by the BOJ and the nearly $7 trillion owned by central banks and their affiliates as a whole.

That’s right. The world’s central banks own more than 50% of the publicly traded US debt of $13.5 trillion, and not one single penny of it was purchased with real savings or anything which remotely resembles honest money. It was all scooped up when central banks hit the “buy” key on their digital printing presses.

In short, the “very low yield” on US Treasury debt is the product of a giant monetary fraud, not a testament to the strength and safety of Washington’s credit. And it most certainly has nothing whatsoever to do with investor “confidence” in Washington’s integrity.

Just the opposite. The Wall Street traders are all in on the scam. The marginal bond price is “discovered”, in fact, when fast money traders buy the stuff on 95% repo leverage while front-running the central banks.

So Donald Trump’s wild pitch in this instance can’t hold a candle to the truly scandalous arrangement under which Uncle Sam’s debt is actually priced. Even the treasury debt in commercial bank vaults is mainly there because regulatory authorities permit the fiction that it is risk-free and therefore require zero capital backing.

Still, that didn’t stop the Washington Post from harrumphing even more self-righteously than the NYT. By its lights, Trump’s purported cave man views threaten financial civilization itself:

If these phrases mean anything, they contemplate at least partial repudiation of the U.S. government’s obligations, sacrosanct since the time of the founding. The “full faith and credit” of the United States, established over centuries and embodied in its debt, is the glue that holds global finances together. The minute the United States tried to reduce its debt load by offering creditors less than 100 percent of principal and interest — i.e., by “discount,” or “making a deal,” like Argentina or Greece — every institution that had taken this country at its word would be instantly destabilized.What the Post was all lathered up about is the official policy

Here’s the thing. What the Post was all lathered up about is the official policy of the United States—–and one that is actually pursued with a punctilious vengeance. According to Janet Yellen and her entire posse of camp followers in the Eccles Building and on Wall Street, the Fed must move heaven and earth to boost the inflation rate to 2% annually.

Not only that, it must use the shortest measuring stick possible (the PCE deflator less food and energy) to track its progress and keep the printing presses running white hot to ensure it stays there. That is, it must deliver 2% inflation at all hazards, world without end.

Then again, isn’t that the very skunk in the woodpile? After all, under a scenario of 2% inflation year-in-and-year-out, a 30-year US treasury bond will be worth exactly 54.5 cents on the dollar at maturity. The Donald could only imagine a discount off that depth.

Yes, the savvy insiders argue its 2% uber alles. That is, everything goes along for the inflationary ride—–prices, wages, profits, rents, indexed social benefits and the works. Except it doesn’t work that way in the slightest. Just like the Donald says, debtors get relieved and savers get creamed.

The deliberate national policy of 2% inflation is the most capricious form of economic injustice imaginable. Not even its perpetrators have a clue as to the utterly random incidence by which it impacts economic agents over time and the resulting windfall gains and losses in wealth which flow therefrom.

And that’s not the half of it. The Fed’s deliberate 2% inflation policy not only results in the arbitrary seizure of deep discounts on the public debt by the government, but also an immense dissipation of economic resources by the private sector. That is, all kinds of racketeers are enabled to make a handsome living peddling information and services which would never be needed under a regime of sound money.

Economists who work the “fed watch” beat are a prime example. If the Fed had stuck to the original passive rediscounting mission conferred on it by Carter Glass in 1913, there would be no open market operations and the Fed would not be stuffing its balance sheet with trillions of public debt, thereby drastically falsifying its price.

And that means that racketeers like the so-called economist quoted below would be as rare as white buffaloes. Lou Crandall thus declaimed in tones of righteous disdain:

“No one on the other side would pick up the phone if the secretary of the U.S. Treasury tried to make that call,” said Lou Crandall, chief economist at Wrightson ICAP. “Why should they? They have a contract” requiring payment in full.

Right!

The do have a contract—-and it’s to have 45% of their investment seized every 30 years by the central bank. And they even get to pay court jesters like Crandall to watch the central bank’s machinations as their wealth steadily erodes.

This is why Trump’s politically incorrect bluster is such a refreshing tonic. It exposes the entire tissue of fraud, corruption and willful deceit that underlies the Washington/Wall Street status quo.

None of his loudly remonstrating bettors, for example, even bothered to mention the context in which he mentioned the possibility of default in the form of negotiated discounts on the public debt. Namely, what happens, the GOP nominee inquired, if interest rates rise by “2, 3 or 4%”?

That is a perfectly valid question and one that is studiously avoided by the Keynesian Cool-Aid drinkers who pass for economists and fiscal experts. The truth is, interest rates must return to something like our current 2.3% core CPI inflation plus a 2% margin for risk, return and taxes or the entire monetary system will someday blow sky high.

Yet ten years from now the public debt will be $33 trillion at minimum—-unless you really believe that the central banks have abolished the business cycle and that the word “recession” will disappear from the face of the earth.

But then again, an average 4.5% carry cost on the prospective Federal debt would amount to $1.5 trillion annually or 6X the $253 billion the CBO currently projects for net interest in 2016.

Can you say with the Donald, “debt discount”?

In fact, perhaps it ought to be pointed out that the scam built into the phony $253 billion net interest figure built into the Federal budget accounts for this year leaves Trump’s alleged voodoo economics far behind. To wit, in the most recent year, the Fed earned upwards of $120 billion from its $4.5 trillion trove of Treasury and GSE debt but paid virtually nothing for its $4.5 trillion of liabilities because, alas, they were conjured from thin air.

So after paying the banks their IOER (interest on excess reserves) bribe of about $12 billion and the salaries of several thousand economists and other apparatchiks of dubious value, it remitted its “profit” of more than $100 billion to the US Treasury as an offset to its interest expense.

Now, that’s voodoo economics, if there every was such a thing.

Indeed, the Capitol Hill guardians of fiscal virtue being implicitly heralded by the Trump bashers, have discovered that the Fed’s phony baloney profits are the gift that never stops giving.

After a two-year stalemate on the matter of the bankrupt highway trust fund, for example, these practitioners of “fiscal responsibility” dipped into allegedly excess system “profits” at the Fed to cover the gap.That is, these phantom revenues were pumped into the highway trust fund because these incompetent cowards could not see fit to cut out the massive waste which goes into mass transit, bicycle paths and the repaving of little-used state roads, on the one hand, or raises the gasoline tax, which hasn’t been adjusted for inflation since 1993, on the other.

So “confidence” is being threatened because Donald Trump has told the truth that the Federal debt is on a track toward unmanageability and default while Washington plays games like this?

Moreover, the highway trust fund caper was only small beans. During the last several years, the reported Federal deficit has been reduced by upwards of $250 billion owing to another scheme of phony “profits” repatriation. Namely, Fannie Mae and Freddie Mac have generated giant profits under an accounting scheme that is a complete circular fraud.

These GSEs are effectively “renting” Uncle Sam’s credit rating in order to be in the mortgage guarantee and warehousing business without paying any meaningful rent for the long-term risks they are incurring. Stated differently, Washington is parking the risks off budget and booking the profits in its current accounts.

And that gets us to the real screeching about the sacred independence of the Fed elicited by Trump’s welcome statement that he wouldn’t reappoint Yellen. Whether that is because she is not a Republican or because she is utterly incompetent as an economist doesn’t matter. The notion that the Fed is not part and parcel of the state and its massive intrusion in private capitalism is a just plain bad joke.

Yes, Uncle Sam’s credit standing is in deep trouble and the Fed is heading for a monetary calamity.

But these untoward prospects have nothing to do with a couple of wild pitches from Donald Trump. Upon closer examination, it is evident that they were right on the money.

Reprinted with permission from David Stockman’s Contra Corner.

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