Karl Denniger: Hurricane Warning

[concrete]

Aiki, if you get a moment I'd be interested in your perception of this guy's argument. His style is a tad overwrought, and his politics don't agree with mine (or yours, I don't think). But I'm unable to dismiss his points, what do you think? It's a little bit scary.

http://market-ticker.org/archives/622-Fiscal-Cat-5-Hurricane-Warning.html

"As each new facility is rolled out by Ben and Hank, a new area of debt becomes backstopped by the government in some fashion, thereby forcing money out of other instruments and causing those instruments to become distressed!

We are rapidly reaching the point where only The Fed and Treasury are providing any lending at all."

[Gordo]

Quote from Karl Dennigers article:

"His production of money in exchange for Treasuries is nothing more than a sham sterilization action. He thinks this will go unnoticed by the markets, because he's swapping a dollar for an "illiquid" asset.

The problem is that this is only monetarily neutral if the asset is actually worth a dollar. If it is in fact worth 50 cents then he printed the other 50 cents, and devalued every other dollar in the world by the same amount."

This is very true and why I am pessimistic toward the market.

As far as Dennigers other points, I saw some that I agreed with and others that I am not educated enough to make a judgement.

[aiki14]

Aiki, if you get a moment I'd be interested in your perception of this guy's argument. His style is a tad overwrought, and his politics don't agree with mine (or yours, I don't think). But I'm unable to dismiss his points, what do you think? It's a little bit scary.

http://market-ticker.org/archives/622-Fiscal-Cat-5-Hurricane-Warning.html

"As each new facility is rolled out by Ben and Hank, a new area of debt becomes backstopped by the government in some fashion, thereby forcing money out of other instruments and causing those instruments to become distressed!

We are rapidly reaching the point where only The Fed and Treasury are providing any lending at all."

Fascinating stuff, gonna need a few hours to digest it and see where I agree and disagree. I will post my feelings after the Giants beat the Steelers this afternoon.

[aiki14]

Ok, I have had a little time to get an opinion formed.
I have posted on this forum I believe the Fed and Treasury to have acted in an incompetent manner over the last 18 months or more and that the ratings agencies have behaved in a manner that is inappropriate and that I now believe was criminal. In that sense I agree with Mr. Denninger.
I do not believe we are going to see a major move downward from this point so I am not in agreement there, nor do I care much for the implication that Mr. Buffett was in some way not honest in saying he was buying. I was buying when we saw the DJIA at 8000 and do not find this odd on Mr. Buffetts behalf.
When Mr. Denninger implies a political agenda it puts into question his objectivity.
The US government owns more foreign debt than US debt is owned by foreigners, if they sell the foreign debt they own they could fund the domestic debt for a considerable time. There are reasons this will not be done both political and monetary, but I mention it to point out the ability of the Treasury to raise money without devaluing the currency. Also the majority of money in circulation is held by foreign entities and if the currency is devalued it would have a net positive effect in isolation due to this imbalance.
I am not sure what Mr. Denninger is implying with his reference to a "crazy tail only a few months into this". What are we a few months into? Which debt is being taken down? And what does he mean by the term "goose"?


Another thing I see that strikes me as odd is the assertion that the 13 week T-Bill yield has risen due to "issue a lot of short-term supply". The Treasury offers auctions of the 13 week T-Bill every week and publishes the results in Public Debt News. On 20 Oct they offered $60 billion and only $25 billion were accepted, the previous week $86 Billion were offered and $25 Billion were accepted. Looking back through historical data I could not find evidence that the Treasury was issuing more than a typical amount of these securities. If the increased yield on the Bill is due to trading on the secondary market it would imply a lower price and therefore a lower demand not a larger supply, which contradicts the assertion made by Denninger. If the yield on short term treasuries is rising the flight to quality is decreasing and the interbank or commercial paper market should be the beneficiary of that money path, and would be evidence of the credit market normalizing (albeit early evidence the worth of which will require analysis).

I also did not see any significant change in the issuing of securities at the various ends of the curve. The issues at both ends are not anomalously out of the typical range for issues of their type over the past 25 years. I do not see a flight into 10's, either in acceptance of issue, or in a sharp rise in the price of 10's not also seen in Bills or 30's in the secondary market.
Mr Denninger says the Treasury has only two options but there is a third, which is to issue in both ends of the curve in historically normal levels. If we are to allow for this it would prevent the two scenarios Mr. Denninger asserts from either flooding the short or long end.

Mr. Denninger says Mr. Bernanke "may be technically correct but is lying through his teeth". Statements like this are inflammatory but devoid of substance, and they make the author look more like a person with an agenda than a logical point. Mr. Bernanke has no real fan in me but I do believe he is an honorable man who has made errors in judgement. To pronounce him a liar is bombastic but otherwise unwarranted nor supported by evidence.

Mr Denninger speaks of a "sham sterilization action". I have no idea what this means and he offers no real explanation.

"Swapping a dollar for an illiquid asset"
Mr. Denninger denigrates this, but that's what we do do one degree or another every time we invest in anything that isn't cash. We are placing some degree of faith in future value of the asset. I don't see any necessity in what Mr. Denninger refers to as "monetarily neutral" assets. His statement that if the asset is worth 50 cents he is "printing the other 50 cents" is meaningless because that is not what he is doing unless the asset never changes value and is then traded. And even if we accept his premise it does not devalue every other dollar by an equal value but by the percentage the amount lost represents of all the money in circulation.
I am also of the belief that there is a significant chance the assets will increase in value downstream. As Mr. Denninger asserts an asset is only worth what a buyer will pay, but that is a static view, and the market is dynamic. He points out that the assets are not worth their face value, but it is a rescue effort and that fact must be assumed or there would be no need for rescue. The premise is that the value will recover, or the gov't will eat the losses to prevent a total meltdown of the system.

I agree with Mr. Deninger that the FED and Treasury produced a dislocation by favoring some debt over another, and the consequences he lays out are self evident. We are not rapidly reaching a point where the FED and Treasury are the only lenders, we are there already.
I do not see the connection he then makes by saying the discipline has been removed, since nobody is borrowing in any serious amounts other than to protect assets. If folks were borrowing from the FED and lending with abandon or buying equity in reckless ways then I would agree but I don't see that happening.
Then Denninger makes the statement that Bernanke and Paulson are "'going to produce the bond market dislocation that I have been warning about". I always see a red flag with statements like that because it points to the possibility that the whole argument he makes is self serving. When authors use terms like "there is exactly one way to stop this idiocy" and then it's his way, I cringe.

I won't go any further on a point to point basis as it would be overlong. I will just say that Mr. Denninger makes statements that are overly bombastic, not backed up by evidence to the degree I find necessary when making such absolute statements, potentially motivated by politics, and potentially motivated by other self interest. I also find his conclusions, even in the cases I agree with them to be unjustified by the evidence he presents.

In his defense, the page I am critiquing is like the 500th in a long series where it is possible Mr. Denninger has already presented evidence for his statements and conclusions. I do not have the time or frankly the inclination to read the last years material he has posted. My admittedly cursory examination of the material indicates a lot of the same sort of stuff, and I am not impressed enough to dedicate my limited resources of time to his posts.

I hope this is of some value.

[concrete]

Good lord! I'm gonna read your post a few times over, seriously. Right off the bat, though, I want to agree that Mr Denninger's remarks about Warren Buffett are indeed silly, as are his observations about the presidential contenders.

Brings to mind, though, we have 500 billionaires in this country, you'd think that a few of them might step up to the plate in one way or another, as Mr Buffett has done. Instead, they're all cowering in the Hamptons or somewhere. Far be it from them to try and help out when this society is in trouble. This society which has enriched them beyond all measure.

[concrete]

Addendum: Can you point me to an authoritative source/analysis supporting this statement: "The US government owns more foreign debt than US debt is owned by foreigners, if they sell the foreign debt they own they could fund the domestic debt for a considerable time. There are reasons this will not be done both political and monetary, but I mention it to point out the ability of the Treasury to raise money without devaluing the currency."

[aiki14]

Addendum: Can you point me to an authoritative source/analysis supporting this statement: "The US government owns more foreign debt than US debt is owned by foreigners, if they sell the foreign debt they own they could fund the domestic debt for a considerable time. There are reasons this will not be done both political and monetary, but I mention it to point out the ability of the Treasury to raise money without devaluing the currency."

Here is the table of foreign holders of our debt from the treasury website
http://www.ustreas.gov/tic/mfh.txt
Total is around 2.7 trillion as Mr. Denninger put it

Here's a list of our assets note line A(1)(a)
http://www.treas.gov/press/releases/200810211726172051.htm
Total in Euro and Yen denominated securities 21.6 trillion

Note also the 11 trillion in gold we have which is valued at $42.2/troy oz or more than 20 times undervalued.

[concrete]

Here is the table of foreign holders of our debt from the treasury website
http://www.ustreas.gov/tic/mfh.txt
Total is around 2.7 trillion as Mr. Denninger put it

Here's a list of our assets note line A(1)(a)
http://www.treas.gov/press/releases/200810211726172051.htm
Total in Euro and Yen denominated securities 21.6 trillion

Note also the 11 trillion in gold we have which is valued at $42.2/troy oz or more than 20 times undervalued.


Now that's an interesting twist on the discussion as to whether or not it was a good thing that we got off the gold standard in the valuation of our currency. Thanks, Aiki!

P.S. Am I missing something? 21,619 million is 21 billion, not 21 trillion.

[John Law]

I read the Market Ticker often, but lately he is even more over-the-top than usual. I hate it when these smart guys get too wrapped up in their internet voice, it gives bloggers a bad name.

I appreciate the work aiki, but I have to disagree with one of your assertions that seems fundamental to your post. I don't believe that we have anywhere near the foreign currency that others, notably China and japan, have in dollars. Not only did you miss a couple of zeros in your post, but the existence of trillions in foreign currency reserves renders a lot of things we know to be true completely meaningless. If we had 12 Trillion in yen reserves, does anyone honestly believe that the Treasury would allow the carry trade to unwind as it has? There wouldn't have been a carry trade with the yen in the first place if that were true. It makes no sense. Japan has no need to sell securities on that level, they have a sovereign wealth fund...that is their advantage over us.

Also, I disagree about Buffett. He is an insurance man with very large stock holdings, and it is in his best interest to influence people to keep buying. The deals that he made were primarily for preferred shares with a large coupon, and I am willing to bet that he hasn't exercised any of the common stock warrants that were part of the Goldman and GE deals (I would love to be corrected on this). it looks to me like he is getting a 10% coupon in exchange for lending his name out. A pretty good deal for both sides, but bad for anyone who 'followed' his trade (as if anyone else could with those favorable terms).

Until someone comes up with some serious evidence to the contrary, I see a mass of Alt-A's being reset, and a whole lot of underwater Americans (including 48% of Nevadans apparently)continuing to feed into this deflation of the largest asset class in the world: American Real Estate. The only way out of this is massive inflation, and I am not as comfortable with that as you appear to be.

[aiki14]

I saw the 2 order of magnitude mistake there, sorry about that. However I got the comparison from treasuries website where they list the amount of debt securities they have issued believed to be held by foreigners to the debt securities of other nations treasury holds. Remember since world war 2 we have been the major lender to every country in the world, both Germany and Japan still have long term debt that is being paid from that era.

[concrete]

I saw the 2 order of magnitude mistake there, sorry about that. However I got the comparison from treasuries website where they list the amount of debt securities they have issued believed to be held by foreigners to the debt securities of other nations treasury holds. Remember since world war 2 we have been the major lender to every country in the world, both Germany and Japan still have long term debt that is being paid from that era.

Wars are expensive!
I wonder when the shock and awe people will finally realize this.