Dollar devaluation and debt monetization is the only out for the US Treasury

The Fed’s economic numbers for the US are the worst in US history. They certainly do not support the representation that the US economy is in recovery. What they show me is that “Economic stimulus” for the US taxpayer and economy has been the most costly economic policy failure in US history. For the supporting Federal Reserve data and charts see The harsh reality of “economic stimulus” using Fed data & charts

The very big hole in the theory that rates can’t rise is there is no one to replace the Federal Reserve and buy 30-100 billion per month of US Treasuries at non competitive rates to fund US deficit spending.

Click here for the current Fed chart and all supporting historical data

Here’s how I believe it’s going to go down

Over the last 7 years of “emergency and temporary rate cuts” the Fed has enabled the US Treasury to suck desperate depositors looking for any interest income at all into the long end of the curve. Currently the average duration for US debt is a little over 10 years with an average yield of 2.37% or the debt service cost for the US on the current 18.1 trillion in debt is fixed at 430 billion per year through 2026, source Treasury direct

Click here for current debt service cost

Had the US Treasury not refinanced their debt and fixed it for 10+ years at 2.37% each 1.00% increase in rates would consume 10% of total tax receipts (181 billion per 1.00%). Considering the US national debt during “economic stimulus” has risen 93% while tax receipts were up only 28%, this would be more than problematic for the US Treasury,

Click here for a current Fed chart and all supporting historical data

Now that the current 18.1 trillion in debt has been locked in at 2.37% through 2026 the Fed can raise rates without the US Treasury worrying about their debt service cost rising and consuming the majority of tax receipts if rates “normalize”.

The Fed can start slowly raising rates going into the US November 2016 election in the name of “economic recovery”

All debt instruments, stocks with high debt loads, precious metals and energy will feel the pressure and potentially move lower in the short term. 

What will accelerate the move lower prior to recovery and new highs

Currently there is 6 trillion of US Treasury debt owned by non US Investors. Currency and instrument risk for these Non US investors is more in one day than annual yields. Non US investors also hold trillions more in non US Treasury debt with these instruments having the same or greater risk.

For Non US investors there is very limited upside potential with debt instrument prices coming off all time highs and the dollar a 10 year high. 

Click here for the chart and all supporting historical data

No alternative to the USD? Think again, there are currently 12 countries that have higher credit ratings than the US the majority of these countries have the same or higher rates with greater currency appreciation potential.

Click here for the supporting data

As the major long term trends for these instruments and the USD move from up to down I believe non US investors  will start aggressively selling these instruments and USD accelerating the downward move caused by the increase in rates.

Currently I can’t see anyone capable of stepping in front of this multi trillion dollar selloff aside from the Fed. For non investors like me we’ll not only liquidate our longs but create net new shorts to capture the move lower. No liquidity for us? Think again the US 3 month rate contract traded at the Chicago Mercantile by itself trades a face value of trades over 2 trillion dollars per day, open interest for futures and options exceeds 20 trillion, there are an additional 40 interest rate futures contracts that trade trillions more

Trillions more traded daily in the forex market making the exodus from the USD painless.

In the short term the move to the downside could get ugly this is why I’ve recommend using “collars” to define risk on all trades and for the duration of all trading periods.

If the “correction” that I’m anticipating occurs the Fed will have the justification I believe they are looking for to fire up the QE printing press with tenacity creating trillions more USD with keypunch entries backed by no tangible assets or income flow to “defend” the dollar and protect the “integrity” of the US financial system.

With trillions more dollars chasing after the same amount of goods and services US inflation will engage.

When the prices of goods and services rise so do tax receipts. The chart below shows  the 50 year correlation between M1 (money supply) and tax receipts

Click here for the current Fed chart and all supporting historical data

Let’s assume between now and the end of 2020 the Fed increases M1 by several trillion more through “quantitative easing” cutting the buying power of the USD in half, the prices of goods and services could double and tax receipts will double as well moving from the current 1.8 trillion to 3.6 trillion.

Problem solved

Debt service cost has been fixed at 2.37% through 2026 at 430 billion annually.

The US treasury through inflation has increased tax receipts from 1.8 trillion to 3.6 trillion giving the US Treasury twice the tax receipts to service the same 430 billion in annual fixed debt service cost on the current 18.1 trillion in debt.

I believe the Fed’s plan is the only out for the US, if the US can control it’s spending and keep deficits contained moving forward it just work.

It’s called monetization and it’s been around since the first “fiat” currency was introduced by China in 1,000 AD.

21 November 2002 speech “Deflation: Making Sure It Doesn’t Happen Here” will provide you more information on monetization. 

Bernanke quote in this speech

“U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation”.

During “economic stimulus” the Federal Reserve has created 4.216 trillion USD backed by no tangible asset or income flow, source the Federal Reserve

Good Trading,
Peter Knight

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