I've Got Friends In Low Places - April 2009 - Contrary Investor

[slipslidingaway]

Full text and charts
http://www.contraryinvestor.com/mo.htm


"...THE TREASURY CALENDAR

To the point, the top clip of the chart below chronicles the issuance of US Treasuries since the beginning of 2006. Alongside is the quarterly level of like period purchases of US Treasuries by the foreign community. As we note in the chart, 3Q and 4Q of last year mark the highest nominal dollar levels of Treasury purchases by the foreign community on record. But these purchase levels were simply dwarfed by the $1 trillion+ issuance of Treasuries over the last half of 2008.

The bottom clip of the chart takes the same data and presents it as foreign purchases of UST’s as a percentage of actual Treasuries issued by quarter since 2006. The “rule” in this view of life is that the foreign community has consistently purchased well in excess of 50% of total Treasuries issued. In fact, from 3Q of 2007 through 2Q of 2008, the foreign community purchased Treasuries at a rate well in excess of 100% of total Treasuries issued. But as is absolutely clear, all of this has changed starting in the middle of last year. The bottom line today is that foreign buying of Treasuries, although at record levels in nominal dollars, has not been able to keep up with what has been and will continue to be for some time Treasury issuance on steroids. Although we will not drag you through yet another data review, you’ll have to trust us when we tell you that domestic buying of Treasuries has not and will not make up the gap. As of today, total domestic ownership of Treasuries rests at a level below that of the foreign community. The Fed is now quite simply the plug figure between projected Treasury issuance, foreign buying and levels of domestic Treasury ownership. The fact is that the Fed had no choice but to come into play right now. And so here we are. No conspiracies, no mysteries, no ranting and raving, simply the factual numbers.

Very quickly, as of right now, the OMB (Office of Management and Budget) has projected at worst an annualized $1.8 trillion deficit for the US later in the current year. From this alone we know Treasury issuance will be incredibly large. Well beyond what the foreign community would ever have the chance of soaking up. In the OMB’s view of life and under the Administration’s budget planning, expectations are for 3%+ GDP growth in 2010 and over 4% in 2011. Although we’ll have to see what happens ahead, we personally believe there is zero chance these GDP numbers will be hit. Zero. As such, the Administration’s belief/projection that the US budget deficit will fall back below $1 trillion in 2010 is wishful thinking at best and probably lunacy at worst. Point being Treasury issuance over the next few years at least should indeed be well beyond current “projections”. If anyone thinks the shortfall between projected Treasury issuance and the ability of the foreign community to soak up this issuance will somehow narrow any time soon, they are dreaming. Given the mosaic produced by putting all of these facts together, we see a picture of a US Fed who has just begun to monetize the Federal debt. Although we are absolutely guessing at this point, before the current cycle is over, Treasury monetization by the Fed may end up being five to six times what has already been announced and begun with the current $300 billion. That’s an appetizer. Don’t be surprised as this is exactly what the real numbers are pointing to dead ahead. And this of course assumes the foreign community at least keeps purchasing at levels we’ve experienced over the last year or so, which is no guarantee at all.


THE CHINA SYNDROME

We all know that at the margin China has been the key foreign buyer of US Treasuries over the current decade. From 2000 through January of this year, China accounted for 37.4% of all Treasuries purchased by foreign entities. As of now, they are the largest holder of US Treasuries on planet Earth, holding 24% of all Treasuries owned by the foreign sector. Bottom line? China’s global capital flows at the margin are extremely important. Let’s face it, it’s China who could change the dynamics of what we talked about above for the better or for a whole lot worse as we move forward. They carry the largest stick and their forward actions will be the key factor influencing just how much monetization of Treasuries the Fed will necessarily need to undertake. Again, not want to undertake, but need to undertake.

The top clip of the next chart looks at actual year-by-year purchases of US Treasuries by China. 2008 was simply off the charts. Although we do need to remember that in many senses Treasury buying in 2008 was in large part about the “safety trade” as opposed to what might be seen as mercantilist economics (essentially financing the purchasing of your exports), it’s hard to imagine China could again experience a 50% year over year increase in their US Treasury holdings in 2009..."