The rising cost of money

[muldoon]

Rising costs of money

I have speculated that as credit has decreased and the money supply stalls we will see the cost of money increase.  For those of you with credit cards this is not a new thing; as this past year credit cards rates have gone through the roof.  I am concerned about this trend and what I see playing out in my mind and want to make a post about it because it scares me.  I want others to be aware of the risks out on the horizon and how they might take steps to protect themselves. 

Skipping the history lesson on what happened last year, everything went boom for various reasons.  How that was reacted to is the key.  The federal reserve in concert with the us treasury stepped in to purchase assets and make loans in an "effort" to keep the economy stable.  Perhaps they did the right thing, perhaps they did the only thing they thought they could do; but the law of unintended consequences is a tough one.  The fed has purchased some 1.5trillion dollars of "Agency" debt.  Agency debt refers to mortgage MBS bonds mostly, the Fanny and Freddy bonds.  They purchased more MBS in 2009 than was issued; indicating not only that they were responsible for every house that got sold, but that they also allowed banks and bond companies to unload what they had into them as a consequence.  They did this by purposefully overpaying for these bonds.  As other countries are beginning to get close to soverign default, our fed has itself in quite a pickle.  They need to exit the market, and fast before they self destruct.  I know many people feel the fed destroyed the economy on purpose for thier own gain, and I believe that as well to some extent, I do not believe they intended to blow themselves up in the process.  But that's quite literally where they are headed. 

I have been hearing rumblings for a while about rates and bonds but this week has been very reveiling in what's been released. 

Bill Gross of PIMCO, the worlds largest bond fund has been quite vocal about the events of late, on Monday releasing a statement that they would be net sellers of US treasury debt and sellers of UK guilt debt.  As there is no longer any foreign debt purchase, and the bond market is rejecting the offering, while at he same time the government wishes to issue more debt than ever (2.5trillion new treasury debt for 2010 on top of 3trillion to rollover vs. 1.5 trillion last year).   Quite the vexing problem. 

One thing I am certain of about Bill Gross, if he is saying something he has an agenda behind it.  To me, the agenda is plain as day - he wont buy US debt at current rates. 

Sure enough, what does he have to say today?
http://www.businessinsider.com/pimco-fed-tightening-is-impossible-without-2010-1

"There's No Way The Market Can Absorb The Fed's Giant Balance Sheet Once It's Time To Tighten", he is very honestly stating that there is nowhere near enough global demand for the issues at current rates and that if the US (or the UK for that matter) need access to capital then they will be paying a higher price.  Sure enough, just a few paragraphs down.

Various studies by the IMF, the Fed itself, and one in particular by Thomas Laubach, a former Fed economist, suggest that increases in budget deficits ultimately have interest rate consequences and that those countries with the highest current and projected deficits as a percentage of GDP will suffer the highest increases – perhaps as much as 25 basis points per 1% increase in projected deficits five years forward.

let's do some math... 
last year the deficit was 7.1 trillion, last years news says the plan is to move that to 9trillion, or perhaps 10trillion with healthcare.  A 10 is 40% higher than 7.1.  25 basis points for each percent comes out to 1012 basis points or roughly 10% increase in federal borrowing.  That places the fed funds at 10%, the 10year TNX at 14% and likely home mortgages in the 18-22% range. 

I cannot express the kind of deflationary disaster this is. 
example:
a 100k house loan with a 5%  interest rate has a payment of 682 a month
a 100k house loan with a 7%  interest rate has a payment of 811 a month
a 100k house loan with a 10% interest rate has a payment of 1023 a month
a 100k house loan with a 15% interest rate has a payment of 1410 a month

In other words, a 100k house at 5% costs about the same as a 50k house with a 15% rate.  As rates climb, home prices fall because the purchasing power of the people do not change.  As asset values decline, everything goes right with it, this is the slow spiral. 

Some may be thinking to themselves that mortgage rates cannot ever get that high, that such a thing is impossible.  I welcome you to go google historic mortgage rates, a quick search from 1983 when my dad bought the house he lives in now shows a good mortgage at 13%, I have heard horror stories of people in the 17-18 range from a few years before that.  The past decade has been the decade of cheap credit, and that is reversing and reverting back to the mean. 

And out from the wires just a few minutes ago.
*FED CALLS FOR `ROBUST PROCESSES' FOR CURBING INTEREST RATE RISK
*FED SAYS EXCESSIVE RISK MAY PROMPT REQUIREMENT TO RAISE CAPITAL
*FED TO REQUIRE CORRECTIVE ACTION FOR FIRMS WITH EXCESSIVE RISK
*REGULATORS RELEASE ADVISORY ON INTEREST RATE RISK IN WASHINGTON
*U.S. WARNS BANKS TO GUARD AGAINST RISK OF RISING INTEREST RATES

There is a bloomberg article on it as well, I guess they got them memo as well. 

THIS is what I refer to when I say that the market and NOT the fed sets rates. 
----
What do do in a area of rising costs of money?  cash is king, but productive assets are better than cash if you can keep them.  If you are considering purchasing home or land or seeking other type of finance consider ways to do it without financing.  Move quick if you need to.  Absolutely reduce or eliminate any variable interest loans or debts you have, there is no telling what rates to consumers will do.  If you own a business, find a way to work with cashflow and do not rely on credit to float, that will be the difference between who makes it and who doesn't.  Well, it already has been but I see more of the same coming.  If you have assets to sell at a price large enough for someone to need financing, you need to ask yourself if they are going to be going up or down in the next 12-18 months and act accordingly. 

Lastly, I dont think this is any kind of doomsday stuff so please dont read it or take it as such.  It is however a large shift in how the economy operates; the sooner you can mentally accept and prepare for it the better you will be positioned to prosper within it. 

[ScottA]

So if you are a government/bank that is printing money to cover your deficits whats the best way to prevent run away inflation? Maybe make money harder to get by raising intrest rates? If you expected the money you where printing to devalue what would you do? Use that newly printed money to buy stocks and other assets? I think it's possible this is what's really going on. We'll just have to wait and see what happens because they'll never tell us.

[pagan]

I think you might be onto something, Scott. We all like to call these guys idiots, but they know what they're doing and always have an agenda that benefits themselves. Look at what Enron was doing. People think how stupid they were, but that company made billions for years before it imploded, and that money went to stockholders, executives, etc. I worked at an investment bank and have first hand knowledge of how they operate. Some people are going to make crap loads of money off this fiasco, and all I know for sure is I won't be one of them.

[muldoon]

So if you are a government/bank that is printing money to cover your deficits whats the best way to prevent run away inflation? Maybe make money harder to get by raising intrest rates? If you expected the money you where printing to devalue what would you do? Use that newly printed money to buy stocks and other assets? I think it's possible this is what's really going on. We'll just have to wait and see what happens because they'll never tell us.

They don't exactly print money directly.  They issue debt.  To issue debt you need a buyer, the buyers have dried up. 

Foreign creditors: http://www.treas.gov/tic/mfh.txt
Note that China has stopped buying in May 2009 and has remained flat.  They do not give us money any more.
Note that the grand total at the bottom has been flat since July.  Foreingers are no longer purchasing US debt.  It's over.

Domestic creditors:
PIMCO:  the worlds largest bond purchasers are no longer purchasing debt from US or UK either.  That was the message in this post.

For inflation to take hold (a currency to devalue) you need an expansion of the money supply, or an expansion of the credit supply because money spends the same as credit.  The credit supply has contracted, and the money supply has stalled.  Every dollar they "print" as it is being called is destroying 10 dollars in credit because of the destruction of credit behind it.  The credit market is much larger than the dollar market. 

-
I dont think they are expecting the dollars to devalue, they are raising rates because of supply and demand.  They wish to sell more than there is demand, so the rates must raise to attract buyers.  As rates raise the price of the things you can buy with the currency goes down.  stock market goes up on rate cuts because the currency is cheaper and worth less, when rates raise the money gets stronger and therefore the price affixed to assets goes down. 

As for what they are trying to do, here is my personal theory:  -- I cannot prove this as just like you said, such things would never be released or discussed. 

Last year, the federal reserve overpaid for assets. 
The bond funds sold into that and unloaded these assets at an inflated price. 
Now the fed wants/needs to unload these assets and at the same time the bond market is saying no mas. 
The only way to sell them back is at a huge discount or increased rates. 
The fed will end QE/MBS purchases in Q1/Q2, and the bond world will scoop them up at pennies on the
dollar as the market for MBS craters. 
The fed will see the further destruction in credit and will act to enable QE2 (or the like) in Q3 or Q4 of this year. 
Then the same bond funds will unload those assets back into the fed at inflated prices. 

The net affect being the rich get richer, the taxpayer gets screwed. 
Interest rates for consumers goes up while asset prices goes down.  Somewhere along the way, I strongly think they will go after IRA's and 401ks and try to force them to be treasury purchasing instruments.  Further stripping of wealth from the middle class. 

That's my read on it.  I certainly could be wrong. 

[ScottA]

I see what you're saying muldoon. Here's the thing though. If no one buys the debt the government folds up and that's not likely. Think of the government and the fed as 2 parts the same entity. The government issues the debt and the fed creates the money to buy it. It's the same as printing money. What I see is right now is that the govrnment and the big banks have merged. And with that they have the power to do what I mentioned in my earlier post.

[muldoon]

What I see is right now is that the govrnment and the big banks have merged.

I agree with that, I also see your point that the fed and treasury are two parts of the same entity.  However, having the power to self destruct does not necessarily mean that they will do so.  I think they are greedy, and with that they wish to keep what they have stolen.  (power and money) I do not think they wish to destroy themselves in the process. 

There are many cases of countries crashing without the government folding up.  Just 15 years ago Russia crashed, but most of the same people stayed in power.  Just 5 years ago Argentina crashed, but the same people retain power their now.  In fact Argentina and Russia are now considered "emerging markets" again and cash never stopped flowing into them.   The 80s Mexico peso crises comes to mind as well, their government did not fold up and go home.  Iceland had a complete currency collapse last year with the krona loosing some 80% in a day.  However their government is still intact.  What did change was the rate they pay to get that cash on the international market, and the taxation and wealth collection policies the governments imposed on their collective people to pay those rates. 

If the government and the banks could just print money without stop, why would anyone work, why would taxes be needed?  Except for zimbabwe I dont see any politicians promising such a thing - and if you look at zimbobwe you can see why no one else wants to go there. 

[considerations]

So the PIMCO message is good for me (I think) because I own some shares?   

[muldoon]

considerations, good luck, sorry I cannot comment on stocks anymore.  I do sincerely wish you luck with it. 

something I saw tonight, its from shadowstats, the hyperinflation guy who republishes information on monetary system using his own algorithms -- allegedly to shows how the data used to be calculated. for example, he still tracks M3.  I thought it was interesting.

here is a year over year chart showing a shrinking money supply. 

[Virginia Gent]

The net affect being the rich get richer, the taxpayer gets screwed. 
Interest rates for consumers goes up while asset prices goes down.  Somewhere along the way, I strongly think they will go after IRA's and 401ks and try to force them to be treasury purchasing instruments.  Further stripping of wealth from the middle class. 

That's my read on it.  I certainly could be wrong.

I'm gonna suggest everyone listen to Muldoon as I think he is on to something: http://www.businessweek.com/news/2010-01-08/americans-oppose-initiatives-limiting-401-k-choices-ici-says.html

[muldoon]

dollar has risen 1.2% in the last 24 hours, something almost unheard of.  The euro has fallen roughly 1.3%.

silver, oil and gold getting hammered straight down.  thats not panic, thats forced selling.  it's liquidation waterfall.  also called margin calls. dollar shorts getting closed and covered on the forced liquidation of assets. 

greek officials went on strike today, looks like EU is going to have to bail them out.  likey or no.  if they dont, they entire EU tanks large, if they do, it tanks small.  If they do, then portugal, spain, italy, ireland all line up for the next one.  If they dont, some of those crash anyway further tanking. 

Dollar 81ish is on the horizon again. 
gbp, eur, nzd all making key lows, usd making yearly highs.  cash is king. 

wheres my dow 10k hat? 

[muldoon]

these are huge moves in the dollar.  something somewhere is blowing up.  With the euro crashing, this points to European banks. 

My bet is Portugal, the CDS spreads on them went berserk last night out of nowhere. 
http://www.cmavision.com/market-data
Thursday, 4 February 2010 — 23:30
Largest Widening Spreads (Greatest Credit Deterioration)
Banco Comercial Portugues SA (SUB) -- 346.77 +102.16 +41.76
Banco Espirito Santo SA (SUB) -------- 358.63 +96.60 +36.87
Banco Comercial Portugues SA ------ 239.14 +63.99 +36.54
Banco Espirito Santo SA ------------ 253.42 +64.31 +34.00
Banca Popolare di Milano SCRL ------- 91.55 +19.91 +27.80

- for reference, that is exactly what happened to Lehman when they popped.  As soveriengs, this is exactly what happens when a country defaults.  The CDS spread is a meausre of the risk.  As risk goes up, the rate goes up they pay for debt.  As they get worse and worse credit, they must pay more and more until they pop.  It's ugly. 

--

[waggin]

wheres my dow 10k hat? 

[muldoon]

fed just raised the discount rate from .50% to .75% in an emergency rate hike. 
that's a 50% increase folks. 
http://federalreserve.gov/newsevents/press/monetary/20100218a.htm

dollar surging again.  dollar just crossing 81 now...

[peternap]

   I may be a bit of subject here . . .   A commercial realtor friend has mentioned that it doesn't matter much what the lending rate is if the banks are not willing to lend money.   Previous commercial properties could be financed with 15-20% down.  Now the banks are requiring 50%.  Also, good luck, trying to refinance a residential mortgage right now.  Doesn't matter if you have good credit and a "good" job.  .  .

/

I think that's one of the big real life issues Bayview. Charting and using profiles are fine but the bottom line in "real life" still boils down to how business is handled. I'm sticking with my melt down theory. We are in a new era and have to compensate on an individual level. The Government ain't gonna help.

[RainDog]

Shilling: Euro Poised to Plunge 27 Percent

"I think the currency could go back to 1-to-1 versus the dollar,"

http://moneynews.com/StreetTalk/Gary-Shilling-Euro-Dollar/2010/02/23/id/350654

[OlJarhead]

Anyone read Thomas Woods:  Meltdown?
James Wesley Rawles:  Patriots?

There are many others but those who listen to the likes of Woods, Roubini, Faber, Schiff have seen this coming for some time....in fact back when the DOW was climbing to 14k.

Sadly, I don't think there is much you and I can do besides stock up for a rainy day and hope for the best...

[muldoon]

I read patriots, a hyperinflationary collapse followed by UN takeover of the US, fought off by survivalists in Idaho. rough novel, weak plot and characters, but lots of detail for those wanting to focus on the details of what a group of survivalists would want to think about. 

The affect of a rising dollar and declining euro coupled with declining credit is 180 degrees opposite of what patriots describes in their financial meltdown. 

The hyperinflation presented in the story is that the value of the dollar will go to zero and that prices would go to the moon ala Zimbobwe or Weimar Germany.   That the dollar became worthless. 

The effects of deflation is that there is less and less debt which manifests the same way as less and less money.  Prices fall, wages fall, unemployment rises, markets decline, because $$$s are in demand.  When you need money now, your 20k boat might just sell for 5k - because you need money.  Thats deflation.   That's the rising "cost" of money. 

While we may one day see the mighty dollar fall, I do not see it in the next few years.  As for par between the euro and the dollar, they were at par just 10 years ago or so.  That by itself does not constitute a crises. 

[muldoon]

there is much going on lately and my thoughts are a bit disjointed.  I also do not wish to wade too deep into political quagmire so I'll keep this on point. 

We have firmly crossed my last target of 81 on the ino usdx, held and today surged again.  My next target for the DX is 84, to come over the next few weeks.  If locking a mortgage rate or seeking a refi - is in you immediate future, I would do so quickly. 

[peternap]

there is much going on lately and my thoughts are a bit disjointed.  I also do not wish to wade too deep into political quagmire so I'll keep this on point. 

We have firmly crossed my last target of 81 on the ino usdx, held and today surged again.  My next target for the DX is 84, to come over the next few weeks.  If locking a mortgage rate or seeking a refi - is in you immediate future, I would do so quickly. 

I tend to go along with that. Like everything in the last couple of years, it's hard to predict especially this week with the country in a tizzy.

It really does look like interest rates will jump soon though. What will happen then is beyond me because the economy sure isn't going to pop any time soon.

[glenn kangiser]

Thanks for the input, guys.

[OlJarhead]

Faber, Roubini, Celente and others all better educated and wiser then I on these matters continue to hold that Hyper Inflation is likely.

many say deflation first then inflation then hyper inflation.

The crisis is starting to heat up again and that's also anticipated by those watching Option ARMS, MUNI's and Commercial Real Estate.

I believe we are in for a very rough ride and I wouldn't want to live in or near any big cities.

[OlJarhead]

http://www.zerohedge.com/article/latest-gold-fraud-bombshell-canadas-only-bullion-bank-gold-vault-practically-empty

If this comes to pass (people asking for their gold and silver) the dollar crashes.

[pagan]

This is from Canada, so it might not impact the US dollar, although I'm sure American banks have been doing the same thing.

Banks don't have all of the money that is held in deposit with them and as long as everybody doesn't attempt to withdraw everything at the same time the bank is fine. Many local banks in 1929 and the first years after the crash were fine, until rumors spread and everybody "ran" the bank. Panicking mobs are the problem.

This article is along the same lines. Although charging people storage fees when nothing is begin stored should be prosecuted, all this article will do is cause people holding gold bonds to request delivery and if enough of them make the request then we've got yet another financial crises that will cost us a few billion dollars to clear up.

[muldoon]

Greece has effectively hit the wall.  They were cut to junk today by moodys.  Consider their death spiral fiancing of late:

Yesterday, their 2 year bond tracked at 10%, today 12% and two hours after that 15%, then the downgrade and they went 17%. 

Portugal was also cut, and their banks were then cut because they held such a high amount of Greece debt.  Italy took a hit as well.

The EU bailout talks continue to fall, seems if Portugal is broke too then they cannot bail out greece.  How can any of them borrow money at 6% to give it to Greece at 5%?  See the dilemma? 

Pound is under 1.32 now, wow. 

As for the dollar, up 1.10 to 82.34.  Tomorrow brings D-day for the euro debt crisis in my opinion.  They are effectively at Lehman failure crises level over there, and have escalated to this level very rapidly.  At it's worst, Lehamn was 700 basis points on CDS, at its worst AIG was around 900 bps, now we have a European sovereign at the same level. 

I expect some European fireworks over the next 24-36 hours. 

[peternap]

Greece has effectively hit the wall.  They were cut to junk today by moodys.  Consider their death spiral fiancing of late:

Yesterday, their 2 year bond tracked at 10%, today 12% and two hours after that 15%, then the downgrade and they went 17%. 

Portugal was also cut, and their banks were then cut because they held such a high amount of Greece debt.  Italy took a hit as well.

The EU bailout talks continue to fall, seems if Portugal is broke too then they cannot bail out greece.  How can any of them borrow money at 6% to give it to Greece at 5%?  See the dilemma? 

Pound is under 1.32 now, wow. 

As for the dollar, up 1.10 to 82.34.  Tomorrow brings D-day for the euro debt crisis in my opinion.  They are effectively at Lehman failure crises level over there, and have escalated to this level very rapidly.  At it's worst, Lehamn was 700 basis points on CDS, at its worst AIG was around 900 bps, now we have a European sovereign at the same level. 

I expect some European fireworks over the next 24-36 hours. 

I'll be interested to see if it slips Muldoon. Actually, everything is getting interesting from the local to the international level..