It was suggested 1.5 years ago that the next stock market crash might be one orchestrated by the Fed to create interest from historic buyers of US debt. The scenario went like this: you let the stock market collapse (i.e. no interference by the infamous “Plunge Protection Team”) to generate a “flight to safety” environment which would push billions, if not hundreds of billions, of dollars into U.S. Treasuries, soaking up its increasing debt issuance and roll-over with little difficulty thereby flooding the bond market with much needed demand. Were the recent dramatic declines in the U.S. stock markets so engineered by the Fed? Words: 852
Graham Summers was the individual who suggested the above back in January 2010 an article* aptly entitled Will the Fed Engineer a Stock Market Crash to Flood the Bond Market With Much Needed Demand? In light of the events of this week Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has revisited that insightful article and presents it below in an edited ([ ]), abridged (…), updated and reformatted fashion for the sake of timeliness, clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. The gist of Summers’ comments was along these lines:
[The events of the past 2 months in Washington, where the underlying dire financial insolvency of the nation was blatantly ignored in favor of expedient short-term political posturing, has clearly demonstrated to the entire world the inability of the U.S. government to resolve the problem let alone even deal with it in a serious non-partisan way. It became very clear that holding the debt of a bankrupt country such as the U.S. was hardly a safe haven for assets.]
The U.S. Treasury is facing a debt spiral; a situation where it needs to issue [large quantities] of new debt every month while rolling over trillions in existing debt at a time when investors are willing to lend to it for shorter and shorter periods of time. The big question has always been: who’s going to be buying this stuff ?
Historically, foreign investors and foreign governments were the biggest buyers of US debt… [but,] suffice it to say,] given the juvenile display of total irresponsibility during the debt ceiling debate] foreign governments [were hardly inclined to] step in to pick up the slack in the Treasury market.
The next biggest purchaser of U.S. debt behind foreign governments… is the Federal Reserve itself via its quantitative easing programs. Given that unpopularity [and apparent ineffectiveness] of this approach it is unlikely to be repeated (at least not in a form large enough to pick up any slack in the Treasury markets).
So what about state or local governments, pension funds, or insurance companies (historically decent sized buyers of U.S. debt)?…These groups have been either net sellers or small buyers of Treasury debt of late so the likelihood that these groups suddenly buy hundreds of billions of dollars of Treasuries is minimal…
The same goes for “other investors” …(comprised of “Individuals, Government-Sponsored Enterprises (GSE), Brokers and Dealers, Bank Personal Trusts and Estates, Corporate and Non-Corporate Businesses, Individuals and Other Investors)… unless, of course, we have another crash in the stock market.
Think about it. The U.S., if it were treated like a corporation, is effectively bankrupt. It has to issue a massive amount of new debt while rolling over trillion in old debt at the very time that most historic buyers of U.S. debt are losing interest in lending to the US for any period longer than a few years.
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So how do you create interest from historic buyers of U.S. debt? Simple, you let the stock market collapse. The “flight to safety” that would follow would push billions if not hundreds of billions of dollars into Treasuries, soaking up the debt issuance and roll-over with little difficulty…
I am not saying the Fed and friends will do this but, given that the Fed is coming under increased scrutiny as public outrage rises, letting stocks come unhinged it perhaps the least politically controversial move the Fed could make as opposed to more quantitative easing which would really get the public upset. [Letting the stock market crash] would do the following:
1) Bring stocks closer to reality…
2) Create great demand for Treasuries (something the US desperately).
3) Have relatively minor political ramifications compared to another quantitative easing program or more bailouts…
Could the Fed be preparing another [indeed, has the Fed engineered the recent] stock crash to flood the bond market with demand? Who knows but it would make plenty of sense to me.
*http://www.marketoracle.co.uk/Article16321.html ( Summers’ www.GainsPainsCapital.com provides a free daily newsletter dedicated to providing daily insights to the stock, commodity, currency, and bond markets and telling investors the REAL story behind the moves in the financial markets.)
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
– Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.