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Fed Lessons: How to Become a Beggar


Only currency markets can tell us when the rampant Ponzi-scheming is over.

If you liked last week's move by the Fed, prepare yourself for much more: One of the few near-certainties of trading is that, when governments get on one side of a trade, everyone and their mother gets on the other.

Think about it: A price-insensitive buyer with a standing bid; you can sell all you want, and it will be bought. When the sellers are exhausted, and the government owns the asset class, only 1 of 2 things can happen: Either the government hangs on to that asset, or -- if the government needs/must sell -- buyers can now sit on their hands and wait for the government to purge its supply at buyer-dictated prices.

Let's translate this dynamic to the Treasury market. Last Wednesday, the Fed announced it would print $300 billion to buy the Treasury's debt. If I am China, or Japan, or any other large holder of US Treasuries, I know that I can sell into it in size, and the price won't budge. The $300 billion bid gets soaked up in no time.

Unless the Fed's move was a bluff, the Fed must come back with more printed cash and offer to buy more, if its intent was to move up the price of Treasuries (move down the yield) . The process repeats itself a number of times, and the US dollar gets destroyed with every printing session.

Let's now say that China and Japan have sold all their US Treasury holdings. On the one hand, they're happy that they were able to unload them without collapsing the Treasury market in the process. On the other hand, the dollar bills they now have in their hands have a purchasing power inversely correlated to the number of dollar bills that were printed. Is it any wonder China is pushing to get away from the dollar as the trade reserve currency?

Meanwhile, back at the ranch, while the Fed is busy printing dollars to buy Treasuries, the Treasury still needs to sell trillions of them to finance our various deficits. It has 2 options: it can force the Fed to print more money and buy those Treasuries (the Zimbabwe economic model); or it can go back to China and Japan and offer to buy back the Treasuries they just sold. Anyone care to guess who's got pricing power in that auction?

A few months ago, I suggested that the Fed's maneuvering was less than sophisticated. The only thing that's changed since then is the size of their maneuvers, which has grown by trillions - and people's desperate need to believe that something will work to end this crisis. They've latched on to the notion that, if the government-sponsored scam is large enough, it will in fact work.

For what it's worth, I will offer that it will not only fail, but will bring about a whole new set of massive problems, that will make the ultimate backlash that much more painful.

I continue to watch the currency markets -- the only markets that no one can rig -- to tell us when the rampant Ponzi-monium is over.

From a more practical standpoint, one may be tempted to ride debt-laden exporters like General Electric (GE), which may benefit from the destruction of debt through currency debasement and price advantages for exports. This may well prove a sucker play, as it's only a matter of time before other countries elect protectionist barriers.

If anything, technology near-monopolies like Microsoft (MSFT) and Cisco (CSCO) may be better choices, considering that there are few alternatives to what they offer, and nominally higher prices will flow through their high gross margins straight to the bottom line.
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