WASHINGTON (MarketWatch) - Monthly capital flows to the United States reversed in December to the first outflow in a year-and-a-half, the Treasury Department reported Thursday. Monthly capital flows reversed to an outflow of $11 billion in December compared to an inflow of $70.5 billion in November. In December, private investors sold $42.5 billion of securities. This was offset by $31.5 billion in purchases by official institutions. Net long-term capital inflows, meanwhile, fell to $15.6 billion in December from $84.9 billion in November. This is the lowest inflow since January 2002.
And here's a corroboroating story from the other side of the world - US$ falls to one-month low versus yen - which appeared in the New Zealand Herald on February 16
It is true, one month does not a "trend" make, but this development is ominous in the EXTREME. It is a well known and often mentioned fact in the financial press all around the world that the US needs an injection of foreign capital totalling well over $US 2 Billion every day to offset its current account deficit. As you can see from the Treasury data reported above, the inflows were woefully inadequate to meet this "demand" in December 2006 - both on a monthly and on a "long-term" basis.
Above all other things, it is this massive foreign "investment" (mostly in the form of the purchase of US debt paper of all descriptions) in the US which has kept US market interest rates from spiking upwards and has prevented the US Dollar from going the way of the Argentine Peso. No other nation (although many, like Australia, are trying) could have consistently run trade and now current account deficits for as long as the US has without long since having succumbed to exruciatingly high interest rates and a plummeting currency. And no nation, including the US, can continue to run up such deficits indefinitely.
There are many obscurities (injected on purpose by the financial "authorities") involved in the US economy at present. But there is one thing on which almost everyone agrees. That is the simple fact that the US economy cannot afford higher interest rates. The bursting of the housing boom and the explosion of defaults and repossessions makes that obvious in the "consumer" sphere. The ongoing destruction of the manufacturing sector and the ever increasing job losses makes it obvious in the corporate sphere. And in the most financially "obscure" sphere of all, no amount of smoke and mirrors can disguise the simple fact that the Bush Administration is increasing the deficit at more than $US 500 Billion per year.
An economy based on debt must be able to sell debt paper to function. It must be able to sell ever increasing amounts of it to continue to preserve an apperance of healthy economic "growth". The higher the debt levels become, the lower the interest rates at which this debt can continue to be "comfortably" serviced. In "normal" times, this is what brings about the end of the boom (built up through credit creation) and the start of the bust. As debt levels increase, the risk of holding the debt increases with it. This is built into interest rates, which rise. The longer-term the debt, the more they rise.
In the US, of course, the situation is anything but "normal". Over a five to six year period during which the amount of money borrowed for real estate doubled, mortgage rates have actually FALLEN. When that was not enough to sustain the debt, fixed rate mortgages began to lose favour to adjustable rate mortgages. When that was not enough to sustain the debt, concessional rates along with interest only mortgages (with no principal repayment) became the rage. But now, none of this is enough, the housing bubble in the US has burst, demand for housing is drying up, and Americans are defaulting on their mortgages at a accelerating speed which is terrifying.
ALL THIS IS HAPPENING WITH US INTEREST RATES AT GROTESQUELY LOW LEVELS, given the indebtedness of the economy. The reason why these grotesquely low levels has been maintained has been the seemingly insatiable appetite for US debt paper by foreigners - notably Asian Central Bankers. If this source of demand was to be cut off, or if it were to slow even slightly, US debt issuing bodies in both the private and "public" sector would face an insoluble dilemma.
If the HUGE decrease in foreign demand for US debt paper continues, the pressure under US interest rates will become extreme. If US corporations, mortgage originators of all descriptions, and local, state, and federal governments cannot continue to sell their debt outside the US, they will have to sell it INSIDE the US. This raises the question, who can afford to buy it? The US has run a NEGATIVE savings rate for two years running now.
There is a way to revive foreign interest in US debt instruments, of course, and that is to offer a higher interest rate. But the US is labouring under such a load of debt that it literally cannot afford to do that, for either prospective foreign buyers or prospective domestic buyers. The data presented at the beginning of this analysis is an indication that the foreign buyers which the US has counted on for so long to absorb its debt are choking under the load. For years, it has been an article of faith that Asia would ALWAYS continue to absorb the ever accelerating US credit creation because to refrain from doing so would not only deprive them of the market they had to have for their exports, it would also lead to gartantuan losses on the pile of US debt instruments they already hold.
There was always going to come a point where foreign buyers of US debt were unable/unwilling to continue to absorb it. The December data shows that this point might have actually ARRIVED. As we said, one month does not a "trend" make, but the evidence of increasing malaise in the US economy is now so stark that the risk of continuing to "soak up" US debt paper - with NO compensation for the risk reflected by the interest rates on offer - is clearly increasing at an accelerating rate.
If foreign investors ARE going to stop financing the US current account deficit, the US has two choices. They can either rein the deficit it - massively - or they can find an alternate source of "funding". With insufficient demand from foreigners, and insufficient means held by Americans, there is only one such source of "funding" left. That source is the Federal Reserve itself.
The Fed is the "lender of last resort". It can - and has to varying degrees many times in the past - acted to "monetise" US debt. When faced with the alternative of doubling US rates and watching the US economy collapse around its ears, it is almost certain to do so again. Mr Bernanke has given fair warning that he is prepared to do it. His (in)famous "helicopter money" speeches are still very well remembered both inside and outside the US.
Yes, the US does have a "printing press". Yes, the Fed can create any amount of paper (or electronic entry) US Dollars. There has never been any doubt about that. But the Fed cannot do these things without bringing about all the effects that they profess their "management" is designed to avoid. They cannot do it without decimating the exchange value of the US Dollar. They cannot do it without causing a potentially immense spike in US interest rates.
Gold had a very quiet week this week, especially considering the abrupt fall of the US Dollar over February 14-15. The Dow is still setting records. US Treasury yields actually plummeted this week too, at the same time as the US Dollar was falling. Conveniently, the government statistic which used to illustrate the speed with which the Fed was inflating - the broad money (M-3) numbers - are no longer available from the Fed and have not been for almost a year now. One can never accuse the US Central Bankers of lacking foresight, can one?
Rising interest rates can indicate two things, a lack of demand for debt paper or a deterioration in the quality of the debt paper on offer. In a credit based economy which functions on a debt backed currency, it is the deterioration of the quality of the debt paper on offer which pushes up interest rates. That is why all BIG Gold Bull markets, wherever they occur, are always congruent with RISING interest rates.
Any slackening of foreign demand for US debt paper GUARANTEES rising US interest rates, it is merely a matter of time.
The table below shows the "calm" in the Gold markets this week. Please note that while Gold reached new 2007 highs in US Dollar terms on February 16, it did not do so in terms of the other currencies listed.
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