Welcome to the New Economy

Charles Hugh Smith described the 12-step process (printed below) in which the wealth of the country now flows from its citizens to the megabanks in his July 8th posting titled "The Con of the Decade."

1. Enable trillions of dollars in mortgages guaranteed to default by packaging unlimited quantities of them into mortgage-backed securities (MBS), creating umlimited demand for fraudulently originated loans.
2. Sell these MBS as "safe" to credulous investors, institutions, town councils in Norway, etc., i.e. "the bezzle" on a global scale.
3. Make huge "side bets" against these doomed mortgages so when they default then the short-side bets generate billions in profits.
4. Leverage each $1 of actual capital into $100 of high-risk bets.
5. Hide the utterly fraudulent bets offshore and/or off-balance sheet (not that the regulators you had muzzled would have noticed anyway).
6. When the longside bets go bad, transfer hundreds of billions of dollars in Federal guarantees, bailouts and backstops into the private hands which made the risky bets, either via direct payments or via proxies like AIG. Enable these private Power Elites to borrow hundreds of billions more from the Treasury/Fed at zero interest.
7. Deposit these funds at the Federal Reserve, where they earn 3-4%. Reap billions in guaranteed income by borrowing Federal money for free and getting paid interest by the Fed.
8. As profits pile up, start buying boatloads of short-term U.S. Treasuries. Now the taxpayers who absorbed the trillions in private losses and who transferred trillions in subsidies, backstops, guarantees, bailouts and loans to private banks and corporations, are now paying interest on the Treasuries their own money purchased for the banks/corporations.
9. Slowly acquire trillions of dollars in Treasuries--not difficult to do as the Federal government is borrowing $1.5 trillion a year.
10. Stop buying Treasuries and dump a boatload onto the market, forcing interest rates to rise as supply of new T-Bills exceeds demand (at least temporarily). Repeat as necessary to double and then triple interest rates paid on Treasuries.
11. Buy hundreds of billions in long-term Treasuries at high rates of interest. As interest rates rise, interest payments dwarf all other Federal spending, forcing extreme cuts in all other government spending.
12. Enjoy the hundreds of billions of dollars in interest payments being paid by taxpayers on Treasuries that were purchased with their money but which are safely in private hands.

The Treasury holds biweekly auctions in order to sell debt. Zero Hedge reported another $35 billion in 3-year denominated US Treasury bonds were sold today.

The US government is another $35 billion in the debt sink hole. The cost of this marginal addition to our existing debt load ($10 trillion? $100 trillion? who cares) was just 1.055%, which was gobbled up briskly at a 3.20 Bid To Cover. The bulk of the buying came from Primary Dealers who took down the highest portion of the auction, or 45.1%, since May of 2009, when PDs were responsible for 56.6% of the takedown. Indirect bidders, coming in at 40.6%, was the lowest indirect take down since January, when they were responsible for just 38%. The balance of 14.3% was left to the Direct Bidders. The Bid To Cover at 3.20 came in well above the LTM average of 3.03%.

Now that the United States is running $1.5+ trillion deficits annually, there simply aren't enough dollars in the world (China, Japan, or anywhere else) to suck up this amount of debt. When the US was running $400 billion deficits, the Chinese and other foreigners bought the excess. One fear in America was that, once the deficits reached large levels like what we are running today, the yields on the treasuries would rise causing interest rates to spike upward which in turn would wreak havoc on the economy. For now, the Fed has come up with a solution. A comment below the Zero Hedge article sums it up this way:

It's brilliant, in a way.  A mechanism for loaning into existence money we don't have at a very low cost, with the system perpetuated by the reality that the overall world economy is so messed up, courtesy of the same Primary Dealers, that there aren't that many real alternatives to Treasury investment.  Thus the ability of the Fed to continue loaning money into existence at ridiculously low cost is limited only by an upper bound where 1-3% of the total public debt becomes prohibitively expensive as part of the overall budget. For example, if the public debt becomes $30 trillion, then an average cost of say 2% is still only $600 billion a year, which can be easily managed by cuts in the Pentagon budget and the elimination of any remaining social safety nets.  We've done it, an end run around the Second Law of Thermodynamics.  It's a proud day in America.

So how does this process effect Americans and the economy? Well, for one thing, it keeps inflation in check. The Fed loans the money into existence (at 0.0 - 0.25%), which the banks then use to purchase Treasury bonds (a nice profit at zero risk) instead of making loans into the economy. Over time, the banks are able to recapitalized.  Because the Fed is creating money, and the money is pouring into US Treasuries, the yield remains low, thus the interest payment on the national debt does not explode, but creeps up at a steady pace. This process is wonderful for banks and allows the government to stay in business rather than quickly going the way of Greece.

There are down sides of course. Because the banks have every incentive to purchase treasury bonds and not loan out money, the economy cannot be expanded via loans. Other than large corporations, there isn't much saved capital available to start business.

As government deficits annually top $1.5 trillion ,  interest payments on the debt continue to rise, albeit at a slower rate as long as yields remain low. In order to pay the holders of the debt (think megabanks courtesy of Ben Bernanke), entitlements must begin to shrink and taxes raised. The downsizing of entitlements combined with higher taxes will further shrink the economy and impoverish the citizenry. The remaining assets of the citizenry will simply flow through the government to the megabanks as these entities hold a larger and larger proportion of the national debt. Instead of primarily paying higher taxes to China in exchange for cheap goods, US citizens will pay higher taxes to megabanks in exchange for .... nothing?

For the immediate future, I'm thinking the next two years at least, the United States and the world in general should see lower employment, higher taxes, and lower real estate values. Smallish banks will be taken over and gobbled up by larger banks. The megabanks will continue to reap profits even as they keep depreciating assets off the balance sheet. The argument we continue to hear is that the system is recovering and the process of restoring the banks is essential for a full recovery - even if it destroys the citizenry in the process.