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Is it all just a Ponzi scheme?

Douglas Caddy

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Is it all just a Ponzi scheme?

By: Eric Sprott & David Franklin

December 2009

Sprott Asset Management LP


In our May/June Markets at a Glance, "The Solution…is the Problem", we discussed how

much debt the US government would need to issue in order to balance the budget for

fiscal 2009. We calculated they would need to sell $2.041 trillion in new debt - or almost

three times the new debt that was issued in fiscal 2008. As a thought experiment, we

separated all the various US Treasury owners and asked our readers whether each group

could afford to increase their 2009 treasury purchases by 200%. In the end, we surmised

that most groups couldn’t, and prepared our readers for the worst.

Almost seven months later, however, nothing particularly bad has happened on the US

debt front. There have been no failed auctions, no sovereign defaults, no downgrades of

debt and no significant increase in rates…not so much as a hiccup in the treasury market.

Knowing what we discussed this past June, we have to ask how it all went so smoothly.

After all – it was pretty obvious there wasn’t enough buying power to satisfy the auctions

under ‘normal’ circumstances.

In the latest Treasury Bulletin published in December 2009, ownership data reveals that

the United States increased the public debt by $1.885 trillion dollars in fiscal 2009.1 So

who bought all the new Treasury securities to finance the massive increase in

expenditures? According to the same report, there were three distinct groups that bought

more than they did in 2008. The first was "Foreign and International Buyers", who

purchased $697.5 billion worth of Treasury securities in fiscal 2009 – representing about

23% more than their respective purchases in fiscal 2008. The second group was the

Federal Reserve itself. According to its published balance sheet, it increased its treasury

holdings by $286 billion in 2009, representing a 60% increase year-over-year.2 This

increase appears to be a direct result of the Federal Reserve’s Quantitative Easing

program announced this past March. Most of the other identified buyers in the Treasury

Bulletin were either net sellers or small buyers in 2009. While the Q4 data is not yet

available, the Q1, Q2 and Q3 data suggests that the State and Local governments and

US Savings Bonds groups will be net sellers of US Treasury securities in 2009, while

pension funds, insurance companies and depository institutions only increased their

purchases by a negligible amount.

So who was the third large buyer? Drum roll please,... it was "Other Investors". After

purchasing $90 billion in 2008, this group has purchased $510.1 billion of freshly minted

treasury securities so far in the first three quarters of fiscal 2009. If you annualize this rate

of purchase, they are on pace to buy $680 billion of US treasuries this year - or more than

seven times what they purchased in 2008. This is undoubtedly the group that made the

US deficit possible this year. But who are they? The Treasury Bulletin identifies "Other

Investors" as consisting of Individuals, Government-Sponsored Enterprises (GSE),

Brokers and Dealers, Bank Personal Trusts and Estates, Corporate and Non-Corporate

Businesses, Individuals and Other Investors. Hmmm. Do you think anyone in that group

had almost $700 billion to invest in the US Treasury market in fiscal 2009? We didn’t

either. To dig further, we turned to the Federal Reserve Board of Governors Flow of

Funds Data which provides a detailed breakdown of the owners of Treasury Securities to

Q3 2009.3 Within this grouping, the GSE’s were small buyers of a mere $5 billion this

year;4 Broker and Dealers were sellers of almost $80 billion;5 Commercial Banking were

buyers of approximately $80 billion;6 Corporate and Non-corporate Businesses, grouped

together, were buyers of $11.6 billion, for a grand net purchase of $16.6 billion.7 So who

really picked up the tab? To our surprise, the only group to actually substantially increase

their purchases in 2009 is defined in the Federal Reserve Flow of Funds Report as the

"Household Sector". This category of buyers bought $15 billion worth of treasuries in

2008, but by Q3 2009 had purchased a whopping $528.7 billion worth. At the end of Q3

this Household Sector category now owns more treasuries than the Federal Reserve


So to summarize, the majority buyers of Treasury securities in 2009 were:

1. Foreign and International buyers who purchased $697.5 billion.

2. The Federal Reserve who bought $286 billion.

3. The Household Sector who bought $528 billion to Q3 – which puts them on

track purchase $704 billion for fiscal 2009.

These three buying groups represent the lion’s share of the $1.885 trillion of debt that was

issued by the US in fiscal 2009.

We must admit that we were surprised to discover that "Households" had bought so many

Treasuries in 2009. They bought 35 times more government debt than they did in 2008.

Given the financial condition of the average household in 2009, this makes little sense to

us. With unemployment and foreclosures skyrocketing, who could afford to increase

treasury investments to such a large degree? For our more discerning readers, this

enormous "Household" investment was made outside of Money Market Funds, Mutual

Funds, ETF’s, Life Insurance Companies, Pension and Retirement funds and Closed-End

Funds, which are all separate reporting categories.9 This leaves a very important question

- who makes up this Household Sector?

Amazingly, we discovered that the Household Sector is actually just a catch-all category.

It represents the buyers left over who can’t be slotted into the other group headings. For

most categories of financial assets and liabilities, the values for the Household Sector are

calculated as residuals. That is, amounts held or owed by the other sectors are subtracted

from known totals, and the remainders are assumed to be the amounts held or owed by

the Household Sector. To quote directly from the Flow of Funds Guide, "For example, the

amounts of Treasury securities held by all other sectors, obtained from asset data

reported by the companies or institutions themselves, are subtracted from total Treasury

securities outstanding, obtained from the Monthly Treasury Statement of Receipts and

Outlays of the United States Government and the balance is assigned to the household

sector." (Emphasis ours)10 So to answer the question - who is the Household Sector?

They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the

Federal Reserve’s Flow of Funds report.

Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all

know that the Fed has been active in the market for T-bills. As you can see from Table A,

under the auspices of Quantitative Easing, they bought almost 50% of the new Treasury

issues in Q2 and almost 30% in Q3. It serves to remember that the whole point of selling

new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing

debts that are maturing. We are now in a situation, however, where the Fed is printing

dollars to buy Treasuries as a means of faking the Treasury’s ability to attract outside

capital. If our research proves anything, it’s that the regular buyers of US debt are no

longer buying, and it amazes us that the US can successfully issue a record number

Treasuries in this environment without the slightest hiccup in the market.

Perhaps the most striking example of the new demand dynamics for US Treasuries

comes from Bill Gross, who is co-chief investment officer at PIMCO and arguably one of

the world’s most powerful bond investors. Mr. Gross recently revealed that his bond fund

has cut holdings of US government debt and boosted cash to the highest levels since

2008.11 Earlier this year he referred to the US as a "ponzi style economy" and

recomended that investors front run Uncle Sam and other world governments into

government debt instruments of all forms.12 The fact that he is now selling US treasuries

is a foreboding sign.

Foreign holders are also expressing concern over new Treasury purchases. In a recent

discussion on the global role of the US dollar, Zhu Min, deputy governor of the People’s

Bank of China, told an academic audience that "The world does not have so much money

to buy more US Treasuries." He went on to say, "The United States cannot force foreign

governments to increase their holdings of Treasuries… Double the holdings? It is

definitely impossible."13 Judging from these statements, it seems clear that the US cannot

expect foreigners to continue to support their debt growth in this new economic

environment. As US consumers buy fewer foreign goods, there are less US dollars

available for foreigners to purchase future Treasury securities. Foreigners are the largest

source of external capital that can be clearly identified in US Treasury data. If their

support wanes in 2010, the US will require significant domestic support to fund future debt

issuances. Mr. Gross’s recent comments suggest that their domestic support may already

be weakening.

As we have seen so illustriously over the past year, all Ponzi schemes eventually fail

under their own weight. The US debt scheme is no different. 2009 has been witness to

spectacular government intervention in almost all levels of the economy. This support

requires outside capital to facilitate, and relies heavily on the US government’s ability to

raise money in the debt market. The fact that the Federal Reserve and US Treasury

cannot identify the second largest buyer of treasury securities this year proves that the

traditional buyers are not keeping pace with the US government’s deficit spending. It

makes us wonder if it’s all just a Ponzi scheme.

1 Department of the Treasury (December 2009) Treasury Bulletin. Ownership of Federal Securities p48.

Table OFS -2 –

Estimated Ownership of U.S. Treasury Securities.. Retrieved on December 20, 2009 from:


2 Federal Reserve Statistical Releases H.41. Release September 25, 2008 and Release September 24,


Retrieved on December 20, 2009 from: http://www.federalreserve.gov/releases/z1/Current/

3 Federal Reserve Statistical Release Z.1 Flow of Funds Accounts of the United States

(December 10, 2009)

Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009. Table L.209

Treasury Securities pg.89.

Board of Governors of the Federal Reserve System. Retrieved on December 20, 2009 from:


4 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89, Line 29.

5 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89, Line 31.

6 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89, Line 13.

7 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89, Line 8 and 9.

8 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89. Line 12 Monetary Authority had a Treasury Securities balance of $769.2 billion

and Line 5 the

Household Sector held a balance of $801.6 billion

9 Flow of Funds Accounts of the United States Flows and Outstandings Third Quarter 2009.

Table L.209

Treasury Securities pg.89, Lines 25, 26, 28, 21, 22, 23, 24, 27..

10 Guide to the Flow of Funds Accounts, Volume 1, page 170. Retrieved on December 20, 2009 from:


11 Goodman, Wes. (December 17, 2009). Pimco’s Gross Boosts Cash to Most Since Lehman Failed.

Business Week Retrieved on December 20, 2009 from:


12 Gross, Bill (January 2009). Andrew Mellon vs. Bailout Nation. Investment Outlook. Retrieved on

December 20, 2009 from:



13 Xin, Zhou and Jason Subler (December 18, 2009). Harder to buy US Treasuries. Shanghai Dialy.

Retrieved on December 22, 2009 from:


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200 Bay Street, Suite 2700, Toronto, ON M5J 2J1


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(for different reasons),

(fort knox needs to be meticulously catalogued.)

as the system convolutedly pass the iou's down the line, massive dormant funds are served uo as gurantees in carefully crafted acquisitions, knowing all along that when this false economy runs out of steam it's not the fund managers who are going to suffer.

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Guest Tom Scully

For the past 25 years, the US trade deficit was financed via a scheme that enabled the US to run annual import/export imbalances that so far have peaked at over $900 billion in 2007.

The scheme effected seemed to suit everyone; the petroleum exporting countries, the exporters of popular and hight tech consumer goods (Japan) and cheap, manufactured items stocked on the shelves in 3800, US Walmart stores.

An example of how it works is, US dollars end up in the Tokyo corporate accounts of Toyota World HQ. The Toyota parent Corp., based in Tokyo, exchanges the US dollars flowing into its accounts, for Japanese yen neede by Toyota to pay for domestic operations, salaries bonuses, etc.

The Japanese government simply "prints" from thin air (probably as a line item entry on the books of Tokyo banks doing the dollar/yen exchanges) "new" yen, in exchange for the dollars.

The ever increasing total number of yen existing, (or the yuan, using China as another example) serves to leep the yen from rising too rapidly against the also, ever expanding numbers of dollars, enabling the exports of Japan or of China to perpetually remain competitively prices, insuring the perpetual demand from the US consuming public, the engine od world economic growth during this period in history.

The huge numbers of dollars, purchased by Japan and China from their home based exporters, with yen or yuan created by the governments of these major exporters literally out of thin air, cost them nothing to create, and serve to keep their own currencies rising against the debt handicapped dollar. Amazingly, oil exporting nations continue to accept these propped up dollars in exchange for the finite petroleum resources they can temporarily pump from the ground in abundance, funding their own growth and development activities, for the time being.

The governments of these exporters, having no pressing use for all of the dollars they took in at almost no cost to them, supported the US government's ability to increase it's national debt by $5 trillion, just during the 8 years of the Bush term, by using the dollars they purchased with yen and yuan they created out of thin air, to finance the US

debt by buying US treasury bills with the dollars.

This scheme worked so well that the US Treasury exchanged all of its longer term debt for shorter maturities, below ten years, at a savings in interest rates that permit the recent $11 trillion debt to be sustained at an annual interest expense of $350 billion. This causes a challenge because annually, a chunk of the short term debt must be refinanced as it matures, at the same time as massive new debt occurs and must also be financed.

The point is that nothing has changed, even if former large buyers of US Treasury bills like Japan and china become net sellers instead of buyers. The US Federal Reserve, can, and is, simply creating dollars out of thin air to "purchase" the massive new issuance of Treasury Bills.

China and Japan still must keep their own currencies from rising against the dollar, especially in a world climate of lowered demand and all exporting countries working to keep the values of their own currencies from rising.

There seems to be a greater chance of capacity to produce exports; manufactured goods and commodities causing deflation of prices than there does a devaluation of the dollar spurred by the creation of ever more dollars to fund the "phantom buying" of US Treasuries.

It also seems that weak demand will be a long term problem, and that the Euro will decline in value compared to the

dollar, over the next several years, at the least.

If it is true that deflation is the biggest risk as a result of over investment in capacity to produce manufactured goods and commodities, an overcapacity due to lag time in the completion of projects begun near the end of the recent boom cycle, the present state of the US fiscal house, necessitating the wholesale creation of new Treasury bill issuance and of dollars to "phantom buy" them, as a buyer of last resort, could not have come at a better time.

The signs that this is an apt assessment are that gold, petroleum, and producer prices seem to have stagnated with no cllear direction, and so have interest rates. More are unemployed in the US and in Europe every month, and the populations in Europe and Japan increase in average age to the point where consumption potential in their home markets diminishes with time. The large wave of the baby boomer generation in the US become net sellers, not buryers, as hopes that the passage of time will bring economic recovery are further pressured by the reduction of artifical stimulus through government spending.

For debtors, there is nothing worse that can happen than deflation, and no better devlopment than inflation, expecially if they are able to pick an opportune time in the current climate of low interest rates to lock in low, fixed inrerest, long term refinancing.

Nobody knows for certain, what will happen, Douglas, but would the near term be any better if the US found itself with a balanced budget and the national debt at year 2000 levels? We have built ahead enough vacant commercial and residential structues in the US to fill any emerging demand for the next ten years. I'll guess it is the same in some European countries, and probably in China's coastal areas, as well.

Corporatism masqerading as a "free enterprise system" doesn't work, and it will end like it always does, in war, acute dislocation and destruction, but...out of the ashes will emerge....besides, the US has the most aggressive and overbuilt, overcapable military, and as an endgame, our government can always threaten to, or even default on its debt obligations, or more likely, use the unspoken threat of military action to negotiate new, more favorable terms.

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