POMO, or Permanent Open Market Operations, see this, is one of the newest acronyms to hit the streets. The caption below is taken from the FOMC website:
The purchase or sale of Treasury securities on an outright basis adds or drains reserves available in the banking system. Such transactions are arranged on a routine basis to offset other changes in the Federal Reserve’s balance sheet in conjunction with efforts to maintain conditions in the market for reserves consistent with the federal funds target rate set by the Federal Open Market Committee (FOMC).
We ask our readers to focus on the bold text above. It appears as if the FED is using POMOs as a means to keep interest rates low in keeping with their target Fed Funds rate. But what is actually going on? It sure seems like market manipulation, but I guess no one really cares as long as the end result is higher stocks and a well bid treasury market.
The problem here is not simply in the POMO activities, but the combination of POMO along side of other stimuli present in today’s markets. What we present here is a simplified explanation though we are confident in having highlighted the major principles of the strategy. Primary Dealers (PDs) are the large banks that buy up US Treasuries and then sell them off to individual investors. What the PDs are able to do is borrow funds at super low rates through the FED’s discount window. What appears to be happening is that these PDs are borrowing FED money, and using it to buy US treasuries ahead of POMO days. Since these POMOs have become an almost daily occurrence, this has become a large part of the stealth monetization taking place right in front of our eyes.
On the POMO days, the FED is buying back previously issued treasuries to the tune of a couple billion/day. The PDs have been able to benefit from these actions as buying a US treasury ahead of the POMO almost guarantees them the ability to sell it back to the FED a few weeks later at a higher price. No one is better than this than PIMCO’s Bill Gross, who hinted in a recent interview that he may have access to information weeks ahead of the rest of us. See this.
Anyway, the PD’s buy USTs with borrowed money from the FED, then turn around and sell them to the FED for a profit. What does the FED get out of this aside from an increasing balance sheet? It gets to keep interest rates low, though a strong bid for Treasuries, and the resulting profits given to the PD’s through the POMO days often rotate right into the stock market. This is truly an ingenious idea on the FED’s part if it were not for the seemingly limitless amount of debt incurred though said transactions. The bottom line for most is that interest rates remain low while the stock market stays elevated. This is precisely what the FED wants. They also want you to be ignorant of the fact that these debts will eventually have to be paid.
The only way to effectively pay this debt off is by devaluing the dollar, which of course is happening right now. The end result is that the price of gold and commodities continue to rise. I am sure that we will hear at some point soon that inflation in the price of goods is a healthy sign of growth to come, but this sure seems like the beginning of the end to me. All that is really going on is that the FED is sacrificing our future to make things look better for the time being. Volume has been absolutely abysmal in the recent stock rally, indicating that no real buying is occurring. Tie in the POMO days with the positive feedback algorithms know as the HFTs, and you get a stock market that continues to run higher on light volume. Any analyst will tell you that bull markets are not formed with weak buying. Should the switch be turned off on the POMOs, what will happen to the stocks and treasuries? The FED has backed themselves into a corner on this one, and the only outcome I see is an eventual collapse of epic proportions. Of course, the FED could keep on printing money to run these POMOs, giving the banks even more underserved profits but it will eventually lead to a global shunning of the US dollar. The only saving grace at the moment is that everyone else in the world is in the same shitstorm as the US. Hopefully this will be enough to keep the relative weakness of the US dollar from turning into an outright collapse but I fear it will not.
These are complicated times, filled with corruption and shell games going on right in front of us. It is worth noting one key point here. Market manipulation was blamed when Crude Oil prices rose above $140/barrel in the summer of 2008. This led to higher prices at the pump and the world was screaming for a stop to all the market manipulation and speculation running rampant. Yet today we are witnessing an event of substantially larger proportions but no one seems to care. I guess if the end result is a higher stock market and low interest rates it doesn’t bother anyone. Forget the long term results, like a weaker dollar and continued anemic growth, today’s positive close in the stock market is all that matters.
Here is what I think a best case scenario will be through such intervention. The dollar will continue to weaken, but given that whole world faces a similar problem, the next few years will be consumed with wild swings in the FX markets as each central bank tries to kill its own currency for the sake of paying off future debts. A global devaluation of currency will keep the US dollar from falling all by itself, but it will have further ramifications. The price of hard goods like food, energy, and metals will begin to skyrocket. Something has to maintain value as investors seek a store of value, money will flood into the commodities markets. This is happening right now, as grains and metals continue their parabolic move higher.
So the price of goods will increase, but without the coinciding increase in wages. In fact, the increasing debt load and low rate schedule will only make it harder for the banks to remain competitive and profitable. This in a sense will take away their desire to lend to individuals or small businesses. In fact why lend to anyone when the POMO scam is such a great way to make short term, guaranteed profits? This will precede a period of stagnant wage growth combined with an increase in the cost of goods. Sadly it will probably not mean an increase in home values as debt based investments will take the heap of deflation that everyone is talking about while inflation runs rampant in the hard goods sector.
What we need now is for the FED to stop all intervention in the markets. True, it would probably lead to a collapse in the stock market and soaring interest rates. But shouldn’t the “free markets” be allowed to find their own bottom. Only then will true buyers re-emerge and start to right our swinging ship back towards the correct course. It will mean more pain in the short term but less in the long run. The actions taken by the Central Banks today will likely only prolong the duration of the current depression we face. In the end the markets will make their way to a bottom at some point, but how much debt will we as tax payers be on the hook for when all is said and done? The only way the US can pay these debts without taxpayer money is to print money which only dilutes the value of the US dollar. The only way to not dilute the value of the dollar is to charge higher taxes from those that actually need stimulus, the individuals. Markets don’t go up forever, nor should they be forced to do so. At some point they will fall and no amount of printed money will stop it.
If you have read this and thought well I’ll just keep my money in stocks because the FED keeps rolling money into the stock market, think of this fun fact. Even though the DOW is now back to where it once was in the early part of this decade, the value invested is down about 30% due to a severely weakened dollar. The only real store of value though this time frame has been gold.
For a great interview check out this one from the European side of CNBC which still maintains a modicum of credibility.
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