Guest Post – The Path Of Easiest Profit

Submitted by reader JMD*.

A lot of hullabaloo is made of the ‘flight to safety’ in ‘investor’ circles, a rising price of the US Treasury bond or rising exchange rate of the US dollar is a ‘flight to safety’. Suddenly ‘risk assets’ become a bit too risky & there is a rush to sell for the ‘safest’ securities. Even a rising gold price is considered a ‘flight to safety’ at times but then when the gold price falls it’s suddenly ‘risk off’. This scenario doesn’t make a lot of sense, either gold is safe or it isn’t & why are ‘investors’ worrying about US dollar devaluation one minute & eagerly bidding for it the next?

The whole concept of ‘safety’ is a false premise, maybe dreamed up by some turkey at the Bank of England decades ago, or some such, to obfuscate the real reason.

What drives the ‘money’ markets is not ‘safety’, or ‘risk on’ or ‘risk off’ but ‘profit‘. A good analogy is water flowing down a hill, it follows the path of least resistance. In the case of the ‘money’ markets, it can be described as the ‘money’ follows the path of easiest ‘profit’.

So what is this ‘profit’ & where is it coming from? The ‘profit’ is rising prices on financial ‘securities’ – bonds, notes & bills – particularly, though not exclusively of the government variety. The ‘profit’ is coming from government, through its central banking arm. As GSI’s Keith Weiner describes, US Treasury bonds (also Japanese, British, Australian, in fact government bonds of most ‘developed’ nations) have been in a ‘bull market’ since at least 1982. By ‘bull market’ is meant rising prices. As an ‘investor’ in government bonds you would have been unlucky not to have made a healthy ‘profit’ from your ‘governments’ at any time in the last 30 years, almost a generation.

Central banks are the ‘purveyors of profit’ in the ‘money’ markets, after all, they issue the currency, they are the market makers. There has been no more consistent ‘profit’ made than in government bonds for the last 30 years. How so? Easy, central banks either lend against or buy outright large amounts of government bonds for their own ‘portfolio’, they bid up the price (denominated in their own obligation) of government bonds. As I alluded to in the paragraph above however, central banks are not restricted to government bonds, they can & do manipulate ‘money’ market spreads by bidding for ‘private securities’. They can, if they wish, hand easy ‘profits’ to ‘investors’ in bank bills, corporate debt & even ‘equities’.

I’ll give you what I think are two good examples of the ‘money’ following the path of easiest ‘profit’, though I’m sure many more can be found.

The first is the recent earthquake & tsunami in Japan. Upon the news, the Yen began to soar against many other currencies, silver fell 6-7% in the space of a few hours, gold was well down, as were share- markets & not just in Japan. It is incongruous that a devastating natural disaster, killing tens of thousands of people & destroying property & livelihoods would have ‘investors’ rabidly bidding up the Yen – natural disasters lead to an increase in productivity? I read how it was Japanese institutions ‘repatriating’ their overseas investments for reconstruction & so on but a more logical explanation was a move to ‘front run’ the ‘big easy’, the Bank of Japan.

The Bank of Japan is notorious for its ‘easy money’ policies. I have no doubt that ‘investors’ speculated on the BoJ ‘easing’ in response to the disaster, that is, they would bid up bond prices & not just government bonds. The ‘investors’ would buy low & sell high.

If you go back to 1995 you will see similar moves in the Yen, right about the time of the devastating Kobe earthquake. Speculating on central bank ‘profit’ has been around for a while.

The second is the very recent announcement by the Fed of ‘Operation Twist’. Upon announcement of the Fed buying, so bidding up, longer term government bonds – gold, silver, oil, share-markets & currencies, in fact you name it, lost their bid against the US dollar & government bonds, particularly the 10 & 30 year. The reason is obvious, ‘investors’ speculating on easy ‘profits’ in the government bond market, as Keith Weiner says “engineered by the Fed”, the ‘investors’ would buy low & sell high.

Having said all this, there is one issue I haven’t addressed & that is as Keith Weiner also says, “the money comes from the capital account of the bond issuer. The speculator carries the bond on the asset side of his balance sheet. The issuer carries it on the liabilities side. No matter whether the issuer marks the liability to market, or not, the loss is taken.” The bureaucrats in Treasury & central banks are neither alchemists or gods, they cannot transmute lead into gold or water into wine. Certainly they can steal the “bread from the mouth of labour” but still, the loss must weaken the credit of the government, there is no way around this. Yet ‘investors’ still rush to bid for government bonds when they think, or know, central banks are handing them easy ‘profits’. This just reinforces my point, ‘investors’ care nothing for safety, the concept is bogus. ‘Profit’ is where it’s at.

It is tempting to speculate that the game will continue until no more ‘profit’ can be given, when the yield curve flattens to a point where it just cannot flatten any further. Can the government issue 30yr bonds with a 0% coupon (no ‘profit’ there) & their credit remain ‘money good’? I guess we’ll find out but I suspect the rising gold price since the Bank of Japan’s overnight rate hit 0% for the second time in 2000, is saying that it won’t.

[This article was originally published by the Gold Standard Institute]

Disclaimer: The views expressed in the above article are the author’s own. They should not be interpreted as reflecting any views held by Senator Barnaby Joyce, The Nationals, or by the barnabyisright.com blog author.

* Please see also JMD’s previous Guest Posts –

Infinite Money

The ‘Moneyness’ Of Debt

Why The RBA Sold Our Gold

Our Government Debt Crisis Is Already Here

Tags: bank of japan, bond yields, central banking, flight to safety, gold standard institute, government bonds, operation twist, speculation