Why you should be watching the Daily Treasury Statement: Figuring out the ‘Deleveraging Pressure’

Here, at greshams-law.com, I update and publish daily treasury statement charts on a regular basis. But why exactly do I bother? Why does it matter? How can it help the contrarian investor?

 

In short, I believe that the daily treasury statement can help us understand the ‘deleveraging pressure’ eminating from the private sector. This is significant because – when the private-sector is under pressure to deleverage – it ends up selling things to ‘buy money’. This can create a cascading set of trades in the current environment and thus can be very bearish for risk assets. I contend that the daily treasury statement can help us figure out the magnitude of the ‘deleveraging pressure’. Combined with a contrarian mindset, these charts can help us execute profitable trades.

 

Debt is a ‘Short on Money’:

 

I often write about debt as a ‘short on money’ here on greshams-law.com. I think that it is an important conception in the current environment. Allow me to explain:

 

Consider what shorting a stock entails. One borrows the stock in question and sells it (for money). At some point, one has to buy that stock back. If one buys back the stock at a low (money) price, one gains; otherwise, one loses. Now consider what taking on a typical debt entails. One borrows a quantity of money and ‘sells’ it for something (e.g. a house). At some point, one has to ‘buy’ that money back. If one ‘buys’ back the money at a low (thing) ‘price’, one gains; otherwise, one loses. In other words, if one sells the thing in question for a higher money price, one gains; otherwise, one loses.

 

Sectoral Balances – Different Sectors take Long/Short Money positions against one another:

 

We can divide an economy’s market participants into three categories; the private sector, the government & the external sector. By noting that GDP = Consumption + Investment + Government Spending + Net Exports = Consumption + Savings + Taxes , we can conclude the following: The private sector balance (net savings) must equal the external sector balance (current account) plus the government-sector balance (surplus/deficit). Thus, by plotting these (see chart below), we can see who owes what to whom.

 

Sectoral Balances US

Click to enlarge. Source: St Louis Fed.

 

The Private-Sector is being squeezed out of its short positions on money; that is, the private sector is deleveraging:

 

After the historic short position in the dollar (debt) taken on by the private sector in 2000, it is now in a trend of paying down its debt. That is, the private sector seems to have reached its maximum capacity for debt (culminating in the TMT bubble), and is now in the process of paying it back – i.e. deleveraging.

 

The essence of this is that people have a profit-motive to sell things to ‘buy money’. As people rush to do this at once, the value of the dollar rises. The implications have been deemed to be socially unpalatable, and thus calls for the government to ‘step in’ have been in full force.

 

The Government is attempting to ‘ease the squeeze’:

 

Due to the unpalatable nature of the deleveraging trend, the government is engaged in a peculiar activity: it is ‘easing the squeeze’.

 

If we think about an orthodox short squeeze in a futures market, we note that it typically involves a group of traders that rush to buy back something at the same time. As everyone does this at the same time, the price must rise to bring out sellers. Well, it would seem that as people – en masse – try to buy back the money they sold short (via debt), the results (massive haircuts on risk assets, foreclosures, etc.) are deemed to be socially unpalatable. Thus, the government are called in to ‘save the day’ (regardless of the economics and morality of this), and are thus acting as the seller of money (i.e. they’re taking on debt). They do so as a crowd-pleaser rather than a profit-seeker – and the implications are profound.

 

The Daily Treasury Statement helps us figure out when they’re ‘easing the squeeze’:

 

Just as short-squeezes are somewhat alleviated by sellers coming to market, so is the private sector ‘deleveraging pressure’ somewhat alleviated by the government spending more than it receives in taxes. Thankfully (for us contrarian speculators), the daily treasury statement gives a day-by-day account of what the government is receiving, and what the government is spending. Thus, as contrarian investors, we can seek to oppose intellectual convictions about the future during periods where the daily treasury statement suggests the contrary. For example, if people are outrightly bearish, and at the same time the government is spending like never before, we can seek to engage in bullish trades. Likewise, if people are outrightly bullish, and at the same time the government is – on a net basis – accumulating cash, we can seek to engage in bearish trades.

 

Conclusion:

 

By plotting the data from the daily treasury statements, we have a rough guide of the degree of ‘deleveraging pressure’. As contrarian investors, we can find opportunities to execute trades.

 

Posted Mar 29, 2011

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