Published March 28, 2014

Is Putin Quietly Dumping Russia’s US Treasuries?

Dear Reader,

Because this edition of The Room is bursting at its digital seams, I’ll quickly introduce my three coauthors, then step out of the way.

First up is Doug French with a brief history of how Putin has been outmaneuvering the US for longer than you think.

Then, Kevin Brekke does some impressive sleuthing to figure out which country just dumped over $100 billion in US debt in one week. Might it be Putin’s doing?

And last but not least, I’m happy to announce that Gerald Simmons of California is the winner of the Casey Research Storytelling Contest. You’ll find his winning story—a fine piece of short fiction—below.

And don’t forget to check out the Friday Funnies.

Let’s get to it…

Putin and Obama Play Chess

Doug French, Contributing Editor

President Obama may have just turned the G8 into the G7 and dismissed Russia as a “regional power,” but this is no Bobby Fischer vs. Boris Spassky. In this geopolitical chess match, the Russian is outmaneuvering the American at every turn.

Putin’s antics are nothing new—he’s been quietly undermining the US for over a decade. Let’s examine some of his more successful gambits from the past, and see what they can tell us about the present.

Dropping Financial Bombs

In 1998, Russia defaulted on $40 billion of domestic debt, forcing the Federal Reserve to engineer a bailout of hedge fund Long Term Capital Management.

Three years later, Putin used the distraction of the Olympics to invade US ally Georgia. While the world was focused on the Beijing games, the Russian leader told George W. Bush, “War has started.”

But the Georgia invasion was nothing compared to the bomb Russia was dropping on US markets. Treasury Secretary Hank Paulson was in Beijing for a family trip to see the games, but he worried about Fannie and Freddie the whole time, as he was told the Russians had approached the Chinese to work together to dump their Fannie Mae and Freddie Mac shares.

In his book On the Brink, Paulson wrote the motivation was “to force the US to use its emergency authorities to prop up these companies.” He went on, “The report was deeply troubling—heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets. I waited till I was back home and in a secure environment to inform the president.”

Of course, Putin spokesman Dmitry Peskov denied the bear raid conspiracy. To this day, the former Treasury secretary claims the two countries never carried out the plan. However, Russia did unload all $65.6 billion of its Fannie and Freddie debt that year.

As for the Chinese, Aaron Back reported for the Wall Street Journal in 2011, “China’s selloff of Fannie and Freddie securities in 2008 was widely credited with pushing up mortgage rates in the US at a time Washington was struggling to revive housing sales.”

He cited US Treasury data, writing, “China has been steadily selling its holdings of agency securities since mid-2008. It sold a net $24.67 billion worth of agency securities in 2009, and $27.35 billion in the first 11 months of 2010, according to the data.”

In the end, less than a month after Paulson was given that information in Beijing, the US government took over Fannie and Freddie and placed them into conservatorship.

Putin the Loan Shark

How many of the world’s leaders would have the foresight to structure a loan as a private-sector eurobond? One sovereign-debt expert called the structure of Russia’s $3 billion loan to Ukraine “clever.”

Here’s why: instead of handing aid money directly to Ukraine, Russia had the Ukrainian government float $3 billion in bonds denominated in euros. Russia then bought the bonds. But that’s not all—the Russians had a provision written into the bond that if the Ukraine’s debt-to-GDP level reached 60%, Russia could call the bonds for immediate payment.

Such a qualification in government bonds is very unusual. Mitu Gulati, a sovereign-bond expert, says he has never seen a government bond with a similar debt-to-GDP provision. Most sovereign debt is ‘covenant-lite.’”

Today, Ukraine has eurobonds outstanding to several countries, so stiffing only Russia isn’t an option, because it would hurt the price of all their debt. America’s beltway pundits agitating for a large aid package to Ukraine should realize that Putin’s foresight ensures that any US aid money will find its way to Moscow.

More Smart Than Lucky

After being out of office four years, Putin took over again in 2012. A year later, the Russian president didn’t just say the US was endangering the global economy with its dollar monopoly—he put Russia’s money where his mouth was. Putin made sure the world’s largest oil producer would become the biggest gold buyer as well, adding 570 tonnes in the last ten years, much of it on his watch.

“The more gold a country has, the more sovereignty it will have if there’s a cataclysm with the dollar, the euro, the pound, or any other reserve currency,” Evgeny Fedorov, a lawmaker for Putin’s United Russia, said in a telephone interview with Bloomberg.

Putin had his central bank start loading up on the yellow metal when the price was just $495 an ounce. This makes him either smarter or luckier than, say, former UK finance minister Gordon Brown, who sold 400 tonnes of the metal when gold traded under $300.

It’s safe to say Putin is smarter than your average politician. For instance, Saudi Arabia’s influential intelligence chief, Prince Bandar bin Sultan, met with Putin last year and offered to buy $15 billion worth of arms from Russia in return for Putin abandoning his support of Syria. Bandar even assured Putin that the Saudis would never sign an agreement allowing a gulf state to ship gas through Syria.

Putin just laughed. He knows a pipeline through Syria would mean Russia’s Gazprom would lose its European gas business to Qatar.

Zero Hedge pointed out last August, “What is shocking in all of this is that Saudi Arabia was so stupid and/or naïve to believe that Putin would voluntarily cede geopolitical control over the insolvent Eurozone, where he has more influence, according to some, than even the ECB or Bernanke. Especially in the winter.”

Saudi promises or not, Putin’s no dummy. Europe obtains 30% of its natural gas from Russia and half of that runs through Ukrainian pipelines. Putin’s energy stranglehold is strongest in Eastern Europe, where several individual countries are at Russia’s mercy: Slovakia relies on Russia for 93% of its gas; Poland (83%), Hungary (81%), the Czech Republic (66%), and Austria (61%) are captive customers of Russia, too.

Ukraine’s prime minister, Arse Yatsenyuk, says Russia could use energy as a “new nuclear weapon.” As it is, Ukraine is $1.89 billion behind in payments to Russian company Gazprom for gas.

Shunned by the West, Putin Looks East

Putin has been a laughingstock in the West for spending a reported $60 billion on the Sochi winter games. But while the world was focusing on curling and ice dancing, he was amassing troops at the Crimea border and managed to engineer a bloodless annexation before the Paralympics were over.

In response, the most powerful country in the world sanctioned a few Russian individuals and a mid-size bank Putin does business with. This toothless action gave Putin another laugh, and he responded by imposing some sanctions of his own on John Boehner, Harry Reid, and others, as well as 13 Canadians.

While Obama and Angela Merkel make nasty noises in Russia’s direction, Reuters reports, “The Holy Grail for Moscow is a natural gas supply deal with China that is apparently now close after years of negotiations. If it can be signed when Putin visits China in May, he will be able to hold it up to show that global power has shifted eastwards and he does not need the West.”

“The worse Russia’s relations are with the West, the closer Russia will want to be to China. If China supports you, no one can say you’re isolated,” said Vasily Kashin, a China expert at the Analysis of Strategies and Technologies (CAST) think tank.

Russia is also looking to redirect the flow of its oil. “Russia is trying to diversify its energy flows away from its core European markets,” according to Reuters, “with Rosneft leading the race with plans to triple oil flows to China to over 1 million barrels per day in coming years.”

Rosneft is the top oil producer in the world and is run by Putin ally Igor Sechin. Sechin wrapped up a recent Asian trip by meeting with the folks at India’s state-run Oil and Natural Gas Corp ONGC, Reliance Industries, an Indian conglomerate, and India’s biggest refiner Indian Oil Corporation. China and India’s combined population is over 2.5 billion. That’s a lot of potential customers.

Experience Matters

Vladimir Putin worked as a KGB officer stationed in East Germany from 1975 to 1989. While the future Russian president worked the front lines of the Cold War, the future US president was going to high school in Hawaii, followed by college in Los Angeles and New York, before heading to Chicago to become a community organizer.

When Putin was instructing his central bank to buy gold, Barack Obama was learning to navigate Capitol Hill as a freshly minted US senator. Obama was on the presidential campaign trail spouting empty campaign slogans when Russia orchestrated the meltdown of Fannie and Freddie.

Today, Obama is waging multiple wars around the globe while gumming up the US economy with increased regulation and the highest corporate taxes in the world. Putin? He’s busy selling oil and gas and buying gold. It doesn’t seem like a fair fight.

Besides having gold, oil, natural gas, palladium, and any number of other critical natural assets, Russia has improved its government’s finances manyfold while the United States has been borrowing its way to insolvency. Russia’s current debt-to-GDP ratio is 8.4%, after being a reported 57% when it defaulted on its debt. Uncle Sam is going in the opposite direction. US debt to GDP was 60% when Russia defaulted in 1998—now it is over 100%.

The bottom line is that Russia is anything but “regional.” Obama should realize Putin’s ground troops are the least of America’s worries. The Russian president’s financial moves are what affect us all. And he’s running circles around Obama in the places it counts—from forging relationships with China and India to his accumulation of gold.

You’re probably wondering how to make money while Putin schools the teleprompter-in-chief. Casey Research Chief Economist Bud Conrad penned an excellent piece on Ukraine and Putin in last week’s Dispatch, and it was just an appetizer for his in-depth report coming in the April Casey Report.

Click here to take The Casey Report for a risk-free spin, and to get Bud’s upcoming in-depth analysis hot off the digital press.

A Few Bumps on the Way to the Dump

Kevin Brekke, Editor, Metals & Mining Division

“Fed-watching.” With the emergence of hyper-interventionist US Federal Reserve monetary policy, keeping watch over the Fed’s every move has become a spectator sport within much of the financial community. The vast data universe of statistics published by the Fed is now monitored with near Sherlock Holmes-like scrutiny.

The Fed’s menagerie of asset purchases and bond buying programs has launched its balance sheet on a moon shot. By now, most of us are familiar with the story, but to save a thousand words, here’s the picture:

In December 2002, the Fed’s holdings totaled US$719 billion. By March 2014, they have grown to US$4.18 trillion. That’s an increase of 480%, the bulk of which has occurred since 2008. The value of the Fed’s assets now exceeds the annual budget of the US federal government.

As the balance sheet has continued to balloon, so has unease about how the Fed will eventually unwind and exit its holdings.

Even Ben Bernanke expressed concern. “As the balance sheet of the Federal Reserve gets large, managing that balance sheet, exiting from that balance sheet become more difficult,” he said at a Washington press conference last December.

Treasury Ownership: Who’s Buying and Selling

Aside from the size and fate of the assets on the Fed’s balance sheet, unease also grows about another issue: who will continue to buy all that government paper?

The central cog in the series of quantitative easing machinery is the outright purchase of bonds by the Federal Reserve. The purchases were made with the intent to drive down, and keep down, interest rates. That, in turn, meant rates on US Treasury bonds would be suppressed and lower the finance cost of US borrowing.

Seemed fine and dandy.

But someone has to buy the US debt, and a large slice of debt is held by foreign investors. More to the point, trillions of dollars of US debt is in the hands of foreign governments.

The US’s reliance on the kindness of strangers to finance its deficits has alarmed Fed watchers for years. If foreign buyers begin to buy less US debt—commonly referred to as the “dumping” of US debt—that could drive up yields on Treasury paper and seriously impact the US budget and the government’s ability to finance chronic deficit spending. So, investors pay particular attention to the Federal Reserve’s custody holdings.

The Federal Reserve summarizes its balance sheet in weekly Statistical Release H.4.1. Within the release is a line item labeled “Marketable US Treasury securities held in custody for foreign official and international accounts.” These are basically US Treasury securities held at the Fed on behalf of foreign central banks.

The Statistical Release for the week ending March 12, 2014 sent Fed watchers into speculation overdrive. The release showed that custody holdings fell US$104.5 billion from the prior week. This was the largest weekly decline on record by a wide margin:

Speculation is that Russia sold, or “dumped,” billions of dollars in Treasury holdings in response to the sanctions imposed by Western governments over Russian actions in Crimea.

Although the wholesale dumping of US debt is possible, it does not look likely on this scale. For one thing, the repatriation of billions of US dollars would require the Central Bank of Russia (CBR) to enter the foreign exchange markets and buy rubles. Not much point for Russia to sell its US bonds, then keep the proceeds in US dollars.

The CBR releases its foreign exchange activity with only a two-day lag. For the week prior to the Fed’s Statistical Release that revealed the big drop in foreign holdings, the CBR only bought US$11.1 billion of rubles. That doesn’t even come close to smoking-gun type of evidence.

We’ll Gladly Pay You Tuesday for Custodial Services Today

Another line of inquiry leads us to the Treasury International Capital (TIC) statistics. Here, too, like the custody holdings stats from the Fed, we can find data on foreign holders of US Treasury securities. The bonus is that the TIC data is further sorted into Treasury holdings by country. The downside is that TIC data is published with a six-week lag.

Nevertheless, the TIC data are instructive. And by that, I mean they will reveal the hazards in an attempt to use either the Fed’s custody holdings or TIC data to draw conclusions about who’s dumping or accumulating US debt. Let’s take a look.

The latest TIC data is for the period that ends January 2014. Of particular interest is that it shows a US$30.7 billion month-on-month rise in foreign holdings of Treasury securities from December 2013 to January 2014. In contrast, the Fed’s custody holdings data show a fall of US34.5 billion over the same time frame.

That is a not-so-insignificant discrepancy of US$65.2 billion that roughly equals the total Treasury holdings of Germany. There are two simple explanations for this.

The first is that the two data sets use different criteria to calculate the holdings. The Treasury website explains the difference quite well, and you can explore the details here. The express version is summed up nicely in this excerpt under Questions on foreign holdings of US Treasury Securities and Foreign Official holdings:

“Differences in coverage: The most important reason for differences between holdings reported in the TIC and the FRBNY custody accounts is that reporting coverage differs. First, not all foreign official holdings of Treasury securities as reported by the TIC system are held at FRBNY. In particular, Treasury securities held by private custodians on behalf of foreign official institutions are included in the TIC but not in the FRBNY figures. In this sense, the coverage of the TIC system is broader than that of the FRBNY custody holdings. Second, the custody holdings at FRBNY include securities held for some international organizations as well as for foreign official institutions. In this sense, the coverage of the FRBNY custody holdings is broader than the foreign official designation in the TIC system.”

The Putin Punt

The second and most probable cause of a discrepancy is the nature of the custody system. Both the TIC and Fed custody holdings only measure Treasuries held in US custody.

A foreign government can opt to hold its US Treasury securities with the central bank of a foreign government other than the US. An arrangement like this can mean that the foreign holding may not appear on either the TIC or Fed custody holdings.

Further, a foreign government can acquire Treasury securities from a private foreign entity where the transaction occurs on a foreign securities exchange, and the security is held outside the US. Here again, the foreign holding may not appear in US data, or it could appear as a holding by the custodial government. Either way, it skews or corrupts the US data.

The first example is what might have happened with any presumed Russia “selling.” Russia could have moved its Treasury holdings out of the US and into foreign custody. This would account for the large drop in the March US data. And there is evidence that suggests where the securities may have gone.

Belgium is a small country. Its GDP and foreign-currency reserves are about US$420 billion and US$29 billion, respectively. Yet, its Treasury holdings are reported at US$310 billion as of January 2014—and the size of its holdings has nearly doubled since August 2013. That positions it as the world’s third-largest holder of US debt, right behind China and Japan. This lopsided Treasury-holdings-to-GDP ratio strongly suggests that Belgium is in the custodial business.

Again, this is a “may have” scenario. But what we do know for sure is that wherever the Russian securities may be, Russia had ample incentive to move its stash out of the US.

Coincidentally, the US Department of the Treasury also houses the Office of Foreign Assets Control that administers the US sanctions programs. And the legal framework for the Ukraine-related sanctions were implemented via Executive Orders 13660, 13661, and 13662 on March 6, 17, and 20, respectively. The sanctions authorize the Treasury to block the assets of certain named individuals.

Connect the dots, and it’s not much of a stretch to conclude that Putin has preemptively relocated Russia’s US Treasury assets ahead of any attempted seizure by the US.

The Usual Suspect

There is certainly ample speculation and assumption in the scenario I outline above. The intent is, however, to underscore an old caveat: approach government data with a healthy dose of skepticism. Dig beyond the headlines. Read the footnotes. Heck, read the warnings that might accompany the data itself. I was as surprised as I was relieved to see the candor on the Treasury website about the shortcomings of its own data.

Both the TIC and Fed’s custody holdings data can act as an analytical windsock. It can set you in the right direction, but probably will fall short of the GPS accuracy that’s needed to make sound decisions. The catch-22 is that an inquiry has to begin somewhere, and there’s plenty of official data to start your research.

It will be interesting to see the TIC report with the March numbers that should be released in May. The numbers for Russia should give us a good idea of the accuracy of the above hypothesis.

And we’ll also have several more data points from the Fed that might show us if foreigners really are taking their Treasuries to the dump.

The Drive

By Gerald Simmons

Morris should never have let Sylvia drive. She was too upset. She had choked back her grief during the funeral service and reception, but now the realization that her best friend of forty years was dead had seeped to the surface. What else could explain the sudden drop in her speed to fifty-five, a suicidal twenty miles slower than the flow of traffic on the crowded Ventura Freeway.

“You okay?” he asked.

“I’m fine.”

On both sides, cars and trucks and SUVs zoomed past at breakneck speeds. Morris clutched the safety strap above his window. He should be behind the wheel.

“Traffic not too much for you?”

“I can do this, Morris.”

“Did I say you couldn’t?”

Sylvia glanced over. “You implied… As always.”

Morris stared ahead, his body rigid. He should never have let her drive.

A double semi overtook them on the inside. The rear of its trailer fishtailed into their lane, threatening to swipe their front end.

“Brake,” he yelled.

“I know.”

“I didn’t know if you’d seen him.”

“I did.”

The freeway took a long, gradual curve to the right. When it straightened out, he was momentarily blinded by the late-afternoon sun. He flipped down the sunshade and glanced at Sylvia.

“I can see fine,” she said.

“I didn’t say anything.”

“I know what you were thinking.”

He picked at his fingernails. He found the familiar clicking noises soothing.

“You know I hate that,” Sylvia said.

He stopped. “Sorry.” No point getting upset. She was only acting this way because of Jennifer’s death.

The air inside the car warmed up. He loosened his tie, undid his top button and turned on the air conditioning.

Sylvia slapped her vent shut.

“Can I turn on the radio?” he said.

“I’m surprised you bothered to ask.”

“I want to see how the market’s doing.” He turned on the all-news station. Too early—the traffic report was on.

A Mustang swerved into their lane. Sylvia slammed on the brakes. Morris’s seat belt seized his waist and clutched his shoulder. It was a goddamn miracle they didn’t hit the asshole.

“Honk him,” Morris yelled.

“He’s just a kid.”

Morris reached across and planted his hand on the horn. “The asshole has to learn. There was plenty of room ahead.”

“Stop it,” Sylvia said.

“He deliberately cut you off. You can’t let him get away with that.” He hit the horn again.

“Don’t do that. Now look what you’ve done.”

The kid was flipping them off.

Morris felt the car slow. Sylvia must have taken her foot off the accelerator.

The Mustang zoomed off.

“Don’t you ever think?” Sylvia said. “What if he’d had a gun?”

“They don’t shoot seniors like us.”

“You have to have an answer for everything, don’t you?”

“What’s wrong with that?”

“That’s it.” Sylvia indicated right, swung into the slow lane and then onto the shoulder.

Thank God. Now he could take over.

The car ground to a stop on the gravel. It swayed side to side buffeted by the wake of passing trucks.

Sylvia turned off the radio.

Morris got out. Though he wasn’t tall or fat, the air, heavy with exhaust fumes, pounded him in a series of waves. The noise of the speeding traffic alarmed him. “Let’s switch. I’ll drive.”

Sylvia stared ahead, her hands gripping the wheel.

He reached in and touched her arm. “You have to move, Sylvia.”

She remained frozen.

Cars skimmed past them.

“It’s not safe here,” he said, glancing at the waves of traffic. “Someone could plow into us.”

She didn’t respond so he got back in. He had to shut the car door in order to drown out the noise. Fortunately Sylvia had left the car running so the AC kept everything cool.

“What’s wrong?”

She looked over. “You are, Morris. You’re what’s wrong.”


“Remember, back at the reception, when Rob said that losing Jennifer was like losing a vital part of himself, like an arm or a leg?”

“Is this because of the crack I made about him being so fat that he could afford to lose a lot more than just an arm or a leg? I was trying to be funny, make you feel better.”

“I’ve been thinking about how I’d feel if I lost you”—she looked away—”I  realized I’d feel relieved.”

“Relieved?” He stared into her eyes. It had been the first thing he’d noticed about her—their blueness, their brightness; that and her thick, shoulder-length hair. Though her eyes were still a little puffy from the crying she’d done earlier, they shone with the same intensity as when they’d first met.

“I want a divorce,” she said.

“A divorce?” He laughed. “Be serious.”

“You stay in the house, I’ll move in with Jane or Ashley until I find a place of my own.”

“You’re not yourself. It’s because of today. It’s making you say these things. When we get home, I’ll make you a nice cup of hot tea. That’ll make everything better.”

“It won’t. It won’t be better until I’m free of you.”

“What are you talking about? We’ve been married forty-two years.”

“For forty-two years I’ve been ignored. I’m tired of it. I want out.”

Morris sighed. They’d had problems in the past. But they’d always blown over when Sylvia had come to her senses a day or two later. This would too, he was sure. He should get her home, give her a sleeping pill and get her to bed. She hadn’t been sleeping well since Jennifer’s death. A good rest would do her good. Lack of sleep made people do and say stupid things.

He became aware of the traffic again. “I can see you’re very upset. Let me drive you home and we can deal with everything there.” He lowered his window. “I’ll get out and when it’s safe, I’ll tell you when you can get out.”

He got back onto the shoulder. He saw that there would soon be a break in the traffic. “There’s a truck and then a white pickup. After that it’s safe.”

The truck passed creating an explosion of air that battered him. When he finished rubbing dust from his eyes, he saw the white truck was passing, and then his car starting to drive off.

“Sylvia.” He yelled, “Sylvia, where are you going?”

“I count, Morris. I always have,” he heard her yell as his car merged into the traffic and disappeared.

Gerald was born and raised in the UK. He is a practicing dentist in California.

Friday Funnies

First-World Anarchists

These people (and dogs) asserted their independence by breaking the rules. Who says anarchists have no sense of humor?

See them all here.

NASA’s Size Problem

Because it’s not easy to go to the bathroom in outer space, NASA fits its astronauts with a “penis sleeve,” a gadget that allows them to urinate in their space suits. It initially came in three sizes—small, medium, and large. But because the astronauts refused to choose any size but large, NASA had to rename them to large, gigantic, and humongous.

The first 30 seconds of this clip from the Science Channel tell the whole story.

That’s It for This Week

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Enjoy your weekend!

Dan Steinhart
Managing Editor of The Casey Report