If you have not yet read Part I: The Periphery is Failing, available free to all readers, please click here to read it first.

When Help Turns to Harm

The story, so far, goes like this:  A global credit crisis so worried the powers that be that they promised to do ‘whatever it takes,’ (Draghi) even if that means lying from time to time (Junker).  This has only resulted in larger and larger interventions in the form of more aggressive QE programs (U.S. Fed), doubling of the monetary base (Japan), and repeated ‘Final Bailout Ever’ goal lines that keep getting moved back (ECB re: Greece).

Each of these interventions, in combination with ultra-low and highly distortive interest rates, has only served to make markets more speculative, more risk-tolerant, and therefore more prone to some future accident.

Puzzlingly, and certainly off-script, has been the steady rise in long-term U.S. interest rates, which we’ve been tracking as the most interesting development in an otherwise boringly placid set of global equity markets.

That began in early June.  Now at August's end, we have a better picture to illuminate why that happened and where it’s probably headed next.

The initial data came to us via the Treasury International Capital (TIC) report that tracks the net buying and selling of financial securities in both directions across the U.S. border.  The June numbers were a real eye-opener, as they marked the first time in history that virtually every category of U.S. financial assets was net sold by foreigners.  It also showed the total amount of selling was even greater than the prior record set in October of 2008:

(Source)

Of course, this data is from June, and the TIC report, as good as it is, always comes out a month and a half after the fact.  So we can only guess at what has happened since.  (The July data will be released Sept 15).

The summary of the TIC data is this:  Countries across the globe are now selling more U.S. paper than they are buying, and that is very much a game-changer.  To understand why the game has changed, all we have to do is understand that the interventionist policies of the Fed, ECB, and Bank of Japan could never last forever and that eventually things would go into reverse.

This will prove to be quite surprising to many, but especially those who hold the belief that central banks actually have everything under control.  Certainly we cannot disagree with the idea that central banks have a tremendous amount of power and that they can distort things for far longer than we might think possible, but eventually they cannot prevent reality from being what it is.

It is our view that the tide has now turned.

From the Outside In

So if the story was one of Western central banks flooding the world with liquidity (including Japan as an honorary ‘Westerner’ in this story), and of that “money” rushing into various foreign markets, driving bond and equity prices up in those same markets, while the respective central banks fought the coincident strengthening of their local currencies by recycling that money back into U.S. paper assets (principally Treasury paper) – well, that story eventually had to flip.

We’ve already seen…