The REAL Big Short

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This week, S&P 500 had its best week in a year and a half. Bet it didn't feel that way, huh? Meanwhile, the price of US treasury bonds has cratered and yields have risen, the short covering rally late this afternoon notwithstanding.  At the American Adversaries we always look inside the numbers to give you the real story, so let's take a look inside the bond market.

President Trump and Treasury Secretary Bessent are employing a strategy to first isolate, by pausing tariffs with everybody except China for 90 days, then fiscally crush China, who has been ripping off the world from the moment they entered the World Trade Organization and received favored nation status. China has broken every single promise they made to gain access to the world's markets. In addition to ripping us off, China has killed millions of Americans without firing a shot as a result of COVID and fentanyl. They are a malign actor in every respect. They are our enemy. Period.

The selling you've seen in the bond market the past few days is coming mainly from Europe. The relationship between the value of the US dollar and US treasury yields has been broken and diverged this week. Yields are up, and the dollar is down. Meanwhile, the Euro is increasing in value at a dramatic rate and yields on European bonds are cratering, a sign of cash inflows. 

We know that China holds hundreds of billions of US Treasury bonds-bonds that we sold them to finance the debt that we incurred in part from our government spending to subsidize the flight of our manufacturing capability to China. A huge portion of those bonds are held in legal entities in Belgium and Luxembourg. China is selling US treasuries and buying European bonds.

They are doing it to buoy its currency, the yuan, which has been getting hit hard since Trump instituted the tariffs. China is liquidating the only asset they really trust because they are in a liquidity crisis and are bleeding cash, and they are buying an asset that is weaker and riskier in the European bonds. Their fiscal hand is shrinking and weakening quickly. This can only go on for a short time before it breaks. Nobody is coming to save them.

The collateral damage to this is the destruction of the American hedge funds' basis trade, which is a leveraged systemic short or derivative trade of bonds. Spiking yields cause margin calls and completely reverse the spread between what the borrowed bonds were purchased for versus what they sell for, and that is the hedge funds' profit, and it has been getting destroyed this week as hedge funds have to liquidate assets to cover the falling basis trade. However, this only exacerbates the situation for China. Nowhere to run, nowhere to hide.

Remember, China's government subsidizes everything-their industries, their population, their markets, their military, their infrastructure, the belt, and road, and they are going through their version of our 2008 real estate crash with the Evergreen crisis. China is spending billions to support all that, and to keep the cost of goods and salaries down so that they can maintain their trade imbalance, which is the vehicle that finances everything. But what happens when it all gets squeezed? Could the Chinese Communist Party implode and fall, as has been the case with every other communist nation throughout history?

In a normal market environment, China would sell bonds into a high demand market with higher prices and lower yields and prop up their fragile economy. But with the price of bonds cratering and yields rising, China is facing a liquidity crisis and their most stable asset that they need to sell to rescue themselves is deteriorating in value at the same time its currency is being devalued. See the issue?

Notice that the Federal Reserve has not stepped in to buy treasuries (QE) to stabilize the market, which is what has happened every time before, the most recent being when China released COVID on the world in 2020. It would seem that this is a coordinated strategy between the White House, Treasury, and the Federal Reserve to pressure China into a liquidity crisis, the biggest economic stress test, and the biggest game of Chicken in the history of the world. Also, you might have noticed that energy prices are plummeting and the inflation numbers this week were promising, with the Producer Price Index posting a negative read for March. The Fed has more room to operate than most folks realize, as inflation is not as big an issue as it was even 12 months ago. It's going to come down to the Federal Reserve vs. the Chinese Central Bank, and I know who my money is on. 

By the way, did any of you have Trump and Powell collaborating to fiscally crush China on your bingo card?

If what is happening looks familiar, it is because it is. It is very similar to the gambit that Soros Fund Management, led by George Soros and Stanley Druckenmiller, used to crash the British pound, Bank of England, and bring the British government to its knees in September 1992. The architect of that strategy? A 31-year-old economist by the name of Scott Bessent, who was running Soros Fund Management in London. The Soros short of 33 years ago is now the Bessent short, and the stakes are so much bigger, not just for the US, but for the free world. 

So try not to get caught up in the day-to-day gnashing in the market, and especially the media, who are also a malign actor, but instead look farther down the horizon, and watch history being made as President Trump, Secretary Bessent, and Fed Chairman Powell reset the world economy, neuter our biggest fiscal and strategic threat, and make America and the world's economy rich again.