Government securities have become so scarce that it is driving down repo rates. A collateral shortage that has become so acute, money dealers won’t part with their stock of government securities no matter what the price. Stop me if you’ve heard this before.

Except, we’re talking about Japan and JGB’s here rather than UST’s. The trick is that both types of government bonds are being hoarded for US$ purposes. The shortage of JGB’s is due to Japanese dealers desperate to source US$ funding.

With so many Japan governments being swapped in US$ money markets, borrowing in yen repo has dwindled pushing the JSDA Tokyo Repo Fixing index below zero and down to a ridiculous -0.88% in yesterday’s trading. Yep, a negative repo rate. 

It has become such a big problem that Japanese dealers are, according to Bloomberg, refusing to sell to the Bank of Japan at the same time the central bank wants to scale up further purchases (for “stimulus” or something). Bank reserves aren’t very appealing in yen, either.

What’s interesting is that the media will openly and willingly talk collateral shortage when it comes to Japan but can’t ever seem to make the same determination in the Treasury market – where the phenomena isn’t just similar it’s practically the same thing.

Call it Fed bias, or the ideological rigidity of the cult. Thus, several years of BOND ROUT!!! despite flattening curves and now record low yields across-the-board.

On this side of the Pacific, the US GC repo rate (UST) rebounded to 0.094% today after having sunk down to just 0.061% yesterday. When there is no collateral, nowhere near enough, cash gets dumped obscuring the generalized illiquidity that reigns all over money markets. I warned about this a little over two weeks ago:

Imagine you are a cash-rich bank while chaos rages all around you. Risk averse, absolutely, therefore you want the highest, best possible security for your cash. The best quality collateral, that is.

What if no one has any?

In other words, you’ve got spare cash and don’t mind carefully parceling it out but you can’t find any takers. Not for lack of willingness, mind you; it’s a crisis, after all, and the line is out the door. Counterparties would love to borrow every last nickel you’d offer, but they can’t because you’ll only accept the highest quality collateral in return which they don’t have and can’t get.

There’s not enough JGB’s in yen repo, and neither enough JGB’s nor UST’s to satisfy the same in US$ repo. Both repo rates tumble leaving the public confused; or, worse, thinking monetary policies are making progress when they are more likely to have done the opposite (removing even more collateral via bond purchases).

With T-bill rates getting comfortable at zero and less, how long before US and eurodollar dealers tell the Fed to take a hike, too?

It’s more than strictly an interesting phenomenon, it’s an enormous dollar “headwind.” For most of the world stuck trying to manage each individual country’s dollar short as best as they can, they’ll now have to deal with the further closing down of both redistribution methods.

There are, by and large, two ways a foreign location can come up with the dollars it needs (the short) to participate in the global economy; and most places don’t have the luxury of being self-sufficient, so trade isn’t a choice and therefore dollar availability is a must.

The first is the old-fashioned way – mercantilism. You sell goods to other places around the world and they give you dollars in return. When people refer to the so-called petrodollar, that’s what it means where oil rich nations have been concerned (and it isn’t anything more than that despite years of people trying to imbue other purposes).

Global trade, however, is about to be curtailed to an extent that will probably exceed GFC1, in terms of depth and likely duration (for many places the Great “Recession” was sharp but ultimately short). Therefore, countries previously dependent upon mercantile trade to source a great deal of their dollar short requirements are about to be almost totally shut out. For the oil producers, it’s already in the price of oil.

Normally, a diminishment of trade would have to be made up from the other dollar redistribution channel – the financial channel. If trade is a little light in any period you could have depended upon the eurodollar market, or Eurobonds in the case of 2016-17, to make up the difference if not create a surplus (“hot money” inflows).

That isn’t going to work, either. The global dollar financial network is in crisis mode already, vital collateral at its center reaching hoarding levels of premiums all across the world. Just when the trade-derived dollars stop flowing there’ll be collateral and margin calls from the eurodollar market you’d have otherwise tapped to make up for the mercantile shortfall.

It’s a double disaster in the making (if you’re wondering what LIBOR banks might be seeing).

Which means rising dollar; and I don’t (necessarily) mean DXY. If the yen repo market can’t find enough JGB’s because they’re all being used up in US$ funding, what’s going to happen as banks in countries around the world aren’t finding trade dollars like they had been (which was already on a downturn) and have to pay enormous premiums to keep from defaulting on the short?

Firms around the world are going to withdraw, be forced out, or just liquidated out of the dollar business. I tend to think we’ve already seen this over the past couple of weeks.

This is what I mean when I write about the potential for lasting damage to the global economy due to GFC2. Maybe the pandemic ends up being a relatively short-lived dislocation, we all hope, but then the fallout from this criminally unnecessary eurodollar crisis registers and it’s lights out in too many places.

Once they are out, you can’t just turn them back on expecting immediate and complete recovery. Capacity shrinks, systemically smaller; an outcome we’ve already witnessed from the aftermath of GFC1.

Dollar bears have assumed this whole time that the end of its status as the sole reserve currency will mean a collapse in its exchange value. I’m as bearish as anyone on the eurodollar system’s longer-term future, but that doesn’t necessarily mean the dollar drops to zero at that end. In fact, it’s far more likely, in my view, that the exchange value continues to do the opposite as the shortage grows worse.

If it gets bad enough to finally force people around the world to seriously consider doing something, it might be that a skyrocketing dollar, not a plunging one, is that last straw. This shortage, not a dollar rejection, is the likeliest endpoint. We aren’t quite there yet.

Then again, maybe Jay Powell and Haruhiko Kuroda get together and hash out a plan to stop being backward about everything, begin working with other central bankers at finally alleviating the collateral problem, learning a little something about how this thing actually works, and then start shoring up the rest of what is and has been such a fragile and harmfully unstable reserve currency system. 

Yeah, right. Given the gloom over how everything is turning out, I thought I’d at least try to end this one with a joke.