* This post was written in 2011 before Mr. Roche founded Monetary Realism, which was formed due to several disagreements Mr. Roche and many other former MMT proponents had with the school of thought.  For more info on the difference in views please see here.  For more on MR’s views please see here.


On March 3rd I asked “Who Will Buy The Bonds?”  I wrote this piece in response to a letter by Bill Gross in which he asked:

“The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recentOutlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?

…I don’t know. Reserve surplus sovereigns are likely good for their standard $500 billion annually but the banks are now making loans instead of buying Treasuries, and bond funds are not receiving generous inflows like they were as late as November of 2010. Who’s left?”

I responded by explaining that the bond auctions will go off without a hitch because savers would choose to buy risk-free interest bearing bonds over holding cash in a low inflation environment.  The Fed and Treasury would coordinate their policies closely, just as they always do, to ensure the demand is strong and that issuance can go off without a hitch.  Hence, the auctions would move along just as they always have and the mysterious (non-existent) bond vigilantes would appear to be in a deep slumber again.

Well, today we got the first bond auction since the end of QE2.  And what happened?  It was as strong as ever.  The bid to cover came in at 3.22 with the Primary Dealers submitting bids for 2X the entire auction.  Of course, I pointed this same phenomenon out several times before and during QE2, but you still heard the same rumblings today from various skeptics who said that the auction was only strong because of QE3 rumors.  Nonsense.  The auction was strong for the same reason they always are – the reserves are tracked in the system and hoovered up in accordance with the scheme that the mainstream media calls the “funding of the USA”.  Of course, funding is not the purpose of US bond issuance, but explaining a boring old reserve drain wouldn’t make for good TV or political theater.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Octavio Richetta

    Remember Japan… IMHO, to me, there has been no surprise to the path T bonds have taken since the financial crisis hit. I really do not understand BG’s position on this. Is he still waiting for DOW 5000? Do you remember that one around 2002?

  • FDO15

    Cullen, how do you rectify the disconnect between Gross’s misunderstanding of the monetary system and his incredible performance? How can someone be so off target and yet outperform?

  • Albatross

    CR: Genuine question: have you written a post describing the huge swing in Treasury yields during the 70s and 80s? Because if I understand it correctly, in your MMT model, these should have happened.

  • http://www.pragcap.com Cullen Roche

    I said on twitter today that a great money manager needs not have superior knowledge of the monetary system to outperform (although it certainly helps). He/she needs only to be a superior risk manager.

  • Ruschem

    What is the point of bashing Gross? He said he could be wrong about the direction of interest rates but regardless he sees better opportunities elsewhere and pursues them for his clients. Would you invest with someone who is always right but somehow doesn’t make any money for you or someone who always wrong but still delivers a decent return over a long period? Both Gross and Gunglach have done it – delivered good returns. What do you have to show for your smarts? And what a new flash that risk management is more important that being right.

  • Different Chris

    God damn I love this site. Just had a convo with a friend who works at Barclays fixed income desk and educated him using the data in this post.

  • FDO15

    Cullen is less than half Bill Gross’s age. And if he ever moves from the beach I would venture to guess that Cullen could give Bill Gross a run for his money by the age of 67.

  • Ruschem

    Exactly. Half his age. Have some respect. No need to bash anyone to express your own opinion. Critique and disagreements can be civilized and respectful. Just my two-cent contribution to blogoshere.

  • FDO15

    Where did he insult Bill Gross? He pointed out a flaw in his commentary. That’s not insulting. It’s called the facts. If the facts insult you then pull the wool back over your eyes and get back to buying shares of PTTRX.

  • Cahn

    Can’t agree more. Truth seeking is all that’s relevant. As a new comer to this site, I certainly feel benefited from knowing both parties (CR vs. BG in this case) involved in the argument. I just do NOT sense any disrespect of BG here. It is a great reminder that even sages (be it be BG, WB, JR, GS, …) might miss a point here and there. That way, I will remember NOT to follow them blindly … … into any pitfall.

  • pezhead9000

    The Magic of Modern Monetary Alchemy – Chartalism or Charlatanism??

  • http://www.pragcap.com Cullen Roche

    I am not bashing Gross at all. Am I not allowed to point out what I view as a flaw in his analysis? Trust me, I have a HUGE amount of respect for Bill Gross and I can only hope to achieve part of what he has achieved in his life. I mean no personal disrespect by these comments and if they come off as such then I apologize. That was never my intention.

  • wh10

    Cullen- what is the rationale behind people who believe the auction was strong because of rumors of QE3? Do they think that bond traders are incentivized to buy bonds because they can flip them during QE3 for a profit? But if that was the case, shouldn’t that already be priced into the yield on the auctioned bonds?

  • http://www.pragcap.com Cullen Roche

    I guess that’s the rationale. But the truth is that this auction was really no different than the auctions before or during QE2. It’s the same old dog and pony show with a different excuse for why the bond vigilantes didn’t show up this time….

  • JWG

    Another prediction by TPC proves out; since I have been visiting this site I have been looking at predictions and outcomes. Because I am my own retirement plan, my interest is in part mercenary: how do you monetize what appears to be a solid track record of predictive capacity? Hanging on to those fixed income positions, I guess.

    Bill Gross has been guessing wrong because he is in uncharted territory. In the 1980’s, a huge bond god named Henry Kaufman kept predicting that federal borrowing to “fund” Reagan’s deficits would “crowd out” other investment and cause skyrocketing interest rates that would kill the economy. A lot of people believed him; in fact, interest rates dropped dramatically once Volcker decided he had broken the inflationary fever, despite the big (at the time) Reagan deficits. An MMTer would have been pointing at Kaufman and saying, “He’s totally wrong! The gold standard is dead!”

    Bill Gross = Henry Kaufman. You can be a bond god, be hugely wealthy and influential, and still be wrong on basic stuff. God Bless America.

  • prescient11

    Cullen, please don’t ever ever apologize to the likes of PIMPCO or Bill Gross. If this had played out like it should have, Gross would be shining shoes on the boardwalk.

    Imagine if the GSE bondholders actually HAD TO TAKE AN F’IN HIT!!!??? Then he has the audacity to run out el erian every f’in day and lecture the government about all the shite and being fiscally irresponsible.

    PIMPCO is right, it’s tough to be them. Those pimp f’ing losers riding high on the taxpayer dime bailing them out time and time and time again. regulatory capture doesn’t begin to describe it.

  • Cahn

    Maybe another factor is his flexibility/adaptability? Recall he was short Treasury a few months back. Then he was long treasury again, and just recently added to his long position. So, he learns from his own mistakes quick and adjusts strategy accordingly.

    By the way, his change of position has served to prove the correctness of your argument. After all he still regards Treasury as a safe haven in a weakened economy and maybe he is even still bullish on it.

  • Diolated


    Some time back, you posted a piece on the mechanism and procedure the treasury uses in bond auctions. Do you think you could dust that off and post a link to it or put up a new article with respect to the how the bond auctions work. Thanks for the site.

  • jswede

    hey Cullen – the way I answer “who will buy USTs after the Fed stops” is the same way I’ve answered it for the last 6mos+, and have posted here before:

    >>After QE2, The Fed’s UST demand will be replaced by UST demand of market participants who, again, and to their general surprise, find themselves back in a deflationary, consumer deleveraging environment. An environment they had previously thought the Fed had ‘intervened’ away, not once, but twice.<<

  • jt26

    Great post. You raise an interesting point, … “a great money manager needs not have superior knowledge of the monetary system to outperform”.

    In fact one could think: Grundlach may actually understand it, but purposely feeds on the misconception (popular conception) to manipulate the markets’ psychology by reinforcing their own thinking? (Don’t short sellers rely on fear?) In fact you (and I), have something like that in common with gold. Maybe this just shows risk management *and* behaviour investing trumps fundamentals … at least in this type of market.

    The other flip side to the MMT “aha” will be … what would happen if every single citizen and legislator actually understood the monetary mechanics? Would that actually be positive, or would it change psychology. Think about moral hazard and the Fed put. Would that become the MMT put?

  • prescient11


    I am a bit confused by one thing. You stated that the government does not fund itself by bond issuance. Well, and please forgive this ignorant question, but we know the government is running about a $1.5T deficit.

    So where does it get that money and how is it accounted for on the government’s books? Many thanks.

  • http://www.pragcap.com Cullen Roche

    It doesn’t get the money from anywhere. That’s the whole point. When an autonomous money issuer spends money it just credits bank accounts. The US govt never has to raise money to spend it. All they need to do is ensure that the currency is not too abundant by controlling the tax rate and the drain taxes cause.

  • prescient11

    And perhaps this is where I need to be led to water, but that money has to be accounted for somewhere, and they do it via bond issuance, correct?

  • jswede

    @jt26; how do you mean “Gundlach purposely feeds on the misconception to manipulate the markets’ psychology by reinforcing their own thinking”

    just want to make sure I am not misunderstanding your point

  • rhp


    In a sense, the accounting is what creates the trouble, because we are so used to thinking in household accting terms. People on this site have used the analogy of a football stadium creating a score, similar to the gov’t. They simply push a button and the numbers are popped up on a scoreboard. The numbers are created from nowhere and there IS no deficit of numbers created in the stadium when the numbers are popped up on the board. No football stadium accting NEEDS to take place, and similarly, no gov’t accting NEEDS to take place, except in trying to make sure the currency issued into circulation doesn’t become too abundant, as Cullen points out.

    here’s a thought to follow……….The first paper currency issued by the US that was a national currency was in the Civil War, and I believe it was around $300 million. If the US had maintained a “balanced budget” since that time, i.e. never spending more $$ into circulation than what it took in via taxes and revenue, the total amount of money circulating would STILL BE $300 MILLION!! (This is not mentioning horizontal “credit” creation by the banks which nets to zero). Do you think the US/World economy could run on $300 million today??

    The amount in excess of $300 million since 1862 HAS to show up as a deficit in trad accting measures.

    The bond issuance is mandated by congress as a holdover from the gold standard when the currency was a demand note that could be traded for gold. Today, it has as much relevance to “debt” as a football stadium selling bonds so it can put more points up on a scoreboard.

    Hope this elucidates rather than confuses…. Peter D, Chris, Adam, CR, and others do a far more eloquent job.



  • prescient11

    That is very well put. The big problem with the inflexible gold peg was the limit on currency liquidity, especially the need for more with a growing population.

    But that’s where I am stuck and what I wanted to hit upon.

    Essentially, bond issuance is printing money, i.e., the recognition that someone is hitting buttons out there and increasing the amount of currency in play.

    So government has two real ways of drawing excess currency back, the interest on the bonds and its taxing power, correct?

  • Adam

    Earlier you said, “So where does it get that money and how is it accounted for on the government’s books?” but the better question is where did the person who bought the bond get the money from.

    The way the system works is that the government spends money, it credits bank accounts. That money comes from no where and going into bank accounts and becomes excess reserves. The FED monitors excess reserves in the system and then calls the Treasury and tells them we need to drain excess reserves from the banking system by $X amount. The treasury then sells bonds to the tune of $X amount.

    Bond sales are a swap of reserves for a bond. The only difference between a treasury bond and currency on the governments books is that one bears zero interest and the other bears a postive interest value.

    The other day Cullen posted this great link you can play around with and see how the balance sheets work via MMT…


  • prescient11

    I think I finally realize what the whole picture here is. So is that why a bond auction will never fail, because they are for the sole purpose of soaking up reserves??

    If that is the case, then why are there targeted numbers for how much bond issuance must happen based on the government’s spending plans though?

  • flow5

    The FED off-loaded most Treasury issuance during QE2 – & the private sector has yet to recover – thus borrowing (loan-demand) is stagnating. Who will buy bonds? No, the question should be what else is there to buy?

  • Adam

    “So is that why a bond auction will never fail, because they are for the sole purpose of soaking up reserves??”

    For the most part yes; I guess it would be theoretically possible for the Treasury to try and issue more bonds then there were reserves and or spending which could be an issue. You see, the moment (and I mean the exact moment) a check hits a banks books it is available for funding assets even though it hasn’t necessarily cleared in a traditionally banking sense. So theoretically the moment the treasury credits a bank’s books there are reserves ready to fund bond sales.

    While not completely related, you might be interested in how correspondence check clearing played in spreading the banking panics of the 1930’s. It has a weakness caused by relying on deposits/funds hitting books before the funds are fully cleared.


    “If that is the case, then why are there targeted numbers for how much bond issuance must happen based on the government’s spending plans though?”

    My guess this is just tied to old laws requiring the government to “fund” itself. Just theatrics that don’t have any real use other than to obscure reality.

  • rhp

    I see Adam is trying to provide support as well! So, maybe your questions are already answerd, but……

    “Essentially, bond issuance is printing money, i.e., the recognition that someone is hitting buttons out there and increasing the amount of currency in play.” No, actually, bond issuance is a WITHDRAWAL of money from the system (at least initially). Think of it like the gov’t giving you a CD in return for you making a deposit with your $$. At that particular point in time, there is actually LESS currency in circulation (when the gov’t issues the bond). When the CD/bond matures, then MORE money DOES enter the system (private sector) because of the interest payment to the bond holder.

    As Adam points out…….there is already money in the system (private sector) that the gov’t SPENT into the system, and that money is used to purchase the bond. Thus, it really becomes an asset swap of non-interest bearing dollars for slight interest bearing trsys. No net money is added or subtracted (except for the interest payments that enter later). This is the point that Cullen hammers on regarding QE2……..it was just an asset swap.

    “If that is the case, then why are there targeted numbers for how much bond issuance must happen based on the government’s spending plans though?”

    I believe the answer to this question (which bugged the h*** out of me for awhile) relates to the amount of trsys that the gov’t has to generate (by law) to balance the accounting out (spending versus revenues). The Fed knows precisely how many reserves there are in the system because they are the ones that SPENT the money into the system to begin with! If there has been excess spending by the gov’t, then there are excess reserves to soak up by issuing a bond that primary dealers will be willing to bid on. Since the amount SPENT into the system is always PRECISELY in balance with the amount of reserves floating around, the accounting identity allows the treasury to know its bonds/bills will have a market.

    Some of the more technical stuff about what banking reserves can and cannot do (like reserves are tied into the trsy/fed and are used to balance out transactions, but are NOT used to lend out or purchase securities) I’ll have to leave to the smarter people on this board…….

    hope this helps a little.

    ps: I’m pretty disgusted with Bernanke right now (ok, now I feel better)………

  • jt26

    TPC says Grundlach (twitter) and Gross do not understand the monetary system, but make money because of other qualities (e.g. risk management).

    I was speculating that, they may be doing it intentionally to either exit or enter positions, *precisely* because they know most people and investors do not understand the system, and have certain preconceptions which create fear.

  • jswede


  • Dumb Ox

    rhp: “I believe the answer to this question (which bugged the h*** out of me for awhile) relates to the amount of trsys that the gov’t has to generate (by law) to balance the accounting out (spending versus revenues)… Since the amount SPENT into the system is always PRECISELY in balance with the amount of reserves floating around, the accounting identity allows the treasury to know its bonds/bills will have a market.”

    This question has been bugging the h*** out of me for the past four months, too. The problem I can’t get my head around is that under this system, the money supply always remains constant. For every dollar spent into the economy by the feds there is a dollar of either bank reserves or deposits removed via Treasury auctions or taxation.

    Interest paid on Treasuries doesn’t solve this problem either, since that interest is just another form of federal spending that has to be rolled into new Treasuries.

    So how can the money supply ever grow?

  • rhp

    oh, s***, i’m in trouble. dumb ox has posed a question i can’t solve right now. if he is truly a dumb ox, then what does that make me!