Posted on 08/05/2012 3:06:21 PM PDT by blam
How To Prepare For The U.S. Treasury Bond Market Apocalypse
Interest-Rates / US Bonds
Aug 05, 2012 - 04:52 AM
By: Investment U
Alexander Green writes: The Wall Street Journal made an interesting observation recently, “Treasury bonds are priced for the end of the world.”
It was a news article, not an opinion piece. But it happens to be the viewpoint of virtually every investor with half a brain – or a modicum of common sense. A few months ago, for instance, the world’s best-known investor, Warren Buffett, wrote in his annual letter to shareholders, “Right now bonds should come with a warning label.”
Yet I routinely talk to investors who still don’t get it. Treasuries are safe they tell me. And the historical returns are quite good, especially compared to the pittance money markets are paying.
Both of these statements are true. But it still makes little sense to plunk for 10-year bonds that pay 1.5% or 30-year bonds yielding 2.5%. And if you’re holding an investment-grade bond fund whose yield is much higher than this, you really need to hit the exit in a hurry. Here’s why…
The World is Not Ending
Let’s start with the fact that Treasury yields are at all-time record lows. Why is this? Inflation is modest. Uncertainty is high. The U.S. may sink back into a recession. The wheels may come off the euro. Uncle Sam seems like a safe bet.
And from a credit standpoint, U.S. Treasuries – even without their vaunted AAA rating – are indeed among the world’s safest securities. Sure, a few blue-chip companies have higher credit ratings. But that could change. Plus, they aren’t able to crank up the printing presses to repay their corporate debt. And some other countries have been fiscally responsible enough to maintain their AAA-ratings. But most don’t have the economic strength, political stability, or military might to attract large capital flows.
Lend the U.S. government money and, yes, it will certainly pay you back. But two dangers loom: inflation – the great bugaboo of bond investors everywhere – and, ahem, the world’s not ending.
Let’s take inflation first. Consumer prices are fairly low, unless you’re looking at healthcare costs (or health insurance premiums) or putting a kid through college. The CPI was 1.66% for June, down from 3.56% a year ago. That trend could easily reverse, however.
Oil, for instance, tumbled more 20% in the first half of the year. But it has moved back up almost as quickly lately. If inflation ticks higher, bond prices will sink lower. Even a half-point rise in inflation could cause 10-year Treasuries to fall 5%. And that might be just the beginning. If you don’t know what happened to bond prices in the early 80s, you owe it to yourself to learn what happens to fixed-income investors when inflation and interest rates suddenly move higher. It’s not pretty…
“If It’s in the Papers, It’s in the Price”
Then there’s that matter of the world not coming to an end. I hear investors recite a litany of woes that beset the global economy today. But every one of these things – anemic GDP growth, currency problems in Europe, the already leveraged consumer, and so on – are already priced into stocks. As the old Wall Street saw reminds us, “If it’s in the papers, it’s in the price.”
As for those bond funds that, despite their high expenses, sport hefty yields, look out below. Many of them are highly leveraged – the bond equivalent of buying stocks on margin – and when bonds head south their shareholders will get routed.
It hasn’t happened yet. But it almost certainly will. In the meantime, with inflation at 1.6% and 10-year yields at 1.5%, bond investors are already earning a real negative return on their money.
What’s the point of owning an investment with very little upside potential and huge downside risk? Govern your portfolio accordingly.
So what is the promised solution?
Bonds are clearly signaling that economy is not likely to recover any time soon. Probably 2 years.
Step one is here:
What’s the point of owning an investment with very little upside potential and huge downside risk?
Get. Out. Of. Bonds.
What apocalypse?
Demand for US treasury securities has only grown since last year.
I guess that downgrade didn’t mean much.
If there is a recession, equities will tank and investors will park more cash into treasuries.
Yes, we should all protect our cash in “solid” stocks. ;-)
International banks have the sovereign nations of the world by the throat, due to their money supplies being based on debt, which the banks largely control.
The money supplies are crashing all around the globe. Nations are attempting to "remedy" this situation by deficit spending like there's no tomorrow.
Notice how Presidents Bush and Obama both focus(ed) on encouraging Americans to take on new debt in order to increase the money supply?
"Trade in your old clunker and take out new debt on a new car!"
"Go to college and get an education with an easily obtainable student loan!"
"Refinance your house for a longer term!"
The fact is that we're in an enormous Depression (as is the world). Take away the deficit spending each year and our GDP would shrink by an annualized rate of over 10%. We're talking 1930's all over again.
When will this stop? When international banks decide to make credit available again.
When will that be? After they have reset the exponential curve on the money supplies of the world and taken their fill of loan collateral.
What will be the sign that we're exiting the Depression and heading towards moderate monetary inflation? A World War. War is always the way that the banks exit Depressions, and has been since the mid 1600's.
We haven't seen the worst yet. And it won't matter if Romney is elected. The Republicans will continue massive deficit spending - since to do anything else would be to admit the Depression that is currently being masked.
Can't we just balance the budget, take our lumps economically, and move forward after a few years?
No, debt-based money doesn't allow for that. Debt-based money is all about men controlling the future actions of mankind (slavery). It's all about making claims on the future labor of others. Our money supply is the total sum of all claims on the future labor of others. Every time principal is paid it causes the money supply to drop by that amount. If all debt were paid off then our money supply would be zero.
The answer is to have a money supply based on the completion of labor, not promissory notes (debt). The only way this can be achieved is to have the US Treasury issue our money - and have it ONLY be issued against completed labor.
Those that have read my previous economic writings over the last four years know that I have not diverged from this teaching. We're now seeing the ramifications come to pass.
Please understand...I fully believe we will be having an international war where very large numbers of men and women will die in a show of patriotism for their respective country. However, the entire war will be about nothing except reintroducing moderate inflation back into the world economies - which will greatly increase the value of the collateral that the banks have been taking. These soldiers will have died for no other reason than to make the international banks wealthier.
By the way, I am a military hawk. I fully believe in armed conflict for the right reasons.
Sorry my FRiend, but that advice is not economically sound. The goal right now is not necessarily to make money - but to avoid losing it. Short-term Tbills offer that.
Think about it this way...all "money" is a claim on a promissory note.
If you own the actual promissory note then your have "1st deed" to the debt (i.e. short-tem Tbills)
If you own currency (what some incorrectly call "money") then you have a "2nd deed" to the debt (securities) that back the currency.
If you put your money into a bank for "safe" keeping then you have a "3rd deed" to debt, since your holding are backed by currency, which is then backed by securities.
A prudent investment goal in a Depression should be to have "first rights" to any debt that you own (such as securities). "2nd deed" and "3rd deed" can be greatly manipulated - or disappear altogether in very bad situations.
The equities market is hanging around 13,000 on the Dow with VERY small volume, and LARGE amounts of High Frequency Trading (HFT). That should signal warning bells to all investors.
Think of it this way...the equities market is Las Vegas on steroids, while the bond (debt) market more accurately tells the real story. There's a very good reason why bond yields have dropped through the floor on US securities.
If you were an investor in the world who needed to determine which country has the highest possibility of actually completing the future labor that it has promised then who would you pick?
Everyone is choosing the United States, which is why bond volume is so high and yields are so low.
This is also why those predicting the US dollar to be "toilet paper" are so very wrong, and have been for quite some time. The US Dollar Index has been strengthening, not weakening. Don't be surprised when it crosses 100 in the future.
Lastly, commodities such as oil, gold, and silver will not be having the spike that people expect (even though oil would do well when/if a world war breaks out).
That's one marker of a Depression.
“Treasury bonds are priced for the end of the world.”
It depends on whether the end comes in fire (inflation) or ice (deflation, with a stable currency). Bonds are priced for the latter.
In the tradition of “fighting the last war”, or investing by looking in the rear mirror, the big disaster most focus on is the Great Depression, rather than Weimar Germany.
“Treasury bonds are priced for the end of the world.”
It depends on whether the end comes in fire (inflation) or ice (deflation, with a stable currency). Bonds are priced for the latter.
In the tradition of “fighting the last war”, or investing by looking in the rear mirror, the big disaster most focus on is the Great Depression, rather than Weimar Germany.
Weimar was an interesting economics study.
The German deutschmark was actually a pretty stable currency immediately following WWI and before the Treaty of Versailles.
German currency was/is debt-based, so it was backed by the sale of German treasury bonds.
The Treaty of Versailles stipulated that the Allies must be paid war reparations by Germany in their respective currencies.
This immediately had the effect of making German bonds extremely difficult to sell. This, in turn, forced the German government to change the value of existing currency - thus creating the eventual hyper-inflation.
The lesson to be learned is that countries only suffer hyper-inflation when they owe extremely large amounts of debt denominated in a currency which is not their own.
This is why the United States will not see hyper-inflation (we're seeing big time deflation right now...masked by deficit spending). We have massive debt, but it is all denominated in our own currency.
Color me skeptical, but in 2006, and ounce of gold sold in the neighborhood of $660, now it's $1604. Almost triple the value. The same with silver and oil. That tells me that the dollar has been losing value.
Then again, even my wife thinks me completely and utterly insane. So be it. I suppose I could squeeze my eyes shut and wish everything to be better, but the CPI is not in any form or fashion a realistic gauge of inflation anymore. Most people I know have been either downgraded in finances, or are treading water performing 2012 work for 2008 wages.
Well, except one, but she works for the government. She's had nine raises since 2008, for doing the same exact job she did in 2008. Yeah, this is going to work...
Oh, look, another city just filed bankruptcy.
That's the common thought process. However, you can go look at the following chart for the US Dollar Index and see that is not the case:
http://www.bloomberg.com/quote/DXY:IND/chart
The rise in the price of gold and silver has more to do with the commonly held incorrect belief that we are in the midst of severe inflation, bordering on hyper-inflation. Gold and silver purchases have been more emotional than based on facts.
I'm not saying that to disparage anyone, but to point out the necessity of understanding debt-based money. We wouldn't be seeing the events unfolding all around the world if there was major inflation in play.
Instead, we're seeing all of the signs of deflation, which is why deficit spending is being done by both parties of Congress.
Western Europe has a major problem. They don't have a "Federal" government with the Euro in which to deficit spend. That's why you're hearing rumors concerning "Euro bonds". They're desperately trying to deficit spend to counteract their contracting money supply.
Many folks are excited about the prospect of property because of the price plunge and low interest rates.
However, taking on debt to finance property is an extremely risky endeavor in my own opinion.
It's my belief that property will continue its decline on average, and that it still has a long ways to fall - while the eventual bottom and long drawn-out growth will take many years to unfold.
I say this because economic history shows we still have another six or seven years of deflation before major warfare breaks out and reintroduces moderate inflation (through many countries gearing up for their war efforts - with the international banks loaning them the money to do so).
When is a good time to buy property? When war is imminent.
Not if the market is being manipulated. We know Bernanke is buying bonds, why not also use the PPT to buy stocks, to prevent a real collapse?
Your posts are interesting. Will you please point to some further reading in support of the position that we are in deflation now?
PM me if appropriate.
Much obliged...
Re your Post 13:
The “in their respective currencies” is important, I agree. But another important factor is whether the debt that is owed is internally owned by the population, or externally borrowed.
In Germany’s case, the war imposed a huge no debt whose owners were the winners of the War—which made the debt external. The fact that the debt had to be paid in external currencies made it far worse, I agree, but I’m not sure whether the dominating factor is whether the ownership of the debt is domestic vs. international, or whether the dominating factor is “own currency” versus “other currency.”
Rogoff and Reinhardt cite both as important factors.
I agree that short term, we’ll have deflation as it is traditionally conceived (dropping prices, low nominal interest rates). But, you can also have net deflation (i.e., real amount of debt in the economy decreasing because of defaults) in the presence of high nominal inflation, which is what I was getting at with the Weimar reference.
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