The Last Bubble to Pop - US Treasury Bond Bubble?
The Next Bubble Has Started To Pop
The nasty problem with most investment bubbles is that they tend to keep
inflating long after prudent people point out their existence. Over time, the
rational folks who warn of trouble ahead lose their credibility and investors
decide that we live in a new world where the old rules just don't apply. So
when the "pop" finally comes, lots of people lose lots of money.
That was the case with the Tech Bubble of the late '90s. Alan Greenspan warned
of irrational exuberance in the stock market in 1997 but when the dot-com
stocks just kept rising, people assumed that Greenspan and Warren Buffett were
just old fogies that didn't understand the internet age. Three years later, the
bubble popped and billions in wealth vaporized.
The same was true of the real estate bubble that has devastated developers and
speculators in the Sun Belt during the last year or two. For years, home prices
just kept rising and rising long after a number of economists warned that trees
never grow to the sky. Those old fogies didn't understand that with thousands
of Baby Boomers retiring every day, it was impossible to have too much real
estate in Las Vegas, Miami, Phoenix, San Diego or the other warm places that
all the retirees wanted to move.
Since most of the speculation was financed with borrowed money, that bubble
popped quickly and violently and has played a major role in creating the
financial crisis we are facing today.
The next bubble--in U.S. Treasury notes and bonds--will be the most shocking in
recent memory--not due to leverage but because investors have flooded into bond
funds specifically because they are supposed to be the most conservative,
low-risk investments in the world.
This flight to the illusion of safety has created so much demand for U.S.
Treasury debt that, despite its precarious financial condition, our government
has been able to borrow money at very low rates of interest.
All the conversation and reports from Washington for the last month have
focused on the financial crisis and the stimulus plan that is being enacted to
jump-start the economy. (By the way, am I the only one who thinks that a
"stimulus package" sounds like something offered in the back room of a
gentleman's club?--But I digress).
While the pols and pundits have been silent, the financial markets are flashing
huge warning signs. The price of gold has gone up by 30 percent and the U.S.
government's long term cost of borrowing has gone up by almost 50 percent
during the last month. The markets are coming to the conclusion that in the
absence of tax increases (which are not even being considered by Republicans or
Democrats), our government will pay for its multi-trillion dollar deficits,
bailouts, and stimulus plans by simply printing more money.
That money will be borrowed from countries and fund managers who are already
demanding a higher rate of interest to cover the inflation risk they are taking
by loaning trillions to an insolvent country.
As rates go up, bond prices go down. Most U.S. Treasury bond funds were down
about 5 percent for the year before last Friday when the popping noise
increased in volume. There was an auction of 30 year treasuries on Thursday
where bonds were price to yield 3.54 percent. By Friday afternoon, those bonds
had lost 4 percent of their value in one day and are now priced to yield 3.70
percent.
Think about that. Investors lost 4 percent of their money in one day by buying
"safe" U.S. government bonds. Over the long holiday weekend, the news channels
were full of conversation and discussion about the final version of the
Stimulus Plan. Did you hear any conversation or reporting at all about the
massive drop in bond and bond fund prices from any politicians or reporters?
Have any of them even discussed the meaning of gold's increase from $700 to
$950 an ounce in just the last few weeks?
Of course not. That's because the politicians and news media have all decided
that they will only discuss whether the stimulus package will work--not how
we're going to pay for it. The financial markets--and the countries and funds
that are financing our spending--didn't get the message. They are becoming
obsessed with how we're going to pay for this and what multi-trillion dollar
deficits will do the buying power of the dollar in years to come. Our creditors
will continue to demand--and get--higher interest rates from us going forward.
As treasury bond yields go up, bond and bond fund prices will plummet.
Earlier this month I wrote (It's Time To Own Stocks and Stuff - Feb. 5) that it
is time to invest in hard assets and solid companies with strong balance sheets
and pricing power. Investors should set aside the cash they'll need over the
next couple years plus whatever else they are willing to invest for zero return
to enable them to sleep at night. The rest of it should go into good stuff--not
bonds.
Investment in long term bond funds at this point is neither conservative nor
safe. U.S. Treasuries were the one asset class that didn't lose value last
year. That's because there was limited supply and seemingly unlimited demand as
panicked investors tried to move out of harm's way.
Up until now the US budget deficit has been financed by the (mainly)
Asian export countries recycling their trade surplus dollars into US
treasuries. This worked out nicely for the US, however there is a
problem now. The trade surpluses of those countries never even
approached the amount that the US government now needs to borrow, even
during the good times. Now, with trade surpluses dropping, those
countries will be able to afford even less US treasuries. The
government will be forced to print the money it needs, thereby
destroying the value of the dollar.
Make no mistake though, this is what the government wants. Paying back
colossal debts in worthless currency is not a difficult task. The US
government wants to spend as much as possible now, and thereby control
the devaluation of the Dollar themselves...before others come to the
realization that America can never pay back it's current debts and
liabilities in the current circumstances. By the time America's
creditors come to this realization, they will be sitting with
mountains of worthless paper; their hard-earned money having gone to
bail out banks, invade foreign countries and propping up the American
consumer.
They will have been victims of the greatest fraud and the largest
bubble in history - The U.S. Treasury Bond Bubble.
P.S. If you think treasuries AREN'T a bubble, ask yourself why people
would buy them at negative interest rates. This kind of thing only
happens during bubble-based booms. Prepare yourselves.
