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Wednesday, February 17, 2010

US Treasuries? No Thanks!

Just under two weeks ago, I did a post on how the price of gold and silver had recently dropped like a stone (the second half of Guns and Gold).   In it, I was explaing how problems in Europe were affecting the perceived value of the dollar (pushing it up), which negatively affects the price of Precious Metals (PM).
At least in the short-term, we need to look outside of our borders.  While we are in horrible shape, the rest of the world is worse off.  Many countries are teetering on the brink of bankruptcy.
Worries over debt levels in Spain and Portugal have increased as investors speculate the two countries may face budget deficit and debt problems like those of Greece. Such concerns helped lift the relatively safer haven U.S. dollar and yen.
That last sentence explains what is going on.  Our economy may suck, but not as badly as the rest of the world.  The dollar is the least-objectionable world currency.

It appears as though the rest of the world has woken up, and realized that the US markets aren't the safe haven they thought were were.  In the post above, I talked about how our crushing debt will make it increasingly difficult for us to function as a nation - piling on more and more debt - with one of the results being that we must monetize that debt.

In short, monetizing our debt means that we - as in the United States government - buy our own debt.  Why would we have to do this?  Because no one else will buy it, and we still need to fund our government "services".  In this case, it is the Federal Reserve Bank buying bonds and notes from the Treasury Department.

I figured it would take a good number of months before the world woke up and slowed down their purchases of our debt.  I was wrong.  It looks like it has already started (Foreigners Reduce Holdings of US Debt by Record Amount) -
Foreign owners of US government debt reduced their holdings by the largest monthly amount ever in December, with China offloading so many Treasury securities that it is no longer the largest foreign holder.
(Note to self:  Why did it take 45 days for this to become public knowledge?)

It looks like this trend is continuing.  With the latest Treasury auction on Tuesday, the yields went up (meaning price went down) considerably.

Mini-primer on Treasury Auctions:  The Treasury Department determines what the market will pay for a given note or bond.  Let's say it's 3% for a 10-year, $10,000 bond.  They offer up these bonds (this week it was $81 billion worth) and the public market decides if the yield is worth the risk.

In this case, the market said NO!  Low demand pushed the price down.  The sales price was lower than the asking price.  So, for a $10,000 bond, you may only pay $9,500.  You get interest earnings as though you paid $10,000 for the bond, so your yield on the bond is greater than the bond face amount of 3%.

The blush has come off the US rose
Ten- and 30-year yields rose the most in seven weeks as sales of the securities drew lower-than-average demand. The European Union said it was prepared to take action to support Greece, while leaving open how it might respond to a fresh wave of speculative attacks against member nations that are also struggling to cut deficits. U.S. consumer prices rose in January, a report is forecast to show next week.
And the experts are aghast this is happening -
“With all of the issues the EU had with the PIGS, one would think we would see a continued flight to quality,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. He used an abbreviation for Portugal, Ireland, Greece and Spain.
Yeah.  Well, apparently investors ARE moving towards quality, and they're not finding it here.

The big item in the article was neatly tucked way down in the story.
A higher yield at the auction than in pre-market trading may have cost the Treasury as much as $61.6 million in interest over the life of the debt, according to Bloomberg data.
Let's do some math here:  This year, we need to print up Treasury funny-money to the tune of $3.5 TRILLION (best case Obama projections) to $4.5 TRILLION (more likely).  If the Treasury sells notes in the same volume they did this week - $81 billion - that will give us $4.2 trillion after 52 weeks.

Assuming that there is not additional drop in demand - not a good assumption - this increased cost will translate into an additional expense of $3.2 billion dollars.  Oh, and it's not going to cost the Treasury the extra dollars, it is going to cost YOU the extra dollars.

Taxes, inflation - take your pick.

Accept The Challenge

At the very best, this drop in demand to purchase our debt will translate into increased inflation.  If the foreign governments won't buy our debt, the Federal Reserve will.

If you as a private citizen were doing this, you'd end up in jail.  It is akin to kiting - floating a check from one of your bank accounts to fund the balance in another of your accounts. 

Rob Peter to pay Paul.  Ponzi scheme.  Pick your own analogy, the result is the same:  We get stuck holding the empty bag.

Buy your tangible goods and PM while they're still affordable.  This is not going to be pretty.

BTW - Two weeks ago, I noted that gold had dropped to $1,064 an ounce.  It closed just under $1,118 yesterday.  That's a 5% increase/recovery in only two weeks...

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Anonymous said...

Since the financial "crisis" and the implosion of my IRA, I have been buying tangible items and not putting money into "electronic deposits."

If things come back, I'll worry about building back some bank account. In the meantime I want things I can use and hold.

Chief Instructor said...

I hear ya. We are either buying tangibles, or at least getting the cash in our hands so we can move quickly on deals. And we're earning next to zero with the accounts anyways, so it's no big loss!

I absolutely do not trust our government not to pull "an Argentina" on us and nationalize retirement accounts overnight.

We also just put away another 250 lbs of dry goods in long term storage. I'm feeling very uneasy as of late.

Ryan said...

We still save for the long term ie retirement. Then again the horizon I am looking at is a lot longer than for you folks. Unless there is some sort of nationalization or genuine hyperinflation it will be a good move. If there is a naturalization I will stop contributing and buy PM's then start looking at small plots of land. If there is hyperinflation I will do the best I can.

Needless to say we also purchase tangibles for other eventualities.

Chief Instructor said...

TOR, it's such a tough call right now. Our government is starved for cash, and I worry right now about them being able to calmly explain to the American people why grabbing all of the retirement plans is in your own best interest.

I hope I'm just being paranoid!