In These New Times

A new paradigm for a post-imperial world

The U.S Treasury Bubble: The worst kept secret on Wall Street

Posted by smeddum on March 24, 2009



March 23, 
By Steve Christ
By now everybody and his/her mother has heard about the U.S. Treasury bond bubble.
In terms of secrets, it is one of the worst kept on Wall Street.
And the truth is the bond bubble really isn’t much different than any of the rest of them. It is just the latest bit of market insanity that is destined to pop. I know it, you know it, and more importantly the market knows it too.
It is a simple fact not lost on many market watchers, including the Oracle of Omaha himself.
In fact, in his most recent annual report to Berkshire Hathaway shareholders, Warren Buffett was just the latest in a string of bubble-callers when it came to the ballooning price of U.S. Treasuries.
According to Warren:
“When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.”
Now, if that doesn’t sound like a train wreck waiting to happen, I don’t know what does. After all, we all know how housing and the boom came crashing down. Neither one of them is something I would like to repeat.
That may just be why the Chinese are suddenly so concerned about the future value of the mountain of U.S. debt they hold. Because, as the world’s largest holder of U.S. Treasury Bonds, the value of those holdings will seriously decline as the bubble bursts.
In fact, the prospect of becoming a bagholder is what Chinese Premier Wen Jiabao was referring to last week when he declared, “We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets.”
Even still, the bubble in U.S. Treasuries persists even though it is as plain as an elephant in the room.
The Treasury Bubble Gets Even Bigger
In fact, just last week Ben Bernanke pumped another big dose of air into it by announcing the Federal Reserve was going to make good on its December promise to actually buy U.S. Treasuries.  
To combat the current crisis, the FOMC decided yesterday to buy as much as $300 billion of long term treasuries and add another $750 billion worth of mortgage debt in an effort to bludgeon interest rates even lower.
As a result, the yield on 10-yr. notes simply got hammered as the price of Treasuries screamed higher on the announcement. It was the biggest one-day move in Treasuries since 1962.
Of course, it is important to remember that bond prices trade inversely to their yields. So when bond prices move higher, yields drop.  Conversely, when the bond market sells off, or demand drops, yields climb higher.
And in the aftermath, it was clear that “quantitative easing” had finally arrived. That, of course, is Fedspeak for printing even more money from its magic checkbook.
Not surprisingly, gold screamed higher on the news, and the U.S. dollar took one of its worst one-day beatings as the markets beagn to price in the inflation that is now certainly coming down the pike.  
In short, it was nothing more than some extra fuel for the bond bubble fire since the prospect of higher inflation will cause an eventual sell off in Treasuries. Bond vigilantes are not easily fooled.
That’s a day of reckoning that simply cannot be avoided—- even though the Fed is determined to force yields lower. At some point, the bubble will most certainly burst — just like housing, commodities, and tech stocks did.
So, while the equities markets cheered yesterday, the Fed only delayed the inevitable with its latest attempt to shock the markets back to life. Of course, we all know how successful the Federal Reserve has been with that mission so far…. Ten or more rescues later, and we’re still in the muck.
Backed into a Corner
But in some respects, Bernanke’s move to print money was also forced by the markets themselves. You see, as we discussed earlier, the bond bubble is pretty obvious by now—especially overseas.
In fact, it is so obvious that foreign countries have now decided funding U.S. consumption isn’t exactly the best use of their capital, creating something of a nightmare for the U.S.
According to the most recent Treasury International Capital (TIC) data, net foreign acquisition of long-term securities actually turned negative to the tune of $60.9 billion in January. That means foreign money is actually leaving the U.S. markets rather than coming in.
So, with hundreds of billions of dollars now needed just to fund all of this new government spending, the Fed has become, in effect, the lender of last resort to our own Uncle Sam. Moreover, if foreign capital continues to shy away from Treasuries, you can bet that the Fed will print even more money in the future to keep it all afloat—sort of like what goes on in your run-of-the-mill banana republic.
A banana republic, by the way, is defined as one that typically has large wealth inequities, poor infrastructure, poor schools, a “backward” economy, low capital spending, a reliance on foreign capital and money printing, budget deficits, and a weakening currency.
Now that about sums it up, doesn’t it?
For investors, however, that does not mean all is lost—- not by a long shot. As inflation returns, and the treasury bubble bursts, investors will begin to stampede into precious metals and commodities as the dollar is left to twist in the wind. That’s why goldoil, and the entire commodities complex went through the roof  on the Fed’s announcement.
Secrets in the markets don’t last long these days.

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