Bad News for Bond Prices
The news this morning is as grey and damp as the weather.
First, the U.S. stock market did nothing yesterday. The Dow ended down 9 measly points. The Dow is about 10% above its November low; have we seen the rebound already?
Oil slipped slightly – down to $39. And gold lost $21. While some may see the drop in the gold price as disheartening, we see it as an opportunity to grab some more of the precious metal while the price is relatively low.
The Banque de France says the country’s GDP is falling. It’s expected to walk backwards by about 1% this year.
The Sarkozy government announced a $12 billion program to support France’s auto industry. “We’ll give you money,” he said, “but you’ve got to promise not to cut salaries or close down.”
Nissan, 40% owned by Renault, announced it was cutting 20,000 jobs worldwide – 9% of its workforce.
Japan is facing an “unimaginable” contraction, its central bank’s chief economist warned yesterday. Orders are drying up…production is falling off…and consumers can’t seem to find anything they want to buy. Industrial production in Japan fell a record 9.6% in December. The country is looking at an annual GDP decline of 1.7%.
Growth is collapsing throughout all of Asia. Singapore, for example, went from healthy 5.3% growth last year to minus 2.4% this year. India and China are still projecting decent rates of growth – though significantly below their highs. We’ll see how long that growth continues…
And poor Latvia. Its economy is not just walking backward…it’s running. Today’s Financial Times tells us that output is falling there too at a depression rate of more than 10% per year.
But the big news yesterday was the sell-off in the bond market.
“All eyes on sudden spike in US Treasury yields,” says the headline in the Financial Times.
The yield on the U.S. 10-year note rose above 3% for the first time in three months. The two-year note, meanwhile, moved above 1% yield. What does it mean?
We are bearish on U.S. government paper – in all its forms. And here’s why. The latest estimate from Goldman Sachs puts US government borrowing for this fiscal year at $2.5 trillion. Meanwhile, foreigners are showing less and less interest in U.S. debt. They’re switching to short term paper – bills and notes, which are less vulnerable to inflation and currency declines. And they’re pulling out of U.S. Treasury market generally. The total percentage of U.S. debt owned by foreigners is falling from 60% down to about 40%…a huge drop.
Either one of two things will happen. If the government funds its deficits honestly – by borrowing from willing lenders – this huge extra demand for credit will force up yields…thereby lowering bond prices. Or, if the government resorts to “monetizing the debt” – that is, funding its debt with printing press money – investors will flee bonds, in fear of higher inflation.
Either way, it will be bad news for bond prices.
Remember, we are only in the Boondoggle Stage of the crisis. Using the collapsing economy as an excuse to waste money, the pols are having the time of their lives. Does your community need a bridge? A new drainage system? A shooting range for blind people? A study of the mating habits of fire ants (how do they get together without getting burnt?) Even in the best of times, politicians have trouble saying ‘no.’ Now, ‘yes’ is the answer to every request.
What strange madness is this? Why would anyone think the economy will be made better off by squandering money now on projects that were deemed unworthy or unaffordable only a few months ago? The country got into trouble because people squandered too much money; now they think they will get out of trouble by letting the government squander money. But we’ll have to wonder about that later. Now, we’re just trying to keep up with the torrent of boondoggles, bailouts and bunkum.
Let’s see, Bloomberg reports that about $3 trillion has been spent fighting the downturn in the last two years by the United States of America. We pass over the issue of whether this has done any good, and stick to our figures… Another $5.7 trillion has been pledged. Plus, this latest Obama Bailout will cost about a trillion more.
Hmmm…a trillion here…a trillion there…pretty soon you’re talking about real money.
“US Taxpayers Risk $9.7 Trillion on Bailout Programs,” Bloomberg figures, or about two-thirds the entire national GDP.
Hmmm….that’s about as much as the total burden of household mortgages. In other words, instead of all these boondoggles, bailouts and bunkum, Congress could have just paid off everyone’s mortgage.
*** Inflation is now only a problem because there isn’t any. In the United States, the consumer price index crested at nearly 6% last year. Now, it appears to be headed down to zero…and perhaps below. That is what the feds are desperate to avoid. When consumer prices fall, consumers become obsessively frugal. They know that if they just wait, they’ll be able to get what they want at a lower price. And then, why not wait a little longer…and get the item even cheaper still? This “propensity to save,” as economists call it, becomes self-reinforcing. As consumers stop spending, lower demand causes prices to fall further…which incites consumers to dilly dally even more…which causes prices to sink again.
That is the Japanese-style ‘deflationary cycle’ that gives Ben Bernanke a nightmare.
But we explained yesterday, there’s not much he can do about it – at least nothing honest. Rupert Murdoch says the financial crisis has caused $50 trillion in wealth to vanish. The feds have put back only $3 trillion (arguably) so far. Just looking at the numbers, it doesn’t seem as though prices will be rising anytime soon. For every dollar the feds put into the system, $17 disappears.
What’s a fellow to do? The only way out, as near as we can see, is the road taken by Gideon Gono. “Monetizing the debt”…“quantitative easing”…“printing press money” – it will no doubt go by a number of different euphemisms and code words. It’s what happens when the Fed buys U.S. Treasury debt directly. For this purpose, it simply creates a ledger transaction…effectively adding to the money supply.
But even printing money does not automatically and immediately cause consumer price inflation. According to classical economic theory, the shelves must be cleared and the excess capacity must be re-absorbed before prices will rise. That could take a very long time. But we’re not sure it works like that. If money were suddenly dropped from helicopters, as Ben Bernanke once pledged to do, merchants probably wouldn’t wait for their inventory to disappear before raising prices. They’d be concerned that there were giving away something that was valuable in exchange for something that was not.
When this kind of inflation happens – perhaps worthy of the adjectival modifier ‘hyper’ – it can happen very suddenly, and very violently. That is why we suggest selling U.S. paper now…even if it turns out to be very early.
*** Drought…fires… plagues…
The poor Australians are battling blazes all over Victoria province. The total cost is climbing up towards 200 dead…and half a billion Australian dollars worth of property damage.
There’s a terrible drought in China too…the worst in 50 years. Peking has put up 10 million euros to help the peasants.
Chris Mayer sends this note:
“China is in the midst of its worst drought since 1951. Beijing has gone 100 days without rain. Nearly one-fifth of China’s wheat harvest is at risk and over 1.8 million head of livestock are short of water. Over 3.7 million people face water shortages, as do nearly 23 million acres of farmland. Rivers and lakes are drying up and farmers are drilling deeper than ever to reach falling water tables.
“As is the way with these things, it couldn’t happen at a worse time. The economy is clearly slumping along with the rest of the world. Unemployment is on the rise. And now food prices may also climb. Not a good combination for a country that already has a fair amount of unrest bubbling just below the surface.
“Water mismanagement has long been a problem in China. Wasteful irrigation is one problem. So is pollution and mass urbanization to the cities, particularly in the more industrialized – but water-parched – areas in the north.
“The government knows this and has swung into action with a number of emergency measures, including financial aid for farmers. One of these measures also increases the subsidies to pay for irrigation projects.
“Over the next several years, I think irrigation equipment is going to play an ever-larger role in helping reduce water use. Water problems will get only worse before they get better. The companies that make the tools and have the expertise to solve those problems will be very valuable. And so will their shares.”
*** And from Argentina comes bad news. Not only is the country parched, the drought seems to be centered on your editor’s farm.
“It’s dry…very dry…” says the farm manager. “We got almost no rain this season. The reservoirs are empty. There’s no way to keep the cattle. There’s nothing for them to eat. We just have sell as many of them as we can.”
So far, the cattle business has not been a big winner for us.
“When the grass is too dry and too short,” the farm manager explained, “the cattle pick up a lot of dirt and sand when they eat. The sand wears down their teeth, so even if they had good grass, they wouldn’t be able to put on much weight. And since they can’t find much to eat and can’t eat it very well, they don’t have the energy to go very far looking for better grass. It’s a vicious circle. But that’s what we’ve got up here…a difficult place to raise cattle.”
Meanwhile, here in Europe, there’s water everywhere. Fields are flooded in England. In France, it’s been raining for days.
The Daily Reckoning