Consensus on the Treasury Debt Bubble
I’ve just returned from Agora Financial’s Investment Symposium in Vancouver. The conference was full of good ideas and interesting speakers.
There is rarely any kind of consensus that emerges from these sorts of things. However, it did seem that virtually everyone saw the folly and risks in the debt-laden U.S. economy.
We all agree: Debt is the story of today’s economy. There is still too much of it. Yet the mainstream view seems to be that more of same is the elixir to see us out of this bust. In fact, debt issuances by governments are hitting new records.
Letís look at the U.S. government. It is spending money hand over fist. Thatís not new. What is new is that the bloated government will try to sell over $200 billion in Treasuries this week — a record amount of new debt. The U.S. is hoping more foolish foreign central banks will line up and absorb the deluge for pitiful interest rates. The 2-year note sells for a yield of 1.01% as of last Friday.
Maybe Washington will pull it off. But one day, people are going to demand a better rate to take the government’s paper. At some point, the marketís appetite for puny yields will go away. When that happens, interest rates will rise significantly and debt prices will crash. Itís not a matter of if, only when. To continue at this pace is clearly unsustainable.
The crazy thing is that the U.S. government is not alone. Emerging markets are also issuing record levels of bonds. The Financial Times reports this morning that ìthe surge in issuance this year [hit] its highest point since records began in 1962. The biggest issuers include China, Brazil, Russia, South Korea and some of the Gulf states.
Incredibly, most seem to look at these debt issuances as positives for the global economy. The FT, for instance, opined (in the middle of its news story) that the debt sales were ìan encouraging sign for the world economy.î
Itís a weird paradigm that thinks growing debt levels are a good thing for the global economy, but it is a mainstream view. Economists, lost in their models and abstract curves, preach the benefits of stimulus — printing money and spending and borrowing.
And people seem to eat this up.
From The Wall Street Journal, I give you another exhibit of this kind of thinking. Reporting on the growth of Asian welfare systems, the WSJ reports:
Asian countries are beginning to build extensive social-welfare programs like those that long have existed in the West, a move they hope will encourage their people to save less, spend more and help put the region — and the world — on a stronger economic footing in the years ahead.
Remarkable, isn’t it? Save less and spend more to create a stronger economy. Only an economist could sell that idea. I think the average person on the street would not believe that if they saved less and spent more their household would be on ìstronger economic footing.
All this debt also crowds out needed investment in the private sector. It all competes for the same pool of capital. It means the capital-starved mining and energy companies are finding it very costly to raise money. It means investment in real assets slows, so governments can prop up ailing banks and do other dumb things.
The fall in energy investing is already here. If you look at the oil picture, you find something interesting about where future supplies will come from. The IEA estimated as recently as November 2008 that the Canadian oil sands would account for nearly 70% of the increase in nonconventional oil production between 2009-2030. However, with the price of oil where it is, investment has been cut way back. Already, the Canadian Association of Petroleum Producers has revised its forecast for investment three times. Itís cut it from $20 billion to $10 billion currently.
It begs the question, of course, where the oil will come from. These swing producers, like the Canadian oil sands, canít stop and start very easily. They take time. And these swing producers need a higher oil price to entice them to invest in new projects.
All of this sets up another leg-up for oil prices. The same thing is happening really across the commodity spectrum as projects are cut or delayed. From an investorís point of view, you get a chance to buy stuff on the cheap.
China is certainly hungry for resources, and it is doing a lot of buying!
In the 10 months since Lehman Brothers imploded, Chinese bidders have been busy, the Financial Times reports today. So far, they’ve announced bids totaling $50 billion. Of these, more than two-thirds have been in energy and mining.
Among those commodities China needs most is iron ore, used in making steel. In fact, cash prices for iron ore delivered to China topped $90 per ton for the first time this year. China is the worldís largest buyer of iron ore, and imports are up 28% this year.
Chinaís voracious appetite has at least one competitor worried: India. As with China, India too is a large growing market. It too needs iron ore to build its budding cities — power plants, pipelines, bridges and more.
India’s steel ministry believes that India should restrict exports to China to ensure Indian steelmakers have what they need at reasonable prices. Such a move would only make it more difficult for China to find iron ore. India makes 200 million tonnes of iron ore a year, about half of which winds up in China.
So the takeaway from all this debt issuance is to invest in real assets. One day, the Treasury debt bubble will pop, and when capital starts to look around for where to go to preserve itself and grow, it will turn to those hard assets such as crude oil, gold, iron ore and more.