Why the Current Strength of US Bonds Will Be Short-Lived

Stocks down…gold down…bond yields flattened…world markets roiled…

And yet, all this pales in comparison to the very real world horror going on right now in a small group of islands in the Pacific Ocean. Tens of thousands of people in one of the world’s most developed economies are without access to clean drinking water tonight and without power in sub zero temperatures. Families huddle together, not knowing if or when the next disaster might be visited upon them.

Millions more around the world watch on with sorrow, horror, perhaps even guilt, at what they see unfolding across Japan. Some will point to the failings of man…others to the mystery of a god…and others still will simply sit and scratch their heads…

“What’s the reason?”…“What does it mean?”…“Why there and why now?”

Before we begin to assess the financial implications of Japan’s 9.0 monster earthquake, we first offer our heartfelt condolences to those who suffered this most recent expression of nature’s blind wrath.

Callous as it must surely seem, sometimes the only thing to do in these situations is to keep on keeping on. Carpenters keep building…engineers keep designing…scientists keep searching for cures…doctors keep administering them…

And reckoners? Well, those of us with little better to offer than our thoughts and words…well, we keep on reckoning…crude and searching as our words must at this time appear…

So we return to our post; to stocks, gold and bonds. Where to from here?

To be frank, it’s probably too early to comprehend the extent of the damage wrought by the quake in Japan with any measure of certainty. We’ll have to see what comes of this in the weeks and months ahead.

However, it’s probably not too early to begin trying to understand what Japan’s crisis might mean for long-term US bond yields. Dan Denning, the Daily Reckoning’s “Man Down Under,” pondered this very question in his Aussie DR musing this morning.

“The Japanese are one of the largest holders of US Treasuries and continue to buy them,” observed Dan, before adding, “That capital might be put to a lot better use in the coming years rebuilding from the quake and tsunami damage.”

Dan raises a very important point. We’re seeing a flight to “safety” right now, no question. US Treasuries rallied yesterday, more or less in sync with the horrific images coming from the Fukushima and Sendai newsreels. The yield on the benchmark 10-year note briefly touched 3.2%, its lowest level this year, reflecting the “safe haven” appeal of bonds. (Bond prices and yields move in opposite directions.)

But what happens when the dust settles a little and Uncle Sam wakes up to find one of the go-to buyers for his ever-accumulating debt has put in a no-show? What happens, in other words, when the second largest holder of US debt discovers he has his own, 9.0 earthquake-sized problem to deal with? According to data released by the Treasury on Tuesday, Japan held $886 billion worth of Treasuries at the end of January, the second largest foreign holder behind China. That’s a big gap to fill…even by fractions.

“Of course in the short term, the ‘risk off’ trade is bullish for US bonds and the US dollar,” continues Dan. “People are cashing in their chips and storing up their cash. But longer term, the US may find it a lot harder to fund deficits without the help of at least one major foreign buyer. This will put more pressure on the Fed to monetize debt right away.”

What then will the Fed do? Well, exactly what the Fed always does, of course; precisely that which it shouldn’t. The Fed will, as Dan points out, continue its attempt to “monetize” (read: print) away its debt.

It goes without saying that this strategy is a complete non-starter, as far as any measure of logic is concerned. Academic types like to argue that a weaker currency and/or more liquidity are great ways to jump-start flailing economies. They argue that a flaccid currency gives exporters an edge abroad and that a blast of paper money stimulates spending back home. In reality, all this does is perpetuate a weakening confidence in that particular currency as a store of value and, thereby, discourage those with whom the offending government might wish to trade from wanting to accumulating them. Who, after all, wants a vault full of Zimbabwean dollars, Hungarian pengős or US Continentals?

And lo! Always on the ball, Addison writes in this morning’s edition of The 5, “Easy money is already having its affect in the US. Wholesale prices, which trotted upward in December and January, reached a full gallop in February.”

The upward-trot-to-record-gallop to which Mr. Wiggin is referring is, at least according to a story we saw coming across the wires this morning, the steepest rise in food prices in 36 years.

Continues Addison, “The producer price index (PPI) rose 1.6%. Even after the usual statistical sleight of hand applied by the Bureau of Labor Statistics, the number is more than double what the Street expected. Annualized, it’s 19.2%.

“That’s for finished goods. If you move further back in the production chain, prices for crude goods rose 3.4% last month. And February was no fluke. PPI for crude goods has risen 20.7% over the last six months.

Of course, the Fed’s own measure of inflation – that nebulous, periodically redefined, terminally elastic non-statistic – remains, according to the Fed itself, “subdued.”


Alas, this news comes to us from an institution that actually admits – with a straight and serious face, no less – that it actively targets a 2% erosion in the value of your money per year. The Feds guarantee, in other words, that they will steal, or do their best to steal, via inflation, 2% of anything you earn or own every year for the rest of your life…or for its. That is its stated “sweet spot.”

It’s enough to make one think of the term “greed” in a whole new light…

Joel Bowman

for The Daily Reckoning

The Daily Reckoning