Next week could be really big – 2/21/09

From Don Sanderson

2/21/09 Ukiah, Northern California Next week, some economically/financially important events are unfolding that well may portend a rapid economic dive off the cliff for the United States, much more quickly than anyone is predicting that I’ve seen reported in the usual media. But, the tracks are there. It concerns the U.S. Treasury bond market where Obama must go to get his stimulus funds and, increasingly, much of the rest of the money he needs to operate the government and fight his wars. Some background:

A good way to track the economy, given the amounts of money the U.S. government is spreading around, is to follow the yields of U.S. Treasury bonds. Whenever the U.S. spends money it hasn’t collected from taxes and fees, it must first get from the sales of bonds.

Some background: When one invests a certain amount of money in a bond, say $1,000, at an annual return of 15 percent, it is said that the bond has yielded 15 percent or $150. If the bond is then sold for, say, $800, the buyer still gets an annual return of $150, but that is a rate of return of 18.75 percent, the bond now yields 18.75 percent. So, if you read that U.S. Treasury bond yield has increased, this should tell you that the market for bonds has fallen, much as the stock market falls. Bond yields have been steadily growing.

The U.S. Treasury sells both short term, say 5 year, and long term, say 20 year, bonds. Those who invest in short term bonds may be uncertain with the future and don’t want to bet long term. So, the relative yields of the two types of bonds should give one an idea of how much faith investors have in America’s financial future. In fact, short term bond yields are low in historical terms relative to long term ones, indicating bond holders feel insecure.

Next week, the U.S. government is going to sell almost $300 billion of U.S. Treasury bonds. I don’t recall the exact numbers or the mix of short and long term. Who is going to buy them? The biggest purchasers historically have been Japan and China. Japan is now going into a economic dive even worse than ours; two of their biggest banks have been found to have invested with Madoff. China has expressed worries about its bond investments, asked for guarantees, and is considering spending the money instead on imports and business investments. With stock markets crashing around the world, private investors such as, particularly, retirement funds may jump to the ostensibly safer bonds with guaranteed yields.

If the yields of bonds sold next week are high and the emphasis is on short term ones, we will have two nearly certain markers that the economy and government are in deep trouble, that investors are jumping ship. These markers would likely be associated with a dramatic fall in the U.S. stock market as investors jump to supposedly guaranteed high yield short term bonds.

There is a small hitch in this argument. The Federal Reserve is fighting high interest rates. The Fed is a private organization owned by ten or so large private American and European financial organizations. Since the Fed is privately held, it need not report ownership details. The Fed alone is permitted by the U.S. to print dollars and does so independently of U.S. government control. Thus, the Fed may and does print money in order to buy U.S. Treasury bonds as it sees fit to control the money supply, but presently owns only about 7 percent of the national debt. In the past few months, it has been printing money by the many billions, some say as much as 10 trillion, of dollars and loaning them out at no interest to both American and foreign financial institutions. The shareholder banks are paid a fixed 6 percent dividend on earnings; any additional revenue is given to the U.S. Treasury.

The Fed has announced that it is prepared to save the U.S. Treasury bond market by buying as many bonds as necessary, of course with their bogus money. Conservative economists are deeply afraid that the piles of money the Fed is printing and scattering around will destroy trust in the enduring value of the dollar; on the other hand, some liberal economists have concluded it will require trillions more to restart the economy than anyone is discussion, but they also fear this would bankrupt the country. In fact, during almost all of the past thirty years, the dollar has been falling with respect to other currencies and now continues in decline. One problem with that is that if I consider loaning you (from Dubai), say, $1,000 today, perhaps by buying bonds with 5 percent return over 5 years, and project the dollar will sink that far or farther in that time relative to my national currency, I must conclude this would be a foolish, stupid, investment. An old rule: anything in excess will lose value and the dollar is providing an example.

If the Fed gets into the U.S. Treasury bond market in a big way to save it, it will likely unnaturally drive down yields and make bond sales uninteresting to private investors while making the Fed the dominant U.S. creditor; i.e. we’ll be owned by the Fed. Funny stuff going on here. Wall Street, the Fed, and the U.S. Treasury Department are so entangled, its difficult to se what is happening, but it appears they are, it is, fighting for survival. But there is no there there except for a lot of phony money. The country has been robbed blind, so they are trying to finish striping the world out there and the world out there is objecting.

There are other bond classes of interest as well: Fanny Mae and Freddy Mac and Municipals, those issued by state and local government entities. The first two may be seen as secure as U.S. Treasury bonds, or not depending upon housing prices and foreclosure rate – Asian investors are now saying they aren’t interested unless these bonds are entirely guaranteed by the U.S. government. On the other hand, Municipal bonds are selling only at very high yield rates, if they can be sold at all.

Note that the U.S. government is only able to pay the interest on its bonds by selling more bonds, at least for the foreseeable, some say imaginable, future. In other words, this is all a Ponzi scheme began by the Bush administration almost 8 years ago and now being continued by Obama’s. Though Madoff had a good run, Ponzi schemes are assured to ultimately fail. In this case, it will be when bonds can’t be sold for any yield (except to the Fed), at which point no one will accept dollars as payments for anything; Zimbabwe is now issuing currency in 10 trillion face values and that will hardy buy a loaf of bread. Of course, Obama assures us that the economy will eventually grow and revenues will become sufficient for yield payments and maybe to reduce the national debt, but he counsels patience, that it may take several years. Investors must make the call as to whether this will happen or not and no economist on Earth is qualified to advise them. Indeed, it appears most economists are scared to death. We are living in extraordinarily interesting times.


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