Friday, June 19, 2009

Rising Treasury Yields Threaten the Economy

The last few months we have seen the casino operators on Wall Street attempt to get their casinos up and running again. They are trying to see how much "dumb money" they can get to invest again into the US stock market.

While this is going on, there is something significant going on with the real economy that Wall Street is ignoring. The yields on all but the very shortest-term Treasuries has climbed sharply. From its low of 2.04% in mid-December, the yield on the 10-year Treasury has soared to nearly 4%.

The 10-year Treasury rate has a direct impact on mortgage rates. Higher mortgage rates threaten to cut off any incipient recovery in the housing market rather quickly.

Why are interest rates climbing? Wall Street is telling you it's because the economy is recovering rapidly and you'd better run out and buy stocks now.

The real reason behind the rate rise is fear. Overseas investors are becoming scared to death of US economic policies. Please recall from prior articles how key overseas investors are to interest rates, the US dollar and our economic future.

Overseas investors are seeing annual trillion dollar deficits for the US for at least several years. This is scary enough but what the Federal Reserve is doing has these investors terrified.
The Federal Reserve is following a policy of what is called quantitative easing which is fancy term for printing trillions of dollars out of thin air with nothing to back them up.

The worry among overseas investors is that either: 1)the US will inflate their way out of debt with very high inflation rates. This way when the debt is paid back years down the road, it will be with dollars that are worth little; or 2) the US will simply renege on its debt and not pay it back at all.

The US has been following a policy of devaluing the dollar and inflating their way out of debt for decades. Readers should recall a fact from a prior article - that a dollar today buys only 20 cents worth of goods as compared to 1970. Overseas investors are worried that the US may go into overdrive in devaluing the dollar.

So right now, led by the largest holder of US Treasuries - China, overseas investors are following a similar game plan. They are selling longer-term maturities such as the 10-year Treasury. This selling is forcing these Treasuries down in price and higher in yield.

Overseas investors are then parking the money from these sales into short-term 3-month and 6-month Treasury bills. In other words, overseas investors do NOT trust the US over the longer-term.

In the sad-but-true column, Treasury secretary Tim Geithner recently went to China to beg the Chinese not to sell Treasuries. While there he gave a speech at a major Chinese university. He said that the US dollar was sound. After he uttered those words, he was laughed off the stage by everyone in attendance. Well, he at least he a profession he fall back on - as a comedian.

1 comment:

  1. This makes perfect sense. I'm also looking at Gold, as what I consider the "fear factor", and I think it's ready for a jump. That correlates well with the interest rates going up. And the result of all this is another down leg of the real estate market and the decline of household wealth, further crushing the economy. No, I don't see a pretty picture in the future either.