Could this be the beginning of the end for our markets’ last great bubble?
An auction yesterday of $34 billion in 5-year U.S. government bonds didn’t go over so well, fetching prices well under what analysts were expecting.
Ruh-roh.
Oh I know, it may not seem like that big of a deal. The debt still got sold, unlike an unsuccessful auction for 40-year bonds in the UK. The fact that our auction resulted in yields (which move in the opposite direction of the price of bonds) of 1.849% versus the expected 1.801% seems like rather unimportant, inside-baseball type of stuff.
And if it’s just one bad auction, then it may not be important (Edit: Demand for an auction of $40 billion in two-year U.S. notes Tuesday was quite strong). But if this weak demand is a signal of things to come, then we are in for a world of hurt.
In the past ten years, we have had a dot-com bubble, a housing bubble, a credit bubble and an oil bubble, but I have contended they will all pale in comparison to the government debt bubble we are now experiencing.
Think about it: The U.S. government, despite owing $10 trillion in debt, despite incurring an additional $1.3 trillion deficit in 2008 (a number which will certainly be crushed this year and likely for years to come if the Obama plan even gets partly realized), has been up until now able to sell almost as much of the debt as it wishes to at extremely low interest rates.
The Pollyannas will say that there’s a good reason for the low cost of our debt, and why that situation won’t change anytime soon. The big concern right now is deflation, not inflation. Other countries have at least as many problems as we do, and too much savings to boot. They need to put their money somewhere, and the U.S. markets are still the world’s best, safest place to invest money. They own too much of our debt to start selling now – it would only lead to mutually assured destruction.
“This time it’s different.” To me, there are no four more dangerous words. It defies the laws of economics and of logic to expect that a nation awash in debt with miles and miles of higher and higher deficits on the horizon will be able to lend more money at virtually zero interest for an extended period of time.
The only question is when do the floodgates open? We’ve heard rumblings of complaints – notably, on the record and not anonymous – from Chinese officials about our country’s economic situation and increasingly high levels of debt. We’ve seen budget deficit estimates from the CBO which far exceed the optimistic ones put together by the Obama team. And now we had a disappointing auction.
Of course, to a certain extent, debasing our currency is what the government wants. If we could control the pace of the move, some inflation would be a good thing since we’re so heavily in debt (as the value of the dollar falls, that means debtors owe less in ‘real’ terms). But it is highly likely that the transition would come too fast and too quick for our economy and our policies to adjust without experiencing significant dislocations and subsequent pain.
I can almost guarantee you that if government debt is a bubble and it does pop, you won’t see our foreign lenders gently exiting the market. It will be a stampede.
And what will be the implications of such a scenario? Believe it or not, they are likely far worse than anything we have seen so far. Interest rates will soar, as will inflation. Savers will be crushed. Investment will grind to a halt. An already weak economy on its knees would get weaker. We will be forced to renegotiate our obligations with foreign lenders, most notably the Chinese.
The end result could be no less than the end of U.S. hegemony.
uhhh…deadman just freaked the dude out. how come nobody is tlaking about this? how can i prepare for this? i thought i was doing well by saving money and having cash on hand, but what youre saying seems the opposite. seriously, what do i do?
well, i wouldnt say no one is talking about it. but i certainly dont think it’s getting the attention it deserves. and then some people are talking about it, but dismissing concerns for the reasons i noted in the piece.
i’m in the same boat as you – wondering whether i am being wise to have savings. there are a couple of options. invest in TIPS (inflation-protected bonds, which i bet won’t even be offered eventually once things really get bad). investing in gold, either directly through coins or gold ETFs, or perhaps other commodities should be a decent hedge. i think there is also a bank online where you can invest your money in foreign currencies, although i think that’s a little too much risk to take on. hard assets like real estate normally do well in inflationary times (on relative basis) although that situation is complicated by our housing bubble.
of course, i could be wrong and this time could truly be different. maybe debt as a percentage of GDP doesn’t matter like it used to!
how do you buy tips? how much do they cost, how do they work? what happens if they arent offered? would my tips be marketable? do you think its possible gold etf’s wont be sold anymore if you scenario plays out? what would happen if i own those? why is an online bank risky if it is fdic insured?
dont stock prices also go up during inflation? why not just use our savings to buy stocks?
I have explored this topic in the past as well. I think the stage is set and and it is just a matter of time. We have already seen rumblings in China. Just when the Treasury is buying up treasury debt instruments to prevent deflation (they are worried about that) the government is borrowing, creating money, and spending at break-neck speed. the problem comes when the Treasury decides they need to put the brakes on inflation by selling those instruments. If the international community is afraid of U.S. debt/economy those will be difficult to sell and inflation could be out-of-control.
http://money.aol.com/news/articles/_a/bbdp/fed-to-buy-300b-in-treasury-debt/387941