Soldiers want their generals to be lucky. As capable and knowledgeable as generals may be, they still need luck to win. And citizens want their central banks to be lucky, because central bankers often fail even if they are capable and knowledgeable.
The Federal Reserve has been very, very lucky. Unrest in Ukraine, territorial disputes in East Asia, the usual morass in the Middle East, and now nationalist parties winning European elections, have all combined to push U.S. Treasury yields down even as the Fed steadily withdraws its quantitative easing. Financial markets mavens who confidently predicted that this would be the year of rising interest rates and falling stock prices have had to substitute excuses and explanations for predictions.
Some still persist in forecasting rising rates and falling stocks. Perhaps they will be proven correct. But if you're betting your money on these predictions, remember that you're, at least in part, betting on the Fed's luck running out. A bet on bad luck is still a bet on luck. If you wouldn't play the lottery or patronize a casino, why bet on (or against) the central bank's luck? The smart thing to do is stay diversified, and be patient. (See http://blogger.uncleleosden.com/2014/05/why-you-should-invest-like-smart-money.html.) The tortoise tends to be a better investor than the hare.
Showing posts with label U.S. Treasury securities. Show all posts
Showing posts with label U.S. Treasury securities. Show all posts
Thursday, May 29, 2014
Wednesday, August 3, 2011
Where Is Financial Safety?
The debt ceiling deal was, more than anything else, an agreement to disagree. It had commensurate impact on the financial markets (i.e., nada). Because the deal resolved very little, Congress will continue to convulse over budget deficit issues. The stock markets, which are driven by politics as much as economics, will convulse synchronously.
Meanwhile, across the pond, the Euro bloc sovereign debt crisis is all the rage again, with Italy getting smacked around by the bond vigilantes. The EU doesn't seem to understand that its strategy of solving debt problems with bailouts that, net net, increase the amount of its debt will only lead to more instability. Because the EU has, in effect, collectively assumed liability for all of the debts of all Euro bloc members and all of their banking sectors, the aggregate amount of continental debt is what matters. The EU's relentless expansion of its liabilities, with each bailout diminishing its capacity for further bailouts, guarantees that the bond bandits will have a never-ending stream of dominoes to knock over. The average citizen, working on a brown bag lunch in a cubicle, will opine that reducing debt is the way to get out of financial trouble. But the hoi polloi, lacking sophistication, just don't understand that these things are complicated.
So, we can look forward to more stock market volatility. Where is there financial safety?
Swiss bonds have risen in popularity. But they don't have the liquidity of U.S. Treasuries. If you buy Swiss bonds, you had better like them because they won't be that easy to exit.
Japanese debt has also gotten attention, even though Japan's sovereign debt is about 200% of GDP, well above American levels. With almost all of Japan's debt held by its own citizens, it isn't likely to face serious capital flight. Indeed, the Japanese government seems to prefer a little capital flight. With the popularity of the yen pushing up its price, Japan's export-based economy is at risk. Even as we write, the Japanese government is intervening in the currency markets to push down the yen. If you buy yen-denominated debt, understand that you'll earn almost no yield and be at risk of currency losses from Japanese government yen smackdowns.
So what's left? Well, oddly, U.S. Treasuries. At least until the current debt ceiling is reached, probably in early 2013, U.S. government debt is safe. You may face some moderate inflation risk. But the long term picture for U.S. Treasuries--which isn't pretty--won't emerge for the next year or two. So, if you're worried about the stock market swan diving into a correction or bear market, Treasuries may be a safe place to hit the mattresses, at least for a while. Money market funds invested solely in U.S. Treasury securities are comparably safe, albeit exceptionally low-yielding.
FDIC insured bank accounts are also safe. The European debt crisis, in the worst case, could hit the U.S. banking sector pretty hard (because of interbank lending, derivatives exposures, and other bank interconnectedness). But the FDIC, with the backing of the U.S. Treasury, will protect insured deposits come hell, high water, plagues, swarms of locusts, loathsome diseases, or anything else. One hard lesson the government learned from the thousands of bank closures leading up to and during the Great Depression is that the loss of bank deposits wallops consumer confidence more than anything else. People don't look to their stockholdings or the equity in the house to cover next month's expenses. But if you take away their bank deposits, you create immediate household crises on a wholesale level. Make sure your bank deposits stay within insured levels (for more detail, see http://blogger.uncleleosden.com/2011/07/fdic-insurance-coverage.html).
We also discuss safe investments at http://blogger.uncleleosden.com/2010/07/safe-investments.html.
Meanwhile, across the pond, the Euro bloc sovereign debt crisis is all the rage again, with Italy getting smacked around by the bond vigilantes. The EU doesn't seem to understand that its strategy of solving debt problems with bailouts that, net net, increase the amount of its debt will only lead to more instability. Because the EU has, in effect, collectively assumed liability for all of the debts of all Euro bloc members and all of their banking sectors, the aggregate amount of continental debt is what matters. The EU's relentless expansion of its liabilities, with each bailout diminishing its capacity for further bailouts, guarantees that the bond bandits will have a never-ending stream of dominoes to knock over. The average citizen, working on a brown bag lunch in a cubicle, will opine that reducing debt is the way to get out of financial trouble. But the hoi polloi, lacking sophistication, just don't understand that these things are complicated.
So, we can look forward to more stock market volatility. Where is there financial safety?
Swiss bonds have risen in popularity. But they don't have the liquidity of U.S. Treasuries. If you buy Swiss bonds, you had better like them because they won't be that easy to exit.
Japanese debt has also gotten attention, even though Japan's sovereign debt is about 200% of GDP, well above American levels. With almost all of Japan's debt held by its own citizens, it isn't likely to face serious capital flight. Indeed, the Japanese government seems to prefer a little capital flight. With the popularity of the yen pushing up its price, Japan's export-based economy is at risk. Even as we write, the Japanese government is intervening in the currency markets to push down the yen. If you buy yen-denominated debt, understand that you'll earn almost no yield and be at risk of currency losses from Japanese government yen smackdowns.
So what's left? Well, oddly, U.S. Treasuries. At least until the current debt ceiling is reached, probably in early 2013, U.S. government debt is safe. You may face some moderate inflation risk. But the long term picture for U.S. Treasuries--which isn't pretty--won't emerge for the next year or two. So, if you're worried about the stock market swan diving into a correction or bear market, Treasuries may be a safe place to hit the mattresses, at least for a while. Money market funds invested solely in U.S. Treasury securities are comparably safe, albeit exceptionally low-yielding.
FDIC insured bank accounts are also safe. The European debt crisis, in the worst case, could hit the U.S. banking sector pretty hard (because of interbank lending, derivatives exposures, and other bank interconnectedness). But the FDIC, with the backing of the U.S. Treasury, will protect insured deposits come hell, high water, plagues, swarms of locusts, loathsome diseases, or anything else. One hard lesson the government learned from the thousands of bank closures leading up to and during the Great Depression is that the loss of bank deposits wallops consumer confidence more than anything else. People don't look to their stockholdings or the equity in the house to cover next month's expenses. But if you take away their bank deposits, you create immediate household crises on a wholesale level. Make sure your bank deposits stay within insured levels (for more detail, see http://blogger.uncleleosden.com/2011/07/fdic-insurance-coverage.html).
We also discuss safe investments at http://blogger.uncleleosden.com/2010/07/safe-investments.html.
Friday, July 15, 2011
A Buyer For 14th Amendment Bonds
There has been speculation that, if the federal debt ceiling isn't raised by August 2, 2011, the President might order the Treasury Department to issue more U.S. Treasury securities anyway, relying on supposed authority from the 14th Amendment to the Constitution. The President has said he won't do this. But if push comes to shove, and the ship is about to hit the iceberg, who knows? Desperate times call for desperate measures.
Legal talking heads have yammered busily about the correct interpretation of the 14th Amendment. Market talking heads have speculated that buyers would be hard to find because the uncertain legality of 14th Amendment debt would make it a pig in a poke that investors would shun.
The legality of such debt is open to vigorous debate. But in terms of finding buyers, that's easy. No sweat. There's a buyer out there who will snarf up all 14th Amendment debt, if necessary, and not worry a bit about its legality. That buyer would be the Federal Reserve.
Fed Chairman Ben Bernanke hasn't said a word publicly about the Fed buying 14th Amendment debt. The thought may not have even occurred to him. But if push comes to shove, and the Sword of Damocles is about to drop on the federal government, the Fed will undoubtedly ride to the rescue with regimental colors flying and Garry Owen playing. A central bank buying its government's debt is said to monetize that debt, a serious no no in the view of many economists because it could trigger inflation. But the Fed hasn't, in recent years, seen any inflation it didn't like. And with the economy slowing again, Chairman Bernanke may well be pondering how to slip a little more quantitative easing into the financial system. Buying up 14th Amendment debt may be the least controversial way to do it, since the Fed could claim it's monetizing debt for the sake of Old Glory.
The Fed need not send a check directly over to the Treasury for the 14th Amendment debt. That might be a tad indiscreet. Instead, it could quietly signal to its primary dealers that they wouldn't take any losses on the stuff. The dealers would likely do the patriotic thing and choke down these latter day Liberty Bonds even if they taste an awful lot like broccoli. The Fed could then buy the stuff up from primary dealers or accept it as collateral for their borrowings from the Fed.
What if the 14th Amendment bonds turn out to be unlawful? The Fed would surely protect its primary dealers and take the losses itself. The uncollectable bonds would simply relieve the Fed of the necessity of withdrawing some liquidity from its quantitative easing program. Nothing would make the Fed happier. Of course, the Fed would have a paper loss. But the loss would consist of money it printed, not real money from member banks or taxpayers. Easy come, easy go.
Legal talking heads have yammered busily about the correct interpretation of the 14th Amendment. Market talking heads have speculated that buyers would be hard to find because the uncertain legality of 14th Amendment debt would make it a pig in a poke that investors would shun.
The legality of such debt is open to vigorous debate. But in terms of finding buyers, that's easy. No sweat. There's a buyer out there who will snarf up all 14th Amendment debt, if necessary, and not worry a bit about its legality. That buyer would be the Federal Reserve.
Fed Chairman Ben Bernanke hasn't said a word publicly about the Fed buying 14th Amendment debt. The thought may not have even occurred to him. But if push comes to shove, and the Sword of Damocles is about to drop on the federal government, the Fed will undoubtedly ride to the rescue with regimental colors flying and Garry Owen playing. A central bank buying its government's debt is said to monetize that debt, a serious no no in the view of many economists because it could trigger inflation. But the Fed hasn't, in recent years, seen any inflation it didn't like. And with the economy slowing again, Chairman Bernanke may well be pondering how to slip a little more quantitative easing into the financial system. Buying up 14th Amendment debt may be the least controversial way to do it, since the Fed could claim it's monetizing debt for the sake of Old Glory.
The Fed need not send a check directly over to the Treasury for the 14th Amendment debt. That might be a tad indiscreet. Instead, it could quietly signal to its primary dealers that they wouldn't take any losses on the stuff. The dealers would likely do the patriotic thing and choke down these latter day Liberty Bonds even if they taste an awful lot like broccoli. The Fed could then buy the stuff up from primary dealers or accept it as collateral for their borrowings from the Fed.
What if the 14th Amendment bonds turn out to be unlawful? The Fed would surely protect its primary dealers and take the losses itself. The uncollectable bonds would simply relieve the Fed of the necessity of withdrawing some liquidity from its quantitative easing program. Nothing would make the Fed happier. Of course, the Fed would have a paper loss. But the loss would consist of money it printed, not real money from member banks or taxpayers. Easy come, easy go.
Friday, June 24, 2011
The Real Reason Why America Might Default on Its Debt
Yesterday, the Republicans in the House of Representatives engineered a vote against supporting the U.S. role in the NATO operation to assist the rebels in Libya. The same Republican Party that avidly supported George W. Bush's arrogant military idiocy in Iraq just gave aid and comfort to Muammar Gaddafi, a monstrous dictator, sponsor of terrorism, and protector of the Lockerbie bomber. America's NATO allies with military personnel over the skies of Libya must be mystified by the spectacle of America's war-making, union-breaking Republican Party all of a sudden trying to put flowers into rifle barrels. Good thing President Obama is insisting on a troop drawdown in Afghanistan because the Republicans just gave our NATO allies with troops in Afghanistan a convenient pretext for pulling out ahead of us. If we won't support NATO in Libya, why would NATO support us in Afghanistan?
The real reason for the Republican kidney punch is, of course, the extreme partisanship of today's politics. Whatever the Obama administration does, the Republicans oppose. Whatever the Obama administration doesn't, the Republicans advocate. Substance no longer matters. Style no longer matters--the last politicians with any style were Reagan and Kennedy. The only thing that matters is opposing the opponent. The Republicans claim to be seeking adherence to the War Powers Act of 1973. But President Clinton engaged in a much more active air bombardment during the Kosovo War without authorization under the War Powers Act.
A much, much larger issue than Libya is raising the debt ceiling. A default by the United States would be 22.5 on the Richter Scale compared to the 9.0 of a Greek default. But talks between Democrats and Republicans aimed at resolving the debt ceiling problem have broken down. Today, the President is reaching out to Senate leaders in an effort to restart the dialogue. But the right wing hot heads in the House will surely do their utmost to prolong the confrontation. After all, compromise would involve doing something other than oppose, and today's right wing Republicans are a one-trick dog that only growls and drools.
Don't be too quick to sell off your Euro-denominated investments. Even though the Euro bloc is courting longer term financial disaster by kicking the can down the road, its member nations are acting with a modicum of maturity in trying to find short term respite from the Greek sovereign debt crisis. They acknowledge that they're approaching an abyss and are actively trying to avoid belly flopping into it. The Republicans in the House want to use the debt ceiling problem as a vehicle to solve the federal deficit problem, all without any tax increase. This is like trying to send astronauts wearing only gym shorts and t-shirts to Mars on tricycles. The cost of this unyielding right wing onrush into tomfoolery would be the mother of all financial crises. But, given yesterday's House vote on Libya, that just might happen.
The real reason for the Republican kidney punch is, of course, the extreme partisanship of today's politics. Whatever the Obama administration does, the Republicans oppose. Whatever the Obama administration doesn't, the Republicans advocate. Substance no longer matters. Style no longer matters--the last politicians with any style were Reagan and Kennedy. The only thing that matters is opposing the opponent. The Republicans claim to be seeking adherence to the War Powers Act of 1973. But President Clinton engaged in a much more active air bombardment during the Kosovo War without authorization under the War Powers Act.
A much, much larger issue than Libya is raising the debt ceiling. A default by the United States would be 22.5 on the Richter Scale compared to the 9.0 of a Greek default. But talks between Democrats and Republicans aimed at resolving the debt ceiling problem have broken down. Today, the President is reaching out to Senate leaders in an effort to restart the dialogue. But the right wing hot heads in the House will surely do their utmost to prolong the confrontation. After all, compromise would involve doing something other than oppose, and today's right wing Republicans are a one-trick dog that only growls and drools.
Don't be too quick to sell off your Euro-denominated investments. Even though the Euro bloc is courting longer term financial disaster by kicking the can down the road, its member nations are acting with a modicum of maturity in trying to find short term respite from the Greek sovereign debt crisis. They acknowledge that they're approaching an abyss and are actively trying to avoid belly flopping into it. The Republicans in the House want to use the debt ceiling problem as a vehicle to solve the federal deficit problem, all without any tax increase. This is like trying to send astronauts wearing only gym shorts and t-shirts to Mars on tricycles. The cost of this unyielding right wing onrush into tomfoolery would be the mother of all financial crises. But, given yesterday's House vote on Libya, that just might happen.
Monday, April 18, 2011
Did the Fed Add to the Fall in Stocks?
Today, Standard and Poor's lowered its outlook on long term U.S. Treasury debt from "stable" to "negative". What happened? U.S. Treasuries went up in value.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Monday, December 20, 2010
An Omen of Financial Stress?
Something strange is happening in the short end of the Treasury securities market. Treasuries maturing in about 1 month are yielding around 0.01%. Just a couple of weeks ago, yields were above 0.10%. Perhaps this may all seem like peanuts (and it is, if you have, say, $10,000 invested). But a yield of 0.01% was last seen during the dark days of the credit crunch in late 2008 and in 2009, when the world's banking system faced a funding crisis. Such a low yield signified that no one trusted anything except the obligations of the U.S. government; that investors didn't care about getting a return. They just want to keep their money safe. The recent 90% plus drop in the short end of the Treasury yield curve in less than two weeks may be a sign that something is rotten somewhere.
Economists and other fortune tellers are raising their estimates for growth next year. Stock prognosticators are full of holiday cheer, predicting rosy returns for stocks in 2011. Consumers may be loosening their purse strings a bit for this year's holiday season. Recent tax legislation will widen the deficit for next year, ensuring that the federal spending spigot won't slow down. All systems are go, it would seem. What's to get stressed about?
Euro Mess. The European response to the Euro bloc sovereign debt crisis, generously assessed, has been tentative and muddled. The only clear impact has been to transfer risk of loss to European taxpayers and give the can a hard kick down the road. The continued uncertainty makes the U.S. greenback look good by comparison (once again demonstrating that it's easy to lose faith in America, until you look at the rest of the world). If you're going to dump Euros for dollars, it makes sense to buy the short end of the Treasury yield curve, where you're not competing against the Fed's quantitative easing program.
One group of potentially nervous investors would be money market funds that hold commercial paper of banks in shaky Euro bloc nations, like Greece and Portugal. Amazingly, in spite of the money market fund credit crunch in 2008, many money market funds bought this foreign issued commercial paper. (One wonders what happened to prudence, but then again prudence is something isn't brought up in polite company.) Those money market funds now may be quietly easing out of Euro bloc bank commercial paper and shifting into Treasuries before year end, when they'd have to disclose their holdings to investors.
Muni Mess. The muni market has fallen, about 5% in the past month. That may not sound like much, but if you held munis and it was your 5%, you'd be peeved. The future for munis isn't pretty. The federally subsidized Build America Bonds program turns into a pumpkin at the end of this year, and there won't be a fairy godmother for it next year. That means states and municipalities will face the harsh winds of the muni market without a quick fix from Uncle Sam. Many financially troubled states are still struggling with their budget problems. To make things worse, questions over states' pension accounting could compel larger state contributions to employee pension funds. Muni investors with battered portfolio syndrome may be seeking a port in the growing storm and heading for the safety of Treasuries.
Bond Mess. The bond market has fallen since early November, when the Fed formally announced its quantitative easing program. Investors who bet that QE would extend the 30 year bull market in bonds may now suspect that this time, things really are different. Those that aren't ready for the quicksands of the stock market may be parking at the short end of the Treasury curve, waiting to see whither the winds blow.
It's unclear that any of this will push the financial system back into the septic tank. Any analysis of that question would require information about who's holding what exposures in the derivatives markets. (Query: are major banks holding the hot tamale because they took the wrong end of the wrong credit default swaps?) But those markets are as opaque as ever, notwithstanding the enactment of the Dodd-Frank financial reform legislation this past summer. All we know is that the short end of the Treasury yield curve is at 0.01%, and the last time that happened, canaries in the mine were gasping.
Economists and other fortune tellers are raising their estimates for growth next year. Stock prognosticators are full of holiday cheer, predicting rosy returns for stocks in 2011. Consumers may be loosening their purse strings a bit for this year's holiday season. Recent tax legislation will widen the deficit for next year, ensuring that the federal spending spigot won't slow down. All systems are go, it would seem. What's to get stressed about?
Euro Mess. The European response to the Euro bloc sovereign debt crisis, generously assessed, has been tentative and muddled. The only clear impact has been to transfer risk of loss to European taxpayers and give the can a hard kick down the road. The continued uncertainty makes the U.S. greenback look good by comparison (once again demonstrating that it's easy to lose faith in America, until you look at the rest of the world). If you're going to dump Euros for dollars, it makes sense to buy the short end of the Treasury yield curve, where you're not competing against the Fed's quantitative easing program.
One group of potentially nervous investors would be money market funds that hold commercial paper of banks in shaky Euro bloc nations, like Greece and Portugal. Amazingly, in spite of the money market fund credit crunch in 2008, many money market funds bought this foreign issued commercial paper. (One wonders what happened to prudence, but then again prudence is something isn't brought up in polite company.) Those money market funds now may be quietly easing out of Euro bloc bank commercial paper and shifting into Treasuries before year end, when they'd have to disclose their holdings to investors.
Muni Mess. The muni market has fallen, about 5% in the past month. That may not sound like much, but if you held munis and it was your 5%, you'd be peeved. The future for munis isn't pretty. The federally subsidized Build America Bonds program turns into a pumpkin at the end of this year, and there won't be a fairy godmother for it next year. That means states and municipalities will face the harsh winds of the muni market without a quick fix from Uncle Sam. Many financially troubled states are still struggling with their budget problems. To make things worse, questions over states' pension accounting could compel larger state contributions to employee pension funds. Muni investors with battered portfolio syndrome may be seeking a port in the growing storm and heading for the safety of Treasuries.
Bond Mess. The bond market has fallen since early November, when the Fed formally announced its quantitative easing program. Investors who bet that QE would extend the 30 year bull market in bonds may now suspect that this time, things really are different. Those that aren't ready for the quicksands of the stock market may be parking at the short end of the Treasury curve, waiting to see whither the winds blow.
It's unclear that any of this will push the financial system back into the septic tank. Any analysis of that question would require information about who's holding what exposures in the derivatives markets. (Query: are major banks holding the hot tamale because they took the wrong end of the wrong credit default swaps?) But those markets are as opaque as ever, notwithstanding the enactment of the Dodd-Frank financial reform legislation this past summer. All we know is that the short end of the Treasury yield curve is at 0.01%, and the last time that happened, canaries in the mine were gasping.
Sunday, August 1, 2010
Will the Bond Market Sandbag the Fed?
Improbably, bonds have rallied for the last 30 years. When Ronald Reagan was elected president in 1980, rates on 30-year Treasuries were in the range of 15%. Today, they pay about 4%. Economists have estimated that real interest rates (i.e., rates net of inflation) run around 3%. Buying a 30-year Treasury today is like gambling on 1% annual inflation for the next thirty years. That's a riskapalooza if there ever was one.
The corporate bond market is also glowingly optimistic about inflation. Recently, McDonald's sold $450 million of 10-year bonds bearing interest of 3.5%. That's like gambling on 0.5% inflation per year for a decade. Then again, if you bought 10-year Treasury notes, which today pay under 3%, you'd be speculating that there will be deflation for 10 years. One would have to go back to the Great Depression to find a time when these investments would have been winners. Reality is we've got a huge bond bubble.
The Fed is desperately seeking inflation. It's keeping interest rates (short, medium and long) ultra low in an effort to stimulate growth, hoping that a little inflation will be like a round of cocktails before dinner that gets the party going. While neither prices nor GDP are cooperating, the Fed persists, in the belief that manipulating the money supply will somehow work a miracle when consumers are scared, corporations are cautious, and Wall Street finances speculations in derivatives rather than production of goods and services.
Here's the catch: if the economy revives, the Fed will have to raise rates. That could pop the bubble in the bond markets, clobbering yet another asset class. If that happened, holders of capital, already pummeled by the 2000 tech stock collapse and the 2008 stock market crash, real estate crash, auction rate securities collapse, etc., would suffer aggravated battered investor syndrome. They'd pull back from risk and consumption. The stagnation the Fed so publicly fears would follow.
But if the Fed doesn't raise interest rates after the economy revives, inflation would flare, ravaging the value of bonds as borrowers repay creditors with cheaper dollars. The bond bubble would pop in this scenario as well, producing severe battered investor syndrome and stagnation.
Thus, the potential for lasting recovery from the Fed's monetary policies may be capped by the bond bubble. There are other reasons why monetary policies may well fail (banks refusing to lend, consumers too scared to spend). But we've got a built-in booby trap set to spring if the economy revives.
The Fed surely knows this, and will probably hold off on raising rates as long as possible. Forget about the widely accepted view that the Fed should raise rates before inflation rears its ugly head to nip the problem in the bud. By incentivizing borrowing as much as possible, short, medium and long term, the Fed faces the possibility of injuring a constituency, creditors, it has tried to protect 100 cents on the dollar since 2008.
The Fed is damned if it does and damned if it doesn't. It has statutory responsibilities to promote full employment and economic growth. But if it succeeds in promoting growth with a little inflation fillip, it will likely pop the bond bubble and produce potentially large investor losses and a renewal of stagnation. Only a slow, agonizing, years-long recovery, with interest rates barely crawling up, would allow creditors to adjust to a rising interest rate environment without sharp losses. But unemployment would have to remain painfully high in such a scenario. Millions of unemployed Americans would pay the price for easing the bond market out of its current dilemma.
The Fed has yet to pop an asset bubble before it became a systemic threat. No doubt, it won't pop the bond bubble now. But it's laying the foundation for painful choices in the future.
The corporate bond market is also glowingly optimistic about inflation. Recently, McDonald's sold $450 million of 10-year bonds bearing interest of 3.5%. That's like gambling on 0.5% inflation per year for a decade. Then again, if you bought 10-year Treasury notes, which today pay under 3%, you'd be speculating that there will be deflation for 10 years. One would have to go back to the Great Depression to find a time when these investments would have been winners. Reality is we've got a huge bond bubble.
The Fed is desperately seeking inflation. It's keeping interest rates (short, medium and long) ultra low in an effort to stimulate growth, hoping that a little inflation will be like a round of cocktails before dinner that gets the party going. While neither prices nor GDP are cooperating, the Fed persists, in the belief that manipulating the money supply will somehow work a miracle when consumers are scared, corporations are cautious, and Wall Street finances speculations in derivatives rather than production of goods and services.
Here's the catch: if the economy revives, the Fed will have to raise rates. That could pop the bubble in the bond markets, clobbering yet another asset class. If that happened, holders of capital, already pummeled by the 2000 tech stock collapse and the 2008 stock market crash, real estate crash, auction rate securities collapse, etc., would suffer aggravated battered investor syndrome. They'd pull back from risk and consumption. The stagnation the Fed so publicly fears would follow.
But if the Fed doesn't raise interest rates after the economy revives, inflation would flare, ravaging the value of bonds as borrowers repay creditors with cheaper dollars. The bond bubble would pop in this scenario as well, producing severe battered investor syndrome and stagnation.
Thus, the potential for lasting recovery from the Fed's monetary policies may be capped by the bond bubble. There are other reasons why monetary policies may well fail (banks refusing to lend, consumers too scared to spend). But we've got a built-in booby trap set to spring if the economy revives.
The Fed surely knows this, and will probably hold off on raising rates as long as possible. Forget about the widely accepted view that the Fed should raise rates before inflation rears its ugly head to nip the problem in the bud. By incentivizing borrowing as much as possible, short, medium and long term, the Fed faces the possibility of injuring a constituency, creditors, it has tried to protect 100 cents on the dollar since 2008.
The Fed is damned if it does and damned if it doesn't. It has statutory responsibilities to promote full employment and economic growth. But if it succeeds in promoting growth with a little inflation fillip, it will likely pop the bond bubble and produce potentially large investor losses and a renewal of stagnation. Only a slow, agonizing, years-long recovery, with interest rates barely crawling up, would allow creditors to adjust to a rising interest rate environment without sharp losses. But unemployment would have to remain painfully high in such a scenario. Millions of unemployed Americans would pay the price for easing the bond market out of its current dilemma.
The Fed has yet to pop an asset bubble before it became a systemic threat. No doubt, it won't pop the bond bubble now. But it's laying the foundation for painful choices in the future.
Wednesday, July 21, 2010
Safe Investments
[As updated July 11, 2011]
There are many reasons for wanting to keep money safe. You may be saving up a down payment for a house or car, bracing for next year's college tuition and board bills, putting together an emergency cash fund, seeking shelter from lunatic stock, real estate and other asset markets, or harboring plain old curmudgeonly mistrust of all the fast-talking salespeople ready to take your money. Even with all of today's uncertainties, there are a few safe places to put your money.
Bank Accounts. FDIC deposit insurance covers, at each member bank, $250,000 per customer (along with another $250,000 per co-owner for joint accounts and yet another $250,000 for retirement accounts like IRAs). All of your accounts of each type at that bank are combined when determining coverage. You don't have $250,000 of coverage per account. For example, if you have $240,000 in CDs in your name, $20,000 in your checking account, and $505,000 in a joint money market account with your spouse, $10,000 in your individual accounts is uninsured, and $5,000 in your joint account is uninsured. But $750,000 at that bank is insured. If you're approaching the FDIC limit at any one bank, move some money over to another bank to get additional deposit insurance coverage. For more information about FDIC insurance, go to http://blogger.uncleleosden.com/2011/07/fdic-insurance-coverage.html. There is a service called CDARS offered by certain banks which takes large deposits and splits them up among a number of participating banks such that your funds and the interest they earn are fully covered by FDIC insurance. For more information, go to www.cdars.com.
U.S. Treasury Securities. Direct obligations of the U.S. Treasury will be paid, even if the government has to print the money to pay you. So these investments are secure. You can buy traditional Treasury obligations, like 4 week, 3 and 6 months, and 52 week Treasury bills, 2, 3, 5, 7 and 10 year Treasury notes, and 30 year Treasury bonds. You can also buy TIPS, a type of Treasury security that offers inflation protection. There are good old U.S. Savings bonds, still alive and kicking, which come in traditional Series EE bonds, and also I-bonds offering inflation protection. One disadvantage of Savings Bonds is that you can buy only $10,000 of each type per year, $5,000 of which must be bought directly from a government service called Treasury Direct. So large amounts of savings can't be invested in Savings Bonds. For more information about buying directly from the government, go to www.treasurydirect.gov. U.S. Treasury securities can also be bought through brokerage firms (although you'll have to pay commissions and/or markups). U.S. Savings Bonds can be bought through banks as well as Treasury Direct.
There is no limit on how much you can invest in U.S. Treasury obligations (aside from the Savings Bonds limits). Every penny will be repaid by the government, so you get a greater amount of coverage than with FDIC insurance.
Money Market Funds Investing Solely in U.S. Treasury Securities. There are a few money market funds that invest solely in U.S. Treasury securities. For all practical purposes, they are as safe as U.S. Treasury obligations. Because they are money market funds, their returns are very, very, and let us emphasize, very low. But the money is safe. Not all such money market funds are open to new investors. But if you want the safety of U.S. Treasuries and the convenience of a money market fund, look for one that is.
If you crave safety, forget about gold. It's a speculation that booms and busts like stocks. Some foreign government bonds, such as those of Switzerland and Germany, may have very low credit risk. But they present currency risk, and that's not to be underestimated. In just the past few months, the Euro has fallen more than 10% against the U.S. dollar, making German government bonds losers (in dollar terms) for Americans who held them. If your native currency is the U.S. dollar, stick to the above-mentioned dollar-denominated investments for safety. They won't pay very high interest rates. But safety isn't free and the low interest rates are the cost of safety.
There are many reasons for wanting to keep money safe. You may be saving up a down payment for a house or car, bracing for next year's college tuition and board bills, putting together an emergency cash fund, seeking shelter from lunatic stock, real estate and other asset markets, or harboring plain old curmudgeonly mistrust of all the fast-talking salespeople ready to take your money. Even with all of today's uncertainties, there are a few safe places to put your money.
Bank Accounts. FDIC deposit insurance covers, at each member bank, $250,000 per customer (along with another $250,000 per co-owner for joint accounts and yet another $250,000 for retirement accounts like IRAs). All of your accounts of each type at that bank are combined when determining coverage. You don't have $250,000 of coverage per account. For example, if you have $240,000 in CDs in your name, $20,000 in your checking account, and $505,000 in a joint money market account with your spouse, $10,000 in your individual accounts is uninsured, and $5,000 in your joint account is uninsured. But $750,000 at that bank is insured. If you're approaching the FDIC limit at any one bank, move some money over to another bank to get additional deposit insurance coverage. For more information about FDIC insurance, go to http://blogger.uncleleosden.com/2011/07/fdic-insurance-coverage.html. There is a service called CDARS offered by certain banks which takes large deposits and splits them up among a number of participating banks such that your funds and the interest they earn are fully covered by FDIC insurance. For more information, go to www.cdars.com.
U.S. Treasury Securities. Direct obligations of the U.S. Treasury will be paid, even if the government has to print the money to pay you. So these investments are secure. You can buy traditional Treasury obligations, like 4 week, 3 and 6 months, and 52 week Treasury bills, 2, 3, 5, 7 and 10 year Treasury notes, and 30 year Treasury bonds. You can also buy TIPS, a type of Treasury security that offers inflation protection. There are good old U.S. Savings bonds, still alive and kicking, which come in traditional Series EE bonds, and also I-bonds offering inflation protection. One disadvantage of Savings Bonds is that you can buy only $10,000 of each type per year, $5,000 of which must be bought directly from a government service called Treasury Direct. So large amounts of savings can't be invested in Savings Bonds. For more information about buying directly from the government, go to www.treasurydirect.gov. U.S. Treasury securities can also be bought through brokerage firms (although you'll have to pay commissions and/or markups). U.S. Savings Bonds can be bought through banks as well as Treasury Direct.
There is no limit on how much you can invest in U.S. Treasury obligations (aside from the Savings Bonds limits). Every penny will be repaid by the government, so you get a greater amount of coverage than with FDIC insurance.
Money Market Funds Investing Solely in U.S. Treasury Securities. There are a few money market funds that invest solely in U.S. Treasury securities. For all practical purposes, they are as safe as U.S. Treasury obligations. Because they are money market funds, their returns are very, very, and let us emphasize, very low. But the money is safe. Not all such money market funds are open to new investors. But if you want the safety of U.S. Treasuries and the convenience of a money market fund, look for one that is.
If you crave safety, forget about gold. It's a speculation that booms and busts like stocks. Some foreign government bonds, such as those of Switzerland and Germany, may have very low credit risk. But they present currency risk, and that's not to be underestimated. In just the past few months, the Euro has fallen more than 10% against the U.S. dollar, making German government bonds losers (in dollar terms) for Americans who held them. If your native currency is the U.S. dollar, stick to the above-mentioned dollar-denominated investments for safety. They won't pay very high interest rates. But safety isn't free and the low interest rates are the cost of safety.
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