Wielding A Tin Cup And A Gun:
Look ahead a few weeks, or at most a few months, to the time when President Obama has to send his Treasurer over to Asia to ask them to fund most of his $US 2.5 TRILLION budget deficit for this fiscal year. All of Asia, including China, says no. Geo-politically, this is already feared. The evidence is simply that the first foreign trip that Secretary of State Lady Hillary will make is to - Asia! She is not going to Europe or anywhere else on this trip. She is going to where the money is, to ask to borrow it.
Here, the global pivot is structural. The fact is that Asia could help the US to fund its budget deficit by stripping themselves of more than half of all their foreign exchange reserves this year. But what about NEXT year? They cannot do that and the Asians know it. The structural point is that there is a forward time horizon in front of the US of only ONE year to resolve its own budget deficit problems as well as its now unrepayable external debts and. That year is THIS year - 2009. The Asians know this too, as does Japan, Russia and the European Union. What they fear is that a financial collapse of the US will hurt them. If Asia lends to the US, it will crash next year, If Asia does not, the US will crash THIS year.
Three Global Deflations:
As analysed in earlier issues of The Privateer, these are the global share market crash, the real estate crash and the commodities crash. All three are still unfolding with more falls to come as the accelerating global factory shutdown cuts in under these vast markets with the unemployment which is now climbing in all industrialised countries. We are now on the verge of the fourth deflation. That is the global bond market crash as exploding government budget deficits will act to force interest rates higher - typically the exact opposite of what is "wanted" - followed by huge leaps in commercial interest rates.
Crowded Out By Political Borrowing:
Climbing interest rates for government bonds can now be observed in the US. Commercial rates of interest in the US have already moved upwards rather drastically in the past few weeks. Here, a phenomenon known as "crowding out" raises its head. When governments increase the quantity of bonds they unload on the market, they decrease the available funds for all other participants who then have to offer a higher rate of interest on their bond offerings until they reach the limits of what they can afford to pay. At that point, such business and private borrowers are "crowded out".
US yields on investment-grade corporate bonds, for example, stood at 8.24 percent on January 22 compared with 6.45 percent at the start of 2008, according to data compiled by the Fed. That, in gearing terms, is an increase of 27.75 percent in the costs to US businesses which are trying to borrow.
Bond Prices Yield To Interest Rates And A Steepening Yield Curve:
On December 26 last year, the difference in yield between US Treasury two-year and ten-year debt paper stood at 1.25 percent. By February 5, this "spread" had blown out to 1.95 percent. This "steepening" of the yield curve and the rising rates are now having their effect. Investors are fleeing US Treasuries. While the Dow was down 8.1percent on the year so far as of February 5, the US 30-year Treasury bond was down about 10 percent.
These are the losses so far this year! In terms of capital, the entire US bond market is much bigger than the US stock market. It should be clear that massive losses have already been taken by holders of US bonds of all descriptions. Across the world and in the US, when current US bond holders revalue their portfolios they will see this fall of more than 10 percent on their holdings.
Caught In The US Headlights:
In the face of all this, buyers of US bonds are only backing off so far. But there is an invisible point ahead where accumulating losses on US bonds, government and commercial, will become too much to bear. At that point, a global cascade sell-off of US bonds is in prospect. This is the danger point! Once a sell-off begins, US bond prices of all descriptions will fall in value, and the inverse will also happen. US bond market rates of interest rates will be soaring upwards. The losses will be astronomical as everybody from central banks to private holders of US bonds see their investments slaughtered. When the dust clears, this event will be seen as not only the greatest bond crash in history, but also as the greatest DEFLATION of them all, putting the three earlier ones completely in the shade.
The US Is The Ignition Point For The Global "Bond Fire":
The US bond market sell-off now in prospect is certain to ignite sell-offs in nations with high government debts funded by their earlier bond issues. Just as the share markets worldwide all joined up together in their crash and the real estate and commodities markets did likewise, so a US bond market sell-off could act as the ignition point for a worldwide conflagration of the present bond markets. From there, it is a short and inevitable step to chaos in the world's monetary system.
Ó 2009 – The Privateer
(reproduced with permission)
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