U.S. Treasury Bond Market Crash Not Stocks the Big Story of 2010Interest-Rates / US Bonds Dec 28, 2009 - 12:26 PM GMT
Let’s pretend the US is a company.
For starters, this company has a massive debt problem. The official number is $12 trillion and counting, which is roughly the equivalent of one year’s annual production. On the surface, that’s not TOO bad.
However, if you treat the US’s balance sheet according to Generally Accepted Accounting Principles (GAAP) you have to also consider future liabilities in the form of Social Security and Medicare, which puts total debt at $65 trillion: an amount equal to 5 years’ worth of production: a REAL issue.
A debt load of this size requires massive sales and cash flow to service it. However, the problem is that the company’s primary sales segment (tax receipts) is plummeting. Indeed, individual income tax receipts are down nearly 30% from last year (a year that the economy was already falling off a cliff). Similarly, corporate tax receipts are negative.
Now, the company has just gotten a new CEO (the old one left after racking up this massive debt load). However, rather than trimming the fat from the company, he’s decided to INCREASE its operating costs/ annual spend. So the company is now having to issue MORE debt (roughly $150 billion a month) at the same time that it is trying to roll some of its OLD debt over.
This MIGHT work if the company’s current debt holders (foreign governments, especially China and Japan), weren’t already beginning to doubt that they’d ever get their money back.
Indeed, a few weeks ago, the Treasury Department released its Treasury International Capital Data for October: the numbers showing foreign interest in new debt issuance. The following is a BIG deal:
Net foreign acquisition of long-term securities, taking into account adjustments, is estimated to have been $8.3 billion (Graham’s note: we’ve issued nearly $2 TRILLION in debt this year).
Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills, and other custody liabilities decreased $43.9 billion. Foreign holdings of Treasury bills decreased $38.3 billion.
In plain terms, this means that foreign governments are no longer willing to buy long-term US debt. In fact, they’ve become SELLERS. To return to our corporate metaphor, the former biggest buyers of debt are no longer willing to pony up the cash to buy new long-term debt from Uncle Sam Inc. Instead, they, along with everyone else, are piling into short-term debt.
Thus, our corporation has got itself a REAL problem. Sales are down, spending/ costs are up, and fewer and fewer investors are willing to lend to it for any lengthy period of time. In fact, Uncle Sam Inc is entering something of a debt spiral where it needs to issue $150 billion of new debt per month WHILE rolling over TRILLIONS in existing debt at a time when investors are willing to lend to it for shorter and shorter periods of time.
Indeed, according to the Treasury, in the next 5 years the US will have 73 days in which it needs to roll over $20+ billion in debt and 46 days in which it needs to roll over $30+ billion.
How will this end?
Badly or VERY badly. Indeed, the long-term bond market is already showing serious signs of deterioration. If bond prices collapse we will see a spike in interest rates, which will give a MAJOR reality check to whatever imaginary economic recovery the pundits believe is currently underway.
Keep your eyes on the US debt markets. There is smoke there. And bonds, NOT stocks, may prove to be the big story of 2010.
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Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets.
Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.
Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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