Saturday, November 21, 2009

The Interest Rate Conundrum

If the economy were truly in recovery, as we have been  told time and time again, market interest rates ought to be MUCH higher.  For example, according to the U.S. Treasury's own website, as of last Friday, 1 month TBills yielded a scant .04%, 3 month TBills .02% and if you entrust the government with your dough for a year, you'll see a "fat" .26%.  If you're willing to tie up your money for 10 years, the yield jumps to a "juicy" 4.03%!

So, one has to wonder why ANYONE would accept so little on Treasuries. My guess is that either people are afraid of yet more bank failures, or the Federal Reserve has become a large clandestine buyer. (As bond prices rise yields go down, therefore significant purchases of bonds would tend to drive yields lower). We know the largest buyer through last year was China but they have stopped buying, and are instead  accumulating  hard assets like Gold. If the Fed indeed is buying Treasuries, it might go a long  way to explain why all attempts to audit the Fed have been blocked despite the support of an overwhelming majority of the House.

To be fair, the United States still carries the highest credit rating, AAA, but so did issuers of mortgage derivatives, who ultimately led the meltdown of 2008. So this rating may not last or be accurate.

The market is telling us that there IS risk to government debt. The financial instrument employed to provide insurance is also known as a Credit Default Swap.  According to Rob Kirby, who writes the fabulous newletter, Kirby Analytics (,  the "cost" of insuring $10MM  of 10 year Treasuries is $25,000.   He further states that this in itself is a fraud, since if the insurance were made good, the proceeds would be in dollars.  Now I ask you, what would a dollar be worth if the U.S. did indeed default?

Normally, one would expect even short term rates to exceed the rate of inflation, which the Bureau of Labor and Statistics claims to be running at about 0% annually, but has turned up markedly from mid-year. By comparison, John Williams, who has a site called Shadow Stats (, puts that figure at 3%.  As you may recall from a prior essay, Mr. Williams computes  key government statistics in the same way as they were calculated prior to a revision in algorithms instituted by the Clinton administration.  His measures reveal a much higher level of inflation: 3% and rising.  With the dollar having fallen so far this year, we KNOW that our imports  are costing on the order of 10% more.

California's rating was recently cut by Fitch  to BBB, a rating which is barely above junk status. Fitch is a respected credit rating agency.  California has begun to issue "IOUs", whose value is at best, uncertain. The "IOUs" may ultimately turn out  to be "worth"  a  fraction of their face value.

Problems like this are cropping up world-wide. For example, Fitch cut its ratings on Ukraine to B-, a very low quality junk bond rating. And, according to a recent Bloomberg news story, both Japan and Switzerland have fallen off the list of the top ten safest sovereign debtors.  Safest countries include Denmark, Finland, Australia, New Zealand and the United States.  The inclusion of the United States surprises me, especially given its enormous unfunded liabilities like Social Security and Medicare.  In addition, the already enormous budget deficits are projected to rise as far as the eye can see.  But then, who am I to argue with the market?

I hope you enjoy these essays and visit often. I appreciate comments, pro or con, and we cover a variety of topics that are simply too convoluted for just about anyone to understand. But, I'll do my best to clarify these issues. Our growing library includes pieces on Gold, Silver, Taxes, and much more.

Marko's Take


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