|
In forecasting the consequences of
current economic policy, many pundits are downplaying the risks associated
with the surging national debt and the rapid expansion of marketable Treasury
securities. Their comfort stems from the belief that a staggering debt burden
will be manageable as long as interest rates remain extremely low; and, as
they believe the Fed is in complete control of setting rates across the yield
curve, they see no danger of rates ever rising past the point of comfort.
Those who subscribe to this fairy tale forget that, in real life, there are
many more hands on the interest rate steering wheel.
The Congressional Budget Office
estimates that the 2010 deficit will exceed $1.3 trillion and total US debt
now stands at $13.4 trillion (92% of GDP). That's a lot of debt that needs
floating. Yet, the 10-year note is yielding 2.8% -- which is 4.5 points below
its 40-year average of 7.3%! Experience teaches that even moderately
long-term investors should be expecting rising rates. Regardless of the extreme
and obvious misalignment of fundamentals and bond prices, the mantra from the
dollar shills remains firm: "The US dollar will always be the world's
reserve currency, and the US bond market will always be regarded as the
safe-haven depository for global savings."
With interest rates having been so
low for so long, it's understandable that many people have forgotten that
central banks are not ultimately in control of interest rates. It is true
that the Fed can be highly influential across the yield curve and can be
especially effective in controlling the short end. But, in the end, the free
market has the last word on the cost of money.
Although the Fed has certainly
created enough new dollars to send prices higher, recessionary forces are,
for now, disguising the evidence of runaway inflation. But when inflation
finally erupts into the daylight, it will be impossible for borrowing costs
to stay low. No one can realistically be expected to loan money below the
rate of inflation. To attract buyers, the Treasury will have to offer a real
rate of return.
Since our publicly traded debt
level is increasing while our personal saving rate is not, we must inevitably
rely more and more on foreign creditors to purchase our bonds. The problem is
that the Chinese have been net sellers lately, and the Japanese saving rate
is chasing ours down the tubes. Europe is also clearly suffering through
their own sovereign debt issues. If not the Fed, who then will buy?
At this point, many economists
breathe a sigh of relief. Since the Fed has no investment objectives, it
could care less how much it loses by buying low-yielding Treasuries. Given
that the Fed has an unlimited supply of dollars to buy such debt, it could
simply choose to pressure rates lower indefinitely, so long as that policy
stance is deemed necessary for a weak economy.
I concede that the Fed can always
place bids for US Treasuries, and keep those rates low, but does that
mean all debt markets will follow suit? Will private banks continue to offer
rock bottom mortgage rates if housing defaults soar or inflation rises? What
about the corporate bond market and municipal debt? Can the Fed order a bank
to loan to a company at a rate the bank does not find profitable? The only
way to keep rates in all debt markets in line would be for the Fed to buy all
kinds of debt, not just Treasury debt. Such a policy has never been
considered, let alone attempted, by any major economic power.
And what will our foreign
creditors think about such a strategy? Anyone with the ability to move
investments outside the US dollar would clearly do so, to avoid the wholesale
debasement that such an inflationary policy would create. Once you take the
argument to its logical conclusion, it is plain to see how futile, ignorant,
and dangerous an attempt to hold all rates down would be. Americans can only
hope Fed Chairman Bernanke isn't as foolish as his groupies.
Ask any historian of Germany,
Argentina, Bosnia, or Zimbabwe why interest rates skyrocketed during their
respective battles with hyperinflation. Why were their central banks unable
to control borrowing costs?
In the end, central banks can only
temporarily distort the savings and demand equation. The more the Fed prints,
the higher the eventual rate of inflation will be. If mainstream pundits
truly believe the Fed can supplant the entire public and private market for
debt indefinitely, then I don't want to be around when that fantasy
inevitably becomes a nightmare.
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A
15-year industry veteran whose career began as a trader on the floor of the
New York Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
|
