By Wednesday, however, they remembered there’s an imminent crisis emanating out of Europe. Hence, they didn’t buy; they sold. The DOW dropped 160 points…giving back Tuesday’s gains, and then some. Then, yesterday, investors didn’t know what to make of things. They sold. They bought. They sold…the DOW ultimately closed out the day with a 26 point loss.
These days the stock market still gets the most attention. But the real market action is taking place in the boring old bond market. On Thursday, if you hadn’t noticed, yields on the 10-Year Treasury Note fell to 1.53 percent…its lowest level in living memory, or perhaps ever.
Here at the Economic Prism we watched the mass exodus from stocks while in a state of awe. In front of our unblinking eyes, fear was compelling collective man from one danger into a much greater one. In a backwards sort of way, risk off could actually be risk on – without the potential upside.
Treasuries may make for a good defensive position for the moment. If the stock market downturn gains momentum, return of capital will be much more important that return on capital. In this scenario, treasuries will be a savvy short term investment.
But, after being the safest investment in the world for the last 60-years, treasuries soon may no longer offer return of capital – unless you consider return of expired goods to be a fair deal. What we mean is buying a 10-year treasury today is like buying a tomato…it may be fresh and juicy today, but tomorrow it will be rotten and smelly. One bite will turn your stomach inside out.
In this respect, using the government’s highly suspicious CPI data, the current inflation rate over the last 12 months is 2.3 percent. Thus a treasury yield of 1.53 percent is an automatic loss. For the safety of a guaranteed return of capital, you get a negative return on your capital. In other words, what you get back is less than you put in.
Moreover, with all the monetary easing and fiscal stimulus, it’s highly likely that sometime over the next 10-years inflation will rise…further reducing the value of the treasury. For instance, what if inflation rises from 2.3 percent to 5 percent or even 8 percent?
Obviously, this is highly possible. And when it happens, like a picked tomato, a 10-Year Treasury Note yielding 1.53 percent will quickly go to rot. The horrendous smell will be gut wrenching for the sorry fellows holding them.
There’s A Great Storm Coming
Eventually, when “official” inflation rises too high – perhaps above 5 percent – the Fed will be forced to stop buying government debt. This will cause yields to rise and will increase the price the government must pay to service its debt. In effect, this will be a forced austerity whether the politicians – or the populace – want it.
In the meantime, a cascading debt deflation could overwhelm monetary and fiscal policy and force austerity upon the American people through a contraction in the economy, rising unemployment, and falling tax receipts. This is what seems to be taking shape.
Anecdotally, from what we gather, smart, intelligent, experienced, and capable people are again losing their jobs. Quite frankly, we don’t like this one bit. Yet, we think it has something to do with the “fiscal cliff” the economy is headed for. Businesses know what’s coming their way…and they’re planning accordingly.
By the time you read this, the Labor Department’s unemployment report for May will have been released. With all the government malleability that goes into fabricating the best number possible we won’t be surprised if the headline number that’s published is greater than 150,000 new jobs. The unemployment rate may even sink a bit too, thanks to a slouching labor participation force.
But in reality, the unemployment report won’t be worth the paper it’s written on. As an economic indicator, it will merely cloud out what’s going on. If you really want to know what to expect all you must do is lick your index and hold it up to the wind, for then you will know…
There’s a great storm coming and you’d better be prepared.
for Economic Prism