The Ultimate Bubble – 10 Year Treasuries At Record Low Rates

The AP reports:

A stampede by investors into Treasurys helped the U.S. government borrow at record low rates for the second day straight.

The Treasury sold $24 billion in 10-year Treasury notes Wednesday afternoon at a yield of 2.14 percent. That’s the lowest borrowing rate for an auction of 10-year notes on record, according to Treasury dealers.

It’s the second day in a row that the Treasury was able to borrow at an all-time low rate since Standard & Poor’s stripped the U.S. of its AAA credit rating. The Treasury sold $32 billion in three-year notes at a record low of 0.50 percent Tuesday.

Let us apply some common sense to the Treasury market.  We all know that S & P just downgraded the US’s sovereign debt rating from AAA to AA+.  In a normal rational market, such a downgrade would raise the interest rate that buyers of US debt would demand due to an increased risk of default.  If an investment is riskier, investors naturally want more compensation.

But the downgrade followed by a decline in rates is just one of many indicators that something is fundamentally out of whack with the Treasury market.  Let us refresh our memories in regards to some simple market mechanics.  If there is an over-abundant supply of something in comparison to the consumer demand for that thing, it should be expected that its price will decline.  The same is true in reverse.  If something is more limited in supply than its demand, that thing’s price will increase.

In looking at how the Treasury markets operate, we can see that there is a monumental supply of Treasury debt with a limited number of buyers.  We know this to be true because if their really was an abundant supply of buyers, the Federal Reserve would not have 1.6 trillion in US Treasuries on its books.

Consider that in a normal rational market, we should expect to see rates increase as the amount of debt the US government issues increases.   Rates should naturally have to increase in order to entice more people into buying the ever expanding supply of Treasury debt.   The Federal Reserve has circumvented this natural tendency of rates to rise in proportion to the amount of debt that is issued by buying up Treasury debt with money it created out of thin air.

Also, as the S & P downgrade suggests, as a government issues more debt, not only should it experience a more difficult time in finding buyers for this debt (which would be reflected in higher interest rates), but it also increases its risk of default on that debt.   Just as a homeowner who continues to take out more credit debt becomes at ever increasing risk for default, so to do governments who continually take out more debt.  As mentioned earlier, this too should drive up the interest rates investors demand.

Obviously these simple mechanics are at complete odds with what we see taking place in the Treasury markets because of the Federal Reserve’s massive debt purchasing operations.  In the same way the housing bubble was inflated by massive government subsidies, guarantees and artificially low rates provided by the Fed, which eventually led to a collapse in housing prices due to a massive oversupply of housing, so too will we see a collapse of the Treasury markets for similar reasons.

So here we are left with a massive artificial bubble in Treasury debt that must ultimately be corrected by the markets.  The markets will correct this gigantic bubble in either one of two ways:

1.  The Fed will cease to buy treasury debt, interest rates will explode exponentially, and the US government will be thrown in to bankruptcy, forcing the federal government to undergo a structured default with monumentally enormous cuts in spending.

or

2.  The Fed will become the sole buyer of Treasury debt, ultimately destroying the value of the dollar down to nothing as it prints trillions upon trillions of funny money dollars in a bid to keep interest rates from rising, which would cause the federal government to undergo the scenario laid out in option 1.

There is no other way out of the situation for the federal government.  Obviously I am of the mind that the government will take the second route because that’s what criminals naturally do in situations like this.

To protect yourself from the coming collapse of the dollar and our coercive system of State sanctioned looting through inflation, I suggest buying Bitcoins, gold and silver as hedges.  I also suggest people start preparing for life in a country where every imported product costs more than they can afford.

The two primary classes of products that consumers should really prepare themselves to deal with will be skyrocketing energy costs and skyrocketing food costs.  These are naturally the most heavily impacted areas of an economy that undergoes hyper-inflation.  Equities will rise in price, but not in value, so we can expect to see phenomenal market gains in terms of nominal prices, but these gains will be overshadowed by the gains in commodities such as gold and silver.  They will also be overshadowed by the devaluation of money.  For example, Zimbabwe had some of the highest market gains in recorded history as it underwent hyper-inflation, but clearly these gains in nominal prices did not reflect a real gain in value.

Watch investing legend Marc Faber explain what happens when a State cannibalizes its citizens’ wealth: