(St. Joseph Partners) — Last week the U.S. Treasury struggled to find buyers for its $24 billion bond sale at its target rate.
To date, the U.S. government has been able to operate with unpayable debt levels because investors have been willing to buy U.S. bonds at historically low interest rates – particularly low for an issuer whose balance sheet is hopeless as is the case with the U.S. government. During the COVID shutdowns, government bonds traded briefly with a yield below 1 percent.
As we detailed in our report, Once In A Generation, that moment was the classic book-end conclusion to a generational decline in rates. This generational cycle began in 1980 when rates touched 20 percent at a moment in time when inflation seemed unquenchable. The cycle ended when headlines made it seem as though no one was ever going to buy anything again amidst the lockdowns of COVID hysteria.
In that environment, well lettered institutional investors loaned governments and corporations money at rates below 3 percent. Some issuers like the nation of Austria were able to sell €16 billion [approx. $17.122 billion] of 100-year bonds with a 0.85 percent coupon. As these same professional bond investors were given smelling salts, to their horror they realized these supposedly safe bonds had lost 80% of their value.
This process has been occurring in the United States as well with rising rates devastating the balance sheets of America’s banking sector. The Federal Reserve itself appears insolvent from the $100 billion of losses it has sustained from its bond investments. Look for many other American banks to announce that bailouts are needed to keep their doors open. These headlines likely begin happening after bank executives receive their year-end bonuses as currently these firms appear in the “lie ‘till maturity” mode.
Last week the U.S. Treasury tried to issue a tiny $24 billion tranche of 30 year U.S. bonds.
While such a number is massive to individuals, it is entirely insignificant to our government as $24 billion represents less than one week’s worth of interest payments the U.S. owes its lenders.
Investors could not be found however to loan the government money at its intended interest rate even for this small auction. As the auction proceeded, the Treasury was forced into the embarrassing position of having to pay higher borrowing costs.
Here is the inverse showing the value of the 30 year bond falling as the auction commenced…
China and other nations which have historically bought U.S. Treasuries have been net sellers, and many foreign countries are also seeing their auctions fare poorly. These nations own over $7 trillion in U.S. debt that they could sell at any time to help fund their native issuances less expensively. Should such sales occur, it would push US borrowing costs even higher.
What we are witnessing is the markets beginning to take away central bank printing presses which to date have been used to solve virtually all government problems.
Fed chairman Jerome Powell was caught on a hot mic cursing after he was told the outcome of yesterday’s auction. In the last month, just the interest payments on America’s debts hit a level that now exceed the total debt of our nation in 1980 when the declining rate cycle began. That is a noteworthy milestone as America’s debt crisis metastasizes.
Thematically, the signature event that marked the declining rate cycle in 1980 was President Ronald Reagan’s strong negotiation with the air traffic controllers’ union, sending them and the airline sector back to work. Unions stranglehold grip on business had been loosened.
In contrast, a month ago the UAW strike ended such that any high school dropout would now be paid nearly $150,000 a year for showing up at an auto factory regardless of his performance. Joe Biden told these workers they fully deserved everything they asked for. His words stoked inflationary fires in a way that will be difficult to extinguish in the foreseeable future.
If the treasury continues to be forced to pay higher interest rates to borrow, investors should fully expect that we will witness an acceleration in the demise of the purchasing power of the dollar and the savings of most Americans.
Investors must understand that higher inflation not only devastates the value of dollar denominated assets such as CD’s, T-bills, savings accounts and cash but it is also very negative for stocks bonds and real estate. Higher inflation means higher costs of financing for those assets leading to lower multiples and cap rates.
And while we recommend gold to investors today with the primary benefit being wealth preservation in times of stress, it may be worthwhile to consider the ten most inflationary years in American history since gold began to trade freely. In those years, gold outperformed the stock market by 5x (that is not a misprint – gold outperformed stocks by 5X during those years). Gold outperformed bonds by 20X in those same years.
Clearly investors need to know that gold carries no guarantees.
As stewards of capital, however, we should be aware of these realities and the performance of gold in such periods should make one question the motivations of financial advisors who recommend 0% physical gold allocations.
Reprinted with permission from St. Joseph Partners.