The Great Depression Online

Great Depression Online Archive Issue:

Why Rising Yields Have Only Just Begun

Great Depression Online
Long Beach, CA
June 02, 2009

Inside This Issue You Will Discover…

*** Playing by a Different Set of Rules
*** 15-Years in the Making
*** Why Rising Yields Have Only Just Begun
*** And More

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.

-- William Shakespeare, “Hamlet”

Playing by a Different Set of Rules

“Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”

The remark was made by Ed Yardeni and picked up in a Bloomberg story last Friday. 

Some years back, if you don’t recall, Yardeni invented the term bond vigilantes “to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds.”  And over the last several weeks bond holders have expressed their disapproval of the extraordinarily inflationary monetary and fiscal policies of the U.S. Government by doing just that…selling bonds.

Here at the GDO we don’t consider it too much to ask for a lender to be compensated by the borrower in accordance with the terms willingly agreed to at the outset of the transaction.  The very notion seems elementary. 

~~~~~~Beer Drinking Riches~~~~~~

When a Chilean says “Una cerveza, por favor,” seven times out of eight, he’s getting a brew made by the most profitable company in Chile.  It absolutely dominates Chile’s beer market with an 85% market share.  A company this dominant would be banned in most countries.  This aggressive growth machine would be slammed with anti-trust lawsuits if it were U.S. based.  Yet you can buy this virtual Chilean monopoly right here on the NYSE for only nine times earnings.  Learn more about these Beer Drinking Riches here.


The government, however, plays by a different set of rules.  For they control the money supply.  And by diluting the dollar they can stiff their creditors unconditionally; paying them back with watered down money.

If you’re retired and have your life savings invested in ‘stable’…’safe’…fixed income assets like Treasuries, there is nothing you can really do to fight back at the government for their dollar debasing policies.  Sure you could sell your holdings and risk putting your savings in the stock market…but unless you’re loaded, the government could care less that you’ve cut off their tab.

15-Years in the Making

Bond vigilantes, however, because of their massive bond holdings, possess the power to stick it to the government good and hard when their spending policies go haywire.  By dumping bonds, thus driving up yields on U.S. debt, bond vigilantes, in essence, force the government to borrow at a higher cost.

Alternatively, the government could borrow less money and live within their means.

The whole issue has to do with future inflation.  And when the Treasury runs massive deficits and the Federal Reserve prints money to help fund the deficits, as is happening now, future inflation is practically guaranteed.

Bill Gross, the manager of the world’s largest bond fund, explained last Thursday that “there’s becoming an embedded inflationary premium in the bond market that wasn’t there six months ago.”

In other words, bond investors are demanding higher premiums to compensate for the risk of future inflation.  The last time bond investors influenced government policy was over 15-years ago.

“Ten-year yields climbed from 5.2 percent in October 1993, about a year after Clinton was elected, to just over 8 percent in November 1994.  Clinton then adopted policies to reduce the deficit, resulting in sustained economic growth that generated surpluses from his last four budgets and helped push the 10-year yield down to about 4 percent by November 1998.

Clinton political adviser James Carville said at the time that ‘I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter.  But now I would like to come back as the bond market.  You can intimidate everybody.”’

Still, why did it take 15-years and nearly a $2-trillion deficit for the government’s creditors to reign in spending?

Why Rising Yields Have Only Just Begun

Today international investors hold a little over half of the $6.36 trillion in outstanding Treasuries.  That’s up from about 35 percent in 2000.  And of the Treasuries now held by international investors, China owns about a third of them.

For years the U.S. consumer spending binge has helped fuel China’s economy.  And by purchasing Treasuries, and keeping lending rates low, China was able to influence lower lending rates for consumers.  The impetus for that trend ended sometime during the economic collapse.

The U.S. government then began spending over four times the previous record deficit to somehow ‘stimulate’ economic growth.  The growth may or may not come but, with all the spending, inflation is almost certainly around the corner.  So finally, about six year to late, interest rates are starting to rise.

Will the Obama administration capitulate to their creditors and get their fiscal house in order like Clinton did?

At this point in the credit market cycle it may not matter if they do or not…interest rates will still go up…they’ll go up a lot…and they’ll go up for a long time.

Here’s what we mean…

Interest rate cycles span long periods of time…often they last between 25 and 35 years.  

U.S. Treasury yields reached a peak in 1920 and then slowly slid until the mid 1940’s.  Then, they rose again – along with inflation – and Franz Pick famously declared that “bonds are certificates of guaranteed confiscation”.

But then, in early 1982, yields again ventured over the mountain and slid down a soft slope to historic lows in December 2008.  Since then, yields have nearly doubled.

Yet the rising interest rate cycle has only just begun.  In other words, yields could easily double again…and again.


M.N. Gordon
Great Depression Online

P.S.  Our friends over at High-Yield International discovered a company so profitable that in most countries it would be illegal.  In fact, a U.S. company this dominant would be targeted with anti-trust lawsuits.  Fortunately, for you, it’s not a U.S. company.  But, even so, it’s traded on the NYSE.  What’s more you can now buy this recession-proof workhorse on the NYSE for only nine time earnings: High-Yield International.


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