When Bonds Go Kaboom!

Posted by Bill Bonner - Diary of a Rogue Economist

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UnknownWe’re not the only ones giving Neanderthal advice about holding on to physical cash. British newspaper the Telegraph reports:

The manager of one of Britain’s biggest bond funds has urged investors to keep cash under the mattress. Ian Spreadbury, who invests more than £4bn of investors’ money across a handful of bond funds for Fidelity, is concerned that a “systemic event” could rock markets, possibly similar in magnitude to the financial crisis of 2008… 

The best strategy to deal with this, he said, was for investors to spread their money widely into different assets, including gold and silver, as well as cash in savings accounts. But he went further, suggesting it was wise to hold some “physical cash,” an unusual suggestion from a mainstream fund manager.

The Fuse Is Lit

The markets seem to be in wait-and-see mode.

Yesterday, we were waiting to see what happens in Greece. Today, we wait to see what happens in the bond markets.

We watch them like we watch a stick of dynamite. For a long time, it might sit there… silent… still…

Then all of a sudden – kaboom!

At the end of January, it looked as though bond yields had finally found their bottom. With $5 trillion of sovereign debt trading at negative yields, bond prices began to fall. And yields, which move in the opposite direction to prices, started to rise.

Not for the first time did we think: The fuse is lit!

We were 33 years old when this bond market made its last turn. The yield on the 10-year Treasury bond hit a high of almost 15% in 1982. Yields have been trending downward ever since.

If we had only imagined what would happen next!

“My partner knew someone who was managing money,” a friend recently told me, describing how he got rich.

“So we decided to put our money with him. I had never heard of him. But his name was Warren Buffett.”

Either by genius, luck, or a little of both, Buffett was in the right place at the right time.

In retrospect, it seems so simple, so obvious. The feds had changed the money system 10 years earlier. Now, the payoff approached. Without the discipline of the link with gold, the financial industry could run wild. It could lend money no one ever made and no one ever saved.

It could lend trillions of dollars that it created out of thin air. And as long as yields were falling, it scarcely had to worry about credit quality. If a borrower got into trouble, it could lend him more… at a better rate.

From 1949 to 1982 bonds were in a bear market. Yields went up, as bond prices trended downward. Then the 10-year Treasury note bottomed. Since then – most of my adult life – there’s been a bull market in bonds.

The Biggest Story in America

Falling bond yields and rising credit have affected almost everyone and everything in the economy ever since.

Falling bond yields mean borrowing costs come down throughout the entire economy.

As it becomes cheaper to borrow, people refinance old debt and borrow more. They buy consumer goods.

What was the biggest retail story in America?

Walmart. It sells huge volumes of (often Chinese-made) merchandise at Everyday Low Prices.

All you had to do was to buy Walmart, sit tight, and let the credit-fueled boom do its work. You could have bought a share of Walmart for $42 in 1982. Today, that share sells for $72.

But wait… That is after the stock split, 2-for-1, seven times! This is a challenge to our math skills, but we think that roughly equals a return of $20,000 for every 100 invested.

And an even bigger beneficiary was the financial sector. Thirty years ago, it accounted for about 10% of U.S. corporate profits. Today, it’s over 30%.

This illustrates the phenomenon known as the “financialization” of the U.S. economy. Instead of producing things to make money, the focus shifted to lending, speculating, and making money from money.

New Money

Behind this phenomenon was something almost no one noticed – a new kind of money.

The new dollar looked just like the old dollar. You could spend it just like the old dollar. You could fold it, lend it, borrow it, and save it – just like the old buck.

Who noticed that it wasn’t the same? And who cared?

If it looked like a duck, waddled like a duck, and quacked like a duck, it must be a duck, right?

And now… 44 years after this new money came into being… and after credit expanded by about 50 times… so much that the whole world is saturated by it… drenched in it… soaked to the bone…

…now we are told that this strange money is precious, and that we should hold some of this cheap money, at home, where we will have access to it in an emergency…

Does that really make sense?

More to come… of course.



Paris, France