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Stop What You Are Doing Moment



February 09, 2008 – Comments (8)

The financial markets seem extremely unstable.  I find the data around what is happening unsettling, yet some of the things you would expect to happen with it seem to defy gravity and remain supported as if by magic.

Today I was reading a piece on Safehaven by Peter Schiff and how he describes treasury bills as the mother of all bubbles.  He outlines his thesis:

"For years I have predicted that the falling dollar, persistent trade deficit,   and the lack of domestic savings would combine to send long-term interest rates   sharply higher. The effects of these fundamental drivers would undermine the   Fed's efforts to lower short-term rates and compound the problems for the housing   market and the U.S. economy. Yet as of today, the yield on the thirty-year   Treasury bond still stands below 4.5%, within 40 basis points of a generational   low. Either this is the one piece of the puzzle that I somehow got wrong, or   other factors are working to temporarily confound fundamental economics and   prop up the bond market. As you might imagine, I am confident that it is the   latter and consider the U.S. Treasury market to be the mother of all bubbles."

It makes sense to me, Americans have little savings these days and are dependent on others to borrow from.  Currently I wouldn't touch anything US as I have so little trust in their currency.  Being Canadian and knowing what Canada has been through to get our debt under control, well that is the path the US must follow and to me it means the US dollar will weaken.  Our dollar declined about 25% relative to the US dollar from when we first started working on our debt problem in 84 to the hardest years when taxes were so high, 54.9% in the highest tax bracket, which was reached at a mere $80k/year.  I have no doubt that Canada is going to go through a rough time as well, but we get to start with a surplus budget, better savings and less debt.

Every time I look at the US debt it looks as bad as Canada looked in 84.  It took us more than 10 years to balance the budget.  Canada's economy is 1/10th of the US.  Our weak dollar meant tourism expanded.  A weak US dollar can increase tourism there as well, but they need 10x as much expansion for the same effect, yet the tourism market is fairly fixed.  That they are a bigger economy to me means that they will hardly feel increased tourism from Canada.  We have 1/10th of their population for travel and they have 10 times as many to split it into.  Between our two countries, we got 100 times the tourism benefit of a weaker dollar than Americans will get.  Say 1% take vacations per year, well, that would mean we got 3 million visitors, or about 10% of our population.  To go the other way, 1% of Canada is 300,000 and that is 0.1% of the US population.  Probably the same could be said for our exports.

So, the level of debt means the dollar has to decline further, and going down to about half of where it is now would not surprise me.  It means that I need a 5-10% premium, depending on the number of years, just to maintain my investment.  I wonder if I have just been breezing over treasury bonds in my reading list, or if everyone is all of a sudden noticing something about treasury bonds. Accrued Interest looks at yesterday's 30-year Auction.   The "coupon" rate of interest is 4 and 3/8th.

With the auction, if you were buying a 30-year treasury bond priced to pay $100 in 30 years at the current 4.449% yield you'd pay $98.780998 today according to the press release. A lot can happen in 30 years and I can't imagine buying such a thing for under 10%.  At 10% interest the purchase price for such a bond declines to $46.76, a 53.24% decline in today's purchase price.

Consider what was posted:

"Consider the facts. The Treasury announces to the entire galaxy that its selling $9 billion in 30-year bonds. They get a yield of 4.449%. According to Bloomberg News, the pre-auction trading had indicated the yield would be 4.41%, indicating the actual results were a 4bps miss. Did the auction go poorly? It sure did. Not only was it a 4bps miss in yield, but 89% of it was purchased by dealer firms, which indicates that actual end buyers only stepped up for 11% of the sale.

But what happened next can't fully be explained by those auction results. The 30-year continued to sell off, rising another 10bps in yield to 4.558, or -1.6% in price, over the next hour. It strains logic to say that the Treasury holds an auction, the price is somewhat disappointing, so therefore the price should be an additional 1.6% lower."

Minute changes in the 30 year yield has enormous changes for the bond price, and these long term rates are unnaturally low right now.  I think the price going lower is perfectly logical.  A yield of 4 and 3/8th percent is grossly inadequate for pricing the risk for tying the money up for 30 years.  

If currency declines by 20% and inflation goes to 5% the loss of buying power is enormous, and this is not an excessive example of possibilities.  At the very least, this ought to be the bench mark minimum for pricing risk into a 30 year treasury bond.  At this modest realm of possibilities you would lose 27.72% of your buying power over 30 years when you finally got you $100 back.  The $100 would actually only buy $18.18 worth of goods, but the interest payments over the years would amount to $54.09 of buying power.  In order for such a treasury bill to actually pay this level of risk it would have to be priced at 5.85% or 5 and 7/8th percent is the closest.  This ought to have been the floor investors insisted upon.

These are the kinds of investments that pension plans can hold because they are "safe" and government guaranteed.  The problem is that they have grossly inadequate risk for inflation and currency declines priced into them.

Today the markets are a very risky place with a shadow banking system that simply makes it impossible for investor to be making informed choices.  Treasuries are a safe place to park while the markets are working through the financial losses, and that inflates their price and keeps a level of demand for them.  Thirty year bonds have considerable risk to trading down on the purchase price due to the excessively low yields, so although they have a perception of being safe, they have high risk of losing enormous buying power and being repriced downwards.  Once investors feel the markets are safe again, the return demanded on these is likely to increase back to reasonable levels.

8 Comments – Post Your Own

#1) On February 10, 2008 at 12:06 AM, floridabuilder2 (97.55) wrote:

you are a blogging machine....  i always keep your thoughts in my back pocket...  i am mainly cash except for two small positions... unfortunately the cash is US currency

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#2) On February 10, 2008 at 2:03 AM, EScroogeJr (< 20) wrote:

There is an exellent Middle Asian parable about  Hodja Nasreddin . Nasreddin comes to the king and promises that given 30 year's time and some modest amount of money (payed upfront), he would teach the king's donkey to speak human language. A worried friend asks Nasreddin: "What have you done? The king will chop off your head when he realizes you lied to him!" Nasreddin replies: "There is no risk whatsoever. In 30 years someone is going to die for sure: either I, or the king, or the donkey".

This sums up the situation with the 30-year bond.

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#3) On February 10, 2008 at 6:57 AM, DemonDoug (31.42) wrote:

The Federal Reserve holds over $780B in treasury bills.  China, Japan, and every exporting country in the world is trying as hard as they can to keep the dollar up so they can keep selling stuff to us.  It's not that hard to see.

I get the feeling the Fed and big banks have a huge influence on this, and that there are a lot of evergreen loans out there that, I'm just not sure what the endgame is with them.  If somehow those evergreen loans ever get called in and stop actually being "evergreen" - like I said, I'm just not sure about the endgame here.

Over the past year I've thought heavily about opening an everbank account in NZ or aussie dollars, euros, loonies, iceland kronas, or swiss francs, still a bit squirrelly on it, mostly because it seems like it's a race to the bottom, and as little faith as I have in the US, I honestly don't have that much faith in Euro, UK, Canada or anywhere else.  Hell, canada is still in it's own stupid RE bubble.

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#4) On February 10, 2008 at 11:50 AM, abitare (29.51) wrote:


FYI - The Plunge Protection Team and thier willingness to "buy the Dow."

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#5) On February 10, 2008 at 1:30 PM, dwot (28.81) wrote:

Well, I came to add a comment from my reading.  I truly do learn and process information as I go, so DemonDoug stating how much in treasury bills are in the federal reserve will be an approximate number I will file in my brain somewhere.  But I wonder what kind of treasury bills.  The 30 year ones are destine to decline so that is a source of stress on the federal reserves that this is the first time I've thought about...  And leverage about 30 to 1... 

How did this get to be such a f---ing mess?  The mother of all bubbles was what the article I linked to was titled.  If anyone knows the break down of treasury bills the federal reserve is holding in terms of length to maturity please share that.  I spend hours upon hours trying to find information that I am not familiar with.

So, on with what I just read related to this post, "We tend to forget that Japan remains the world's top creditor nation by far, the shy master of fate. The country's net foreign assets of $3,000bn roughly match the net debts of the US."  It doesn't say how much of US holdings it has.  I see a figure like $3 trillion and I think about how much a 1% increase in debt servicing costs would be, $30 billion.  That's just the foreign part of the debt.  Total is $9.2 trillion, so $92 billion increase...

I followed Canada's debt problem very closely through the 80s.  In 84 we had $39 billion more in program spending than tax money coming in.  Our total debt actually wasn't that high, but Trudeau had been a totally irresponsible, negligent, should go down in history for theft of young people's lifestyle and giving us the greatest decline in living standards in modern times.

I just found a document that on page 6 has a graph and if you follow it and my explanation here, you may understand why I am the biggest bear on this site.  Go to page 6 and look at the graph of Canada National Debt to GDP.

You can see that in 1984 when Trudidiot left office our debt was at about 40% and was clearly on an upward trend.  If you just look at that graph without understand what Trudidiot left the next Prime Minister to deal with you could be inclined to blame our debt problem on Mulroney, but imho, we should have shrines of the man on every corner.  From the day he took office he started hammering to Canadians that we were in trouble and we needed to stand together and fight our debt.  We paid as much as 54.9% income taxes starting at a wage of $80k.

Mulroney and Wilson were the best Prime Minister and Finance Minster partnership Canada has ever known.  Look at the graph up until about 1990.  It is completely concave down, meaning the rate of growth of the debt is declining.  Unfortunately Wilson left politics around then and Don M (I can't remember how to spell his name and he isn't worth remembering) was a dork and you can see the curve heading concave up again where debt was getting out of control again and Mulroney left office in 93.

By 93 the Canada budget went from a $39 billion deficit in program spending to taxes matching program spending.  It could have happened sooner, but not everyone was co-operating with Mulroney in terms of how important it was to tighten our belts and work together to make Canada strong.  Our deficit went down under Mulroney despite having a recession in the 80s.

So, the graph shows that just undoing the Trudidiot mess of negligent spending the debt rose enormously under Mulroney, a 40% of GDP to 65% when the GDP is also increasing is huge compared to what looks like maybe 32% to 40% under Trudidiot, and most people only interpret the face value numbers, not that the debt was growing concave up, or increasing in an unmatched precident in history.  They see Mulroney as the bad guy because the actual face value of the debt increased like it never had in history.

Think about the numbers, $39 billion in Canada with 1/10th the US population.  That would be like the US having a $390 billion dollar deficit in program spending without debt servicing costs in 1984.  We had that with debt at 40% of GDP.

The US debt is at 67% of GDP, and GDP has been grossly inflated due to the financial sector's basically corrupt practices.

The US is currently at a debt level very comparable to where Canada was in 84.  Maybe inflation means it is a little less, but that 67% versus 40% of GDP starting point makes me feel stressed when I think about the how big that difference is.

There was no dummy economics inflating our 40% GDP in 1984 like the financial market have done today.

Now, consider the vast differerence in the age of the population.  We are entering the era of the fast growth in social spending for pensions and medicare.

Canada is doing so with having a $13 billion dollar surplus budget and debt at about 40% of GDP, and the US is doing so with what, a $450 billion deficit and 67% of GDP?  You end up with a greater growth in absolute debt during the period of trying to get the debt under control...  I don't see today's debt, I see the process of how you dig yourself out and it is butt ugly.

The graph on page 6 ends in 2004 with Canada debt at 45% and it has since declined to below 40%. 

The world financial markets scare me a lot, but because Canada worked so hard on debt and contintued to make it somewhat of a priority, we are simply in far better shape heading into this mess. 

No question that we also have a Real Estate bubble, but if you look at the median home price to median income the Canadian average is 3.1 compared to the US 3.7.  Vancouver, where my home has been most of my life, has the worst of the real estate bubble.  All of our seriously unaffordable cities are in BC, which has 12% of our population.

Do a search on Demographia to get their report if you didn't check it out when I did a blog on it.  Page 15, you can see that Canada's median multiple is the lowest of all the developed countries shown.  The US has been declining, from a peak of 3.9 in 2005/2006 to 3.6 now.  I think the 3.1 is actually a peak or close to a peak for Canada as it is the most recent data and I think Canada is going to stop going up now.  That the US has popped first and all banks are tightening their standards I think limits Canada to where it is.  We've had an increase in 2007, which is included in the data, but lending practices have been tightened so I think we don't go up much more.  We have some very affordable markets that may continue up so the 3.1 can continue up.

But, we've had stronger lending practices throughout this mess.  Our mortgage insurance on high leverage loans is 2.5% up front.  We have more put aside to help deal with the problem.

The housing financing looks bad for Canada, page 30 of 52.  There isn't a huge difference between Canada and the US, 7.9 years of median income in Canada compared to 8.3 in the US.  The report isn't saying how this difference comes about.  It could be because of interest rate differences, we have higher interest rates perhaps.

Vancouver is our 3rd largest city and it is at 8.4 affordability.  Toronto is our largest city and it is at 4.8.  Montreal is at 3.9.  Calgary has gotten quite big, at 4.8, it has topped and is declining now.  Less than 10% of our population is in the seriously unaffordable cities, or 5 and up.

How much of the US population is in LA, Salinas, San Francisco, Honolulu, San Diego, San Jose, Santa Rosa, Ventura County, Miami-West Palm Beach, Riverside-San Bernardino, Santa Barbara, New York, Stockton, Vallego, Boston, Fresno, to name the worst?  US has 23% of cities covered severely unaffordable compared to 14% in Canada.  The survey covers all of our cities about 100,000 people or more.

I don't think Canada has the degree of speculation that the US has had.  I have talked to two people that I know were speculating last year.

I am not saying it is good in Canada, but I think we are in the least trouble.

I see Canada's biggest potential problem not the real estate problem but that we've got all of our Canada Pension money, $121 billion, in the markets.  I have decided that if they have lost everything that we worked so hard to get control of, I am not sticking around to pay for it again.

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#6) On February 10, 2008 at 9:01 PM, dwot (28.81) wrote:

I just read a post that gives some idea of the resets coming for 2008,


"All in all, first-half 2008 high-risk resets will run higher than a year earlier, but only very mildly, with the increase skewed towards the later months. According to the foreclosure study's proposed timeline, then, we can expect reset-driven foreclosures to be slightly higher in late 2008 than they were in late 2007."

 The banks financial issues and need to raise capital is going to continue well into 2009, and some aren't going to survive.

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#7) On February 11, 2008 at 11:53 AM, GS751 (26.67) wrote:

Has anybody seen the articles popping up lately about a lot of stores in the Big Apple accepting Euro's and Pounds as currency versus the greenback.  Interesting.

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#8) On February 11, 2008 at 1:38 PM, TMFKopp (97.40) wrote:

I'd encourage taking a look at T-Bill rates on a real, as opposed to nominal basis... going back to '58 I've calculated the median to be around 1.6%. For 2007 we were at that, if not slightly above.

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