To all those pundits who believe that a less-than-2% yield on 10-Year Treasury bonds is a good thing - a reality check. by Bill Gee
(centrist)
Tuesday, September 6, 2011
As the equity market continues to reel from the realization that we are in the middle of a second recession, the yield on the 10-year Treasury bond hit an all-time low today of under 2% as market values on bonds continue to rise. Financial pundits are telling the rest of the world that this bodes well for the world’s reserve currency, but I fail to follow their logic. It is my firm belief that these new bonds are worthless and I’m willing to provide some math to prove it.
Let’s assume that today you plan to purchase a $10 million US Treasury bond at today’s going rate of 1.974% interest. Currently, bonds are trading at about 5% above par value based on demand, so you will need to pay a premium of $500K for the privilege of owning the bond, which already puts you half a million dollars in the hole. But let’s say that you only intend to hold the bond for a couple of years and then you hope to re-sell it in the market for what you hope will be a nice profit as markets around the world continue to tank and investors continue to search for “quality” investments.
Negative Yields
First let us look at what you will be earning in interest. Each year, on a stated yield of 1.974%, you will be getting a payment from the government of $197,400 for your $10,500,000 investment, which most financial advisors will tell you is a piss-poor return on your investment. To explain how, we only need to look at the current inflation rate of about 3%. At that rate, rather than earning $197K per year, your investment would actually be losing about $118K per year. That’s because the 12-month present value of $10.5 million at a 3% inflation rate is $10,185,000. That means that your money has lost $315K of value in just one year. You can make up for some of these losses with your pitiful interest yield, but you are still losing money.
If inflation goes up, your investment loses even more value because the interest yield is fixed and will not adjust to inflation. At 4% inflation, you’ll be losing about $223K per year, at 5%, $328K, at 6%, $433K, at 7% - well, you get the picture.
The Market Rate Bubble
The smart money manager will tell you, “Hey, only a fool in this market holds their Treasury Bonds to maturity! Hold the bond for a year or so and then sell it at a profit!” They would correctly point out that on average, the market value of US Treasury bonds have increased by 20-40% over the past year as investors are fleeing out of stocks in favor for investments with more predictable returns even if they are negative. Therefore, you shouldn’t worry about buying your Treasury bonds at a 5% loss, because at the end of a year, the market value will be 20% higher and so you’ll have a 15% profit margin.
Didn’t we hear that song before?
There is every reason to believe that the sudden increase in market value in the US Treasury bond market is just another market bubble that will eventually pop. All it would take is for the world’s investors to finally become fed up with buying our declining dollars as they create a new reserve currency. Other shocks include the sudden collapse of the Euro Zone, China, Russia or any other global trading partner, supply shocks to key economic commodities such as oil or food, a global pandemic (even a mild one) or any number of other catastrophes brought about by Climate Change or Political Unrest. Once the bubble pops, then hyperinflation will follow which will make your Treasury bond worth even less than it is right now, except then you won’t be able to find anyone to buy it at any price.
If you don’t believe me, ask anyone who has some CDO’s to sell at your local flea market.
A Fool’s Game
The bottom line is that anyone in the market for purchasing US Treasury bonds is playing a fool’s game and the historically low interest yields only prove the point that there are far too many fools in the market. I suppose that some investors will tell you that at least if you own a bond you’ll still see some return on your investment where stockowners are likely to see nothing if their corporations go belly-up, but in a collapsed market, two of nothing is still nothing. Some “Doom & Gloom” investors say Gold and Emerging Markets are the best places to put your money, but Gold is not safe as long as it is exchanged in US Dollars, and Emerging Markets are plagued with a high potential for political unrest.
Again, I say the smart money is on items that will help you survive once hyperinflation and the accompanying supply shocks arrive.
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The views expressed
in this article are those of Bill Gee only and
do not represent the views of Nolan Chart, LLC or its affiliates.
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