British Debt, the U.S. Treasury Bonds, and You

First, let me take a moment to congratulate myself on being an oracle. Here's what I wrote in the early part of January.

Unfortunately, so far all indications are that he (President Obama) will likely do the exact wrong thing. He wants a major stimulus right away. They are talking about $500-$700 billion and he still will likely have half of the current stimulus to spend (not to mention that Obama maybe forced to bailout the autos if President Bush doesn't and he now wants to bailout cities and states) In order to do this right, he wants borrow a little at a time on a regular schedule. That way the stimulus from your purchases will be mild at any given time. It also gives the President the ability to monitor what effect his massive borrowing will have on the Treasury bond market. Instead, he is likely to request a bunch and have the Treasury get it for him almost as soon.

The possibilities for disaster if this is done wrong are enormous. There are all sorts of technical scenarios that could be frightening. For instance, there is something known as moving averages. If any investment, of which the Treasury bond is one, takes off in any direction and continues up staying above a certain level it will continue to go up until it breaks through the plane of the so called moving average. In other words, if Barack Obama does it wrong it will ride up for a while and soon the Treasury bond will be holding records only the other way.

Now, at the time, I was warning all about the pernicious effects to the Ten Year U.S. Treasury of Obama's borrow and spend policies and what those pernicious effects would have on the entire economy. At the time, the 10 year U.S. Treasury was at just over 2%. It's currently at about 3.45%. That's a near 70% increase in five months.

Yesterday, we may have had the beginning of the next disastrous step in the 10 year progression. In the morning the bond rating on the British debt was downgraded. Almost immediately following, rumors began to spread that U.S. debt may also be in jeopardy of being downgraded. The reality is that it may be days, months, years, decades or never that the debt would actually be downgraded. That's almost beside the point. Now that the rumor is out there there is an obscene amount of upward pressure on the bonds.

How much pressure is there? Before the announcement the 10 year was trading at 3.15%. Now it is trading at 3.45%. A move that large in that short a time is nearly unprecedented. Ultimately, what this means is higher, much higher, borrowing costs for everyone, the U.S. government included. This means that mortgages will be more expensive, along with car loans, student loans, and business loans. It also means that the trillions that the U.S. still needs to borrow will cost our own treasury much more. The borrowing cost of one trillion dollars just increased by $30 billion in the last day.

The other option is for the Fed to engage in "quantitative easing". In other words, the Fed will begin a program of buying trillions worth of U.S. treasuries themselves in order to manipulate their rates down. That isn't without pitfalls as that would eventually spell inflation.

So, why is this happening? Why are there rumors that our debt might be downgraded? That answer is simple. In four months in office, President Obama has engaged in an unprecedented spending spree the likes of which we haven't seen and he isn't about to stop. Everything I feared in January is essentially unfolding right now.

Higher interest rates means that any recovery would not only be stunted but eventually return us right back into a recession. Quantitative easing means that any recovery would eventually be followed by out of control inflation. Rumors that our debt might be downgraded is really nothing more than our markets telling the president that they simply won't allow him to continue on his domestic agenda.

So far, the president and all his economic advisors have totally ignored the effect the sum total of his policies have had on the U.S. Treasury. He dismisses it at his own, and our own, peril. Out of control interest rate increases on the Treasuries mean out of control interest rate increases everywhere. Here's how I described the potential destruction then.

If he dumps too much it could shock the system in all sorts of ways. If someone is NOT aware of the fury they are about to unleash all sorts of bad things are possible. Frankly, everything is already volatile and now Barack Obama has an opportunity to explode as volatile a potential combination as I have seen in a while.

The sort of fluctuating interest rate market he could create would make it nearly impossible to do any business especially with the situation as it is. Imagine if banks are locking loans and the rates are a full percentage point higher the next month. In fact, that's how a lot of pseudo banks went out of business back in the end of 2003. Rates went up like crazy and by the time they were able to sell they weren't making enough to get by.

Finally, it will almost certainly make interest rates bad enough that the real estate market won't have a chance to get better. Imagine if several hundred billion Dollars worth of new bonds are issued within three months. That could cost at least a full percentage point to the mortgage rates. If it's handled poorly we could easily see rates at 8%.

Unless the president recognizes that it is his policies creating this, the nightmare I described will be a reality. Treasuries at 5-6-7% in this environment will have an onerous effect much larger than allowing the autos and banks to fail. I called this his first test then and so far he is failing miserably.