Central Bankers Encourage Debt Booms That Become Debt Bombs

A new Goldman Sachs report warns of a “likely to return to energy shortages.” It predicts crude futures will reach $85 by the end of this year and $95 by the end of next year. For what it’s worth, crude futures were up 4.1% in New York to $68.71. That’s a seven-month high. Just like old times, isn’t it?

Energy is a great long-term investment theme. As we’ve mentioned before, the collapse in capital spending in 2008 almost guaranteed that any resumption in demand growth would trigger higher prices because of much lower supply growth. Everyone’s been focused on inventories and the global recession. But it’s supply that you should keep your eye on.

Of course Goldman is just talking its own book. Everyone is talking his own book, come to think of it. But in this case, we like the book. And more importantly, we think a carefully selected portfolio of energy shares (conventional, unconventional, and alternative) is big part of making money as an investor over the next five years.

Switching gears, did you see what RBA governor Glenn Stevens said yesterday? He said the RBA would be willing to cut rates again if it needed to. But he also said, “It would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates.”

Wow. What’s gotten into these central bankers lately? First Ben Bernanke puts on his serious face and tells the U.S. Congress that large deficits threaten financial stability. And now we have Mr. Stevens pointing out the dirty little secret of lower rates. They encourage debt bombs that become debt bombs.

Shhh though. Don’t tell anyone else. It would be bad for confidence.

Do you think maybe Dr. Bernanke is just trying to talk his book too? After all, the U.S. Treasury has heaps of debt to sell this year (gross issuance over $3.25 trillion according to Goldman). If Dr. Bernanke makes adult sounds come out of his mouth, it might give people the impression the U.S. is returning to sobriety and fiscal sensibility.

And on due, ten-year bond yields did in fact fall in Thursday trading in New York. Ten-year yields on U.S. notes now stand at 3.54%. Remember that after the Fed said it would be buying U.S. bonds, yields plunged to 2.04% in November of last year. But by May 28th-as the true scope of America’s debt bonanza became apparent to global investors-yields soared to 3.75%.

We still think bond yields are the prime mover in this market, but not for the reason that you’ll read in the paper. Investors aren’t selling bonds because the economic recovery is sound and stocks hold better value. You’re seeing a bear market in sovereign bonds because many governments are running into a fiscal and demographic brick wall.

Bond yields also hold the key to explaining how a higher Aussie gold price is possible given the Aussie dollar’s recent strength against the greenback. With the Aussie chugging along against the USD, it’s been an uphill climb for gold prices in Australian terms. But just you wait.

The yield on Aussie ten-year notes was 4.88% in mid-May. It’s now 5.67%. That’s a 16% rise in three weeks. Granted, it’s not the huge spike you’ve seen in U.S. yields. But it does tell you something.

It tells you that the Australian Office of Financial Management has its work cut out for it in selling the $1.4 billion in debt a day to finance the country’s growing federal deficit. You borrows the money and you pays the higher interest rates. Or, your central bank-like the Fed-does its part if necessary to buy your debt.

Inflation on the way with real interest rates negative

Source: Reserve Bank of Australia

That sort of debt monetisation isn’t on the cards yet in Australia. For now, there should be plenty of domestic and foreign investors willing to add a little high-yield government debt to their portfolios. But given the chart above that shows-by the RBA’s own admission-that real interest rates are already negative, there are plenty of monetary forces already in the mix in Australia that will lead to expansion of the money supply.

That sort of monetary expansion, along with deficit spending and higher yields, is just the sort of thing that’s going to power Aussie gold and precious metals prices higher. If it doesn’t, we’ll eat every single hat here at the Old Hat Factory.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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4 Comments on "Central Bankers Encourage Debt Booms That Become Debt Bombs"

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Coppock Gude turns up. When looking at where we are Today the 1930s and 1970s provides a template – contraction-expansion-contraction. (In this model the 1980 recession, the 1981-82 recession and the time between the early eighties recessions are counted as the final contraction for the seventies). The recession years of 1929-1932, 1973-75 and 2007-2009 are counted as the first contractions of the cycles in question. In 1932, 1974 and 2009 the Dow hit twelve year lows. These market lows signaled the beginning of the expansion. The Coppock Guide turned up in 1932, 1974 and 2009. (Other below -20 bottoms include… Read more »
Agreed. Dan is it possible you could explain to DR readers the erosion of the USD and what is happening to precious metals, as compared to the strengthening of the AUD and the gold price. Surely it’s primarily down to what happens to the USD (Firstly) the Euro, the Yen and the Yuan now that would affect prices of gold internationally? Once the world standard in currencies continues to devalue (almost a certainty) there is only one way for commodities to go. I guess if you hold a lot of AUD then at least it wont devalue as quickly compared… Read more »
The Outback Oracle
Real Interest rates negative….this is news?????? Real interest rates AFTER TAX are prtetty well ALWAYS negative!!!! That is why we have no savings!!!!!!! That is why we have an External Debt equal to about 80% of GDP!!!! Great Scott! I thought you blokes might have grasped this nettle. Now as to the plenty of money sloshing around to soak up these yawning deficits, where are the savings at any level to explain this? The general population has record levels of debt and the debt in the external account has been rising for 50 years and rising exponentially in recent years.… Read more »
…dr. bernankle..eh…what’s wrong with us?….well ms. banks, it’s your feet, you’ve been chasing profits so excessively….eh, you mean fiat fever, doctor??…yes ms. banks….eh, how much theys gonna cost ta get betta?….well so far you O nothing for your diagnosis…eh? you mean so far we OWE nothing for our diagnosis….no ma’am, we don’t charge you for the “O”, we’re not in this for the money, we’re just trying to help you and we only charge for the “WE” and so far as we know, your uncle sam is going to pay for that…how longs its gonna take dr. eh…bernana…look chaquitas, do… Read more »
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