“Shorting US Treasuries is a slam-dunk trade if ever there was one,” our friend Paul Van Eeden wrote not long ago. I agree.
Treasury yields have been going down along the entire yield curve since 1983. This trend reached a crescendo during the crisis of 2008, when 10-year Treasury yields plunged to 2% and 90-day T-bills paid negative yields.
For a few moments in the heat of the credit crisis, some investors were so scared of losing money in any other asset; they took a guaranteed loss just to keep their money “safe.” Better to lose 0.1% on a short- term bond, the theory went, than risk losing 50% on GE, Citigroup, GM or Bank of America.
The US government recognized this insatiable thirst for the “security” of American bonds. And it abused this opportunity to the fullest extent – setting record budget deficits in 2008, 2009, 2010 and likely beyond. Mainstream economists like Paul Krugman, James Galbraith and Dean Baker applaud these deficits as a necessary remedy for economic malaise. They maintain that when consumers can no longer consume and corporations are locked out of the credit markets, the government is the only actor in the economy that can save us all from financial Armageddon.
Further, they argue that inflation is the devil we know whereas deflation is the devil we don’t want to know. They argue the government is not spending enough money right now, and that those who encourage fiscal restraint and austerity during an economic downturn are only asking for more trouble, more pain.
Further, they say, it is the government’s responsibility to coax inflation back into the system, which would in turn spur growth in GDP. Then when the economy gets “back on track,” we can deal with the deficits and begin addressing the national debt.
Trouble is, since the 1980s, we’ve never, but for a few short years in the late 1990s, gotten to the second half of that Keynesian equation. As one reader insightfully observed:
“Keynesian economics really does (or did) have a legitimate function in a capitalist economy wracked by business cycles. Any honest, solvent government can use Keynesian strategies to good ends when a cycle tanks.
“The problem, which you guys so rightly observe is that our government is far from solvent; it uses what are called ‘Keynesian’ strategies to mask what Marx would have called ‘internal contradictions’ – and it’s not being honest with itself or its citizens, either. What we see now is not Keynesian – it’s simply consequences of overreach by an empire in decline. It’s not Keynesian at all, just chronic overspending.”
Following what we feel is a deeply flawed economic strategy, the Obama administration issued over $2 trillion in government bonds – a record, by a long shot.
Mostly with the help of Asian governments, the Treasury managed to sell them all. But many thanks go to the Federal Reserve itself. Through its program of quantitative easing, the Fed bought billions upon billions of Treasury paper to suppress American mortgage rates and ease the pain of the housing bust.
This, to put it bluntly, cannot last. The Fed ended quantitative easing on March 30. Mortgage rates have already reached an eight-month high since then.
But the real threat to the plan to keep rates low may come from outside the Fed’s purview. On January 25, 2010, the Obama administration announced a $6.4 billion arms deal with Taiwan. Two weeks later, the Treasury auctioned $16 billion in 30-year Treasury bonds. The Chinese failed to show up in customary fashion. Yields ticked up from 4.68% to 4.72% by the end of the auction.
The fear that the Chinese would simply slow their consumption of US debt was all that was needed to drive up rates in the US.
The worst inflations in history took place when savers and investors lost confidence in the integrity of the currency, while governments handed out purchasing power to entities that did not earn this purchasing power through past production.
By promising to suppress dollar-based interest rates well into the future, the Fed is giving investors little reason for faith in the dollar. Except for the inherent weakness of the euro, the dollar would already have “exited stage left.”
The American government cannot continue financing bailouts and future growth with borrowed money. The national debt stands at 90% of annual GDP, the highest since World War II. In the face of looming entitlement disasters like Medicare and Social Security, our debts might grow even larger… but our creditors will assuredly not grow any kinder.
“We are very concerned about the lack of stability in the US dollar,” Chinese Premier Wen Jaibao said last month. He oversees the biggest cache of US government debt in the world – roughly $889 billion in US Treasuries. As China’s worries grow – along with the rest of the world’s – creditors will demand higher rates of return. Bond yields will go up, prices will go down.
What’s more, China and many other foreign creditors have historically bought Treasuries in order to suppress the value of their currencies. Now that so many emerging markets have “emerged,” currency suppression isn’t providing the boost that it used to. If inflation becomes a problem in emerging markets, currency suppression will cease to become an objective. This would also remove a major source of demand for Treasuries.
When will it happen? How bad will it get? We don’t know. But our money says it’ll happen in the next 10 years. Holders of US debt will wish they were holding something – anything – else. Anything but the promise of a fixed stream of steadily debased US dollars. Investors will wish they sold US bonds short when they had the chance.
So how do you short US bonds without going to the trouble of borrowing them? Fortunately, there’s an exchange-traded fund (ETF) that lets you do just that.
The ProShares Short 20+ Year Treasury ETF (NYSE:TBF) returns the daily inverse of TLT, the Barclays 20+ Year US Treasury Index. The focus is on long-dated bonds – the securities that Treasury will have the most trouble floating if global confidence in US debt wanes.
In the last half of March, Treasury had a series of lousy auctions. TBF responded just as you’d want it to – rising 2% in just a couple of weeks. This is just the beginning.
All of that probably makes intuitive sense to you. After all, we’re betting against an investment class that’s gone nowhere but up over the last generation. So don’t be surprised if this asset goes nowhere but down during this generation.
for Markets and Money