Bond Bubble Bursts

Sometimes, seemingly dull details can be very important. Like bond markets—who notices them? In case you haven’t been watching, big movements are occurring in the bond markets that could have big implications for the U.S. economy, the U.S. government and even the world economy.

People sometimes assume that you cannot lose money holding U.S. debt instruments. In fact, however, you can. How? Consider that the price of Treasuries—like the benchmark 10-year Treasury note—varies inversely with their yield. Bonds and notes typically have a fixed interest payment. So if you buy at one yield, and the market yield rises, that means that the market price had to decline to produce the higher yield. You can only recover if you hold it to maturity.

The yields on U.S. Treasuries and many other U.S. debt instruments have been artificially reduced by the Federal Reserve’s “Quantitative Easing” policy, which means that the Fed has been buying massive amounts of bonds. That drove up the prices, producing what many analysts considered to be a “bubble” in the bond market. And everyone knew that the policy was unsustainable over the long term.

Economist Herbert Stein, chairman of the Council of Economic Advisors under U.S. President Richard Nixon, coined what he jokingly called “Herbert Stein’s Law,” which holds: “If something cannot go on forever, it will stop.” He meant that if a trend cannot go on forever, there is no need for action or a program to make it stop—it will stop of its own accord. This is often rephrased as, “Trends that can’t continue, won’t.”

That seems to be happening to the bond markets now. The yields on 10-year U.S. Treasuries were 1.86 percent at the beginning of this year. On September 3, they were yielding 2.86 percent—exactly a 1 percent increase. And they have continued to climb since then.

Mauldin Economics reports, “In June, foreign investors dumped $5.2 billion of Fannie Mae, Freddie Mac, and Ginnie Mae bonds, $5 billion in corporate bonds, and $40.8 billion in US Treasury bonds-all part of the $66.9 billion in sales of other long-term US securities. That is the biggest monthly dumping of Treasuries by foreign creditors since 1977! So which of our country’s creditors are doing the most selling? None other than our two biggest creditors, China and Japan…. Despite Bernanke’s promise to keep rates low, the free markets are taking over, and long-term interest rates are starting to rocket higher. As a result, sovereign bond prices are plunging….”

 “When rates are artificially low as a result of the financial repression coming from central banks, there is nowhere to go but back up… Investors around the world are finally realizing that central banks can keep interest rates artificially depressed for only so long” (Aug. 20, 2013).

All this means much higher borrowing costs for the U.S. government and the U.S. consumer. And a major portion of the budget of the U.S. government is in the payment of interest on the trillions of debt held in the U.S. and broad.

The Bible warns us that, “…the borrower is servant to the lender” (Proverbs 22:7). And the creditors of the U.S. will want to be paid. They are keeping a close eye on the bond markets.

The economy is facing hard times, and the Bible makes it clear that harder times are yet ahead. If you would like to know more about this subject and how to prepare, order your free subscription to Tomorrow’s World, and pay special attention to the articles “The Debt Bomb!” and “The Good Life in Hard Times.”