Since November 1, long-term U.S. Treasury bonds have fallen 7% in value. That's not supposed to happen. But it's happening.
Since November 1, the municipal bond market has fallen 6%. That, too, isn't supposed to happen. But it's happening.
For most of the last century, the whole world has believed the
obligations of the U.S. government – and the obligations of thousands of
states, cities, towns, and other municipalities in the U.S. – were the
safest investments in the world. These "safe" investments aren't
supposed to crash.
The reason U.S. Treasurys and municipal bonds are crashing is by far the most important financial development of 2010.
The crash has affected and will continue to affect the value of
every stock, bond, exchange-traded fund... every type of investment
If you've already looked for the reason bonds are crashing, it
hasn't been hard to find. This past month, for example, the reason bonds
were crashing was on the front page of all the major financial
websites. It's been there since November 3, when the Federal Reserve
announced it would print $600 billion between now and June 2011 and buy
Treasury bonds with it.
On one day last week, the headline at Financial Times' website read, "Fed maintains asset purchase plan." The Wall Street Journal's website read, "Fed Sticks To Bond-Buying Policy." And Bloomberg's site read, "Fed Retains $600 Billion Bond Buying Plan to Boost Economy."
It all means the same thing: The Federal Reserve
will keep printing money. The dollar will continue to get weaker. The
bond market will continue to fall. Interest rates will continue to rise.
Moody's Investors Services is a ratings agency. It publishes bond
ratings. A low rating means a bond is more likely to default. A high
rating means a bond is unlikely to default. The highest bond rating is
During the financial crisis, Moody's damaged its credibility by
giving junky mortgage securities the coveted triple-A rating. Now it's
desperate to get some of that credibility back.
U.S. Treasury bonds are rated triple-A, the highest rating there
is. But that might be about to change. Moody's doesn't like the
implications of the new $858 billion tax cut deal worked out between
President Obama and Congress. Recently, Moody's said, "Unless there
are offsetting measures, the [new tax] package will be credit negative
for the U.S. and increase the likelihood of a negative outlook on the
U.S. government's triple-A rating during the next two years."
That means Moody's is thinking about lowering the U.S. government's
triple-A rating. The lower your credit rating, the higher the interest
rate you have to pay on your debts. The U.S. has about $14 trillion of
debt. If interest rates go high enough, it could bankrupt the country.
As usual, the American ratings agencies are late to the party. U.S.
Treasurys have already been downgraded to double-A by analysts in two
of the largest, fastest-growing emerging economies in the world: China
Brazil's economy is larger than all other South American countries
combined. It's an important trade partner with the U.S., China, and many
other countries around the world. What Brazil thinks of the U.S.
government's credit rating is important.
China is the largest holder of U.S. Treasurys. It has no economic incentive to allow U.S. Treasurys to be downgraded. But it can't afford to ignore reality, either.
Just weeks ago, China and Russia announced they would no longer use
U.S. dollars in their trading with one another. And earlier this year,
the Bank of China reported a doubling of its gold holdings. Right on the
cover of the November 8 issue of Barron's magazine, an ominous
subhead reads, "With the dollar more vulnerable, China for the first
time is investing more overseas in hard assets, like copper, oil, and
iron, than in U.S. government bonds."
That's not what you do if you believe in the ultimate safety and sanctity of the U.S. government's credit rating.
When foreigners start questioning the credit rating of the United
States, they're essentially rejecting the U.S. dollar. It's as if a
billion Coke drinkers have suddenly decided they're better off with
orange juice. Imagine what would happen to Coke's stock and bonds...
In short, the jig is up. The world knows the Federal Reserve is
compromising the country's credit rating. The more money the Fed prints,
the higher the interest rate bond holders will demand to compensate
them for the risk taken, the lower bond prices will fall.
I urge you to sell bond holdings. And I urge you to sell
preferred stocks, which face the same problems as Treasurys and
municipal bonds. When interest rates rise, these investments decline in
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