A little while back, former Fed Chairman Alan Greenspan sounded the alarm about the “dire consequences” of swelling U.S. debt, as we may soon face higher borrowing costs.
Here’s another newsflash for you: The Chinese won’t always be on call when we need them!
The Chinese have provided the U.S. with short-term satisfaction. Satisfaction that felt so good that the U.S. became quite addicted to it. The reality is that we’ve been addicted to Chinese stimulus and, although we have a guilty conscience, we keep on doing it.
What we have been doing is focusing on only half the equation: The short-term satisfaction we’ve been getting. But what about the cost? Uncle Sam borrows the money from China to stimulate the economy by giving the cash to (“stimulating”) banks that are looking at mounting losses each month.
The government has become quite two-faced, even by historical standards.
Question: Why would the government be surprised that the banks aren’t willing to lend money out when the banks know what the reality of the situation is? They know they are just deferring losses, and that’s why they are hoarding cash. Duh.
Would you lend money out if you knew you had a massive margin call that you’d eventually have to pay? Imagine having a margin call (when you borrow money to pay for a stock purchase and when the stock declines the broker calls you to tell you to send in more money to “meet the call”). Then you sit there, watching that stock decline, praying that your stock advances enough in price to make that margin call go away. Some of you who’ve been there just got a chill up your spine.?
And those of you who have been in this position know the broker won’t accept that. Even if the stock advances back to where it started, you still have to send in money to meet the margin call.?
Well the banks have an asset–one ! thatR 17;s just slightly bigger than any stock position you’ve ever held–that they borrowed to buy … and it’s down BIG.?
They have nobody barking at them to come up with the funds. And guess what: They are actually sitting there hoping prices will advance enormously one day. And if you were a bank, why on Earth would you lend money out when you know you’re in the hole?
So do you believe the government when they pretend they are trying to encourage banks to lend more money to stimulate the economy?
The government, in essence, is encouraging the seemingly successful banks to “massage the numbers.”
The government obviously knows the scoop though, as they relaxed mark-to-market accounting rules for the toxic mortgage assets that banks carry on their books at inflated values. And they call that stimulation?
Stimulate away!
But how much will you have to pay for a happy ending to this financial mess?
The Chinese have always been the most reliable when it comes to relieving our stress. Gosh, they certainly get a ton of business here in the United States, and that continues to motivate the Chinese to be on call waiting to dabble dirty in our debt markets. Why not? We’re the biggest buyer, and have been the safest bet on the block!
But what happens when prices go up? (The price of money that is.) Where will the U.S. go to get that short-term satisfaction it needs when the Chinese, who dominate that market, want more? The Russians?
Alan Greenspan knows a little something about this topic. He recently wrote in The Wall Street Journal about the dangers of the complacency the government has about federal debt, saying:
“The U.S. government can create dollars at will to meet any obligation, and it will doubtless continue to do so. U.S. Treasuries are thus free of credit risk. But they are not free of interest rate risk. If Treasury net debt issuance were to double overnight, for example, newly issued Treasury secu! rities w ould continue free of credit risk, but the Treasury would have to pay much higher interest rates to market its newly issued securities.”
Although we haven’t seen a huge spike in interest rates, it’s possible to see a sharp spike in a very short period of time. As Greenspan points out, “Between early October 1979 and late February 1980, for example, the yield on the 10-year note rose almost four percentage points.”
That’s right! Four percentage points in four months!
Greenspan said:
“Federal debt to the public rose to 59% of GDP by mid-June 2010 from 38% in September 2008. How much borrowing leeway at current interest rates remains for U.S. Treasury financing is highly uncertain.”
For those who don’t understand the bond market, let me put this in simple terms: Let’s say your friend, who has a reputation of financial success, wanted to borrow money. And at the same time, you wanted to park your money somewhere. So you might lend him cash for a low rate of return (like treasuries have been paying lately–10-year Treasuries pay just over 3%.) But if you realized that your friend has been progressively borrowing more and more at an alarming rate, thus creating a higher degree of risk to your loan, you probably wouldn’t lend the friend money unless he paid a very high rate of return.
Federal debt to the public has risen during the past year and a half to $8.6 trillion from $5.5 trillion.
This is exceptionally dangerous, and Greenspan says in his WSJ article that the U.S. is feeling rather complacent about these dangers because so far we haven’t felt the pain of what, historically, have been the consequences of such behavior (rising inflation and interest rates).?
He talks about the fact that Congress has handed out hundreds of billions of dollars, and the fact that it becomes difficult for them to not give an extra couple billion here and a couple billion there. Compared to what’s ! already been handed out, a few billion doesn’t seem like a heck of a lot. In fact, it looks like a great big slap in the face when they say “NO!” So as they release the money, they shout “YES!”
The higher rates move, the less sense it makes to invest in the stock market. That’s one reason why higher interest rates are bad for stocks. When the cost of borrowing increases, it becomes harder and harder to operate profitably as a company, making stocks with lower growth potential less attractive. The more cash we print, the more likely it is that we see runaway inflation. That means we would be looking at higher cost of goods coupled with a higher cost of borrowing money.??
Sure, there is always the possibility of deflation. In fact, some of the smartest investors say that’s a more likely scenario. But if we have deflation, what happens to the value of the homes that banks are holding on to? They go down. And what happens to the banks when they don’t meet their margin calls? The FDIC–that’s what. In other words, you own them. Yes, you.?
Sorry to stress you out with this not-so happy ending. But there are two things you can do to relieve your stress.
1. Go get a massage.
2. Become completely comfortable with making bearish bets so that you can profit from falling equity prices. Because, while we can’t save the world, we sure can make sure OUR ending is a happy one.
Your Guide to Profiting From Asia’s Explosive Growth
For access to the best-kept secrets about investing in China and the rest of Asia, plus the hottest stocks to buy and sell, sign up now for Robert Hsu’s FREE Investing Newsletter, Asia Insider. It’s sent right to your e-mail inbox every week — absolutely FREE!
Here’s another newsflash for you: The Chinese won’t always be on call when we need them!
The Chinese have provided the U.S. with short-term satisfaction. Satisfaction that felt so good that the U.S. became quite addicted to it. The reality is that we’ve been addicted to Chinese stimulus and, although we have a guilty conscience, we keep on doing it.
What we have been doing is focusing on only half the equation: The short-term satisfaction we’ve been getting. But what about the cost? Uncle Sam borrows the money from China to stimulate the economy by giving the cash to (“stimulating”) banks that are looking at mounting losses each month.
The government has become quite two-faced, even by historical standards.
Question: Why would the government be surprised that the banks aren’t willing to lend money out when the banks know what the reality of the situation is? They know they are just deferring losses, and that’s why they are hoarding cash. Duh.
Would you lend money out if you knew you had a massive margin call that you’d eventually have to pay? Imagine having a margin call (when you borrow money to pay for a stock purchase and when the stock declines the broker calls you to tell you to send in more money to “meet the call”). Then you sit there, watching that stock decline, praying that your stock advances enough in price to make that margin call go away. Some of you who’ve been there just got a chill up your spine.?
And those of you who have been in this position know the broker won’t accept that. Even if the stock advances back to where it started, you still have to send in money to meet the margin call.?
Well the banks have an asset–one ! thatR 17;s just slightly bigger than any stock position you’ve ever held–that they borrowed to buy … and it’s down BIG.?
They have nobody barking at them to come up with the funds. And guess what: They are actually sitting there hoping prices will advance enormously one day. And if you were a bank, why on Earth would you lend money out when you know you’re in the hole?
So do you believe the government when they pretend they are trying to encourage banks to lend more money to stimulate the economy?
The government, in essence, is encouraging the seemingly successful banks to “massage the numbers.”
The government obviously knows the scoop though, as they relaxed mark-to-market accounting rules for the toxic mortgage assets that banks carry on their books at inflated values. And they call that stimulation?
Stimulate away!
But how much will you have to pay for a happy ending to this financial mess?
The Chinese have always been the most reliable when it comes to relieving our stress. Gosh, they certainly get a ton of business here in the United States, and that continues to motivate the Chinese to be on call waiting to dabble dirty in our debt markets. Why not? We’re the biggest buyer, and have been the safest bet on the block!
But what happens when prices go up? (The price of money that is.) Where will the U.S. go to get that short-term satisfaction it needs when the Chinese, who dominate that market, want more? The Russians?
Alan Greenspan knows a little something about this topic. He recently wrote in The Wall Street Journal about the dangers of the complacency the government has about federal debt, saying:
“The U.S. government can create dollars at will to meet any obligation, and it will doubtless continue to do so. U.S. Treasuries are thus free of credit risk. But they are not free of interest rate risk. If Treasury net debt issuance were to double overnight, for example, newly issued Treasury secu! rities w ould continue free of credit risk, but the Treasury would have to pay much higher interest rates to market its newly issued securities.”
Although we haven’t seen a huge spike in interest rates, it’s possible to see a sharp spike in a very short period of time. As Greenspan points out, “Between early October 1979 and late February 1980, for example, the yield on the 10-year note rose almost four percentage points.”
That’s right! Four percentage points in four months!
Greenspan said:
“Federal debt to the public rose to 59% of GDP by mid-June 2010 from 38% in September 2008. How much borrowing leeway at current interest rates remains for U.S. Treasury financing is highly uncertain.”
For those who don’t understand the bond market, let me put this in simple terms: Let’s say your friend, who has a reputation of financial success, wanted to borrow money. And at the same time, you wanted to park your money somewhere. So you might lend him cash for a low rate of return (like treasuries have been paying lately–10-year Treasuries pay just over 3%.) But if you realized that your friend has been progressively borrowing more and more at an alarming rate, thus creating a higher degree of risk to your loan, you probably wouldn’t lend the friend money unless he paid a very high rate of return.
Federal debt to the public has risen during the past year and a half to $8.6 trillion from $5.5 trillion.
This is exceptionally dangerous, and Greenspan says in his WSJ article that the U.S. is feeling rather complacent about these dangers because so far we haven’t felt the pain of what, historically, have been the consequences of such behavior (rising inflation and interest rates).?
He talks about the fact that Congress has handed out hundreds of billions of dollars, and the fact that it becomes difficult for them to not give an extra couple billion here and a couple billion there. Compared to what’s ! already been handed out, a few billion doesn’t seem like a heck of a lot. In fact, it looks like a great big slap in the face when they say “NO!” So as they release the money, they shout “YES!”
The higher rates move, the less sense it makes to invest in the stock market. That’s one reason why higher interest rates are bad for stocks. When the cost of borrowing increases, it becomes harder and harder to operate profitably as a company, making stocks with lower growth potential less attractive. The more cash we print, the more likely it is that we see runaway inflation. That means we would be looking at higher cost of goods coupled with a higher cost of borrowing money.??
Sure, there is always the possibility of deflation. In fact, some of the smartest investors say that’s a more likely scenario. But if we have deflation, what happens to the value of the homes that banks are holding on to? They go down. And what happens to the banks when they don’t meet their margin calls? The FDIC–that’s what. In other words, you own them. Yes, you.?
Sorry to stress you out with this not-so happy ending. But there are two things you can do to relieve your stress.
1. Go get a massage.
2. Become completely comfortable with making bearish bets so that you can profit from falling equity prices. Because, while we can’t save the world, we sure can make sure OUR ending is a happy one.
Your Guide to Profiting From Asia’s Explosive Growth
For access to the best-kept secrets about investing in China and the rest of Asia, plus the hottest stocks to buy and sell, sign up now for Robert Hsu’s FREE Investing Newsletter, Asia Insider. It’s sent right to your e-mail inbox every week — absolutely FREE!
