America has been left with a choice and there is no right answer. Due to the two-party system prevalent in American politics voters might be staring down a sequel that no one wants to see again, Donald Trump vs Joe Biden. I personally think that Trump will be convicted, and Biden will be replaced by someone that has a little more footspeed as he has clearly lost a step not to mention his fastball since taking office. I have seen them both govern and I know that they are spend,spend, spend candidates and I expect nothing more from either them or their replacements for the next four years. Therein lies the problem. This has gone from a political issue to a Treasury issue, and it won’t be going away anytime soon.
Brett Arends writes a great piece for MarketWatch and offers a brilliant view of how risky the US Treasury has become. It has been a worse investment vis a vis gold bullion since 1990. “Ten-year Treasury notes have now proved a worse investment than plain gold bullion going all the way back to the time of the first Gulf War, in 1990. Seriously. Based on New York University data, if you’d invested $10,000 in 10-year Treasurys at the start of 1990, you’d have just over $20,000 today (measured in constant dollars, meaning after adjusting for inflation). The figure for gold bullion over the same period: $23,000. That’s about 15% more.”
Gold, the original Bygone Relic. Gold has no usb port or twixy pixy camera or even a cupholder. Now this has been in a bond bull market but this decline in value highlights the increasingly dysfunctional spending of the US government. Moody’s came out last week and downgraded the US outlook to negative from stable and that the AAA rating could be in jeopardy. Janet Yellen trotted out afterwards and said that the US Treasury is still safe and sound. I would disagree with her because our debt profile is accelerating further and further into debt.
Arends continues, “Chicago-based money manager Josh Strauss puts it well. “On the one side you’ve got the Democrats, who want to tax and spend, and on the other side you’ve got the Republicans, who want to untax and spend. The U.S. citizen has gotten totally used to a government that spends a lot of money, and they think it could do it with less taxes.”
In the U.K. they have a term for this: “cakeism,” meaning a political program based on having your cake and eating it. Lower taxes? Higher spending? Why choose one when you can have both! Britain is no better run than the U.S. is, but at least they have the sense to call b.s. on their political class. Here in the U.S., someone can lay out an entire political program based on cakeism, and the audience just claps.”
The UK is better run than the US. Did I just read that right? Have we forgotten poor Liz Truss and her 44 day fiasco? No, and the US is still worse? It is because we have the world’s reserve currency, but that doesn’t mean we are immune from financial difficulty. In God we Trust is written on our coinage, but the rest of the world trusts in the coin itself or more specifically the US dollar and it has since the Bretton Woods agreement of 1944. Liz Truss forgot the to cut spending and she got her term cut short and if the United States isn’t careful, we will get our debt rating cut again. That trust is being jeopardized slowly with every budget that doesn’t balance and every bit of pork that gets put into every new spending bill.
Many people are talking about how we are in a soft landing or a Goldilocks economy right now. We went through the inflation impulse, and we are now recovering with the next step being the Fed cuts interest rates back to zero and we can go back to pre-Covid interest rates.
From Arends, “The federal government is currently running a bigger budget deficit, in relation to the economy, than Franklin Roosevelt ran at the depths of the Great Depression: 5.9% of GDP today, compared with 5.8% in 1934.” In essence, we are currently experiencing a recovery with more federal spending than FDR used in the New Deal during the depths of the Great Depression.
Arends continues and it is as if he has been reading my mind. “Even after all this disastrous performance, to buy a 10-year Treasury bond today is to make a bet, explicitly, that inflation will crater any day now and then stay low. Based on the so-called “break-evens,” which compare the returns on regular Treasury bonds and inflation-protected Treasury bonds, anyone buying regular 10-year Treasurys is assuming that inflation will average 2.3% over the next decade.
Good luck with that.” Arends words not mine. We have discussed last year how crazy and inaccurate the forward-looking projections have been and continue to be. Charlie Munger famously advises to not use forward looking EPS figures because they are just guesses. Yet people continue to treat forward looking projections like they are facts, yet every quarter we see stocks report earnings that miss these expectations, and the stocks rise or fall 10-20%. This reflects the dependence on these forward-looking measures and reflects how investors get offsides when these expectations don’t match their own.
What I really enjoyed about Arends article was the push back versus the narrative of buy fixed income now. 5% bonds in an inflationary environment is not the same as a 5% bond 5 years ago when CPI was 1%. If we flash back to that 1% environment people were buying bonds and now they are finding themselves down 40-50%. This is a crash, and we need to ask why. The bond market sits quietly in the 60/40 portfolio yet it is not offering the diversification to stocks in portfolios of markets past. The rates aren’t leading the news like the stock market headlines, but there is something fundamentally broken in America’s financial system. The inability to sell long term bonds at auction is yet another leading indicator that the world is not believing in the path that the United States is going.
The government has been spending money and just paying the interest on the principal since Andrew Jackson paid off the national debt in the 1830’s. There is a difference though between running a 30% debt to GDP level as there was in 1980 when Paul Volcker was raising rates vs now at 120% debt to GDP when Powell is attempting to do the same. We often focus on the debt piece and we should but we also need to look at how our economy is structured, we manufacture so much less than 50 years ago. We are spending focused and we are allowed to do so because we exported jobs overseas because of cheap labor so that we can buy a shirt at Wal-Mart for 10 bucks and a pair of Nikes for $100 versus the cost a domestic production cost profile that is 3 to 4 or even 5x. Try buying something made in America. It is just so damn expensive. That is another element that has been hidden. If our answer to China and Russia’s aggression is to source manufacturing here at home then folks, inflation is just getting started. Ultimately the first thing that happens in inflation is that the amount of units that we can buy has to go down, and that is a reduction in the perceived cost of living.
I personally scoff, yes scoff, at the fact that the poor American has to buy less stuff. Look at kids with every toy in the store sitting in a toy box unused, the boat in the driveway that gets used single digit times per year, and the makeup counter and closets that are bursting at the double wide walk in seams. The beauty of a slowdown in America unit buying is bad for business but frankly it is only going to cause a spoiled temper tantrum for a bit. The fat can be cut from many many households, but there is another portion of Americans that have not enjoyed the boom of the last decade and are still struggling and have been since the 2007 housing recession. This segment of America is living paycheck to paycheck and have not owned a treasury bond or a stock. They are not taking advantage of company offered 401k plans because they need the money on their paycheck. These people feel the full brunt of inflation because they are the ones paying higher costs for survival and they can’t afford a reduction in units.
The low unit buyers all have a vote, and the issue is that they are faced with as Arends said two parties- one that wants to tax and spend and the other wants to untax and spend. Can it be that Democrats are more fiscally responsible than Republicans? Trump taught us that untax and spend explodes deficits. The public is going to have to stop spending because the government won’t. Until these voters have a responsible party to represent them, they have a lose lose.
Unfortunately, the voters are caught up in the hysteria that markets can only go up and the Fed put will always be there to care for them like a guarantee on the box from Calahan brake pads. They see days like yesterday when prices are rising and they misinterpret this to mean that inflation is over, yes, it is but only for a spell. The economy is crashing, and we are heading to recession and that will mean pain or pivot. Pivot means the pain will be later as inflation will gather steam and come back with a vengeance. Pain or Pivot. My guess is that Powell will allow pain, but can he see it through? If he does the marshmallow generation gets its first look at austerity and rising unemployment and if he doesn’t inflation roars back.
Sincerely Yours,
C Thomas Printer
On this date in history… 159 years ago to be exact, General William Sherman began his march from Atlanta to Savannah destroying everything in his way crushing the proud Georgia resistance and showing everyone how to win a war.
Today’s factoid is the letter j is the youngest of all the letters. Before 1524, the “i”and “j” made the same sound like the name of god, Jehovah, but in the Latin alphabet Jehovah begins with an “i.”
Also born on this date, the original proctologist and discoverer of Uranus, William Herschel.
https://www.marketwatch.com/story/u-s-treasury-bonds-are-not-safe-f365a8c0?mod=home-page