Tag Archives: United States Treasury security

Currency devaluation’s effect on the markets and the importance of diversification

With commodities rallying across the board this year (most are up between 20% and 100%), copper is at an all-time high, palladium at a 10-year high, oil near its two-year highs, and the Treasuries falling, traders are obviously look for real assets.

The realest assets are commodities, but behind those are shares in companies that produce real goods and earn real profits. We tend to look at those profits in Dollar terms, but they really aren’t. A company making a 10% margin is making a 10% margin in the goods it sells, not in Dollars. In other words, a company could sell 90% of its goods to breakeven and hold the other 10% of the goods produced as profit instead of converting it into Dollars. Or that extra 10% could be converted into gold, silver, or whatever it wants, as long as it has a place to store the profits. Therefore, as long as a company continues to sell, the devaluation of currencies should affect it less than non-performing assets, such as Treasuries which will get hit by rising interest rates and inflation.

Actually, stocks tend to do well during periods of inflation, as long as the economy does well too. If a company’s costs rise, it simply passes along all or most of that to its customers. So if costs rise 10%, a company raises its selling price by the same amount to maintain its margin. As long as all countries experience the same inflation, there will little effect on the company. If we are seeing a worldwide currency devaluation, as I believe, stocks should rise as long as the economy holds up. Of course, commodities will likely do best, but stocks won’t be far behind. They’ll continue to earn a real rate of return of 4% to 7% or so. Bonds though will get double hit by rising interest rates and devaluation. Buying a bond yielding 4% today will yield a negative return if inflation exceeds that amount. And rising interest rates will reduce the Present Value of the bond too.

I would add a major caveat to all this: there is a chance of a major economic decline. With government’s deep in debt and many cutting back, the economy could suffer. Whether we see sub-par growth for the next generation or a double-dip recession remains to be seen. But if this economic decline occurs, stocks will get hit, of course. Commodities will also fall. Industrial commodities, such as copper and oil, may do even worse than stocks while precious metals will hold up better, but they too are likely to decline as they did during the 2008 market crash.

I’m not an economic adviser, but I always recommend diversification. Unless you have a lot of time to spend analyzing the market and become very good at it, chances are you won’t be able to “beat the market.” In fact, even the experts have a hard doing so and, statistically speaking, it has not been proven that anybody can beat the market (those that appear to do so may just be black swans). So own some stocks, some bonds, some commodities, and hold some cash. How much in each depends on your age and risk tolerance. You will not make a killing by diversifying, but in this political and economic environment, protecting your money is paramount. And with the future so uncertain, diversification is the only way to be sure your wealth won’t disappear in a market crash or rally, if governments go bankrupt or become solvent, or if the economy strengthens or weakens. No single investment will perform well in all the possible situations. Remember gold’s decline in 2008 or the larger decline from 1981 to 1998. Cash could be eaten up by inflation. Treasuries by rising interest rates. Stocks by an economic decline. But it is very unlikely that all four will decline together.

For example, learn more about Harry Browne’s Permanent Portfolio. I don’t necessarily recommend his portfolio as is. Much depends on your age and risk tolerance and ability to purchase these funds/instruments. But it certainly gives you a clearer picture of the importance of diversification.

Worldwide backlash against quantitative easing.

Apparently, I’m not the only one concerned about the Fed’s quantitative easing.

Yesterday, I wrote a piece: Quantitative easing. What is it good for? Absolutely nothing!

Today, we get similar sentiments from around the world:

Could this move turn out to be a modern-day Smoot-Hawley? For those of you who are too young to remember, the Smoot–Hawley Tariff Act was passed in 1930, raising tariffs, and being a major contributor to the Great Depression.

Quantitative easing. What is it good for? Absolutely nothing!

The Federal Reserve “unveiled plans to purchase $600 billion of Treasurys by the end of June 2011 to revive the economy.

Maybe one of my readers can explain to me how the Federal Reserve buying Treasury bonds will “revive the economy.” I just don’t get it. The Federal Reserve will be doing nothing more than printing Dollar bills and exchanging those Treasuries. Nothing of value will be created. No new goods will appear on the market. No jobs will be created. Simply put, Treasury bonds owned by individuals or corporations will be replaced by Dollar bills.

Owners of Treasury bonds own them because they want to save/invest their money. Buying the bonds from these people won’t convince them that they need to spend what they had been saving. They will simply invest their money elsewhere: in stocks, corporate bonds, overseas, gold, or in cash. No real wealth will be created through this so-called quantitative easing and it will not encourage any wealth-creating activities. It is simply moving money from one pocket (Federal Reserve cash) to another (Treasuries bonds) from the government’s perspective and the converse from Treasuries to cash from the people’s perspective.

The argument is that buying Treasuries will help keep interest rates low. But who benefits from this? Investors/savers will earn less on their deposits/bonds, but creditors (corporations, mortgages) will pay less interest. But those two will largely offset each other. No net benefit.

In the end, there is one entity that has so much debt that it will be the largest beneficiary: the United States government. Instead of paying interest on bonds, the government is choosing to print money instead. On $600 billion of intermediate-term debt yielding between 0.33 (2-year yield) and 2.57 (10-year yield) percent, the government would “save” about $600 million a month. That’s it? With a deficit running at about $125 billion a month, that’s just 0.5% if the deficit. Again, what for?

The Federal Reserve is simply manipulating the economy for no real purpose. Oh yes, it has the purpose of enabling the government to spend with reckless abandon and run large deficits because it now has a ready market for its debt. But to do so, it must print all those Dollars, and that is driving down the value of the Dollar which is very evident by the huge rally in gold since the “Great Recession” began.

The government is destroying OUR long-term prosperity for ITS short-term gain. A good deal for the Federal Reserve and the Treasury Department, but not for you and me.

Second Fed official opposes Quantitative Easing.

In a follow-up to my previous blog post Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work, another Fed official announced his opposition to the planned trillion Dollar quantitative easing:

Dallas Fed President Richard Fisher, who will get a vote on the policy setting Federal Open Market Committee next year, on Friday made his case against a new round of bond purchases, saying it is not clear the benefits of further quantitative easing outweigh the costs. Fisher, according to a copy of prepared remarks he’s due to deliver in Vancouver, made the case that removing or reducing the tax and regulatory uncertainties is the best way to promote business spending and have firms “release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity, rendering moot the argument for QE2,” he said. “I consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet.”


Doesn’t this seem to the motto of our current government? Purchase mortgages, expand the Fed’s balance sheet, and print more money even if there is no evidence that this helps the economy. Enact a trillion Dollar stimulus bill, pass a TARP bill, extend unemployment benefits to two-years and drop the requirement to look for work, and raise taxes on the rich even though logic and history prove that this things also do nothing for the economy.

Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work.

The Fed is currently planning a one trillion dollar quantitative easing program. As Jonathon Trugman of the NY Post reports:

The Fed will likely undertake a very large quantitative easing program sooner rather than later, if the economic data doesn’t get markedly better in the very near future.

This QE2 will need to be far more aggressive than most expect, for there is not going to be a QE3. It is essentially the last chance the Fed has. It will want to eradicate any doubt about its ability to work; it is, in essence, the nuclear option.

The measure could be as much as $750 billion to $1.5 trillion. And expect far more aggressive purchases than in QE1.

Mortgage-backed securities, the root cause of the economic collapse, will be the cornerstone of the purchases, thereby allowing a possible 10 percent to 15 percent increase in home prices, which would do wonders for the flat-lined economy.

Credit card-backed paper will be on the tab as well as some auto loans to keep the administration happy.

Sadly, with credit still unavailable to the “middle class” due primarily to poor fiscal policy and economic leadership, the Fed will have to dramatically increase the money supply in order to spur spending. It will work, but it’s going to be complicated.

So Mr. Trugman believes this quantitative easing will work, but that it has to be huge to spur spending. He fails to ask the simple question: will such an aggressive program be worth the benefit?

But others are arguing that the quantitative easing will have no effect at all. Marketwatch reports:

A new round of Federal Reserve purchases of bonds would have little impact on markets or the economy, Minneapolis Fed President Narayana Kocherlakota said in a speech on Wednesday.

Speaking in London, Kocherlakota on Wednesday outlined several reasons why buying government bonds wouldn’t make a major impact. For one, banks already have nearly $1 trillion in excess reserves. “QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones,” he said, according to a copy of the text he was due to deliver.

As to the first round of quantitative easing by the Fed, Kocherlakota cited an academic study showing that the $1.5 trillion purchase of agency debt, agency mortgage-backed securities and Treasuries by the Fed between Jan. 2009 and March 2010 reduced the term premium on 10-year Treasurys relative to 2-year Treasurys by about 40 to 80 basis points, which in turn led to a slightly smaller fall in the term premia of corporate bonds.

Kocherlakota estimates a new round of QE would have a more muted effect, because financial markets are functioning much better than they were in early 2009. “As a result, the relevant spreads are lower, and I suspect that it will be somewhat more challenging for the Fed to impact them,” he said.

So Trugman says this aggressive quantitative easing will work, but Kocherlakota says it won’t. In reality, who knows? The real problem is that there is so little discussion of the risks and costs involed. Marketwatch explains the risk in one sentence:

Kocherlakota also said that the impact of quantitative easing is to shift the interest rate risk on bonds from investors to taxpayers.

So the real impact of this quantitative easing will be to socialize risk. The Fed risks creating further moral hazard. The Fed risks producing interest rates that are too low, which will create more bubbles. The Fed is going to create distortions in the market system. But despite these risks, there is no guarantee of success.

I applaud Minneapolis Fed President Narayana Kocherlakota’s efforts to restore reason and common sense to our ineffective and inefficient monetary policy.