While wondering what to write about today I remembered seeing something that was shocking even though I was aware of it. I have not paid much attention recently to 10 yr. yields in the Eurozone. The non logical yields had just slipped through the cracks of my cognitive memory. The story I read pointed out the various countries in Europe where their 10 yr. yields were trading below U.S. rates, in some cases, WELL below. I knew many Eurozone countries were below U.S. rates but the vast majority?
For example, the rates in Germany, Belgium, Italy, Spain, Ireland 10-Year, Denmark, Sweden, Austria, France and the UK are all trading with yields lower than U.S. Treasuries. The only two with yields higher are Portugal (3/4% higher) and Greece (a basket case). Looking at this from a broad perspective, it should tell you several things. First, either the U.S. is underpriced or the Eurozone is overpriced. Another way to look at this is either market participants are currently making a bet the U.S. is more "risky" or Europe is "safer" by comparison. Of course the same could be said about the currencies themselves, maybe market participants feel the euro will do better in the future versus the dollar? This really does not add up though as the dollar has been strengthening and the euro weakening. Is it because there is fear of deflation in the Eurozone which theoretically should cause interest rates to drop? Or maybe "growth" estimates? I might be on to something with these two?
Let's walk this "insanity" through to see why it makes no sense. Let's assume the market participants are correct and the U.S. will grow faster than Europe (I do not make this assumption personally because both are on the same Titanic). There is one question which is not entering the equation, this question is the one of "solvency". In other words, will the issuer of the bonds have the ability to pay back the interest and principal? What I am saying here is "risk" has absolutely zero input to the pricing of all of these bonds! Do you really believe Spain will remain solvent? Or Italy? France? Or whomever? Remember, these countries have no ability whatsoever to "print" the euro currency, they can only borrow more to pay current retiring obligations. It is the same thing in the U.S. but at least we know that enough dollars are always readily available via the Fed. Maybe this is it? This is why "deflation" is the expectation in Europe?
They can't print as fast as we can?
But hold on a second, deflation? How would any of these sovereigns be able to pay their outsized debt loads back during an outright deflation? The answer of course is "they can't", because individually no Eurozone country has the ability to print, which is a core problem. Let's look a little further at the "deflation" question as it does pertain to gold and silver. Of course, deflation is the reason put forth by the Harry Dent's of the world as to why PM prices are down and will collapse ... So we assume the deflationists are correct, what happens to the currencies of these countries (including the U.S.) who have such low interest rates because inflation is "too low"? This is THE question, what happens to the currencies? If sovereign after sovereign fall to boogeyman of deflation, they go bust or "restructure" their debt somehow, right? And we are to believe the currencies issued and backed by their "full faith and credit" will remain the same value ...or somehow strengthen? Really?
Let's take Spain for example, but it could be anyone. Spain's economy just plain sucks. Real estate is glutted and has crashed, unemployment, particularly of younger workers is 25% or more. They are already in recession ...again. Looking out past the end of your nose, they will default. What sense does it make to invest for 10 years in a piece of paper promising less than 2% per year? Oh, and the promise is ...to give you back more pieces of paper which MUST be inflated just to pay current obligations, forget about future ones! This is not even logical.
Let's compare this situation to that of instead putting your money into ounces of Gold. I will do this exercise in dollars for sake of ease (mentally) for me. If you invest $1,200 today into a U.S. Treasury you will get back 2% per year for the next 10 years. Assuming you compound this money into some more "safe" Treasuries along the way, maybe your total return will be 23-25%, so you get back a total of let's say $1,500. Compare this to purchasing one ounce of gold at $1,200 (even though you cannot purchase gold or Silver at paper spot). You have "risk" here as opposed to the Spanish bonds because "gold might go down", right? You don't get any contract explaining what you will receive. In fact, you won't receive anything over the 10 years. So in owning gold instead of Spanish Treasuries, you assume risk your gold "might go down" AND you don't even get any interest as compensation for your risk! (What I just did by the way is give you the spiel Warren Buffet and the other elite misdirectionists will give you).
Now for the reality. Gold doesn't pay interest, it isn't "FDIC" insured, it is not legal tender (except at stupid face values), and it isn't guaranteed ...but the Spanish bonds ARE all of these. They pay interest, backed by the sovereign government of Spain, any bank will accept them as deposit, payment or collateral. ...But who guarantees Spain? Germany? Who guarantees Germany? The U.S.? Because we have all these reserves of gold which we can't give back to Germany? Sorry for the rant, I hope you get my point?
What I am trying to say here is the "sovereign bond" markets don't make any sense at all. The various yield curves are out of whack and don't make sense. This market is now larger than $100 trillion! The principal can never be repaid in current currency values and if interest rates ever normalize to 6%, neither can the interest. Think about it, can the world's sovereigns really support over $6 trillion of interest payments annually? The problem in a nutshell is this; the global bond market is now THE biggest bubble in the history of history. It was so much fun "spending" the borrowed money, it always is ...but the hard part is paying it back! ...And this is exactly where we are now.
We have been at a crossroads for several years now as to "how" will all of this be paid back. In Europe there was (past tense) waffling between austerity and (U.S./Japan) "pedal to the metal" policy, this is no longer because each effort at austerity was met by "oops" market temper tantrums. None of the current Western sovereign debt can or will be paid back in current currency values, this is mathematically so. What we are watching now is nothing but "dancing".
Think about this for a moment, have you ever had anyone who owed you money, "dance" while explaining they'll "have it next week"? This is where we are today. Yes, sovereigns have borrowed to pay interest and roll debt over for years, and it worked ...but we have hit the ceiling so to speak twice now. First, we hit the ceiling prior to 2000 when debt built up to unsustainable levels...the answer of course was lower rates. Then another reflation (debt orgy) took place and we are again at unsustainable levels but rates can go no lower. The answer? Hyperinflate and devalue currencies as there are no other options. The only way to "pay" is to not pay ...in current values.
Let me finish by mentioning the "deflation" option which is no option at all. If by "mistake" deflation does take hold, all fiat currencies will be deemed worthless because the issuing sovereign will have bankrupted. In other words, the currencies will still end up busted and we will experience hyperinflation by another road. With either inflation (printing) or deflation (defaults), all fiat currencies will bust. Do you hold or save these? As the advertisement says, "what's in your wallet"?
Regards, Bill Holter