Friday, January 9, 2009

Linked: Bonds and FX

A friend from the broker community called me a couple of days ago and asked me what I thought about the dollar, i.e. its value against foreign exchange (in this case the euro). I replied that I was pretty much a euro/dollar agnostic these days, but that my gut told me the dollar would appreciate against most major currencies. My view surprised her because her first take was that the US needs to keep the dollar low to boost exports and thus help revive the economy .

I don't disagree on the need for exports, but my analysis is based on another, much more pressing need. With $1 trillion plus budget deficits projected for several years, the US must sell a record amount of bonds to cover the gaps. Who will buy them?

Domestic investors cannot raise the money. If the personal saving rate was to rise to 5% of disposable personal income (see chart below) - and stayed there - the amounts involved would be less than one half of what is required to finance the deficits. And even this assumes that all savings would go to US Treasurys - a completely unrealistic expectation.

So, a very large amount of bonds will have to be purchased by foreigners, many of whom have fiscal problems of their own, right now. How to make US bonds attractive to them? For a foreign investor, total return on dollar-denominated bonds comes from three sources:

(a) Interest payments,
(b) Capital gains (or losses) and,
(c) Foreign exchange gains (or losses).

Let's look at each one..

  • Interest rates are near record lows: right now the 5-year note yields 1.6% and the 10-year bond 2.4%. Not exactly designed to attract precious capital, they currently reflect fear instead of a sensible rate of return on long-term investment.
  • The prospect for capital gains/losses is a corollary of the above: bond yields can't really fall below 0%, at least not for long. And since we are already close to 0%, capital gains will be hard to come by in the future.
  • This leaves (c), gains on foreign exchange. Given the poor prospects for (a) and (b), an appreciating dollar is key to attracting foreign investors, in my opinion.
Now, I'm not talking about a "zooming" dollar, you understand. But even a 5% "steady" appreciation against, say, the euro would make US bonds quite a good proposition for a foreigner in this environment of limited investment choices.


  1. but you forgot one thing. foreign reserve are going down. where they gonna come up with anything to buy dollar flood by FED's quantitive easing?

  2. Indeed. How would they prop up the dollar ?

  3. I agree with Anon and Camabron, can't the Fed's quantitative easing be the source of funds the US government needs to fund it's deficits as the socialist nerds take their turn at the trampling of our common's?

    Then wouldn't the dollar still collapse relative to an absolute standard? And whether it collapsed vs. another currency would entirely depend on what their socialist nerds did?

    That poor commons, its grass just keeps getting trampled by everyone... I wonder if it is any coincidence that Austria is the only place in the world I have ever been where the average citizen lectured me to not walk on the grass?

    But I guess they do have very healthy grass in Austria.

  4. The US is a huge debt-berg. As such, it will continually act as an anchor to the rest of the world as conditions get worse.

    At some point, very soon, foreigners will revert to survival instinct. I believe they will be forced to come up with a new world reserve currency just to survive.

    The US will have to be cut loose and when we lose reserve currency status, it is game over.

    Joe M.

  5. My views are preconditioned on the US having enough sense to work hard to maintain the dollar as THE global reserve currency.

    If not then it is, indeed, game over for The American Empire.

  6. So that giant sucking sound I hear is not the US swirling down the drain (yet) but rather the US switching on a giant money vacuum to suck up the world's savings glut whether they like it or not?

    The ability to delay and keep kicking the can down the road is really something. It's like the Coyote falling off a cliff. As long as he keeps pulling out something to try as a parachute, be it a hanky or a hammer, the fall continues; when he's out of things to try he hits the canyon floor. And all this after walking over the edge and out into space for several feet before realizing he was no longer on solid ground.

  7. A. Who is brazen enough to play currency imo?
    B. Will trade reflect moderate balance within 5 years or game over?
    C. Will petro dollars tip A to spiral to the bottom to force energy innovation since reason and data suggest peak oil.
    D. Will group think overcome avarice. Hmm?

    Wonderfull people to read here and thank you all.

  8. hell,

    I appreaciate your optimism but do not share it. Hard work and good decision making left the building long ago.

    It began as the corporate empire gutted our manufacturing base in search of short term profits overseas.

    Replaced with the ill-fated consumer economy. US consumers are now at debt-saturation. This paradigm is over.

    We are now a begger state that depends on foreign money just to keep the doors open. This too is now over.

    Obama, with his Clinton-redux-family, now will attempt to pour on more debt as a cure. It will not work at debt-saturation. Period.

    No modern entity can be blamed for the current situation we are in. It all goes back to the creation of THE-FED in 1913.

    When they got control of our money we were a dead country walking. It is truly game over and this year.

    Joe M.

  9. Achtung! The reason anal Austrians lectured you not to walk on the grass, Thai, is because, being every bit as Germanic as the Germans, they are desperate that every one follow the rules and/or the ruler.

    The rest of the world, probably led by China, will, at some point in the future, see to it that the U.S. dollar is displaced as the globe's reserve currency. In the interim, the U.S. will dare the rest of the planet to do something about the deeply unsatisfactory status quo.

    Rest assured though, that short of Thai's commons going on strike, China will, in time, hold the line with its own brand of Keynesian fiscal stimulus. They certainly have a better chance of such nostrums working then the U.S. what with their immense surplus and prudently saving citizenry.

    IF the Chinese can get through this period intact, and it's a decent sized if, they will then embark on
    developing other markets for their goods, both at home and abroad. If they succeed, even to a modest degree, the U.S. will be in even more trouble then now. At that point our nation's economy and its currency will be, for all intents and purposes, expendable.

    Such is the fate of nations that kill their golden goose.

  10. Edwardo, it's a pun. Is Austrian Mish anal? Is Hell?

    They are both trying to protect our commons, only the endless see of Neos keep looking at that woman in the red dress (really can you blame them?).

    I was complementing Hell in a round about way. You have to admit, his last few posts have been very very good

  11. The Fed/Treasury have limited power to support USD vs. other currencies. To do that they would need a vast amount of FX reserves, which is not the case. Alternatively, they could raise the interest rates relative to other currencies, but this is obviously not going to happen. The Fed/Treasury could devalue USD by monetizing debt and selling USD on the FX market, but propping up USD is beyond their power.

  12. Here's an excellent blog entry from Charles Hugh Smith that deal with tonight's topic.

  13. Here 'tis.

  14. And this bears big time on the discussion as well.

  15. The problem was too much debt. What are "we" doing to save the day? More debt, by the trillions. Sorry, but I don't see this having a happy ending.

  16. I agree Yoski, but it seems to me if it is going to be a game of musical chairs, the collective at least has some ability to decide who the music stops on.

    I was eating dinner last night at a local Thai restaurant (of course) and a young girl (obviously from South East DC) slipped in to the restaurant and proceeded to go table to table selling candy until the Maitre d' asked her to leave.

    I would suggest that we have the ability to say it need never stop on someone like her

  17. Hi Hell,

    you are certainly a financial expert and, specifically one on currency matters.

    When it comes to currencies, I believe you definitely get it wrong. Much in the way a rich person with a background of massive wealth on say a couple of generation cannot understand poverty... Until they can. When they can it is certainly too late for them to cope.

    If you want to understand what a currency is and what a monetary crisis is you must be a NON-US national.

    This is not a brain issue, not even a cultural issue or an educational one.

    Counting you on that league is stressful, hell.


  18. "slipped in to the restaurant and proceeded to go table to table selling candy"

    Ah jeez, that's sad. Anecdotes like that remind me of Edwardo's comment that the recession "won't be televised".

    Contrasting against Austria's healthy grass, I hear that tourism is nearly extinct in Tijuana due to the drug wars. Gangs are having shootouts in restaurants. Gangs have stepped it up by kidnapping executives and demanding ransom from their corporate offices.

    Reading Sudden Debt (and a fictional story of an asteroid strike) has made me appreciate that there is NOTHING more valuable than a safe, functioning society (or "commons").

  19. What is really troubling is we have yet to see a viable and realistic road, proposed by the Administration or other power close to the throne, out of this mess.

    There are ideologues on both sides that offer solutions but nothing workable in today's moderate political climate.

    Therefore we have to assume that the economy will get much worse before one of the radical solutions ala Karl Denninger ( is tried.

  20. Marcus said "... we have yet to see a viable and realistic road..."

    I agree, though not really having all that much faith in leaders over personal responsibility, I would add myopia is a much larger public health problem than just leaders needing glasses.

    Edwardo put it nicely on his blog the other day "I think we have come to the point that we must acknowledge that our entire culture is something of a bubble, literally and figuratively."

    As EzraKlein rightfully points out, we have lost the ability to discuss as a collective when an extra 3 months of life is worth better education for our kids. We have lost the ability to discuss this subject vs. any of the near infinite other ways in which we could spend our dollars ("promises on future labor"). I am still flabbergasted at what Massachusetts did... And still the media looks at their approach as a model we should consider. I have no problem with everyone getting care but endless spending was always the easy part. It is limits which is the difficult part.

    We all have the consumer bug bad. And just as HIV likes to hide in our immune system to avoid detection, so the consumer bug like to hide in our own collective cognitive dissonances.

    Unless we re-acquire the ability to discuss this as individual citizens, regardless of whether our leaders ever discuss them, the dollar will be the least of our worries.

    And our leaders won't discuss this if we won't. The very structure of our system, where leaders are elected, guarantees this is always true. Leaders don't create energy out of nothing, they tap into it and channel it.

  21. You are absolutely right, Thai, about the nature of leaders, especially in a (nominally) democratic system such as ours. It seems fairly clear to me now that the area of the country I live in, which relies so much on the education and health care infrastructure will be particularly hard hit going forward. The din of bubbles popping grows louder with each passing day.

  22. And we have lost the ability to discuss the hardest issue of all, that the nature of spending in scale free networks is always non-linear (because we live in a fractal world).

    It will always be a few who spend the most in ANY system we look at. It will ALWAYS be this way. And since this is so, when is the collective simply allowed to say "enough".

  23. I see all sorts of excellent common sense comments and solutions. There is only one solution.
    Get rid of the Fed and credit/debt based money.
    All roads lead to London. The "authorities" such as Bernanke and Paulson are mere employees. Blair now has a job for GBP2.5m with JPM -for doing what he was told. Why does Paulson have to keep going to London ? Who is Barclays Global UK LTd ? Or rather, who owns it ? What happened to the Czar of Russia's fortune ? Who bankrolled Rockerfeller(s) ? Why could Victor Rothschild walk in and out of MI5 as if he owned the place, and then go and spend the week end with Heath the then Prime Minister ? Where are all the Rothschilds today ? Why was David Rockerfeller treated like royalty whenever he visited the Soviet Union ? Why doesn't the media give the full story about anything important ? How come Daddy Bush can walk in and out of the CIA ? Henry Kissinger ? Israel ? No proper investigation into Kennedy's assassination. No proper investigation into 9/11. The list goes on and on.
    The solutions put forward by politicians who are mere lackeys who prostitute themselves to certain interests, are not to the benefit of you and me. They are to keep the leech-fraud going. They are for the benefit of those who gain, namely certain low profile but very powerful parasites. Everything else is a waste of time. Research all these kind of things and then the solution is somewhat Trotskyesque

  24. Could the Fed engineer a world-wide stock market crash of sufficient magnitude to stampede worldwide investors into Treasuries and thus continue the supply of debt buyers for the next few years?

  25. Anon sounds like a proper Bilderberger conspiracy theorist. I have no problem with that from the standpoint that very powerful people, who went to great lengths to achieve position and power, go to equal or even greater lengths to maintain their power and position.

    History shows, with some notable exceptions, that they generally succeed. A certain ruthlessness and the maintenance of a low profile while not allowing a surfeit of megalomania to take hold seem to be the keys to success.

    Jesus said "The meek shall inherit the earth."

    Frank Zappa observed that "The meek shall inherit nothing."

    One comports with what we know of human evolutionary biology and the other not so much.

  26. Well said, although I might add that to truly appreciate evolutionary biology, you have to be true nihilist.

    Why are some people willing to become suicide bombers? Why will soldiers knowingly die for their comrades or country (or "The hive" or "The collective" or any other term for The Village" you might care to chose to use?)

    Remember, Tit for Tat lost!. All Southampton had to do was convince a 'meek' program to cooperate with a sleaze program by sacrificing itself for the good of the whole.

    If the meek had another agenda and was willing to sacrifice itself, then the meek's agenda indeed inherited the earth. Ever noticed that the Pentagon has said the one thing they readily admit they can never defend against is the attacker who is willing to sacrifice himself in the attack. It is a fundamental of game theory and they know it.

    Why do we see homosexuality across all mammals?.

    It still gets back to 'what is your aesthetic'?

    Don't ever be so foolish as to think you can outsmart evolution.

  27. To share but one recent example of how the meek inherited the earth, Atomic spies gave the Soviets the information needed to build its first A-bomb. They did this all because they were convinced communism was somehow more compassionate than the capitalist system that had rejected them since childhood.

    Boy did these meek nerds inherit the earth.

  28. Thai wrote:

    "To share but one recent example of how the meek inherited the earth, Atomic spies gave the Soviets the information needed to build its first A-bomb. They did this all because they were convinced communism was somehow more compassionate than the capitalist system that had rejected them since childhood.

    Boy did these meek nerds inherit the earth."

    I think they inherited ignominy, prison time and/or death, and of course a surfeit of bad food and cold weather if they managed to defect?

    Having said that, the (spy)chology of these characters was, I suspect, a bit more involved than revenge of the nerds. Suffice it to say that these spies were not, by my definition, meek; they were willing to take definite and highly risky, albeit surreptitious, action. Treason takes balls.

  29. how does your option C tie with your supply and demand scenario? by increasing supply and decreasing demand you increase the price of the good (currency in the case).
    how about option D. the fed monetizes all new debt issues and voila, puzzle solved.