Wednesday, June 10, 2009

Treasury Sale not Successful - Just the Beginning

Quick lessons on treasuries.  When the government wants to get more money it sells treasury bonds.  The government needs to do this to fund any spending in excess of what it can collect in tax revenue.  It essentially sells future tax revenue to whomever wants to trade it for bonds.

U.S. treasury bonds are bought by all sorts of people.  U.S. citizens buy them but so do foreign countries and their citizens.  The Chinese have bought quite a bit over the last decade or so.  The U.S. is seen as a very safe bet.  This allows the U.S. to borrow money at very low interest rates.  Some of the lowest interest rates in the world.  Like anything else, demand drives prices higher. Since the demand for treasuries has been high for several years, the price of treasuries has rallied higher.

One odd thing about bonds though is that as prices rise, yields drop.  That is, the more people want treasury bonds, the lower the interest rate the U.S. has to pay to people to buy these bonds.  This has allowed the U.S. to borrow money cheaply.   This has been great for the U.S. and has allowed it to finance a debt load in the trillions.

All that is changing and it isn't good for the rest of us.  Today, the treasury auction went badly pushing the ten year treasury to just short of 4%.  Not high by historical standards, but high when you consider that short term treasuries are near 0%.   Why should you be worried?  Think about how debt spirals start.  The U.S. is going to have deficits as far as the eye can see.  The only way to fund this is to sell bonds.  Now the borrowing is getting more expensive.  So you have to issue more bonds to cover expenses.  Well this means more and more of the money is getting diverted to just paying the interest.  How to pay for all the interest?  Issue more bonds.  That creates more supply, lowering prices, and raising interest rates!  Rinse, repeat.

It's like someone with massive credit card debt whose interest rate is rising.  They keep spending and using one car to pay off another.  It is a story that just doesn't end up well.  I have a position in TBT, an ETF that shorts treasuries.   I will look to enlarge that position.

1 comment:

  1. Not so sure about this. The 30 year treasury auction was pretty successful.