by Summary On Wednesday, Janet Yellen pressed on the broken buttons again. After the two day FOMC meeting, the Fed Chair announced they’d continue pressing the federal funds rate down to just a ¼ to ½ percent – effectively zero. What type of insanity is this? If she keeps it up, and whole thing doesn’t implode, the yield on the 10-Year Treasury note could also slip below zero…along with the hopes and dreams of three generations of retirees. A Sucker’s Deal The yield on the 10-Year Treasury note’s accelerating its descent toward zero. The last we checked the yield was at about 1.56 percent. But in every practical sense, for income investors, a yield of 1.56 percent may as well be zero. For example, at that rate, if you gave the government ,000, you’d earn 6 over the next 10 years. That comes out to just .60 per year. As far as we can tell, that’s a sucker’s deal. What’s more, it’s likely inflation will significantly erode the buying power of the initial principal. Using the government’s own highly understated inflation calculator and looking back ten years, we find that ,000 today has the buying power that 2 did in 2006. Thus a nominal return of 6, when added to the eroded principal of 2, amounts to an inflation adjusted loss of bucks.
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MN Gordon considers the following as important: Central Banks, Credit Markets, Debt and the Fallacies of Paper Money, Featured, German Bund yield, Janet Yellen, newsletter, On Economy, US broad money supply, US CPI, US Treasury
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Summary
On Wednesday, Janet Yellen pressed on the broken buttons again. After the two day FOMC meeting, the Fed Chair announced they’d continue pressing the federal funds rate down to just a ¼ to ½ percent – effectively zero. What type of insanity is this?
If she keeps it up, and whole thing doesn’t implode, the yield on the 10-Year Treasury note could also slip below zero…along with the hopes and dreams of three generations of retirees.
A Sucker’s DealThe yield on the 10-Year Treasury note’s accelerating its descent toward zero. The last we checked the yield was at about 1.56 percent. But in every practical sense, for income investors, a yield of 1.56 percent may as well be zero. For example, at that rate, if you gave the government $1,000, you’d earn $156 over the next 10 years. That comes out to just $15.60 per year. As far as we can tell, that’s a sucker’s deal. What’s more, it’s likely inflation will significantly erode the buying power of the initial principal. Using the government’s own highly understated inflation calculator and looking back ten years, we find that $1,000 today has the buying power that $842 did in 2006. Thus a nominal return of $156, when added to the eroded principal of $842, amounts to an inflation adjusted loss of $2 bucks. |
 Even though the US treasury note is like the one-eyed man in the land of the blind these days, it still is a guarantee to lose money in real terms if held to maturity – click to enlarge. |
| However, erosion of principal is not the only concern. An investment in U.S. Treasuries could be a bad investment for another reason. According to Michael Hasenstab, manager of the Templeton Global Bond Fund at Franklin Templeton Investments, investors in U.S. Treasury bonds could face “a big capital loss.”
Specifically, Hasenstab thinks rising inflation will force the Fed to raise interest rates more than they’d like to. When that happens, he expects U.S. Treasury bonds to plunge in value. He also fears many American retirees could be hurt. |
 US CPI, y/y percent change. For the moment it still remains very low, but there could be a significant increase in coming months due to base effects alone. What if it returns to a more “normal” level? – click to enlarge. |
Impossible OccurrencesNo doubt, Hasenstab offers a compelling thesis. It’s certainly one we see the logic in. In fact, we’ve been anticipating the bursting of the great U.S. Treasury bond bubble for the last 8 years – maybe longer. Somehow, year after year, despite sound logic and common sense, we’ve been proven wrong. For over this time something rather strange has happened. In particular, the U.S. Treasury bond bubble hasn’t popped. Instead, over the last 5 years, the yield on the 10-Year note has skidded along, bouncing between 1.6 and 3 percent. Every inkling in our brain and gut says the gig is up for U.S. Treasuries. But what do we know, really? Perhaps yields could sink and stumble to zero…or less. Crazy, impossible, things are happening before our very eyes. Take German bunds, for instance. Earlier this week the seemingly impossible happened. For the first time in history, the yield on the 10-year German bund slipped into negative territory. Various reports offered various reasons for the subsurface move. Some pointed to next week’s potential Brexit – British exit – from the European Union. Others point to weak global growth prospects. We have our reservations… |
 German Bund yield – stop the presses! It’s back at a positive 2 basis points as of Friday’s close! – click to enlarge. |
Down Go the Hopes and Dreams of Three GenerationsNamely, we believe that credit markets are broken. Yields no longer reflect an equilibrated price of money determined by the financial market’s supply and demand for credit. Instead, they represent a flat lined market similar to an ECG measuring a heart that has ceased to beat. This, no doubt, would be entirely impossible if we were living in an economy with a free market in credit. But, alas, we’re not living in a system that is remotely close to being free. Rather we’re living in a highly managed monetary system with heavy handed central bank intervention. |
 ECG of recently deceased bond markets |
| This, unfortunately, has had the ill-effect of government debt offerings with negative yields. It has also had the ill-effect of distorting the economy in so many ways it’s near impossible to comprehend. Without honest price discovery countless decisions have been made in error.
The point is, the clever fellows have pressed their fat fingers firmly down upon the buttons of credit creation with such gusto they’ve successfully broken the credit market. Nonetheless, they keep pressing and pressing. On Wednesday, Janet Yellen pressed on the broken buttons again. After the two day FOMC meeting, the Fed Chair announced they’d continue pressing the federal funds rate down to just a ¼ to ½ percent – effectively zero. What type of insanity is this? If she keeps it up, and whole thing doesn’t implode, the yield on the 10-Year Treasury note could also slip below zero…along with the hopes and dreams of three generations of retirees. |
 US broad money supply TMS-2 and the FF rate…a lot of money, and very little interest… – click to enlarge. |
Charts by bigcharts, St. Louis Federal Reserve Research
Chart and image captions by PT
M N. Gordon is the editor and publisher of the Economic Prism. This article was originally published as “How Capital is Allocated in 2016”