Everybody’s watching the “canary”

The benchmark global borrowing rate is based on the 10 year U.S. Treasury Bond.  On March 1st, the yield was 3.61% whereas on March 26th, the yield was 3.91%, up 30 basis points (.3%). See: http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml  That may not seem much to the average person but in global finance, this is a major move that could affect sovereign borrowing costs in the billions.  Washington’s optimistic views on healthcare costs are based on low borrowing rates, optimistic healthcare needs, and healthy economic expansion. “Not gonna happen”.  Expect the 10 year cost of healthcare to run $3 Trillion and will add an unhealthy extra $1 Trillion to the U.S. debt level.  I’m not the only one who knows this, the bond market is beginning to flex its muscle.

California is worse off than Greece.  Being the most populous state in the Union, California may be the first domino to fall.  The State Treasurer is once again warning about the re-instatement of IOU’s.  The housing crisis continues to be a drag on their economy and the commercial real estate crisis will reach full swing this year.  The Federal stimulus dollars are drying up and the jobs bill may not be enough to keep Congressmen in office this November.

Illinois’ bond rating has been lowered by Fitch.  See: http://www.bondbuyer.com/news/-1010228-1.html .  This does not bode well for the other states who are also heading for the cliff.  Schools around the U.S. are being downsized or closed.  Teachers are being cut from the payrolls and schools are looking for ways to cut expenses, even going to a 4 day week.  City, state, and local municipalities cannot run budget deficits like the Federal Government can.  They have no printing presses.

What puts the Federal Government in check?  Interest rates in the Bond market.  Interest rates on Sovereign debt is what the market uses to assess risk.  The higher the risk, the higher the rate.  The U.S. has been able to recklessly respond to its woes by printing money and creating more “Debt”.  A U.S. Dollar is the debt of the country since it is not backed by gold.  If the bond market concludes the U.S. debt is out of control, interest rates will rise when the Treasury attempts to refinance its debt through the bond market.  Who are the largest foreign holders of U.S. debt?  China ($889B) and Japan ($765B).

The U.S. is in a mess and everybody knows it.  The bond traders are watching each other to see who leaves the dance first.  If a major player decides not to participate in a Treasury auction, remaining players will demand higher rates.  Higher rates will negatively impact a U.S. economic recovery.  If the bond market gets chaotic, a global depression could develop.

Where could the U.S. Treasury get funds to support its addiction to debt?  You and me.  Your 401K looks mighty yummy to the Treasury.

Inflation in the emerging markets will force rates up.  The savers in the U.S. will be rewarded with higher interest income after several years of low rates that favored the banks and borrowers.  However, that lost interest income will not be offset anytime soon.

There is no real  protection for investors in any financial instrument if the sovereign debt crisis comes home to roost.  The Federal Reserve has an incentive to devalue the Dollar to deal with the huge debt bubble.  The investment community knows this reality and will demand higher interest rates to offset risks.  A showdown is coming at the OK corral.  The one who flinches will lose.

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