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Friday, January 23, 2009

From "Crowding Out", to "Running Away"

While I don't agree with the entire piece, the following portion of Hoisington Investment Management Company's The Great Experiment caught my attention :

If there is a desire to increase government spending, the federal government must either increase taxes on the far larger private sector, an option that would presumably be precluded under the present circumstances, or borrow funds in the financial markets that would have gone to the private sector. At this point we have to ask which sector has the better track record of growing the economic pie—private or government expenditures? The private sector has demonstrated the greater flexibility and creativity to expand the economic pie, increasing productivity and thereby improving living standards for all. The risk is that increased federal borrowing will stunt the private sector's ability to grow.
In other words, the attractiveness of Treasuries has increased relative to U.S. equities and corporate debt. As of 2007 (the latest data available), Foreign investors owned $9.1 Trillion in Long Term (i.e. more than 1 year) U.S. Securities, split almost evenly between equities, private debt, and public (Treasury / Agency) debt. If the blue portion of the pie is growing, it is coming at the expense of the red, which explains part of the pressure on corporate spreads and equity prices.

But as Interest Rate Roundup details, there is no such thing as a "free lunch":
You can't simply bail out anyone and everyone, especially when you're a debtor nation, and expect your creditors to just grin and bear it forever.

Now investors seem to be waking up. Treasuries have been getting mauled this week, losing value every single trading day this week (Long bond futures are going for around 128 21/32 vs. 136 7/32 last Friday). Yields on 10-year Treasury Notes have shot up to 2.68% from their December 30 low of 2.06%.
The problem is that while investors are fleeing Treasuries, they aren't flying back to private securities, as both equities and corporate debt are down on the week. In other words, they may just be selling all of the above outright, but what are they buying? Mike Larson at Interest Rate Roundup seems to believe it is the old doomsday standby:
I have a thesis that might explain what's going on: Global investors are starting to sour on government debt all around the world. They can see that the cost of bailing out banks and economies here in the U.S., in Asia, and in Europe is spiraling out of control. They know that means governments are going to be issuing trillions of dollars in new debt, driving down the price of existing securities. Result: They’re flocking to alternative stores of value -- including silver and gold.
Source: InvestorsInsight