This Is By Far the Most Important Financial Development of 2010 By Dan Ferris | Thursday,
December 23, 2010
Since November 1, long-term U.S. Treasury bonds have fallen
7% in value. That's not supposed to happen. But it's happening.
Since November 1, the municipal bond market has fallen 6%.
That, too, isn't supposed to happen. But it's happening.
For most of the last century, the whole world has believed
the obligations of the U.S. government – and the obligations
of thousands of states, cities, towns, and other municipalities
in the U.S. – were the safest investments in the world.
These "safe" investments aren't supposed to crash.
The reason U.S. Treasurys and municipal bonds are
crashing is by far the most important financial development
of 2010.
The crash has affected and will continue to affect the
value of every stock, bond, exchange-traded fund... every
type of investment there is.
If you've already looked for the reason bonds are crashing,
it hasn't been hard to find. This past month, for example,
the reason bonds were crashing was on the front page of
all the major financial websites. It's been there since
November 3, when the Federal Reserve announced it would
print $600 billion between now and June 2011 and buy Treasury
bonds with it.
On one day last week, the headline at Financial Times' website
read, "Fed maintains asset purchase plan." The
Wall Street Journal's website read, "Fed Sticks To
Bond-Buying Policy." And Bloomberg's site read, "Fed
Retains $600 Billion Bond Buying Plan to Boost Economy."
It all means the same thing: The Federal
Reserve will keep printing money. The dollar will continue
to get weaker. The bond market will continue to fall. Interest
rates will continue to rise.
Moody's Investors Services is a ratings agency. It publishes
bond ratings. A low rating means a bond is more likely to
default. A high rating means a bond is unlikely to default.
The highest bond rating is triple-A.
During the financial crisis, Moody's damaged its credibility
by giving junky mortgage securities the coveted triple-A
rating. Now it's desperate to get some of that credibility
back.
U.S. Treasury bonds are rated triple-A, the highest rating
there is. But that might be about to change. Moody's doesn't
like the implications of the new $858 billion tax cut deal
worked out between President Obama and Congress. Recently,
Moody's said, "Unless there are offsetting measures,
the [new tax] package will be credit negative for the U.S.
and increase the likelihood of a negative outlook on the
U.S. government's triple-A rating during the next two years."
That means Moody's is thinking about lowering the U.S. government's
triple-A rating. The lower your credit rating, the higher
the interest rate you have to pay on your debts. The U.S.
has about $14 trillion of debt. If interest rates go high
enough, it could bankrupt the country.
As usual, the American ratings agencies are late to the
party. U.S. Treasurys have already been downgraded to double-A
by analysts in two of the largest, fastest-growing emerging
economies in the world: China and Brazil.
Brazil's economy is larger than all other South American
countries combined. It's an important trade partner with
the U.S., China, and many other countries around the world.
What Brazil thinks of the U.S. government's credit rating
is important.
China is the largest holder of U.S. Treasurys. It has no
economic incentive to allow U.S. Treasurys to be downgraded.
But it can't afford to ignore reality, either.
Just weeks ago, China and Russia announced they would no
longer use U.S. dollars in their trading with one another.
And earlier this year, the Bank of China reported a doubling
of its gold holdings. Right on the cover of the November
8 issue of Barron's magazine, an ominous subhead reads,
"With the dollar more vulnerable, China for the first
time is investing more overseas in hard assets, like copper,
oil, and iron, than in U.S. government bonds."
That's not what you do if you believe in the ultimate safety
and sanctity of the U.S. government's credit rating.
When foreigners start questioning the credit rating of the
United States, they're essentially rejecting the U.S. dollar.
It's as if a billion Coke drinkers have suddenly decided
they're better off with orange juice. Imagine what would
happen to Coke's stock and bonds...
In short, the jig is up. The world knows the Federal Reserve
is compromising the country's credit rating. The more money
the Fed prints, the higher the interest rate bond holders
will demand to compensate them for the risk taken, the lower
bond prices will fall.
I urge you to sell bond holdings. And I urge you to sell
preferred stocks, which face the same problems as Treasurys
and municipal bonds. When interest rates rise, these investments
decline in value.
If you're an income-focused investor, I urge you to focus
on dominant dividend paying companies instead. We've featured
a big handful in them in DailyWealth already... and in the
coming weeks and months, I'll update you on these ideas...
and exactly when you should buy them.