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The government is handing out low-hanging fruit

March 29, 2010
Mexico City, Mexico

I was reading some US government propaganda disguised as educational literature the other day, something from the Treasury Department and Federal Reserve… it’s the sort of corrupt dogma is typically used to instill blind and unquestioning faith in a defunct money system.

Laughably, I noted the following passage from the Philadelphia Fed’s “Money in Motion,” intended for children aged 11-14:

“For money to be useful it must function as a unit of account, store of value, and a medium of exchange.  To be a good medium of exchange, money must also be portable, divisible, durable, scarce, acceptable, and stable in value.”

In my imagination I see Comrade Bernanke leading a group of America’s youth on a guided tour of the Federal Reserve, reading aloud from this text as he explains the natural of the Federal Reserve System.

“Yes, that’s right. Scarce. As in, cannot be conjured out of thin air. Now please excuse me, children, I need to go buy $30 billion worth of Treasury securities.”

It is for this reason that I really have a difficult time getting behind bonds, particularly US Treasury securities.

In fact, there is a fundamental question that any serious investor must ask: given the government’s massive deficit spending and printing spree, does it possibly make sense to loan this bureaucracy money for 30-years at 4.75%?

Before dismissing the concept altogether on instinct alone, the idea is at least worth exploring.  Consider that there are essentially two ways to make money, i.e. generate a positive inflation-adjusted return on a 30-year bond investment:

First, the investment would be reasonably sound if the US government does not default on its payment obligations, and if the rate of inflation stays below the 4.75% yield for the duration of the bond’s term.

Unless a massive fiscal restructuring occurs soon, it certainly seems doubtful that the federal government would be able to make good on all of its payments for 30-years.

On its current path, the US will eventually be obliged to spend the preponderance of its cash on interest payments, all before buying a single cruise missile or bridge to nowhere.

Given the political no-brainer of having to choose between paying the ‘Chinese,’ or providing for America’s common defense, America’s politicians will clearly choose to default… at least to foreigners that will be branded the new axis of economic evil.

Additionally, the prospect of inflation not spiking beyond 4.75% for the next 30-years also seems quite dismal.  Based on the fiscal hole that will need to be plugged, there are few realistic options beyond inflating the currency and higher taxes.

Higher taxes are like steroids for prices– they experience massive growth, practically overnight. And it absolutely will happen… when people like Bill Gates, Sr. say things like “society has a just claim on these fortunes,” in regards to estate taxes, you can bet on higher taxes.

So, effectively, an investment in 30-year bonds does not appear to be sound since there is significant likelihood of the government defaulting and/or inflation spiking beyond 4.75%.

The other way to make money on bonds is if the value of the bond increases; this would typically happen if future interest rates will be lower than today.

Needless to say, as interest rates are at historic lows, the likelihood that future rates will be even lower is negligible.

The best scenario one could hope for is that interest rates will stay at current levels for the long-term… though the prospect of sustained historic lows for three full decades certainly seems unlikely.

What seems more likely is that rates will eventually move higher, in line with their historical averages. Since 1980, the 30-year has yielded 7.80% on average.  If this occurs again, the market value of today’s 30-year bonds will fall substantially.

Overall, given the prospect of inflation, default, and declining value, US long-term bonds are clearly financial folly, especially when one considers the risk-adjusted, inflation-adjusted return.  There’s less risk in stuffing it under your mattress.

Finally, it’s worth noting that, since December, the 30-year yield has been quite volatile. Just in the last week, the yield has risen 20 basis points, which is not insignificant.

Former Fed Chairman Alan Greenspan recently called this a ‘canary in the coalmine,’ suggesting that the rapid rise in yields indicates the market’s intense concern for the growing federal debt.

Clearly, Greenspan has an agenda. He’s doing his best to shape a historical legacy that doesn’t blame him for the current economic mess… which is completely laughable. Regardless, though, he’s probably right on the money about the treasury yields.

It’s possible (and likely) that another panic will send investors rushing back into the perceived ‘safety’ of bonds, pushing yields down and bond prices up.  This would be a short-term anomaly, though, and mostly affect the 12-month and 2-year notes much more than the 30-year bond.

Overall, I’m short 30-year debt, and I think this is long-term low-hanging fruit. There are a variety of ways to play this, which I can discuss in future letters if you’d like.

About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

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Comments on this entry are closed.

  • michael


    “It’s Official – America Now Enforces Capital Controls”

    Is this true? What would the impact be on US citizens seeking to plant a second flag and the impact on the global economy/ US$?


  • Patti

    Dear Simon,
    I truly love reading and absorbing all the information you put out
    there for all of us Americans that are “fed up”.
    I do wonder if you could elaborate on the workings of how bonds work.
    I understand they are federal debt with interest to be paid, but from
    an investing point of view, I haven’t really understood the quotes, ie;
    11/32 and the interest rate paid. How do bonds work when yields go
    up and price goes down? And visa versa. Wouldn’t the investor purchasing the bonds make more money with higher yields? You had
    mentioned you would short the long term 30 year bonds, but before I
    would trade that, I would need to know the workings of these bonds.
    I would appreciate it if at some point in the near future, you could
    spell this out in an example.
    Thank you so much for all the great information. Looking forward to
    hear about the communities you are thinking about developing in Panama.

  • Pat

    Simon…..are you familiar with Natwest Bank in Jersey? A friend has recommended them as a solid bank where I can hold cash in several different currencies….just looking for your comments please. Thanks for all the valuable information you provide….it’s very appreciated!

  • Anonymous

    Simon and all: It seems to me that Walter Burien’s campaign to expose the apparent fact that state and their respective local governments are sitting on top of MASSIVE amounts of illicitly gained, unreported wealth is absolutely worth further investigation —no financial expert am Eye (Freelance Pro Photographer/Life-Energy Coach/Professional Finder); nevertheless: it appears that the uSA may not be so bankrupt per se, as we might hold …

  • Andrew

    Learned about HR 2487 this morning from link to zero hedge about capital controls (It’s Official – America Now Enforces Capital Controls – posted 3/28/2010 14:27). Was interested in any thoughts/feedback. Thanks!

  • Latindog

    Forget about flags, PTing and multiple passports.

    As Americans we’re done. It’s over. Put a dick in it.

    • Jan

      Well put Latindog.
      Forget about flags, PTing and multiple passports.As Americans we’re done. It’s over. Put a dick in it
      The proud American will go down into his slavery without a fight, beating his chest and proclaiming to the world, how free he really is.



  • Ken Smith

    I see by your dateline that you are back in Mexico. A couple of months ago you wrote you wrote about flying from Mexico to Vancouver, then on to Asia because you wanted to avoid any stops in the US.

    Another route may be of interest. Aeromexico has twice weekly flights from Mexico City to Japan (Narita) with a brief stop in Tijuana. There was a fuss last year that this flight entered US air space on take-off and landing, but evidently this has been resolved.

    The air space issue is interesting. Last year, an Air France flight from Paris to Mexico City was diverted from US air space, requiring refueling in Guadaloupe, because a passenger was on TSA’s no-fly list. The passenger was a journalist for Le Monde Diplomatique, and we all know how dangerous left-wing journalists can be. What this incident demonstrated is that Air France shares passenger manifests with TSA, even when the flight is to another country.

    More travel news — I saw a report on Mexican TV last week that Aeromexico had started a new service to Shanghai. My Spanish is less than fluent, but I gathered that this flight was a continuation of Tijuana-Narita and on to Shanghai.

  • Captain

    Black –
    ABSOLUTELY would I like to hear about the various ways to play short 30-year debt!

  • Latindog


    I find your recomendation the ultimate in irony.

    Short US debt so the the government needs more money to go after.

    Then stripping us of what’s left of our financial freedom.

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