Financial topics

[jwfid]

WHAT IF THE TREASURY BUBBLE BURSTS.

Ok, I admit it, I have a challenge understanding all the financial repercussions of this crisis. I have a fair amount of money in treasury funds (i.e. money market funds that invest in short term T bills). This is the first I have heard about a "Treasury Bubble" - I'd appreciate if someone could explain what the repercussions are. THANKS!!!!! And as a bonus question - what do you do if your $$ are in T-Bill funds because you have no idea WHAT is safe.

Dear Jim,

I have to caution any reader of this post. I have very little financial knowledge except for my stock market investing experience over the last 10 years. I am basing my investment decisions now on only what I have learned over the last three months basically.

I've read quite a bit on this website and others about the financial crisis. I've read some recommendations from some on this website who believe Treasury bills are the best way to protect your capital right now. I have personally sold all my stocks, etf's and mutual funds, and are primarily in money market and FDIC insured bank accounts. I also have a significant portion in US savings bonds I bought during the 2000-2003 bear market.

However, I don't trust banks anymore and I don't trust the safety of US Government debt that much anymore either. I'm trying to keep my cash diversified between FDIC insured bank accounts and US savings bonds. However, I am reducing my cash positions too. I know this sounds crazy, but it is contrarian. I am buying some rural real estate and a little gold (just in case). I'll probably lose money on the real estate and gold, but my intentions are to try and preserve what I have left in the best way I can. I'll keep my savings bonds for as long as I can, but I may use more of my FDIC insured cash to purchase improvments on the real estate if the situation continues to deteriorate.

Maybe the best thing to do is to diversify.

I came to the conclusion about two months ago that it probably isn't going to be worth anything anymore unless you can stand on it or you can hold it in your hand.

I hope to God I'm wrong too.

I would love to hear comments on what I'm doing to prepare.

Good luck,

Joe

[John]

Dear Fred,

> Signs we have a long way to go and a few lessons yet to learn:

I've been collecting a few of these lately. Here's my list:

• "I think most of us are going to bid a fond farewell to 2008. I
  feel certain that 2009 will be a better year."
• "After January 20, things will change. Banks will start lending
  again. New administration will raise spirits."
• "Financial stocks are so beaten down that they really snap back
  after they reach bottom."
• "Energy stocks are poised for rapid growth when things return to
  normal."
• "Obama's stimulus package will stimulate growth across the entire
  economy."
• "Banks don't want to make a loan right now - they don't want to
  show loans on the books to investors -- that attitude will change
  after the new year."
• "It will get better - we've seen this before - in the early 90s -
  I don't know how long it's going to last this time - in your
  business, just keep trying to offer the quality of service - and just
  survive it."
• "Looking for a rally in 2nd week in January."
• "Change in sentiment after the new year."
• "Obama's honeymoon rally will catch fire."
• "The recession has already lasted a year -- it's the anniversary
  -- our forecast is for a long recession - 18-20 months."
• "We've seen a lot of panic selling, and historically, panic
  selling is a good time to buy."
• "You have to separate the economy from the stock market. The
  economy will do poorly, but the stock market will do well. Look at
  past history: In the early 1980s, unemployment was high, interest
  rates were high, but the stock market did well."
• "Even the gloomiest prognosticator, Nouriel Roubini, is expecting
  a recovery at the end of 2009."
• "My money has to work for me."
• "For the last couple of months, investors have been going on
  emotions rather than facts; we have to to educate investors to get
  back to making investment decisions on the basis of facts."

The last one is the funniest of all. I should have made a note of
that analyst's name.

Sincerely,

John

[John]

Dear Jim and Joe,

> WHAT IF THE TREASURY BUBBLE BURSTS.

> Ok, I admit it, I have a challenge understanding all the financial
> repercussions of this crisis. I have a fair amount of money in
> treasury funds (i.e. money market funds that invest in short term
> T bills). This is the first I have heard about a "Treasury Bubble"
> - I'd appreciate if someone could explain what the repercussions
> are. THANKS!!!!! And as a bonus question - what do you do if your
> $$ are in T-Bill funds because you have no idea WHAT is safe.

> I've read quite a bit on this website and others about the
> financial crisis. I've read some recommendations from some on this
> website who believe Treasury bills are the best way to protect
> your capital right now. I have personally sold all my stocks,
> etf's and mutual funds, and are primarily in money market and FDIC
> insured bank accounts. I also have a significant portion in US
> savings bonds I bought during the 2000-2003 bear market.

In the past I've recommended cash, an FDIC insured bank account, and
T-bills (short term Treasuries).

My assumption was that all of those were extremely safe AT THAT TIME,
and that when things started to get bad, there would be time to
reassess the situation and make changes. Well, things are starting
to get bad, and so many things are up in the air that it's hard to
know what's going to be safe.

Let's look at some of the options:

• Cash. This is by far the best choice for most people. If you
  live in a house with a basement, you should find a way to bury some
  cash there. Or in your mattress. Otherwise, an FDIC insured bank
  account is probably the best choice, but keep an eye on events, and be
  prepared to withdraw if things get worse.
  
  It's interesting that there's no longer any talk among pundits about
  inflation and superinflation. Today, almost everyone agrees that
  we're in a deflationary spiral, and cash will become more valuable.
• T-bills. I have mixed emotions about this. T-bills used to have
  the advantage that you could earn a little interest, but these days
  that factor is negligible. More important is the possibility that
  the US government might default, and T-bills would be discounted.
  
  Note that a US government default would not change the value of the
  dollar currency; it would only change the value of US government
  debt.
• Gold. I cannot see any way that gold makes sense for the
  ordinary person.
  
  For one thing, gold is still in a bubble, and that bubble is still
  going to crash to the $300-500 per ounce level. Furthermore, in a
  deflationary spiral, gold may actually fall to a lower level than
  that. If there's an international emergency, then gold may spike up,
  but that will be only temporary unless there's a massive world war.
  
  So this brings us to the other argument for gold: We're expecting a
  massive world war, and there's no way to predict the value of gold at
  that time. The problem for most people, however, is that if your
  family is starving, and all you have to buy food with is a gold bar,
  then you're going to have to discount the gold bar out of
  desperation.
  
  If you do invest in gold, make sure that you take possession of the
  actual gold coins or metal, and have a safe place to put it. Do not
  count on proxies such as gold-related stocks or securities. They'll
  probably turn out to be worthless.

If you have plenty of money, you may wish to diversify, with cash
spread around various banks, for example.

These are the best ideas I can think of. Does anyone have any
comments or suggestions?

Sincerely,

John

[Higgenbotham]

Let's look at some of the options:

• Cash. This is by far the best choice for most people. If you
  live in a house with a basement, you should find a way to bury some
  cash there. Or in your mattress. Otherwise, an FDIC insured bank
  account is probably the best choice, but keep an eye on events, and be
  prepared to withdraw if things get worse.
  
  It's interesting that there's no longer any talk among pundits about
  inflation and superinflation. Today, almost everyone agrees that
  we're in a deflationary spiral, and cash will become more valuable.
• T-bills. I have mixed emotions about this. T-bills used to have
  the advantage that you could earn a little interest, but these days
  that factor is negligible. More important is the possibility that
  the US government might default, and T-bills would be discounted.
  
  Note that a US government default would not change the value of the
  dollar currency; it would only change the value of US government
  debt.
  
  ......
  
  If you have plenty of money, you may wish to diversify, with cash
  spread around various banks, for example.
  
  These are the best ideas I can think of. Does anyone have any
  comments or suggestions?
  
  Sincerely,
  
  John

I would say that treasury bills are a safer choice than cash (Federal Reserve Notes). The Federal Reserve Notes are the liabilities of the Federal Reserve. At this time, the Federal Reserve has about 849 billion in net Federal Reserve Notes outstanding and their balance sheet currently has 476 billion in US government treasury securities to back the Federal Reserve Notes. This can be seen in this weekly release from the Fed:

http://www.federalreserve.gov/releases/h41/Current/

Scroll down to item number 8 to review the balance sheet of the Federal Reserve Banks. There was a time when the Federal Reserve Notes were backed by an equivalent amount of US government treasury securities on the balance sheet. Since the advent of the various facilities that are loaning out treasury securities in exchange for less worthy collateral, that is no longer the case although, in theory, these are just loans and the full backing of treasury securities for the Federal Reserve Notes is "out there" on the balance sheets of the various financial institutions.

With that background, now onto the question of default. It can be seen in the above-mentioned release that treasury bonds constitute the majority of assets on the Federal Reserve Bank balance sheet with TIPS and treasury bills being a smaller percentage of treasury assets. There are various ways I can think of that the government could default on its treasury obligations. I don't think a total default on all government debt (treasury securities) will happen all at once and if it does it is not in the immediate future but in that event Federal Reserve Notes would become worthless because the Federal Reserve Banks would not have any collateral to back the notes. Any partial default would trim the value of the Federal Reserve Notes accordingly (edit--see some additional comments 2 messages down as it would seem to me upon further thought that it's possible the Fed could be recollateralized or folded into the Treasury Department in the event of a partial default--any other ideas?).

I should mention that this situation is vastly different from that in the 1930s where the Federal Reserve Notes were backed by gold and since it is impossible for gold to default, it was impossible for Federal Reserve Notes to lose value in the marketplace unless the government came in and devalued them as Roosevelt did. Today, since the Federal Reserve Notes are not backed by gold but are instead backed by debt securities that can be defaulted on they are only as safe as the underlying securities that give them value.

As far as why I believe treasury bills are safer than Federal Reserve Notes, it is because any partial default by the US government is likely to be a bond default that will not affect bills. As noted in a post a few weeks ago, treasury bills are only 20% of total treasuries outstanding and the government should be able to accommodate a partial default in all but the worst circumstances. Bills are at the core of our monetary system and must be preserved at all costs (if there is to be a monetary system) because in a fiat money system the cash notes must have an underlying equivalent. That's my understanding anyway. If the Federal Reserve Notes were backed by gold, then all of the treasury debt could be defaulted on and it wouldn't matter--Federal Reserve Notes would still have value.

If all treasury securites are defaulted on then the only "money" that will have any value is gold and (to a lesser extent) other potential monetary items like silver coins or cigarettes or whatever the marketplace comes up with.

[John]

-- "The scariest housing chart in the world"

California median home prices:



( http://mrmortgage.ml-implode.com/2008/1 ... hart-ever/ )

Note that home prices have been falling rapidly, and show no signs of
leveling off.

John

[Higgenbotham]

I've been researching this topic some more and reviewing some of the past articles I've read that touch on this subject. The quote below is from a 1991 interview with John Exter where he discusses the sort of thing we've been discussing here with regard to treasury bills vs cash (Federal Reserve Notes) vs gold. There may be something I missed in the above post with regard to Federal Reserve Notes in the event of a partial US government default. It could be that in the event of a default the government could fold the Federal Reserve into the Treasury Department and issue "United States Treasury Notes" to replace "Federal Reserve Notes" on an equivalent basis so that cash does not lose value. That seems quite probable actually. I believe that under Kennedy such a thing was attempted for different reasons and some of those old Treasury Notes still exist as currency. I don't know what Exter would say about the current deterioration of the Fed's balance sheet or if he was aware that the various facilities would be attempted in the event of a financial crisis. It seems to me that some similar things were tried in the Great Depression so he should have been aware of that possibility.

http://the-moneychanger.com/articles_fi ... xter.phtml

This interview has an interesting generational component too. Exter, born in 1910 and having studied economics at Harvard during the Depression, was very worried about the credit excesses that occurred in the 1990s. Now he and his generation are dead and nobody has worried about such things too much until recently.

This will be a deflationary collapse rather than an inflationary blow-off because creditors in the debt pyramid will move down the pyramid [See pyramid chart -- Ed.] out of the most illiquid debtors at the top of the pyramid -- junk bonds, failing banks, S&Ls & insurance companies, Donald Trump, & Campeau. [Trump has survived until now, 1998, but Long Term Capital Management & other ailing hedge funds fit the same bill. – Ed.] Creditors will try to get out of those weak debtors & go down the debt pyramid, to the very bottom: currency (dollar bills), even though they pay no interest. Next above currency are Treasury bills, issued by the government & backed by the Federal Reserve, which supports the market through its open market operations. They are by far the largest component of Reserve Bank credit, so are really as safe as currency notes, plus they pay interest. Still, you can’t buy anything with Treasury bills; you have to liquidate the bills to get money of some sort to buy something.

[Gordo]

When you use peak earnings to compute price/earnings ratios, the
result is basically suspect, because there's no historical data on
which to base a comparison.

Huh? The data going all the way back to the 1800's was posted right here in this thread.

And for the record I never said that just because price/peak earnings was at the same level it was in '31 that it was a good time to buy stocks. As I've said before, I do not use any form of price to earnings ratio to determine when I buy or sell. However, if price to peak earnings did hit something like 5 or 6 I think that could certainly be used as a reasonable justification all by itself, to buy stocks. We would have to fall by another 50% to get there.

And why would you accuse Thomson/Reuters of fraud for reporting analyst estimates? They can report on anything they want, even indicators that are notoriously horrible at turning points in the economy (analysts as a group always remain wildly bullish long into downturns, well they are normally bullish at all times anyway).

[Gordo]

US government default

So can you explain how the US government CAN default when our debt is in dollars, which are backed by nothing and we can print any quantity of dollars we want at any time? The Fed just printed $2 trillion worth in the last 6 months, with no transparency at all. Congress just printed almost a trillion, with an almost equal lack of transparency.
When are they going to "run out" of money? They can print another $10 trillion and we will still remain below the debt to GDP ratio of Japan!

Yes, but won't that be inflationary? OF COURSE, and that's exactly what the politicians want! This is how they intend to "stabilize" housing prices (they will keep going down dramatically in real terms, but eventually flatten out in "dollar" terms). Conning idiots into believing they solved some problem when the reality is they are making things worse.

Best of all, they have the media eating out of their hand right now. Just look at all the buzz about deflation! A perfect excuse for the Fed and Congress to spend like mad. Biggest con job since man made global warming

TBT (leveraged short treasury ETF) was up over 5% on Wednesday. This is something to keep track of. The turning point could be in. Perhaps one more bottom test next week, but I expect continued gains to be the new trend.

I'm not sure I'm smart enough to follow that interview you posted about. Here's one quote from the interview:
"It’s stupid for people to hold currency. The Fed can simply print all they want at very low cost. Paper money is as abundant as leaves on trees"
I'm not sure how that squares with "deflation"? Also this interview was in '91 and the guy is talking about being "close to a collapse" because money in circulation was increasing at the time. I'm sorry, but what is the difference between being almost 20 years early and being wrong? This was just as we were coming out of a recession, so of course money supply was being artificially boosted as is the pattern with the Fed and congress in recessions (no different then compared to right now). It also happened to precede one of the biggest bull market booms of all world history! This guy was not just completely wrong, but it probably cost him dearly in terms of investment returns.

[freddyv]

TBT (leveraged short treasury ETF) was up over 5% on Wednesday. This is something to keep track of. The turning point could be in. Perhaps one more bottom test next week, but I expect continued gains to be the new trend.

TBT is looking very enticing but I've learned to watch these ETF's for strange, unexpected behavior before utilizing them and I have only glanced at this one from time to time; have you notice anything odd with this one?

--Fred

[freddyv]

-- "The scariest housing chart in the world"

California median home prices:



( http://mrmortgage.ml-implode.com/2008/1 ... hart-ever/ )

Note that home prices have been falling rapidly, and show no signs of
leveling off.

John

Having been born in California and lived there off and on throughout my life I can say that those prices look dirt-cheap to me and either suggest a tremendous buying opportunity or a coming depression.

I came across this 60 Minutes report from just a few weeks ago earlier today and it fits right in...
http://www.cbsnews.com/stories/2008/12/ ... age2.shtml

A great case is made for another year or two or three of a weak housing market but I was rather amazed at the end where the guy says how bullish he is on the stock market. I am more bullish on housing prices because at some point the market will just dry up but at least people will have a reason to keep their houses and house prices do not have a history of crashing, whereas the stock market does. At this point both are down about the same amount (in the worst housing markets) so its easy to argue that real estate shouldn't go much lower; it's much more difficult to make that claim for stocks.

--Fred