Thursday, July 28, 2011
Executive Summary
- How stocks, bonds, precious metals, commodities, the dollar and, real estate will most likely fare post-August 2nd
- Why August-October will be a period of particularly high stress for the Treasury market
- What the “big picture” endgame is beyond today’s debt ceiling histrionics and how it is now accelerating towards its inevitable conclusion
- Why it’s now time to hedge your bets
Part I – Debt Ceiling Dilemma: The Foul Choice Facing Investors
If you have not yet read Part I, available free to all readers, please click here to read it first.
Part II – What Should Happen and What Will Happen
As always, we can easily describe what should happen, but that’s not what will happen. Deflationists sometimes fall into the “what should happen” camp and find themselves mystified, if not disappointed, when those events fail to materialize. So do inflationists, just in the other direction.
My view is that what should happen almost always never does. There’s no such thing as a free market defined by willing, free-thinking participants. Instead, far too many market prices are managed, influenced, and/or manipulated, and this distorts both the timing and the severity of what actually happens.
For example, right now market participants should not be buying ten-year US Treasury bonds at 2.5%. Looking at the rates of inflation and the fiscal train wreck approaching the US government, a fair rate might be closer to 7.5% or higher. Where Treasury interest rates actually are and where they should be are very different propositions.
The thing that will most impact the world financial system will be if the US suffers a credit downgrade, which would be a near certainty if and/or when the US defaults on its obligations, even briefly.
Here’s what should happen if the US defaults:
Bonds: Prices should go down, and yields should go up. This happened once before, on April 26, 1979, when the US did not make payments on maturing T-bills and it ultimately cost the US about 0.6% (60 basis points). Today there’s some speculation that a credit downgrade might cost the US about 80 basis points. However, with the Fed and other central banks standing at the ready to buy, I expect a more muted response. What should be happening is for US Treasury bonds to fall far enough to offer a compelling return that compensates for both inflation and risk. In
by amanda 
