US Treasury Notes vs. Gold: Knowing the Price of Everything and the Value of Nothing

According to Marketwatch, from the beginning of 2021 through February 26, 2021 the price of gold has declined approximately 9%, and for the week of February 22, 2021 its price declined about 2.8%. On the other hand, during the same time frame, the 10-year US Treasury Note yield has increased from 0.917% to 1.415%. This increase in bond yield has put downward pressure to gold prices, given that it is a non-yielding asset.  

It is widely reported that the increase in bond yields is the result of positive expectations that the economy will improve at a faster pace than initially thought. Following the conventional economic logic of this argument, as the economy improves faster than expected, general pressure in consumer prices will increase, which leads to inflationary pressures and thereby increasing the premium in bond interest rates. Viewed from a different perspective, when we look at the 10-year Treasury Inflation-Indexed Security (TIPS) we see that at the beginning of 2021 it stood at -1.08% and as of 2-25-2021 the rate stood at -0.60%. Negative TIPS rates mean that when the principal is paid it is adjusted downward and obviously interest payments are less than they would be otherwise when compared to a regular bond. Currently for TIPS, if at maturity the adjusted principal is less than the original principal, the government will give you the original amount invested. Nevertheless, the point made here is that at this moment, based on TIPS rates there is an expectation of consumer prices increasing, which as I have said earlier it is because there is an expectation of improved economic conditions happening more quickly than initially believed.

Based on my view, however, the economic improvement currently underway is the result of increase “opening” of the economy from government lockdowns. Coupled with massive liquidity injected by government authorities, it is giving the illusion of prosperity. Like a massive Ponzi scheme, only more debt will sustain the illusion. But like all illusions, when reality sets in there will be a massive amount of disappointment. The market’s pullback from the last couple of days is merely a canary in the coal mine. No one knows the day and time when reality will set in, but in the meantime you would be wise to consider what I shared earlier today.

Rendezvous With Destiny - by Bill Bonner

Note: The following is an excerpt of a commentary written by Bill Bonner, a legendary investor and market commentator who everyone needs to hear. The original is here. He provides some good insight and appreciation of our current times with respect to historical standards. You would be wise to consider what he says and plan accordingly.

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Rendezvous With Destiny

Cycles take time. The credit cycle, for example, can last a lifetime. The last time interest rates were this low was around the time we were born – in the late 1940s.

A complete stock market cycle, too, is surprisingly long. But we have to look at them in terms of old money – the gold-backed dollar – to see them clearly.

The last major low came in 1980. Then, it took only 1.3 ounces of gold (equal to about $700 at the statutory rate) to buy the entire Dow 30 stocks.

Twenty years later, the bull market had run its course, hitting a high of over 40 ounces of gold in 2000. That was the high-water mark for U.S. stocks. They had never hit such a high before… and never have again since.

[For more on the Dow-to-Gold ratio, click here.]

And there’s still no bottom in sight, 40 years after the last low.

Investors and the financial press applaud every up move in the stock market. “Dow 30,000,” they cheer.

But to get back to its real level of 1999 – at 42 ounces of gold to buy the Dow – it would have to go to 67,000.

Even as stocks go up in new, nominal dollars, gold goes up more, leaving them further behind.

And our guess is that this pattern will continue, too… and when the Dow finally finds its bottom – its rendezvous with destiny – it will be under 5 ounces of gold.

End of an Empire

According to Sir John Glubb, the imperial cycle lasts 250 years.

Maybe so. Maybe not. But the U.S. empire definitely seemed on the downswing after 1999. And once the cycle turns, none of the king’s horses and none of his men are able to do much about it.

That is a recurring pattern of history, too – like it or not, empires die. All of them.

We have been chronicling the many promises of the 21st century that didn’t pan out.

The dot-coms blew up in March 2000.

The Information Revolution buried us under a mountain of data.

The stock market headed down… and in real terms, is still only at half its 1999 level.

The mission, whatever it was, was never accomplished in Iraq.

The war in Afghanistan has turned into the longest ever. The U.S. military still hasn’t won a war in 75 years.

New technology failed to produce a new boom.

The most aggressive Federal Reserve response ever (to the crisis of 2008-2009) yielded only the weakest recovery on record.

The Obama election failed to heal racial wounds.

The Trump tax cut failed to increase growth.

The Trump trade wars made no appreciable improvement in America’s manufacturing sector.

And the Baltimore Ravens did not win the Super Bowl in 2020.

The seasons change, in other words… even for empires.

Disappointments accumulate.

And MAGA never had a chance.

Regards,

Bill

ECB and BOJ Balance Sheet – Other Beasts

I have written about the FRB’s monstrous balance sheet, which quite frankly has ballooned by about 80% since February 2020. The reality is that both the European Central Bank (ECB) and the Bank of Japan (BOJ) has not lagged far behind. As noted in the graphs below, the ECB’s and BOJ’s central bank assets have increased 50% and 22% respectively since February 2020. These staggering figures all combined have led to an overabundance of liquidity in world markets – which is no surprised why we have seen a sharp upswing in world equity prices since 2Q2020. Despite the market sell-off today (2/25/2021), liquidity is still ample to buoy the current markets run. But my previous warnings still apply: do not be caught off guard during the coming storm.

ECB

BOJ

Margin Accounts at Brokers and Dealers

A not well-known metric that gives some insight into the health of the equity market is the margin accounts at broker and dealers. These are loans made by brokers and dealers to households to meet margin calls, which happen when a customer’s account value declines below some required level set by the broker or dealer. Generally speaking, in times of exuberance, loans are more easily extended; and in times of panic, loans contract. That is what you see when looking at the chart below showing the trend for the last 20 years. At the moment, exuberance is evident and so loans have been increasing. This chart, which is indexed to March 2001 as the base (i.e. = 100) gives further support as to why the stock market has made strong moves upward.

But a word of caution is warranted: This is a quarterly metric, so the lag is quite pronounced given that the last data point is as of 3Q2020. I am looking forward to see what the next data release next month will show. My expectation is an increasing value, given the general low interest environment.

How well statistics work: a lesson learned from Pfizer Covid Vaccine

Today I deviate somewhat from the financial markets to bring forth a relevant point that equally translates from the medical field. We look at the reported effectiveness of the Pfizer Covid vaccine. Please be advised that I do not have a personal opinion on the vaccine’s effectiveness; however, I merely report what it has been less obvious when reading the government data.  Here I will take you through the process by which the reported effectiveness is derived and how it might not necessarily be obvious from the initial CDC reports.

 The CDC states that “based on evidence from clinical trials the Pfizer-BioNTech vaccine was 95% effective at preventing laboratory-confirmed COVID-19 illness in people without evidence of previous infection.” How was this 95% effectiveness derived? Here is the short answer: by a mere 170 patients! However, you will have to dig, critically analyze written statements, and cross-reference to other medical materials to clearly see that answer.

The point above from the CDC is linked to its Morbidity and Mortality Weekly Report where it explains in further detail how the 95% effectiveness is derived. Specifically, the relevant section (copy/pasted below in italics and in parenthesis) states the following [with my comments in brackets]:

“The body of evidence for the Pfizer-BioNTech COVID-19 vaccine was primarily informed by one large, randomized, double-blind, placebo-controlled Phase II/III clinical trial that enrolled >43,000 participants (median age = 52 years, range = 16–91 years) (5,6).”

[My Comment: 43K seems like a large number of people tested for a vaccine.  My mind thinks: this number of people from where the 95% effectiveness was derived.]

“Interim findings from this clinical trial, using data from participants with a median of 2 months of follow-up, indicate that the Pfizer-BioNTech COVID-19 vaccine was 95.0% effective (95% confidence interval = 90.3%–97.6%) in preventing symptomatic laboratory-confirmed COVID-19 in persons without evidence of previous SARS-CoV-2 infection.”

[My Comment: Here is the first catch: how many “symptomatic laboratory-confirmed COVID-19 in persons without evidence of previous SARS-CoV-2 infections” are we talking about? If they clearly call out this group, it must mean that the 43K sample noted previously included people who were infected or had been infected, or were not able to be determined. Nowhere in the CDC article are we told the number of “symptomatic laboratory-confirmed COVID-19 in persons without evidence of previous SARS-CoV-2 infections”]

“Consistent high efficacy (≥92%) was observed across age, sex, race, and ethnicity categories and among persons with underlying medical conditions.”

[My Comment: Presumably, this is representative of “symptomatic laboratory-confirmed COVID-19 in persons without evidence of previous SARS-CoV-2 infections”.]

“Efficacy was similarly high in a secondary analysis including participants both with or without evidence of previous SARS-CoV-2 infection.”  

[My Comment: Here is another clue leading us to conclude that the 43K sample included a mixed bag of people who were exposed to COVID. But, again, nowhere in the CDC article are told of this breakdown.]

With that background and question at hand, namely, how many “symptomatic laboratory-confirmed COVID-19 in persons without evidence of previous SARS-CoV-2 infections” are there, we went to The New England Journal of Medicine where they clearly state that “[t]here were 8 cases of Covid-19 with onset at least 7 days after the second dose among participants assigned to receive BNT162b2 and 162 cases among those assigned to placebo; BNT162b2 was 95% effective in preventing Covid-19 (95% credible interval, 90.3 to 97.6).”

When you divide the 162 who did not get COVID by 170, and then multiply by 100, you then get the 95% vaccine effectiveness that is being widely reported. It is not, as you might be led to conclude, based on the 43K total being reported in the CDC article.

Lesson Learned: Always check the data and the critically think through categorical statements being made.

Money Multiplier: A Warning Sign to the Stock Market

I have written about the exorbitant expansion of the FRB’s balance sheet. An equal important measure is how fast that money injection is multiplying in the economy. Putting it simply, when the FRB injects money in the economy it ends up creating additional money via the banking system. For example, assume the FRB injects $100 in the economy, and assume that banks are required to hold 10% on demand and lend the rest, that would translate in an additional $900 dollar created out of thin air ([100/0.1] – 100). In this example, the money multiplier would be 10%. In the real world there are other variables to consider, but broadly speaking, the example is indicative of how the money creation process works and the importance of taking into account the rate of multiplication. It goes without saying that the extra funds created would chase other goods, and what we would expect to see is prices rising somewhere in the economy. And this is what we have seen starting about May 2020. I have estimated the money multiplier as the ratio between M1 and the Monetary Base. 

The graph below shows you the time period from April 2018 to the present. What is obvious that the money multiplier was picking up speed during most of 2018, which fueled the stock market bull run prior to the government-induced shutdown of the economy. The economic shutdown had the obvious effect of decelerating the money multiplication process. But what becomes obvious is that the money multiplier has picked up speed in particular during the latter part of 2020. This has translated at present in record setting numbers in the equity market. It is critical to understand that the money multiplier metric is backward-looking, so we must make some sort of assumption about the future. What we know is that the money creation process is still continuing and that gives support to the continuing rise of the equity market in the very short term (which I define here in the next 2 months), all things being equal. However, as this rate continues to decline, it will be another sign that a correction in prices is soon coming.  

Money Multiplier

Data Source: FRB's H.6 Statistical Release

Federal Debt Held by Private Market

Expanding from a previous post, it is concerning to observe the increase of public debt monetization by the Federal Reserve. Put differently, the private market holding of the public debt, based on rough estimate, has been on a general decline. As noted from the Table below, the estimated share of debt held by the public as of 2/18/2021 is about 53%, some 8% decline since September 2020. Now, the precision of these amounts are less of a concern, given that by the time this post is published or read, the amounts will have changed. What matters is the trend. And here we are seeing that the additional debt being issued is being gobbled up by the Central Bank at a faster rate when compared to the private market. At the logical extreme, the FRB will at some point be the only buyer in the market. But before that actually happens, expect yields to increase to account for the increase in counterparty risk.

[In billion of dollars] 

*Total Privately Held has been adjusted to reflect FRB holdings, as reported by the FRBNY. February 2021 amounts obtained from US Treasury. Other amounts in Table come from US Treasury report, Table OFS2.

Bond Yields Primer: Recognizing the difference between price and value

When yields decline, bond prices increase. The fact that prices are increasing means that there is more demand for those bonds. In other words, people are buying more bonds than before. As more people buy, price pressure increases and therefore bond prices rise. The question then becomes why people buy: many buy because some underlying belief about the future – irrespective whether that underlying belief is grounded in sound analysis or not. Others buy because they are mandated by their institutions (e.g. bond funds, pension funds, FRB open market operations). When we focus on those buyers who have a negative view of future economic activity, they will de-risk their investment portfolios and move to more liquid and less risky investments, such as bonds. In other words, money is leaving some other non-bonds market and entering the bond market. As more money rushes in, bond prices rise and bond yields decline. The reserve is also true: when yields increase, bond prices decline. Price declines mean people are selling bonds and purchasing other assets because in their view they believe other assets are more attractive (this trade-off is what economists call Opportunity Cost).  

When we look at the recent trend in the Treasury bond market we see a general widening of spreads (i.e. difference) between longer tenor (i.e. maturity) bonds and shorter tenor bonds. For example, the difference between the 3-month yield vs. the 10-year yield stood at 0.84% on 12/31/20, and it is now (as of 2/19/21) at 1.3%. In this instance, the yield for the 10-year bond has been increasing (from 0.93% to 1.34%; bond prices declining) and the yield for the 3-month Note has been declining (from 0.09 to 0.04; prices increasing). In other words, people are selling the 10-year bond (or decreasing the rate of purchase) and buying the 3-month Note at a faster clip.  

The increase in yields means money is leaving the US Treasury market and going somewhere else. Some of it is going to the shorter end of the Treasury curve, and some of it is going to other financial markets. At this time and in this context, this dynamic is being perceived as positive for market participants who hold riskier assets. However, it can also mean that the increasing yields are representative of a rate of market malinvestment (i.e. bad decisions increasing). I think the case for the latter point is more appealing. Market reversals tend to be poignant and sudden. Caveat emptor.

Lender and Buyer of Last Resort

After the 2008-2009 Financial Crisis, it became fairly obvious that the FRB would be engaged in a more meaningful manner when another crisis would occur. Any doubt has been removed when we look at what happened at the outset of the 2020 Pandemic crisis. It is a fine distinction, albeit somewhat controversial at this point, that the economic distress that has been experienced since March 2020 has been the result of government policy and not the virus itself. In other words, had the various productive institutions of society – that is, those bearing the direct costs of policy decisions – been allowed to drive the health mitigation efforts perhaps the course taken would have been different. At this point, that counterfactual is purely an academic exercise. The present circumstances are what they are. That said, what this present crisis has brought to bear is the reality that the level of support to the markets by the FRB has been unprecedented, although not at all unforeseen. Below is a Table that highlights the various lending facilities initiated by the FRB, the markets impacted, and their amounts outstanding: close to $90 billion of support remains outstanding. If history is any guide, and the Japanese experience comes to mind, the market interventions in a future crisis by the FRB will continue to be more obvious and we will ultimately reach a point when it will effectively become the buyer of last resort for everything.

Source: Periodic Report: Update on Outstanding Lending Facilities

US Federal Reserve's Balance Sheet: A Monster

As evidenced from the Table below, from February 2020 to February 2021, the Federal Reserve’s balances sheet has increased by a staggering 80%, mainly driven by increases in its US Treasury and Agency MBS holdings. The FRB purchases these securities in the open market, thereby increasing the amount of liquidity (money) in the economy and concomitantly increasing the money supply. When it sells securities the FRB is draining liquidity from the economy, and therefore decreasing the money supply. The FRB’s balance sheet will continue to increase for the foreseeable future, as they have committed to purchasing monthly at least $80 billion of US Treasuries and $40 billion of Agency MBS.

In thousands of dollars. Source: Federal Reserve Bank of New York

Interest Cost on US Treasury Securities

Another perspective to get a sense of the US Government debt burden is to look at the interest cost side of the equation. Delving into the US Treasury Department’s Treasury Bulletin, we find some interesting data. We note (see table below) that the annual interest cost on US Treasury securities has been inching up since 2016. Interest costs as a percentage of total government receipts (that is to say, tax it collects), has gone from 13.16% in 2016 to 15.28% as of fiscal-year-end 2020 (which was on September 2020). The upward trend post-2016 was the combined result of an uptick in both debt issued and increases in interest rates. In 2020, however, although the amount of debt increased, the FRB’s action to lower interest rates provided a cushion by preventing interest costs from rising when compared to the previous year – in fact, costs declined.

In million of dollars. Source: December 2020 Treasury Bulletin; October Average Interest Rates on UST

Turning into the private market holdings of US Treasury debt (see Table below), we see that the lion share of the distribution of debt maturity is within the 0 – 5 year span, ranging from 69.74% to 75% of the total. Short-term refinancing poses a risk when it comes to the rolling over of debt: as debt reprices in a higher interest environment, interest costs will spike; and similarly there may be less investors willing to enter the market at the prevailing interest rate, and as such demand much higher rates. Costs can therefore spiral out of control fairly quick. In the case of the US, as it is evident from recent experience, the FRB will step in and purchase US Treasuries if excess supply exists. However, the FRB cannot indefinitely continue to do so, unless it “pays the price” by way of a currency depreciation – which in fact it is what has happened since 2Q2020 if one looks at the US Dollar Index (ticker: DXY).

In million of dollars. Source: December 2020 Treasury Bulletin 

Subtraction by Addition: Why Federal Borrowing Makes No Sense

Following up on my last post on Total Federal Debt, another angle to consider is its productive capacity. In other words, we would like to know exactly how much “bang for our buck” we are getting for each dollar we borrow. If borrowing does not generate value greater than the amount borrowed, then we must question the rationality of continuing to do so. For example, if we borrow $1,that means that I am hoping to achieve more than $1 in total output in order to make it palatable to borrow. If we borrow $1, which we then invest, and then observe that total output has declined by more than the amount we borrow, then it stands to reason that the productive capacity of debt is actually negative for us. In this last case, the more we borrow, the more we are sinking deeper in debt. This is exactly what has been happening in the US.

Just take a look at this graph of Total Public Debt to GDP, courtesy of the St. Louis FED Fred:

Source: https://fred.stlouisfed.org/series/GFDEGDQ188S

In particular consider the time period since 1992. During the Clinton Administration, it can be seen that borrowing was sustainable because as debt increased, GDP increased at a faster pace, thereby reducing the ratio. But post-2001, under what was supposed to be a conservative Administration of Bush, the trend reserved upward. But starting in 2Q2008 the Total Debt/GDP ratio has been on a steady upward trend. The trajectory is particularly stark, especially when compared to the previous years. And that trajectory in a longer term perspective, we can see that it has been deteriorating even more so recently. 4Q2015 was a pivotal time in that it marked the beginning of the marginal decline in debt utility. In other words, prior to 4Q2015 we see that each dollar of Federal Debt created more than one dollar of GPD. To take the example of 2Q2008, at that time the Total Debt/GDP ratio stood at 64, which meant that 64 cents of debt generated $1 of GDP. But in 4Q2015 it took $1.029 of Federal Debt to generate $1 of GDP. And as can be seen by the latest available figure for 3Q2020, the ratio stood at 127.279, which in other words says that it takes about $1.28 cents to generate $1 of GDP. 

As GDP improves in the subsequent quarter, we would expect the current elevated ratio to decline or somewhat stabilize. But if history is any guide, just as noted in 2008, there is reason to expect a new trajectory has been established.

Total Federal Debt: The Road to Perdition

Particular numbers or data do not matter in and of themselves. They must be taken in context with respect to the broader trend. One of these data relate to the Total Federal Public Debt, as published in FiscalData.Treasury.gov.

I looked at the Federal Debt at various points in time considering the last 4 US Presidents’ start and end date of their Administration: Bill Clinton (Jan 1993 – Jan 2001), George Bush (Jan 2001 – Jan 2009), Barak Obama (Jan 2009 – Jan 2017), and Donald Trump (Jan 2017 – Jan 2021). What becomes fairly obvious when looking at the data is that Total Federal Debt been on a deteriorating trend. Each President has fared worse than his predecessor, which is to say that all of them added to the Federal Debt and each one outdid the previous when we look deeper into the numbers.

As can be seen in the data analysis below, Bill Clinton added approximately $1.48 trillion to the federal debt. George Bush outdid Bill in adding about $4.9 trillion. Barack Obama added $9.3 trillion. And last but certainly not least, Donald Trump added $7.8 trillion. Now bear in mind that Donald Trump was President for only for 1 Term, so we have to take into account that fact when comparing these amounts versus the other Presidents who presided for 2 Terms. When we take the total additions to the Federal debt and then divide it by the number of days each President was in Office, we can then see the daily average of total debt that was added. And by this last metric, Donald Trump has been by far the worse. The daily average of total federal debt for Clinton was about $506 million; Bush was about $1.7 billion; Obama was about $3.1 billion; and Trump was about $5.3 billion. 

The amounts are staggering. One can only reasonably conclude that the Biden Administration will likely dethrone Trump in breaking the daily debt accumulation record. My expectation is that the new Administration will likely add to the federal debt about $7 to $9 billion on average daily, which means that the total federal debt by the time the next President is inaugurated will be about $38 trillion to $40 trillion. 

The trend is ominous. The trend is catastrophic. Prepare accordingly. 

Data Analysis: