Could Your 'Safe' Treasuries Implode?

Treasury traders heaved a sigh of relief this week after the Treasury Department sold $40 billion in 2-year securities, an amount that matches a record high set last month. Foreign buyers showed up … this time.

And then they showed up for a $34 billion sale of 5-year Treasury notes on Wednesday … though yields had to rise to attract buyers.

The fact is, with a deficit of nearly $2 trillion, the flood of Treasury debt coming on the market has the potential to simply overwhelm buyers.

And if that happens — if a government debt auction fails — it will be a shockwave heard round the world. The prices of U.S. Treasuries will plummet!

The Federal Reserve is clearly worried about this, and it’s buying U.S. Treasury securities, starting with debt maturing between 2016 and 2019. A government buying its own bonds is like a snake eating its own tail.

And failure of “once-safe” bonds can happen. We’ve already seen hundreds of auctions in the $330 billion municipal bond market fail since late January. Buyers are fleeing in the face of rising worries about the bond insurers that backed much of the debt. But buyers of U.S. Treasury debt don’t have to worry, right?

Since late January, hundreds of municipal bond auctions have failed.

Oh, if only that were so.

Here are some of the things that keep me awake at night …

* Soaring deficit could get bigger! Because of the economic slowdown, the stimulus package and various financial-relief measures, this year’s federal deficit could come in close to $2 trillion. If things go wrong — and they haven’t exactly been going right, lately — the deficit could be even larger.

* We have to borrow more to fill the gap. Usually, federal tax receipts provide 80 percent to 90 percent of the money needed to fund the U.S. budget. This year, Uncle Sam will need to borrow 45 percent of the money the government will spend. Not since World War II has the government borrowed anything close to what it is borrowing now.

* Reserve balances ballooning like the Hindenburg. When we say the Fed is “running its printing presses” to create money, that’s only partly true. The Fed creates money mostly by crediting banks with deposits at the Fed.

Those deposits are called reserve balances. Reserve balances are the key component — along with currency — of base money or central bank money which ultimately brings about changes in broader money supply measures.

These deposits or reserves have been exploding as the Fed has made loans and purchased securities. Six months ago reserves were $8 billion. As of last week, reserves had soared to $778 billion — an increase of 9,625 percent!

The reserve balances are soaring as the Fed creates money to finance loans as it attempts to unwind the mess created by AIG and other banks. Just to keep up with what it plans this year, the Fed will likely have to increase reserves by another $1.15 trillion to $3.37 trillion!

* All this spending is worrying our creditors. China’s premier, Wen Jiabao, recently expressed concern about the safety of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to provide assurances that its investment would keep its value in the face of a global financial crisis.

“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets,” Wen told reporters. “To be honest, I am definitely a little worried.”

Does that sound to you like a guy who’s ready to shift more of his country’s foreign reserves from Treasuries to gold? It sure does to me.

China has a mere 0.9 percent of its reserves in gold (600 metric tonnes). That’s the lowest of any industrialized economy. In contrast, the United States has 77.3 percent of its foreign reserves in gold. Just to raise its gold reserves to 5 percent, Beijing would have to purchase nearly $100 billion worth of bullion.

And such a move would have a devastating effect on U.S. Treasuries.

The risk of credit default remains high. While the credit default risk on 10-year U.S. Treasuries has backed off its peak, it still remains very high — and looks like it could be turning up again.

The credit default risk is, just like it sounds, the risk that U.S. Treasuries will default. Obviously, China isn’t the only one that’s worried.

And by the end of this year, our creditors will have 2 trillion more reasons to worry.

We’re not the only ones in trouble. Germany already suffered through the failure of an auction of its government bonds. Britain saw an auction of its 40-year bonds fail on Wednesday. Fitch Ratings warns that Britain’s public debt will explode to nearly 70 percent of gross domestic product by the end of next year.

A debt-to-GDP ratio that high is pretty much unsustainable. It won’t end well. And in this inter-connected world we live in, bad news for Germany and Britain can ripple across the Big Pond and impact us.

Add it all up, and it sure looks like “super-safe” Treasuries may not be so safe. We’d better hope that President Obama’s bank bailout plan works. Because if it doesn’t, well …

If investors balk at buying U.S. Treasury debt, things will go downhill pretty quickly. You know those cranks who hang out on street corners preaching the end of the world? They might start to look prescient. An implosion of the U.S. Treasury market is probably a prelude to the meltdown of our financial system.

Things could still work out okay — I’m still recommending natural resource funds and stocks to my subscribers. I think there’s still big money to be made there. I don’t think a bond failure is imminent. But the possibility of such a failure is out there and growing, and you might want to make some adjustments in how you distribute your investments, just in case.

Three Places to Put Your Money

Having too much of your money in any one investment is never a smart move. But many investors are so burned by the stock market that they’re sticking all they’re money in Treasuries. Here are three other investments to consider for part of your portfolio.

Consider devoting some of the money in your portfolio to gold.

Investment #1 — Gold. And I mean physical gold — the kind you put in a safe. You don’t buy physical gold to get rich; you buy it to preserve wealth. If Treasuries implode, gold will make a mighty fine insurance policy. Also, you might want to pick up gold in forms that you can easily barter if paper money becomes worthless — simple gold rings, for example.

Investment #2 — Silver. Again, I mean physical silver. If our economy, financial system and paper money go South, you’ll want gold AND silver. Flashing around too much gold could make you a target. Silver doesn’t attract as much attention and it’s still a precious metal. In fact, silver is undervalued compared to gold by some metrics.

Investment #3 — Land. I mean the kind of land where you can grow food. It’s pretty cheap now that the real estate bubble has burst. And if you already have a nice big back yard, or even a small back yard, I strongly recommend you consider putting in a garden.

Gardening will calm your frayed nerves and put food on your table that’s a change from the chemical-soaked Frankenfood being sold at your grocery store. Another point — you can’t eat gold or silver — but you can eat your own vegetables.

I don’t want to scare you too much. But I strongly believe in preparing for the worst and hoping for the best. Good luck to President Obama, good luck to us all, and good trades.

Sean

P.S. For daily updates, be sure to check out my blog at: http://blogs.uncommonwisdomdaily.com/red-hot-energy-and-gold/

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