Sure there are real problems. But these two mischief makers are making things a lot worse than they need to be.

So much so that we are seeing interest rates approaching zero. Read on for the story.

Investor fear drives US Treasury yields to near zero

Dec 7 06:50 PM US/Eastern

The panic in global financial markets has sparked an unprecedented rush into safe US Treasury securities, driving yields on short-term government notes down to almost zero.

Due to stampeding demand for safe short-term investments, the US Treasury’s four-week and three-month bills on Friday yielded an effective rate of 0.01 percent — down sharply from 1.515 percent and 1.785 percent, respectively, in early September.

Other Treasuries are also showing record low yields. The 10-year bond yield fell as low as 2.505 percent and the 30-year bond yield slid to 3.005 percent at one point on Friday. The six-month bond yielded a mere 0.20 percent.

The low yields reflect a surge in demand for these instruments, seen as the safest in the world during times of turmoil.

“Investors seem to be content to sell stocks and park into the bonds for now,” said Greg Michalowski of the financial website FXDD.

Analysts say the fear factor has pushed up demand for Treasuries, since investors are virtually certain the US government will not default.

Other factors include worries about deflation and the overall trend in interest rates, with the Federal Reserve having cut its base lending rate to a historic low of 1.0 percent, and further reductions possible.

But Bob Eisenbeis, analyst at Cumberland Advisors, said the unprecedented low yields are a sign of “dysfunction” in markets.

Eisenbeis said US municipal bonds are paying upwards of 6.0 percent tax-free and corporate bonds even more, but that fears of default and a lack of knowledge about underlying bond quality have led investors to shun these alternatives.

One reason for the surge in demand for Treasuries, said Eisenbeis, is the Federal Reserve’s decision to flood financial markets with liquidity including through other central banks.

Many central banks and commercial banks are reluctant to use this cash for traditional lending, and are buying Treasuries to ride out the storm, Eisenbeis added.

A big question for the market is whether the Treasury market has become a bubble that will burst.

Although the low rates allow Washington to borrow money cheaply, Eisenbeis said such a scenario could be perilous for the economy and the dollar.

“When you have this huge flood of liquidity into the marketplace, that can’t last forever,” he said.

A bursting of this bubble could mean a rush out of Treasuries, forcing the government to pay higher rates on an unprecedented amount of debt.

“We would have huge increases in our costs and people wouldn’t want to hold Treasury obligations anymore because of the capital losses,” Eisenbeis said.

“You could have a huge switch in interest rates very quickly.”

Mike Larson, an analyst at Weiss Research, says the long-term bond market could be “the biggest bubble of all,” worse than the dot-com and real estate bubbles.

“Treasury bonds almost never move this far, this fast. And interest rates, which move in the opposite direction of bond prices, almost never fall this far, this fast,” Larson said.

Larson said the yield on the 10-year Treasury bond plunged from a mid-October high of 4.08 percent to nearly 2.5 percent this week, “yielding lows not seen since the mid-1950s.”

“There are lots of reasons to believe this Treasury rally is unsustainable, and that a day of reckoning is fast approaching,” he said.

Sal Guatieri, economist at BMO Capital Markets, acknowledged that “investors are throwing money at Uncle Sam with the same conviction that they bought houses and dot-com stocks in their heydays.”

But he argued that if inflation is quashed and investors retain confidence in the US government, the dangers have not yet hit a boiling point.

“While Treasuries may be overpriced, they probably are not yet in a bubble,” he said.

Copyrighted by the author.

Recognize those numbers?

I know that some of you do. And those do should be fatally disappointed with them.

Why?

Because they represent the opening and closing Dow Jones Industrial Average numbers for 2007.

2007 opened at 12,463
2007 closed at 13,264

A whopping 801 point increase for the year.

An increase of 6.4%. For the entire year. (But don’t feel so bad – the S&P 500 posted an increase of only 3.5% for the year)

That stinks. 3.5%? 6.4%? My money market account pays something close to that. Without the risk OR the volatility.

And don’t get me started again on volatility. Did you realize that during the year the Dow posted nearly a dozen days where the average dropped more than 2%? I don’t know how some investors sleep at night!

So my question to you is this. What’s your plan for 2008?

More of the same and another 3.5% or 6.4% with the sleepless nights thrown in for free?

Or are you ready for something better. A better way that’s more secure, less volatile, and with a fixed rate of return. Basically everything the Dow is not.

Isn’t finally time to look at something different?

Then why not rocket out of the gate in 2008?

Visit www.MPSG-LLC.com to learn more.

Take a closer look at the chart – over the last six months the market has been down – despite those huge peaks that you see. That means a negative ROI – and the fact that you probably lost money – and lost ground. Is this going to impact when you can retire? 

Now take a look at the chart below. This is the annual ROI that my private investors have earned since the beginning of the year. Notice any difference? The chart below kind of looks like the tortoise, doesn’t it? And the one above the hare?

My question to you is – which ROI do you think is going to come out ahead at the end of the year?

Which chart would you rather have associated with your retirement accounts?

www.MPSG-LLC.com 

The first line is the report was:

“Consumers, battered by a steep downturn in housing and a severe credit crunch, slowed their spending growth in September while a key gauge of factory activity flashed its weakest reading in seven months in October.”

And this is a surprise?

And the article continued:

“. . . manufacturing index dipped to 50.9 in October . . .” and “A reading below 50 indicates that manufacturing activity is contracting.”

Yeah, so? Why are you surprised by this?

And finally:

“The Federal Reserve on Wednesday cut a key interest rate for the second time in six weeks in an effort to make sure the economy does not tumble into a recession. However, the central bank also expressed concerns that surging oil prices could fan inflation pressures. Oil prices have soared to record highs in recent days.”

No s*** Sherlock.

Haven’t we been talking about this now for TWO months?

Let’s recap. Central banks around the world dump a couple of hundred billion into the economy for the SOLE purpose of propping up sagging stock markets without any concern at all about inflation. It works temporarily, then the markets get jittery again. So they dump MORE.

In the mean time, the subprime mortgage sector crashes and burns, and pretty much every financial institution tightened up on their credit criteria. This was actually a good thing, because it should have counteracted the Fed’s reckless dumping activity.

But unfortunately the Fed wasn’t done yet. Now shifting their focus from the stock market back to the economy (which by the way are two VERY different things) they decide to lower interest rates. Several times. Which counteracts the credit crunch but makes the inflation problem worse.

Do you know what the worst part is? Let me defer to the AP report again:

“The worse-than-expected economic news sent stocks lower with the Dow Jones industrial average down more than 200 points in the first hour of trading Thursday.”

So after all of the meddling, the dumping, and the interest rate monkey business, the stock market reaction is exactly OPPOSITE of what the Fed meddlers wanted.

Great. They ignore their 30+ year strategy of focusing on the economy, and start meddling to save the stock market.

And in the end they will end up tanking both the stock market and the economy.

No, this is a post about economics. And basic economics at that.

I have long believed that the framers of our constitution should have included a minimum number of basic economics courses at the university level as requirement for holding any elected or unelected position in any federal or state-level government. And with so many idiotic decisions being made in terms of “handling” the economy, my belief gets validated over and over again.

Case in point – my great state of Michigan. (Notice that was a small-g great).

Did you hear the latest? After all of these months, and with a budget due by Sep 30 or the government will shut down, our small-g governor is STILL sticking to her belief that she can tax the state back into prosperity. With all the job losses, all the foreclosures, all the uncertainty, with Comerica, Pfizer, and now Volkswagen high-tailing it out of the state, her BRILLIANT idea is to RAISE taxes.

Unbelievable.

My frustration stems from the fact that economic data has been proven time and time again that raising taxes DOES NOT improve the economy. Conversely, though, the economic data has CONSISTENTLY shown that cutting taxes increases TOTAL tax revenue. Counter-intuitive, yes, but true nonetheless.

A prime example of this total lack of understanding of basic economics is the cigarette tax. Cigarette smoking declines, so cigarette tax revenue to the government declines. The government counts on this money, so their solution is to raise the cigarette tax. This causes MORE people to stop smoking, so tax revenue declines again, so they raise taxes again. And so on, and so on.

I feel sorry for the last guy left smoking in America – he’s going to have to pay a billion or so dollars a pack for cigarettes. (Although if the Fed keeps monkeying with the economy, with inflation a billion dollars won’t be a billion dollars anymore. But don’t get me started on this again).

This behavior is so stupid that it’s comical. Yet it continues to occur, over and over again.

Why is this so hard to understand?

I had written up a long follow-up post on this Federal Reserve intervention that I had planned to post yesterday, but I got hung up in meetings and couldn’t get to it.

I wrote long (and eloquently, I might add) about how there was NO possible way that after their dump-and-run “liquidity injection” they could even THINK about lowering interest rates for AT LEAST the next two to three months. About how the economy has been experiencing pretty significant inflationary pressure in the food and fuel sectors over the last 12 months. And about how all of this pointed to the rational decision for them to retreat back to their 30 year old policy of targeting inflation as Public Enemy #1. Boy was I wrong.

Not only have they and their colleagues dumped nearly $350 billion dollars into the economy, just in the last few days, but they lowered interest rates a half percent as well.

This is bad news for the economy. Really bad news. Because these acts together pretty much guarantee an onslaught of inflation.

You see, inflation is a bad thing. In the most simplest terms, it’s an oversupply of money in the economy, and anything that is in oversupply decreases in value. The same goes with money. So what inflation does is decrease the value of your paycheck faster than you can make it up with raises. In short, it silently lowers the standard of living for just about everyone that works for a paycheck, and it particularly impacts retirees and others on fixed incomes, because their payments are rarely set to adjust anywhere near the true rate of inflation.

So you end up working more and making less. And if that’s not bad enough, the cure for inflation is worse than the disease.

How do you cure an oversupply of money? You raise interest rates! And raise them, and raise them, and raise them. It’s a bitter pill to swallow for everyone.

The problem is, we’ve gone so long without any real appreciable inflation that everyone has forgotten what it’s like. Remember 20% mortgage rates in the late 70’s and early 80’s? They actually peaked in June 1981, and these staggeringly high rates in turn had a crippling impact on business, because nobody could afford to invest in new business or new equipment. This caused a massive recession to start in July of 1981, which lead to the economic double-whammy – staggeringly high unemployment rates that peaked at almost 11% in 1982.

The interest rates alone were enough to cripple the housing market. The high unemployment only exacerbated it and caused the greatest number of foreclosures in history. Wait – that sounds kind of familiar, doesn’t it?

So enjoy your rally today in the stock market. You paid a high price for it but don’t know it yet.

It’s kind of like everything else we do in this country – we put it on a credit card and figure we’ll worry about it later.  

And unfortunately it’s not just the Fed – it’s a number of other central banks around the world as well. They all blinked. Or more appropriately, they all made a knee-jerk reaction and dumped nearly $300 billion dollars into the economy, nearly overnight, simply because stock markets around the word were adjusting. And they stand at the ready to add more. Their actions typically have the impact of dropping a rock into a lake; this is more like dropping a boulder into a mud puddle. Talk about inflationary pressure! Paul Volcker would be turning over in his grave if he weren’t still alive.

Ever since the days of malaise, aka Jimmy Carter, aka stagflation, the Fed has held as it’s main policy goal the limiting of inflation. After seeing the damage that rampant inflation had on the economy, that has always seemed to be a prudent choice. And they have executed the policy with such dogged persistence that they have, on occasion, come close to tanking the economy through their ever increasing interest rates.

But overall they have been very successful in battling inflation. In fact, they have perhaps been too successful, because right now there is an entire generation of adults out there that have never experienced it, and probably another whole segment of the adult population that did experience it but that has since forgotten about it. And as the philosopher George Santayana wrote back in 1905 “Those who cannot remember the past are condemned to repeat it.”

Hold onto your brokerage account statements, because it appears that that’s exactly what’s about to happen.

If you can’t (or just don’t want to) remember the impact that inflation has on the stock market, let me refresh your memory a bit. I went back and did some research on the DOW average between 1978 and 1981, the years of some of the highest inflation rates every recorded in the US. On December 31, 1977 the DOW closed at 831.17. On December 31, 1981 it closed at 875.00.

So over four years the average closed a total 43.83 points higher.

A whopping 5.3%. Over FOUR years.

So say goodbye to your IRA and 401k returns if you’re invested in stocks.

If you’re interested in diversifying OUT of stocks and away from the volatility of the national economy in general and earn stable, predicable returns, then visit my website at www.MPSG-LLC.com and request my Special Report “How to Buy a US Post Office, a Wal-Mart, and a Meijers, with your IRA”.