Time for Treasury to Walk the Walk

Time for Treasury to Walk the Walk

Will the Need to Fund Trillions in Spending
Burst the Bubble?

Dear A-Letter Reader,

So it begins.

2008 was the year of big promises for the U.S. government. Trillions in bailouts, emergency lending programs and otherwise free money buoyed the financial system and may have helped prevent a disastrous collapse of the world economy.

But now, in 2009, it’s time to pay the piper.

Even before funding Obama’s proposed US$900 Billion stimulus plan, the U.S. government will need to raise some US$1.5 – 2.5 trillion before the end of fiscal year 2009 (September 30th) to keep up with the spending plans of Congress and the Treasury. To make that possible, the Treasury is re-introducing the seven-year-note and doubling the number of 30-year auctions planned for ’09. It may also start monthly auctions of all of its benchmark securities.

And now the floodgates are officially open. According to today’s Financial Times, the US government announced plans for a U.S. $67 Billion debt sale in February, the first of many enormous auctions. As new sales come online, investors are wondering whether the flood of Treasury securities will drive interest rates up. Is all this issuance going to take a toll on prices?

Some are even wondering whether this might be the beginning of the end for a Treasury Bubble…
Mr. T’s Wild Ride

In the last year, while most investments simply plummeted, Treasuries have been on hell’s hayride. As investors waffled back and forth between the need for a safe haven and the sheer magnitude of U.S. debt issuance in store for 2009, Treasury yields reached historic lows (and – in turn – prices reached historic highs).



After peaking in mid-June, yields on the 10 and 30-year Treasury bond bottomed in late December, tumbling by 49% and 47% respectively. In between those dates, Lehman Brothers collapsed, global credit came to a standstill, and Bernanke unleashed a horde of emergency lending programs and lip service about buying up the long end of the curve to keep rates low.

But since mid-December, yields have surged back up – gaining 40% and 43% on the ten and thirty-year bond – on concerns about 2009’s funding obligations and rising deficits in the U.S.

While this bounce in yields – from 2% in December to 2.95% now – might seem like a major move, keep in mind that there’s definitely still room for more upward movement. Yields could gain another full percentage point and still settle under 52-week highs.
Calling the Giant’s Bluff

In the December issue of our flagship publication, The Sovereign Individual, Investment Director Eric Roseman took a position on Treasuries…one that’s returned over 32% since mid-December.

Using the ProShares Ultrashort 20+ Yr ETF (ticker symbol TBT), Eric took a short position on Treasury debt, citing the increasing size of Treasury offerings and the decreasing appetite for Treasuries worldwide…

“The writing is on the wall,” Eric said in December, “Betting against long-term Treasury bonds over the next 3-5 years is as close to a sure thing as we can get in this volatile market. Remember – market risk has not been eliminated. Rather, it has been transferred from the global banking sector to national governments.”

“To expand credit and fund bank liabilities,” Eric went on, “they will embark on a massive global fund drive – and put upward pressure on U.S. Treasury yields. When they ultimately succeed, the resulting nemesis won’t be deflation, but aggressive inflation.”

“This process won’t transform itself overnight. But as the desperate issuance of debt grows, I expect inflation to make a formidable comeback, probably starting in 2010 or 2011. I have no doubt that over the next 12 months, the U.S. long-term Treasury market will face higher interest rates.”
…But Keep your Eyes Open

While interest rates are on the rise and the market is looking like it might balk at the flood of new issuance on the way in 2009, the climate is still incredibly volatile.

We believe that Treasury yields are headed up in the long-term and likely to spike again in the short-term, but there’s an immense amount of government interest in keeping them low for the time being. Low rates are crucial to recovery, as they can keep mortgage rates low and – in turn – minimize the damage to the U.S. real estate market…the epicenter of the crisis.

To that end, Bernanke has repeatedly mentioned buying up the long end of the curve…a maneuver that seems to generate less and less of a response each time he mentions it. But the U.S. government has demonstrated its willingness to do anything and everything to keep this crisis under control, so for now this is more of a short-term trading opportunity than a long-term investment strategy…and traders should proceed with caution.

TBT is a double-inverse ETF, meaning that it provides twice the inverse of the daily performance of the Lehman Brothers 20+ yr Treasury Index. So it can be especially volatile, ranging between a 52-week high and low of about US$75 and US$35.51. Make sure to keep a 25% trailing stop in place.
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Minimizing Hidden Forex Fees

"While offshore banks provide access to many investments you simply can't buy in the United States, or only buy with great difficulty, you'll pay for the privilege." Wealth Preservation & Tax Consultant Mark Nestmanntold us recently, "And nowhere is that truer than when you purchase securities denominated in foreign currencies. But you'll never know it unless you do some digging and then negotiate with your foreign bank to reduce those charges."

"For instance, last spring a Turkish lira-denominated bond that I hold through my Austrian bank account matured. The bank credited my account for the interest. Since my base account is denominated in euros the bank converted the lira to euros. It charged me a commission (outlined on a statement) of the lira equivalent of EUR 9 to convert the equivalent of a little under EUR 1,000 from Turkish lira to euros."

"That's perfectly fair. But what the bank didn't disclose was that the foreign exchange rate they used for the currency conversion was about 1.5% above the prevailing inter-bank rate. That resulted in an undisclosed debit of around EUR 90."

"I'm not complaining that I didn't get the inter-bank rate. As a retail customer, I understand that I won't have access to inter-bank rates for small forex transactions. It's also possible that the inter-bank rate fluctuated substantially on the day that the bank made the conversion. However, I think that they bank should have disclosed this to me, and they didn't."
Mark went on to explain a few ways that you could minimize these hidden fees...

"First, if you're purchasing securities from your foreign account, try to stick to securities denominated in your base currency unless you have a compelling reason to purchase securities in another currency. (In my case, the opportunity to buy AAA-rated Turkish bond with an 18% annual interest rate was such a reason.)"

"Second, if you do change currencies, ask your account representative how far above the inter-bank rate you can expect to pay for the conversion. You're likely to pay a higher premium for relatively "exotic" currencies like the NZD than for more mainstream currencies like the euro or Swiss franc."

"Third, if you're conducting a really large transaction—say, above US$100,000—it's fair to ask the bank to conduct it at or at least very close to the inter-bank rate. The worst they can say is "no." If they do say no, ask them to at least document on your statement how far above the inter-bank rate the forex exchange was conducted."

"Incidentally, if you're a U.S. taxpayer, you can't deduct these hidden debits on your tax return. You have to add them to your basis in that security, and then use that higher basis to reduce whatever capital gain—or increase whatever capital loss—you have upon sale or redemption."
Utilities Showing Relative Strength in ‘09

While they may not be as exciting as tech companies or derivatives, Investment Director Eric Roseman recently pointed out the promising performance in an otherwise nightmarish year for equities...

"With the Dow Jones Industrials Average down 8.5% this year, one of the few areas of the market posting any gains at all is the Dow Jones Utilities Average or DJUA, up 1.6%."

"Though it's still too early to confirm a primary bull market trend for this sector, utilities might emerge as a leader if stocks finally escape the wrath of this relentless bear. That's because utilities are heavily regulated in most states and underwent a major legislative overhaul years ago - something that awaits the financial services sector after years of fat profits and excessive bonuses."

"One caveat for utilities is the trend in credit spreads, or the difference between the interest rates yielded by utility bonds versus benchmark Treasury bonds."

"These spreads have widened sharply over the last 60 days and indicate utilities might run into severe headwinds ahead of major expansion plans and funding requirements amid a tight credit environment."
"Still, if the DJUA breaks its 200-day moving average, I'd be bullish on the sector."

"Staid and stodgy might be dull. But there's nothing wrong with a 4.2% annual yield and reliable earnings in a bear market. Watch the utilities."

Obama, Obama Obama.

The relationship between the President and the public has taken a rapid turn for the normal as we transition from, "The Audacity of Hope" to "The Audacity of Appointing Tax-Dodgers to what will likely be one of the spendiest administrations in U.S. government history."

Today, Legal Counsel and Former Congressman Bob Bauman shares his perspective on Obama's first few weeks in office, and what they tell us about this otherwise relatively unknown politician...

Yours in Personal Sovereignty

MATTHEW COLLINS
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The Audacity of Nope

By Bob Bauman


Since the election last November, (especially in the last two weeks since he took office), events are tending to make Barack Obama appear not as the agent of promised hope and change, but more like the typical Chicago politician, (Rod Blagojevich most certainly excepted).

What's more, when it comes to policy decisions and appointees, our new President appears to need more than just a little on-the-job training.
Can't Get No, Satisfaction

In 2005, most likely in order to gain the support of organized labor in his long-shot Presidential campaign, then U.S. Senator Barack Obama voted against ratification of the Central America Free Trade Agreement (CAFTA), a harmless free trade agreement that he knew would help both Americans and our neighbors in six poor countries to our south, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and the Dominican Republic.

As he candidly described his decision-making process a year later in his celebrated memoir, The Audacity of Hope, Obama knew that CAFTA posed absolutely no economic threat to the United States. The combined economies of the Central American countries were roughly the size of New Haven, Connecticut. The agreement allowed free U.S. foreign investment for six countries that badly needed it. "Over all," Obama concluded in his book, "CAFTA was a net plus."

Nevertheless, Obama admitted: "I ended up voting against CAFTA, which passed the Senate by a vote of 55-45. My vote gave me no satisfaction but I felt it was the only way to register a protest against what I considered to be the White House's inattention to the losers from free trade."
Politics, Pragmatism, Not Principle

During the raucous, two-year battle for the Democratic Party's presidential nomination, both Senators Hillary Clinton and Obama dumped all over various aspects of free trade, pandering for votes from nervous workers and union bosses with trash talk about American jobs being shipped overseas by greedy global companies with their headquarters in tax havens.

Both candidates, paying their union dues, also opposed ratification of other free trade treaties with our strongest South American allies, Columbia and Panama - and both went to extremes, even claiming they would re-negotiate the NAFTA treaty between the U.S., Mexico and Canada (although one of his campaign advisors said Obama didn't really mean that...and got fired for his impolitic admission).

As a Senator from Illinois, Obama even went further, co-sponsoring Michigan Senator Carl Levin's pet hate project, The Anti-Tax Haven Act, a bill that would allow the U.S. Treasury to control, and even ban, offshore private capital flows and investments by Americans. This nonsense comes at a time when the U.S. government desperately needs foreign capital and offshore investors to finance Obama's trillion dollar deficits.
Will the Real Obama Stand Up?

In the next few weeks, President Obama gets the opportunity to cast another vote on American protectionism - this one with truly global importance - and his decision will reveal whether he will once again honor the political demands of labor union bosses at the expense of the best interests of the majority of Americans.

Last week, in passing the so-called "stimulus" legislation, Democrats in the U.S. House of Representatives included a "Buy American" requirement that seeks to protect iron and steel (roughly 0.5% of U.S. GDP).

The U.S. Senate bill now being debated provides protection for "all manufactured goods" (roughly 14% of GDP). But both the House and Senate bills leave the final decision to Mr. Obama, giving the President authority to grant waivers, in whole or in part, to any country he wants.

Importance of Free Trade

As I have explained before at length, underpinning the Sovereign Society's advice concerning offshore banking, asset protection and profitable foreign investments is an important freedom that too many Americans take for granted - the unfettered ability to move capital, goods and services across international borders with a minimum of government interference - in other words, free trade.

Historically, free trade has been a winner for America and the world. Undeniable proof shows that, on balance, free trade creates more U.S. jobs than it harms. But it is always easier to point to jobs lost through foreign competition than jobs created from exports.

But there really may be some of that "hope" about which candidate Obama spoke so eloquently. He may be backing away from his past pandering and the Democrats' "Buy American'' legislative clause - which has produced major alarm among America's key trading partners all over the world.

In an interview with Fox News Channel, the president acknowledged it would be a mistake to send a protectionist message in the current global economic climate. "I think it would be a mistake, though, at a time when worldwide trade is declining, for us to start sending a message that somehow we're just looking after ourselves and not concerned with world trade,'' he said.

Perhaps Mr. Obama does believe in real change - at least changing wrong past political positions. He even hinted that he would seek to remove the Buy American provisions from the legislation.
History Lesson

Yesterday the European Union warned the U.S. government against worsening the global recession by adopting a "Buy American" policy that they think could lead to a trade war.

No doubt EU officials had in mind the onerous 1930 Smoot-Hawley Tariff Act that, in the opinion of many economists, was a direct cause of the severe reduction in U.S.-European trade from a 1929 high, to the depressed levels of 1932. Most see that act as a major contributing factor to the severity of the Great Depression and a U.S. unemployment rate as high as 25%, that persisted for nearly decade

Other then the Presidential remarks quoted above, the administration has not yet stated an official position on the "Buy American" clause. But as usual, Vice President Joe Biden didn't get the word. In an interview last week, Jumpin' Joe said, "I think it's legitimate to have some portions of 'Buy American' in it."

Good Advice

Let's hope the freshman President will carefully study history and take the advice he was given by Robert Rubin, Bill Clinton's U.S. Treasury secretary, when Obama asked advice on his 2005 CAFTA Senate vote - and on what he should tell "the Maytag workers in Galesburg" who feared that free trade agreements with low-wage countries would cost American middle class jobs.

Mr. Rubin gave this sage advice, "There is one thing [to] tell the workers in Galesburg that is certain. Any effort at protectionism will be counterproductive, and it will make their children worse off in the bargain."

And that same advice discredits the proposed Obama/Levin restrictions on the free movement and investment of capital offshore in this highly interdependent world of ours.

Americans are now caught in a financial twilight zone. For your own sake, we urge you to join the Sovereign Society today and open the door to safe and secure offshore asset protection and investing - while you still can. We welcome you.