Tuesday, December 16, 2008

The Economic Reality Proves My Point

The interest rate on U.S. Treasury Bills, these are discounted notes issued by the U.S. Treasury, are selling to yield the investor four one hundredths of one percent, also known as four basis points. A little review, 100 basis points equals one percent. The women will understand this better than the men because women know that a one carat diamond has 100 points, so the arithmetic is the same for interest rates (100 basis points = 1 percent) as it is for diamonds (100 points = 1 carat). Why have interest rates on U.S. Treasury Bills, Notes and Bonds fallen to such low levels? The answer is that investors around the world are seeking to place their money in, first, a safe currency, and second, in a country that is going to be around in the morning. It really is that simple, investors are scared, and when investors are scared they put their money into the safest instruments they can find. The safest vehicle for their wealth, remember not everyone buying U.S. Treasury Bills, Notes and Bonds is an American citizen, is in their mind, U.S. Treasury securities.

The U.S. Treasury yield curve is almost a perfect positive sloping yield curve. Treasury interest rates are running like this:

3 months 0.04%
6 months 0.26%
1 year 0.47%
2 year 0.76%
3 year 1.03%
5 year 1.48%
10 year 2.49%
30 year 2.94%

If you take a piece of graph paper and place a dot on the paper to represent each interest rate and date to maturity and then connect the dots, you will have created a yield curve. The line will start at the bottom left hand corner of the graph and run upward and to the right. As investors are willing to part with their money for longer periods of time, the interest rate they are paid goes higher. This is known as a positive sloping yield curve. Remember also that the longer the maturity the greater loss in value when interest rates go up because of the concept of present value and the inverse relationship between price and yield. (see posting from April 10, 2008 for more information about price/ yield and present value.)

The problem that the economy is facing is that the banks are not lending money and borrowers are not borrowing money. The Federal Reserve Bank is now going to reduce the Fed Funds rate to try and encourage more economic activity. The talk is that the Fed may lower the Fed Funds rate, that is the over night rate banks lend money to each other to meet their reserve requirements, to as low as a half of one percent or also known as 50 basis points.

Houston we have a problem. What is the problem Ben Bernanke? We can not get enough people to borrow money to get economic activity going. Borrowing is key to expanding the money supply and developing economic activity. Well, just imagine if we took away all the traffic lights on the streets and highways. Then we turned off all the railroad signals across the country, and then we sent all the air traffic controllers home and told the airlines to just take off and land whenever they felt like it. Do you think such a plan would reduce the movement of people around the country, the states and even the cities? How might such a plan affect economic activity in the United States? Well, that is about what happened to the financial markets with the stupid idea and philosophy of deregulation. People are so scared that they are not borrowing money and they are investing their money in the safest instruments they know of, U.S. Treasury Bills. Basically, economic activity as we have known it over the last several years has shut down. You can thank the idiots we sent to Washington, D.C. to make the laws that run this country for the financial crisis, the bond market meltdown and now the recession. They have succeeded in running this country’s economy into the ground.

Some politicians may think a complex financial system can run without regulations, but any idiot knows that that is impossible. The economic reality we all are experiencing today proves my point.

Stay tuned.

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