Circling Vultures
Research for Online Investors

by John Dalt

4/14/11

The Bond Vigilantes are circling, looking for a corpse.  Who will it be?  It looks like Greece is the “winner” this week.  Greek debt dropped in value yesterday.  Ten-year bonds sold at a discount to yield 13.26%, the highest since 1998.  Two-year note interest rates jumped to 17.96%

German Finance Minister Wolfgang Schaeuble said that Greece may need to renegotiate its debts.  Moritz Kraemer of S&P Ratings said that debt renegotiation by Greece would involve imposing loses of 50% to 70% on investors.

Irish debt was quoted at 9.25% on their 10-year bonds.  Portuguese 10-year yields rose to 8.89% their highest since 1997.  Two year notes were quoted at 9.33%.  Spain’s 10-year bonds also dropped in price.  They were quoted to yield 5.32%.  Italian debt costs climbed on new issues to 4.72% yield for the 10-year bonds.  German bonds gained as investors sought safety.  The yield on German 10-year Bunds slipped to 3.39%

Moritz Kraemer, head of sovereign ratings for Standard & Poor’s commented on Bloomberg about Poland’s economic imbalance is due to pension reforms from the 1990’s.  Poland is seeking to cut pension contributions by the government.  Poland is taking this action because the country’s budget deficit is expected to hit 7.9% of GDP this year.  Their public debt is close to 55% of GDP.  Under Polish law, when this threshold is reached the government must enact spending cuts.

The International Monetary Fund (IMF) produced a working paper on the U.S. fiscal situation.  The paper is titled “An Analysis of U.S. Fiscal and Generational Imbalances; Who will pay and how?”  The opening line in the introduction is a warning to those who believe the U.S. can paper over the huge government expenditures currently budgeted.  It says, “The United States is facing an untenable fiscal situation due to a combination of high fiscal deficits, an aging population and rapid growth in government-provided health care benefits.”

The IMF and the Congressional Budget Office (CBO) both come to the conclusion that U.S. debt will rise rapidly relative to gross domestic product (GDP) over the short, medium and long term.  The IMF paper determines that U.S. spending compared to U.S. Gross Domestic Production would have to be improved 15% EACH year to avoid financial turmoil.

The ‘Generational Imbalances’ the IMF addresses are the spending today to support Social Security, Medicare and other transfer payments that are paid for with borrowed money.  These costs are added onto the federal debt that will be ‘inherited’ by future generations.

Under Obamacare, the IMF estimates healthcare costs to rise above 18% by 2050 and perhaps by 2026.  Historically, the U.S. collects 18.4% of GDP in tax revenues.  The IMF suggests the government could raise ALL taxes and cut all transfer payments (Social Security, Medicare, Unemployment, Disability, Food stamps, Aid for Dependent Children, etc) by 35% immediately to avoid a future fiscal crisis.

The IMF study cautions that delay only makes the pain worse.  Every year the U.S. waits to address the fiscal imbalance creates a larger problem.

The IMF study affirms the necessity to address the current deficit spending by the Federal Government, now.  Poland, a former communist country, is addressing their deficit because they fear it may reach 7.9% and public debt 55%.  The current U.S. deficit is over 10% of GDP, and Government debt stood at 95% of GDP at the end of 2010.  This debt does not include the future payments for Social Security, Military retirement, Disability or other government ‘social contracts.’

Is it really plausible to think U.S. interest rates will remain low?  For six months?  When will it be our turn to face the ‘bond vigilantes?’  Will Obama and Congress gain religion, and cut spending?  Our Long-Term portfolio subscribers own the TBT Ultra Short 20-year Treasury ETF.  It increases in value as interest rates on long-term bonds increase.

The mailbag:
Obama’s speech made a lot of sense, a brilliant man…the republicans are smoking dope…we have to take back the Bush tax cuts.----paid up subscriber G.O.

John’s reply:  Huh?  Did you read yesterday’s MarketToday?  If the government confiscated ALL of the assets of the Forbes 400 richest men, it would not bring the budget in balance THIS year.  Who would be left to pay taxes next year?  The problem is not taxes, it is spending.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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