Too Many Refunds
Research for Online Investors

by John Dalt

11/06/09

Treasury released their refunding statement on Wednesday.  Refunding occurs quarterly, the next announcement will be February 3, 2010  Next week the U.S. Treasury is auctioning $81 billion in notes and bonds.  $42.5 billion will be new money, and $38.5 will be to refund maturing securities.  Refinancing maturing securities will add to the financing problem facing the U.S.  The government needs to borrow money to meet the deficit, but has to borrow even more to pay off maturing debt.  This looks like the snowball that will get larger and move faster as it rolls down the hill.  Hold on, the ride could get interesting.

Buyers have other options for investment returns.  Money seeks the highest return, or perceived return.  When the expected return, on a percentage bases, is higher in another asset class, fixed rate securities MUST offer a higher interest rate (return) equal to or greater than the other investment.

The Treasury auctions have been successful in the last year, in part, because of the volatility of the stock market.  Investors moved to the ‘sidelines’ to avoid the big ups and downs in stocks.  As investors feel safer returning to equities, will they accept 3.5% for a ten-year bond?

The REAL interest rate is computed by subtracting the rate of inflation from the bearer rate.  If a ten-year bond pays 3.5% but the inflation rate is 3% during the term of the bond, the REAL interest rate is 0.5%  Investors should do this calculation using the best information available to them.  This calculation forces the subjective judgment that triggers the perceived return of different asset classes.

Not all is knowable, but buyers of investment vehicles will become wary of government bonds paying less than the expected rate of inflation.  This cautiousness will grow just as the additional credit needs of the U.S. Treasury come into full bloom.

The competition for investments does not come just from equities.  Other countries issue bonds, introducing the variable of currency fluctuations.  Do I want a bond paying 3% from country “A”, or a bond paying 6% from country “B”?  You may think 6% sounds good.  If the currency returned to you when your bond matures, from country “B”, is worth less than country “A”’s currency did you really do better?  What if the currency is worthless?

Have you ever heard of Gideon Gono, Zimbabwe’s Central Bank Governor?  In 2007, when interest rates were 800%, he said, “I never would have dreamt that we would get to these levels of inflation” but vowed to “not be deterred.”  Oh! Bama, Bernanke, and Geithner should read some recent history.  Never mind Germany in the 1920’s or any other country that tries to ‘print’ their way out of a recession.

We own TBT in the SwingTrader.  We have traded it a few times in the last year, but were caught on the last dip.  Why be nervous?  Oh! Bama, and congress, are spending money like drunken sailors (my apologies to Navy veterans).  Supply and demand dictate higher interest rates.  Supply is increasing; demand does not increase just because of increased supply.

To the mailbag:
“Citing Plato and your sense of humor in other letters makes it all good. I bought USO yesterday and decided I was just going to keep it long term…..There is no way crude in the future is going to be cheaper or more plentiful in my opinion.” ---Paid up subscriber S.C.

Thank you, I liked the Plato quote so much, we put it on the Home page of the website.  I have always been amazed at people that express no interest in current affairs.  Living their lives in ignorance of what is happening that foretells future destruction.  Thanks for subscribing.  Now we just have to "do the dance" in the market and make money.---John

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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