First, if you haven't already done so, please take a look at the charts of US Treasury debt on this page (Privateer subscribers only). Astonishing, aren't they. The first thing that leaps off the page is the simple fact that the entire yield curve (3-month to 30-year) is substantially below the Fed Funds rate which has been 5.25 percent since the end of June this year. The last time that the 6-month yield, the highest in the series, was at or above the Fed Funds rate was way back on July 27.
But there are much more ominous signs on these charts. First, there is the fact that the yield curve is inverted (on a 2-year vs 10-year comparison) and has been in this position for most of the year. Note the data at the bottom of the page which shows the time period during which the curve has been inverted. Note further the most recent "bout", which has now been going on in an unbroken sequence for more than three months.
Note also that the inversion is getting steeper. Up until this week, the biggest "inversion" on the curve took place back in late February this year, when the 10-year yield dropped 16 basis points (0.16 percent) below its 2-year counterpart. That was surpassed this week when the 10-year rate dropped 19 basis points below its 2-year counterpart on November 15 and 16.
There are three things which have to be taken into account when assessing the extroardinary nature of the present yield curve for US Treasury debt.
First, and most fundamental, is the simple fact that an inverted yeild curve is historically the most reliable indicator of a pending recession or depression known to economics. The present curve screams recession, and of course we have been claiming for several issues now in The Privateer that the US is actually IN recession. In our Late October issue (Number 564 - published on October 29), The Privateer pointed out that according to official government numbers, the US economy "grew" by 1.6 percent in the third quarter while year on year "core" consumer prices rose by 2.3 percent. Thus in REAL terms, the US economy is indeed in recession.
The second aspect of the yield curve is the simple fact that Treasury yields are the basis of all interest rates - notably mortgage rates - in the US. The fact that these yields are now dangerously low translates to the fact that US mortgage rates (both fixed and "adjustable") are equally low. Any rise in the rates from these levels would turn what is already a fast imploding US housing market into an outright collapse. And this, in turn, would choke off the only remaining impetus for future US economic "growth" - consumer borrowing and spending.
The third aspect pertains to the fact that the US still clings tenaciously to the global reserve currency nature of its currency, the US Dollar. The indebtedness of ALL sectors of the US economy - "public" and private - is unprecedented in the history of any nation, let alone the nation which produces the world's reserve currency. Were it not for the status of the US Dollar, US interest rates would be literally at multiples of their present levels and the US economy would have imploded years ago.
As you probably already know, both the UK and the Australian Central Banks raised their rates (both by 0.25 percent) within 48 hours of the November 7 US mid term elections. The European Central Bank (ECB) has given every indication short of an outright promise that they will follow suit when they meet on December 7. The last FOMC meeting for 2006 will take place five days later on December 12.
Lately, there hasn't been much coming out of the Fed. But the latest pronouncements have what they euphemistically call "inflation" as their number one concern. Of course, "inflation" properly defined as an increase in the total stock of money is always the first concern of any Central Bank. It is, after all, what they do. But when a Central Banker talks about "inflation", he or she is talking about rising prices, which are one of many inevitable adjuncts to an increase in the total stock of money.
Of course, if "inflation" IS the Fed's number one concern, one could expect them to be contemplating another rate rise to cut borrowing and thus spending and thus "pressure" on prices. But nobody knows better than the Fed that the US economy and the myriads of debtors which comprise literally cannot afford any more rate rises. That's why they stopped at the end of June, when they realised that the housing market was teetering on the brink
In current economic circumstances, the only thing that would induce the Fed to raise rates would be a CRASH DIVE of the US Dollar. Even that might not do it. The Dollar could, of course, crash dive at any time. Foreigners wouldn't even have to sell it, all they would have to do is stop buying it. And the Chinese, who recently saw their pile of "foreign exchange reserves" (mostly US Dollars) top the $US 1 TRILLION mark, are busily looking for "alternatives" to the Dollar.
How "lame" is the US economy? It is in a state where the only thing holding up the currency on which it is based is the simple fact that the world is sitting on such a huge pile of them that they don't (yet) dare to stop buying for fear that the purchasing power of that which they already hold would plummet disastrously. Their other problem is that there is no other market big enough to absorb this huge pile of US Dollars.
The entire stock of Gold in the world amounts to about 160,000 Tonnes - or about 5.145 Billion troy ounces. At its present spot price of just over $US 620 per ounce, the Chinese alone could buy just over 1.6 Billion ounces or nearly one-third of all the Gold in the world with their foreign exchange reserves alone. Put it another way. The entire world Gold stock of 5.145 Billion troy ounces at its present spot price is worth just under $US 3.19 TRILLION. That would keep the US federal government going for about 15-16 months or pay off about 37 percent of the US Treasury's funded debt.
That is, of course, what makes the financial establishment everywhere scoff at the very idea that Gold could form any official part of the modern financial system. With the total (funded plus unfunded) debts of the US alone somewhere between $US 60-90 TRILLION, and with global derivatives contracts totalling somewere in the region of $US 200 TRILLION or even higher, how could there ever be enough of it?
Of course, in reality, the reason that global indebtedness and the total of tradable instruments denominated in the various fiat currencies of the world are so grotesquely large is precisely because Gold has NOT played any official role in the modern financial system for a bit more than thirty-five years now. This system has long been a galactic financial accident waiting to happen. With a lame duck President and a lame duck economy, the US is right on the verge of pushing it over the edge. Gold will return as money. That much is certain. What we don't know is where, and when.