EVERYONE and I mean EVERYONE is in a panic over our massive deficits and the subsequent borrowing by the U.S. to cover them – because it has the potential to push interest rates through the roof!
Last week alone, Moody’s downgraded U.S. Debt (or lowered its bond rating over deficit concerns) and a Treasury auction “failed,” meaning there were not enough buyers for our Treasury bonds at the offered rates. I personally received dozens of texts and emails from readers and agents expressing their concern over these events.
The very justifiable fear is that the U.S. will have to borrow so much to cover our multi-trillion dollar deficits that we will have to jack yields (interest rates) way up to attract enough buyers of our debt.
Here is an excellent video by Joe Brown explaining how the Treasury bond market can fail: This is What a Failing Treasury Market Looks Like.
But yet, despite our continued borrowing, despite the Moody’s downgrade, and despite last week’s “failed” auction, rates fell this week! Why???
One of the reasons is that the Treasury started to issue more short-term debt (maturities under 10 years) instead of longer term 10 and 30-year bonds, as there is sufficient demand for shorter term debt.
Overseas Dollar Demand Keeps Treasury Market Afloat
The other reason bonds are still finding buyers no matter what is… the dollar.
While the dollar and U.S. Treasuries are not the same thing, they are very closely related because other countries hold Treasuries when they need dollars – and other countries need dollars badly.
This is because other countries need dollars to pay off dollar-denominated debts and to pay for imports because most of the world’s trade is in dollars (countries must have dollars to buy imports).
U.S. Treasuries in fact represent the foundation of the entire world economy because the dollar is the world’s reserve currency. So, if a Treasury auction ever actually fails completely, the world economy will go down with it – and most other countries understand this and thus are not cheering for the collapse of the Treasury market.
And, we need to remember that no matter how pathetic our financial situation gets, most other countries are worse off than we are! They have similar debt and deficit issues, but they don’t have our military, and most importantly – THEY CANNOT PRINT MONEY LIKE WE CAN, AS THE HOLDER OF THE WORLD’S RESERVE CURRENCY.
As Brent Johnson reminds us often – the U.S. remains the cleanest dirty shirt in the laundry.
I got most of the info for this blog from Mr. Johnson, and I highly recommend watching this podcast of his: The world stares down a sovereign debt crisis as the U.S. safe haven is questioned. I also recommend following Mr. Johnson on Twitter, as he explains all this much better than I ever could, and he tweets interesting examples of dollar-strength constantly.
I also got much of the above info from Alf Peccatiello, and from this Twitter thread in particular: Here is why you keep hearing about a De-Dollarization but it just never happens. I HIGHLY recommend following Alf as well.
When analysts get things wrong or overstate short-term concerns, it is often because they don’t understand the demand for dollars overseas and just how big the overseas dollar (“Eurodollar”) market is – and how much it influences our economy no matter what the Fed does.
Last point: the “too much debt doomsday scenario” probably will play out eventually, and we will see much higher rates as a result – making real estate an excellent hedge once again. BUT – we will probably not see this play out in the near future.