My prediction on what will happen to the bond market in different case scenarios

Discussion in 'Economics' started by alexandercho, Jul 18, 2011.

  1. Guys the printing press requires the Federal government to continue lending 100B Dollars of currency into existence. Right now the US government is no longer borrowing money, and with the anxiety investors feel. They invest based on their algorithmic principles, that still imply that the US bond is a non-risk asset. Therefore they buy the US Bond regardless of a potential risk, for a partial default. That being the case every single month banks, and major institutions carry trade, and buy all available US T Bonds. So in order to carry trade, by borrowing from the federal reserve at a low prime rate, and buying t-bonds. In order to earn the difference between the prime rate, and the interest rate on t-bonds. But, what happens when the US government is no longer issuing bonds, with more cash following the same amount of bonds available?

    The answer is simple demand increases, while supply decreases. Therefore it increases the price of t-bonds while lowering interest rates. Observe the phenomenon of technical analysis in full swing. This is why understanding technicals, and how it truly apply in a market setting is extremely important. Now, let's examine the fundamental characteristics even closer.

    Treasury bonds are going up temporarily because the government is not issuing bonds. That's purely technical supply/demand characteristic of a market. That is currently playing out. However, the fundamental reasons, for why it should fall are extremely valid, and here's why. In the case of partial default, or an approval to raise the debt ceiling. The value of US T-Bonds should fall.

    Because if in the case the debt limit is raised. There will be a huge surplus of supply that will most likely overwhelm demand. Because of this treasury bond interest rates will rise, and the value of t-bonds will fall.

    In the case of a Partial-Default we will see a rapid contraction of credit. Therefore causing a hyper-deflationary event. Because the higher cost of credit will reduce the amount of lending. Thus reducing the amount of M3 currency, or basically all existing currency (M3 currency is real accessible currency in non-physical form). The Partial default will lead to a downgrade on our debt rating. Thus making borrowing more difficult, and more expensive, for the US government, and all US corporations. Interest rates on all forms of debt will go up, and therefore slow economic growth. That implies deflation, and that will lead to asset devaluation. Stocks, bonds, commodities (including precious metals) will fall. The dollar will rally against a basket of other currencies. Because the scarcity of the US dollar will increase.

    If in the case the US government were to completely default, and everything that was suppose to happen in 2009 after the Lehman Collapse happened in the following months. The value of the dollar would rapidly appreciate with the rapid collapse in valuation on all asset classifications. All paper US currency, which is currently estimated at 500B Dollars would appreciate in value, by 20-30X, with the rapid depreciation of all forms of assets. Just because a government collapses, or seizes to function. Doesn't mean people will not defer to the most trusted asset they possess, which in fact. Is the US dollar. People will rely on their paper currency, because all currency in their bank accounts will evaporate as if it did not exist. Currency is for the purpose of facilitating exchange. Which means it does not need intrinsic value. It only needs implied value, and in times of fear. That implied value increases drastically.

    A scarcity of the dollar. Is the most likely of outcomes. Causing rampant panic, and hoarding. The price of all goods will fall, with less money following the same amount of goods. Therefore supply rapidly increases, while demand drops to a trickle. Again, this is the most likely outcome in the case of an outright default, along with a bankrupt banking system. People would not trash their dollars, they would worship them. Gold, and Silver will still retain value in hyper deflation. But, it would not rapidly appreciate. It would rapidly depreciate. However gold, and silver is a neutral hedge. That protects you from both deflation, and inflation, by always retaining value. However, the strongest hedge against rapid deflation is always paper currency that is not deposited in the bank. The best hedge against inflation is income producing investments with business growth that exceeds the rate of inflation. Even after a defunct government. People would still accept US bills. Because it's all they've used their whole life, and it's convenient. People do not use gold, or silver to transact. Ignorance carries a price, and the ignorance of the masses. Is what will determine the market value of paper currency. My bet is that the masses will be busy bidding up the value of their currency, rather than throwing them in the trash can.

    This is economics 303, and not 101. One must observe the theoretical boundaries of what's reality first, and understand the governing physics of our current monetary system.