|
August 11, 2005 – A major
ongoing debate has consumed the investment community regarding whether
inflation or deflation is in our future. This is understandable because the
impact of its resolution, upon both our investments and our personal lives,
hangs in the balance. I believe that the recent official pronouncement that
30-year Treasury Bonds will again be offered, likely announces our
government’s opinion of our fate.
The four-year hiatus of the U.S. government’s issuance of 30 year Treasury
Bonds is coming to an end. Prior to its slated permanent termination in 2001,
it was a mainstay in the Treasury Department’s debt issuance arsenal. For
decades they were actively sought worldwide by investors who desired the
safety and liquidity that they offered. This global demand gave our
government a willing contingent from which they could fund their capital
needs, thereby allowing our officials to pay our bills. They were auctioned
whenever budget deficits occurred, and offset America’s regular tax revenue
shortfalls.
When the 30-year bond was eliminated the Fed was already in the midst of
actively orchestrating a major reduction in interest rates. Further, they
were simultaneously flooded the banking system with liquidity. They were
performing these acts in an effort to reverse the recession that was
consuming our nation.
At that time, it seemed odd to me that they would retire the 30-year bond
primarily for the stated reason that demand for it had dwindled. After all,
it had served for decades to help the government acquire the capital needed
to remain solvent.
To my mind, the recent announcement that this vital monetary instrument would
again be issued may have far reaching implications. And, if I am correct, the
reasoning behind its reinstatement exhibits good business judgment on the
part of our government, and insight into what they believe is our future.
In 2001, and with short-term interest rates plummeting, the U.S. Treasury
ceased issuing bonds of 30 years duration. I believe that this was a
monumental error. After all, with rates moving towards generational lows the
U.S. had the ability to borrow needed funds while paying little in the way of
interest. Additionally, they would have the use of the proceeds for the
following three decades.
With their recent announcement I believe that our government finally
acknowledged their judgment error in terminating the Treasury Bond offerings.
Further, I feel that their reason for reintroducing them at the present time
is crucial. It is due to their belief that interest rates are destined to
move to loftier levels, and denotes their view that inflation is likely.
This, despite the rhetoric that inflation will remain under control.
Many in the deflation camp have written off the Federal Reserve’s past ten
federal funds rate hikes as being a mistake in judgment. These individuals
state that the declining long bond interest rates, while short rates are
simultaneously rising, indicate that deflationary winds are being fanned.
After all, history is replete with periods when long-term interest rates
declined whenever our economy approached or experienced a recession. Further,
they point to the flattening and possible inversion of the yield curve, as
testimony to the inevitability of this event. I now believe that they are
wrong.
It is my belief that like the Fed, our government now believes that the
economy has sufficiently strengthened to prevent a return to recession.
Further, by reissuing the long bond they can attract a substantial amount of
funds to our government coffers.
I have read that the government expects to hold two annual $20 billion to $30
billion bond auctions. I believe their hope is that they will be successful
and attract far more than this modest sum. Further, if inflation is in the
cards it will erode the ultimate value of the dollars that the government
must repay upon the maturity of these bonds. In effect, when the bondholders
redeem their bonds the proceeds will purchase far less than the money they
used to buy them.
Given the fact that the dollar has lost well over 85% of its purchasing power
during the past seven decades, it is reasonable to assume that purchasers of
the new Treasury Bonds will suffer a similar fate as have earlier
bondholders. In effect, when the investors redeem their bonds the proceeds
will purchase far less than the money would have when they bought them. This
will accrue to the benefit of our government and nation, as this debt will be
repaid in cheaper dollars.
If my analysis of our government’s reasons for issuing the long bond is
correct, what is its significance? First, it indicates that Fed sponsored
rising short-term interest rates will continue for the foreseeable future.
This will further pressure lower all Treasury paper as well as other domestic
debt instruments, and simultaneously force higher their interest rates. Next,
the threat that the advancing rates will spark housing market and economic
declines will increase. Further, inflation will be our leaders dominant fear.
This does not mean that inflation is a certainty and that deflation will not
occur! It only indicates the fashion in which an investor should expect our
government and Federal Reserve to act, and how they will attempt to influence
the markets. The government may very well be wrong, but I believe that they
are now directing their actions to stave off inflation. This will be the
dominant direction of our monetary and fiscal policy’s influence for the
foreseeable future.
In any event, the action of the Federal Reserve will be the easiest and
likely the most reliable indicator to watch. They will give investors the
first sign of what our government is thinking and fighting. If the Fed
continues its measured Fed Funds increases, it will signal that inflation
remains their greatest concern and that its assertive return is likely.
However, if they begin to reverse their rate hikes and instead lower their
Fed Funds targets, beware! It will be the first indication that they are losing
control and that the likelihood of deflation and recession is rising.
This is only a theory at present. However, if I am correct about the
government’s rising belief that inflation is our primary threat, the ultimate
investments will be those that parallel the best performing items during the
inflationary period of the 1970's. They were gold, silver, gold and silver
stocks and tangibles such as commodities and rare coins.
Again, we have a major advantage by being able to observe the Federal
Reserve’s actions. The direction in which they move their Federal Funds rate
target will be the leading indicator. It will tell us what they are thinking,
and it will announce the rise of inflation if it continues higher, or the
likely spread of deflation if they reverse course.
*******
I publish Financial Insights.
It is a monthly newsletter in which I discuss gold, the financial markets, as
well as various junior resource stocks that I believe offer great price
appreciation potential.
CAVEAT
I
expect to have positions in many of the stocks that I discuss in these
letters, and I will always disclose them to you. In essence, I will be
putting my money where my mouth is! However, if this troubles you please
avoid those that I own! I will attempt wherever possible, to offer stocks
that I believe will allow my subscribers to participate without unduly
affecting the stock price. It is my desire for my subscribers to purchase
their stock as cheaply as possible. I would also suggest to beginning
purchasers of these stocks, the following: always place limit orders when
making purchases. If you don't, you run the risk of paying too much because
you may inadvertently and unnecessarily raise the price. It may take a little
patience, but in the long run you will save yourself a significant sum of
money. In order to have a chance for success in this market, you must spread
your risk among several companies. To that end, you should divide your
available risk money into equal increments. These are all speculations! Never
invest any money in these stocks that you could not afford to lose all of
Please call the companies regularly. They are controlling your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard Appel and is made
available for informational purposes only. Dr. Appel pledges to disclose if
he directly or indirectly has a position in any of the securities mentioned.
He will make every effort to obtain information from sources believed to be
reliable, but its accuracy and completeness cannot be guaranteed. Dr. Appel
encourages your letters and emails, but cannot respond personally. Be assured
that all letters will be read and considered for response in future letters.
It is in your best interest to contact any company in which you consider
investing, regarding their financial statements and corporate information.
Further, you should thoroughly research and consult with a professional
investment advisor before making any equity investments. Use of any
information contained herein is at the risk of the reader without
responsibility on our part. Past performance does not guarantee future
results. Dr. Appel does not purport to offer personalized investment advice
and is not a registered investment advisor. The information herein may
contain forward-looking information within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. In accordance with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the statements contained herein that look
forward in time, which include everything other than historical information,
involve risks and uncertainties that may affect the company's actual results
of operations. © 2005 by Dr. Richard S. Appel. All rights are reserved. Parts
of the above may be reproduced in context, for inclusion in other
publications if the publisher's name and address are also included for
credit.
|
|
