A complete collapse in the value of US treasury bonds is likely in the near future. Such a crash could have a catastrophic effect on the US economy. Among other things, it could raise interest rates on mortgages and loans, trigger high inflation, and wipe out the savings of millions of Americans who own the bonds.
It could also send the Chinese economy into a tailspin, because the Chinese government is one of the largest holders of US treasury bonds. Such a Chinese downturn would hurt America because China is the largest customer for a lot of US products, including agricultural goods.
The most frightening thing about the treasury warning is where it comes from: Michael Hartnett, the chief investment strategist at Bank of America. This isn’t a wild claim from some TV pitchman trying to sell you gold coins. It’s coming from America’s largest bank, which is also one of Warren Buffett’s favorite stocks.
Hartnett made the warning in a letter to clients. He wrote that “risks of a bond crash are high.” Hartnett thinks a bond crash is likely because the Federal Reserve could stop buying $85 billion in treasury bonds and mortgage bonds each month.
The Fed is Artificially Inflating the Value of Treasury Bonds
Basically, what Mr. Hartnett is saying is that the Federal Reserve is artificially inflating the value of treasury bonds with its stimulus program. The only reason treasuries are worth anything is because the Fed is buying large numbers of them.
The Fed is doing this because nobody wants to buy treasury bonds anymore and it is easy to see why. The interest on a 10-year treasury bond is now 1.38%. There’s no way that anybody can make any money investing in treasuries. The return on investments is now slightly above the rate of inflation, which means a person that buys treasuries loses money on the deal.
The current rate of inflation in the US is around 1.1%, which means that a person who owns a 10-year treasury bond will be making a profit of .28%. That means treasuries are now a worse investment than most money markets and CDs. For the average investor, there is no advantage to buying a treasury bond. A savings account at the local bank will give you the same rate of return and the same level of safety. More importantly, you’ll be able to get the money out anytime you want.
The Federal Reserve and Central Banks in China and Japan are buying treasuries for political reasons to prop up the US economy, not as an investment. The whole arrangement looks a lot like a pyramid scheme in which investment money is used to inflate the value of investments.
This also means that the Federal Reserve and other central banks are losing a vast amount of money through stimulus. The Fed has essentially been loaning out $85 billion in money it knows it will never get back each month. Obviously, no organization can keep that kind of lending up forever, as even Ben Bernanke has recently acknowledged.
How Will a Treasury Collapse Affect the US Economy?
The most likely effect of a treasury collapse on the US economy will be far higher rates of interest, particularly on mortgages. Mortgage interest rates are pegged to five- and 10-year treasuries. If the interest rate on treasuries collapses, banks will start basing the interest rate on mortgages on something else, such as the S&P 500. That will probably mean far higher interest rates on mortgages and fewer mortgages being issued.
It will also put the brakes on the so-called real estate recovery and economic recovery. If mortgages become hard to get, real estate will stop selling and property values will start falling. Instead of a real estate recovery, we’ll see another real estate crash as bad as that in 2007.
Actually, it could be worse because real estate was never allowed to truly collapse. We never hit bottom because Bernanke and his company stopped the fall with a net; well, now the net is starting to break. The Fed and the real estate industry artificially shored up prices. Part of the way they did that was to underwrite large numbers of questionable mortgages. News reports indicate that even some of those who went through foreclosure are now able to qualify for new mortgages under programs like HARP.
The real estate collapse will send the rest of the economy, including the stock market, falling back down. Instead of recovery, we could see a depression or at least a long period of economic stagnation.
How Will it Affect Average People?
The main effect of a treasury crash on average people will be to destroy property values. People who have most of their wealth tied up in real estate, which is much of the middle class, will see that wealth destroyed. Individuals who own treasuries won’t be able to sell them or they’ll have to sell them for pennies on the dollars.
The two best pieces of financial advice at this time are to not buy treasury bonds, period. Don’t invest in real estate right now either. Treasury bonds are simply a bad investment; if they were a good investment, there would be no reason for the Fed to be propping them up. Real estate prices are also artificial and propped up.
People with a lot of money in treasuries and a lot of real estate investors are about to take a bath. A better piece of advice right now will be to leave your money in cash because of the low inflation rate. If you can sell any real estate you own and cash out at the higher prices, then do it. If not, then hang onto the real estate you have and concentrate on paying off the mortgages. That way, when the bubble does crash, you’ll be able to pick up a lot of property at really low prices.
A lot of people will say “this won’t affect me because I wasn’t stupid enough to buy treasury bonds.” Don’t be so sure. A lot of banks, mutual funds, and investment funds buy treasuries. If you have a 401K or a mutual fund for retirement, check it right now and see how much of your retirement money is invested in treasuries. If you find a lot of those funds are in treasuries, it is time to find a new retirement investment.
You should also check what your parents and other elderly relatives have their money invested in, because many older Americans have a lot of faith in treasuries and view them as a foolproof investment. Those older people will be badly hurt by a treasury collapse. They could be left with no savings and no emergency funds.
Like it or not, average people are going to be affected by the treasury collapse. Some people will be affected more than others.
One good thing may come out of the treasury collapse, however. It might wake politicians up and get them to start questioning what’s happening at the Fed. Why is the central bank creating artificial bubbles like that in treasuries that help speculators put the funds of average people at risk? Perhaps we’ll finally get some real efforts to clean up the Fed out of such a nightmarish scenario.