Please note that The Capital Spectator will be unavailable for a few days. We’ll return on Monday, August 23.
►The Great American Bond Bubble
Jeremy Siegel and Jeremy Schwartz/Wall Street Journal
A decade ago, we witnessed the most significant bubble in U.S. stock market history during the Internet and technology frenzy, where many tech stocks traded at over 100 times earnings. The consequences were predictable: numerous high-flying stocks plummeted by 80% or more, and the Nasdaq is currently valued at less than half its peak from a decade ago. Today, another bubble is forming, potentially posing even greater risks for investors—this time within bonds, particularly U.S. Treasury bonds.
► China Reduces Holdings of Treasury Debt in June
Martin Crutsinger/AP
In June, China decreased its holdings of U.S. Treasury debt for the second consecutive month, while the holdings from Japan and Britain increased… These debt statistics are under close scrutiny, especially as the U.S. government racks up unprecedented annual deficits. A decline in foreign investment could lead to rising interest rates in the United States.
►China Hiding Treasury Purchases
Derek Scissors/Heritage Foundation
Reported U.S. Treasury bond holdings from China sharply declined again in June, now nearly $100 billion lower than they were in July 2009. Many in the media consider this significant, but it’s not necessarily concerning. Notably, American interest rates have not soared; rather, they remain at historical lows. This stability can be attributed to two factors: First, contrary to popular belief, U.S. interest rates are not heavily influenced by China. Second, over the same period, reported British holdings of U.S. Treasuries surged by $265 billion. Why would the UK increase its holdings by 273% in 11 months while Treasury yields are close to zero? The answer lies in China’s State Administration for Foreign Exchange (SAFE), which has an office in London. Purchases made through this office are initially recorded as made by Britain, not China, allowing SAFE to reduce China’s visible reliance on the U.S.
The president of the Minneapolis Fed, Narayana Kocherlakota, elucidated in a speech yesterday why deflation is a possibility, albeit an unlikely one. Toward the end of his address, he outlined the concerns: “I previously mentioned that inflation has recently been around 1 percent. This data has raised alarms for some regarding the potential for a prolonged period of declining prices—known as persistent deflation. However, I do not consider this scenario likely. It would necessitate the FOMC making the uncharacteristic error of neglecting long-term factors in their efforts to address short-term issues.”
In a recent interview with Morningstar, Roger Ibbotson discusses the critical importance of liquidity (or the lack thereof) as a distinct risk factor in equity investing.
This August, economic anxiety is affecting volatile assets significantly. A summary of major asset classes thus far shows a distinct trend: bonds are appreciating, while stocks, REITs, and commodities are declining. High-yield fixed income has also suffered losses on a price basis up to August 16, as highlighted by the representative ETFs in the table below.
Is the current surge in risk aversion merely speculation? Absolutely not. There are fundamental factors at play that are creating new obstacles for economic recovery. Central to this issue is the decline in inflation expectations. A series of posts from May raised questions about whether these emerging warning signs were merely transient. After three months, it has become evident that the economy is facing renewed struggles for reasons that are unlikely to resolve quickly.
►Bank Loans: Still Contracting
Data from various sources indicate a continued decline in the number of loans banks are issuing to businesses. This contraction appears to stem from both supply and demand: banks are providing less credit while businesses are seeking less. This restriction of credit may be a critical factor hindering the current recovery, especially for small businesses that depend on bank loans to finance operations, capital investments, and growth.
►In a sluggish economic summer, no easy fix ahead
“You cannot compel individuals to take out loans or to spend money they do not wish to spend,” states Alice Rivlin, who served as the Fed’s second-in-command in the late 1990s.
Retail sales showed a modest increase in July, and consumer prices also advanced, providing valuable counterarguments to the late-deflation narrative. However, a deeper analysis of the data reveals plenty of room for debate regarding the economic outlook. Financial ‘beggars’ can’t be choosers, so while the latest numbers are a welcome sight, they are hardly cause for celebration.
For several months, the situation has remained stagnant. This was concerning enough, but recently it has begun to rise, raising fears it could escalate further. The latest update on weekly jobless claims reveals that new applications for unemployment benefits increased to 484,000 last week—the highest level since February.
Does high debt hinder economic growth? Or is high debt a consequence of other catalysts leading to recessions? This is a pressing question that needs answering.
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