The Next Contagion

by Martin D. Weiss, Ph.D. 02-01-10

The next contagion is beginning to spread around the globe.

It is unexpected on Wall Street, misunderstood in Washington — and very dangerous.

It could sabotage the plans of the U.S. Treasury, the Federal Reserve, and many of their counterparts overseas.

It is …

The Collapse of Sovereign
Government Bonds

This is certainly not the first financial contagion of recent memory:

Back in 1997, we witnessed a currency contagion —hatched in Thailand, spreading quickly to the rest of Southeast Asia … smacking Russia in the gut … and sinking a major player in the U.S. derivatives market.

Then, 10 years later, came the debt contagion —incubated in a subsector of America’s mortgage market … soon infecting nearly all credit instruments … striking Wall Street like a sledgehammer … and mortally wounding the global financial system.

Those contagions were bad enough. Now, however, the contagion is beginning at a much higher level, in the most important financial instruments on Earth — long-term bonds issued by sovereign governments.

The Saga Begins in Greece

Just 116 days ago, on October 8, Greece’s benchmark 10-year bond was selling for 112.295. Today, it has collapsed to 92.13.

And the drama of its yield surge is even more striking — from only 4.41 percent to 7.14 percent, a jump of more than 60 percent in less than four months.

Coincidentally, I was in Greece not long ago, visiting the origins of Western democracy.

If a local soothsayer had told me that the next global debt contagion would begin there, blocks away from the Pantheon, I would have been incredulous. Yet that is precisely what has just happened in recent weeks.

Already, this contagion is spreading to other countries …

Portugal’s 10-year government bond reached a peak on December 1, 2009, just 62 days ago. And now it has also started to plunge virtually nonstop, with its biggest declines registered late last week.

British government bonds (gilts) are equally vulnerable.

Sovereign bonds in Spain, Japan, and other major deficit nations are also starting to get hit.

Next Victim: U.S. Government Bonds

In the global competition for investor funds, U.S. Treasuries are typically viewed as the “least ugly.” So global investors have usually been willing to pay a relatively higher price for them, grudgingly accepting lower yields.

This helps explain why U.S. government bonds have not been among the first targets of the contagion. But that does not protect them from becoming one of the next targets.

Indeed …

• The U.S. government suffers from the same, or worse, underlying disease as Greece, Portugal, or any other victim of the contagion — massive, out-of-control federal deficits. America’s red ink was $1.4 trillion last year and ANOTHER $1.4 trillion this year.

• Washington has buried its head in the same mound of sand as Athens and Lisbon — grossly underestimating (a) the size of the deficit, (b) its potential impact on investor confidence, and (c) the speed by which its bond prices can fall.

• Like his counterparts in Athens and Lisbon, President Obama ignored advisors who warned of a deficit disaster and has only just begun to seriously consider deficit-reduction measures. And yet he continues to avoid steps that can make a significant difference.

Specifically …

The president supports a commission to study deficit reduction (rejected by the Senate last week) … but the commission’s recommendations would be nonbinding with no clear process in place for implementation.

The president has proposed a freeze on some domestic spending, but the freeze will impact only a small portion of the budget, would not kick in until next year, and would include a mix of spending cuts and spending increases. It would have zero impact on the 2010 deficit and little impact on future deficits.

The president has promised to give TARP funds back to taxpayers, but has also proposed applying unspent TARP money to community bank lending — another lost deficit-reduction opportunity.

The president supports “pay as you go” rules for Congress — requiring new spending to be balanced against spending cuts or revenue increases. But the devil is in the details. If the rules have no truly sharp teeth, they will be ineffective.

My view: If the deficit was just $200 billion or even $300 billion, I might support and even applaud these small steps.

But in the context of back-to-back $1.4 trillion deficits and in the face of a looming bond market collapse, they represent barely more than too-little-too-late tinkering.

The Consequence of
This Complacency
Is Catastrophe

Sadly, although most advisors on the Obama team are now more conscious of the rising political tide against Washington bailouts and deficits, they not yet see the approaching tsunami arriving from Greece.

Money and Markets’ Mike Larson explains the situation this way:

“Imagine what would happen if Uncle Sam’s borrowing costs shot up like they have in Greece — by 60 percent! Imagine what that would mean for the cost of car loans, mortgages, and other products whose rates track Treasury yields! And imagine the impact on an economy still struggling to recover from the Great Recession! This is the next big story that few people are talking about.”

He’s right and he has been warning about it tirelessly.

But, alas, unless the Obama administration and Congress can somehow ax the budget or find a new gusher of revenues — both extremely unlikely anytime soon — collapsing U.S. bond prices and sharply higher long-term interest rates are unavoidable.

Like we saw during the contagions of 1997-98 and 2007-09 …

• Confidence in vulnerable investments — this time, long-term U.S. government securities — will suddenly collapse. Then, it was certain geographical regions or market niches. Now it’s threatening the CORE of our national essence.

• Investors will yank their money out in great haste …

• The avalanche of selling will drive ALL bond prices — government, corporate, and municipal — into an uncontrollable swan dive. And …

• The contagion will spread to any country on the planet that has the same obvious vulnerability to the disease — massive federal deficits.

There is, however, one outstanding silver lining in this new crisis: Sinking government bond prices — bringing surging costs for government borrowing — are the single most powerful market mechanisms for persuading governments to end their print-and-spend madness.

Provided we don’t fall again for the false promises of politicians — and provided we are willing, as a nation, to make the needed sacrifices — there IS still hope for America.

That’s one reason I don’t recommend you abandon the safety of Treasury securities. Rather, all along, I’ve made it clear the real concern is not with ALL Treasury securities. It’s strictly with longer term Treasuries.

The other reason is that shorter term Treasury notes (under a couple of years in maturity) are far, far less vulnerable than the longer term variety.

And U.S. Treasury bills (always shorter than one year) suffer virtually no price declines, even in the midst of a bond market collapse.

So stick with them. Yes, I know. Their yield is miserably low. But they still provide the world’s best safety and liquidity.

Just make sure you avoid all longer term notes and bonds — whether government-issued or not. When the market price of bonds declines, so does your principal value. And because of that loss in principal, any extra interest they might pay you could be wiped out in a heartbeat.

Good luck and God bless!

Martin

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About Money and Markets

For more information and archived issues, visit http://www.moneyandmarkets.com

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Marci Campbell, Amy Carlino, Selene Ceballo, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

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I am so worried about this.........................

Kaya betul orang cina di China

........ Many economists argue that Chinese people are culturally bred to be heavy savers. They say that Chinese tuck away 40% of their incomes and refuse to buy on credit. But that just isn't true anymore.

It is true that Chinese over the age of 50 often save 50% or more of what they make, because they worry about soaring medical costs and weak pension systems. However, younger Chinese like to spend. China's traditional high savings rates are more a function of poverty than of a cultural aversion to spending. The lack of buying on credit results more from a weak consumer finance system than anything else.

The number of credit cards in use in China rose from 13 million in 2005 to 180 million by the end of 2009, and that growth was fueled largely by younger consumers. Despite the financial crisis, we expect the number of cards to grow 25% a year for the next three years, as consumers demand them and the financial system becomes more consumer-oriented and less reliant on servicing state-run enterprises.

We have interviewed several thousand Chinese under the age of 32 in 15 cities about savings. Our findings suggest they have savings rates near zero. A combination of optimism about their futures and impatience to enjoy life now leads many to buy on credit.

Take Anna, a typical 24-year-old Shanghai woman we tracked. She earns $700 a month as a marketing analyst and has three credit cards. She lives at home with her parents, who provide her food and housing. Because she has few costs at home, she spends her entire salary "enjoying life." She dines with friends in restaurants like Yum Brands' Pizza Hut (a higher-end chain in China than in the U.S.) and gets pedicures weekly. She buys cosmetics from Estée Lauder and clothes from Zara and Uniqlo. She has a cracked Apple ( AAPL - news - people ) iPhone. She travels twice a year on vacation, both within China and abroad to places like Malaysia. She saves nothing, because, as she says, "I want to enjoy life now before I get old. My salary keeps rising, and spending will help me get the career I want."..................

adapted from .... china-myths - forbes.com

Kaya betul mereka ni, optimisnya mereka sampai tidak fikir jika berlaku masa susah, belanja dan terus belanja. Hebat betul polisi kerajaan China sekarang sehingga boleh rakyat mereka rasa sentiasa senang. Kita orang muda di sini, nak pergi melancong domestik pun fikir 3-4 kali nak pergi ke tidak.

Wake up.......

Bila DNA kita diceroboh....

Filem sci-fic ni dah lama keluar, sejak 2007, tapi hari ni baru kesempatan nak tengok. Ceritanya agak menarik dengan penggunaan cgi and whatever special effect bla..bla...bla... tapi jalan ceritanya yang agak membosankan skit (skit jer la). Isu yang menarik minat aku nak tengok is about "DNA hacking". Aku masih memikirkan lagi, adakah isu ini akan wujud pada masa hadapan. Is that can be realised?, if yes, we all in great..great trouble.

High cost of living - are we ready?

Be Prepared For Higher Cost Of Living, Says Mahathir

KUALA LUMPUR, Jan 19 (Bernama) -- The people must be prepared to pay higher prices for goods and services if they want to enjoy higher incomes under the proposed New Economic Model, former Prime Minister Tun Dr Mahathir said Tuesday.

He said that the cost of living would have to go up under high income economy as the government too would have to increase taxes and reduce subsidies.

"Without the cost of living going up, you cannot have higher income," he told reporters when asked to comment on the New Economic Model. OF COURSE!

"For the government, it is the question of increasing taxes and reducing subsidies. Then the government will also have the money to pay their staff higher wages," he said after a signing ceremony between Petronas Lubricants International and Proton Holdings Bhd here, today.

"GOVERNMENT CAN PRINTING MONEY, BUT HOW ABOUT 'RAKYAT'?."

Nevertheless, Mahathir said a higher income would also enable Malaysians to purchase more as the income increase would be greater than the increase in the prices of daily necessities. -------> INFLATIONARY PRESSURE!!

"LOW-INCOME EMPLOYEE SUFFERED"

He also said Malaysians should not complain of price hike in goods and services as the country had the lowest price for almost everything, compared with even the neighbouring countries.

"Even most of the oil producing countries sell their petroleum products at a higher price. So if the people want to have higher income, they must accept paying more for whatever they buy," he said.

Mahathir said the government was also studying foreign direct investments that could help generate higher income via industries with greater value-addition, adding that this was how high cost countries in the world could remain competitive despite expensive labour.

"We're not going to be as costly as some of these developed countries, but we will need to accept that we have to pay more in order to enable the producers to pay higher wages," he said.

-- BERNAMA