Think of it as the early rumblings of thunder preceding the storms that will eventually explode into a tornado. The more lyrically-minded might see visions of a single butterfly flapping its wings somewhere off Bora Bora, creating the tiniest of ripples on a glasslike sea and setting in motion the eventual tsunami that will wreak havoc many thousands of miles away. That was the role of the bond market yesterday, as the yield curve—the difference between yields on the Treasury’s two-year and ten-year notes—expanded to 2.75 percentage points, their widest differential ever. That’s right—ever. Thus did the bond market herald the inception of the developing inflation tidal wave created by out-of-control spending and ever-yawning budget deficits.
As part of the stimulus/recovery package, the Fed has been buying up massive amounts of Treasurys as well as mortgage-backed securities. But as the grim reality of delusional social-realignment programs and trillion-dollar deficits emerges from the dissipating post-election rapture, it is becoming clear that the government’s printing presses will have to keep spinning at dizzying speeds around the clock to fund both the stimulus as well as future outlays as the government either nationalizes or “reforms” anything that moves or breathes—financial institutions, autos, healthcare, markets, energy, credit cards—the list grows by the day. The money has to come from somewhere, and not even fleecing the “wealthy” will cover the cost of recasting the nation in the Obama vision. No, the government will have to continue to sell massive amounts of Treasury bonds, although it is no longer clear who will be lining up to buy them as the world begins to lose faith in robustness of the dollar and the ability of the U.S. to control unthinkably profligate spending in its quest for a utopian society—or at least one that more resembles Europe’s mildly-modified socialism.
Ah, supply and demand, one of the myriad simple economic laws that for some reason appear to exist beyond the grasp of an Obama administration chock full of Harvard graduates and Nobel laureates: When supply outstrips demand, prices fall. The burgeoning surfeit of Treasury securities is beginning to overwhelm the demand for them, so the price goes down and the yield rises. This will make it even more expensive, of course, to kite this bacchanalia of government growth, influence, and power over its citizens. So investors shun and abandon long-term paper, with its open-ended inflation exposure, and seek safe haven in short-term securities. That’s how the yield curve steepens.
And so the vicious cycle continues: The more the administration proposes to spend, aided and abetted by congressional cohorts, the more funds the government will have to raise at increasingly disadvantageous terms. Higher Treasury rates will, of course, push up interest rates across the board. Attention, Obama acolytes: It’s called inflation, and it is a cancer that eats away at a nation’s economic well-being and social fabric. Go and ask nearly any Latin American or Eastern European country.
(Particularly puzzling is the role of former Fed chief Paul Volcker in all of this. Standing both literally and figuratively a head above the rest of the financial experts lined up behind Obama during his first press conference, Volcker is justly revered for his role along with Ronald Reagan in cleaning up the economic mess and runaway inflation created by the Carter administration. Here is the great inflation-tamer of the early ‘80s with first-hand knowledge of the ravages of 20% interest rates. Has he really signed on to all of this, or is he simply too embarrassed to abandon ship?)
In fact, it’s already happening here with mortgage rates, which have risen significantly over the past week in spite of the administration’s pledge to pursue policies that will help revive the moribund housing market. It looks like somebody has failed to think it through—to connect the dots—perhaps to even consider the law of unintended consequences. That’s precisely what happens during an unchecked frenzy of opportunistic political activity, an effort to ram through a radical anti-capitalist and ultimately undemocratic agenda under the guise of meeting the challenges of a national calamity. It’s otherwise known as the Rahm Emanuel school of governance, the tenets of which admonish politicians to “[n]ever allow a crisis to go to waste.”
As noted before in these columns, it is a governing style that relies on the ability to evade or ignore the rule of law, the bedrock principle upon which the nation was founded. A severe economic crisis, coupled with an irritable electorate and sycophantic, uncritical news media, provides just such an opportunity. In its rush to reform the role of government, “reset” the country’s relationship with adversaries, and repent for the sins visited upon the world by an insensitive and uncaring America, the new administration is making the most of it.
The administration’s casual disregard for the rule of law was on vivid display in its treatment of Chrysler’s secured bondholders who, for the sin of demanding to be repaid, were vilified by the president as “a small group of speculators” who jeopardized the entire bankruptcy plan. However, last week the identity of some of these “speculators” was revealed by Indiana Treasurer Richard Mourdock, who announced that Indiana’s police and teachers pension funds had lost millions in secured Chrysler bonds as the result of a plan “which is fundamentally wrong and a dangerous precedent to the capital markets.” Mr. Mourdock noted that these retirees should have been first in line but instead were sacrificed to the interests of the White House-protected UAW. As a result, Mr. Mourdock vowed, he will prohibit any state fund for which he is responsible from investing in the securities of companies that receive federal bailout funds. “The risk,” he noted, “is too great for any prudent investor to accept.”
Finally, Mr. Obama evidently looks to infect the Supreme Court with the same disdain for the law as his administration has demonstrated, at least based on his pick for the upcoming Supreme Court vacancy. Several years ago in a speech at Berkeley nominee Sonia Sotomayor stated: “I would hope that a wise Latina woman with the richness of her experiences would more often than not reach a better conclusion than a white male who hasn’t lived that life.” She’ll never have to worry about being labeled a strict constructionist.
Steven M. Cohen is a money manager based in New York and has spent more than 25 years in the hedge fund business. He writes the blog buyselljump.com.