US Treasury Speculations & Treasury Bonds

by Wes Bridel on September 24, 2010

in Stewardship

The US Treasury issues Treasury Bonds, but if the value of the Dollar drops because of all this borrowing (and printing by the Fed), your Dollar could be worth much less soon.  We’ve been discussing asset management in a crazy economy.  We last looked at International Investing as well as Blue Chip Investing.  We believe this trend will be one of the most important in the coming decade.  If so, Treasury Bonds (and other bonds) will drastically lose value. 

The US Treasury & Fed (along with Congress & the White House) could be doing irreparable harm to your financial well being.  But there are ways to protect yourself.

If you believe that higher inflation is on the horizon, there is a way to protect your assets and even profit directly from this understanding.  We believe a massive devaluation of the US Dollar is coming (we’re just not sure when it will begin) and therefore is the most important economic trend for you to be on the correct side of if it does indeed happen.  We’ve mentioned the fact that gold and silver do extremely well at protecting value in times of inflation.  Gold and silver should always be your first and second choice when protecting your assets from inflation!  Commodities and other “hard/real assets” do as well.

We’re going to cover two different way to use Treasuries to either somewhat protect yourself from this danger of inflation and rising interest rates or to go a step beyond and profit from a speculation of this event.

Let’s first explain what Treasuries are and how they work…

Treasury Bonds, Notes, & Bills are the instruments that the US Government uses to borrow money through the US Treasury.  The US Treasury has an auction at which they receive money from investors/lenders who then receive a promise of future dividend payments and a return of premium at some point in the future.  The demand (competition) from investors/lenders at the auction, will determine how high or low the interest rate on these bills/notes/bonds is.

A Treasury Bill is for a duration of 1 year or less.

A Treasury Note is for a duration between 1 and 10 years.

A Treasury Bond is for a duration between 10 and 30 years.

For many decades (perhaps not including the 1970’s) the United States Dollar has been considered the safest currency in the world and has thus enjoyed the lowest rate of interest demanded to borrow money.  But this rate is established at an auction.  Recently, the auctions have been quite busy because the US Government is borrowing unprecedented amounts of money.  We won’t spend much time here the many reasons why lenders could demand a higher rate of interest from the US Government.

We will state the greatest reason why staunch deflationists believe that the incredible printing and borrowing of money won’t result in inflation.  They believe that the economy will crash to such a degree that people will be fearful and look to put their money where they feel is safe, which for everyone’s life has been the US Dollar.

Still, we don’t believe that just because many other major currencies are bad, people will continue lending money at very low rates of interest to the country which has the largest debt in the history of the world and no real or imagined plan to ever pay it back.  (Even the Congressional Budget Office’s numbers which looking back historically have tended to be wild eyed optimistic, say that our debt will continue to grow massively over the coming decade.  When you look through their assumptions, the huge growth in government income assumed in a time of terrible economic activity makes it clear that the reality will be far bigger debts and deficits…..and interest rates.

As interest rates go up, the value of bonds outstanding goes down.  Let’s look at an example.  Imagine I own a bond that pays 4% interest and the going rate increases to 5%.  If you wanted to buy a Treasury bond, and I wanted to sell mine, would you buy mine paying 4% or would you buy the newly issued one paying 5%?  Of course, you would buy the 5% bond unless I accepted less than the face value (principle) of the bond.  Therefore, if I had bought my bond with $100,000 and received one interest payment, to only then sell the bond to you at $90,000 because of the change in interest rates in the market, I would have lost money on a guaranteed bond.

In the next post in this series, we’ll look at how and why this works and what the ramifications are to you.  If you have any thoughts or questions on this or other topics, please let us know.

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