History Lesson from Niall Ferguson

A couple of months ago, Niall Ferguson was asked to speak at the Ninth Annual Niarchos Lecture. Niall Ferguson is a famous historian from Harvard. He has written many books like the following: The Cash Nexus, War of the World, and The Ascent of Money: A Financial History of the World. When he speaks people listen; here are some of the points of interest from his speech (most bullet points taken directly word-for-word from Niall himself):

• There is a suddenness to things when they go wrong in finance
• Canada is one country that is NOT involved with the extraordinary debt increase that most of the rest of the world is experiencing
• Crises of either war or internal politics (sometimes both), drove investors to sell bonds and therefore to drive up the yields on the bonds
• Exploding deficits to pay for the war and surging public debts caused an increase in risk in the eyes of investors
• It is striking the way in which very suddenly confidence can be lost in a country
• Ken Rogoff made the point that 90% debt-to-GDP is the threshold after which public debt tends to be associated with problems of low growth or high inflation, usually both (currently we are at 89% debt-to-GDP)
  
• Italy is much less vulnerable than Greece in the respect that most Italian debt, like most Japanese debt, is held by natives; it's not actually held by foreigners
• In the months ahead, look for debt default synonyms like repudiation, standstill, moratorium, restructuring, rescheduling, etc...Don't be fooled by the language, it still equates to debt default
  
• US treasuries are a safe haven the way Pearl Harbor was a safe haven in 1941; safe but not for much longer
• Favorite cartoon: Chinese sub threatens the US Navy. The Chinese submarine captain is says, "Turn around or we sell all our T-bills!"
• When you're spending more on your debt than on your army or your navy, it's all over as a great power
• It's not a thousand years that separates imperial zenith from imperial oblivion. It's really a very, very short ride from the top to the bottom
  

US Treasury Market Looking Shaky

Take a look at the numbers below of a fairly recent 30 year US government bond auction, things are not looking good.

(Source: SeekingAlpha.com)

Out of the highlighted numbers two of them are particularly horrible; the Bid to Cover and Indirect. The bid to cover is calculated by taking the number of bids received divided by the number of bids accepted. Essentially the higher the bid to cover the higher the demand. In the bond auction community, a bid to cover of 2.0 or less is considered an auction failure, and we came very close to that.

Soft demand in a low bid to cover ratio is verified, as foreign demand for treasuries is falling. China recently sold about $35 billion worth of their treasuries, and Japan sold about $10 billion worth of their treasuries. Also, Dec 2009 was the worst sell off on record. Interest rates could be increasing in the near future at the worst possible time for the US because of the sheer amount of debt to be auctioned in the near term future.

Then the indirect number is high. An indirect bid is a bond bid that does not go through a dealer, and this is generally viewed as quantitative easing because there is no transparency in who is bidding. Nearly 30% of the winning bids came from indirect bidders. In the bond market community this is seen as the US govt purchasing more of their own debt with the intention of selling at a later time when demand is stronger.

Bond market is currently leaning more towards inflation instead of deflation. This could be largely because of the long term weakness in the US dollar. A good indication of confidence in the US dollar is shown in the price of the treasuries. If the chart was extrapolated five years in the past we would see that the current price level is what the price was in 2002.
(Source: Google Finance TLT quote)

Conclusions:
1. This decade we should see some serious inflation
2. Interest rates must rise to entice foreign buyers to take on the risk
3. This decade is going to be a horrible one for the US dollar's purchasing power; hyperinflation is probable
4. Quantitative easing will not slow down, but rather accelerate as demand lessens over time