Have you ever stopped to consider what the largest investment market is in the United States? If you said the stock market, then you are wrong by a long shot.
The correct answer is the bond market. The bond markets are so much larger than the stock markets as if the stock markets were only a few drops in the bond market’s proverbial bucket.
Bond markets have long been held as sacrosanct, considered by most people to be far safer than the stock markets. The unfortunate truth is that the bond markets are likely to be where the next crash occurs.
If this in fact proves to be the case, then it will be catastrophic for you personally, as well as for everyone who is heavily invested in bonds, especially for fixed income retirees who depend on these investments to survive. In the following paragraphs, you will read the disturbing reasons why the bond market is likely to be the next shoe to drop in the continuously unfolding economic crisis begun in the Great Recession.
Background for The Possible Fall of the Bond Markets
Many of you will no doubt shake your heads at this assessment advanced by Robert Kiyosaki. You wonder how it is possible that the U.S. bond markets could be sick and worsening in their condition by the day. The answer to this troubling question goes back to 1971.
It was in this year that you saw the U.S. led by then President Richard Nixon abandon the gold standard. The dollar ceased almost immediately to be an instrument backed by tangible value. Instead, it became an instrument backed up only by debt and the world’s faith in the ability of the American tax payer to repay the increasingly growing obligations.
These debt obligations have only increased in time until the year 2007. At this point, thanks to the arrival of the Great Recession and the monumental financial collapse, the American debt level jumped exponentially, going from a matter of only billions to more than fourteen trillion dollars in forty years.
It has become so bad that in mid May of this year, you actually heard Moody’s Investor Service come out and claim that the venerable United States government may soon see its much envied AAA credit rating, and that of the U.S. Treasury bonds, tested for the first time in the American century that began following World War I. This is no laughing matter.
A First Bond Market Downgrade
Moody’s will not be the first significant ratings agency in the world to downgrade the U.S. debt and bonds. You might wonder how anyone can know this. The answer is because the premier Chinese bond rating agency, Dagong Global Credit Rating Company, has already done this.
In late July of this year, Dagong dropped its AA+ rating of the U.S bonds and credit worthiness one notch down to AA. That still ranks above its opinions of Germany and Japan, which it holds at AA-, but it came along with a negative outlook remark. This signifies that they intend to downgrade U.S. debt even further in the coming months.
Why the Dagong Global Credit Rating Matters
You are possibly rolling your eyes at the news that a Chinese rating agency is the one that downgraded U.S. debt and bonds. This is not Moody’s, S&P, or Fitch after all, you say. Why should it matter at all what the Chinese think about the U.S. bond markets?
The disturbing response is that the Chinese are the world’s largest buyers of U.S. sovereign debt, better known as Treasury bonds. The value of American government bonds is dependent on more demand constantly appearing in the bond markets. Someone has to buy these new bonds to hold up the prices. This is because of the fact that the U.S. continues to issue new supply.
The Growing Supply and Demand Problem with U.S. Bonds
As supply in anything increases, and demand does not keep up pace with the mounting supply, then prices have no where to go but down, according to the law of supply and demand. This is why the increase in government spending that has only exponentially increased under the present administration is such a dangerous problem.
Government revenues are falling. This means that all of the new spending has to be paid for from increased amounts of debt. So more and more treasury bonds are being created and floated in order to finance the debt spending. It represents a ticking time bomb of disastrous proportions.
The Bond Market Crash Impact on Bond Holders
The possible resulting collapse of U.S. bonds will be especially bad for the holders of U.S. Treasury bonds. Countless American corporations and banks hold these, believing them to be guaranteed. Fixed income retirees collect these in their retirement portfolios, believing them to be supremely safe. Once they were. But if you see the bond market crash as a result of U.S. government debt downgrades, these IOU pieces of paper also known as Treasury bonds will become pariah.
Plummeting bond prices will be devastating for the retirees who depend on the income from these instruments and the gradual sales of them to finance their retirements. Banks have only recently come off of their sub prime real estate collapse and defaults too.
Imagine them having to now weather a severe deterioration in what they up till now believed to be their most trustworthy assets. The consequential damage to the U.S. financial system will be catastrophic. You thought bank failures in the hundreds were bad. Imagine closing banks by the thousands. If the bond market crashes, this will only be one of the unfortunate results.
The Bond Market Crash Impact on All Americans
As bad as bankrupt retirees and rapidly failing banks sound, this is only the tip of the iceberg for the way that average middle class Americans will be affected by the collapsing bond market. You might not be immediately clear on why this would be the case. Your average American middle class person is not holding significant quantities of U.S. Treasury Bonds, after all.
The relationship between Treasury Bond prices and rates are inversely related. Because treasury bond prices are high and stable, the government, and hence all Americans, are able to borrow money for ridiculously low interest rates. The government only has to pay between zero and point twenty-five percent interest on its massive debt now. But if the bond market prices plummet with the lack of demand to keep up with supply, the the interest rates will move the other direction, sharply higher.
You might wonder how much higher they could go. A sudden precipitous plunge in U.S. Treasury bond prices could send interest rates up to double digits, according to some economists. The effects of this would be devastating and widespread in their immediate impact. In order to fight inflation, the rising costs of goods and services, as foreign investors fled the U.S. Treasuries market altogether, the Fed would be forced to raise interest rates to match.
This would be necessary not only to fight off a sudden surge in inflation, but also a potentially crashing dollar value. The resulting rates that you pay for every form of debt, from cars to credit cards, to home mortgages, would skyrocket. Government services would have to be drastically reduced, as Washington was forced to spend the majority of its annual income on servicing the debt at the much higher interest rates.
This is not as far fetched as it might seem. Both the financial editor of the prestigious Financial Times of London and the former head of the IMF have painted this scenario as a specter likely to face the U.S. and its tax paying citizens in the near future.
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