Return-Free Risk

Bond market meltdown, housing begins to wobble, and what's that smell coming from the attic?

(Source: Getty Images)

Bill Bonner, reckoning today from Youghal, Ireland...

The force of a correction is equal and opposite to the delusion that preceded it.  

Given that the jackassery of the last 23 years was unprecedented in US history, so we can imagine that the correction will be also unparalleled.

Already, we have seen more losses in the bond market than ever before. As described yesterday, bonds have been going down in value since July 2020, with losses for the 10-year US Treasury bond of about 26% so far. That reflects losses from inflation (in the sense that the threat of inflation reduced bond prices)…but to get actual purchasing power losses for bond owners, you have to take off another 16% (that’s how much consumer prices have gone up since 2020) – for a total real wealth loss over 40%. (The math is a little tricky, because the inflation adjustment applies to the residual, current value, not to the face value of the bonds). 

Bonds are meant to be safe-ish sources of income. They’re not meant to be gambles or speculations. The US 10-year Treasury, for example, is supposed to be money-in-the-bank. It is considered ‘risk free.’ Banks were required to hold treasuries as financial ballast. Retirees relied on them for their old age. Insurance companies use Treasury bonds to make sure they can meet their obligations. This loss of real value in Treasury debt shakes the entire financial edifice…from the humblest credit card balance to $33.5 trillion in loans to the federal government itself.   

Unbalanced Sheets

So far, the losses are still on balance sheets…mostly unrecognized, sometimes hidden. Like the corpse of an aged relation whom no one bothered to visit, the horror of it has yet to be discovered.  

And the presumption remains, that if you hold to maturity, you won’t lose a dime.  This is like saying: if you postpone your visit long enough, it won’t really matter…you’ll have forgotten all about Uncle Harry anyway.

But you can’t ignore bonds losses. The feds are running $2 trillion budget deficits. One way or another, those deficits need to be covered, currently, not in the far-distant future.

Either higher interest rates bring forth more savings (and buyers of Treasury debt)…or more money-printing brings forth higher interest rates (as inflation expectations drive them up).  

Either way, money is on the move. Trillions of dollars’ worth of it. Some assets disappear entirely as debtors cannot repay. But much wealth simply changes hands.  The federal government, for example, must spend a lot more to cover its deficits.   But it’s not all bad news, from the feds’ point of view. Inflation reduces the real value of federal debt. 

Costs Skyrocket

Savers earn much more money. But borrowers struggle to keep up with higher financing costs. All up and down the great edifice of American capitalism cracks appear as adjustments need to be made. Zombies go out of businesses. Stock prices go down. Banks go bankrupt. Builders stop building. 

Just look at what is happening in the housing market. The average mortgage rate in 2020 was under 3%. Now, it’s 8%. Who can afford that? Not many people. Housing sales are now down to levels not seen since the Mortgage Finance Crisis of 2008.

While interest costs have skyrocketed and affordability has sunk, house prices have actually gone up! The average house buyer can no longer afford to buy the average house. So, the average builder stays home. Housing starts are down 25% in the last two years…back to where they were when John Kennedy was elected – when the US had 150 million fewer people.

The lay of the financial land has fundamentally changed. Oceans have appeared on what was recently dry land. Rivers have dried up. Great chasms have opened on the prairies and orchids bloom at the North Pole.

When you need to refinance loans, creditors want more interest. The US government itself is now paying five times as much interest on today’s debits as it did in 2020. 

Dirty Harry

When you send your children to college – tuition goes up with inflation. If you were planning to pay for it with the yield on bonds you bought in 2020, you will need six or seven times as many of them to pay for the same year of college expenses.

Bread, gas, rent…all go up. Ten years ago, you could have bought the median house with about $52,000 in household income. Today, you need more than twice as much. And the median household income is only $75,000 – about $40,000 short.

None of this is surprising. Or unsettling. It’s just what happens – normally – in a correction. And since the things in need of correction were abnormally large and malefic, so will the correction be abnormally severe and uncomfortable.

But there’s always more to the story…much more…which we’ll get to tomorrow.

In the meantime, Dear Readers are advised to check on Uncle Harry.

Regards,

Bill Bonner