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How Do People Destroy Their Capital?
How Do People Destroy Their Capital?
I have written previously about the interest rate, which is falling under the planning of the Federal Reserve. The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one here.
Artificially low interest makes it necessary to seek other ways to make money. Deprived of a decent yield, people are encouraged (pushed, really) to go speculating. And so the juice in bonds spills over into other markets. When rates fall, people find other assets more attractive. As they adjust their portfolios and go questing for yield, they buy equities and real estate.
Dirt cheap credit is also the fuel for rising asset prices. People can use leverage to buy assets, and further enhance their gains.
And it’s wonderful fun. A bull market, especially one that is believed to be infinite—if not Fed-guaranteed—seemingly provides free money. All you have to do is buy something, wait, and sell it. You can get your capital back plus something extra.
Many people spend most of this extra. This is their gain, their income. Their brokers, advisers, and other professionals also make their income off of it.
However, there’s a contradiction. Common sense tells us that it should be impossible to consume without first producing something. How can this be possible? How can an entire sector of economy get away with it?
It can’t. There is no Santa Claus. Something else is happening, something insidious.
The falling-rate-driven bull market is a process of conversion of someone’s wealth into your income.
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Credit Market Warning: Long-awaited signs of danger are materalizing
Look, we all know that this centrally planned experiment forcing financial assets ever higher is simply fostering multiple bubbles, each in search of a pin. As all bubbles do, they are going to end with bang.
I keep my eyes on the credit markets because that’s where the real trouble is brewing.
Today’s markets are so distorted that you can reasonably argue that there’s not much in the way of useful signals emanating from them. And I wouldn’t put up too much of a counter-argument. But it’s my contention that the bond market is the place to watch as it will provide the most useful clues that a reckoning has begun. And when these markets eventually return to earth, there will be blood in the streets.
While some may hope that rising yields are signaling a return to more rapid economic growth, or at least that the fear of outright deflation has lessened, the more likely explanation is that something is wrong and it’s about to get… wronger.
Rising Yields
Let’s begin with the first canary in this story, rising yields. The yield of a bond, expressed as a rate of interest, moves oppositely to its price. The higher the price goes, the lower the yield goes. The lower the price, the higherthe yield. Imagine the relationship like a playground see-saw.
Over these past few weeks and months, we’ve seen yields moving up quite a lot across a wide variety of bonds, at least in terms of the percentage size of the move (yes, the yields are still historically low by any measure).
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