Last week, Fed Chairman Ben Bernanke made a speech in Chicago where he warned that a long period of interest rates could lead to asset price bubbles or speculative lending ending in a new financial crash. Sadly, Bernanke is like a general fighting the last war. He’s worried about another banking crisis, fearful of another bubble caused by bank lending while low interest rates and Fed manipulations have already led to a new bubble. It’s in US Treasuries, where interest rates are at record lows.
How many articles did we seen over the past month about how smart money had abandoned gold for risk free US debt? However, consider this about what the so-called smart money is doing.
Thursday last week, the Financial Times carried an article that should be an eye-opener to investors. The article was titled US Treasuries suffer brain drain as universities ditch their holdings.
The first sentence read:
Some of the smartest money in America is getting out of US government debt.
The article noted that many university endowments have scaled back their holdings of Treasuries from as much as 30% in 2008-2009 to zero in some cases. According to the Times, one expert said, “Now everyone (university endowments) is holding less than 5%.”
According to the article, Princeton’s $17 billion endowment converted its Treasuries to cash; Duke’s $5.5 billion has gone from Treasuries to high yielding stocks; Cornell’s $5 billion endowment decided to reduce its Treasury holdings to just over 3%; and, as of June last year, Yale University’s $19 billion had only 4% of its holdings in Treasuries.
This action has to portend problems for the Treasury Department and the Fed. If such Establishment notables as our nation’s premier universities’ endowment funds do not want to buy US debt, will other foundations follow suit? If so, who will buy the Treasury Department’s debt issues? The answer, of course, is the Fed, which has the ability to create unlimited money.
Already, though, the Fed is buying $45 billion of Treasuries a month in addition to the $40 billion in mortgage debt it’s purchasing. That’s at an annual rate in excess of $1 trillion in new money creation. This buying, according to JPMorgan Chase, effectively absorbs about 90% of net new dollar-denominated fixed-income assets.
Somewhere down the line, price inflation will set in and lenders (except the Fed) will demand higher interest rates, which–as all professional money managers know–will result in bonds sinking in value. At the first sign of higher interest rates, there will be a massive run for the door in Treasuries, with the Fed being the only buyer. At that time, the dollar will take a huge hit on the Forex markets and gold will soar. There is no good end to the game the Fed is playing.
Rightly so, Bernanke needs to be worried about another financial crisis, but he should also be aware of another dangerous game that he is playing with interest rates at next to zero for an extended period of time. Alan Greenspan’s artificially low interest rates gave us the housing bubble. Bernanke’s artificially low interest rates appears to have given us a Treasuries bubble.