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Thursday, December 16, 2010

Bonds, Cost of borrowing is the heart of all finance

The stock market, derivatives, real estate, natural resources, and the host of other financial instruments put together does not compare to bond interest rates.

True, unregulated derivatives markets total over 600 trillion, and they alone could destroy the world economy. But bond interest rates is the foundation of the solvency of most countries, corporations, and citizens.

The cost of borrowing for a day, 1, 5, 10, 20, and 30 years is the lifeblood of the economy. Credit, not cash, is where the real action is at.

Americans have enjoyed a relatively stable US bond market for about 25 years, after my favorite Federal Reserve board chairman, Paul Volcker, used the federal reserve bank to tame the markets back in 1981. He did this by RAISING rates to control credit creation and inflation.

Unfortunately, after Mr. Volcker we got Greenspan and Bernanke, who have used their position to use monetary policy to blow financial bubbles in stock markets, real estate, banks, and now resources.

The counter to such wreckelss monetary policy is the US treasury bond market. The rates paid for the government to borrow is the basis for much of private borrowing costs.
The US has enjoyed a DECLINING cost in borrowing since about 1985. Recently bond rates have been accelerating at a rapid rate. If rates break the trend line established back in 1985, we will be in new territory. It doesn't mean the financial world comes to an end.

But it DOES mean we are in a new financial world. The cost of debt will be on the rise for the first time in 25 years. The implications of impact are enormous.

The first chart is bond rates since World War 2 to today. Notice once Volcker tamed bond rates, and Greenspan/Bernanke took over, rates have been on a trend lower.

The lines represent experienced trading channel during this time. A brake of the trend line signifies a NEW trend. The second chart is from bigcharts.com, depicting 30 year rates since 1994, for a closer look.
We are possibly weeks away from witnessing a shift in American debt cost, one that years from now will have meaning, and currently will be noticed by very few.

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