Economy Slowly Ebbing in Rising Tide of Inflation

Two things, each going in the opposite direction, make the headlines repeatedly today—neither of which the Fed wants to see.

The Dow tumbled fairly hard today (-400), but the real news is the reason it fell. According to CNBC, the stock market’s most troubled day in over a month is happening because Treasury yields have been rising and competing with stocks. Treasury yields started rising when the Fed started lowering rates; and, according to John Rubino, there may be no surer sign of a bond vigilante rebellion. Or, as he put it, “Bonds don’t trust the Fed.”

When the Federal Reserve cuts short-term interest rates, long-term rates generally fall in tandem. But since the Fed’s “shock and awe” 50-basis point cut in September, bond yields have spiked….

Bond traders appear to doubt the Fed’s ability to lower rates and hold inflation in check. That’s bad in the long run since the only thing that gives value to a fiat currency is the market’s belief in central bank omnipotence.

[(As I wrote yesterday, it will be the Fed’s mismanagement of its fiat money that does the dollar in, not some rising-star competitor. That will most likely happen because the Fed loses trust, but there won’t be some other currency that has risen to take its place. More likely a move toward gold and silver.)]

Until long bonds pay more, maybe substantially more, many will just stay in Treasury bills, which pay 4.5%. The 4.25% that 10-years currently pay is way optimistic about future inflation. Precious metals markets involve way too many other variables, and aren’t really big enough to provide the liquidity money managers demand. Without that liquidity, they will lose significant amounts just buying or selling.

For retail investors buying and selling gold coins, it’s even worse. If you buy a Krugerrand today and sell it tomorrow, without any price change, you will lose 5% of its value, because that’s the gap between what dealers will buy and sell at. Whereas any given money market mutual fund will cost you nothing to get in and out of. The value going in and coming out is the same: $1. And unlike gold, money market funds (Invesco, Fidelity, et al) will pay you at least the current T-bill rate, about 4.5%.

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