At 10/14/12 11:40 PM, TheMason wrote:
When I spoke of deflation...I meant of the value of the dollar not the cost of goods. A devalued/deflated currency can lead to inflated costs of goods...kind of a double edged sword.
Deflated and devalued are not interchangeable terms. Simply, deflation occurs when the supply of money and credit decreases relative to the supply of goods and service. Devaluation is a reduction in the value of a currency with respect to those goods and services.
You're correct. Some treasury bonds have fixed rates which means that they earn a fixed percent. Now if the dollar's intrinsic value decreases China and other bond holders are getting hosed because they are receiving money that is worth less then as it was when they purchased the bond. Think of it this way: you're the Emir of an oil rich Persian Gulf country and OPEC has set the price per barrel at $100. But then QE3 causes the value of the dollar to decrease by 10%...so now your $100 only buys $90 worth of stuff. Each barrel of oil still produces the same amount of gas, diesel, lubricant and/or plastics...so your product's value has not gone down. So are you going to trade your products, whose value is unchanged, for the same amount of a devalued currency? No; you're going to raise the price of your product by 10% to $110 to compensate.
And so is everyone else. However, if you've bought a $100 Series EE Bond at 4.6% interest when you go cash it in you're going to get $104.60 (assuming you've only held it for that year)...which will only buy you $94.14 worth of stuff. You're in a worse position than you started! Even though you have 4.6% more dollars than you started...it's worth less.
Okay but you've yet to demonstrate to me that inflation is somehow going to make China go batshit insane and control America or whatever? US Bonds have been exceptionally cheap since 2000, and the Chinese government has needed a stable investment. The increased budget deficit because of TARP, bailouts, and stimulus in the US gave them more bonds to buy, as well. However, it's not like they were just swimming in money and gobbled up our bonds; the Chinese government knew that American bond purchases would continue to keep American markets open and lending to American consumers who buy their goods moving. And like I already noted, US bonds are also an extremely stable and return-generating investment for anyone holding them (their government). China's currency (the Yuan) gives it a pretty significant advantage in exchange rates; its labor costs are remarkably low, they have an incredible integrated supply chain and material transportation infrastructure. Many of the companies that are based there are neither American nor Chinese, but entirely multinational. The CCP has enough sway in commercial banking and national regulatory management to shape their industrial policy in ways we cannot. This is not a simple problem with an easy explanation, and is only distantly related to jobs/recession or to spending/debt, and is not the result of a rouge Chinese economic insurgency or what have you.
Now Series I bonds have a fixed and variable interest rate component. The problem is deflation can wipe out the fixed rate's return.
Uhh no, devaluation will do that, not deflation. The only scenario in which this will happen is some runaway hyperinflation scenario which is virtually impossible. Please demonstrate to me projected inflation rates and show me how much it will cut into China's profits adjusted to inflation.
Also you have T-Notes which are considered safe investments with a fixed interest rate. The problem is since it is safe; the interest rate is not going to be all that great. It is designed to keep up with inflation at that time period. Now if inflation increases, especially b/c of the devaluation of the dollar, when you go and cash these bonds in you will have more than you started. However, now since the dollar buys you less...you are in a worse position than you started.
Except the real interest rates are actually negative. A negative interest rate means the interest rate is lower than the rate of inflation. TIPS are bonds that pay a fixed coupon rate, but adjust the principal based on the movements of the CPI. Let me just demonstrate how this works so other readers know what the hell this technobabble means.
Let's say you're buying a $1000 bond with a 10% coupon rate (a coupon rate is the interest rate that the borrower pays the lender). YouâEUTMd get $100 per year in interest. Now let's say hypothetically that the inflation rate is 5% over the course of that year. The principal ($1000) is adjusted to $1000*1.05 = $1050, to reflect the inflation. The 10% coupon rate is now worth $105 per year. The coupon rate is adjusted to inflation as well.
All Treasury securities are issued via auction. The interest rate is determined by the price that the buyers are willing to pay. For example, if buyers are demanding a high interest rate on the bond, theyâEUTMll be willing to pay less than the principle. Here's how that would work:
Let's say IâEUTMm auctioning $1000 bond with a 10% coupon rate and 1 year maturity (maturity is when the bond expires and pays out), and the market is only willing to pay me $990 for it. It's demanding a higher effective interest rate. So in this scenario, I would be forced to lend out $990. I get paid $100 interest (note: coupon payment is based on the coupon rate and the face value, the selling price). At the end of the year, I get the $1000 back (again, I don't get only $990 because the selling price isn't what matters in this case, it's the face value of the bond). In this scenario, this is how you would calculate the actual interest rate: ($1000 (face value of the bond is what's owed to me, not selling price) + $100 (amount of interest) - $990 (how much I loaned)) / $990, which would be 11.11%.
The exact opposite of this is happening with US bonds. The buyers of the bonds are willing to accept a negative interest rate on their investment, which means they're willing to pay more than the face value of the bond. Using an interest rate of -1.36% (the 5-year quote for 9/5), a face value of $1000, a maturity of 5 years, and a bond valuation formula, we get an auction price of $1006.83. That means, currently, people are willing to pay the US Federal government $1006.83 under the stipulation that the Federal government would pay them $1000 in 5 years. The Treasury is also considering selling government debt for negative interest rates since its T-Bills (which have an essentially zero interest rate) are being bought as fast as they can offer them. People will literally be paying $101 today for $100 in 5 years time. This is a perfect time to spend money to get us us out of this hole we are in. People would not be doing this if they had the same fears you have. There's essentially zero fear of high inflation rates. China understands this as well as the US markets do.