Saturday, February 2, 2008

A Graveyard for Capital

"The [Fed's] unexpected inter-meeting cut of 0.75% in the Federal Funds rate to 3.5% was accompanied by a sharp rally in the dollar bond market, as the 10-year Treasury bond yield dropped to 3.4%. With inflation well above 4% and rising, one can only ask why? ... A 3.6% return is wholly unacceptable in a currency suffering from 10% inflation; returns of 2% in yen, 4% in euros, 4.5% in sterling or even 13% in Brazilian real will appear more attractive to the savvy international trader. ... Since the problem will initially be one in inflation, it may be thought that [TIPS], indexed to inflation are an adequate solution. Unfortunately, they are not. For one thing their inflation index is subject to the 'hedonic pricing' distortion, whereby reported inflation is adjusted for imaginary 'hedonic' benfits and hence lags true inflation by close to 1% per annum. ... The arrival of the new Volker ... would cause a further bloodbath in the bond market. ... There are three underlying trends that suggest long term US Treasury bonds may be an even worse investment in the long term than in the short term ... First there is the social security system. ... Contrary to Washington belief, this problem will be exacerbated by a continued high immigration of younger, less skilled people. Since poorer people require more services and pay relatively less into the social security system than rich people, the actuarial deficit will worsen, and it will become clear that the young and foreign-born are paying relatively heavy taxes in order to support a large retired native-born cohort with most of whom they have no genetic, ethnic or cultural links. ... The second actuarial problem is Medicare. ... Finally, there is the problem ... of the migration of an increasing proportion of US jobs to the Third World and the consequent decline in US relative living standards and very likely in absolute living standards. ... The US is currently in the position of General Motors in about 1970. ... In summary, like General Motors in 1970, the [US] does not deserve its AAA rating and its obligations, particularly those denominated in the local 'Bernanke pesos' should be avoided", Martin Hutchinson (MH) at, 28 January 2008.

I agree with MH. Continued levels of immigration will lead the US to a sociological catastrophe. I borrowed Franz Pick's phrase for this piece's title.

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