Scales of justice weighing two currencies.
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Bonds have been wobbling worldwide. The 30-year U.S. Treasury bond, now over 5%, is at its highest level since 2007. The British 30-year yield is surging to 6%. Japan spent years suppressing interest rates to virtually 0%. Now its 10-year is almost 2.8%, the 30-year, over 4%. Yields of German government obligations are rising as well.
The immediate cause has been the fallout of the Iran war, but there’s something far more fundamental at work. What has been happening in recent years is that governments have been weakening the value of their currencies. The most reliable metric for measuring that is gold. For a variety of reasons, the yellow metal has largely kept its intrinsic value for thousands of years. When you see gold prices change, what you’re actually witnessing is the changing values of currencies in which the gold price is denominated.
The dollar price of gold per ounce was under $2,000 three years ago. Today it’s well over $4,000, even going over $5,000 a few months ago. Many other currencies are weaker than the dollar.
What makes Japan particularly worrisome is that its huge national debt, which is proportionately more than twice that of the U.S., has been financed until recently with virtually 0% rate bonds. Japanese financial institutions, not to mention the country’s central bank, have enormous unrealized losses because they are loaded down with government paper. Banks, insurance companies and the Bank of Japan (BOJ), all knew they had no choice but to buy these bonds.
Unfortunately, a big part of Japan’s binge spending went to largely unneeded infrastructure projects that did nothing to strengthen its subpar economy. Taxes are ghastly. Social security taxes are over 30%; the top personal income tax rate is over 55%; and the corporate tax levy for large companies is nearly 32%. There’s also a 10% national sales tax.
Japan is doing all it can to keep the yen from falling apart. The yen/dollar rate Japanese officials don’t want to see breeched is 160 yen to the dollar. A weakening yen could set off a panic in which bond buyers around the world hold back. They’ll still buy American bonds, but at a stiff price. Pressure would grow on the Federal Reserve to relieve that pressure by purchasing Uncle Sam’s IOUs. Other countries would resort to the printing press far sooner.
While Japan’s condition is extreme, most other countries are headed in the same direction. They are not pursuing pro-growth policies, such as lowering tax rates, removing suffocating regulations and ditching disastrous climate-change policies.
Astoundingly, central bankers and treasury officials almost never refer to the need for stable currency values. Lessening the value of a currency is the very definition of monetary inflation. The belief that central banks can constructively guide economic activity remains strong. Until this destructive mindset changes, expect pressure on bonds. It’s true that a resolution of the Iran war will temporarily boost bond prices, but the long-term pressure is not going away.