The Big Picture for the Week of May 8, 2005

We had a lot of what I think will be big things happen this past week.

I am not in favor of the Treasury reissuing the 30 year bond. I believe in the line of thought that says inflation and interest rates have been relatively low thinks in part to no new 30 year issuance. I for one would like to see less debt, less deficit and less spending (same as everyone else, I realize) and lengthening our debt does not achieve any of the lesses mentioned. We are already borrowing enough from our future.

From the department of careful what you wish for; it seems like a big step, emotionally if nothing else, was taken toward yuan revaluation. I am familiar with both sides of the argument, as you should be, and I'm not sure we should be pressing for this. I believe it will mark the beginning of the end of US as the world reserve currency. Here's my thinking on why this may matter, down the road. Over the last (insert what ever time period you want) the dollar is been in a serious down trend. I believe one thing that limited the amount of dollar selling was its role as the world reserve currency. The dollar is very important, economically, to many countries. Yuan revaluation is the start of making the dollar less important. At some point down the road the US will face another downtrend only there may be less propping up of the dollar at that point. Another byproduct could be less demand for our debt in the future. Since it doesn't look like our debt will be reducing anytime soon, foreign demand for our debt may become more important not less.

The other big thing was the GM and Ford debt downgrades. According to Alan Abelson (subscription required) the junk bond market is $600 billion. I don't know if that is correct because he cited $80 billion in GM and Ford debt as new junk supply and by my reckoning it is closer to $460 billion. Either way a downgrade from the other ratings agencies seems to be inevitable. Assuming that to be the case, that will be when some real dislocations in the bond market will happen. My concern is about what this does to liquidity and corporations ability to borrow money. Will this make borrowing more expensive for non-junk companies? This much supply changing this way could have all sorts of side effects that I am not smart enough to think of. One that I can think of is a massive amount of treasury bond buying that flattens the curve even more than it is now, I mean literally flat. If long dated debt yields the same of short dated paper it will be difficult for companies to access capital through debt offerings. Inability to access capital is not a good thing. What of GM and Ford, the companies? Both issue a lot of debt because they need it to function and pay retirees. I don't think their respective borrowing needs will lessen anytime soon. Can this possibly end well?

A few caveats. I may not be right about any of this, I will let the message from the market dictate my actions. If I am right about any of this, I would not expect the stock market to feel the consequences of any of these things for years. In fact I would not be surprised if we cycled through another roaring bull market before consequences from the 30 year bond and the yuan stories are fully known and understood. Big change is not easy. The point of this post is to begin to think about what could be out there waiting for us, thats all.