Ten Reasons Why Dollar Denominated Bonds Aren’t as Safe as You Think

January 7, 2007 – Many people think of any type of dollar denominated bonds, whether they are U.S. corporate bonds or U.S. Treasury bonds as a safe place to park your money for reliable sources of income stream. In fact, the U.S. Treasury Department on their own website, even tout U.S. Treasury Securities as a “great way to invest and save for the future.”

Many people believe this rubbish because they are advised of this by a horde of financial consultants that have zero understanding of how the political-corporate-banking triumvirate operates, and how this financial triumvirate has produced a most unattractive likely scenario for dollar-denominated bonds going forward from 2007. Many people think of U.S. Treasury bonds as safe because of the “federal guarantee”. The ten reasons below render that federal guarantee irrelevant.

And don’t think this doesn’t affect you just because you aren’t American. Non-Americans aggregately hold a lot more U.S. dollars in this world than Americans do. If you are one of those misled people, American or non-American, reading the below ten reasons can save you a lot of grief in the future.

(1) The often repeated financial consultant statement that bonds are a “safe place” to park your money, especially if you are older, is a myth. Who cares if you earn a 5% revenue stream from bonds if the currency they are denominated in loses 15% in value over that same time span?

Think of the losses of the U.S. dollar versus other major global currencies in 2006. An 11% decline against the Euro; An 11% decline against the New Zealand dollar; A whopping 14% decline versus the Pound Sterling; and a incredulous 15% against the Thai Baht ( I mention the New Zealand dollar and Thai baht because these currencies are commonly held currencies in Asain currency baskets offered by major banks as a hedge against the falling dollar). If you hold dollar denominated bonds with a 5% income stream and your dollars just lost 15% of purchasing power, are you really happy with a net 10% loss?

(2) Many of those in the retirement phase of their lives are convinced to invest in longer maturity bonds because of poorer yields of short-term bonds. As the Euro gradually replaces the U.S. dollar as the international currency of choice, the longer maturity necessary to ensure a return of face value on bonds presents a significantly greater risk.

(3) As interest rates go up, the face value of bonds go down. Although Wall Street strongly expects the U.S. Federal Reserve to cut interest rates soon to stimulate a faltering U.S. economy, this is how I see it.

At some point and time, the U.S. Federal Reserve will try to block global flight from the U.S. dollar by propping up interest rates, not cutting them. Here you suffer twice. Once from a loss of purchasing power and twice, from a devaluation of the face value. See number (2) why holding a long term bond until maturity may not be an option. And even if the Federal Reserve keeps in line with Wall Street expectations, that’s bad news too.

(4) As the dollar loses value over time, banks and other financial institutions will increase interest rates on loans and other financial instruments to compensate for the heavy losses they are incurring on a weakening dollar. As your costs of doing business and living rise, yields from bonds won’t cut it anymore.

(5) As the massive yen carry trade continues to unwind, and the Bank of Japan takes increasing measures to strengthen the Yen as the Japanese economy continues emerging from its recession, the strengthening of the Japanese Yen in addition to the Pound Sterling and Euro will threaten dollar supremacy. Last year as every single major world currency pounded the dollar, the Yen was just about flat against the dollar. In the coming year to eighteen months, it will be the Yen’s turn to pound the dollar.

(6) While most people think that there has been no further attack on the U.S. by terrorists since 9/11, there has been a far more devastating ongoing attack – an ongoing economic war. Though this fact is not discussed at all in the mainstream media, Osama bin Laden has repeatedly stated that his number one goal is to topple the U.S. as an economic power. The attacks on the Twin Towers were symbolic of that goal. However, if he achieves his goal of debilitating the U.S. economy through the draining of U.S. resources in the current prolonged war in Iraq, this would make him far happier than any overt attack he could accomplish.

So far in this economic war, Osama is winning, and with U.S. President Bush poised to send more U.S. troops to Iraq in 2007, the war will have an even heavier toll on the U.S. economy in 2007.

(7) In response to (6), the U.S. Federal Reserve has expanded the dollar money supply to provide funding for the war. With no end in sight to this war, we can expect the dollar money supply to continue to expand, therefore placing more downward pressure on the dollar.

(8) The U.S. has no powerful allies to keep the dollar strong. With protectionism sentiment growing stronger among the newly elected Democratic U.S. Congress, the U.S. certainly has no friends in China, the largest holder of dollar denominated debt at over $1 trillion. Certainly when the U.S. Congress moved to block the Chinese state-sponsored bid for U.S. oil giant Unocal because they viewed such an acquisition as a threat to national security, the Chinese government certainly viewed this action as hostile to their business interests.

Certainly, this incident will remain fresh in the minds of Chinese government officials when U.S. Secretary of Treasury Hank Paulson or U.S. Federal Reserve Chairman Ben Bernank make continued please to the Chinese government for assistance.

(9) The largest holders of Petrodollar reserves include Russia, Venezuela, Iran and other Middle Eastern countries. Read that list again. There is not a single nation strongly friendly to the U.S. on that list.

(10) When people finally realize that (1) through (9) are true, there may be a flight from the bond market, causing bond prices to tumble.

When you realize the shakiness of your situation as a dollar-denominated bond holder, think about this? Don’t you think foreign governments and wealthy private institutions and individuals, holders of dollar-denominated assets in massively greater quantities, realize the same? When they realize the facts that I’ve laid out above, their aggregate actions will reflect poorly upon dollar denominated bonds as well.

J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.

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