http://contraryinvestor.com/mo.htmSeptember 2008
"Fun With Funding...You know that for some time now we have been preaching about what we believe to be one of the most important macro themes of the moment that is deleveraging. Important both for financial market and real world economic outcomes ahead. And, whether we like it or not, it's a theme that we believe will be with us for a good while to come...
Enough of the ranting and raving. Let's get to the point. As this process plays out and the Federal government is continually forced to expand its balance sheet as an offset to the leverage contraction occurring largely throughout the remainder of the economy and domestic financial markets ahead, THE big question becomes, where will the funding for this balance sheet expansion come from and what will it ultimately cost? A question near and dear to the hearts of US taxpayers everywhere, to say nothing of the investment community. This, we believe, is now and will continue to become one of the most important questions for our investment activities. We cannot take our eye off of this ball as we move ahead. Point blank, and we could not be more serious when we ask this, will the US face a funding problem at some point?
...Once again, in the clarity of hindsight, the initial Japanese response to the equity and, several years later, property bubble peaks and subsequent busts was to lower interest rates. Classic monetary policy 101. As the decade of the 1990's wore on, the cost of what was accelerating government spending (expansion in the government balance sheet), was indeed in very good part supported and able to be accomplished by a lower interest rate structure. As Japanese government funding needs expanded, the cost of that funding declined. Why? It was financed internally. Just what the doctor ordered. The following chart is a proxy for longer term interest rates in Japan over the identical period covered in the chart above...
We hope that by now you can see why we believe the forward US funding issue is so important. We believe the question mark is huge as to who will be willing to meet these funding needs during a period of greater US non-government sector balance sheet contraction. Will the US continue to be able to procure low nominal cost funding as its already very large balance sheet (liability) expands ever further by necessity in the coming period? The US faces a series of obstacles that were absent in the similar cycle reconciliation experience of Japan. And THE primary obstacle and question mark is cost of funds. We're not preaching end of the world here. In fact, we're really not even questioning the ability of the US to procure continued foreign funding.
THE critical issue looking ahead is COST OF FUNDING. At the outset we asked the question, will the US face a funding problem at some point, given that the US is beholden to foreign financing? It's the cost of funding that will be key to forward outcomes both in the real US economy and financial markets.In the past we have suggested that perhaps THE most important chart we can think of is the long term chart of the 30 year US Treasury bond. What we have described above simply puts an exclamation point behind this thought. The following is nothing but an update of the non-logarithmic 30 year UST. To suggest the red rising bottoms trend line is important is a multi-decade understatement. Will the whole forward funding question ultimately be the straw that breaks the proverbial camel's back for the US bond market? Or in this case the back of the rising bottoms trend line?..."
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