Illogical Justifications for Owning U.S. Treasuries

Includes: TBT, TLH, TLO
by: The Manual of Ideas

We Could Use Some Training On Compelling Ad Copy

Sorry if this doesn't sound as enticing as one of those "Double Your Money in 14 Days" advertisements, but we can actually tell you how to double your money in 30 l-o-n-g years. Move in a little closer so we can whisper this special tip in your ear -- BUY THE 30-YEAR U.S. TREASURY BOND!

At a fixed yield to maturity of 2.55%, $1,000 invested in 30-year Treasuries today will grow to all of $2,126 in 2038. Oh, did we mention you will get $2,126 only if you reinvest all of the little interest coupons you receive along the way (so, no shopping sprees along the way either)?

Do You Really Want To Say "'Till Death Do Us Part" To The U.S. Government?

Now tell us, would you really give the U.S. government your money today, only to see 2.1 times your money back in 30 years? Do you really think that $2,126 in 2038 will even buy the same amount of stuff $1,000 buys today? We are talking U.S. dollars here, folks, and 30 years should be plenty of time for the government's current binge of monetary stimulus to depress the dollar's purchasing power, if ever so slightly.

Okay, so we agree that no sane person would make a 30-year investment that will grow to only $2,126 for every $1,000 invested today. It's simply not worth the opportunity cost nor the inflation risk.

Well, I'm Not Buying, But...

Why then is the 30-year Treasury Bond trading at this ridiculous implied yield of 2.55%? "Easy," you say. "Flight to safety. Everyone wants the safety of Treasuries right now -- at least they're not going to destroy cash." You add, "Besides, buying a 30-year Treasury doesn't mean you are locked in for 30 years. I can always sell the Treasury Bond in the market if I think inflation will rise."

Debunking Illogical Justifications

Those are plausible arguments, but they are plain wrong. If a rational person wants safety in Treasuries, she will buy short-term Treasuries. For example, three-month Bills will preserve your cash just fine, and you won't be taking a risk that inflation will erode your principal. For, if inflation suddenly became a concern, your Bills would mature and you could then reinvest the cash in a security that would reflect the market's new-found concern for inflation, thereby inevitably promising you a higher nominal return than your original T-Bill had done.

If, on the other hand, you "parked" your cash in 30-year Treasuries instead of three-month Bills, resurgent inflation concerns could obliterate the value of your principal even in a span as short as three months. This is because whoever takes the 30-year Bond off your hands in the market will demand a much higher interest rate than the current 2.55% for the next 29+ years. Of course, such a demand for a higher yield to maturity would send the price of your 30-year Treasury plummeting. Conclusion: Flight to safety is only possible into short-term Treasuries. Flight into long-term Treasuries is flight to nominal safety and real destruction.

As for the argument that a buyer of a 30-year T-Bond can sell it in the market at any moment and is therefore not actually locked into a 30-year commitment, I believe the previous paragraph debunks this argument as well. Essentially, unless you are suddenly the only one concerned about inflation, you will not be able to escape the 30-year Treasury by selling it in the market without leaving a lot of principal on the table to compensate your buyer for her willingness to take on the risk of accelerating inflation.

Still Nothing New On The Western Front...

As specious as the arguments put forth by 30-year Treasury bulls are, they appear to have been widely accepted in today's market. It reminds us of the almost universal acceptance of the hitherto justification of the leveraged buyout and real estate booms: "There is just so much liquidity out there, and as long as there is so much liquidity, these booms will continue. Moreover, there is no apparent catalyst that will remove liquidity from the market." Neither is there an apparent catalyst that will cause the implied yield on the 30-year Treasury to rise from the current 2.55% to a more appropriate high single digit or even low double digit yield. However, history teaches us that by the time a catalyst becomes "apparent," it is apparent to almost everyone, rendering you unable to get out of long-term Treasuries unscathed.

We are not urging you to short long-term Treasuries, though this is precisely what we have done. However, we do ask you to reconsider your participation in what appears to be today's last remaining asset bubble.

Disclaimer: Copyright 2008 by BeyondProxy LLC. BeyondProxy and its affiliates may have positions in and may make purchases or sales of the securities discussed in this report. It is the policy of all Related Persons to allow a full trading day to elapse after the publication of this report before purchases or sales of any securities discussed herein are made. One or more Related Persons held a position in TBT as of the date of publication. Use of this report and its content is governed by the Terms of Use described in detail at