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The Good News and 'Very Disturbing News' of Zero-Yield Treasuries

Posted Dec 10, 2008 12:30pm EST by Aaron Task in Investing, Recession
Related: TLT, ^DJI, ^gspc, IEF, PST

One of the most shocking developments in a shocking year occurred yesterday when the Treasury auctioned $30 billion of four-week notes with a yield of 0% (yes, ZERO, as in nada).

Incredibly, demand for the zero-yield notes was so strong the government could have sold four times as much, and previously issued four-week notes traded with negative yields Tuesday.  In other words, investors were content to suffer a quantifiable loss of 0.1% to 0.2% vs. risk bigger losses in other assets.

This is "good news" because it means the government can finance the massive stimulus package necessary to aid the economy, says James Galbraith, economics professor at the University of Texas at Austin and author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.

But the reality of zero-yield Treasuries is also "very disturbing news [because it] says there's a wholesale flight from the private credit markets into the safety of public bonds," adds Galbraith, the son of famed economist and author John Kenneth Galbraith.

It is because of this "collapse of the [private] credit mechanism" and "violent decline of private sector activity," that Galbraith believes the economy needs as much as $1 trillion of fiscal stimulus, as detailed here.

"Every which way it is up to the capacity of the U.S. government to step up and act," he says. Otherwise, the causes of the mass layoffs announced to date (and the impact of the layoffs themselves) will spill over into other sectors of the economy and cause "much, much more complicated problems in a few months."

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