One Of The Most Terrifying Predictions For The Year 2014

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/11/24_One_Of_The_Most_Terrifying_Predictions_For_The_Year_2014.html

An Unprecedented $660 Billion In Excess Debt Demand, And What It Means For Bond Yields

This article declares the bond market will collapse with an accompanying soaring gold price.  But between now and then, bonds should continue their rally (yields and interest rates should continue to decline as QE artificially boosts demand for bonds, therefore outstripping supply)--and gold prices may further decline, despite the Fed's and Bank of Japan's balance sheets continuing to grow to grotesque levels.

In other words, expect choppy markets if you're long precious metals, but your day will come eventually, when inflation rears its ugly head.

http://www.zerohedge.com/news/2013-04-21/unprecedented-660-billion-excess-debt-demand-and-what-it-means-bond-yields

10 Year Treasury Yield Breaks To New All-Time Low

http://www.zerohedge.com/news/10-year-treasury-yield-breaks-new-all-time-low

Banks buying Treasuries

http://www.bloomberg.com/apps/news?pid=20601087&sid=ab.TUjV2SQNE&pos=5

Banks are increasing purchases of U.S. government securities to pump up profits while lending to businesses languishes near the lowest levels since credit markets started to freeze almost three years ago.

Banks, facing increased regulation after posting $1.78 trillion of writedowns and losses since the start of 2007, are taking advantage of the record gap between their borrowing costs and yields on U.S. debt instead of lending, according to data compiled by Bloomberg.

The increase in government debt comes as banks shrink their balance sheets for the first time since the Great Depression, further restricting lending, particularly for small businesses that rely on banks for financing, according to Brown Brothers Harriman & Co.

Buying longer-term debt is reminiscent of Japan, where banks increased their holdings of government bonds to record levels during the country’s so-called lost decade of economic stagnation that began in the 1990s, according to Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey.

Like Japan’s response to the real estate collapse in the 1990s, the U.S. flooded the economy with cash only to see financial institutions sock the money away in bonds instead of making loans. Yields on 10-year Japanese bonds ended last week at 1.27 percent.

“It’s the Japanese movie, just an American version,” said Cheah, who worked for Singapore’s central bank. “The next scene is that after banks buy more and more government bonds it will be very difficult for the Fed to raise interest rates because they will lead to massive losses in the banks and cause them trouble all over again.”

Even allies are ganging up on the US

It's understandable that China has criticized US monetary policy and erected trade barriers in the form of import tariffs. Even Japan is lashing back at Washington DC for calling out Toyota executive in the brake scandal.

And now Swiss banks are declaring US government debt at high risk of default. Perhaps this is retaliation for the US attacking Swiss private banking laws.

Here's the problem I see developing: our foreign traders have historically funded our overconsumption, buying US Treasury bonds. Without their participation in future bond auctions, there will be no buyers to replace them. Other than the Fed, which means the US Treasury just has to print more money, and down the drain the dollar goes. It's already occurring, as 30-year Treasury bond yields ticked up last week. That does not bode well for an already fragile economic recovery.

And yet folks still view the USDollar and Treasury bonds as safe havens.

Notice where US sovereign debt ranks relative to the rest of the world. It may surprise you--but then again, it may not.

http://ftalphaville.ft.com/blog/2010/02/10/146606/handy-sovereign-risk-table/

Oh oh...looks like quantitative easing won't work after all

As I've ranted on endlessly, quantitative easing (QE), a method of monetizing debt where the central bank purchases it's own government bonds, has a poor track record. QE, which the Bank of England initiated two weeks ago, and the Fed is implementing this week, has the aim of reducing long-term interest rates, in order to facilitate an economic recovery. When homeowners can obtain low-interest mortgages (which are tied to bond yields), it is stimulative to the economy. It works great in theory, but in practice, it is disastrous long-term, as QE induces unintended inflation down the road. You can't print money and not expect inflation, once it flows into the economy. So the net effect is opposite to the desired effect long-term, even if its desired positive effect (lower interest rates) is temporary.

As someone who is betting on higher rates (and lower bond prices), I figured we had at least several quarters before 10- and 30-year yields would increase again--there would be a time lag before the stimulative effects took hold. But something more insidious is in play, and something I've also warned against frequently. This reversal of long-term interest rates rising again is already happening this week.

The Chinese sovereign fund has been the largest purchaser of said US Treasury bonds for their reserves, historically. Due to their distrust of our central bank's print-and-spend policies, they are unwilling to step up their buying anymore. This reduced demand from the Chinese and other foreign central banks result in lack of participation at these bond auctions. QE is inflationary, and no one wants to hold our debt for 30 years, betting there will be no inflation in that span of 30 years. Remember: inflation is a bond killer, as it eats into the income bond yields promise. Hence, this bubble will burst also. And when it does, yields will spike up, raising our country's borrowing costs (higher rates = lower bond prices). This will make it more difficult for the US Government, the borrower of last resort, to repay their IOU's. In this scenario, a default is imminent, ushering in not the Dark Age, but squarely into the Stone Age. This is my biggest fear, and why I was totally against QE--hence, my comments about the Fed selling its soul to the devil. There is no turning back now, because if rates keep climbing up, and our borrowing costs keep increasing (along with our debt), the Fed will keep buying more US Treasuries in a vicious spiral. I also mentioned the bond vigilantes resurfacing, the small group of big bond investors who keep irresponsible central banks in check. When this irresponsibility pops up, the vigilantes drive down bond prices, driving up interest rates simultaneously. This is bad for not only bonds, but it also very bad for stocks. Equities don't like high interest rates, because it makes the low yields on stocks unattractive (remember: investors buy stocks by betting on asset appreciation, not necessarily for income. They theoretically take on more risk in exchange for reaping greater rewards on rising equity prices).

The UK had a bond auction that actually failed, as there were NO buyers. So it's not just our bonds sovereign funds worldwide are shunning; there just isn't any demand for our debt as other countries hunker down and try to repair their economies.

Bottom line: there's just too much supply of debt out there, and not enough demand from untrusting foreign bond buyers. This will lead to long-term interest rates, no matter how much intervention central banks attempt. Using QE, these central banks are just distorting interest rates short-term, but harming the long-term economic health of our economy.

Seminal Event today

The equities and bond markets celebrated today, as they rallied when the Federal Reserve Bank announced they were going to purchase over $500 billion of mortgaged-back bonds and $300 billion of 10- and 30-year US Treasury bonds. Bond prices spiked up, as yields plummeted, in tandem with equities leaping forward. Main Street celebrated also, as mortgage rates, tied to interest rates, dropped to 4%.

However, this is premature celebration, because this will negatively impact our economy and financial systems long-term. What? Has Greg gone crazy?

No, I am not crazy--I am a student of financial history. This so-called "quantitative easing", or "monetizing the debt", is fancy-speak for "creating dollars out of thin air". This is a desperate attempt by the Fed to artificially suppress interest rates to aid in the economic recovery. The short-term result is that we will have a mild recovery as credit is loosened and liquidity is injected into the economy. But just like the real estate bubble, this will be false prosperity, as it is debt-financed. In other words, it is what got us into trouble in the first place, and this Fed action only exacerbates the problem, and prolongs this recession.

It satiates the general population because it provides a floor for our 401K's and the value of our home prices, but it is an artificial floor, and will delay the bottoming out process.

But let's look at the other side of the ledger--our nation's liabilities. This increases our nation's debt by at least another trillion dollars. This will obviously dampen future gross domestic product growth. But the most insidious unintended consequence is hyperinflation. We will now have too many dollars chasing too few resources. The proof is that the price of gold shot up $50 in a matter of minutes within the Fed's announcement.

Our parents taught us that there is no free lunch, and that we had to work for everything we received. We will all learn this lesson going forward. You can't just create dollars out of thin air and not pay the price.

My prognosis? Expect markets to rally on the short-term news. But expect future economic growth to be choked off for years. Expect inflation to soar--think the 1970's decade, when we had stagflation--stagnant growth, high unemployment, an anemic economy made worse by high inflation (and decreased consumer purchasing power). Investors lost money in equities and bonds, as inflation soared as did interest rates. Savers, investors, and retirees living on a fixed income will get crushed by inflation. Perversely enough, debtors will be rewarded, and 30-year mortgage borrowers will benefit due to deflated dollars servicing that debt. Of course, the United States is the largest debtor nation in the world, so there is one silver lining with inflation. But sovereign funds holding US Treasuries in their reserves won't be too happy left holding the bag on a declining asset.

As much as I disagree with our government's fiscal and monetary policies, I have prepared for this day for several months. I am long gold, silver, oil, commodities, and will short 30-year Treasury bonds again. Equities will rally short-term, but will decline again. That's why I am only long one biotech company that I believe will explode later this month. Otherwise, I will avoid stocks until I see blood in the streets, which I expect sometime in the future. Long-term (2-5 years out), expect rising inflation, and a bull market in hard and soft commodities.

This will put the Fed in a pickle, as they will have to raise short-term interest rates to stifle inflation. But the political will to do so will be absent, as raising rates will inhibit economic growth before it can even have a chance to recover. My prediction is that they will have to let inflation soar to aid growth and reduce the burden of our huge national debt (inflation lessens that debt level because it is paid back in the future with deflated dollars). High interest rates make that debt harder to service. Inflation becomes the lesser of two evils at that point, as inflation becomes a hidden tax on unknowing consumers. Some of you wiser (i.e. older) folks probably remember gas lines and soaring inflation in the 70's. That is a best-case scenario for us today, unfortunately.

Eventually 30-year Treasury bonds will plummet in value in the biggest bubble, as long-term interest rates soar. The Fed influences short-term interest rates with policy, but the long-end of the curve cannot be manipulated long-term. Bond markets anticipate inflation--or lack thereof. If a bond investor anticipates higher inflation, he/she will demand a higher yield to offset that inflation. Higher yields mean a lower price for that bond. That is exactly what the Chinese sovereign funds are worried about, as they hold almost a $1 trillion of our IOU's.

The effects of Fed intervention like we saw today are temporary. The short-term effects of the Fed buying US Treasuries is stimulative, but long-term, it ironically achieves the exact opposite, stoking inflation and forcing those same interest rates higher.

One can profit from this populist, but wrong-headed move by the Fed, but I will not celebrate it. Our elected government officials have doomed our economy for several years, if not for a decade.

Our government really only has two options: Inflate, or die. Obviously, they have chosen to inflate. But this option has unintended consequences down the road. Be like the Boy Scouts. Be prepared.