Tuesday, June 16, 2009

Bond Market Meltdown Approaching

Bond Market Meltdown

Forget the printing press; the bomb that will blast gold prices into the stratosphere is the coming collapse in the Treasury Market

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This past Monday I spent lunch at an eatery in downtown Calgary near the foot of Bankers Hall, twin towers whose name is a misnomer because they were built with petro-dollars, not banking ones.

Any signs of a Great Depression where noticeably absent. The restaurant was packed and across the street three giant cranes ground along, building up the base of what promises to be another hulking skyscraper.

I was lunching with my brothers, one of them Richard, a senior partner with Canada’s largest law firm and a former economist with the Bank of Canada. One of the topics was the U.S. dollar.

A long-time associate of Rick’s has been commenting on how the U.S. is running the printing presses around the clock.

It is, of course, an anachronism that the U.S. Treasury is printing money. What they are doing instead is creating debt and they are doing it without paper or ink. They are doing it with keystrokes on a computer.

There is actually less than $600 billion in total currency in circulation. Most of it is offshore. And if all those bills and coins were sitting in some giant repository, there wouldn’t be enough of them to bailout the banking industry.

What is really being pumped at an unprecedented pace is debt.

The graph below shows that the U.S. is piling on debt in a fashion not seen since World War II.

[Image 1]

You can see that national debt now equals close to 80 percent of the nation’s GDP.

If you think that’s not so bad; we did it before and came out of it fine, consider this: the huge debt burden of the 1940s was taken on to defeat fascism and imperialism. In victory that debt paid huge returns. American democracy and goods spread around the world and the United States became the world’s largest creditor. By 1950 the U.S. accounted for half of the free world’s GDP and one out of every two cars sold was a GM. This is the same GM that is now in bankruptcy.

Today’s resurgence of debt is simply paying the bill for the party we had. We are in this position now because of low taxes, runaway spending and foreign wars. The borrowing being undertaken today isn’t to secure freedom but to simply keep the nation afloat.

And there is something else. In the 1940s through the 1990s, Washington borrowed from Americans. We owed the money to ourselves.

Today the money we are borrowing is coming from mullahs, pontiffs and dictators. In fact, foreigners own $3.3 trillion in U.S. Treasury debt. And the United States is begging them to take on more each and every week.

[Image 2]

Rather than printing money, Washington is borrowing it.

As I have said before, more money does not mean greater wealth. Inflation is an economic Band-Aid. It is applied by governments that don’t have the courage to accept remedies that would cause a recession, or in today’s case, a depression.

Instead leaders almost always opt to prop up a soft economy by creating ever greater amounts of money. But nations that pursue this course are really no different than an individual that plays the futures market. Sooner or later they are going to face a margin call. America’s margin call on the buck has arrived.

By buying up Treasury debt, other countries have enabled the United States to live beyond its means. They don’t do this because they are altruistic. They do it because the United States has a huge hunger for imported goods. Nations like China and Japan are lending money so America will keep buying Hondas and dog food.

Heading for a Dollar Debacle

These countries have been happy to do this for the past three decades because until just lately, Washington seemed intent on maintaining the dollar’s integrity.

That is no longer the case says Jim Rogers, the charismatic chairman of Rogers Holdings.

According to Rogers, a currency crisis is imminent.

"I’m afraid they're printing so much money that stocks could go to 20,000 or 30,000" Rogers said. "Of course it would be in worthless money, but it could happen and you could lose a lot of money being short."

Rogers called the U.S. dollar a "terribly flawed currency," adding that we could be the starting point for the next currency crisis.

"I would suspect that somewhere along the line...someone's going to say, 'I'm going to start selling mine before everybody else does,'" Rogers said. "That's when you have a currency crisis."

Rather than put money into stocks, Rogers says investors should buy real assets. His number one pick to beat the dollar’s meltdown is gold.

To read all of Rogers’ comments go to: http://www.cnbc.com/id/31106964.

In Gold They Will Trust

While I agree with Rogers that a currency crisis is imminent and that investors should buy gold, I don’t agree with his Dow 30,000 scenario. My reasoning is simple – long before the buck becomes so worthless we have 20,000 on the Dow, we will have had a bond market collapse. As I mentioned last week, China has already baulked about the buck being the world’s reserve currency and for good reason.

[Image 3]

The chart above shows the cost to nations that are holding the bag with U.S. Treasuries. China alone has lost tens of billions as the dollar has weakened. With the buck now within striking distance of all-time lows, the Chinese and others are likely to start asking for a risk premium (a higher yield) on their Treasury bills, notes and bonds. In fact, right now the yield spread between the 2-month T-bill and 10-year T-bond is at a record.

If Washington is unwilling to raise interest rates and attract foreign buyers to its 100 remaining Treasury auctions this year, those countries will start investing their wealth elsewhere. I am convinced that some of that money will go into gold.

And I cannot harp on this enough. The gold market is extremely thin. Last week I pointed out that all the gold mined in the world this year will be worth around $80 billion. Yet, this week alone the U.S. Treasury will auction off $65 billion in new debt! If just a fraction of this money went into bullion instead of Treasuries, gold prices will quickly soar above $1,500 per ounce.

Action to take: Continue to add to your physical gold holdings. Next week I will have more on the Midas metal, including why I believe it is an incredible bargain below $1,000 per ounce.

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