Safe Money editor Mike Larson and I have warned you repeatedly that the bubble would burst.
Now it’s happening!
And we’re not talking about a small bubble on the periphery of the global markets. We’re referring to the largest bubble in the history of civilization — in bonds, especially government bonds.
Just this week, bond prices plunged anew, smashing through critical support levels on the charts … prompting even more bond investors to unload their holdings … sending bond yields sharply higher.
And it’s no coincidence.
This week we are at exactly the half-way point between a fiscal cliff that was postponed … and a whole SERIES of fiscal cliffs that are still dead ahead:
- The deadline for major tax hikes and government spending cuts that were postponed 60 days.
- The debt limit, which was postponed for 90 days.
- And most important, a unique market event that no one can postpone, that can happen at almost any time, and that is far more deadly than any fiscal cliff made in Washington.
This morning, to help prepare you for that event, we will take you on a voyage through time.
We will visit three incredible periods of the past.
We will come back here for a reality check of an even more incredible present-day reality.
And we will travel into the future to see, first hand, a scenario that we believe is absolutely unavoidable.
The first stop on our time machine is over a half century ago …
It’s the year NASA chooses its first 7 astronauts … the year Buddy Holly dies in an airplane crash … and the last year General Dwight D. Eisenhower is president of the United States.
The federal budget deficit is on its way to a postwar record, and the U.S. Congress is hell bent on spending even MORE.
My father, J. Irving Weiss, and I work closely together, and we watch the events with growing concern.
But we see no budget protests in Washington, no debt fears on Wall Street, and certainly no mass movement for change.
No one seems to give a damn.
However, to our pleasant surprise, President Eisenhower decides to make the deficit a major issue.
In his State of Union address he complains about the excessive costs of military hardware.
He insists that “we must avoid extremes of waste and inflation which could reduce job opportunities, take us out of world markets, shrink the value of savings.” And most important, he announces that he will submit a BALANCED BUDGET to Congress.
But still no one gives a damn.
Dad is outraged. He vows to do something, and although I’m just a teenager, I promise to help.
We create a nonprofit, bipartisan organization to rally public support for a balanced budget, against inflation and for a strong U.S. dollar.
We call it the Sound Dollar Committee.
We need prominent names with a bipartisan balance. So we choose former President Herbert Hoover to be the committee’s Republican co-chairman. And we choose Bernard Baruch, a friend of Dad’s and adviser to several presidents, to be the Democratic co-chairman.
We figure that Baruch, a friend sharing a similar philosophy, will gladly join our cause. And we assume Hoover, whom we don’t know personally, will be tougher to convince. As it turns out, their response is exactly the opposite. Hoover is very eager to join. Bernard Baruch declines.
So we decide to make a final attempt to win his support, and Dad gives him a call.
Baruch says: “Your timing is bad. We really can’t do anything about this deficit problem until we see the whites of their eyes. I’ve tried time and time again to give them the same advice — to keep the budget balanced, to protect the dollar. But they wouldn’t listen to me.”
This is a disappointment. But it doesn’t stop us. We go ahead anyhow and get other prominent individuals join our executive committee.
We get Leonard Spacek, who later becomes the second managing partner of Arthur Andersen & Co.
We get Leslie R. Groves, the general who built the Pentagon and who was responsible for the Manhattan Project, where the first atom bomb was made.
Next, we gather up just enough money to place a full-page ad in The Wall Street Journal.
Donations begin pouring in. And those donations pay for more ads. Then, other newspapers begin picking up the theme on their own.
The owner of the Chicago Tribune calls us and says: “I believe in what you guys are doing. I’d like to put in a two-page spread of my own at my own expense. Is that OK?”
“Sure! Absolutely! Be our guest,” Dad responds.
The Los Angeles Times and the New York Daily News follow suit. Even the Reader’s Digest jumps in. Soon, scores of newspapers and magazines join our Sound Dollar Committee in a nationwide campaign — to balance the budget, to fight inflation, to protect the U.S. dollar.
Congressmen walk into their offices and are struck immediately with the clutter of mailbags. They ask their clerks:
“What the hell is this? Where did all this mail come from?”
The clerks answer: “They’re protests, sir. They’re coupons protesting inflation — cut out from the newspapers, sir. They’re running big ads for a balanced budget and against inflation.”
It’s an avalanche! According to a survey by the Chicago Tribune on Capitol Hill, the total response is 12 million postcards, coupons, letters, and telegrams.
As a result, the public’s attitude switches from extreme apathy to intense interest. Business Week writes:
“Just about anywhere you go these days, the talk will turn to inflation. The subject comes up with friends at cocktails, in the brokers’ boardrooms, and among businessmen who feel a responsibility to avoid price increases.”
“All of a sudden,” Business Week continues, “Washington is a city full of inflation fighters. Leaders in Congress began the session talking like big spenders; now they are talking about cutting Eisenhower’s budget.”
Senator William Proxmire, who has been steadfastly in favor of the deficit spending, changes his mind and votes for the balanced budget. One congressman after another shifts his vote to support the Eisenhower budget. And THE BUDGET IS BALANCED!
Our Sound Dollar Committee wins a great battle. But alas, we lose the war. Baruch is right. Our timing is off. How far was it off? Well not too much. Just a half century!
Soon after the budget is balanced, that balanced budget is blamed for the recession that follows, and A LONG line of big spenders take the reins of power in Washington. From that day forward, if ever there is ONE thing in American that has massive, consistent bipartisan support, it is GOVERNMENT SPENDING!
Next, we set the dial on our time machine to …
Inflation is rising. And now, the imbalances in America’s finances and money are much WORSE than in 1959.
Plus, a new, powerful force has appeared on the scene:
Bond market vigilantes!
Who are they? They are individual investors and institutions who own government bonds, who are willing to dump those bonds any time they fear their bonds might go down in value for any number of reasons.
It could be the fear inflation.
It could be big government deficits or the expectation of bigger deficits.
Or it could even be they’re disappointed in what Washington is doing.
And these vigilantes wield growing power.
To meet some of them and their dealers face to face, we go to downtown Manhattan — to the trading rooms of Salomon Brothers, Merrill Lynch, and other big firms.
This is where most U.S. government securities are traded, bought and sold on the market like any corporate bond or municipal bond.
It’s a bit different from stock trading because of the dealer system. The dealers are like automobile dealers. They buy the merchandise wholesale from the issuer. They put them in inventory. They mark them up. And then they sell them retail.
Right now, the Federal deficit is out of control. And consumer price inflation is surging to double digits. So bond prices have been going down. But it’s an entirely new, unexpected trigger that sets off the really big collapse.
Care to guess what the final trigger was?
The Soviet Union invades Afghanistan! And because of that conflict, the bond vigilantes fear a new escalation of the cold war … a new round of defense spending and … even bigger federal deficits.
So they go on a buyer’s strike. No matter what Wall Street or Washington says, they refuse to buy government bonds.
What’s worse, many bond vigilantes are DUMPING their existing holdings of bonds. And by the end of 1979, U.S. Treasury bonds have suffered their worst monthly declines in history.
But that’s just the beginning of the bond market collapse.
We shift our time machine forward by a small notch to …
February 5, 1980
Bond prices have fallen a lot further driving yields on longest-term U.S. government securities through the ELEVEN percent level. The last time this happened, the entire country was split in two, during the Civil War.
So bond traders are calling it day Black Tuesday. And since debt markets are so much bigger than equities, it’s worse than any Black Monday or Tuesday on the stock market.
February 6, 1980
Some panicky bondholders are unloading at any price, but there are few takers. According to The Wall Street Journal, the flood of sell orders has prompted all except two of the largest, best-capitalized bond houses to effectively abandon their market-making role.
What that means is that this is no longer merely a case of a price collapse. The market mechanism itself is collapsing. The dealers themselves are packing up and going home!
February 11, 1980
The pressure on Washington to do something drastic is mounting by the minute. By some estimates, investors have losses totaling 25 percent of the market value of their bond holdings, or more than $400 billion. At several major banks, just the losses in their Treasury bonds alone are enough to wipe out their capital.
February 19, 1980
The collapse continues to gather momentum. Just today, Treasury bonds have lost over 5 percent of their face value, double the 2.5 percent drop that caused traders to refer to February 5th as “Bond Market Black Tuesday.”
February 24, 1980
The bond market collapse is now three times worse than in 1979, formerly the worst bond collapse in modern history.
In Washington, President Jimmy Carter is in more financial trouble than any other president since George Washington. He has reached a point where, if he can’t get people to buy his bonds, he may as well shut down the government and start a new republic. Forget about the presidential election coming in November! The folks in Congress and the White House won’t have enough money for payroll this week. Their own paychecks will bounce … which leads me to the last day in this episode.
April 15, 1980
Today was a great day of reckoning for the U.S. government. And today, Jimmy Carter, a Democratic president in an election year, has just caved in to the bond vigilantes.
To fight inflation and revive the bond markets, the White House has announced an unprecedented package of CREDIT CONTROLS that will deliberately force the economy into a nosedive.
That’s right. For the first time in history, a Democratic president, in a presidential election year, has taken actions to severely restrict credit and kill the economy.
Next we make a brief stop in …
We want to stop in 1994 for a moment to point out two things:
It’s the biggest collapse in the bond market of any full calendar year in history.
And it’s NOT caused by inflation.
Rather, it’s caused almost entirely by bond market vigilantes who are upset at $200-billion deficits year after year, and who are worried that the economy might improve enough to put pressure on the Fed to raise interest rates.
Remember that: Not caused by inflation! And not caused by any major policy change — just some improvement in the economy and some rate hikes.
Those are our three visits to the past — Eisenhower’s battle for the budget, Carter’s defeat at the hands of the bond vigilantes, and another major bond collapse in 1994.
But before we set our time machine to the future, let’s return to …
And let’s take a hard look at where we stand:
After decades of borrowing piled onto more borrowing, we now have, by far, the largest debt bubble in the history of the world.
Compare, for example, where we are now with where we were in 1959, 1980, and 1994.
Back in 1959, even if Eisenhower had not balanced the budget, the federal deficit would have been about $10 billion.
But today, even if Mr. Obama and the House of Representatives can agree to a so-called “grand bargain,” the red ink in Washington won’t be just three or four times larger than it was in 1959. It won’t be just 10 or 15 times larger. It will be approximately ONE HUNDRED times larger!
Plus, back in 1959, the U.S. government had NO NET DEBTS WHATSOEVER TO FOREIGNERS. Quite to the contrary, foreign investors owed us a lot more money than we owed them!
Today, over 56 percent of our nation’s publicly traded debt is held by foreign governments, institutions, and individuals.
This is critical, because foreign bond vigilantes can be even more vicious than domestic ones. In addition to losing on their bonds, they also lose on their dollars. So they’re willing to dump their bonds that much faster.
Or consider this: Back in 1959, Social Security was deep in the black, with $21.9 billion in reserves. Today, it’s deep in the red, on a collision course with chaos, with $6.5 trillion in unfunded obligations.
Back in 1959, try and guess what the government’s future obligations were to Medicare recipients!
Zero! There was zero in Medicare debts for the simple reason that Medicare didn’t even exist in 1959.
Today, between Medicare, Social Security, and other unfunded, government obligations, the net future obligation, based on the government’s own data, is $70 trillion, according to David Walker, former U.S. Comptroller of the Currency.
Or compare today’s situation with that of 1980 when bond markets collapsed so sharply, they forced Carter to drive the economy into recession.
At that time, the federal deficit was under $74 billion. Today it’s over $1.3 trillion. That’s 17.6 times larger in nominal terms. And even in proportion to our GDP, the deficit today is over three times larger!
Even if you compare today’s situation with 1994, when we had the worst calendar year decline in bonds, the situation is far more severe today: The deficit is 6.5 times larger in nominal terms and STILL about three times larger in proportion to GDP.
We have the biggest bond market bubble in history.
And here are the four key principles you must never forget about bubbles!
Principle #1. All bubbles burst.
Principle #2. The bigger they are, the harder they fall.
Principle #3. They can wreck tremendous damage on investors’ portfolios.
Principle #4. But for sophisticated investors, bubbles create enormous opportunities — and the bigger the bubble, the more money it can make you.
We have searched history and found absolutely no exceptions to these principles.
Moreover, we have a new kind of bond market danger that makes all prior dangers in the bond markets pale by comparison:
A Massive Ponzi Scheme by
the U.S. Treasury and the Fed
The U.S. Treasury Department, one agency of the government, issues its new bonds.
Then the Fed, which is effectively another arm of the same government, buys up to 80 percent of those bonds.
And with this cozy relationship, they created a total fantasy — the fantasy that has elevated bond prices to the stratosphere and pushed yields down to the floor.
And remember: All Ponzi schemes collapse.
So to see how that can happen, let’s shift our time machine to the …
A perfect storm descends on the market for U.S. Treasuries from all sides. We have …
- The biggest peacetime deficits in history — far bigger than 1959, 1989, or 1994.
- A series of fiscal cliffs that paralyze the government — far worse than anyone has ever seen in Washington.
- The threat of selling by foreigners at the drop of the hat —something that was not a very big factor in prior collapses but now is.
- The threat of ratings downgrades, also something that never existed in prior bond market collapses.
- And the collapse of the Ponzi scheme orchestrated by the Treasury and the Fed — something that never existed in this form in past bond market collapses.
As in 1994, inflation does not even have to rear its ugly head. Nor does the Fed have to change its policies. Any unexpected trigger can set off the collapse.
In 1979, it was the Soviet invasion of Afghanistan. This time, it may also come from an unexpected source — maybe the collapse of Pakistan, maybe new involvement of the U.S. in another terrorist conflict, or perhaps just a slight uptick in the economy — anything that might spook the bond vigilantes.
Suddenly, as in 1980, an avalanche of selling strikes U.S. Treasury bonds, and even the Fed is unable to buy enough to offset it.
As in 1980, Treasury bond prices fall so swiftly, and government securities dealers withdraw from the market, making it next to impossible for the Treasury to refund maturing bonds — let alone raise new money.
Interest rates, which automatically rise when bond prices fall, surge rapidly.
The most vulnerable are those who can least afford to suffer losses: Those approaching — or in — retirement, who have shifted large amounts of their money into fixed income investments.
Their tax-free municipal bonds tank.
Many fixed annuities and other cash-value insurance policies are at risk.
And money invested in bank and insurance company stocks vanishes right before their very eyes.
They are shocked, and they ask: “How was this possible? Who are these bond vigilantes? And how come they never did this before?”
The answer: They DID do exactly the same thing before but most people didn’t notice or have forgotten.
We witnessed the power of bond market vigilantes in 1980, at a time when most of them were in the United States. Now it’s much worse because such a large group is overseas.
We witnessed their power again in 1994, at a time when there was virtually no inflation scare. Now, it’s much worse because all the Fed’s money printing is spooking investors about future inflation.
We also saw their power many times in 2011 and 2012, when they dumped the bonds of Greece, Spain, and Italy. Now it’s much worse because, unlike the situation in Europe, there’s no country or union in the world big enough to bail out America.
Even sophisticated investors are shocked.
“I thought the Fed was buying almost 80 percent of new Treasury issues anyhow,” they say.
“I thought the Fed could easily keep them at bay by buying whatever they didn’t want to buy,” they argue.
“Why didn’t that work? Why did bond markets collapse anyhow?” they ask.
The answer: Because the Fed was only buying 80 percent of the NEW bonds the Treasury was issuing, and even that was a huge risk.
The problem was that the bond vigilantes still owned trillions of OLD Treasuries which they dumped on the market, driving bond prices into the gutter and interest rates into the stratosphere.
In conclusion, we are looking at the potential for one of the greatest disasters in the history of U.S. bond markets. But not all is lost.
In fact, in some ways, the bond market collapse is a blessing in disguise. Ultimately, it forces Washington to come to its senses, just like it forced Carter to do the same, just as it forced Greece, Spain, and Italy to make long overdue changes.
It also brings two great opportunities to investors — first to profit from the historic decline in bond prices … and then to lock in some of the highest safe yields in decades.
Good luck and God bless!