Your Trip on My Time Machine

This week, U.S. financial markets crossed a critical historic threshold that could change the lives of millions of investors:

Just as Mike Larson has warned, the combination of big federal budget deficits and widespread selling by bond investors has driven 10-year Treasury prices to their lowest level in over two years. This, in turn, is …

* Driving yields past the critical 3 percent barrier …

* Paving the way for far higher interest rates in 2014 …

* Building pressure on the Federal Reserve to let short-term rates rise for the first time since the great debt crisis, and …

* Potentially setting off a chain reaction of repercussions in trillions of dollars of other assets — especially real estate.

How fast and how far could interest rates rise?

How soon would they impact other sectors of the economy?

How can you profit from this powerful megatrend?

On a quest for the answers, I invite you to a voyage through time:

We will visit five critical — and incredible — periods of the past.

We will return for a reality check of the even more incredible present-day reality.

And then, we will take a quick trip into the future to see, first hand, a scenario that we believe is absolutely unavoidable.

Our first stop is over a half century ago …

1959

This is the year NASA chooses its first 7 astronauts, Buddy Holly dies in an airplane crash, and Dwight D. Eisenhower is about to end his second term as 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. Treasury-bond prices are starting to fall, and long-term interest rates are beginning to rise.

J. Irving Weiss

I’m just a teenager. But I work closely with my father, J. Irving Weiss, and together, we watch the events with growing alarm: No one — in Washington or on Wall Street — seems to give a damn.

However, to our pleasant surprise, President Eisenhower himself decides to make the budget deficit a major issue.

In his State of the 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.

Early the next morning, we run down to check the papers. We look for some sort of big headline such as “IKE SHOCKS CONGRESS! PROPOSES BALANCED BUDGET.” But we find nothing of the kind anywhere.

In fact, the only conspicuous reaction to Eisenhower’s speech comes in the form of an unrestrained yawn by the Senate Democratic leader, Lyndon B. Johnson.

Dad is outraged. He vows to do something.

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, 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; Baruch declines.

Bernard Baruch

Baruch says to Dad: “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 past presidents the same advice — to keep the budget balanced, to protect the dollar. But they wouldn’t listen to me. In the end, today’s presidents will be no different.”

This is a disappointment. But it doesn’t stop us. We go ahead anyhow — and we prevail upon other prominent individuals to join our executive committee. They include:

* Leonard Spacek, who later becomes the second managing partner of Arthur Andersen & Co.

* Leslie R. Groves, the general who built the Pentagon and who was responsible for the Manhattan Project, where the first atom bomb was made.

* Dean Alfange, libertarian candidate for governor of New York, and others.

We gather up just enough money to place a full-page ad in The Wall Street Journal, and donations begin pouring in. Other major media — the Chicago Tribune, The Los Angeles Times and the New York Daily News and Reader’s Digest — place similar ads at their own expense.

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. They’re running big ads for a balanced budget and against inflation.”

It’s an avalanche! According to a survey on Capitol Hill by The Chicago Tribune, 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:

“All of a sudden, 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 is it off? Well, not too much. Just a half century!

Soon after the budget is balanced, that same 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’s one thing in Washington that has massive, consistent, bipartisan support, it is government spending!

There’s just one thing that survives our pyrrhic victory: A letter thanking the Sound Dollar Committee for its success from Vice-President Richard Nixon — ironically, the same man who launches the nation on the opposite path 12 years later …

1971

Nixon devalues the dollar and abandons the gold standard. In one fell swoop, he starts the destruction of everything Eisenhower and the Sound Dollar Committee fought for.

He unleashes a decade of easy money at the Fed unlike anything we have experienced before.

He launches years of big federal deficits, trade deficits and debt.

And ultimately, all the ghosts of inflations past, long forgotten, return to haunt America.

1979

Now, the imbalances in America’s finances are much worse than they were in 1959: The federal deficit is far bigger. The Fed has been buying bonds in large quantities, creating a speculative bubble in bonds. Moreover, an entirely new and formidable force has appeared on the scene — bond market vigilantes!

Who are the bond market vigilantes?

They are individuals 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.

One reason could be the fear of inflation. Another could be big government deficits or the expectation of bigger deficits. Or it could be they’re just disappointed in something else Washington is doing.

And the bond market vigilantes wield growing power.

For quite some time, they have been increasingly squeamish about buying U.S. bonds because consumer price inflation has been growing worse and worse.

But right now they’re especially upset because the Federal Reserve has suddenly stopped buying U.S. government bonds, largely abandoning its aggressive support of the bond market.

And this move — which many years later might be called “tapering” — is what finally sets off a disastrous panic in the bond markets.

No matter what Wall Street or Washington says, the bond vigilantes refuse to buy government bonds. What’s worse, many are dumping their existing holdings of bonds. It’s the worst collapse in bond prices in modern history.

And it continues into …

1980

February 5. Bond prices have fallen so far that the yield on longest-term U.S. government bonds has surged past the 11 percent level. The last time this happened, the entire country was split in two — during the Civil War.

Bond traders are calling this day “Black Tuesday,” and since debt markets are so much bigger than equities, it’s worse than any Black Monday in the stock market.

February 6. 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 this means is that we no longer have merely a case of price collapses. Now, the market mechanism itself is collapsing — the dealers themselves are packing up and going home!

February 11. 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 Treasury 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. 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 5 as “Black Tuesday.”

February 24. 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.

If he can’t get the bond vigilantes to buy U.S. Treasury bonds, his own paychecks — and the paycheck of every other government employee — will bounce. He’s reached that ultimate point in which his only other option would be to virtually shut down the government and start a new republic.

Carter asks his advisors: Why can’t the Fed just buy all the bonds these guys are selling?

Because, they say, the most the Fed can buy is measured in the billions. In contrast, bonds they own are measured in the trillions! The only solution is to get them to stop selling. And the only way you can do that is to make sure the Fed stops buying bonds, stops flooding the economy with easy money, and stops the resulting inflation.

April 15. Today was the day of reckoning for the U.S. government. Jimmy Carter, a Democratic president in an election year, has just caved in to the bond vigilantes.

To persuade the bond vigilantes that the president is serious about fighting inflation, the White House has announced an unprecedented package of credit controls that will stop inflation in its tracks, and deliberately or not, will 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 virtually kill the economy.

This demonstrates the ultimate power of the bond vigilantes to dictate policy. But the story doesn’t end here.

Next week, we will continue this journey through time —

* first to 1994, the year of one of the worst bond market collapses in history …

* second to 1995-2008, a period of major booms and busts …

* next back to the present, and …

* finally to the future for a clear-eyed peek at what’s to come.

Good luck at God bless!

Martin

 

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EDITOR’S PICKS What Turbulent Times Mean for Gold by Larry Edelson I hope you had a wonderful Thanksgiving weekend with family and friends. I did! But now, it’s back to work. It’s back to protecting and growing your wealth. As we come closer to 2014, that’s more important than ever. Staying Fully Invested in Stocks Is Insanity by Bill Hall In last week’s Money and Markets column, I showed the following chart, which uses the Shiller P/E ratio to measure the value of the U.S. stock market on a price-to-earnings basis. Why 2014 Will Be Even Worse Than 2013 for Bond Investors by Mike Larson The bloodbath in bonds is showing no signs of letting up. The evidence: ==> Benchmark 10-year Treasury note yields have risen from 2.5 percent a few weeks ago to 2.83 percent this week, while the 30-year yield is less than 20 basis points away from the critical 4 percent mark.

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