The Coming Bond Debacle
Mike Hoy
July 19, 2004
We have entered an era where the old standard and norms of "what
is and what was" are two completely different things! We
have entered an era that is as complicated as any we have ever
seen. If ever there was a time when economists could write
two different endings to the saga that has gone on, in this country,
for years; now is that time.
Whether we have inflation, hyperinflation, stagflation, recession,
deflation or in the end depression does not matter; they are
all coming and several at the same time. There is no way
out of the mess that we have thrown ourselves into. The
whole world has made its bed and soon will have to sleep in it. The
failure, of the lowest interest rates in decades, to produce
a thriving economy and Country is proof that the Fed has failed.
The United States experienced tremendous growth and prosperity
from the 1980's to 2000 and we have absolutely nothing to show
for it. Unless you want to count the record amounts of debt
we have as a result of leaving our minds and common sense at
the car dealers or real estate offices. Without doubt, we
had an opportunity to put the financials of this country in order
as a result of the growth and prosperity our nation experienced
over the past twenty years. In fact, in 2000, our government
officials were just beginning to realize that we might be able
to truly put black ink on the books again. Unfortunately
they were looking in the past rather than the future. Y2K
was gone and so was the money that was spent on new computers
and the internet growth was slowing down. As a result the
tech market bubble burst and the beginning of the end was here. Very
few people recognize the significance of Y2K and the positive
effects it had on our economy. Unfortunately, that all ended
with the passing of the millennium.
I have never been able to understand this talk of recovery. It
is impossible to recover to a bubble! The only way that
can happen is to create a bigger bubble than the initial bubble. I
will give our government officials credit; they truly gave it
their best shot. They have done everything in their power
to put Humpty back together again. They lowered interest rates
to levels that were unprecedented. They pulled every rabbit
out of the hat that they could. They convinced the American
public that borrowing was the key to growth, survival and economic
recovery. They were successful beyond their wildest imaginations. The
consumer borrowed and consumed like he has never done before. Only
problem was that the end result will not be recovery but a deeper
depression. Future generations, if there are any, will read
back on these times and view our generation as the most selfish
and ignorant of all times. How can they view us any differently;
we destroyed their financial futures for our own greed?
We have saddled them with debt and financial burdens that any
normal society would have seen coming years before. They
are the generations that will be responsible for paying the bills
from our generation. They will have to live in the world
we have left behind; without a doubt the freedoms that they will
have will be less than the freedoms our generation has had and
destroyed. How they can view our generation with anything
but disgust is beyond me. Our greed is unprecedented in
history. A new home with an SUV in the driveway is a great
dream; but that in the end is all it is.
We have entered a whole new ballgame and the rules are exactly
the opposite of what they have been for years. Rising interest
rates have changed everything. This is the period of time
upon which we have now embarked. The ship has left the dock
and if you are not on it you are out of luck. If you have
not made your money, the traditional way, then you are way too
late. There is very little chance that you are going to
thrive in the stock and bond markets over the next several years,
based on strategies from the past. For years we have heard
discussions dealing with diversification. For the majority
of investors diversification is a great thing. Normally
I would believediversification is a prudent means of investing
one's money. In today's world diversification may be a recipe
for mounting losses. There comes a time when taking care
of your money is more important than making a decent return on
your money. The risk of not understanding this is greater
now than at any time in the past 70 years.
The topic that I want to address today is the topic of long term
bonds. With interest rates now beginning to rise, I believe
the necessity for investors to realize that the principal amount
of their investments in bonds is at big time risk. I personally
believe there has never been a time when their principal has
been at greater risk in bonds. I was a broker back in the
1970's and half of my business dealt with bonds. I remember
buying tax free municipal trusts with a 6.25%-6.50% tax free
yield. This was considered a very safe investment with a
good tax free return to the investor. Most people bought
these trusts and completely forgot about their principal investment. They
cashed their interest checks and life went on. This was
all fine and dandy unless they needed to sell their bonds and
get their principal back. I watched as interest rates rose
and bond prices fell. I was young at the time and never
really understood the carnage going on behind the scene. Oil
prices rose dramatically through the decade and inflation was
roaring as a result. This was a time when our government
officials did not have the inflation index's tweaked to give
them the inflation numbers they desired to deceive the public
into believing there was no inflation.
Over the last twenty years our officials have learned how to
master the numbers so as to make John Q Public believe his rising
expenses has nothing to do with inflation. Their game is
up; over time their lies will be fully uncovered. In getting
back to the safety and security of the long term municipal trusts
I bought for my clients; they were creamed over the ensuing 3-4
years. I had one client who needed his money in 1980-81;
he received less than one half of his money back on the sale
of his trust. This brought home the true meaning of loss
in the bond market. I have failed to mention the fact that
this money was no longer available to take advantage of interest
rate opportunities when interest rates did finally peak. The
ironic thing about investors when interest rates did finally
peak was the fact that I could not get one of my accounts to
invest in the thirty year US Government bond when the return
was 14%-15%. Not one client bought the bond. Why?
The answer was that they were getting 17% in the money market
and felt there was no reason to switch. No amount of logic
would change their minds. I did finally put three utility
companies together so they could receive a dividend check each
month. This investment idea was highly successful; not to
mention the fact that the three companies had great records for
increasing their dividends.
Today we have a situation where most people believe that interest
rates will have only a small increase. This is possibly
the greatest financial misjudgment that they will ever make.
Our society has been conned into believing things are different
this time. They have been led to believe that a few quarter
point increases will more than be sufficient to stop inflation
in its tracks. I'm sorry but these people could not be more
wrong.
For years I have wondered if the 20.5% prime rate that was hit
in 1980 was the high for the cycle. I could not begin to
imagine that we would go higher at some point in time. I
believe time has given me the answers to my questions. The
answers are not going to be pleasant; no one else is talking
or writing about it so I believe I must. I believe the astronomical
amount of debt our government has accumulated, over the last
twenty-five years, will come back to haunt us in a manner that
will leave the financial world speechless and broke. Our
Country has sold its soul and future to foreign investors, Central
Banks and Governments. The amount of debt that is now held
in foreign hands is an absolute financial disaster in waiting. The
true weapons of mass destruction lie in the hands of these foreign
bond holders. The only point that we must understand, to
know that interest rates will rise, is the FACT that someday,
soon, this money will decide that it no longer wants to be in
US Government bonds.
When this "Day Of Reckoning" arrives interest rates
will rise to levels that we can not even begin to comprehend,
at this point in time. Without a doubt, we have inflation
that is growing stronger and stronger everyday; with the Fed
now beginning to raise rates, I have to believe that their biggest
fear is the movement of this money that now resides in the bond
market. There is no question that at some point in time
this money will decide it is far better off somewhere else. When
this "Day Of Reckoning" becomes a reality the financial
markets in this country and the world will be forced to face
the fact that our leaders made huge mistakes that we must now
be held accountable for. As these foreign entities sell
their bonds, interest rates will rise to give the New "SUCKER"
inducement to make the mistake of his or her financial lives. I
believe rates are rising now in hopes that this money will stay
a little longer. In the end it does not matter and the result
will be the same. There is no question the dollar will fall
as a result of this blanket of debt; at the same time there is
no question that as rates rise the value of their bonds will
fall.
This is a double whammy that will destroy foreign investment
in the US Bond Market. We have to be insane to believe that
these foreigners will continue to lose money for our sake. Americans
have had a way oflife that has been the envy of the rest of the
world. For years we stood out as being the poster child
of growth and prosperity. In the future, the only poster
we may appear on is the 10 most wanted, by the rest of the world. We
are naïve to believe that the rest of the world views us
in thesame manner that we view ourselves; and since I believe
the encouragement in the growth of debt is totally wrong I must
believe the rest of the world may have a point. Regardless
of how one feels about that subject the reality of the whole
situation is the impending fact that the foreign countries will
be the ones calling the shots in the near future when the subject
of interest rates come up. Do you really feel secure in
the fact that countries like China and Russia hold the hundreds
of billions of dollars in debt that they do? Do you think
that they care about anything or anyone other than themselves?
Take note of Russia destroying one of its largest oil companies;
why would they want to do this if not to break capitalism and
regain control of the corporate assets? Do not believe
for a second that they will not use their ownership of our debt
to their advantage when the time comes. They also know that
when they sell their bonds our interest rates will rise and rise
dramatically; they also know that a rise in interest rates will
be more devastating to our economic system than a successful
military campaign.
To top everything off is the fact that we have now entered an
era where debt will continue to increase at levels that is unprecedented
in history. The saying of "you ain't seen nothing yet"
has never been more appropriate than now. What are our officials
doing about this mess? Simple, more of the same; then they
try to convince you and me that we are on the road to recovery. Sorry,
but I don't buy it! There comes a time when a person has
to realize that earning a very small rate of return is better
than taking a beating he or she may never be able to recover
from. I know many of you must have a better rate of return
than what T-Bills pay and for those of you in this position I
feel very bad. The returns that you seek are not there in
dealing with the amount of capital you have to work with. Do
not allow the lack of capital to destroy the future earning power
of your money. As rates rise you will be able to generate
a much greater return on your money. Do not allow yourself
to be sucked into investments that will deny you the opportunity
to take advantage of the higher rates in the future. If
my thinking is correct the future will hold returns of 3X on
your capital versus what your money will earn you today. I
know that it will be tough to get by for the next several years;
if you can put yourself into a position where you can buy the
time I think you will be very thankful of the end result.
I have often wondered about the long term interest rate cycles. Is
it an accident that the highest yielding thirty-year bonds will
mature at a time when our interest rates may be about to peak
on theupside again, in a few years? Seems like a pretty
good game to me. I must also mention that gold and silver
peaked about the same time too. Do you see a pattern here?
I do!
Not only will your investment in bonds get clobbered but; where
do you think the money will come from to replace the foreign
money that is fleeing the bond market? Do you think it
might come from the stock market or the real estate market?
Without a doubt money will flow from these markets and seek a
new home. I believe gold, silver, oil and gas will be huge
beneficiaries of this transfer of wealth. I have a problem
trying to understand why more people do not see this coming. I
get a huge chuckle when I read about all the forecasts being
made by the technicians and their charts. They all seem
to believe that their charts are telling them the future. I
have yet to read one prediction from these technicians telling
us of the impending disaster that awaits the long term bondmarket. Seems
to me the charts are pretty clear.
Diversification will still be a very important component of an
investor's portfolio; the makeup of the diversification will
differ entirely over what the definition of diversification has
been over the last twenty-five years. Those who understand
this makeup will have a much better chance of surviving the coming
storm; those who don't understand will just have to wait for
the next bull market to make them even. Actually, your beneficiaries
will have to wait for the next bull market; time will run out
on you.
I have always felt that diversification was a sales tool used
by financial peddlers to sell their clients anything they want,
for the sake of earning a commission. Another belief I have
had is diversification is used by people who do not understand
the difference and the reasons why one should or should not have
his money invested in an industry or individual stock. Using
diversification in this manner will always mean less returns
in bull markets and less losses in bear markets. This is
not a bad thing for most people. The questions I pose, for
long term bond holders, is a question of logic; does it make
sense to hold long term bonds after emerging from a period of
historic low interest rates? Does it make sense to hold
bonds knowing that interest rates have just moved off the lowest
levels they have seen in decades? History has a way of
repeating itself. History has taught me that any Government
that has suffered severe financial problems and bankruptcy; have
seen their currencies destroyed, inflation soar and interest
rates skyrocket. We will be no different if we continue
down the path that we are now headed.
There are two lines of defense that one could take in supporting
his holding of bonds. That is the defense of the economy
going into the tank and rates falling as a result of the impending
recession. I could agree with this line of thinking except
for the stance I have taken on the amount of debt and who owns
it. I believe these two topics will dictate the future of
interest rates. The falling dollar in conjunction with the
astronomical increase in debt will eventually lead the foreign
investors to question to true financial strength of our country. Why
should the US be allowed to issue huge amounts of debt when the
rest of the world has to jump through hoops to continue to get
loans from the IMF? What makes the US different?
In reality, nothing! The US has failed to pay its debt
down in the best of times; how can one expect to get their investment
back when we are about to enter the worst of times? Like
I said folks, the times are a changing. The second defense
is that of being forced to have the income to live on. This
is the tough one to deal with. Sometimes we get stuck without
an exit. You can thank Greenspan for this. If you can
possibly get by, the opportunity to put your money back to work
at much higher rates will avail itself down the road; between
here and there is a tough road to follow. In the end there
will be a new sheriff in town. The rules will not be set
by the Fed; they will be set by those who own our debt, they
are the true possessors of weapons of mass destruction, and there
is absolutely nothing that George can do to stop them from selling
when the time comes. I get a charge in the fact that we
feel that we have the right to dictate to our creditors what
our interest rates shall be. In the end, I believe all currencies
will move in the same direction at the same time. No more
dollar down euro up. After all, they are in the same boat,
with a few less holes.
If you were a foreign entity with a bad feeling about the direction
of the US; would you continue to take losses on your bonds knowing
that the level of debt issuance was only going to grow?
Would you continue to buy new issue stock on companies like Enron
and World Com knowing that their financials were accelerating
down the path of self destruction? You would have to be
a fool to do so. In the case of the debt of the US Government;
we are in a period of denial, we have yet to even begin to question
the full faith and credit of our Government. There are so
many people who openly profess that the debt is meaningless. I
hope the future destroys their savings just like their advice
has kept today's investors from protecting their savings and
thinking for themselves.
There is no doubt that I am a gold bug, after all sheriffs have
gold badges. Many people have asked me how high gold will
go and where I will sell my gold investments? These are
both excellent questions; the answer to how high gold will go
is "I don't know." What I do know is the fact
that the movement in gold has just begun. I will not even
begin to think the high is in until I see money move from the
bond market into the metals market. This is a long way down
the road. As to the second question; I will begin to sell
my gold and silver investments when I see panic in the US Government
bond markets. When the whole world comes to the conclusion
that US Government bonds are a risky investment, it is at this
point in time that I believe gold may be nearing a high. Whether
it is at a high or not is irrelevant; the important point is,
at this point in time I will have made enough to satisfy my needs.
Yeah, when I sell my gold, silver, oil and gas investments I
plan to roll right into US Government bonds and clip coupons
for the rest of my life. Only problem with that strategy
is the fact that I too may be scared of the "Full Faith
and Credit" of our Government. Under these circumstances
I will SPECULATE on the safety of the US Bond; and yes it is
at this point in time that I feel interest rates will finally
be in a position to peak over their long term cycle.
Like I have said, these are very interesting times and economic
events could go in many different directions at the same time. The
important points to remember is the long term ending to the story. I
believe the handwriting is on the wall and in plain site. It
would be a grave mistake to not head the lessons of the past.
In closing I ask you one question. How would you feel, today,
if you had bought the thirty-year US Government Bond back in
the early 1980's with a current yield of 14%-15%? You will
probably get the opportunity again!
Be prepared!
July 17, 2004
Mike Hoy
Mhoy1954@aol.com
321gold Inc
Miami USA
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