Why the Current Strength of US Bonds Will Be Short-Lived

03/16/11 Salta, Argentina – Stocks down…gold down…bond yields flattened…world markets roiled…

And yet, all this pales in comparison to the very real world horror going on right now in a small group of islands in the Pacific Ocean. Tens of thousands of people in one of the world’s most developed economies are without access to clean drinking water tonight and without power in sub zero temperatures. Families huddle together, not knowing if or when the next disaster might be visited upon them.

Millions more around the world watch on with sorrow, horror, perhaps even guilt, at what they see unfolding across Japan. Some will point to the failings of man…others to the mystery of a god…and others still will simply sit and scratch their heads…

“What’s the reason?”…“What does it mean?”…“Why there and why now?”

Before we begin to assess the financial implications of Japan’s 9.0 monster earthquake, we first offer our heartfelt condolences to those who suffered this most recent expression of nature’s blind wrath.

Callous as it must surely seem, sometimes the only thing to do in these situations is to keep on keeping on. Carpenters keep building…engineers keep designing…scientists keep searching for cures…doctors keep administering them…

And reckoners? Well, those of us with little better to offer than our thoughts and words…well, we keep on reckoning…crude and searching as our words must at this time appear…

So we return to our post; to stocks, gold and bonds. Where to from here?

To be frank, it’s probably too early to comprehend the extent of the damage wrought by the quake in Japan with any measure of certainty. We’ll have to see what comes of this in the weeks and months ahead.

However, it’s probably not too early to begin trying to understand what Japan’s crisis might mean for long-term US bond yields. Dan Denning, the Daily Reckoning’s “Man Down Under,” pondered this very question in his Aussie DR musing this morning.

“The Japanese are one of the largest holders of US Treasuries and continue to buy them,” observed Dan, before adding, “That capital might be put to a lot better use in the coming years rebuilding from the quake and tsunami damage.”

Dan raises a very important point. We’re seeing a flight to “safety” right now, no question. US Treasuries rallied yesterday, more or less in sync with the horrific images coming from the Fukushima and Sendai newsreels. The yield on the benchmark 10-year note briefly touched 3.2%, its lowest level this year, reflecting the “safe haven” appeal of bonds. (Bond prices and yields move in opposite directions.)

But what happens when the dust settles a little and Uncle Sam wakes up to find one of the go-to buyers for his ever-accumulating debt has put in a no-show? What happens, in other words, when the second largest holder of US debt discovers he has his own, 9.0 earthquake-sized problem to deal with? According to data released by the Treasury on Tuesday, Japan held $886 billion worth of Treasuries at the end of January, the second largest foreign holder behind China. That’s a big gap to fill…even by fractions.

“Of course in the short term, the ‘risk off’ trade is bullish for US bonds and the US dollar,” continues Dan. “People are cashing in their chips and storing up their cash. But longer term, the US may find it a lot harder to fund deficits without the help of at least one major foreign buyer. This will put more pressure on the Fed to monetize debt right away.”

What then will the Fed do? Well, exactly what the Fed always does, of course; precisely that which it shouldn’t. The Fed will, as Dan points out, continue its attempt to “monetize” (read: print) away its debt.

It goes without saying that this strategy is a complete non-starter, as far as any measure of logic is concerned. Academic types like to argue that a weaker currency and/or more liquidity are great ways to jump-start flailing economies. They argue that a flaccid currency gives exporters an edge abroad and that a blast of paper money stimulates spending back home. In reality, all this does is perpetuate a weakening confidence in that particular currency as a store of value and, thereby, discourage those with whom the offending government might wish to trade from wanting to accumulating them. Who, after all, wants a vault full of Zimbabwean dollars, Hungarian pengos or US Continentals?

And lo! Always on the ball, Addison writes in this morning’s edition of The 5, “Easy money is already having its affect in the US. Wholesale prices, which trotted upward in December and January, reached a full gallop in February.”

The upward-trot-to-record-gallop to which Mr. Wiggin is referring is, at least according to a story we saw coming across the wires this morning, the steepest rise in food prices in 36 years.

Continues Addison, “The producer price index (PPI) rose 1.6%. Even after the usual statistical sleight of hand applied by the Bureau of Labor Statistics, the number is more than double what the Street expected. Annualized, it’s 19.2%.

“That’s for finished goods. If you move further back in the production chain, prices for crude goods rose 3.4% last month. And February was no fluke. PPI for crude goods has risen 20.7% over the last six months.

Of course, the Fed’s own measure of inflation – that nebulous, periodically redefined, terminally elastic non-statistic – remains, according to the Fed itself, “subdued.”

Hooray!

Alas, this news comes to us from an institution that actually admits – with a straight and serious face, no less – that it actively targets a 2% erosion in the value of your money per year. The Feds guarantee, in other words, that they will steal, or do their best to steal, via inflation, 2% of anything you earn or own every year for the rest of your life…or for its. That is its stated “sweet spot.”

It’s enough to make one think of the term “greed” in a whole new light…

Joel Bowman
for The Daily Reckoning

Joel Bowman is managing editor of The Daily Reckoning. After completing his degree in media communications and journalism in his home country of Australia, Joel moved to Baltimore to join the Agora Financial team. His keen interest in travel and macroeconomics first took him to New York where he regularly reported from Wall Street, and he now writes from and lives all over the world.

View articles by Joel Bowman

The articles and commentary featured on the Daily Reckoning are presented by Agora Financial.

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EU Politicians Seek to Unload PIIGS Bonds. Two Steps You Should Take Now …

Since last Friday all eyes have been geared toward the catastrophe in Japan. That’s indeed understandable. However, there has been another important development with far-reaching implications that is worth discussing today …

While the media was totally focused on the Japanese disaster, German Chancellor Merkel and her European brethren insidiously decided to make a major change within the European Financial Stability Facility (EFSF), the EU’s euro rescue fund …

That change will let the European Central Bank (ECB) stop buying sovereign bonds from debt-ridden PIIGS countries like Greece. And it could transfer all those bonds it’s currently holding to the EFSF.

The decision came as a major surprise, since discussions of this controversial topic were officially scheduled to take place at the end of March.

So why now?

There Could Be Two Reasons …

First of all, the European bond market started sending stress signals again. As you can see in the chart below, interest rates of Greek 3-year government bonds shot up from 13 percent in January to 18 percent by March 10.

And last week Portugal was forced to borrow money at 5.99 percent, up nearly 2 percentage points since September — an unbearable leap.

These renewed bond market turbulences may have been an important driver for this emergency summit.

But there could be a second, more cynical explanation for the timing …

German Chancellor Merkel faces some important elections. And the concept of Germany as the main paymaster for troubled PIIGS is very unpopular amongst German tax payers.

And then German Finance Minister Schäuble said that the EFSF was too small and had to be increased.

Consequently, the EFSF’s funding was increased from $347.5 billion to $611.5 billion. Plus, it will now be allowed to buy bonds directly from ailing European governments. To crown this outgrowth of stupidity, it comes without any coercive rule to detain former and probably future sinners from further fiscal recklessness.

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Incentive for Profligacy
Leads to More Inflation

Unrestricted bailouts lead to more profligacy, more government debt, more inflation, and finally to more hardship somewhere down the road. There is absolutely no incentive for any politician to return to prudent policies. And the prudent ones will be punished since they will have to pay the bills of their imprudent brethrens.

European politicians have just decided to dig deeper into the hole they find themselves trapped in. And a return to prudent fiscal and monetary policies has become even less likely than it was before.

Just like the U.S. dollar, the euro is poised to take an extended beating.

By taking on more debt, Europe is following in the U.S.’s footsteps, which will lead to a weaker euro, higher inflation and rising interest rates.

So unfortunately the euro is no alternative to the equally beleaguered dollar. And European sovereign debt bonds are no better than longer-term U.S. Treasuries. They both seem to be doomed.

All of this tells me that interest rates are sure to rise — both in Europe and in the U.S. And I have two ways you can use to potentially profit …

The first, is with ProShares UltraShort 20+ Year Treasury ETF (TBT). This fund seeks daily investment results that correspond to twice the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index. That means for every 1 percent the index drops, TBT is designed to rise 2 percent.

And the second, learn more critical background information about money printing, asset bubbles, opportunistic central bankers, and government debt and what this all means for your financial health. I suggest you get a copy of my new book, The Global Debt Trap. Click on your choice of bookseller to order it online — Amazon, Barnes & Noble or Books-A-Million — or stop by your nearest bookstore.

Best wishes,

Claus

Claus Vogt is the editor of the German edition of Safe Money. He is the co-author of the German bestseller, Das Greenspan Dossier, where he predicted, well ahead of time, the sequence of events that have unfolded since, including the U.S. housing bust, the U.S. recession, the demise of Fannie Mae and Freddie Mac, as well as the financial system crisis. Claus is currently the editor of Million-Dollar Contrarian Portfolio and has just completed his book The Global Debt Trap.

View the original article here

Who Will Buy the Bonds Japan Needs to Sell?

03/15/11 Baltimore, Maryland – The world seemed to hold its breath yesterday. People watched videos of the tsunami…of the earthquake…of the nuclear reactors. Japan’s nuclear reactors were on the verge of a meltdown.

Here at The Daily Reckoning, we predicted a meltdown in Japan – but not that kind of meltdown!

In January, seers and forecasters turned in their predictions for the year ahead. Now, we are in March, and we have already run into two major events that no one predicted.

First, the Arab world exploded. Now, the blow-ups are happening in the least-explosive part of the world, Japan.

Japanese stocks sold off yesterday. If they were a bargain when we recommended them a couple weeks ago, they are an even bigger bargain today. US stocks didn’t do much of anything.

Perhaps some kind of turning point has been reached.

Japan has been suffering from a manmade disaster for the last 20 years. It is a long, slow, painful form of national economic suicide. Now it is time to pick up the pace. This from Bloomberg:

The Bank of Japan poured a record amount of cash into the financial system and doubled the size of its asset-purchase program to shield the economy from the effects of the nation’s strongest earthquake on record.

The central bank pumped 15 trillion yen ($183 billion) into money markets to assure financial stability amid a plunge in stocks and surge in credit risk. Governor Masaaki Shirakawa and his board also increased their facility that buys assets from government bonds to exchange-traded funds to 10 trillion yen.

“We are providing as much funds as needed to dispel anxiety in financial markets,” Kazushige Kamiyama, an official in charge of the central bank’s money market operations, said before the policy announcement. “We will continue to add ample funds to stabilize financial markets.”

It used to be that central banks were charged with maintaining the integrity of the people’s money. Then, mission creep set in. Maintaining full employment was added to the job description. And then, Ben Bernanke took it upon himself to boost stock prices. Higher stock prices would encourage people to spend and invest, he thought.

And now, the Bank of Japan takes another step. It is playing a leading role in earthquake remediation – like the Red Cross or the National Guard.

The Bank of Japan is going all out. Not only is it putting emergency funds into the economy, it’s also stepping up its own QE program.

What else can it do? It was already doing all it could. The BOJ has been “zero bound” for the last 15 years – meaning, it has been lending money as cheaply as it possibly could. If monetary policy were a pair of pants it would be around Japan’s ankles. And fiscal policy? The country already has $20 of debt for every dollar of tax receipts. What’s left? Thirty dollars, surely – or bankruptcy.

There’s unconventional stimulus too. That’s right…the old printing press…is getting a good workout.

Onward!

The Japanese camel has a remarkably strong back. He’s held up to more than two decades of counter-cyclical stimulus programs…and central government debt that now measures 200% of GDP.

The poor long-suffering beast has seen everything. The Japanese trusted the government with their retirement money. The government spent the money. And yet, bond buyers seem none the wiser. They still lend to the Japanese government at less than 2% yield.

And now the old-timers are beginning to dis-save. That is, after saving so much for their retirements, now they are retired. And now they are drawing down their savings.

This puts the Japanese government is in a real fix. Net savings in Japan are now negative. So, who will buy the bonds Japan needs to sell in order to rebuild its economy? Who will buy the bonds Japan needs to sell in order to rebuild its infrastructure? Who will buy the bonds Japan needs to sell in order to fund its government? Who will buy the bonds Japan needs to sell in order to pay back the people who bought bonds last year…and the year before…and all the way back to 1990?

The answer is likely to be: no one.

Instead, Japan will be forced into more QE, forced to print money to make up for the money she can no longer borrow.

This will have a couple knock-on effects. First, the Japanese famously helped Europe and America finance their deficits and bailouts. Recently, Japan funded a major part of Europe’s bond sales – helping to hold down rates. Also, the last time we looked, Japan had the largest stash of US bonds in the world.

Under pressure to bring money back to the home island, you can expect Japan to be doing some selling – which might be the final straw.

Second, the Japanese are making such an obvious mess of their finances that they are bound to attract attention. Investors might notice that the Japanese aren’t the only ones. As we’ve pointed out several times, the developed economies all now count on low interest rates, huge deficits, and printing press money. Even with these massive in-puts of cash and credit grease, the economy still barely creaks forward. Without the extra grease, they will probably slip backward.

Bill Bonner
for The Daily Reckoning

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning . 

View articles by Bill Bonner

The articles and commentary featured on the Daily Reckoning are presented by Agora Financial.

Sign Up for The Daily Reckoning e-letter and receive a copy of our newest report How to Survive the Fall of Social Security… at NO CHARGE.

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We Value Your Privacy.

View the original article here

Should We Be Alarmed That The Biggest Bond Fund In The World Has Dumped All Of Their U.S. Treasury Bonds?

Bill Gross, the manager of the biggest bond fund in the world, has forgotten more about bonds than most of us will ever learn. That is why the big move that PIMCO has just made is so unsettling.  At one time PIMCO held more U.S. government debt than any other bond fund on the globe, but now news has come out that they have gotten rid of all their U.S. government-related securities.  So should we be alarmed?  For months Gross has been warning that the bull market in bonds is coming to an end, and now it looks like he is putting his words into action.s  Gross has often publicly decried the rampant government spending that has been going on over the last several years, and apparently he has seen enough.  He is taking his ball and he is going home.  This really is a stunning move by PIMCO.  Gross must really believe that something fundamental has shifted.    Gross didn't get to where he is today by being stupid.  But so far world financial markets are taking this news in stride.  Nobody seems all that alarmed that the largest bond fund in the world has dumped all of their U.S. Treasuries.  But with world financial markets in such a state of chaos right now, shouldn't we all take note when one of the biggest players in the game makes such a bold move?

Gross believes that interest rates on U.S. Treasuries are way too low right now and that they will start going up when the Federal Reserve ends the current round of quantitative easing in June.  Gross has indicated that if interest rates on U.S. Treasuries go up high enough, PIMCO might get back in.

But if interest rates do start going up that is going to make servicing the monolithic U.S. national debt much more expensive, and that would not be good news for U.S. government finances.

But would the Federal Reserve really allow interest rates on U.S. Treasuries to go up substantially?  Wouldn't they just step in at some point and start buying U.S. government debt again?

Probably.

But the truth is that the Ponzi Scheme of the U.S. Treasury issuing bonds and the Federal Reserve buying them up cannot last forever as Gross noted in his March newsletter....

"Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t."

Gross also noted in his newsletter that the Federal Reserve is currently buying up about 70 percent of all new U.S. government debt.

So what is going to happen when that stops?

Nobody knows for certain, but it sure is going to be interesting to watch.

The market for U.S. Treasuries has not been working "normally" for quite some time now, and there is some legitimate doubt as to whether it will ever fully get back to "normal" again.

Meanwhile, the sovereign debt crisis in Europe continues to get even worse.

The yield on 10-year Portuguese bonds is now above 7 percent, the yield on 10-year Irish bonds is now above 9 percent and the yield on 10-year Greek bonds is now above 12 percent.

Most people expect European leaders to soon come to an agreement to add billions more to existing bailout funds, but there is no guarantee that is actually going to happen.

In fact, the Germans are making waves by insisting that the financially troubled nations in the EU must be willing to agree to limits on their future budget deficits.  A recent article on CNBC described the situation this way....

Before the Germans will agree to pump in extra cash from their taxpayers, backed by the French, they want each leader to agree to legislation at home that will limit the size of their future national deficits. The Greeks are already refusing point blank. Things may boil to the surface at an extraordinary summit on Friday.

So what if an agreement can't be reached?

Could the dominoes in Europe start to fall?

Very few people actually want to see a wave of sovereign defaults in Europe, but the current situation cannot go on forever.  At some point the Germans are going to get sick and tired of bailing out other members of the EU.

The global addiction to debt is about to start having some very serious consequences.

For decades, most of the governments of the industrialized world have been running up debt as if it would never come back to haunt them.  Now the world is absolutely covered in red ink and everyone is looking for a way to solve the problem.

But there is not going to be a debt jubilee to come along and save everyone.  This debt bubble is either going to keep expanding or it is going to burst.

At one point, at least some of the debt-ridden nations will try to inflate their way out of debt by recklessly printing money.  To a certain extent that has already been going on.  But it will not work.  It will only cause a whole lot of inflation.

This is just more evidence that any economic system based on debt is destined to fall.  When we allowed a private central bank to start issuing debt-based currency in this country back in 1913 we set ourselves up to fail.  As I have written about previously, the Federal Reserve should never have been allowed to come into existence, and it should have been shut down by Congress long before now.

But now the United States is caught in the same debt trap that most of the other nations around the world are caught in.  The global addiction to debt is going to have some very, very serious consequences.  Instead of moving into a great time of peace and prosperity, everything is about to come falling apart.

Things could have been different.  Things did not have to turn out this way.  But here we are on the edge of one of the biggest financial disasters in human history and most Americans still don't understand what is happening.

So what do you all think about all of this?  Please feel free to leave a comment with your opinion below....

View the original article here

Should We Be Alarmed That The Biggest Bond Fund In The World Has Dumped All Of Their U.S. Treasury Bonds?

Bill Gross, the manager of the biggest bond fund in the world, has forgotten more about bonds than most of us will ever learn. That is why the big move that PIMCO has just made is so unsettling.  At one time PIMCO held more U.S. government debt than any other bond fund on the globe, but now news has come out that they have gotten rid of all their U.S. government-related securities.  So should we be alarmed?  For months Gross has been warning that the bull market in bonds is coming to an end, and now it looks like he is putting his words into action.s  Gross has often publicly decried the rampant government spending that has been going on over the last several years, and apparently he has seen enough.  He is taking his ball and he is going home.  This really is a stunning move by PIMCO.  Gross must really believe that something fundamental has shifted.    Gross didn't get to where he is today by being stupid.  But so far world financial markets are taking this news in stride.  Nobody seems all that alarmed that the largest bond fund in the world has dumped all of their U.S. Treasuries.  But with world financial markets in such a state of chaos right now, shouldn't we all take note when one of the biggest players in the game makes such a bold move?

Gross believes that interest rates on U.S. Treasuries are way too low right now and that they will start going up when the Federal Reserve ends the current round of quantitative easing in June.  Gross has indicated that if interest rates on U.S. Treasuries go up high enough, PIMCO might get back in.

But if interest rates do start going up that is going to make servicing the monolithic U.S. national debt much more expensive, and that would not be good news for U.S. government finances.

But would the Federal Reserve really allow interest rates on U.S. Treasuries to go up substantially?  Wouldn't they just step in at some point and start buying U.S. government debt again?

Probably.

But the truth is that the Ponzi Scheme of the U.S. Treasury issuing bonds and the Federal Reserve buying them up cannot last forever as Gross noted in his March newsletter....

"Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t."

Gross also noted in his newsletter that the Federal Reserve is currently buying up about 70 percent of all new U.S. government debt.

So what is going to happen when that stops?

Nobody knows for certain, but it sure is going to be interesting to watch.

The market for U.S. Treasuries has not been working "normally" for quite some time now, and there is some legitimate doubt as to whether it will ever fully get back to "normal" again.

Meanwhile, the sovereign debt crisis in Europe continues to get even worse.

The yield on 10-year Portuguese bonds is now above 7 percent, the yield on 10-year Irish bonds is now above 9 percent and the yield on 10-year Greek bonds is now above 12 percent.

Most people expect European leaders to soon come to an agreement to add billions more to existing bailout funds, but there is no guarantee that is actually going to happen.

In fact, the Germans are making waves by insisting that the financially troubled nations in the EU must be willing to agree to limits on their future budget deficits.  A recent article on CNBC described the situation this way....

Before the Germans will agree to pump in extra cash from their taxpayers, backed by the French, they want each leader to agree to legislation at home that will limit the size of their future national deficits. The Greeks are already refusing point blank. Things may boil to the surface at an extraordinary summit on Friday.

So what if an agreement can't be reached?

Could the dominoes in Europe start to fall?

Very few people actually want to see a wave of sovereign defaults in Europe, but the current situation cannot go on forever.  At some point the Germans are going to get sick and tired of bailing out other members of the EU.

The global addiction to debt is about to start having some very serious consequences.

For decades, most of the governments of the industrialized world have been running up debt as if it would never come back to haunt them.  Now the world is absolutely covered in red ink and everyone is looking for a way to solve the problem.

But there is not going to be a debt jubilee to come along and save everyone.  This debt bubble is either going to keep expanding or it is going to burst.

At one point, at least some of the debt-ridden nations will try to inflate their way out of debt by recklessly printing money.  To a certain extent that has already been going on.  But it will not work.  It will only cause a whole lot of inflation.

This is just more evidence that any economic system based on debt is destined to fall.  When we allowed a private central bank to start issuing debt-based currency in this country back in 1913 we set ourselves up to fail.  As I have written about previously, the Federal Reserve should never have been allowed to come into existence, and it should have been shut down by Congress long before now.

But now the United States is caught in the same debt trap that most of the other nations around the world are caught in.  The global addiction to debt is going to have some very, very serious consequences.  Instead of moving into a great time of peace and prosperity, everything is about to come falling apart.

Things could have been different.  Things did not have to turn out this way.  But here we are on the edge of one of the biggest financial disasters in human history and most Americans still don't understand what is happening.

So what do you all think about all of this?  Please feel free to leave a comment with your opinion below....

View the original article here

Guest Post: The Coming Rout (In Stocks, Bonds, Commodities and Precious Metals)

The following article has been contributed by market analyst and contrarian thinker Chris Martenson.

Editor’s Note: As stock markets, commodities, and precious metals heat up due to a variety of factors, including excessive quantitative easing and stimulus, Chris Martenson warns that prices may be set to collapse. For years we’ve maintained that the longer-term trend for essential goods like food, energy, gold and silver will be higher prices, as central banks the world over, starting with our very own Federal Reserve, continue to intervene in the free market by printing more and more money to stimulate and stabilize the economy. So too have we warned economic crisis and confusion lead to extreme global volatility, not just in financial markets, but geo-politics. As food costs go through the roof, oil approaches $150 a barrel, and gold reaches new historic highs, caution is called for.

If there’s one thing we should have learned over the last few years, it’s that the consensus is usually well behind the curve, and when everybody believes the same thing is going to happen (in this case, continued rising prices), the exact opposite takes place. If you own a 401k or IRA with stocks, bonds and commodities, we suggest you consider Chris Martenson’s views on what we may see in financial markets in the near term.

As we did in the summer of 2008, we may now be approaching another breaking point. And as we saw in 2008, nothing but the US dollar was spared. Does this mean you should immediately sell all of your precious metals and other safe haven assets? Chris Martenson suggests not, especially if you’ve planned to hold those asset for a long investment horizon of years as opposed to months. Nonetheless, given what has transpired so far, it is important to understand that nothing is outside the realm of possibility. We urge our readers to remain vigilant, and if Mr. Martenson is correct in his forecast, there may be yet another great opportunity for investment and preparedness, especially in precious metals, in the very near future. If the ‘S’ hits the fan within global asset prices, we shouldn’t be surprised. Rather, we should embrace the opportunity, as it may not last long, especially in investments that have historically been the assets of last resort, such as commodities and precious metals. If Mr. Martenson’s forecasted scenario were to play out, we strongly believe that governments will act immediately, in unison, and without restriction to flood the economic system with yet more monetary stimulus.

The Coming Rout
By Chris Martenson

There’s a scenario that could play out between May and September in which commodities (including my beloved silver) and the stock and bond markets could all sell off between 20% and 40%.  The trigger will be the cessation of QE II and a multi-month pause before QE III.

This is a reversal in my thinking from the outright inflationary ‘buy with both hands’ bent that I have held for the past two years.  Even though it’s quite a speculative analysis at this early stage, it is a possibility that we must consider.

Important note: This is a short-term scenario that stems from my trading days, so if you are a long-term holder of a core position in gold and silver, as am I, nothing has changed in my extended outlook for these metals.  The fiscal and monetary path we are on has a very high likelihood of failure over the coming decade, and I see nothing that shakes that view.

But over the next 3-6 months, I have a few specific concerns.

It’s time to build on the idea I planted in the Insider article entitled Blame the Victim (February 28, 2011) where I speculated on the idea that the Fed might be forced to end its quantitative easing programs, almost certainly because of behind-the-scenes pressure.

Here’s what I said:

How I read [the Fed's recent propaganda tour] is that the Fed is taking some heat for its inflationary policies, mainly behind closed doors, and it is trying to do what it can — with words — to soothe the situation. Perhaps China is making noises, or perhaps Brazil’s finance minister is making the phone lines feeding the Eccles building smoke ominously, or perhaps it is internal pressure coming from politicians with restless voters. Or all three.

The big risk here is that the Fed will be forced by this rising pressure to discontinue the QE program in June at the normal ending of the QE II efforts. Couple that with a possible federal showdown over the debt ceiling right at the same time, and you have the makings for a massive fireworks display, possibly involving derivative mortars bursting in air.

At the time, I speculated that all of the Fed’s pronouncements about inflation being almost nonexistent were actually signs that the Fed was taking some behind-the-scenes heat for the inflation its policies was creating.  And I worried about what would happen if the Fed were to end the QE program in June.

Let’s just say it won’t be pretty.

Everything would tank.  Stocks, bonds, and commodities.  All of the risk assets that have been unnaturally supported by a flood of liquidity, too-low interest rates, and thin-air base money would give up those ill-gotten gains.  Gold might behave a bit differently, because along with these market declines will come an enormous amount of uncertainty about the financial system itself, usually a condition for higher gold prices.  So I expect gold to correct somewhat, but not nearly as much as everything else, and it could even gain.

The story is, admittedly, getting more confusing by the week, with some calling for hyperinflation and some calling for massive, outright deflation.  I am trying to surf the probabilities and stay one step ahead of whatever curve balls are coming our way.

The basic idea is this:  The Fed has been dumping roughly $4 billion of thin-air money into the US markets each trading day since November 2010.  The markets, all of them, are higher than they would be without this money.  $4 billion per trading day is an enormous amount of money.  It’s gigantic by historical standards.  As soon as the QE program ends, the markets will have to subsist on a lot less money and liquidity, and the result is almost perfectly predictable.

Hello, downdraft.

The markets are quite substantially elevated due to the efforts of the Fed.  T, and then some, is quite likely to be rapidly eliminated as soon as the QE program has ended.

It’s really that simple.

To make the story even more difficult to follow, the Fed has been sending out teams of PR agents in an effort to guide the markets with their words.

First, on March 2, 2011 Bernanke said this:

Bernanke Signals No Rush to Tighten When Asset-Buying Ends

March 2, 2011

Federal Reserve Chairman Ben S. Bernanke signaled he’s in no rush to tighten credit after the Fed finishes an expansion of record monetary stimulus, seeing little inflation risk and still-slow job growth.

A surge in the prices of oil and other commodities probably won’t generate a lasting rise in inflation, Bernanke told lawmakers yesterday in semiannual testimony on monetary policy. A “sustained period of stronger job creation” is needed to ensure a solid recovery, and the Fed’s benchmark rate will stay low for an “extended period,” he said.

The “no rush to tighten credit” statement is a signal that the Fed will neither raise rates at the end of the QE program nor perform reverse POMOs where it reels cash back in and pushes MBS and/or Treasury paper back out.

Upon the cessation of the QE efforts, and the cessation of $4 billion a day in Treasury buying pressure, it’s a safe bet that market interest rates will rise.  Bernanke is at least on record as saying that if this happens, it won’t be because the Fed has taken the lead.

Bernanke was being a little bit sloppy in his statements, because stopping QE will serve to tighten credit simply because there will be a lot less liquidity sloshing around the system.  It’s a situation where the absence of excess is the same as the presence of tightness, if that makes any sense.

Then on March 5th, a much stronger and clearer signal was given, confirming my worries:

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

March 4, 2011

Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month.

Whoa.  This is important news.  Not only a cessation of QE, but the possibility of a sudden stop is being telegraphed.  This will change everything.

The old saying ‘sell in May and go away’ might never be truer than this year, although with this sort of a warning, the cautious investor may want to get a head start on things and sell in March or April.

For some time there have been rumors that the Fed has been splitting into factions, with some of the inner team becoming increasingly uncomfortable with the QE program and its effects.  But so far they’ve either spoken in code to reveal their displeasure or quietly resigned.  So we’re pretty sure there’s an admirable level of support within the Fed for ending QE, and it has now bubbled to the surface and reached the public arena.

Of course, there’s some form of gobbledy-gook reasoning being floated to justify the plan for a sudden stop rather than a gentle wind-down, and it involves the distinction between ‘stocks and flows’ (from the same article as above):

Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman.

“We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.”

Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”

The idea that Brian Sack, a 40-year-old economist with a PhD from MIT, is winning the day in the argument of “stocks over flows” is somewhat troubling to me.  MIT is a quantitative shop, home to some very brilliant people, but how markets will actually respond is another specialty altogether, one that requires a bit of on-the-street experience.  Markets have a bad habit of not being logical, not fitting neatly into tidy formulas, and ignoring things like ‘stocks and flows.’

I’ll go even further. I’ll take the other side of that bet and opine that the flows are much more important than the stocks, because it is the flows that support the continued budget deficits of the US government — which, it should be noted, will still be with us each and every month long after June 2011.  Those deficits are baked into the cake and will require in excess of $125 billion in new Treasury sales each and every month.

Who will buy all the Treasury bonds after the Fed steps aside?  That is unclear.  If there are not enough buyers at these artificially inflated prices, then the price will have to fall until sufficient buyers can be found.  Falling bond prices are at the other side of the financial see-saw from rising bond yields; one goes down while the other goes up, and the Fed has been pressing firmly down on yields for a while via the QE II program.  When that’s over, pressure will be reduced and yields will rise.

So what to do? For those concerned enough about this possible scenario to consider taking action, please see Part II of this article (free executive summary; paid enrollment required to access). In it, I predict the extent to which stocks, commodities, Treasury bonds and precious metals prices may be impacted in the near term.  I also detail the key indicators to look out for in order to determine if and when this scenario is unfolding - as well as recommended strategies to preserve capital during this corrective phase.

Chris Martenson is the father of three young children; author; obsessive financial observer; trained as a scientist; experienced in business; has made profound changes in his lifestyle because of what he sees coming.

As we did in the summer of 2008, we may now be approaching another breaking point.

Author: Contributing Author
Date: March 8th, 2011
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