THE COMING BOND DEBACLE
by Mike Hoy
July 17, 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 1980s 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 believe diversification 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 of life 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 the same 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 the upside 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!
