I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.

                                         — James Carville, Professional Spinmeister

The ride of the vigilantes

Whenever I hear about the threat of bond vigilantes, I think of Wagner's “Ride of the Valkyries” and that scene from Apocalypse Now when the Hueys fly in low and shoot up some village in Laos...

I don't know why I think that, but it seems appropriate.

For those who don't know, a bond vigilante is an investor who believes that inflation is a risk and demands higher yields to compensate for this risk. It's a very logical stance.

However, back in the halcyon days of the Bill Clinton presidency, the spinmeisters — such as Carville, quoted above — invented a name that would cast blame on these investors. (It is the first reaction of most politicians who have no working knowledge of finance to shout names and point fingers.)

It couldn't be the unsustainable deficits and budgetary irresponsibility that drive up yields... It's the “bond vigilantes.”

This was all a reaction to the fact that from October 1993 to November 1994, 10-year yields climbed from 5.2% to just over 8.0%, fueled by concerns about federal spending.

A deer in headlights

We all know that Obama is over his head when it comes to the economy...

He has nationalized a good portion of it, given the unions special deals, kowtowed to bankers' needs in a fluff regulation bill, and forced 40 million people to buy health insurance from select private businesses.

Obama on The Economy

On the flip side, he has “kept his foot on the neck of oil companies," threatened tax hikes for the rich, pushed an fiscally deadly cap and trade bill, spent trillions on a failed TARP bill and preached wealth redistribution.

Obama himself said, "A strong government hand is needed to assure that wealth is distributed more equitably."

The one effect of being pawned and manipulated by all sides is that Obama has saddled the country with unsustainable debt.

The national debt clock has the debt today at $13.455 trillion — or $43,532.97 per man, woman and child (not worker or taxpayer, mind you).

The debt is expected to rise to 100% of GDP in 2012. This doesn't include the off balance sheet stuff like the $5 trillion of Freddie Mac and Fannie Mae debt that we all own. But no one wants to talk about that, so I'm not going to bring it up.                                                                   

The only way to pay off this debt is to raise taxes or destroy the currency through inflation.

In the long run, you want to be out of U.S. debt and the U.S. dollar.                              

Bond bubble 

Given all this, why whould anyone want to own suspect U.S. debt at paltry interest rates?

Lemmings

Back in June, the fear of a stock market crash coupled with a general lack of faith in equities had everyone rushing into bonds.

If you remember, I recommended you go long the ProShares Ultra -7-10 Year Treasury (UST). That winning trade is now played out.

Bulls turn bearish

As you can tell by the treasury chart above, bonds are starting to break down as fears of a equity crash have dissipated.

Today, Barclays put out a report saying that current yields spreads on U.S. government bonds means that risk to the economy from deflation is ending:

Treasuries that protect against rising consumer prices, the difference between short- and long-term interest rates, and so- called real yields show investors anticipate a 28 percent chance of deflation. That’s down from 70 percent in the aftermath of the collapse of Lehman Brothers Holdings Inc. in 2008.

If the bond market thinks that deflation is no longer a real threat, then inflation must be — and therefore buying bonds is no longer the safe play.

Yes, theoretically it could stay in a perfect balance of very low inflation.

But it won't, and I'll tell you why...

Inflation

History tells us that every time the Federal Reserve cuts interest rates, it takes two or three quarters to show up. And when it shows up, it generally manifests itself as some sort of liquidity-fueled bubble.

The Fed cut the Fed Funds rate from 5.25% to 0.25% starting in August 2007 and ending in December 2008. It hasn't moved it since.

That's a huge, massive, unbelievable cut to the cost of money which hasn't shown up anywhere (except maybe in Chinese inflation and investment bankers' bonuses) in two years.

But that is changing...

Right now — perhaps due to tight consumer spending in most areas — this excess cash is showing up in food prices. You gotta eat, right?

The U.N. has reported that global meat prices are at a twenty-year high. Pork bellies (think bacon) are at a record $1.50 a pound; Australian lamb prices are at $5.50 a kilo — the highest price since 1973.

Wheat is up 74% this year... Corn is at a fifteen-month high in Chicago, up 33% since late June... Sugar is up 53% in four months.

Last month, a JPMorgan analyst who tracks food prices reported that a standard basket of Wal-Mart food in Virginia increased 5.8% over last year. In India, food prices were up 14.05% in the second quarter.

This is a big deal. Despite what the CPI tells you, food inflation counts.

Soon, the bond vigilantes will rise again. They will demand a higher yield from bonds to cover inflation.

Higher rates will crush the housing market

Right now, houses aren't selling at record low mortgage rates (4.33) and at a 30% price discount to their highs. What happens when rates go up?

The cost of your monthly mortgage payment goes up. The price of you house must go down by the same amount.

If you can't buy equities, treasuries, or houses because you just got burnt on all three... Where do you put your money?

In a mattress? A mason jar?

Some will, for sure.

Remember, inflation means that the value of the dollar will fall. It is already falling relative to food. It will also fall relative to gold, oil, wolfram, cobalt, uranium, and silver.

You want your money out of the United States and into hard assets.

My favorite oil stock is up 727% this year alone.

I'm buying gold stocks on yesterday's new high, and waiting for a breakout to buy calls on Market Vectors Agribusiness ETF (NYSE: MOO), where $47 is the breakout buy.

There are lots of ways to make money on this coming trend.

Join us, let's make some money together.

All the best,

Christian DeHaemer,
Wealth Daily

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