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These Bloodhounds Want to Raise Rates by 10%

By Tom Dyson, publisher, The Palm Beach Letter
Tuesday, February 3, 2009

 In the 1980s, there was a group of traders called the Bond Market Vigilantes. These traders were like the guardians of the free market economy. They kept the government in check by driving up interest rates every time it tried to increase its finances or induce inflation.

Richard Russell, the dean of the newsletter world, calls them "bloodhounds."

Whenever the Bond Market Vigilantes sensed inflation, they sold their bonds. As prices on bonds fall, their interest rates rise. Higher interest rates made it more expensive for the government to borrow. They made it harder for people to buy houses. They hurt the economy. In short, the Bond Market Vigilantes prevented the government from engaging in reckless borrowing and spending by always threatening higher interest rates.

Today, the Bond Market Vigilantes are too weak to make a difference. To keep their economies strong and their citizens employed, Asian counties, especially the Chinese, lend gargantuan sums of money to the U.S. government. This massive intervention smothers the Vigilantes. It stops them from doing their job. 

As things currently stand, the government and the Fed may take any steps they want to stabilize the economy, no matter how much these steps cost. 

Now, the government is like a fat schoolboy taking candies from a well-dressed stranger. It has spent $8.5 trillion of future taxpayers' and foreign creditors' money guaranteeing debt and bailing out failed companies. But the government doesn't have its own money to pay for these remedies. So it borrows and inflates. 

Analyst Jim Bianco's research shows the government's remedies have now cost America more than World War II. The Fed is expanding the money supply at a current rate of 151% a year... and in the last three months, the Treasury borrowed $485 billion. It has never borrowed this much in 12 months. In 2009, the government will run the world's first trillion-dollar deficit.

In 2010 or 2011 
 when the Chinese arrangement ends – the Bond Market Vigilantes will return. Watch gold for the signal. Gold is a much smaller market than the bond market, so it's more nimble. When gold makes a new high above $1,050, you should immediately start looking for shelter. It means the Chinese arrangement is winding down and the Vigilantes are coming.

The Vigilantes will run interest rates up by at least 10%. They will force the U.S. economy to deal with its debt problem, the root of all our troubles today. No more bailouts, no more government guarantees, no more expensive spending programs, and no more printing money. This is what the situation was like in the early 1980s. It was chaos, but those who prepared ahead of time made a fortune. 

This time around, while the vigilantes restore balance, you should own only gold, cash, and short-term money-market instruments. 

In the meantime, you should use the stability to earn as much income as you can by selling options against blue-chip stocks and holding high-yield bondsand other income investments. These investments prosper when there are no Bond Market Vigilantes around. 

Good investing,


Market Notes


Our award for the "smoothest" downtrend of the past few years has to go to the newspaper business.

As you'll see from today's chart of USA Today publisher Gannett, the newspaper business is in a sorry state right now. During a grinding downtrend, Gannett shares have declined from $50 in 2007 to around $5 now. The chart of fellow newspaper giant New York Times tells a similar story.

As our colleague Porter Stansberry described in this essay, it's the story of a business swirling down the toilet bowl. Companies are conserving cash and advertising less… folks are using free websites like eBay and Craigslist instead of classified ads... and most people under 30 never read the newspaper (most papers are terrible, so we don't blame them).

"Trend following" traders enjoyed huge profits in 2008 shorting stocks, commodities, and just about everything else. For any of you "trend guys" looking to make similar returns in 2009, have a look at newspapers.

In The Daily Crux

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