THE COMING BOND MARKET COLLAPSE

THE COMING BOND MARKET COLLAPSE

THE COMING BOND MARKET COLLAPSE How to Survive the Demise of the U.S. Debt Market MICHAEL G. PENTO

Cover Design: John Wiley & Sons, Inc. Cover Image: Mike Kemp/Jupiter Images Copyright 2013 by Michael G. Pento. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. Disclosure: Michael Pento is the Founder and President of Pento Portfolio Strategies (PPS). This work has been written solely for informational purposes and readers should contact an investment advisor before acting on any information contained in this book. No information in this work constitutes an offer to sell or buy any financial instruments or to provide any investment services. Readers understand that there is inherent risk in investing. PPS is a Registered Investment Advisor, registered with the State of New Jersey. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data Pento, Michael, 1963- The coming bond market collapse : how to survive the demise of the U.S. debt market / Michael Pento. pages cm Includes bibliographical references and index. ISBN 978-1-118-45708-5 (cloth) ISBN 978-1-118-45717-7 (epdf) ISBN 978-1-118-45716-0 (Mobi) ISBN 978-1-118-45715-3 (epub) 1. Bond market United States. 2. Bonds United States. I. Title. HG4910.P426 2013 332.63'23 dc23 2012049828 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1

To my wife, Jenifer, and my two children, Michael and Giamarie. It is my hope and prayer that my kids will grow up in a land that offers them the freedom to bring their dreams to fruition, rather than a government-provided guarantee of mediocrity. To my parents, Frank and Mary, who ignited my passion for freedom. And to God for allowing us all the autonomy to choose.

Contents Introduction Acknowledgments xi xv Chapter 1: As Good as Gold? 1 The Great American Money Machine 4 Dad, Where Does Money Come From? 8 The Implications of a Fiat Currency 11 Notes 14 Chapter 2: The Anatomy of a Bubble 15 The Great Depression A Historical Comparison 19 Two Decades of a Bubble Economy 25 Does CDO Rhyme with Tulip Bulb? 29 Today s Bubble in Bonds Rhymes with the Debt-Fueled Real Estate Crisis 31 Notes 33 Chapter 3: Bernanke s Hair-of-the-Dog Economy 35 Austrian Trade Cycle Theory versus Keynesian Toys and Candy 36 vii

viii CONTENTS End This Depression Now! The Game Show 41 I m Not Addicted to Easy Money...and I Can Stop at Anytime 50 No Way Out Starring Ben Bernanke... 56 The Thirty-Year Party in the Bond Market 62 Notes 65 Chapter 4: Deflation Phobia and Inflation Philos 67 Fed Busters 69 Common Fed-lore Myth 1 The Myth of the Deflationary Death Spiral Monster 69 The Truth about Price Deflation 72 Fed-Lore Myth 2: Japan Proves that Debt and Deflation Go Hand-in-Hand 77 Myth 3: The Keynesian Fed-Lore of the Phillips Curve 86 Myth 4: You Can Rely on Government Statistics 92 Myth 5: The Fed Was Created for Your Benefit 100 Notes 101 Chapter 5: The Bubble Reality Check 103 The Investor Reality Check 104 The Interest Rate Reality Check 110 The Teaser Rate on U.S. Debt Reality Check 115 Banker Reality Check 119 The China Reality Check 127 Washington s Addiction to Debt Reality Check 134 Notes 140 Chapter 6: The End of an Empire 141 The End of a Monetary System 145 The Economic Laws of Debt 152 U.S. Debt This Time It s Different 153 Is Austerity a Bad Thing? 157 Where Will All the Money Go? 160 The Bell Is Ringing for the Bubble in the Bond Market 163 Banana Ben to the Rescue 167 The Cost of an Empire 169 Notes 173

Contents ix Chapter 7: Real World Europe 175 The Creation of the Euro 176 Greece 183 Dr. Hayek vs. Dr. Keynes 190 Dr. Keynes and Dr. Hayek and America s Bout with Hyperinflation 195 I ll Take Currency Debasement for $40 Billion...aMonth 200 Final Jeopardy 203 The Canary in the Coal Mine 204 Notes 205 Chapter 8: The Debt Crisis 207 From Pioneer to Penurious... 207 The Sixteenth Amendment...The Beginning of the Slippery Slope 209 Mexican Debt Crisis 215 The Asian Contagion 218 Russian Debt Crisis 220 The Debt Crisis Fallout 223 What Would It Look Like Here? 225 It Can t Happen Here? 233 I Don t Want to Be Right 238 Conclusion 247 Notes 248 Chapter 9: What Can the Government Do to Mollify the Debt Collapse? 251 The Principles of a Free Market 252 Solution 1: Allow the Deleveraging Process to Happen 257 Solution 2: Strengthen and Stabilize the U.S. Dollar 260 Solution 3: Allow Interest Rates to Rise to the Supply of Savings versus the Demand for Money 262 Solution 4: Balance the Budget 264 Solution 5: Aggressively Reduce the Amount Of Regulatory Burden 270 Solution 6: Simplify the Tax Code 273

x CONTENTS Solution 7: Fair Trade and a Free Trade 276 Solution 8: Overhaul Education 277 Conclusion 278 Notes 283 Chapter 10: How to Invest Your Money Before and After the Bond Bubble Bursts 285 What to Own When U.S. Debt and the Dollar Collapse 289 Notes 294 About the Author 295 Index 297

Introduction In November 2011, I founded a money management firm, Pento Portfolio Strategies, for the primary purpose of preparing clients investments for what I saw as the next financial crisis. Back in 2005, I correctly predicted the bubble in real estate. However, the new catastrophe I see emerging makes the housing bubble pale in comparison. America now sits in the latter stages of the biggest asset bubble in the history of the planet. The bursting of this bubble will send shock waves throughout the global economy and will have a gravely negative impact on the American standard of living. This bubble will have a profound effect on all Americans especially those who fail, or refuse, to see it coming. It will affect your job, the value of your house, your savings, and your way of life. The bubble is U.S. Treasury debt. But don t think of this author as some Cassandra that is calling for the end of the United States. Cartographers will not have to expunge America from their maps. This great country will survive and thrive after the collapse of the U.S. debt market occurs. The point of this work is to guide our leaders down a path that leads toward a direction that mollifies the damage already done. It will also offer investors the best chance to preserve their current standard of living. xi

xii INTRODUCTION Investors, seeking refuge in what they perceive as the safest of all havens (U.S. Treasuries), have been procuring government debt at unprecedented rates despite the record low interest rates they offer. The Federal Reserve, under the stewardship of Ben Bernanke, has rendered our continued solvency as a nation dependent on the perpetual continuation of artificially produced low interest rates. However, it is clear that Bernanke cannot keep rates low forever. The Federal Reserve s misguided effort to counterfeit our way to prosperity, coupled with the flawed Keynesian deficit spending model that our government embraces with alacrity, has led to record debts that will never be able to be repaid. The bursting of the bubble in Treasuries will cause a massive interest rate shock that will drive the U.S. consumer and the government into bankruptcy and send many people throughout the globe into poverty. In order for you to survive the coming debt crisis, you need to be informed and prepared. In this current economic environment, our government seeks a condition of perpetual inflation in order to maintain the illusion of prosperity and solvency. The problem with this addiction to money printing is that once a central bank starts, it can t stop without dire, albeit in the long-term healthy, economic consequences. And the longer an economy stays addicted to inflation and borrowing, the more severe the eventual debt deflation will become. As a result, our central bank is now walking the economy on a very thin tightrope between inflation and deflation. The prevalent idea among our government and central bank is that we can borrow and print even more money in order to eliminate the problems caused by too much debt and inflation. But more inflation can never be the cure for rising prices, and piling on more debt can t solve a condition of insolvency. Since its inception in 1913, the Federal Reserve has been the perpetuator of asset bubbles. From the Fed-induced bubble of the 1920s that led to the Great Depression, to modern-day bubbles in Nasdaq and real estate, the Federal Reserve s manipulation of the cost of money has created a bubble economy. And today, the Federal Reserve is perpetuating its largest bubble since its inception the bubble in the U.S. debt. This book will give you the tools to understand how the Fed created these bubbles and what we as a nation can do to return this economy to

Introduction xiii a more stable footing. In addition, investors will learn the best way to protect their wealth before and after the bubble bursts. After World War II the world moved away from hard metal currencies in favor of fiat currencies. Fiat currencies are created by government decree, backed by nothing, and have their worth based on the faith placed in autocrats. Governments can incur tremendous amounts of debt and can always make good on their principal and interest payments because they can print money. Therefore, default initially comes through inflation. Default via inflation is worse than actual default. Inflation is a hidden tax that disproportionately affects those least able to pay it: the middle class and the poor. Default via inflation is always the last step before an actual default. The fiscally irresponsible administrations of both Democrats and Republicans have placed this great nation on the brink of bankruptcy. And in this book you will learn that throughout history, government spending and money printing has always led nations down the wrong path the path that leads to a currency and debt crisis. Currently, the Federal Reserve is pumping scores of billions of dollars each month into the economy in an attempt to reflate the housing bubble. Of course, rising prices occur every time the central bank prints money in excess of what is necessary to address population and productivity increases the Fed knows this. Inflation is often defined as too much money chasing too few goods. The Fed wants the too much money they are pumping into the economy to start chasing real estate in order to reflate the real estate bubble and rescue the banking sector. But the Fed s fake money isn t only going back into real estate; sure, it s driving mortgage rates to the lowest they have been in history, but it s also driving up the costs of food and energy, while most importantly allowing the federal government to, for now, painlessly take on an enormous amount of debt. Bernanke and Company are operating under the assumption that they can turn off the easy money spigot anytime they want. Instead of providing a strong and stable dollar that would encourage saving and investment, they have opted for cycles of counterfeiting and monetizing that will lead this economy into a depression never before seen. But the truth is, in the long term, the free market controls the cost of money and when our creditors demand an interest rate closer to historic norms, the