Contents Introduction Acknowledgments Chapter 1: As Good as Gold? The Great American Money Machine “Dad, Where Does Money Come From?” The Implications of a Fiat Currency Notes Chapter 2: The Anatomy of a Bubble The Great Depression—A Historical Comparison Two Decades of a Bubble Economy Does CDO Rhyme with Tulip Bulb? Today’s Bubble in Bonds Rhymes with the Debt-Fueled Real Estate Crisis Notes Chapter 3: Bernanke’s Hair-of-the-Dog Economy Austrian Trade Cycle Theory versus Keynesian Toys and Candy “End This Depression Now!”—The Game Show “I’m Not Addicted to Easy Money and I Can Stop at Anytime” No Way Out—Starring Ben Bernanke The Thirty-Year Party in the Bond Market Notes Chapter 4: Deflation Phobia and Inflation Philos Fed Busters Fed-Lore Myth 2: Japan Proves that Debt and Deflation Go Hand- in-Hand Myth 3: The Keynesian Fed-Lore of the Phillips Curve Myth 4: You Can Rely on Government Statistics Myth 5: The Fed Was Created for Your Benefit Notes Chapter 5: The Bubble Reality Check The Investor Reality Check The Interest Rate Reality Check The Teaser Rate on U.S Debt—Reality Check Banker Reality Check The China Reality Check Washington’s Addiction to Debt—Reality Check Notes Chapter 6: The End of an Empire The End of a Monetary System The Economic Laws of Debt U.S Debt—This Time It’s Different Is Austerity a Bad Thing? Where Will All the Money Go? The Bell Is Ringing for the Bubble in the Bond Market Banana Ben to the Rescue The Cost of an Empire Notes Chapter 7: Real World Europe The Creation of the Euro Greece Dr Hayek vs Dr Keynes Dr Keynes and Dr Hayek and America’s Bout with Hyperinflation I’ll Take Currency Debasement for $40 Billion a Month Final Jeopardy The Canary in the Coal Mine Notes Chapter 8: The Debt Crisis From Pioneer to Penurious The Sixteenth Amendment The Beginning of the Slippery Slope Mexican Debt Crisis The Asian Contagion Russian Debt Crisis The Debt Crisis Fallout What Would It Look Like Here? It Can’t Happen Here? I Don’t Want to Be Right Conclusion Notes Chapter 9: What Can the Government Do to Mollify the Debt Collapse? The Principles of a Free Market Conclusion Notes Chapter 10: How to Invest Your Money Before and After the Bond Bubble Bursts What to Own When U.S Debt and the Dollar Collapse Notes About the Author Index 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 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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, 1963The 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) Bond market–United States Bonds–United States I Title HG4910.P426 2013 332.63′23—dc23 2012049828 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 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 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 Clark, Jeff Clinton, Bill Cogan, John Coinage Collateral damage Collateralized debt obligation (CDO) Communism Community Reinvestment Act (CRA) Competition, in free market Congressional Budget Office (CBO) Congressional oversight Constitutional rights Consumer Price Index (CPI) all urban consumers “constant-standard-of-living measure” statistical manipulation of Consumer price inflation Consumer Product Safety Commission Coolidge, Calvin Cost of living Cox, Chris Creature from Jekyll Island, The (Griffin) Credit default swap (CDS) Credit rating agencies Currency collapse Currency debasement Currency devaluation Currency exchange rates Currency manipulation DaveManual.com Debt economic laws of foreign ownership of to GDP ratio income tax and restructuring Debt ceiling increases Debt crisis in East Asia in Latin America in Russia in U.S Debt service payments Default, via inflation Defense budget Deficit spending Deflation deleveraging process depression of 1920–1921 and Federal Reserve’s view of in Japan necessity of real economic growth and as solution to imbalance of inflation “Deflationary death spiral” Deleveraging allowing process of consumers and deflation and worldwide Demand deposits DeMarco, Doreen DeMarco, Eugene Depardieu, Gerard Department of Agriculture Department of Housing and Urban Development Depression (Great Depression) Derivatives Devaluation, of the dollar Dimon, Jamie Diocletian Disability insurance program Discount rate (discount window) collapse of Japanese market after cutting of Japan and Disney, Walt Dodd-Frank Dollar, U.S bond collapse and weakening of devaluation of Federal Reserve and purchase power of Keynesian theory of weak/debased as reserve currency strengthening and stabilizing DollarDaze.org Dollar-denominated debt Donahue, Phil Dot-com bubble Dow Jones Industrial Average Draghi, Mario Dutch Central Bank Dutch Golden Age Early Speculative Bubbles and the Increase in Money Supply (French) East Asian debt crisis Easy-money policies Economic and Monetary Union (EMU) Economy economic laws of debt pillars of a strong economy Edison, Thomas Education spending Education system Einstein, Albert Election campaigning Emergency Economic Stabilization Act End This Depression Now! (Krugman) Energy prices Energy resources Energy sector England fractional reserve banking and free trade and Enron Entitlement reforms Environmental Protection Agency Equilibrium price Equity prices Euro bailout guarantee idea of Europe See also Specific country austerity and social support system European Central Bank banking license control debt monetizing European Economic Community European Monetary System European Stabilization Mechanism European System of Central Banks (ESCB) European Union labor market rigidity weaker/stronger members of Eurozone central banks Evans, Charles Exchange-traded funds Fair trade Fannie Mae Farm subsidies Federal Deposit Insurance Corporation (FDIC) Federal Funds rate Federal Housing Administration (FHA) Federal Open Market Committee Federal Reserve benchmark lending rate creation of money and inflation and interest rates and maximum employment mandate MBSs and Treasuries money creation and economic imbalances mortgage bond purchases need to strengthen/stabilize the dollar powers purpose of in 1920s economy short-term cash loans to banks Treasuries and Federal Savings and Loan Insurance Corporation (FSLIC) Federal Trade Commission Fed Speak Fergusson, Adam Fiat currency Field of Dreams (film) Financial obligation ratio (FOR) Fiscal cliff Food and Drug Administration Food prices Forbes, Steve Ford, Henry Foreign aid Foreign exchange reserves Fractional reserve banking France Greek debt crisis and Mississippi Company and Frank, Barney Freddie Mac Free coinage Free market principles balancing the budget and competition deleveraging and education system overhaul fair trade and free trade interest rates and personal responsibility strengthening/stabilizing U.S dollar and supply/demand equilibrium tax code simplification and Free trade Free Trade Agreement (FTA) French, Doug Friedman, Milton Fuller, Ida May “Gales of creative destruction” Gates, Bill Geithner, Tim General Motors Geometric weighting Germany hyperinflation of 1922–1923 unemployment war reparations Weimar Republic Gokhale, Jagadeesh Gold exchange-traded funds Goldman Sachs Gold market Gold prices Gold standard as money supply regulator Nixon and end of Goodwin, Doris Kearns Government-sponsored enterprises (GSEs) Government statistics, manipulation of Consumer Price Index gross domestic product Great Depression Bernanke study of Great Society Greece austerity measures bailout loans to bonds public spending and suicides in taxes and Greenspan, Alan on bubbles discount rate and Griffin, G Edward Gross, Bill Gross domestic product debt-to-GDP ratio EU debt to housed sector debt household debt interest rates and manfacturing sector statistical manipulation of total U.S debt as percentage of Gross national debt, as percent of GDP Haines, Mark Harding, Warren Hedge funds Heritage Foundation Hilsenrath, Jon History of Money and Banking in the United States: The Colonial Era to World War II (Rothbard) Hollande, Francois Home construction Home equity Home ownership Home sales Hong Kong free trade and sovereignty of Hoover, Herbert Housed sector debt, as percentage of GDP Household debt, as percent of GDP Household debt service, and financial obligation ratio Housing and Urban Development Housing bubble Federal Reserve and Housing prices Hurricane Sandy Hyperdeflation Hyperinflation currency devaluation and in Germany United States and in Yugoslavia Income tax Indonesia IndyMac Bank Inflation default and Federal Reserve and Phillips Curve myth and quantitative easing and unemployment rate and U.S policy of Inflation hedges Interest rates allowing rise of bonds and debt/inflation and in Europe Federal Reserve and GDP and national solvency and low rates S&L crisis of 1990s and U.S debt and International Monetary Fund (IMF) Internet start-up companies Intragovernmental holdings Inverted yield curve Investing/investment in debt crisis importance of portfolio hedging Investor psychology Invisible hand Irrational exuberance It’s a Wonderful Life (film) Japanese-American relocation camps Japanese economy deficit spending and government bonds inflation and interest rates and market collapse ownership share of U.S public debt privately-funded debt Jefferson, Thomas Jingle mail Jobs, Steve Johnson, Gary Johnson, Lyndon B John Williams’s Shadow statistics JPMorgan Chase Kennedy, John F Keynes, John Maynard Keynesian economics deflation and inflation and “King Dollar” Korean debt crisis Krugman, Paul Kudlow, Larry Labor unions Laffer curve Laissez-faire Latin American debt crisis Law, John Lee, J Bracken Lehman Brothers Lewis, Ken Liar loans Liberty bond Lincoln, Abraham Liquidation, of wasteful investments Liquidity Lobbyists Locascio, Francesco Long, Huey Long dollar funds Long Term Capital Management Maastricht Treaty Madoff, Bernie Manufacturing sector Marshall, John Marshall Plan Medicaid Medicare Mellon, Andrew Meltzer, Alan Merrill Lynch Mexican debt crisis Military expenditures Misery index Mississippi Company Monetary base Monetary system barter currency creation currency devaluation retooling of Money and Trade Considered, with a Proposal for Supplying the Nation with Money (Law) Money market funds Money multiplier Money supply increase of, and speculative bubbles rising prices and Monsanto Moore, Stephen Morgan, J P Mortgage-backed securities (MBSs) Mortgage broker lobbies Mortgage deductions Mortgage rates M2 money stock Municipal bonds Murphy, Robert NAFTA Nasdaq bubble National Association of Realtors (NAR) National Housing Act of 1934 Netherlands, tulip mania and New Deal Nixon, Richard “New Prosperity” plan price fixes price-wage freeze North American Free Trade Agreement (NAFTA) North Jersey Community Bank Obama, Barack budget forecasts Social Security and taxation policy Occupational Safety and Health Administration (OSHA) Oil Open market operations (OMOs) Open market transactions Operation Twist OSHA Ostrowski, James Overleveraged economy Paine, Thomas Panic of 1907 Papademos, Lucas Paul, Ron Paulson, Hank Pelosi, Nancy Pemex Pento, Frank Pentonomics Perkins, Frances Personal Consumption Expenditure Price Index Pets.com Philadelphia Savings Fund Society Phillips Curve PIIGs countries Platinum exchange-traded funds Plaza Accord Political Action Committees Portugal Precious metals Price discovery Price-to-earnings (PE) ratios Productivity Progressives Public debt, foreign ownership of Purchasing power Putin, Vladimir Put options Quantitative easing (QE) inflation and QE III QE IV unemployment and Quinn, James Rand, Ayn Reagan, Ronald “Real Bills doctrine” Real estate loans Real estate prices Realtor lobbies Regulation Regulation Q Reich, Robert Reinhart, Carmen M “Rescript of Honorius” Research Reserve currency Reserve requirement Restructuring debt Retirement income Reverse Plaza accord Ricardo, David Roads and highways Rockwell, Llewellyn H Jr Rogoff, Kenneth S Roman Empire Romney, Mitt Roosevelt, Franklin Delano gold legislation on national debt New Deal and Social Security and unemployment launches Roosevelt, Teddy Rostovtzeff, Michael Rothbard, Murray Russian debt crisis government bonds (GKOs) interest rates medical system and standard of living and wages St Louis adjusted monetary base Sarbanes Oxley Sarkozy, Nicolas Savings Savings and loans Schultz, George Schumpeter, Joseph Securities and Exchange Commission (SEC) Securitization September 11 Sequestration punt Shanghai Stock Market Short-term debt, refinancing Silva-Herzog, Jesus Simpson Bowles Committee Sixteenth Amendment Smith, Adam Smithsonian Agreement Smoot-Hawley tariff Socialism Social Security Social welfare programs Solyndra Sorrentino, Frank South Korea Speculation, bank loans created for Speculative bubbles Stagflation Standard & Poor’s Stapley, Mitch Steinreich, Dale Stewart, Potter Stock market Strip mall investment Subprime mortgage market Subsidies Supply/demand equilibrium “Sweeping” Tacopino, Peter TALF (Term Asset-Backed Securities Loan Facility) TARP (Troubled Asset Relief Program) Tax code Taxes budget balancing California and income Taylor, John Teachers unions Tenth Amendment Term Asset-Backed Securities Loan Facility (TALF) Thailand Thatcher, Margaret This Time Is Different: Eight Centuries of Financial Folly (Reinhart and Rogoff) Thorton, Mark Time deposits Time-outs Trade agreements Trade cycle theory Tragedy of the Euro, The (Bagus) Treasury Inflation-Protected Securities (TIPS) Treaty of Versailles Troubled Asset Relief Program (TARP) Tucker, Jeffrey Tulip mania Twain, Mark Two-tier gold market U S Treasuries financial institutions acquisition of ten-year yield Underconsumption Unemployment compensation Unemployment rate inflation and during 1970s United Auto Workers (UAW) United Kingdom United States austerity measures credit rating downgrade debt debt crisis defense budget economic crises hyperinflation and Keynesian economic theory and national debt turning point of 1970s unemployment U.S Treasuries U.S Treasury Borrowing Advisory Committee Ushakov, Yevgeny USSR Utilities Vieira, Edwin Volcker, Paul von Mises, Ludwig Voucher system, for education Wachovia Walpole, Robert Warburg, Paul War on Poverty Warren, Elizabeth Washington Mutual “Wealth effect” Welfare “We Should Not Imitate the Austerity of Europe” (Reich) West Texas Intermediate crude oil price Wilson, Woodrow World War I Wozniak, Steve Yahoo! Yield curve Yongchaiyudh, Chavalit Yugoslavia, hyperinflation and YUPPY Zimbabwe, hyperinflation in Zombie banks ... class the money has inflated To conclude that an asset class is a bubble, you need to understand that all bubbles share the same basic genesis and structure Of course, Fed-heads are notorious... This occurs when nearly everybody seems to own the asset, the asset has become too expensive to purchase, and there is a massive overhang in supply During the boom, business was misled to invest... of your entire salary? ?to your accumulated level of debt Figure 3.4 Total U. S Debt as a Percentage of GDP Sources: Bureau of Economic Analysis, Federal Reserve Census Bureau: Historical Statistics