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Bond rates are rising because the Fed has no control over one part of the bond market, says Martin Weiss, and this could crucially impact the economy sooner than you think.

My guest today is Martin Weiss, and we’re talking about the next bubble that’s ready to burst in the economy. Hi Martin, and thanks for joining me.

Ready to burst...or already burst is the question.

Maybe already? I did read your blog and it looked pretty dire, so why don’t you tell me about it.

Well, we’re talking about the bond market and the debt bubble. It’s bigger than any bubble we’ve seen before.

And growing.

Well, and beginning to burst, because just in the last few weeks we’ve seen bond markets go down sharply in price. What’s amazing about that it’s in the midst of QE-Infinity.

So what is QE infinity? It means that the Fed is buying bonds hand over fist—$85 billion a month—and promising to buy more. That should drive bond prices up.

But no.

So why are bond prices going down? And the answer is a force that most people have totally forgotten about, and it’s coming back into the marketplace right now.

And that is?

The bond market vigilantes.

Explain yourself.

The bond market vigilantes are the guys that own the bonds—individual investors in the US and overseas who are sick and tired of no action in Washington. They're beginning to get very worried about all this moneyprinting by the Fed, and they’re saying, "Why should we hold on to these very low yielding bonds anymore?"

And they hold a large percentage of our government bonds.

They hold a huge percentage.

It’s 59%, something like that.

Overseas, it's 56% of the publically traded bonds, and even domestically you have a large number of bond market vigilantes—and they’re selling. So people say, well the Fed can just buy more.

Why not? They’ve been doing it for a long time.

Well, the answer...the problem is, the Fed can offset the new issues. It can buy 50% to 60%, a large percentage of the new issues that the Treasury is putting out. But the Fed cannot offset the selling by the bond vigilantes of the old issues that are out there and that are in their portfolios. That quantity is potentially overwhelming.

So that’s really going to just splatter bonds everywhere.

And we’ve seen this happen before. It’s just it’s so long ago that most people, even in your generation, don’t remember.

I don’t remember. Tell me, when was the last time?

Thirty years ago, in early 1980, was the last time you really saw a major collapse in the bond market, to the point where the government couldn’t even find buyers for its short-term and for its medium-term notes.

What did that do to the economy?

What it did was it had a huge impact on policy. That’s when President Carter, in an election year, was forced to slam the brakes on the economy, something that no Democrat has ever done before and hopefully will not have to do again. But the point is that it had a major impact on policy, and it was the only way to satisfy the bond vigilantes.

So, in effect there are two sides to this story. No. 1 is when a bubble bursts, it can have tremendous effects; wreak havoc on the portfolios of average investors. But the silver lining is that it sends the right message to Washington to finally do something.

And do you think they will?

I think if the bond market vigilantes dump their bonds and the Treasury can’t sell its bonds...or it’s going to face much higher interest rates and higher interest costs then they will finally have to.

So maybe a silver lining after all.

Yes.

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The Outlook for Government Bonds