The Fed Is Conjuring Inflation

02/21/2011 11:24 am EST

Focus: BONDS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Interest rates and gold are headed much higher as a result of money printing by the Fed, argue Pamela and Mary Anne Aden of The Aden Forecast.

Interest rates are on the rise. The 30-year Treasury yield hit a ten-month high this month, and if it stays near current levels a new mega uptrend will be getting started.

That would be a huge deal. Why? Here’s a quick review.

The Biggest, Baddest Market
First, the bond market is a massive free market. It can’t be controlled by the Fed or anyone else.

So when the Fed says they’re going to keep interest rates down, they’re talking about short-term rates like those on T-Bills, not long-term rates.

When long-term interest rates go up, bond prices fall—and it’s been a long time since interest rates have risen sharply. Since the early 1980s, interest rates have been declining. The mega trend has been down. These mega trends last for decades and if it stays up, interest rates are going to go much higher in the years ahead.

What could drive rates up for such a long time? Inflation, the declining US dollar, loss of international confidence in.the dollar and bonds, the Fed’s reckless monetary policies, lack of demand and so on…and currently, all of these factors are coming into play.

Recipe for Inflation
The most important causes are the Fed and US government spending.

As you know, the Fed has been stimulating the economy using bond purchases known as quantitative easing (QE1 and QE2) for the past couple of years, and it’s working. The economy is looking a lot better and is picking up steam, but that’s not the point.

The point is, the amount of money involved to boost the economy will be over $2 trillion when QE2 is over in June. This is resulting in the largest spending spree, debt and money creation ever, which is extremely inflationary.

Considering all the money that has been created worldwide, inflation is going to get a lot worse. That’s why bonds are falling and interest rates are rising, because the bond market detests inflation.

The Buyer of Last Resort
China and Japan have been the biggest US debt financiers, but here’s the real shocker: the Fed just passed them up and is now the biggest buyer of US debt.

In other words, the Fed creates money out of thin air and it’s buying bonds with that money. It is monetizing the debt by doing this, at a record rate.

There are not enough lenders, so the Fed has become the lender of last resort. This is about as fiscally unhealthy as could be.

What’s happening is something you normally see in war-torn or underdeveloped countries, not in the country that’s in charge of the world’s reserve currency. That’s why the dollar’s going to keep falling and interest rates will rise. They have to in order to attract bond buyers.

Too Many Sacred Cows
Okay, but what if spending is cut? Everyone agrees this needs to be done but as our dear friend Richard Russell points out, defense, entitlements and interest on the debt, which is the fastest growing expense, already take up 80% of the entire budget.

So there’s only 20% left to cut to lower the deficits. That’s not much and it’s the main reason why S&P, Moody’s and the Fitch ratings agencies have been warning that they may have to lower the US’s AAA rating.

The bottom line: Aside from a weaker dollar and higher interest rates, inflation is poised to intensify, and gold’s going much higher in the years ahead.

Long-term bond holders should sell. That goes for muni bonds too and our indicators are reinforcing this.

It’s going to be a time of big changes. But if you’re prepared, it’ll also be a time of great opportunity.

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