Look out! It’s The Bond Vigilantes!

In Washington a deal is close on the stimulus. Stocks were up. But gold was up more, hitting a seven month high of US$944.50.

Ten-year U.S. Treasury bond yields are coming down as investors lose confidence in Tim Geithner's plan. Yes, it's really weird that the U.S. government can successfully auction US$21 billion in ten-year notes at the same time it plans on growing its annual deficit by $1.5 to $2.5 trillion. But it's a weird world we live in. Foreign central banks snapped up 38% of the auction, according to Reuters. This is like buying a lead life vest as your ship goes under the waves.

The Treasury is hawking $187 billion worth of U.S. debt this week. That's ambitious. Most of it, though, is shorter-maturity notes and bills. Only $14 billion in 30-year bonds will be auctioned. Meanwhile, $32 billion in three-year notes is up for grabs to the highest bidder.

The good news for Team America is that Treasuries are joining gold as a safe haven asset. Investors are growing more convinced that the banks are simply lying about future losses they know they'll have to take. The banks don't want to sell impaired assets at a loss. It would force them to ask for more government capital with strings. Or, it would make them insolvent.

So Treasuries go up. But the bad news is that yields are creeping up too. The three-month yield is at 1.41%, the highest it's been since November. It's an extremely boring subject, but if you look at the composition of America's publicly traded debt, more and more of it has shifted to the short-end of the interest rate curve, 2-year, 5-year notes and 10-year notes. If you get a sudden spike in interest rates, the cost of these monthly auctions--and there are going to be a lot of them this year and next--goes dramatically up for Uncle Same.

Dig deep you taxpayer you!

What would cause a sudden spike in interest rates? It's not what. It's who. The bond vigilantes!

This is the media name for the bond traders who scuppered Bill Clinton's big spending plans during his first term. Back then, the market was capable of imposing some fiscal discipline on the U.S. government by forcing it to pay higher rates of interest for the debt it sold to finance its spending plans.

Today, those spending plans are much larger. The government is not behaving in a fiscally disciplined way. But the bond vigilantes are at war with the equity nervous nellies. That is, the shock and dread of higher inflation that would normally accompany such big spending plans and send rates higher is at odds with the paralyzing fear that owning stocks is an even bigger risk than owning U.S. Treasury bonds and notes.

Maybe this was Geithner's plan all along. Drag his feet on the bank plan to maintain the foreign bid on U.S. debt. Sell the debt to finance the stimulus, then screw the bondholders later when you have to monetise the debt to finance the aggregator bank. Hey, it's not so unlikely is it?

Reuters reports that, "The Bank of England will probably have to ease monetary policy further to get the economy growing again, and could start buying gilts as soon as next month to achieve that, Governor Mervyn King said on Wednesday." Quantitative easing is pure money printing. The central bank prints money to buy government debt. Someone has to buy that debt, you know. And if no one in the marketplace is going to do it, in steps the central bank.

This is a recapitulation of the strategy in Japan that failed. It's a preview of what the U.S. will probably do as well. The government is pouring trillions into the sinkhole of a decade's worth of bad investment in residential housing. All that money--which is capital not going to the private sector to build tomorrow's factories which would create tomorrow's jobs and incomes--is borrowed from the future. The interest on it will have to be paid with higher taxes.

What has the government done to our money? More on that tomorrow.

We have to call it quits on the DR for today so we can wrap up the February issue of Diggers and Drillers. The flip side of the snowballing U.S. public debt is, of course, the rise in precious metals and inflation hedges. If there is a "golden parachute" the inflationary crisis, it's going to be in the metals that have historically been money. As the bullion angle is well covered elsewhere, we've taken a look at platinum this month, as well as the Aussie gold miners and which ones are most likely to follow bullion up, should it keep going up.

One last note. Brokers and talking heads are talking up gold. That's worrisome in the short-term. It means you could see a big spike up in gold back to $1,000. And then? Profit taking. That doesn't change our long-term outlook at all. Just keep in mind that any time you get this much momentum, it's bound to exhaust itself. You'll get a shakeout, a consolidation, and, if we're right, a resumption of the move higher.

Until tomorrow!

Dan Denning
for The Daily Reckoning Australia

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