The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (44 page)

And the problem will not stop with just corporate bonds from companies that can no longer pay their debts. It will also extend to governments that can no longer pay their debts, whether it is state munis or U.S. Treasurys. Even CDs and money markets will be in trouble.

As we’ve already said, there are factors delaying the onset of inflation. But once it gets going, it can snowball very quickly. When inflation passes 5 percent, as measured by the CPI, and then approaches 10 percent, it will become impossible to ignore. Interest rates will rise regardless of what the Fed wants, as lenders become cautious to tie up their cash and get it back at a lower value.

We already know that inflation eats away at a bond’s value, and the rising interest rates that follow hurt bonds in the secondary market. For example, with 10-year Treasury rates hovering around 2.2 percent as of March 2012, imagine how much the value of these bonds would fall if inflation hit double digits less than halfway into their lives. But this is only the beginning of the problem. In a bubble economy overextended with debt and artificially propped-up markets, inflation is the first big trigger to send it all toppling down.

The first casualty will be the housing market. New home purchases will be out of reach for most at higher interest rates. And homeowners who are already in precarious debt situations will not be able to make payments on adjustable-rate mortgages. When real estate prices fall accordingly, even homeowners who were once in relatively stable positions will find themselves underwater, and new debt defaults will spike upward.

Banks will be forced to write off huge amounts of loans. Mortgage-backed securities will fail. Insurance and derivatives meant to protect against failure will turn out to have little value when everyone is overextended. Failures lead to government bailouts. Bailouts mean more money printing. More money printing means more inflation. And the vicious cycle continues.

Clearly, inflation cannot go up significantly without also raising interest rates. Who in the world will lend anyone any money if they cannot at the very least be compensated for what they will lose to inflation? That means if inflation is 10 percent, interest rates will have to be at least 11 percent for lenders to make even 1 percent on their money. Interest rates will have to exceed inflation.

When interest climbs, in addition to harming businesses, real estate, stocks, and corporate bond values, we will have one other devastating problem: State governments and the federal government will have to make interest payments on their debt with newly borrowed money at the higher and higher interest rate, adding exponentially more and more to the total public debt as time goes on. Eventually, they will not be able to borrow more at any interest rate level because investors will have no confidence in their ability to repay. At that point, the public debt bubble will pop and the borrowing will end. Without newly borrowed money and without the ability to print more money (due to high inflation caused by earlier money printing), state and U.S. governments will not be able to pay on their debt and will be in default—just like overextended homeowners, businesses, consumers, and investors.

Index

A

Absolute Investment Management

Achuthan, Lakshman

Aftershock

Aftershock
(Wiedemer)

Aftershock wisdom investing

“Airbags,” temporary

American Stock Exchange (Amex)

America’s Bubble Economy
(Wiedemer)

Annuities.
See also
Insurance, whole life, and annuities

Argentina, economy in

B

Bank of England

Berkshire Hathaway

Bernanke, Ben

Best, A. M.

Bond ladder

Bonds

Book value

Bubble blindness

Bubble economy.
See also
U.S. economy

Bubblequake

Buffett, Warren

C

Call (bond)

Capital goods sector, impact of falling bubbles on

Case-Shiller Home Price Index

Central Registration Depository (CRD)

Certificates of deposit (CDs)

Chanos, Jim

China

Commodities, investing in

Common stock

Consumer discretionary spending bubble

Consumer Price Index (CPI)

Conventional wisdom (CW), key to

Corporate bonds

Credit risk

Current yield

D

Defined benefit pension plans

Defined contribution plans

Deflation, myth of

Discounted cash flow (DCF) model

Discretionary spending bubble

Discretionary sector, impact of falling bubbles on

Dollar bubble

Dow Jones Industrial Average

Dutch tulip bubble

E

Economic Cycle Research Institute (ECRI)

Economists

Emergency Banking Act

Estate planning, Aftershock

Europe, financial crisis in

European Central Bank (ECB)

Exchange-traded funds (ETFs)

Exile on Wall Street
(Mayo)

F

Federal debt.
See also
Government debt bubble

Federal Employees Retirement System (FERS)

Federal Reserve

Financial advisers

Fisher, Irving

“Fool in the Shower” analogy (Friedman)

Foreign currencies, Aftershock investing in

Foreign-held U.S. assets, growth of

Friedman, Milton

G

Gold

Government debt bubble.
See also
Federal debt

Graham, Benjamin

Great Depression

Greece, economy in

Greenspan, Alan

Gross domestic product (GDP)

H

“Hamptons Effect”

The Hedge Fund Mirage
(Lack)

Hedge funds

I

Individual retirement accounts (IRAs)

Inflation

Initial public offering (IPO)

Insider selling

Insurance, whole life, and annuities

Interest rate risk

Interest rates, Aftershock and

International equities, investing in

Internet stock bubble

Investment outlook

Investment portfolio, Aftershock

Iran

Italy

J

Japan, quantitative easing in

Jobs and businesses, Aftershock

K

Keogh retirement plan

Kynikos Fund

L

Lack, Simon

Leveraged buyout model of stock valuation

Life insurance.
See
Insurance, whole life, and annuities

Liquidation value

Long-term care and disability insurance

Long-term equity anticipation securities (LEAPS)

M

Mayo, Mike

Merrill, Charlie

Miller, Bill

Monetary base

Money managers

Money market funds

Money printing.
See
Quantitative easing

Mortgage-backed securities

Multibubble economy.
See
Bubble economy

Municipal bonds

N

Nasdaq

Natural growth rate, myth of

Necessities sector, impact of falling bubbles on

New Monetarist Theory

New York Stock Exchange (NYSE)

Northwestern Mutual, investment portfolio of

O

Oil

P

Patriot bonds

Pension Benefit Guaranty Corporation (PBGC)

Preferred stock

Preservation of capital

Presidential election (2012)

Price-to-earnings ratio (P/E)

Price-to-revenue ratio

Private-company valuation

Private debt bubble

Probate

Productivity growth, slowing

Put options

Q

Quantitative easing (QE)

R

Real estate