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[Freedom Lawyers of America] IT'S LONG BUT INFORMATIVE

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  • sheldon waxman
    A LANDMARK TURNING POINT IN INTEREST RATES A radical shift of monumental dimensions is sweeping the globe, and the shift is about to hit the fan ... After
    Message 1 of 1 , Aug 1 6:03 PM

      A radical shift of monumental dimensions is sweeping the globe, and the
      shift is about to hit the fan ...

      After years of calm and complacency, bond investors are suddenly panicking,
      bond prices are crashing, and interest rates are surging.

      The shift is affecting Treasury bonds, Ginnie Maes, Fannie Maes, tax-free
      municipals, and corporate bonds. It has struck high-rated bonds, junk
      bonds, and foreign bonds. It is happening in New York, London, Frankfurt,
      and Tokyo.

      There is no escape and no exception. When long-term interest rates rise,
      bond prices inevitably decline across the board. Indeed, right now, every
      single long-term bond on the planet is falling. To better understand the
      impact, put yourself in the shoes of bond investors:

      If you bought the 5 3/8% Treasury bond of 2031 at its peak of $120.80, you
      have seen your investment plunge to $103.62, a 14% loss in just 36 days.

      If you bought the 7 3/8% Cummins Inc. of 2028 at its peak price of $101.08,
      you've watched it sink to $87.92, a loss of 13% in just 43 days.

      Investors holding bonds issued by Japan or Germany, or by IBM, GMAC, or
      hundreds of other companies, have suffered similar declines.

      If declines of this magnitude were in stocks, it would not be so
      surprising. But remember: We're talking about bonds, and their declines are
      ringing alarm bells in Washington ... sounding a wake-up call for fixed
      income investors ... and throwing into doubt a list of widely believed myths:

      The myth that bonds are "safe." The reality: The bond markets of the world
      are a great bubble, artificially pumped up by the Federal Reserve and other
      desperate central banks that have been trying to save their economies. Now,
      that bubble is beginning to burst.

      The myth that the Fed can always lower long-term interest rates (and boost
      long-term bond prices) simply by cutting short-term interest rates. The
      shocker: The Fed just lowered short-term interest rates to 1%, but as soon
      as it did, long-term interest rates went up - not down. (See July issue).

      The myth that interest rates rise only when the economy and employment are
      growing. The truth: The economic recovery is still weak, with employment
      still stuck in the mud. But long-term interest rates are already surging.

      The myth that long-term interest rates rise only when inflation is rising.
      The truth: Rates are rising despite the fact that deflation is still raging
      across the globe. (I'll explain why in a moment.)

      The ultimate myth - that the Fed and central banks control short-term
      interest rates. Most of the time, yes. But as you've just seen, when bond
      investors are determined to sell - for whatever reason - they drive bond
      prices down and bond interest rates up, and there's virtually nothing the
      Fed can do to stop them. Later, if bond rates rise far enough, the Fed will
      have no choice but to let short-term rates go up as well.

      In the final analysis, it is the natural forces of supply and demand - not
      the Fed - that determine the fate of interest rates.

      A Ticking Time Bomb for the World Economy

      Even with US and foreign interest rates at the lowest level in more than
      half a century, the major economies of the world were in a funk -

      The United States in a so-called "jobless recovery" ...

      Japan facing its fifth recession since 1990.

      Germany in the first stages of a recession ...

      These are the first-, second-, and third-largest economies in the world! If
      they are already struggling, even with ultra-low interest rates, what will
      happen with higher interest rates?

      These three economies have the most modern financial systems, the most
      powerful central banks. If they can't control their long-term interest
      rates, who can?

      All three countries are now running the largest budget deficits in the
      history of mankind. If they have already lost control of their finances
      even before big declines in their economies, what will happen if their
      economies sink further?

      All three are beginning to find it more difficult to attract willing buyers
      for their bonds without offering higher yields. If this is already a
      problem now, even with their promises of permanently low short-term
      interest rates, what will happen if they are forced to break that promise?

      The answer: Higher interest rates (whether long- or short-term) will
      fracture the already-fragile, arthritic spine of the world economy.

      Higher interest rates will drag down the profits of virtually every company
      with large debts; and large debts is a permanent feature among a majority
      of companies in America and around the world.

      Higher interest rates will slow down corporate financing and investment,
      consumer borrowing and spending. Higher interest rates will affect
      trillions of transactions in virtually every sector of every economy in the

      In the United States, for example, one sector - easily the most vulnerable
      of all to rising rates - has already begun to weaken ...

      Is the Mortgage Bubble Bursting?

      No economist anywhere will dispute the fact that the most pivotal - and
      fragile - industry in the US is housing and construction.

      Throughout the last three years, while techs wrecked and manufacturing
      tumbled, housing has been the last bastion of support for consumer
      spending, retail sales, and the entire economy.

      Problem: The housing bubble was driven by the mortgage refinancing boom;
      and the refi boom, in turn, was driven by ridiculously low mortgage rates.

      Now, take away the low mortgage rates, and what do you get? You get a chain
      reaction of events that could lead to the greatest housing bust in decades:
      A sharp slowdown in refinancing ... a sudden disappearance of cash in the
      market ... a new wave of mortgage defaults ... a cascade of prices ... and,
      ultimately, a bursting bubble that could make the tech wreck seem tame by

      Is it already happening? It's too soon to say with certainty. But the MBA
      index of mortgage loan applications - both for new purchases and for
      refinancing - has plunged 27% just in the past six weeks. If this trend
      continues, it implies a prompt end to the housing boom.

      An end to that boom will rock the boat of every major player in this market
      - Fannie Mae, Freddie Mac, and other major mortgage lenders ... insurance
      companies, banks, savings and loans, plus any investor who has bought
      mortgages or mortgage-backed securities. It will knock the wind out of
      consumers. And it will be murder for corporate profits.

      Why the Interest Rate Rise You've Seen So Far Is Just the First Phase

      In recent months, bond investors had been counting on deflation to keep
      interest rates low and the value of their bonds up. They were encouraged
      when, for the first time in 70 years, a Fed Chairman began to publicly
      voice his own fears of deflation. And they were absolutely delighted when
      Mr. Greenspan actually hinted he'd buy bonds in large quantities if that's
      what it would take to prevent deflation from spreading.

      But now bonds are falling (and interest rates rising) despite deflation,
      and investors are wondering: WHY?

      The answer: Bond prices are going down for reasons that have little to do
      with inflation or deflation:

      Reason #1. Bond prices are falling because they were way too high to begin
      with. They were artificially pumped up by a dozen Fed rate cuts. As with
      any investment vehicle - stocks, commodities, real estate - when prices
      rise to the stratosphere, all it takes is a subtle shift in market
      psychology, and prices come crashing down. Bond prices are no different.

      Reason #2. Bond prices are falling because bond owners are selling; and
      they are selling because they need the money. They need it to pay bills. Or
      they want to use it for other investments.

      Reason #3. Bond prices are falling because of the growing supplies of new
      bonds being issued - plus the threat of still bigger supplies on the way.
      Who is issuing all these new bonds? The list of just the major issuers
      would fill every issue of Safe Money until the end of 2005. It includes:

      US corporations like General Motors, Dominion Resources, El Paso Natural
      Gas, JP Morgan Chase, Westlake Chemical, and hundreds of others! The CFOs
      see that borrowing costs are still near the lowest levels in their
      lifetimes, but they also see those costs starting to move higher. So, many
      are scrambling to lock down any funds they might need - for future
      emergencies or for future growth - now, while they still can.

      Cities and states! Many just can't raise taxes or cut spending fast enough
      to eliminate their bulging deficits. So, they have no choice but to borrow
      the money. That means issuing new bonds in large amounts. Westchester
      County, Philadelphia, Washington State, and Minnesota are just some of the
      many with major recent issues.

      Mortgage companies! Although the refinancing boom is beginning to cool, the
      number of new mortgages created each day is still near the highest levels
      of all time. These mortgages are then bundled up and sold to investors as
      mortgage-backed bonds in huge amounts. Just last year, Fannie Mae sold $325
      billion ... Freddie Mac, $191 billion ... and other companies another $323

      Then, while each of these big players is scrambling for their share of your
      money, brace yourself for the onslaught of debt issues from the biggest
      borrower in the world ...

      The US Government Will Dump at LEAST $350 Billion in New Debt on the Market
      Before Year End

      Why does the government need to raise so much money so fast? The reason is
      obvious: To finance its out-of-control budget deficit.

      Until recently, bond investors ignored the deficit. They assumed the Fed
      would protect them, by continually lowering interest rates or even by
      buying bonds directly.

      No more! Today, no one can possibly ignore the most rapid swing from
      surplus to deficit in over a half century ... the largest federal deficit
      (in absolute terms) in the history of mankind ... and most troubling of all
      ... the fact that the government's deficit estimates are shifting so darn

      Just two years ago, the Office of Management and Budget (OMB) projected a
      surplus of $2.9 trillion for the six years between 2003 and 2008. Now, the
      same government agency is estimating a total deficit of $1.9 trillion. It
      is one of the most dramatic reversals of all time - a total swing of $4.8

      Heck, just in January, it said the deficit for 2003 would be $300 billion,
      already a shocker at that time. Now, only six months later, it says it's
      going to be $455 billion?!

      I don't expect perfection, and I I'm sure you don't either. We can tolerate
      forecasting errors of 5% or even 10%. But an error of over 50% in just six
      months?! It's both unbelievable and unforgivable.

      Do you fully recognize how serious this really is? It means that the
      government and its agencies will probably have to raise at least $350
      billion in new funds between now and year-end.

      Moreover, it means that no one - let alone bond investors - can trust the
      government's projections any more. The estimates have been so wildly
      optimistic, they have lost all credibility.

      And sadly, the current government figures are equally wild in their
      optimistic assumptions - rosy forecasts for the economy, rosy expectations
      for the reconstruction of Iraq ... plus dicey budget accounting.

      I've warned you about this repeatedly in Safe Money. Back in 2000, I told
      you the so-called "budget surplus" was a mirage that would soon be
      transformed into the largest budget deficit in history. In 2001 and 2002, I
      repeated those warnings.

      Then, just three months ago, I warned you again. I told you that the
      administration's budget estimate was far off target, and that you should
      expect the deficit to mushroom to the $500 billion level.

      That's exactly where it is today. We have the admission by the OMB of the
      $455 billion deficit excluding Iraq reconstruction costs plus the admission
      by Defense Secretary Donald Rumsfeld that those costs have doubled to $3.9
      billion per month. Add them together, and there you have it: A $500 billion
      official deficit.

      But that's just the tip of the iceberg. Much like big companies jury-rigged
      their pension fund gains to make it look like they had bigger profits ...
      the US government manipulates Social Security surpluses to make it look
      like it has bigger revenues. And much like Enron and others hid debts and
      expenses in subsidaries and partnerships, the US government hides big
      deficits in government-related agencies.

      Last year, the total amount the government and its agencies borrowed was
      $812 billion, and in the next two years, it could average over $1 trillion.
      This is the real deficit. It's huge, and it's not going away.

      The Stock Market: Between a Rock and a Hard Place

      The stock market may have some more room to rally - there's no law that
      says it must respond immediately to the interest rate rise. But overall,
      it's between a rock and a hard place:

      * To justify its recent rise, it desperately needs to get a lot more
      confirmation of an economic recovery.

      * BUT ... any new evidence of a recovery will send bond markets into a
      tailspin, drive long-term interest rates skyward, and doom that recovery to
      a premature end.

      In the weeks ahead, you may see some additional news of economic
      improvements in some sectors. And you will no doubt hear many Wall Street
      analysts dismiss the interest rate rise and its causes. Watch out!

      Don't believe Wall Street when they tell you "the interest rate rise is of
      little importance." As you've seen already, its consequences can be dramatic.

      Don't believe administration officials when they tell you "the deficit is
      manageable." That's hogwash - even in comparison to GDP, it is near the
      highest levels in history.

      Most important, don't count on Fed Chairman Greenspan's promise to keep
      short-term interest rates low. As long-term interest rates go higher, they
      force borrowers to get their money from medium-term markets; and as
      medium-term rates are driven higher, they force borrowers into the shortest

      Slowly at first, but with gathering momentum, the demand for money cascades
      down the yield curve, from long term to short term. The rates on Treasury
      bills, commercial paper (short-term corporate IOUs) and other money market
      instruments will drift higher. Sooner or later the Fed will have no choice
      but to recognize the reality.

      Mark my words: One day in the not-to-distant future, Mr. Greenspan will
      shock the world with the first of a series of interest-rate hikes.

      It will be Wall Street's worst nightmare. But they have no inkling it's
      coming. Their heads are buried in the sand.

      Posted by sheldon waxman to Freedom Lawyers of America at 8/1/2003 09:03:44 PM

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