While the market surges and the herd stumbles around trying to decide if this 30% run in the market is real, there is another scenario unfolding that could very well be the single biggest driving force in our economy and the rest of the world.

The problem is the details of this developing story aren’t exciting or anything the average person wants to hear about. Most have little or no understanding about the specifics and frankly don’t want to know. But, this is a story that will be the make or break issue in the stock market, our economy, and the recovering world economy.
Monetizing the Debt

Essentially we are buying our own debt to keep the treasury prices up and the yields low. This is being done for two reasons; keep mortgage rates low to try and create a floor for real estate prices, and bail out Congress after its 30 year spending spree.

It isn’t working. Rates are moving up despite the White House’s efforts. This presents two very big problems.

First, our debt holders, China in particular, are worried that the U.S. debt they hold will become worth a lot less if this pattern of artificially propping up bond prices continues. Our government’s efforts to artificially hold up anything has always had the opposite result. In this case that would mean rates skyrocket and prices for our debt plummet.

If this happens China is stuck with our debt in a market where they can’t get what they paid for it. I know two things about the Chinese; they don’t lose and they don’t lose. They will not wait for this to happen which means if they believe we are sacrificing them for our own benefit they will dump our debt in a defensive move.

This means our bonds will be trapped in a death spiral of dropping value, exploding interest rates and a world market flooded with our debt. This is the worst possible scenario for us and the rest of the world.

The second problem is more fundamental. Where is Congress getting the money to buy this debt? We are broke! We are worse than broke; we are 10 trillion dollars in the hole.

Are those printing presses I hear? How much longer can we print money to buy up the debt from money we spent last year that we didn’t have? How about the money we spent in the first few months of this year that we didn’t have?

There may be some magic behind those doors in Washington, but I don’t see it. The most likely outcome of this situation, at least we better hope it unfolds this way, is much higher interest rates and a slowing to a stalled economy. This is the optimistic outcome.

Inflation with negative or no growth; 1974 all over again.

The obvious play is the same I recommended a few moths ago. Short the bond.

The best play is the TBT, Ultra Short 20+ Year Treasury ProShare. This pays twice the daily performance of the 20+ year treasury index. In other words as bond values drop and interest rates go up, this will pay you twice the value of the drop in the bond. If the bond drops 10% in value, you get 20% from the TBT.

The TBT is currently about half way between its 52 week high and low. Not cheap, but still way down from its highs.

The entire U.S. government has been handling our affairs like a bunch of drunken sailors on liberty. Vote buying with our money has reached the point of being criminal. It’s been a 30 year binge and now it’s time to pay the bills. You might as well make some money on it.