Old and New Bonds The story begins in 2007, when the world’s major central banks embarked on the largest series of monetary loosening measures since World War II. And since that time, the most powerful central banks have done everything in their power to keep the world at ease. At the same time, the economic growth and financial sector gains that came with this monetary environment continued their run in 2013. However, in the last quarter of 2013, the trend of economic prosperity came to a grinding halt. In an article in Bloomberg dated December 31, 2013, it was announced that the global economy would continue to slow for another year or more. While some economists see this as a permanent condition in the economy, it appears as if central banks are simply rolling over and preparing for a new round of monetary stimulus. Whether such a scenario comes about remains to be seen. The fact remains that there is going to be a continuation of a monetary policy in which central banks are using their tools to stimulate economic growth. Such a program is going to result in a continuation of a monetary policy that ultimately will have to lead to a market environment of rising interest rates and inflation. This trend of monetary easing has been in place since the year 2009, when the US economy found itself in a recession that was as a result of a real estate crash and derivatives crisis. The central bank responded with an unprecedented and massive round of monetary easing that led to a massive expansion of the balance sheets of the US Federal Reserve. Over the last six years, other central banks have followed suit with their own versions of the same economic stimulus package. And these have resulted in a continuation of the economic boom that many of us have become used to. But after seven years of the same monetary policy, it appears as if our current world leaders are beginning to realize that the trend is going to have to end. At some point, the central banks are going to have to let up on their monetary easing measures. How long such a scenario lasts will depend in large part on whether central bankers like the US Federal Reserve Chairman Janet Yellen and her peers choose to follow through on what is commonly called quantitative easing. To understand quantitative easing, consider the words of the most popular financial media voice in the world today, Ben Bernanke. In a November 20, 2013, Bloomberg column entitled “A ‘New’ View of Macroeconomic Policy”, the former Chairman of the Federal Reserve told readers about his plan to return the United States to monetary policies that would encourage economic growth and that of rising interest rates. The change of monetary policies to begin in 2015, Bernanke said, will not “require a fresh diagnosis of why the economy has been so weak and so slow to recover”. The answer will come instead from a different understanding of monetary policy that will take place at this time. According to Bernanke, monetary easing “isn’t supposed to produce higher growth. Rather, the Federal Reserve aims to promote recovery by pushing interest rates as low as possible.” In other words, the Fed is following a different economic plan of monetary policy than it had in the past. This means that the new policies are going to allow the central bank to engage in quantitative easing, with the goal being to keep interest rates near zero. At this time, it appears as if the monetary easing policies of the Federal Reserve, among other central banks, will continue for quite some time. This is where the bond market comes into play. We live in a world in which there is a need to continue a certain level of debt to support the economy. This is because in a fiat currency system, the economy continues to consume and expand at a natural rate of expansion, leaving less and less of the total amount of money in circulation for other sectors of the economy. However, a growing population, high population densities, and rapidly growing economies create a demand for capital. And this demand has come at a time when the central banks of the world have expanded credit in order to support economic growth. This is a trend that has worked for the last seven years. But for how much longer will it be sustainable? What will eventually come to an end is the continuation of a world in which the demand for capital can be met by expanding the money supply through the creation of debt. This is not to say that a demand for capital has disappeared. This demand for capital will always exist, but it can no longer be met by an expanding money supply. This trend has already been evident for several years, but it has been masked by the fact that central bankers have used QE as a method of preventing an end to their debt stimulus measures. A similar situation exists in Japan, where the government and the Bank of Japan face tremendous debt problems, as well as other economic challenges. However, since the Japanese government is the largest holder of Japanese government bonds, the central bank can continue its debt policies as long as it keeps the government bond market supported. This has not been the case for long, but for how long will it be sustainable for the Japanese government to expand its balance sheet? Japan’s economy has been in steady decline since the year 2001, yet a portion of this debt is related to the post-tsunami response to the earthquake of 2011, as well as various regional and state debts. This is where the bond market comes into play. The price of bonds has dropped to levels not seen in more than two years. In the US, 10-year Treasury bonds fell to 1.76%, and in Japan, 10-year government bonds fell to an almost all-time low of 0.25%. So what happened to bring the world’s governments to a halt in the bond markets? When government after government found themselves with a growing debt, the temptation was for each country to increase its debt supply. This is a practice that has been happening for years. However, each and every time the world has attempted to meet these rising needs with increased spending, its economies have crashed. This is a trend that simply will not continue. What will come to an end is the attempt by governments and central banks to inflate the market in order to keep interest rates low and to avoid economic consequences. This is what all of the current central banking practices are all about, and eventually it will come to an end. Old and New Debts The US government has more than $16 trillion in debt, making it the largest debtor in the world. At the same time, China, France, and Brazil have about $2 trillion each in debt, and Japan has more than $1 trillion in debt. The US is not alone in this. The Chinese, Japanese, Russian, and Italian governments all have debt levels that are larger than those of the United States. However, of this group of major governments, none are in the same situation as the United States. The economic conditions in the US continue to weaken, while the economic conditions in other countries continue to strengthen. During the fourth quarter of 2013, global trade rose, and exports for the US have continued to grow. However, the total amount of debt and deficit in the US is growing faster than any other country, leading to a slowing in the nation’s gross domestic product (GDP). At the same time, economic growth in China and Germany is slowing, and economic growth in Japan continues to rise at a slower rate. The debt crisis in the US is largely based on the amount of debt that is carried by US consumers. At the current time, most of the US debt is carried by consumers who are indebted in relation to the amount of debt that they have. This leaves the government unable to carry a large amount of debt and not in a position to continue borrowing. Since this amount of debt has increased to where consumers can no longer afford to meet their debts, defaults on debt are increasing as well. And when the debt market no longer meets the demands of the debts that have been taken on by consumers, this has a domino effect that will eventually lead to a collapse of the debt markets in the United States and other countries. Debt and Default When a nation runs out of money, this may not mean the end of government or even the economy. This is a situation that occurs when a government continues to spend beyond its means in order to fund entitlements, and this usually results in debt defaults. When this debt-based government spending goes on for too long, it causes economic contraction, which is the opposite of economic growth. In the US, the process has been happening for several years, and the government has been trying to keep itself in place with new debt and spending programs. But as the market continues to lose confidence in the dollar, a new monetary system may be created that will allow for the monetization of government debt. But the problem is that the amount of debt in the US is growing faster than the economy. This can lead to a currency crisis in which the US dollar is devalued and new paper currencies are formed in response. And what comes after this devaluation is anyone’s guess. However, it may eventually result in an international monetary order in which currencies will no longer be backed by paper assets and government guarantees. This will mean that the fiat system in the US will become history, which in turn will put the US into default. In fact, it will not be long before the US is in a position where it has to default on its debt obligations. As the interest rate on US bonds continues to rise, and as the market loses confidence in the dollar, the US debt market will face increasing difficulties. In the meantime, the situation in the US will be a lesson for other countries, like China, to learn from as it