Aftershock: Protect Yourself and Profit In The Next Global Financial Meltdown, Second Edition

Rule Number Three: Stay Away from Long-Term Bonds

When inflation and interests rates rise, asset values across the board will fall, and the dollar and government debt bubbles will finally pop (see Chapters 3 and 4). Foreign investors will no longer lend us money, and much of our bubble wealth will have gone to Money Heaven, which will greatly constrict the supply of capital and further raise the price of borrowing money, pushing interest rates higher. That will leave the government with little choice but to print even more dollars, causing even higher inflation and higher interest rates.

Even before the dollar and government debt bubbles pop, just a moderate rise in interest rates will have a terrible effect on bond prices (see sidebar). As inflation continues to rise, higher and higher interest rates will devastate the value of all fixed-income securities.

Here’s a good way to think of the relationship between rising interest rates and falling bond prices, and how the risks of short-term, mid-term, and long-term bonds compare to each other. Imagine a very long seesaw. On one end of the seesaw is interest rates, and at the other end is bond prices: As interest rates go up, bond prices go down. But because this is a very long seesaw, the long-term bonds that are out at the far end of the seesaw go down in price the most, while short-term bonds that are much closer to the fulcrum, don’t go down as much. Short-term and mid-term bonds are at less risk than long-term bonds to movements ...