Line up, dear reader. It’s time to pay the government to hold your money.

The economy is barely showing any signs of life…meanwhile the government and the Fed are trying everything they can to get gross domestic product (GDP) growth going again.

One area for economic stimulus that has been explored to the point of being completely exhausted is reduced interest rates. Or so I thought. Short-term interest rates can’t go any lower, can they?

I stand corrected. What I’m about to tell you gives a whole new meaning to “desperate times call for desperate measures” when it comes to U.S. Treasuries.

In May of this year, the Treasury Borrowing Advisory Committee is going to discuss how to modify its regulations in order to permit the sale of U.S. Treasuries with negative interest rates. Yes, negative interest rates.

It may soon be possible to pay the government for the “privilege” of owning U.S. Treasuries, for the privilege of holding your money in safe government securities. Yes, at 100% debt-to-GDP and over $15.0 trillion of U.S. debt and counting, it is amazing that U.S. Treasuries are deemed so “safe” that one would pay the government for the privilege of holding U.S. debt.

With the financial turmoil in Europe (more on that in “Michael’s Personal Notes”) investors flocked to U.S. Treasuries, sending rates so low that some investors actually paid for having their money in a perceived “safe” area of the world. The U.S. and Germany have lived such experiences recently.

After having witnessed this transpire in the markets, the U.S. Treasury naturally is thinking, “Let’s just issue U.S. Treasuries at negative rates.”

It will soon be your choice, dear reader, to either stuff your money in a mattress and earn zero interest rates or pay the government for holding it through U.S. Treasuries—with the reminder that U.S. debt has surpassed $15.0 trillion, with the $16.3 trillion U.S. debt ceiling to be breached by the end of this year (U.S. debt will grow to at least $16.3 trillion by the end of the year).

Just yesterday, I commented on the recent budget proposal by President Obama, and highlighted the staggering projected increase in U.S. debt over the next few years. (See: Trillion-dollar Budget Deficits…Getting Used to the Norm.)

The idea of keeping interest rates at zero for years to stimulate borrowing is clearly not taking place in the real economy. As crazy as it sounds, if interest rates were to rise to levels that have been common over the last 100 years—four percent to six percent—then borrowing might be stimulated.

Firstly, savers would earn interest on their money greater than the inflation rate, which means their purchasing power would increase. If consumers become more confident through real purchasing power growth, then they’ll spend.

If consumers spend, then businesses would rather pay more interest on capital spending if they can see visibility of demand for their product or service, rather than pay little interest on their capital spending in an environment of no demand.

Instead of earning zero interest on U.S. Treasuries, I would urge investors to look into gold bullion. It historically always thrives in a negative interest rate environment (where rates are below the level of inflation). Gold bullion’s bet continues to be more attractive…especially now with the government considering selling U.S. Treasuries at interest rates below zero.

Michael’s Personal Notes:

I’m all for fiscal discipline and spending within one’s means, but austerity measures as medicine for fiscal discipline can literally kill the patient.

I have no doubt: the U.S. economy will feel the ramifications of what transpires in the eurozone. Make no mistake about that. (See: Payback Time: Europe to Export a Recession to America.)

I have been talking about the horrible unemployment rates recently in the eurozone, but there are other developments concerning austerity measures that warrant watching.

There is no question that the countries of Greece, Portugal, Ireland, Spain and, to some extent, Italy have spent beyond their means. Germany and France have instituted strict policies—austerity measures—these countries must abide by in order to receive future bailout money.

This is understandable and makes complete sense. Fiscal discipline must be the order of the day. Obviously if your son or daughter spent more than they earned and came to you for money, you would demand they cut spending—your own version of austerity measures. (I wish the administration here in the U.S. would initiate some austerity measures, like balancing the budget, but I digress.)

The problem with these austerity measures is that they prevent growth and, in some cases, actually assure that an economy will contract.

Here are two examples. In order for Greece to receive the next bailout money from eurozone, the country has been asked to, among other austerity measures, cut 15,000 government jobs in 2012, eliminate 150,000 government jobs by 2015, and reduce the private-sector minimum wage by 22%.

Once minimum wage is cut, those people affected spend less and pay fewer taxes, which results in less government revenue.

If the 15,000 jobs are eliminated, then these people pay no taxes to the government and, worse, receive some unemployment benefit from the government instead. Furthermore, these people cut their spending dramatically, which leads to the economy slowing. It’s a snowball effect.

What have the austerity measures done for Greece thus far? The country’s manufacturing output contracted by 15.5% in December, from the same period last year. Greece’s industrial output contracted by 11.3% in December. As a consequence, unemployment has jumped to 20.9%. Greece’s economy has now contracted for five consecutive years!

This, dear reader, is what a death spiral looks like.

Portugal has been the model country thus far. Since the crisis hit, the country has implemented the austerity measures that have been asked of it by other eurozone countries and, therefore, has received the bailout money from the eurozone to date.

Even though it is playing by the rules, Portugal’s debt-to-GDP is growing from 107% in 2011, to a projected 118% by the end of 2012. Is this because the country is growing its debt? No. Portugal has followed the austerity measures and has not increased debt.

The problem is that Portugal’s economy continues to contract. The austerity measures mean more people out of work or a cut in salary for those still with a job. That translates into less money for the government.

These scenarios are playing themselves out in Spain and Italy. These two countries are following the austerity measures, but their debt-to-GDP levels continue to grow, not because of debt, but because their economies continue to shrink. Italy’s debt-to-GDP was 105% in 2009, with the country now expecting 126% debt-to-GDP by the end of this year!

The protests are mounting. There is a breaking point somewhere not too far down the line with these austerity measures. If the eurozone breaks apart because countries like Greece, Spain, Portugal or Italy leave the euro, the U.S. dollar will not be the winner. Because the U.S. dollar is backed by so much debt, because the U.S. economy will suffer from of the demise of the euro, the only currency that will really benefit is gold bullion.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average closed yesterday only 100 points away from 13,000. How about this theory, my dear reader…

Greece gets its second bailout, the euro takes off on the news, the U.S. dollar falls, and the Dow Jones Industrial Average breaks through 13,000. Everyone is happy. Stock advisors turn solidly bullish and then, bang, we finally get that final blow off for the bear market rally. Just a thought…

What He Said:

“The proof that the party is over in the U.S. housing market could not be clearer to me. The price action of the new-home builder stocks is telling the true story—these stocks are falling in price daily (and the media is not picking it up). Those who will hurt most when the air is finally let out of the housing market balloon will be those buyers that bought in late 2005. In fact, the latecomers to the U.S. housing market may end up looking like the latecomers to the tech-stock rally that ended so abruptly in 1999.” Michael Lombardi in PROFIT CONFIDENTIAL, March 1, 2006. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.

Looking at 2011, the only asset class in the U.S. that fell in value was residential real estate (the same will happen in 2012). The stock market was up this year; the bond market was up; precious metals’ prices were up in price, too. Oil prices rose aggressively in price in 2011.

As for consumer goods, food prices were up sharply in 2011. So much so, even McDonald’s Corp. (NYSE/MCD) needed to raise prices. Our neighbors to the north, Canada, just announced that their inflation rate rose 2.9% in November from a year ago. Other countries are reporting sharply higher inflation. Buyers of government-issued bond in the Western world are seeing their capital erode, as the inflation rate is higher than the return on the bonds!

During the year, I have written about how the Federal Reserve’s actions of artificially keeping short-term interest rates at zero for five years (the Fed said it would keep interest rates low until 2013) and the $2.0-trillion increase in the money supply are extremely (almost critically) inflationary.

Investors and consumer who believe that interest rates will be kept low indefinitely are in for a rude awakening. Sure, only few believed me in 2005 when I said the U.S. housing market would crash and create havoc for the U.S. economy. And few believed me in 2006 when I said we were entering a recession.

My most important message this year, dear reader, is a warning about higher inflation and higher interest rates coming our way much faster than we expect. And you should prepare yourself for this.

The last time interest rates fell so low for such a prolonged period was 1935 to 1940. Interest rates went up for 40 years after that. It’s the same old story: Each time the economy collapses, interest rates are brought near to zero. Inflation is then created by interest rates being so low and by fiat money printing; interest rates then unexpectedly spike higher. It will be no different this time around, my dear reader.

The rise in interest rates fueled by sharply higher inflation will catch the majority of investors—not including my readers—off guard.

Michael’s Personal Notes:

A tale of two cities…

I was in Manhattan this weekend and have to report to my readers, I’ve never seen it so busy. The city is booming. Walking on 5^th Avenue after 11:00am is difficult because of the sea of people (forget even trying it at about 3:00pm). The most popular restaurants are full (9:30pm first sitting for a good place) and hotels have jacked-up prices as hotel occupancy is high.

The line-up at well-know toy store FOA Swartz at Central Parkstarts around the block. You’ll have to wait a long time to get into the Apple Store next door, as well. Home prices in Manhattan are going through the roof once more. Soho is booming with shoppers walking the streets, hands full of bags from their favorite retail stores.

9/11 and the Great Recession of 2008? No sign of the economic after-affects in New York City. Just getting a cab in this town is a chore.

Last night, I returned from Miami. In what is suppose to be the beginning of the “Season” for heavily traveled vacation destination; hotels are lowering prices to attract customers. Any of the popular restaurants I frequent, no problem getting in, lots of empty tables. The strip plazas and malls, plenty of empty stores. It’s like the Great Recession of 2008 is only starting to end here.

Home prices in the Miami condo market? Still a glut of home foreclosures on the market. Home prices are not rising; great deals can still be had. The further away from the ocean, the better the home prices.

The rude and elementary importance real estate makes in a local economy”

The biggest real estate condo boom the world has ever seen came to a crash in Miami in 2006. The crashing real estate market has severally affected the economy in Miami; home prices are no where near recovering in Miami. In New York City, home prices never crashed; there is nothing to recover from.

The benefits of the Fed’s policy of zero short-term interest rates and an aggressively expanded money supply can easily be seen in New York City. In Miami, crashing home prices have been too severe for the Fed’s extraordinary measures to take any desired affect. (Also see: “Why We Can’t Have a Sustained Economic Recovery.”)

Where the Market Stands; Where it’s Headed:

With six trading days left in the year, the Dow Jones Industrial Average opens this first day of winter up 4.8% for 2011 excluding dividends…about 50% short of last year’s 10.8% stock market gain.

In case you didn’t see the numbers…

The Dow Jones Industrial Average gained 18.8% in 2009, 10.8% in 2010 and 4.8% so far in 2011. It’s not a co-incidence the market’s advance has been declining about 50% per year. It’s simply the sign of an aging bear market rally. (See: “A Few Numbers That Say a Thousand Words About 2012.”)

We continue to trade in a bear market rally that started in March of 2009.

What He Said:

“Over the past few weeks I’ve written about subprime lenders and how their demise will hurt the U.S. housing market , the economy and the stock market. There’s no escaping the carnage headed out way because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom the peaked in 2005, have yet to arrive.” Michael Lombardi in PROFIT CONFIDENTIAL, March 22, 2007. At the same time Michael wrote this former Fed Chief Alan Greenspan was quoted as saying “the worse is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”

Things are looking up for the economy again. Unfortunately, things are not always as they seem.

The U.S. Commerce Department said that the U.S. economy grew at 2.5% in the third quarter—the fastest pace in a year. Moody’s Investor Services last week raised the corporate ratings of both Ford Motor Company (NYSE/F) and General Motors Company (NYSE/GM), an indication that the car companies are doing better as well. All of a sudden, people are feeling good about the U.S. economy again.

But it was only this summer that analysts were calling for a second U.S. recession. Some economists said we were already in a recession. The numbers being released on the economy beg to differ. Or do they?

Fickle…that’s the word I use to describe today’s modern economists. The stock market starts heading down (as it did this past August) and all of a sudden we are headed for a recession. The stock market gets close to new high (as we are now), and the economists say we’ve turned the corner and are out of the recession.

What’s the truth? How do we make sense of all these numbers to make the right decision for our investment portfolios and for our businesses.

I’ll get right to the point, my dear reader. We cannot have a sustained economic recovery without a recovery in the real estate market (see Without This Fixed, the Economy Cannot Recover). Job growth in the U.S. will not happen unless the construction industry, housing industry and real estate market in general come back. And, from all sides, we can see that the housing market is far from a recovery.

Consider these facts about the real estate market:

The median price of a new U.S. home fell 10% in September 2011 from September 2010, the biggest drop in two years.

The median price of a resale home, which makes up 94% of the real estate market, fell 3.5% in September 2011 from September 2010.

Cash deals account for 30% of all home resale transactions in the U.S.

The Dow Jones U.S. Home Construction Index, an index comprised of the largest U.S. homebuilder stocks and a great leading indicator of the real estate market, is still down 80% from its 2007 high—the worst performance of all Dow Jones sub-indices

Now here’s the scary part about the real estate market: According to Bloomberg, there are 11 million homes in the U.S. where the mortgages are higher than the value of the homes.

Until we have a recovery in the real estate market, which could be years off, we can’t have a bankable economic recovery. That’s the bottom line. And that’s why we simply continue to be in a bear market rally—a period in which the stock market moves higher as the bear completes its Phase II cycle of luring investors back into the stock market before stock prices fall again.

New Cycle of Rising Interest Rates Closer Than We Think

If there is one thing that keeps me up at night, it is this simple question:

What will happen to the U.S. economy when interest rates start to rise?

The U.S. economy is ever so sensitive, likely the most sensitive it has been since World War II. The Federal Reserve has done an excellent job at keeping us away from a second Great Depression. The Fed has kept short-term interest rates near zero for years. The Fed has bought U.S. Treasuries (an unheard of action) and is trying to keep long-term interest rates down by buying long-term securities.

But we must face the facts: after a 25- to 30-year down cycle in interest rates, the unprecedented expansion of the U.S. money supply will create inflation. This is what the 10-year bull market in gold bullion has all been about. And, as inflation sets in, interest rates will rise (see The Economy? Stocks? This Is a Bigger Risk).

And herein lies the biggest problem with the economy.

The U.S. real estate market is already in trouble (read my lead story for today). If interest rates start to rise, the proverbial final “nail in the coffin” will have been delivered to the already-hurting real estate market.

My historical studies show that interest rates move in 20- to 30-year cycles, either up or down. Given the record increase in the money supply and record increase in the national debt, rising inflation will be the catalyst that leads to higher interest rates.

There is no doubt in my mind that interest rates will start a new 20- to 30-year up-cycle. It is only a matter of when it starts…and it might be earlier than most of today’s economists think.

Where the Market Stands; Where it’s Headed:

Last trading day of the month and it looks like October is going to go out with a bang! What a difference a month makes. We started out October close to 10,400 on the Dow Jones Industrial Average. We are closing the month around the 12,000 level. But, despite the market’s recent run-up, pessimism still reigns with stock advisors, investors, and consumers.

We are in Phase II of a secular bear market. This phase of the bear market will move stock prices higher, as the bear convinces investors that stocks are a safe investment again. Phase II of bear market rallies can last three to four years. This bear market rally has lasted 32 months thus far and shows no signs of abating.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in PROFIT CONFIDENTIAL, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.

Without getting too technical, investors have two ways to bet on the price direction of stocks. They can go “long” the market, which means they believe that stock prices will rise. Or they can go “short” the market, which means they are betting that stock prices will fall.

Going “long” is easy; all investors need to do is buy stocks. And usually, when investors have a strong general consensus that the stock market will move higher, like they last did in October of 2007, stock prices go the opposite way and fall.

Going “short” is easy, too. Investors simply borrow stocks they do not own and promise to repay later. If the stock falls in price, the person shorting the stock keeps the difference between the price he/she borrowed the stock at and the price it is repaid at. Short selling is a huge function of the market.

Borrowed stock climbed to 11.6% of the market in August from 9.5% in July, according to Bloomberg. This is the biggest monthly increase in five years.

Let’s face the facts. The stock market took a big beating this summer. Worldwide, trillions of dollars were whipped off the value of equities. Investors thought the market was headed back to test the March 2009 lows and started selling stocks and shorting stocks.

But the bear market is too smart. He doesn’t make it easy. “Not so fast, I’m not finished the rally I started in March of 2009,” the bear market told investors as stocks started to rally late last week.

Historically, stocks have rallied when investors have taken a large short position in equities. I don’t see it being any different this time around. A recipe for higher stock market prices: lots of short sellers and lots of bears. We have both in the tent right now and it’s getting crowded.

Michael’s Personal Notes:

The Bank of England (BOE) is doing exactly what the Fed did, buying government bonds. And it’s doing it big-time!

The BOE has pledged to buy the most bonds since the depths of the 2008-started crisis, as the central bank races to stop the current euro-region debt crisis from pushing Britain back into recession.

To date, quantitative easing, which is what the Bank of England and Federal Reserve have done by buying their respective government’s bonds, has had no effect on job creation or economic growth. The action of buying government debt serves two purposes: 1) it insures there is a buyer for the debt (in case foreign investors, who buy most government bonds, get cold feet); and 2) it helps push domestic interest rates down.

However—and there is always a “however”—there is a big negative to central banks buying their own country’s government bonds. The money to buy the bonds needs to be created. In the old days, the printing presses would just print more fiat currency. These days, I believe the money supply is simply expanded electronically.

The problem with more and more money in the system is that the money being “printed” brings in more supply, and as per Economic Analysis 101, the more of something there is in supply, the lower the demand. In the case of fiat currencies, the more the supply, the more paper currency is needed to buy goods and services, and that’s how we get inflation. I believe this is exactly what the 10-year bull market in gold bullion has been telling us…rapid inflation ahead.

Where the Market Stands, Where it’s Headed:

Stocks are making their anticipated comeback from a state of being severely oversold.

I continue to believe we are in a bear market rally that started in March of 2009 and that this bear market rally will bring stock prices even higher before it’s over.

What He Said:

“I personally expect the next couple of years to be terrible for U.S. housing sales, foreclosures, and the construction market. These events will dampen the U.S economic picture significantly in the months ahead, leading to the recession I am predicting for the U.S. economy later this year.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2007. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.