If you are like the average American, you probably could not care less about interest rates on government bonds. And who could blame you? With Government Treasury bonds paying dismally low interest rates, the income gained is hardly worth writing home about.

In fact, as of Dec. 28, 2005, if you were to purchase a $1,000 two-year government Treasury bond, the interest earned after one year would be only $43.47. Now if you were to buy a longer-term, 10-year government Treasury, the interest you would earn after one year would be $43.43—even less.

Wait—let’s read that again. Is it possible that the interest earned per year for locking your money away for 10 years is actually less than when locked away for two years?

Yes, for the first time in nearly five years, the benchmark yield curve on U.S. Treasury notes trading on the New York Stock Exchange inverted (see chart)—which could have major implications for the economy and the stock market.

An inverted yield curve occurs when, all things being equal, the yield of long-term bonds falls beneath that of short-term bonds. This is a strange occurrence: Normally, investors expect to receive more interest for the additional risk taken when holding long-term bonds.

In 1996, Federal Reserve Bank economists Arturo Estrella and Frederic S. Mishkin published a paper in which they found that an inverted yield curve actually foreshadows recessions. In later papers, Estrella and Mishkin showed that, of 26 different indicators, an inverted yield curve was the only true predictor of a recession—even predicting recessions four to six quarters in advance. The 1996 paper, to the point of its assessment, also showed that every U.S. recession in the post-World War ii era had been preceded by an inverted yield curve.

Since then, the inverted yield curve has only given two false signals. One, in 1998, may have been caused by some extraordinary occurrences: At that time, the inversion was blamed on investors jumping into what they felt was the comparative safety of long-term government bonds in the wake of the demise of hedge fund Long-Term Capital Management and the Russian financial melt-down (Wall Street Journal, Dec. 29, 2005). As these investors purchased long-term government bonds, it increased their demand, thereby driving up the price of the bonds and subsequently driving down their yield.

So just what does this latest yield curve inversion mean for the economy?

Many analysts are saying it means nothing because the curve has become less predictive than it once was. Additionally, some people say that compared to other inversions, this one so far is minor and therefore nothing to worry about. Even Federal Reserve Bank Chairman Alan Greenspan says it’s different this time (ibid., Dec. 27, 2005).

However, “It’s different this time” is the exact reasoning most major Wall Street banks used when the yield curve inverted in 2000—after which the stock market crashed and the economy went into recession. Prior to the crash, banks said the government was running a budget surplus and was therefore selling fewer long-term bonds. They explained how this pushed long-term bond prices up, and their yields down, causing an inverted yield curve. Deutsche Bank, for example, said, “When this spread went negative in the past, it either foreshadowed a recession or a sharp slowdown in growth …. Fortunately for Main Street, we do not think the … [yield] inversion is sending us that message” (ibid., Dec. 29, 2005).

Furthermore, in a survey conducted just a few months prior to the last recession in 2000, 50 out of 50 Blue Chip economists failed to predict the imminent economic downturn later that year. According to John Mauldin, economic analyst and president of Millennium Wave Advisors, llc, “they ignored the yield curve, all finding reasons why this time it’s different” (www.321gold.com,Dec. 31, 2005).

This same tendency was also noted by above-mentioned Fed economist Estrella, who published another work documenting how “each recession since 1978 produced major academic papers telling us why ‘this time it’s different.’ … They were all wrong” (ibid.).

Mauldin does go on to say that the present yield curve inversion has not continued long enough to absolutely predict a looming recession, but as Estrella cautions, “it should definitely raise warning flags about future output growth” (Estrella, “The Yield Curve As a Leading Indicator,” October 2005). Paul Kasriel, chief economist at Northern Trust Co. in Chicago, agrees, saying, “This is a warning signal … that we are on the recession watch now” (Wall Street Journal, Dec. 28, 2005).

Although yield inversions produce several consequences, they do not cause recessions; rather, they are a symptom of a weakening economy. One consequence is, as the yield curve flattens (long-term yields approaching short-term yields), it destroys a means for banks and other money-lending institutions to make money; thus, they become more reluctant to lend it out.

This cycle can negatively affect the economy in three ways. First, it makes it harder for people and businesses to borrow, subsequently reducing investment and consumer spending. Second, as banks start looking for ways to maintain profits and cut costs, it often leads to them slashing jobs, further hurting the economy.

A third consequence to a flat or inverted yield curve is that it leads to more risk-taking by banks and hedge funds in an attempt to boost income. For example, as the difference between long-term and short-term interest rates narrows, banks can’t make the same profit margins by borrowing short-term and lending long-term. This reduces the incentive for banks to lend money, and may cause them to make riskier investments and lower the amount of reserves they hold to cover bad loans.

Only time will tell if this present yield curve is truly signaling a soon-to-arrive recession. The yield curve has missed only two predictions over the past 50 years. But each time it has been right, recession has followed four to six quarters later.

Regarding the stock market, Mauldin cautions, “When you have something as reliable as the yield curve telling you there are problems in Dodge City, it may be time to think about leaving town” (www.321gold.com,op. cit.). After all, statistics show that the stock market drops an average of 43 percent before and during a recession (ibid.).

So, what should the average person do? Watch and prepare. The American economy is in a shaky position and about to collapse. We are truly in uncharted territory. When it starts to unravel, it will likely lead to the biggest bust in world history, hurtling the U.S. economy into chaos reminiscent of the Great Depression—or worse! The shock waves could lead to a major global recession like we’ve never seen. When that happens, it will clear the way for a dangerous new world force to emerge out of the heart of Europe. The Trumpet, basing its analysis on the sure word of Bible prophecy, has made this prediction for years.

This month Federal Reserve Bank Chairman Alan Greenspan is due to retire and, as Peter Schiff of Euro Pacific Capital says, “Never has a changing of the monetary guard taken place with the U.S. economy in so precarious a position.”

“Perhaps new [Federal Reserve Bank Chairman] Ben Bernanke can solve the [yield curve] problem before it emerges,” but are you ready to bet your future on it?