How to make hyper gains when Washington hyper-inflates the dollar.

Back in the bad old days of the previous century -- around 1984 -- a visionary gentleman by the name of Ed Yardeni coined an interesting phrase: “Bond Vigilante.”

The idea was that when the federal government gets up to its usual stupid fiscal tricks -- like printing and circulating way too many dollars or selling way too many bonds -- the folks who might normally buy and hold those bonds and dollars would express their anger by selling their holdings back into the market.

By reversing the relationship between supply and demand, these vigilantes could force Washington either to mend its ways, or at least add a little vigorish to the deal, in the form of dramatically increased yields.

Sounds eerily familiar, eh?

Washington Floods the Market

Once again we have Washington literally quadrupling the national debt as it attempts to cover Mr. Obama’s massive spending spree. And once again, Mr. Yardeni is warning that “the Bond Vigilantes are up in arms over the outlook for the federal deficit.”

How much damage can these rebels in suits and ties do? 2009 has seen the worst start for U.S. Treasuries since Merrill Lynch began tracking such things in 1977, with prices falling more than 5% and yields creeping 1.5% over a few short months.

Now the last thing in the world Washington wants is for rates to go up just as a little mini boomlet in used-house sales is coming along. So, in order to quell this brewing bondholder rebellion, the Federal Reserve has kindly offered to buy up any notes the Treasury department can’t flog at their little flea market.

The Biggest Scam in Human History

I am assured by more than one professional economist that robbing Peter to pay Paul is a perfectly legitimate fiscal plan. But personally, it sounds to me like a giant check-kiting scheme. Or perhaps the grandest three-card Monte scam in human history.

And apparently, I am not alone. Word is circulating that the entire country might be about to lose its AAA rating.

To give you a sense of scale here, Moody’s has rated U.S. debt at AAA without fail since 1917. This sort of repudiation of our ability to pay our bills has simply never happened in the modern era.

Horribly Unique

It didn’t even happen back in 1929 when Wall Street turned its white belly to the sky. It didn’t happen when Roosevelt paid hacks to paint on walls and sing camp songs into tape recorders in the 30s and 40s.

It didn’t happen when Johnson tried to put everyone on welfare AND pay for the war in Vietnam. It didn’t happen when Nixon took us off the gold standard, or when Ford and Carter diddled around while inflation ran up to 14%.

It didn’t happen when Reagan and Bush Senior ran up the previous biggest deficits by percentage of the economy, or when Bush Junior ran up the previous biggest dollar deficit.

And Horribly Possible

But now, Moody’s senior debt analyst Steven Hess has warned publicly that this may be exactly what will happen now if Washington’s debt ratios continue to climb.

Unfortunately, it appears that this is exactly the road Washington is headed down as fast as its million little feet can carry it. When our credit gets downgraded, it will become more expensive to raise money. But don’t expect Washington to tighten its belt. That would be sane, but it also would be extremely unpleasant for those folks who have to get elected if they want to keep those chic inside-the-beltway addresses.

Rather, they will react by printing more and borrowing more simply to service this enormous debt. Which is why another one of those old school visionaries, Marc Faber, warned in a recent Bloomberg interview that he is “100 percent sure that the U.S. will go into hyperinflation. The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Too Dark For You?

Dr. Faber is somewhat infamous for the dark tenor of his prognostications. One could thus forgive you for taking his statement that we will approach Zimbabwean standards of fiscal corruption with a grain of salt.

But as unpleasant as his warnings may be, he is seldom off but so far off the ranch. So let’s say we take the conservative road and cut Marc’s prediction in half. That still leaves us with an inflation rate of 115 million percent.

Forget Those Pansy Tea Parties…

Now I don’t know for a fact that such a monumental disaster could happen here. Quite frankly, I suspect folks like our own Jim Arnheim would travel to Washington -- along with several thousand of his best friends -- and do something rather “vigorous” to stop such foolishness.

We may be a tad past the age for storming barricades -- but what do you say to chipping in for their train tickets? (To any of you fine law enforcement types who feel compelled to read my mail, it’s just hyperbole – really!)

In the meantime, I suspect it is still a good bet to hedge any and all dollar-denominated assets via shares of PowerShares DB US Dollar Index Bearish ETF (UDN:NYSE). I have already advised my WaveStrength Options Weekly readers interested in leveraging that position a bit to purchase mid-dated UDN calls.

Even if inflation does nothing more than double (a virtual lock, considering the way things stand) potential gains on these calls could reach 124% in short order.

Other Related Topics: Currency Investments , Editor Adam Lass , Inflation Rate , WaveStrength Options Weekly

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