Treasuries mauled as my "no free lunch" theme gains traction

I have been hammering home a clear point for several weeks -- there is no such thing as a "free lunch." You can't simply bail out anyone and everyone, especially when you're a debtor nation, and expect your creditors to just grin and bear it forever. Click here or here or here for more of my views on this topic.

Now investors seem to be waking up. Treasuries have been getting mauled this week, losing value every single trading day this week (Long bond futures are going for around 128 21/32 vs. 136 7/32 last Friday). Yields on 10-year Treasury Notes have shot up to 2.68% from their December 30 low of 2.06%.

As a refresher, we’re flooding the world with hundreds of billions of dollars in Treasuries to fund our ever-growing deficit. Next week alone, the government is selling $40 billion in two-year notes, $30 billion in five-year notes, and $8 billion in 20-year inflation-protected securities. Total borrowing needs may hit $2.5 TRILLION this fiscal year, according to Goldman Sachs, up from the firm's previous forecast for $2 trillion in issuance.

As if that weren't enough, incoming Treasury Secretary Timothy Geithner just fired a shot across China’s bow by saying the Chinese government is “manipulating” its currency, the yuan. The Obama administration believes that China should allow the yuan to strengthen against the buck.

There’s just one problem: China is the world’s biggest holder of our government debt, with $682 billion as of November. Geithner’s comments could lead to a new round of financial and diplomatic tension between China and the U.S. It may even lead China to retaliate by dumping bonds.

One other market signal that's worth mentioning: Silver and gold prices are rising even though the dollar is climbing. For the longest time, the metals traded inversely to the dollar. When the dollar rose, the metals fell, and vice versa. But that is now starting to change.

I have a thesis that might explain what's going on: Global investors are starting to sour on government debt all around the world. They can see that the cost of bailing out banks and economies here in the U.S., in Asia, and in Europe is spiraling out of control. They know that means governments are going to be issuing trillions of dollars in new debt, driving down the price of existing securities. Result: They’re flocking to alternative stores of value -- including silver and gold.

The decline in bond prices says that thesis is right on target. So does the rise in metals prices. And so does the surging cost of insuring against SOVEREIGN debt defaults. On example: Credit default swaps on U.S. 5-year debt just hit 74.9 basis points, or $74,900 for every $10 million in Treasury debt. That’s the most expensive it has ever been to buy insurance against a U.S. default, and a big rise from only 6 basis points in early 2008. CDS costs on European and U.K. debt are climbing, too.

Are those levels still extremely low? Yes. But the trend is clear. It offers yet another warning sign that the market's appetite for funding unlimited bailouts with multi-trillion dollar price tags is waning. Policymakers better sit up and take notice before these minor market tremors grow into something far more damaging.