Countdown to Armageddon: The Fed Bubbles Itself Up

A few days ago the Treasury auctioned about $7 billion in five-year inflation-indexed securities (TIPS), and demand was robust. The bid-to-cover ratio according to Bloomberg was 3.10, the highest since October 1997, signaling that investor appetite for government paper is far from being exhausted. Indeed, since TIPS ensure against inflation, they are probably even better than gold as a hedge against future volatility at this stage. If you don’t believe that the government is going to supply the dollar massively in excess of demand in order to meet its future obligations, and are confident that the exchange rate risk is manageable, TIPS provide a credible opportunity to hedge against volatility and uncertainty in the markets.

Meanwhile, even as TIPS meet robust demand, the ten-year government note fell, in spite of the somewhat gloomy outlook for the stock market. As it is prone to happen, every once a while, sellers like to dump U.S. assets in bulk, including, bonds, stocks, and currency, in response to the occasional fear that a resurgence of the crisis is around the corner.

In spite of all the action, what is most interesting about the government bond market, in our opinion, is that it holds so well against all the odds in the face of a potentially cataclysmic outlook for the finances of the U.S. public sector. Some of this is easy to explain; the perennial clients of American debt, such as the Chinese and the Japanese, simply don’t have any other option for reallocation of their capital.

The Chinese are clearly worried about the gloomy prospects of the sick American public sector, but they have tied themselves in such an inextricable way to the fortunes of the dollar that they are practically without any real choice while deciding whether to bail out America. Their dilemma is that if they cut off the umbilical chord with which they feed American consumers, buy American debt, and sustain the dollar, they will probably become poisoned when the amorphous baby disintegrates. And if they do not cut it off, do not keep re-channeling their savings to American pockets so as to keep them spending, they are very well aware that when someone calls the Emperor naked, there will be nothing to prop up the economic house of cards that they have built in California and Shanghai.

And all that brings us to a conclusion. The present bubble economy began in the Reagan Era, when the first efforts at deregulation created the savings and loans crisis. Although the economy recovered from that crisis, the savings habits of the American public never did. The passionate love of the American people, and the passion for ever increasing levels of debt essentially has its beginnings in the 80s.

Probably this fondness for debt was acceptable at that time, coming after the horrible experience of the 70s, but thereafter the debt bubble kept inflating during the roaring 90s, as everything seemed to be better than it could ever be. At the beginning of this decade first the stock market, then, in quick succession, real estate, oil, and financial firms all had their bubbles. All of them bursting at various stages of this crisis. It is safe to say that just about every sector that could experience a bubble has had one. Right now, the private sector is exhausted and really bankrupt, both morally, and practically, and clearly it can no longer create the bubbles that the government needs to keep the “American Dream” going. The American citizen is of course already quite bankrupt. Nobody really is willing to lend him seriously after the subprime debacle and 10-percent unemployment.

So what does the Fed and the Treasury do? They simply bubble up themselves. Just about no-one in the financial sector is really willing to take up the offer to gamble these days, because everybody is, more or less bankrupt. But there’s still some confidence that the government cannot go bankrupt. It has the printing presses, the legal mandate to pay off anyone with fiat money, we’re told, so even in these days of volatility and uncertainty, it is possible to find some error-proof risk-free asset in the Treasury market discussed in the beginning of this article. After all, in economics we measure the risk of everything on the basis of the risk of government paper, which is thought to be the closest thing to being essentially risk-free.

And that, friends, is the most basic stuff of which bubbles are made. When there’s unquestioning acceptance, and a belief that something just can’t go wrong, it is essentially a certainty that it will go wrong. As it happened with oil, top-rated CDOs, the dot-coms, and many other assets throughout history. The last phase of this crisis is where the government bubbles up itself to keep the game going.

It is the surest way to Armageddon and since nobody in the world seems to have the slightest qualms in executing this scam, we’re sure to see a general economic collapse that will make this one seem like child’s play. Civil War, and anarchy in China, general collapse of the global economic system, a period of introversion among nations, and evaporating global trade could well be the outcome, along with political extremism on a worldwide basis. Needless to say, all this could be averted by first recognizing that a problem exists in the bailout culture, but since that’s conspicuously lacking today, it’s hard to see how a salutary solution can be found to the economic malaise that we are suffering from today.

Comments

[albertpeia:]

Grantham speaks to that very troubling reality after discussing same below:

Grantham: Overvalued Markets Due for an Adjustment Marc Faber, Dollar Will Eventually Go to Value of Zero U.S. Jobless Rates Rise Again in September; Large Divergence Between States UPDATE 2-US home price gains not be sustainable-Shiller NEW YORK, Oct 27 (Reuters) - The gains in US home prices in recent months may not be sustainable and increases in some areas of the country appear to be in "bubble territory," an economist known for his property market expertise said on Tuesday. Is New York Facing a Financial China Syndrome? Jonathan Turley | We are now piling on debt faster than gross domestic product. Celente: Wall Street Criminals/Frauds have hijacked Washington DC U.S. Economy: Consumer Confidence Drops on Unemployment Concern Grayson calls Fed adviser ‘K street whore’ Galbraith: Fed is Unlawfully Withholding Information from Congress

Grantham: Overvalued Markets Due for an Adjustment …First, economic and financial data will disappoint, revealing the longer-term troubles of the developed economies. This will put pressure on profit margins at a time when labour cuts are no longer a quick fix. Second, with U.S. stocks looking overvalued, gravitational force will at last kick in.“I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again,” he said. “I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels.” For him, “painfully” implies a dip of 15%. But a drop below fair value is more likely, and that could bring a 22% setback…
SELL / TAKE PROFITS WHILE YOU CAN IN THIS PREPOSTEROUS AND FRAUDULENT ENVIRONMENT WITH CONTINUED SUCKERS’ COMPUTER PROGRAMMED /SHORT-COVERING /BEAR MARKET RALLY INTO THE CLOSE TO END MIXED WITH MODEST LOSSES RELATIVE TO REALITY (ON NEW RECORD DEFICIT 1.42 TRILLION, HIGHER OIL PRICES, EVER MORE WORTHLESS DOLLAR, B.S. SERVICE SECTOR MEANINGLESS REPORT, LOTS OF FORECLOSURE SALES) BASED ON FAKE DATA (WATCH FOR CORRUPT GOV’T, IE., COMMERCE DEPT., ETC., FALSE REPORTS TO FROTH MARKET), BAD DATA (JOB LOSSES UP, BANKRUPTCIES UP 41%, CAR SALES / MANUFACTURING DOWN, ETC.), BULL S**T (IE., MERGER MANTRA-LIKE CHURN AND EARN COMMISSIONS GREAT FOR WALL STREET FEES BUT BAD FOR EVERYONE ELSE ESPECIALLY SINCE LEADING INDICATORS WITH B.S. STOCK COMPONENT THE ULTIMATE BOOTSTRAP, MORE WORTHLESS WEIMAR DOLLAR, ETC.), BETTER THAN EXPECTATIONS MANTRA John Browne…And the markets just don

Oct 28 06:53 AM

[aussiereader4:]

Forex this ignores the low level of debt in the rest of the world. It is America that has the problem. Have you thought that maybe China will keep America going just long enough to allow its Economy to change focus to a domestic one. They are gradualy moving there assets into commodity based investments all over the world.

Every day in Australia is another takeover offer for a mining company from China

Oct 28 06:59 AM

[socrateaz:]

I liked your article other than the propaganda ploy blaming deregulaion on the Reagan administrtation. They did have a hand in that. However, I believe, and I think it will be real history (if not propagandized in as different) that the deregulation was an attempt to solve the problems which were already there. It just did not work! As far as the US fixing their problems and curing much is long past. The ballon is moving into the stratosphere and raising. Fixes may stop it from raising higher. I do not see it coming down under any of the current leaders. Obama is more an outing of professorial idiotcy than a thinking man with experience. He has so many incorrect beliefs, It would be amazing indeed if any kind of real fix will be found from his group.

Oct 28 08:58 AM

[Pat C:]

I agree with socrateaz, we are way beyond the blame game.

Oct 28 09:51 AM

[buzzard:]

You conveniently dismiss the economic disaster with 22% interest rates that Jimmy Carter handed to Reagan. No mention made of the repeal of the Glass-Steagal Act in 1997 which allowed all the robber barons to leverage the skin off our corpses by the Clinton Administration! Not to mention the export of our industries and sharing of our missile technology by the Clintons! Armageddon is what is being meted out by the Bernanke-Obama consortium! Let them eat cake while the printing presses destroy our preferred currency status and usher in an inflationary cycle which will be cataclysmic. May God have mercy on us. Paschal Edmond

Oct 30 07:48 AM