The Looming Bond Bubble and Other Problems. Abandon Hope.

Somewhere along the political process we traded the idiot George Bush for a new absurdity: wild spending and Neo-Marxian hype from the Obama Socialism.[1]  Bush2 had no concept of what excessive spending would do to our economy and even offered to just give Africa a 57 bln dollar as a ‘gift.’ That was just a dollop. I suppose we are to just ignore a few thousand years of monetary policy and believe that if we merely publish money in blizzard fashion that we will prosper and dig the world out of this debt-driven deflationary spiral that threatens to sink several economies.

At this time the bond holders are taking a beating.  Our most marvelous government has decided, a  priori, to push secured bondholders in the phony and worthless Chrysler auto company bankruptcy[2] to the back of the bus  so as to take big loses and  they were called ‘unpatriotic’ for their refusal to take a big loss for the sake of something  related to politics. The UAW, the penultimate example of a greedy union that sucked the blood out of the auto industry like they did with rails, textiles, steel and others, winds up with 55% of the common stock? The dilution factor is so high with this stock that such common shares are essentially worthless and the book value is probably zero or less. The Obama administration now changes the rules of the finance game by ignoring the top level position of bond holders to claim that their debts be paid off first. He seems to think that we all have ‘some skin in the game’ and that will bring the predictable result that NOBODY will buy bonds in government-tainted businesses. He just compromised the bond market.

A reading of the recent book Read The Ascent of Money by Niall Ferguson[3] gives us several exciting examples of past bond bubbles [Mississippi!] and the aftermath of such foolishness. The central issue here is that we do not have enough capital to finance our federal debt nor do the Brits or many others in our new global economy. The Asians do however, but they are unimpressed at our recent antics. The Chinese have been buying US Treasury bonds and have accumulated a pile of money from this but now wonder how their reserves can keep their value if we print money under the guise of QE or ‘quantitative easing.’ If we mess around with our bonds we may create a bubble that may burst and obliterate our currency. We saw that happen in Iceland lately.

Here are some of the Chinese comments:

“"A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report.”

"As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.”[4]-- China fears bond crisis as it slams quantitative easing.  China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets. By Ambrose Evans-Pritchard Last Updated: 1:13PM BST 07 May 2009 [Emphasis is mine in all quotes.]

Bond prices run inversely to interest rates so if the US needs to raise rates the Chinese and other major bond holders such as the Japanese will see their bond prices fall. A doubling of current interest rates would mean that a $1000 would only be worth $500 on the bond market. Now, they can hold to maturity and get their $1000 back, but if inflation soars the value of the absolute number of dollars might be only a few hundred dollars or in hyperinflation a few dozen cents.

It appears that the Obama administration is hell bent upon printing money and paying off our massive federal debt with inflated dollars. Maybe our grandchildren will not inherit any debt after all if the inflation rates soar high enough.  This means that our ability to sell bonds may be in jeopardy.

“Premier Wen Jiabao left no doubt at the Communist Party summit in March that China is irked by Washington's response to the credit crunch, suspecting that the US is engaging in a stealth default on its debt by driving down the dollar. "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries," he said.”

Ambrose Evans-Prichard comments on all this:

“Some economists say China is suffering from "cognitive dissonance" by anguishing so much over its reserves, accumulated as a result of its own policy of holding down the yuan to promote exports. Quantitative easing by the US Federal Reserve and fellow central banks may have saved China as well, since the country's growth strategy is built on selling goods to the West.

China's fears of imported inflation may reflect its concerns about over-heating. The M2 money supply rose 25pc in March on a year earlier, and there has been explosive credit growth since the government relaxed loan restraints. There are concerns that the stimulus is leaking into a new asset bubble rather than promoting job growth. The Shanghai bourse is up over 50pc since November.”

What we have here is a mélange of deceit across the planet. The Chinese have deliberately kept their money [yuan] low so as to pursue their 16^th century mercantilism that has recently served them so well. They cheated to win. They probably cannot fully internalize their economy as they are export focused. Japan is in the same fix with few natural resources. The US Fed is also deceitful as they are pushing trillions of dollars around the Zombie Banks in a nefarious manner defying the Obama nostrum of ‘transparency,’ because they are telling us this is a stimulus and little of this massive mountain of cash actually is. Barrowing from the future taxpayers and shifting that money to workers is NOT capital formation. Gordon Brown in the UK is not deceitful. He is bankrupting the island in public with no regrets.

Here is what I see happening:

[1] There are four segments to our global economy, third world, the EC, the US [with Canada and parts of Mexico], and Asia.

[2] The EC is deflating and some of the members are sinking in debt like the PIGS [Portugal, Ireland, Spain and Greece.] Some of these PIGS will default.  The socialists in the UK are wildly spending money with irresponsible abandon. The Germans and French are against quantitative easing as they know it will bring on inflation.

[3] Asia  holds ‘reserves’ from their successful export trade balance and now holds much of the essential capital[5] necessary for the global economy to move forward in growth.  China is now worried about the QE in the sense that their holding will inflate quickly if the US dollar gets out of control. Their predicament is what to buy or how to hold their mercantile profits for future growth.

[4] Third world in South America and Africa have a small part of the commercial action in the world with some bright spots in Brazil and abject failure in Africa. The Middle East is a middle case as they still depend on petrodollars to exist.

[5] The US has some 10-12 Zombie Banks that have nothing left buy stale accounts and an umbilical cord attached to the fed balance sheet. These 10 account for some 60% of the banking in North America. The US debt as a fraction of the GDP is going to be about 15%, a level that is not sustainable.

The Next Set of Potholes:

The next #1 crusher is commercial real estate—mostly malls—that will crash and release their workers into the unemployment lines.

The second crusher will be consumer credit and the credit card business. Consumption will fall and the GDP will suffer.

The big kahuna will be massive inflation from the wildly expanding money supply [M2].  Look for about 10-30% per year inflation  until things get hot and the government panics. Then, multiply that by 10 or so.

Unemployment will continue to soar and reach 12% by the end of August 2009.

The leftist thrust is to tax energy based only on the hallucinations of the rabid left. [6]  There is also some serious efforts afoot to bring the mentally disnimble into high perches of power based on the nostrum that all of us are essentially ‘equal’ and that hard work is the solution to success. [7][8]

All these factors will force the ‘global economy’ to degenerate into a global flea market where all rules are ignored. The EC will probably fractionate and some countries will be forced to withdraw from this august body and issue their own currencies, worthless that they might be. China will put up tariffs and such to try to protect their internal economy so they can attempt the conversation from mercantilism to isolationism. India must do the same and Japan is already focused on that outcome.

Several US states, notably California[9], New Jersey[10] and New York will default and beg for money from the government. As they are loyal blue votes and would maintain the socialists in power at this time they will get their gifts and will spend it all away and crawl back to the soggy, beer-splattered and vomit-soaked saloon floors to root around in the overflowing cuspidors for more alms.

And all this is much deserved by our voters who voted for ‘change. ‘ We all deserve this ‘change’ and will pay for it for generations.

Think about this.

rycK

Comments to: ryckki@gmail.com