You know the World is coming to an end when ALL the central bankers and ALL the various finance ministers and ALL the various free and not- so- free world leaders are acting like Gomez in the Addams Family.

I’m seeing more and more of this sort of thing, from Satyajit Das

Recently, an acquaintance in financial markets announced his retirement to a life of rustic simplicity in Umbria, Italy. He had acquired a farm and was restoring it with the help of local “serfs” (his word not mine!) The farm would be self sufficient producing essentials of life ─ wheat, milk, wine and meat. The plan was to avoid the coming financial Armageddon in financial markets and the money economy.

When market professionals start going off the grid … there are problems. Why? You ask …

Danger! Bond Market Ahead!

As usual, the numb skulls @ the Federal Reserve have come up with another brilliant idea to ‘Stimulate’ the economy. Their best idea would be to all resign. The economy is dead, it cannot be stimulated! Time for a new economy! Hello!!!

The Federal Reserve will buy longer- term Treasury and GSE securities in an attempt to prod the broken credit system into making more loans. It is going to pay for these purchases by ‘wishing’ the cash into existence.

The term used is ‘Quantitative Easing’ and the idea is the central bank will flatten the yield curve. The Fed already buys short- term Treasury debt along with other purchasers who do so seeking safety as there are few other investments that are not overburdened with risk. This selling of short term rates to near zero has done nothing to induce lending – the technical term is ‘pushing on a string’.

I guess it’s the because other investments are overburdened with risk 🙂

To raise the price of a bond causes yields to decline. – as interest rate yields on bonds move in the opposite direction to price. The desired outcome is lower mortgage and commercial lending rates making loans more attractive to borrowers.

The New York Times described the Fed’s actions:

…the committee (Federal Reserve Open Market Committee FOMC) said it had decided to purchase an additional $750 billion worth of government-guaranteed mortgage-backed securities on top of the $500 billion that the Fed is already in the process of buying.

In addition, the Fed said it would buy up to $300 billion worth of longer-term Treasury securities over the next six months. That would tend to push down longer-term interest rates on all types of loans.

The plan is for the Fed to buy these bonds now and when bank lending returns to normal, the bonds will be sold back into the market and the liquidity generated by this action ‘mopped up’.

The instant reaction is that this activity is dangerously inflationary or even hyper- inflationary. This is true to a point; sweating money out of thin air is what the banking system has been doing for the past fifty years. Most of what is called ‘growth’ is simply the excreta of long- term inflation. With inflated asset values unsupportable by wage and earnings growth the inflationary trend is finished. At best, the Fed is simply wasting its time and making itself look out of touch (idiotic) in the process.

At worst, the Fed will cause the outcome it so desperately seeks to avoid, a complete lock up of credit! The problem is the central bank cannot support the bond market on its own, it requires a great number of other investors to lend to the government alongside itself. The quantitative easing is a tout; it guarantees a profit to investors by placing a floor under longer term bond prices … but for how long?

At first, bond investors will see this price floor, it will generate demand. The Fed is gambling that the credit market will start lending again on its own before the bond market notices the price floor is another Ponzi scheme. The wager is one country – the USA!

Take that, Bernie Madoff … you piker! I’ll see your fifty billion and raise you a trillion!

At that point, the problem begins … when investors decide to sell. Here, perception is critical. The first out the door will get paid while the rest will wind up holding the bag; the Treasury is the source for tens of trillions of debt to be sold so that any fools in the market beyond a certain point will be inundated with supply. When this perception takes hold there will be a mad rush out of Treasuries.

Soon enough the cost of borrowing will be too great for the government to bear or there will be no market for Treasury debt. Ten percent yield ought to do the trick. The debt- addicted government may as well put up a ‘Going Out Of Business Sale!!!’ sign.

There is no guarantee that ten percent will be the upper limit. It could be fifteen or twenty or a Yeltsinesque thirty percent interest on US Treasury bills, notes and bonds!

Brother, can you spare a bond?