Monday, December 13, 2010

Bond bubble about to burst

Today the Fed bought up 9.7 billion in US Treasury bonds. From what I understand of the bond market is that the Treasury issues bonds at a specific starting interest rate and gives them to the Fed and the Federal Reserve sends over cash in exchange. If there are high demands on bonds then the rate will go lower, if there are low demands on the bonds the rate goes up. Last week after the Obama tax cut deal with the Republicans, the bond market had a huge sell off which rose interest rates almost .5%. This is a big deal because people's mortgage payments go up based upon these interest rates. Today the Fed bought up bonds which dropped interest rates a little lower.

The speculation is that without keeping interest rates lower it will allow people to borrow more and keep those people who can afford their homes in there without putting extra pressure with rising interest rates which raise their mortgage payments. The thing the people are denying is that by creating this cheap money it's driving bond investors away for a couple of reasons. One reason is that we're devaluing our currency by monetizing our debt which is growing bigger by the day. Another would be that bond investors see how much debt we currently have and realize that our spending habits aren't changing which will ultimately cause us to either default or even worse monetize our debt even more.

This is all part of a chain reaction. In 2006-07 the housing bubble burst which caused the credit bubble to burst which will lead to the bond market bubble bursting. Bubbles are defined as exceptionally high demand artificially driving up prices or in a bond market, driving down prices. When the housing bubble burst, people had to choose between paying a credit card or mortgage payments. Most people chose to pay their mortgage. With some people defaulting on their mortgage and even more on their credit cards the banks started requesting bailouts. With the Fed printing money to pay for these bailouts it caused accelerated devaluing of our currency which in turn started a bond sell off because of loss of market confidence. With this happening the fed started the QE program. This is what will ultimately be linked to the bond bubble bursting and collapse of the US economy.

The Federal Reserve has put itself between a rock and a hard place with these QE's. Either Bernanke wants to collapse the US economy and currency or he just doesn't have basic common sense that an IT guy with a computer and the internet can figure out. Because of the credit bubble bursting the economy will not be back to the way it was during the 80's and 90's because we no longer make things. Our wealth has been borrowed away for the last 25 our of 30 year. The only reason that America's economy was so robust is because we could use our credit to borrow to pay for that new car, house, or trinket that we want. The thing is until we start making things here and manufacturing, we're going to be at this rate of prosperity for a very long period of time because we need to pay off our debt so that we can go back to borrowing. Bernanke is trying to artificially keep interest rates lower so the whole country including the government can borrow money at low rates, but if everyone is in so much debt, you can't load them up with more otherwise it's robbery.

People are complaining because the banks are holding onto an estimated $2+ trillion dollars including businesses. The question I ask you, why wouldn't banks hold onto their money? I think they're seeing the bond market crashing while the Fed is artificially propping it up through QE's that they're preparing for bank runs and possibly worse case scenarios than that. This is their only hope of staying alive once everything goes belly up. The only thing they have on their side, from what I hear, is that they're not being required to give high risk loans anymore. With the economy almost in shambles and just barely plugging along, no one has good enough credit to get any loans. I know people who have over 750 beacon scores who can't even get a good car loan and they've even had their job for years. Before my mother's boyfriend passed away from cancer his credit score was so high he could get a million dollar loan on just a signature, he only made about $35k a year.

There's two things you should take away from this article. First, the economy is going to remain in its current state as long as we're not manufacturing goods, a service based economy is no longer sustainable. Secondly, the bond market is about to crash, but when? As long as people keep getting out of the US bond market we're going to have to keep doing QE's. Every time we do a QE, we're going to have to make it bigger and bigger. Sooner or later, within next couple of years, we're going to be the Wiemar Republic. People will start burning money because it will be cheaper than firewood.


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