The Next Bubble is already here
November 21, 2008 – 1:38 am
And it’s in Treasuries. Hopefully, Brad Setser doesn’t mind me borrowing one of his charts:
Remember, bond yields vary inversely with bond prices (see chart below for what flight to quality looks like in terms of bond prices). People are willing to pay virtually any price to own short-term Treasuries. (For any of my bond-trading readers, is it possible for a bond yield to go negative?)
People are so afraid to hold ANY risky asset, they’re willing to lend to the U.S. government for free. Inflation? Capital appreciation? These are distant concerns next to capital preservation. And yet the fundamentals of the federal govt’s balance sheet suggest this is a losing long-term bet.
Hopefully, this bubble doesn’t pop. Hopefully it just slowly deflates. Then again, take a look at this chart for LT debt circa the Great Depression (chart from Karl Denninger via Aaron Krowne):
That chart is for the long-bond index, and here’s Karl’s take-away:
The point here is that in the 1930s the government ringfenced and DID NOT contaminate its own balance sheet. The rest of the bond market cratered but the US Treasury market DID NOT.
This time around the government IS the bond index because it has taken all the crap on itself. Therein lies the danger…. if TREASURIES do what the index did in the 30s…… BOOM!
I fear there is no escaping major wealth destruction even from these levels as investors everywhere rush to exit all their investments. What do they do with the money? Much of it may be taken from them involuntarily as banks implode and their deposits disappear. In the meantime, they’ll try to get as much cash out as possible amidst a global bank run.
The run has been on for some time, of course, though primarily at higher levels of the financial food chain. It was a bank run that destroyed Wall Street, as well as IndyMac, WaMu and Wachovia.
An attentive reader noted that his mother, a bank employee, explained to him that fractional reserve banking is effectively a pyramid scheme. New credit must always be available to roll over the loans of prior borrowers. With the disappearance of credit, the pyramid scheme implodes. Well said.
…
One thing I don’t understand is the cognitive dissonance of some very smart economists. For instance, Paul Krugman. For all his liberal bombast, the guy is a great economist and very worthy of his Nobel. That said, he seems positively surprised by the financial “emergency” implied by Treasury yields.
The most fundamental rule of economics is that there is no free lunch, you can’t have something for nothing, the government can’t absorb infinite liabilities without blowing up its own balance sheet. And yet Krugman, and even Roubini, are arguing we need a massive fiscal stimulus. Hey, it would be great if we could afford it. But we can’t. I mean, if there’s no money to fund anything, and the banking system is literally on the verge of collapse, why are we wasting breath about fiscal stimulus?
We need to be worried about banks imploding, not automakers or more fiscal stimulus. (Both of which Krugman and Roubini are on record supporting.)
Posted in Economy, Interest Rates, banking, bankruptcy, bubble, credit crunch, inflation |
9 Responses to “The Next Bubble is already here”
But why, now that gov’ts worldwide have said they will cover bank deposits, is there still a rush to gov’t securities?
If the big banks go down, their depositors are supposedly covered and, with the ability of the gov’t to come up with unlimited dollars they should be able to cover any amount, inflation be damned.
If they aren’t able to cover a massive bank failure then what good are gov’t securities anyway? In fact, wouldn’t the gov’t throwing up its hands and saying they couldn’t cover a large number of bank failures only cause a flight from gov’t securities?
They will never say that. They may roll the presses but they will remain standing and as long as they do, so will the deposits in the banks. No?
By CB on Nov 21, 2008
I kind of believe the opposite. We’ve done all that can be done and more than should be done about “banks imploding”. We need to look at preserving and increasing real economic production. I don’t believe Detroit should be bailed out, carte blanche, but if the benefit of “money printing” is to be directed anywhere, why is protecting manufacturing jobs less privileged than protecting bankers?
By Aaron Krowne on Nov 21, 2008
You have surprised me with this post. I thought of you as of a smart guy, and now you have spoken … May-be I was wrong about you and you are not so smart after all, just incredibly hard-working (which looks the same, but isn’t).
Are you seriously considering Krugman and Roubini as worthy “Economists” ? “His Nobel”? What? Are you kidding?
Pay attention. Roubini had blubbered with his blubbering accent already, that we need more regulations. If you are smart, you know this to be a biggest lie, so why then are you wasting your time, listening to likes of Roubini, who is either a liar or an idiot?
You can’t do this sort of mistakes if you want to know the truth, i.e. things kept secret and plans of others. Life isn’t kindergarten. Every single word that someone drops, means a lot.
Hope I am wrong about you, I really liked your advance.
By Rav on Nov 21, 2008
Not sure what your definition of “economist” is Rav, but certainly Krugman qualifies based on his scholarship regarding trade. Perhaps you only know him from his NYT column?
I’m not sure of Roubini’s contribution to economics, but his prescience with respect to this crisis makes his a voice worth listening to.
By RolfeWinkler on Nov 21, 2008
MORONS.
By Marc Authier on Nov 24, 2008
Yields can’t get negative, as the coupon is always positive (with limit zero in math terms). Positive/Positive = Positive.
So even if you pay 100,000 for a 1,000 bond with 5% coupon, your yield will be 50/100,000 = 0.05%.
Love your blog,
Chris
By Chris on Nov 24, 2008
Chris
From a math perspective, what you state is true. However, from an investment point of view, you are paying a $99,000 premium for a $50 coupon payment. So your return is negative, is it not? It certainly isn’t good.
By MW on Dec 7, 2008
To clarify my previous post, the nominal yield would be positive but the yield to maturity would be negative.
By MW on Dec 7, 2008
The eventual Treasury bubble bursting will make the current mortgage crisis look like a piece of cake.
Look - 1.) the Fed is increasing the M1 money supply at an unprecedented 38% annualized clip last quarter and the monetary base has doubled over the past year, 2.) the US Treasury this year has to borrow an unprecedented $1.2 trillion to fund the ballooning federal deficit and bailout nonsense, and 3.) banks are afraid to lend at current market interest rates and instead idly holding $774 billion in excess reserves (think about it, if banks do what the normally do - lend out excess reserves, the money supply would increase 51% tomorrow morning). All these numbers are literally off the charts.
OK - We have a flight to quality or US Treasury bonds, bills and notes, and the dollar has appreciated. The yield on 10 year treasuries has been driven down to 2.18%, and 30 year to 2.63% - record lows. The Fed is doing everything in its means to avoid current deflation, and Bernanke is a student of the Great Depression avoiding current deflation where fixed nominal interest payments rise in excess of lower real income.
now with the money stock is like having a car stuck in a ditch and putting on the gas and having nothing happen with the wheels spinning, then putting the petal to the metal or as much gas as possible, and just digging the ditch deeper with the risk of getting traction and jumping out just to crash into a tree.
The Fed has a temporary reprieve with lower velocity but has mortgaged the future recovery by current actions setting the stage for future stagflation. Jezzz - credit default swaps insuring payment upon default for 10 year for US treasuries are at 40 basis points - incredible.
This is not the next Great Depression, in fact the polar opposite with respect to the money supply where the money supply contracted 25% between 1929 and 1933. Eventually banks will lend, pent up demand will increase for consumer durables such as cars, but when we recover from the recession, such will be cut off by the historic increase in government borrowing and money supply as we must pay the piper. Flight to “quality” can only go so far, and treasury yields cannot go below 0%, but it is crazy to think that inflation say over the next 10 years will be less than 2%. While some markets have anticipated the future inflation, - two year crude oil futures up 56% over spot, treasuries have not. Current US Treasury and Fed policy has mortgaged the future. When inflation creeps back in, the US government will have to refinance at higher rates, debt servicing will skyrocket, they will not increase future taxes to pay for current bailout or cut off the recovery, only thing left is to print money. Commodity prices and interest rates shoot up like a rubber band and there will be a lost confidence in the dollar which will collapse. Many central banks such as China holding huge sums of US government debt, and if they get smart will not want to hold so much if they discount future inflation over the long haul. The inflation rate over the last 30 years was 218% via CPI, annual average of 4.2%, crazy to think the future rate will be less than 2.6% via 30 year US treasuries, shorting US nominal treasuries and taking money to buy US TIPs (inflation protected securities) with principle adjusted to inflation may be a good bet.
This US treasuries bubble has red ink witten all over it, only thing is question of timing - does it burst in 3 months, 6 months or 1 year.
By Joe Pomykala on Dec 29, 2008