“The Biggest Bubble Of All . . . U.S. Government Debt”

GEORGE WASHINGTON BLOG

WEDNESDAY, DECEMBER 17, 2008

“The Biggest Bubble Of All . . . U.S. Government Debt”

PhD economist Marc Faber said in a recent interview that the last bubble to crash will be in long-term U.S. treasury bonds. Indeed, Faber has suggested shorting long-term treasuries at just the right moment. (He also is confident that - sooner or later - the U.S will go bankrupt).

Reuters correspondent and former Sempra economist John Kemp points out some irony regarding the fed's policy regarding long-term treasuries:

The Fed's decision to cut interest rates to between zero and 0.25 percent, coupled with a promise to keep them there for an extended period, and the threat to conduct even more unconventional operations in the longer-dated Treasury market risks the biggest bubble of all, this time in the U.S. government debt.***

The Fed is misleading investors into the biggest bubble of all time. Bernanke is making what learned economists call a "time-inconsistent" promise to hold interest rates at ultra low levels for an extended period.

The problem is that if the unconventional monetary policy works, and the economy picks up, the Fed will come under pressure to "normalize" rates and reduce excess liquidity to prevent a rise in inflation. The resulting rate rises will inflict massive losses on anyone who bought bonds at today 2.25 percent rate.

Bizarrely, Bernanke and Co are in fact inviting investors to bet the policy will fail, the economy will remain mired in slump for a long period, deflation will occur and interest rates will remain on the floor, as Japan's have done since the 1990s . . . . Bernanke and Co are gambling memories will prove short and investors will prove just as eager to pay top prices for long-term government and private debt even though the downside is large [as previous times when they've bought at the top of the market].

[The fed is really saying] Let us have one last bubble, and when it collapses, we promise not to do any more in future...honest.

The must-create-big-bubble-to-fight-the-big-bust-we-created-with-the-last-bubble shenanigans of the Fed are leading us into disaster.