The Treasury Bubble in One Graph

What are the classic signs of an asset bubble? People piling into an asset class to such an extent that it becomes unprofitable to do so.

Treasury bonds are so overbought that they are now producing negative real yields (yield minus inflation):

That’s right, after taking into account inflation, many investors in treasuries are standing over a drain and pouring their money down it. 

And so America’s creditors are now getting slapped quite heavily in the mouth by the Fed’s easy money inflationist policies.

I propose (much, I am sure, to the consternation of the monetarist-Keynesian “print money and watch your problems evaporate” establishment) that this is a very, very, very dangerous position. And I propose that those economists who are calling for even greater inflation are playing with dynamite.

See, while the establishment seems to largely believe that the negative return on treasuries will juice up the American economy — in other words that “hoarders” will stop hoarding and start spending — I believe that negative side-effects from these policies may cause severe harm.

There is the danger of a bursting treasury bubble. What would happen if America’s creditors decide they want to liquidate their positions? After all, they’re getting slapped in the mouth , and the Fed is promising to continue with the zero interest rate policy until at least 2014.

And we know for sure that even before real rates on treasuries turned negative that China were selling:

The Fed has been picking up the slack, and will have to continue to do so for the forseeable future (the private domestic and international markets have no reason to increase purchases assets of with a negative real rate of return).

This means that to keep the Treasury’s interest payments low, the Fed will have to start printing more money, which brings us to the second danger: the danger of runaway inflation.

Bernanke might well believe he can do this without triggering runaway inflation. He might point to his track record of tripling the monetary base without triggering hyperinflation.

But inflation has stayed (relatively) low for one reason: the money he printed isn’t circulating. The primary dealer banks are holding the money as excess reserves. Can this last?

I doubt it. As I noted last month:

So, does the accumulation of excess reserves lead to inflation?

Only so much as the frequentation of brothels leads to chlamydia and syphilis.

Excess reserves are only non-inflationary so long as the banks — the people holding the reserves — play along with the Fed-Treasury game of monetising debt and trying to hide the inflation . The banks don’t have to lend these reserves out, just as having sex with hookers doesn’t have to lead to an infection.

But eventually — so long as you do it enough — the condom will break.

This trend of amassing excess reserves (done, lest we forget, as a stability measure to protect primary dealers against another shadow banking collapse) is closer to going to sleep upon a bed of dynamite. 

But inflation is only the most obvious risk.

The greatest danger is illustrated here:

America — for most of last century exporter and creditor to the world now runs the biggest trade deficits the world has ever seen.

Let’s not forget that these creditors that U.S. monetary policy is now slapping in the face produce most of our consumption, much of our military hardware, and most of our oil

Of course, many neocons seem to believe that this position is sustainable; that America can slap her creditors in the face all she likes because she has thermonuclear weapons and can tell the rest of the world to go and bite the big one.

Not so fast.

As VeteransToday noted in December:

“Surprise, Surprise, Surprise”,  to quote Gomer Pyle. The secret spy mission to create photographic proof of Iranian nuclear intentions has gone horribly wrong.

China is the country of origin for many, many of the semiconductors used by the US Military. It was most likely that China provided the hardware with the secret backdoor that allowed the Iranians to seize control of the Stealth drone while the drone was on a secret CIA mission over Iran.

Working together, they captured a state of the art US Military stealth aircraft.

What this means to all US Military personnel serving anywhere in the world? It means that control of any electronics system in any type of platform, can be seized and used against the military that launched it.

I don’t doubt America still has great technological and infrastructural advantages over her Eurasian creditor rivals. But do we really want to test the limits of our power? Do we really want to try and provoke a trade war with China and the other Eurasian nations (who of course are testing the petrodollar reserve to its limits by creating their own reserve currency agreements) by obliterating the value of their dollar-denominated assets?

So now we know, beyond a shadow of doubt that U.S. Treasuries are in a historic bubble.

We know that to some degree the Federal Reserve and Ben Bernanke are guilty of stoking up this program by buying U.S. Treasuries (artificial demand) and thus constricting supply. We know that this is screwing America’s creditors who happen to produce a lot of America’s consumption, components, military hardware, energy and resources. We know that these nations are using increasingly violent rhetoric regarding their relationship with the United States (Putin for instance described America as a parasite), and are activating agreements to ditch the dollar as the reserve currency.

Do we really want to continue in this vein? Do we really want to continue screwing our creditors by forcing them to accept negative real rates on their investments? Do we really want to risk the inflationary impact of continuing to print money to monetise debt (and hiding the money in excess reserves, thereby temporarily hiding the inflation). Do we really want to find out if all those Chinese semiconductors in our military hardware have backdoors that allow America’s enemies to shut down American military hardware?

I’d call that playing dice with the devil.

63 thoughts on “The Treasury Bubble in One Graph

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      • You are aware that FOFOA is not an Austrian, right? (Nor a Keynesian, obviously.)

        Judging by your linked article (though I’ve admittedly only skimmed through it), the two of you seem to see hyperinflation quite similarly. FOFOA’s thesis, as I understand it, is that HI in the US will be caused by the fatal inability of the US, or more specifically the US government, to rein in its huge consumption. (The government budget deficit is now more than double the size of the trade deficit.) So when China and others become gradually less interested in dollars as payment, the US will print more and more dollars, and pay higher and higher prices, in order to keep getting its daily fix of import goods. This is what will eventually cause confidence in the currency to collapse. To me, that sounds about the same as your thesis that HI will be caused by a shortage of goods.

  4. “What are the classic signs of an asset bubble? People piling into an asset class to such an extent that it becomes unprofitable to do so.”

    Hmm… not certain I agree completely with this. People piling into an asset class until its no longer profitable is a sign of -possibly- a top. I see more people doing this in every corner of the market on a daily basis. Price adjusts accordingly. Swings are the way the market works.

    When the general public dismisses all risk associated with the asset, continues to buy, and there is almost nobody left out – for a VERY long time – that’s a bubble.

    In the case of Bonds, treasuries – the general public is *way* more interested in playing the market – GREED – people have very little interest in protecting themselves – thus our multi-year – all time high – challenging equity prices.

    The bond market has been limping along with little or no yield for decades…. showing little interest from investors, in my opinion. When everyone is IN bonds – and not equities – it’s time for a reversal. Heck – even gold has more of an appeal to the public than bonds – more likely of being in a bubble.


    • Erik, “the public” (i.e. retail investors) has nothing to do with this, this market is defined (to a lesser degree) by institutional investors and funds, but mostly by sovereigns. Less than 2% of funds own gold. Follow the money. There’s no money in retail anymore, mainly cause real wages have been stagnant for years, and the public don’t trust the markets very much.

      Now let’s look at your definition of a bubble:

      When the general public dismisses all risk associated with the asset, continues to buy, and there is almost nobody left out – for a VERY long time – that’s a bubble.

      Exactly right, except it’s not the general public but the funds, institutions and sovereigns (and of course the Fed) who keep buying, buying, buying irrespective of the reality of negative returns and the fact that Treasury debt is becoming less and less scarce ($2 trillion deficits, etc).

      Financial media keep pumping out nonsense about “treasuries being the one investment you can’t afford not to make” (they have been for the last four years) and that’s a pretty good cue that this is irrational exuberance.

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  7. I think the 10 year bonds are negative, because people fear deflation. Already oil is below 100 a barrel, commodities such as aluminium (Key for most manufacturing) are well down. China is under capacity, so deflation in consumer goods is a real possibility.

    I have reiterated for months that Governments have got their policies all messed up. When Obama’s response to the GFC, was a few shovel ready projects, instead of a massive infrastructure spend (Ports, High speed, freight rail, investment in RD for new age technologies etc) I knew they had lost control. When a debt fuelled consumer bubble pops, like in the late 20’s early 30’s the only way you can stimulate growth is through State directed private investment in infrastructure. Third Reich Germany is a classic example of a recovery. People don’t want to use the same policies because of the negative association.

    I note with bemusement, the response from Christine Lagarde. She has no idea!

    • Third Reich Germany took the notion of state-engineered recovery to the nth degree, by eventually instating slavery via the camps. I think that the concentration of power in government-engineered recovery is problematic at the very least. Centralisation always means the concentration of power, concentration of control, it always means the suppression of market signals, and quite often the maldistribution of wealth (usually from middle class to elites).

      Personally I think Lagarde has it right: try to gradually reduce deficits. Of all the establishment figures I think Lagarde is the brightest and most truthful. She is subtly rebuking Merkel, etc.

      I do think nations should have started massive infrastructure projects (because a lot of infrastructure is broken and decayed) once the GFC hit, but they did not save during the boom years, instead optimising and pushing crappy stimulationism like the Bush tax cuts, so it was politically difficult, and the notion of counter-cyclical spending is still too advanced for dimwit politicians. Saving during the boom creates flexibility and robustness.

      • You are wrong on this John. My grandmother was in a labour camp. At the start they lured Ukrainians to work in production, because men were at the front, and back then women did not work in factories so they promised great wages etc. The end game of concentration camp slavery turned hostile, when the Eastern Europeans lured to Germany realised they were “Scum” due to German snobbery and rude treatment and wanted to return. That is when the Germans got nasty. They used Zyklon B to kill lice and shaved heads burned clothes, replaced with “issued clothes” because of a lice problem. Ask my Grandmother. Supply lines were cut at the end of the war, hence why you had a malnutrition issue. She actually had to serve horses head to officers in the end. She is still alive to tell the real story.

        Up until the war was declared, Germany was back on track economically. It was a system that was about to destroy the “system”

        • A large part of the government spending also flowed into the arms industry. Seems the easiest way to boost short term prosperity is build and train weapons. The spending however was not free as they needed resources and finances to sustain an unsustainable spending spree. This resulted in increasing diplomatic and military tension and eventual conflict with the rest of Europe. So short term prosperity, ultimate ruin.

          Government spending doesn’t work because the men that generally rise to power are corrupt and self righteous power mongers. So money will never flow into what is desperately needed. Only to what is convenient and profitable.

          “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” Hemingway

        • Excellent blah blah.

          Buddy, I have been studying the SS recently (Kammler, Eichmann, Himmler, etc) and I can only conclude that the SS in particular was very much a modern slaving empire.

        • I would not disagree that corrupt SS certainly took advantage of the influx of Eastern European Labour.

          Did I mention my grandmother worked for 5 years building bombs and was never paid. In the 90’s she was offered $800 compensation and told them to shove their Marks!

      • Last time I checked the Japanese are selling their cars and high tech gadgets to Australians. I don’t see that from the US.

        I know people say the Japan stock market has gone down – sideways, they are deeply in debt etc, but they still convert raw materials into valuable products and earn a living from it by exporting. To me that is what an economy should do.

        If their government did not spend on infrastructure, how would they have the ability to import raw materials, convert, then re-export?

    • I don’t feel comfortable comparing the New Deal to SS enslavement… I will say that grants coming out the top has kept my humble garden products business afloat.

      This isn’t really an argument that can ever be won. I think spending during a depression is a no-brainer and debt is not nearly as bad as the misery that the unemployed are going through. I guess I’ll always be a Krugman kind of guy until proven otherwise. Aziz loves Taleb and I love Graeber. Two mind blowers of different kinds.

      But alas, what do I know. I am but a simple communications director marketing my simple wares.

      • I think spending during a depression is a no-brainer and debt is not nearly as bad as the misery that the unemployed are going through.

        I actually agree with you. I am a deficit hawk but during a depression slashing spending tends to make deficits bigger due to falling and stagnant tax revenues. I am not an austerion:

  8. ETFs in Australian Government bonds are doing very well, especially with the latest Reserve Bank of Australia 50 bp cut.

    I am very happy with my investment in RGB 🙂

  9. The only question I have is: Are guaranteed negative returns of -.5% to -5% so bad when other sovereign debt carries a potential -50% to -100% return? I think there is some belief that as long as the rest of the world is in the fire, our being in the frying pan is still a better bet. Just a thought.

    • I can borrow at 0% and lend at 2% with no risk of default. Guaranteed profit! How can you possibly turn that down. Can Greece, Italy, Spain, or anyone else offer me that?

      • When gold is yielding 10% or 20% a year over inflation, and Treasuries are afflicted by negative real rates, well. Let’s just say that’s problematic.

        • Inflation wouldn’t matter because I would post treasuries to secure my loan at 0% to buy more treasuries at 2% and pocket a nifty 2% with no risk associated. I have no stake in the game because both treasuries and dollars were provided by the government and FED and I would just be the middle men in a twisted convoluted way. And on the long dated paper, well I front run the FED on its asset purchases. Guaranteed win. Free money provided by the FED on the long and short end. Doing’s god work to grease the wheels of government. God’s work ain’t free.

  10. in short—courtesy of mr. cash: “And I heard a voice in the midst of the four beasts—and I looked, and behold a pale horse—and his name that sat on him was Death—and Hell followed with him.” sooner than later, we will pay what we owe…

    also—if you have time for philosophical reflection, the Sunset Limited is badass…

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