Regular readers will be aware that I believe that American government debt (and by extension, cash) is in a once-in-a-century bubble.

A recent article from Bloomberg typified this ongoing (and quite hilarious) insanity:

The biggest bond gains in almost a decade have pushed returns on Treasuries above stocks over the past 30 years, the first time that’s happened since before the Civil War.
Fixed-income investments advanced 6.25 percent this year, almost triple the 2.18 percent rise in the Standard & Poor’s 500 Index through last week, according to Bank of America Merrill Lynch indexes. Debt markets are on track to return 7.63 percent this year, the most since 2002, the data show. Long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.

The combination of a core U.S. inflation rate that has averaged 1.5 percent this year, the Federal Reserve’s decision to keep its target interest rate for overnight loans between banks near zero through 2013, slower economic growth and the highest savings rate since the global credit crisis have made bonds the best assets to own this year. Not only have bonds knocked stocks from their perch as the dominant long-term investment, their returns proved everyone from Bill Gross to Meredith Whitney and Nassim Nicholas Taleb wrong.

"I CAN'T SEE A WOOD?! ALL I SEE ARE TREES!"

When will the bond bubble end? It will end when the people and governments of the world tire of giving their pound of flesh to creditors. Creditors and debtors have fundamentally hostile interests — debtors want to take money without paying it back, and creditors want to take value without getting their hands dirty. A history of the world (the decline of Rome, the decline of Britain, the decline of America) is in some ways a history of hostility between creditors and debtors.

This hostility has been tempered (and conflict delayed) since the Keynesian revolution, by mass money printing. Everyone (except savers) wins — creditors get their pound of flesh (devalued by money printing), and debtors get the value of their debt cut by persistent inflation.

But there is an unwanted side-effect. Debt mounts & mounts:

And eventually, debt repayment means that “kicking the can” becomes “kicking a giant mountain of debt” — a very painful experience that necessitates either painful austerity, or huge money printing — neither of which encourage savings, or investment.

Europe, on the other hand, has decided to skip the can-kicking (“price stability, ja?“) and jump straight to the cataclysm of crushing austerity for debtor nations. Unsurprisingly, Greeks don’t like being told what they can and cannot spend money on. Surprisingly, the Greek establishment have decided to give the Greek people (debtors) a referendum on that pound of flesh Greece’s creditors (the global banking system) are so hungry for. Default — and systemic collapse — seems inevitable.

(UPDATE: Greece, of course, has undergone a Euro-coup and is now firmly under the control of pro-European technocrats — creditors will get their pound of flesh, and Greece will get austerity)

Some would say Europe has forgotten the lessons of Keynes — print money, kick the can, hope for the best. But really, the Europeans have just hastened the inevitable endgame every debtor nation faces. With a mountain of external debt crushing organic growth the fundamental choice is default, or default-by-debasement. That’s it.

And that is why, however elegantly America massages its problems, American government bonds are in a humungous bubble.