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Have Central Bankers Lost Control? Could The Bond Bubble Implode Even If There Is No Tapering?

Panic - Photo by Wes WashingtonAre the central banks of the world starting to lose control of the financial markets?  Could we be facing a situation where the bond bubble is going to inevitably implode no matter what the central bankers do?  For the past several years, the central bankers of the planet have been able to get markets to do exactly what they want them to do.  Stock markets have soared to record highs, bond yields have plunged to record lows and investors have literally hung on every word uttered by Federal Reserve Chairman Ben Bernanke and other prominent central bankers.  In the United States, it has been remarkable what Bernanke has been able to accomplish.  The U.S. government has been indulging in an unprecedented debt binge, the Fed has been wildly printing money, and the real rate of inflation has been hovering around 8 to 10 percent, and yet Bernanke has somehow convinced investors to lend gigantic piles of money to the U.S. government for next to nothing.  But this irrational state of affairs is not going to last indefinitely.  At some point, investors are going to wake up and start demanding higher returns.  And we are already starting to see this happen in Japan.  Wild money printing has actually caused bond yields to go up.  What a concept!  And that is what should happen - when central banks recklessly print money it should cause investors to demand a higher return.  But if bond investors all over the globe start acting rationally, that is going to cause the largest bond bubble in the history of the planet to burst, and that will create utter devastation in the financial markets.

Central banks can manipulate the financial system in the short-term, but there is usually a tremendous price to pay for the distortions that are caused in the long-term.

In Bernanke's case, all of this quantitative easing seemed to work well for a while.  The first round gave the financial system a nice boost, and so the Fed decided to do another.  The second round had less effect, but it still boosted stocks and caused bond yields to go down.  The third round was supposed to be the biggest of all, but it had even less of an effect than the second round.  If you doubt this, just check out the charts in this article.

Our financial system has become addicted to this financial "smack".  But like any addict, the amount needed to get the same "buzz" just keeps increasing.  Unfortunately, the more money that the Fed prints, the more distorted our financial system becomes.

The only way that this is going to end is with a tremendous amount of pain.  There is no free lunch, and there are already signs that investors are starting to wake up to this fact.

As investors wake up, they are going to realize that this bond bubble is irrational and entirely unsustainable.  Once the race to the exits begins, it is not going to be pretty.  In fact, the are indications that the race to the exits has already begun...

During the month of June, fixed income allocations fell to a four-year low, according to the American Association of Individual Investors, as major bond fund managers like Pimco experienced record withdrawals for the second quarter. That pullback sent places like emerging markets and high-yield bonds reeling—just as the Federal Reserve signaled plans to taper its easy-money policies within the coming years. Benchmark bond yields ticked up on that news, and in an unexpected twist, the stock market nosedived as well.

A lot of people out there have been floating the theory that the Fed will decide not to taper at all and that quantitative easing will continue at the same pace and therefore the markets will settle back down.

But what if they don't settle back down?

Could the bond bubble implode even if there is no tapering?

That is what some are now suggesting.  For example, Detlev Schlichter is pointing to what has been happening in Japan as an indication that the paradigm has changed...

My conclusion is this: if market weakness is the result of concerns over an end to policy accommodation, then I don’t think markets have that much to fear. However, the largest sell-offs occurred in Japan, and in Japan there is not only no risk of policy tightening, there policy-makers are just at the beginning of the largest, most loudly advertised money-printing operation in history. Japanese government bonds and Japanese stocks are hardly nose-diving because they fear an end to QE. Have those who deal in these assets finally realized that they are sitting on gigantic bubbles and are they trying to exit before everybody else does? Have central bankers there lost control over markets?

After all, money printing must lead to higher inflation at some point. The combination in Japan of a gigantic pile of accumulated debt, high running budget deficits, an old and aging population, near-zero interest rates and the prospect of rising inflation (indeed, that is the official goal of Abenomics!) are a toxic mix for the bond market. It is absurd to assume that you can destroy your currency and dispossess your bond investors and at the same time expect them to reward you with low market yields. Rising yields, however, will derail Abenomics and the whole economy, for that matter.

The financial situation in Japan is actually very similar to the financial situation in the United States.  We both have "a gigantic pile of accumulated debt, high running budget deficits, an old and aging population, near-zero interest rates and the prospect of rising inflation".  In both cases, rational investors should demand higher returns when the central bank fires up the printing presses.

And if interest rates on U.S. Treasury bonds start to rise to rational levels, the U.S. government is going to have to pay more to borrow money, state and local governments are going to have to pay more to borrow money, junk bonds will crash, the market for home mortgages will shrivel up and economic activity in this country will slow down substantially.

Plus, as I am fond of reminding everyone, there is a 441 trillion dollar interest rate derivatives time bomb sitting out there that rapidly rising interest rates could set off.

So needless to say, the Federal Reserve is scared to death of what higher interest rates would mean.

But at this point, they may have lost control of the situation.

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  • Tim

    Personally, I don’t see how the Fed can stop QE. Who else is going to finance our trillion dollar annual deficits? Maybe Portugal? Or perhaps Italy? :-)

    • Tim

      Zero Hedge wrote this morning that tapering is almost assured, what with the June BLS data better than expected and the May data revised upward. What a crazy, bizarro world we live in! Nothing, I mean nothing, makes sense.

      • Sueychop

        For answers look to Jesus.

    • Sueychop

      The point is that money printing can’t go on forever. If it could you could just print up 500 trillion dollars and we’d have no taxes and we could all retire to the Caribbean together – albeit a crowded Caribbean.

  • K

    I believe the addict comment is very accurate. And just like most addicts, it will take a near death experience, before they will even consider change. Does not sound too good does it?

  • Shmeggle Marxist

    who knew lead was such a precious metal? when availability=0, watch out!

    • Sueychop

      Try cold hard steel.

  • Graham

    “Plus, as I am fond of reminding everyone, there is a 441 trillion dollar interest rate derivatives time bomb sitting out there that rapidly rising interest rates could set off”.

    Derivatives in my book is the one to watch. The rest is just cake mix compared to the “icing”. The whole cake is however relative as each part has a knock on effect with another.

    Study the chemicals produced in the brains of the people who have brought all this about. Those chemicals naturally stimulate the pleasure zones. How are you going to stop the the addiction?

    DMT? What if those at the top of the chain already use this substance in synthetic form and sit back watching their global game unfold where accumulated wealth is not their primary goal or objective, but outright control over the masses is?

  • RICHARD

    You can only kick the can down the road for long and so far until it all comes crashing down, and I think we are just about to the end of our rope.There is a lot of people that will be standing there with there mouths wide open going what happened. I am glad I am ready, I hope all of you are?

  • Gene Baugh BBA

    The Fed has been trying its dead level best to produce inflation for over three and a half years now. They have failed.
    Money is flowing into the stock market, leveraged 30 to 1 by hedge funds, gold and lately real estate instead.
    Interest rates are not rising because the Fed wants them to.
    Now the Fed has raised bank reserve requirements.
    Something they normally do to curb an overheating economy. We don’t have that. Maybe they are trying to protect the banking system from the popping of these bubbles.

  • MichaelfromTheEconomicCollapse

    Unfortunately, there have been some people that have chosen to write false things about me and post them on the Internet. Normally I would ignore such things, but they have caused some confusion. So I have decided to set the record straight.

    Who Is Michael Snyder?…

    http://theeconomiccollapseblog.com/michael-snyder

    Please let me know if you have any other questions.

    Michael

    • Jimbo

      I read the wiki entry on you when I first came across your site. Kudos. The fact is, if you were a total crank you wouldn’t warrant any attention at all. I have learned over the years that when some people don’t have an answer to an argument, they change tack and they belittle the other party and try to discredit them. They try to turn attention away from their own shortcomings. If you are a crank with nothing valid to say, then why do they feel threatened?

    • K

      When people lie and slander you, it means you are making a difference. Your blog is getting a lot of coverage as of late. Sorry that means there will be more of this nonsense. Also, I am sure you have noticed how much anger there is in this Country. It is no longer allowed by many to agree to disagree. Someone who disagrees must be attacked, and brought into line. Last but not least. You run an open blog site, which is the American way. Often opinions posted by others are confused, as being your opinions. Why, because you allow them. Silly, I know. But we live in a very strange world as of late.

    • Tim

      It’s probably because of your success and because you’re truthful. I have seen your articles posted on many different sites on the Web. Zero Hedge regularly posts your articles. So does Silver Doctors, etc. If it’s any consolation, others with popular and successful sites have been attacked. Dr. Joseph Mercola has been attacked both by government agencies and by individuals who are obviously jealous of him. That’s the downside of the internet: anyone with a computer and internet service can write whatever they want about whoever they want.

      On a different note, I realize that I have at times gotten carried away with my comments here. When readers come to your sites, they are basically guests in your home and they need to behave accordingly. I will still read your articles, as you have some of the best articles on the Web, but I will not comment as often.

      Keep up the good work.

    • Mark Caldwell

      Your info is everywhere, I’m seeing your articles at the very top of the web news cycle. Your doing great work and more people understand the dire situation this economy and the global economy are facing.

      Not to toot my own horn but I share everything you write and have since you started this site.

      • MichaelfromTheEconomicCollapse

        Thank you so much for that Mark. That means more to me than you could probably imagine. I spend so many countless hours in front of the computer, and it is very encouraging to know that there are people out there that actually appreciate the hard work that I do. :)

        Michael

        • Sueychop

          Keep it going, man.

        • Gary hillerich

          Hi Michael..Your articles are nearly always posted at RBN & Infowars,& Drudge report..Drudge is the #1 Internet news site & therefore the worlds #1 news outlet..i listen to both RBN talk radio shows & AJ show religiously & read their articles with hardly a day goes by where an economic collapse article isn’t posted on one their websites..I would assume Drudge posts your articles as well…. AJ has infowars really humming as his listenership continues to climb[3.5 million per show including repeats] while the old MSM continues to lose listeners[ as they well should] as their blonde bubble headed talking heads show evermore cleavage & continue to spew the same ol tired lies, propaganda,deception,& BS..it seems they still don’t understand the main stream news media IS now the Internet,as the old dinosaur TV news media is quickly losing viewers as ther sheep are finally hungry for some truth! bout time too……

    • el tortuga

      personally, I love your site. sometimes I am astounded with the angles you come up with.
      oh, and your formatting (fonts, etc) are perfect, pleasing to the eye.

  • JailBanksters

    To QE or Not QE, that is the question.
    The main reason people stay alive is due to a fear of death and uncertainty at what lies beyond life.
    It funny because it also applies to Washington and the Federal Reserve.

    • el tortuga

      good one.

  • Saved4Glory
    • Guest

      I used to be affiliated with a Christian who is into the type of stuff at the link you provided. But he did it to try to predict the Rapture. Of course, all of his predictions failed. I had to separate from him because he was out of control. (That was 9 years ago.) We don’t know the date of the Lord’s return. He has told us so in His Word. But we’re to be looking for it.

  • el tortuga

    the hubris of the fed is unmatched anywhere in the world. apparently, they’ve never heard that best laid plans of mice and men often go astray. guess they were too busy reading their Keynesian theory to understand how the world really works.

  • Trailer Park Investor

    More Steam, More Steam, MORE STEAM, man every boiler, feed them well, forget the pressure, more coal, more coal, feed the fires…

  • Naturally Rational Rant

    Does this mean disaster, the next time Bernanke chews gum and blows a bubble? Will it pop and send an economic blast wave across the country?

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