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Farewell Bernanke – Thanks For Inflating The Biggest Bond Bubble The World Has Ever Seen

Barack Obama And Ben BernankeFederal Reserve Chairman Ben Bernanke is on the way out the door, but the consequences of the bond bubble that he has helped to create will stay with us for a very, very long time.  During Bernanke’s tenure, interest rates on U.S. Treasuries have fallen to record lows.  This has enabled the U.S. government to pile up an extraordinary amount of debt.  During his tenure we have also seen mortgage rates fall to record lows.  All of this has helped to spur economic activity in the short-term, but what happens when interest rates start going back to normal?  If the average rate of interest on U.S. government debt rises to just 6 percent, the U.S. government will suddenly be paying out a trillion dollars a year just in interest on the national debt.  And remember, there have been times in the past when the average rate of interest on U.S. government debt has been much higher than that.  In addition, when the U.S. government starts having to pay more to borrow money so will everyone else.  What will that do to home sales and car sales?  And of course we all remember what happened to adjustable rate mortgages when interest rates started to rise just prior to the last recession.  We have gotten ourselves into a position where the U.S. economy simply cannot afford for interest rates to go up.  We have become addicted to the cheap money made available by a grossly distorted financial system, and we have Ben Bernanke to thank for that.  The Federal Reserve is at the very heart of the economic problems that we are facing in America, and this time is certainly no exception.

This week Barack Obama publicly praised Ben Bernanke and stated that Bernanke has “already stayed a lot longer than he wanted” as Chairman of the Federal Reserve.  Bernanke’s term ends on January 31st, but many observers believe that he could leave even sooner than that.  Bernanke appears to be tired of the job and eager to move on.

So who would replace him?  Well, the mainstream media is making it sound like the appointment of Janet Yellen is already a forgone conclusion.  She would be the first woman ever to chair the Federal Reserve, and her philosophy is that a little bit of inflation is good for an economy.  It seems likely that she would continue to take us down the path that Bernanke has taken us.

But is it a fundamentally sound path?  Keeping interest rates pressed to the floor and wildly printing money may be producing some positive results in the short-term, but the crazy bubble that this is creating will burst at some point.  In fact, the director of financial stability for the Bank of England, Andy Haldane, recently admitted that the central bankers have “intentionally blown the biggest government bond bubble in history” and he warned about what might happen once it ends…

“If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally.” he said. There had been “shades of that” in recent weeks as government bond yields have edged higher amid talk that central banks, particularly the US Federal Reserve, will start to reduce its stimulus.

“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history,” Haldane said. “We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”

Posted below is a chart that demonstrates how interest rates on 10-year U.S. Treasury bonds have fallen over the last several decades.  This has helped to fuel the false prosperity that we have been enjoying, but there is no way that the U.S. government should have been able to borrow money so cheaply.  This bubble that we are living in now is setting the stage for a very, very painful adjustment…

Interest Rate On 10 Year U.S. Treasuries

So what will that “adjustment” look like?

The following analysis is from a recent article by Wolf Richter…

Ten-year Treasury notes have been kicked down from their historic pedestal last July when some poor souls, blinded by the Fed’s halo of omnipotence and benevolence, bought them at a minuscule yield of 1.3%. For them, it’s been an ice-cold shower ever since. As Treasuries dropped, yields meandered upward in fits and starts. After a five-week jump from 1.88% in early May, they hit 2.29% on Tuesday last week – they’ve retreated to 2.19% since then. Now investors are wondering out loud what would happen if ten-year Treasury yields were to return to more normal levels of 4% or even 5%, dragging other long-term interest rates with them. They know what would happen: carnage!

And according to Richter, there are already signs that the bond bubble is beginning to burst…

Wholesale dumping of Treasuries by exasperated foreigners has already commenced. Private foreigners dumped $30.8 billion in Treasuries in April, an all-time record. Official holders got rid of $23.7 billion in long-term Treasury debt, the highest since November 2008, and $30.1 billion in short-term debt. Sell, sell, sell!

Bond fund redemptions spoke of fear and loathing: in the week ended June 12, investors yanked $14.5 billion out of Treasury bond funds, the second highest ever, beating the prior second-highest-ever outflow of $12.5 billion of the week before. They were inferior only to the October 2008 massacre as chaos descended upon financial markets. $27 billion in two weeks!

In lockstep, average 30-year fixed-rate mortgage rates jumped from 3.59% in early May to 4.15% last week. The mortgage refinancing bubble, by which banks have creamed off billions in fees, is imploding – the index has plunged 36% since early May.

If interest rates start to climb significantly, that will have a dramatic affect on economic activity in the United States.

And we have seen this pattern before.

As Robert Wenzel noted in a recent article on the Economic Policy Journal, we saw interest rates rise suddenly just prior to the October 1987 stock market crash, and we also saw them rise substantially prior to the financial crisis of 2008…

As Federal Reserve chairman Paul Volcker left the Fed chairmanship in August 1987, the interest rate on the 10 year note climbed from 8.2% to 9.2% between June 1987 and September 1987. This was followed, of course by the October 1987 stock market crash.

As Federal Reserve chairman Alan Greenspan left the Fed chairmanship at the end of January 2006, the interest rate on the 10 year note climbed from 4.35% to 4.65%. It then climbed above 5%.

So keep a close eye on interest rates in the months ahead.  If they start to rise significantly, that will be a red flag.

And it makes perfect sense why Bernanke is looking to hand over the reins of the Fed at this point.  He can probably sense the carnage that is coming and he wants to get out of Dodge while he still can.

Good Economic Numbers? Don’t Be Fooled By The Financial Sugar High

The U.S. financial system is like a junkie that needs continually increasing amounts of “junk” to get the same “buzz”.  So what is the U.S. financial system addicted to?  It is addicted to money and debt.  For many years, whenever the Federal Reserve would lower interest rates or the U.S government would borrow and spend more money, the U.S. economy would respond positively.  But just like with any other kind of artificial stimulation, over time it has taken greater and greater amounts of debt and cheap money to get a response from our economic system.  So yes, the fact that the official unemployment rate went down 0.1%  last month is good news, but considering the massive amount of spending that the U.S. government is doing and considering the gigantic quantity of money that the Federal Reserve is injecting into the financial system, the truth is that the unemployment rate should be falling much faster than that.  So don’t be fooled by the good economic numbers and don’t be fooled by the financial “sugar rush”.  The U.S. government and the Federal Reserve have been pulling out all the stops to stimulate the economy, and the fact that all of their efforts are barely moving the unemployment rate at all is an indication of just how far our economic situation has degenerated.

Many in the mainstream media were extremely excited when the U.S. Bureau of Labor Statistics announced that the U.S. unemployment rate declined to 8.8% in March.  U.S. stocks soared as investors enthusiastically welcomed the news.  But should we all really be jumping up and down over this?

The truth is that some other measures show that the unemployment situation in the United States is becoming worse.

According to Gallup, the number of Americans that are either unemployed or working part-time but desiring full-time work actually rose from 19.8 percent in February to 20.3 percent in March.

So let us not get too excited about the employment situation.  Yes, unemployment is not spinning wildly out of control at the moment and that is good news.

However, when you look at the larger picture things look rather grim.

What the U.S. government and the Federal Reserve have been doing is that they have been mortgaging our future big time for short-term economic gain.

This year alone, the U.S. government is going to run an all-time record budget deficit of approximately 1.6 trillion dollars.  By borrowing 1.6 trillion dollars that we do not have and spending it into the system, it does stimulate the economy.

There are some members of Congress that would like to implement substantial budget cuts, but most members of Congress fear doing too much budget cutting right now because it would “harm the economy”.

And you know what?  They are right – budget cuts would harm our economy in the short-term.

But continuing to pile up all of this debt is setting the stage for an absolute economic nightmare in the mid to long term.

We have lived far, far beyond our means for decades, and most of our politicians are acting like this can go forever.

But tell me, does anyone out there actually believe that we can keep expanding the national debt like this indefinitely?….

Yes, government spending does stimulate the economy.  The Keynesians are right about that.

However, by accumulating a national debt that is spinning wildly out of control, we have completely destroyed the economic future of this nation.

The Federal Reserve has been very busy trying to stimulate the U.S. economy as well.

Over the past couple of years, the Fed has been injecting massive amounts of money into the financial system.  The theory is that the financial system will loan this money out to the American people and that will stimulate the economy and create more jobs.

Well, that may very well be true to a certain extent in the short-term, but as I wrote about yesterday, in the long-term this is going to create a substantial amount of inflation.

The chart posted below cannot be emphasized enough.  It shows how the Fed has dramatically increased the size of the adjusted monetary base since mid-2008….

Yes, all of this new money will stimulate economic activity, but it is completely and totally ludicrous for Ben Bernanke to attempt to deny that this is also going to cause significant inflation.

So when taking a look at the economic numbers, it is absolutely critical to keep in mind that our “authorities” have pushed all the chips to the middle of the table in an all-out attempt to stimulate the economy in the short-term.

The small economic “sugar rush” that we are experiencing right now is all we have gotten out of it so far.

Sadly, this is about the best that the U.S. economy is going to do from now on.  Things really are not going to get much better than this.

Yes, unemployment numbers might come down a little more, but pretty soon inflation is going to really kick in and that is going to have a really negative impact on tens of millions of Americans.

First of all, when inflation really starts taking off it is going to be absolutely devastating for those on fixed incomes.  Many of them will be completely wiped out.

Secondly, those that do have jobs are going to find that their incomes are not nearly keeping up with inflation.

In fact, we are seeing this starting to happen already.

According to the Bureau of Labor Statistics, U.S. workers in the private sector only saw their pay increase by 2.1% during 2010.

So did what we are paying for food and gas only go up 2.1% in 2010?

Of course not.

So are things getting better so far in 2011?

No.

One of the depressing things about the new numbers released by U.S. Bureau of Labor Statistics was that wages for U.S. workers did not increase in March.

According to the BLS, the average U.S. worker earned $22.87 an hour during the month of March, which is exactly the same number we saw in February.

So inflation is going up and wages are staying flat.

That means that American family budgets are going to be squeezed even more.

In addition, the numbers from the BLS show that it is still incredibly difficult to get a job.  In fact, the average length of unemployment in the U.S. is now an all-time record 39 weeks.

So is anyone doing well right now?

Well, yes – as I have written about previously, those at the very top of the food chain are doing quite well these days.

According to USA Today, median CEO pay soared 27 percent during 2010.  For the year, median CEO pay was a stunning $9.0 million.

Wouldn’t you like to be making 9 million dollars a year?

According a recent report by CNN, the 25 highest-paid hedge fund managers in the United States combined to bring in an astounding $22.07 billion in income during 2010.

Wouldn’t you like to get just a small piece of that?

All of the measures that the government and the Federal Reserve are using to stimulate the economy are causing tremendous distortions in our financial system.

Wall Street is absolutely swimming in cash right now.  There are some people that are making obscene amounts of money.

But ultimately the party is going to end for all of us.

It has been incredibly foolish for the government and the Fed to go “all in” in a desperate attempt to boost short-term economic numbers.

Our long-term economic future is completely gone.  Our financial system is heading for a horrible collapse.  It is not a matter of “if” it will happen, but rather “when” it will happen.

You better buckle up and get ready.