Jun 29, 2009


Most People think they have seen enough asset bubbles to last them a lifetime. Even Mark Haynes The CNBC anchor has this mentality and he has been covering the financial markets for ages. Not that I think CNBC is great to begin with, in fact quite the opposite, nor do I think anything of Haynes. That being said even the so called "professionals" were and will be in for a rude awakening. He had Peter Schiff on as a guest in 2006 and looked at Peter as if he had four eyes for saying "Their was a housing bubble" (which turned out to be oh so true).
What made Haynes reaction interesting was when he went on to say to peter "you expect me to believe there is another bubble, these things come around once in a lifetime". Well who looks stupid now? Way to go Peter, give it to the man.

Thus far we have seen the NasDaq bubble, housing bubble & a bubble in the U.S markets as a whole (although people think we will soon return to ridiculous valuations from 2 years ago). But what if I told you 3 or 4 more bubble just in the next 2-4 years. You would think I'm crazy right? Well people thought Peter was crazy as well, so being crazy in the eyes of the mainstream is of no importance.

The Bond Bubble - For those who haven't been paying attention or are unfamiliar with the treasury market, The Fed has been artificially suppressing the natural rate of interest for nearly a decade a now. Not only does this cause an inter-temporal missallocation of resources, but it has also set the stage for unprecedented inflation and wealth destruction. Back to the first consequence those who invest capital deeper into the structure of production (those which take longer to reach the consumer) i.e electronics or other technological innovations,etc are more interest rate sensitive and rely heavily on an accurate forecast of the economy's time preference. The Fed by selling bonds via treasury auctions artificially suppresses the interest rate, eventually making these capital investments worthless as mid and long term rates can only be contained for so long. Not to mention to constant inability to forecast people's time preference as it is distorted by the FED.
So where does the bubble come in? Well if you have been watching treasury yields this year, you will notice the FED is starting to have difficulty keeping rates down forcing them to sell bonds via open market operations on a weekly basis. These aren't small auctions either, usually totaling 30-60 Billion. But where the real danger comes in, is when you look at the types of treasuries on the auction block, which have been 5,10 & 20 year. Never before has the fed interfered with the long treasury market as they are now. Obviously these auctions aren't 100% subscribed to, so the fed is monetizing the debt without having to publicly say so. Ok onto the main argument: The FED will soon be unable to control mid-long term rates, which will then send yields to the moon. You also have to remember mortgage rates are highly correlated to the 10 year. In other words, not only will this bubble cause inflation and interest rates to go sky high, but it will also cause a enormous increase in defaults for those with ARMS.

2)The bubble(ALTERNATIVE ENERGY) - Many people will disagree with the following, but I would never touch this group. I am referring to many of the alternative energy groups. I think it will play out as follows: These companies will initially be given large government subsidies to invest in their "green energy solution" i.e solar, wind,etc and report great earnings for a couple of quarters. Well of course they will be good because they have no real input costs as the government subsidizes these as well as be given generous tax credits or something of that nature. Like the dot-com bubble, people will catch notice and once again the hooker turned day trader will appear. It is instinctual for humans to try to accumulate as much wealth with doing the least work.
3) The Commercial Real Estate Bubble - This will be identical to the residential housing bubble but will take place later to the nature of commercial real estate. As many people own shopping centers as opposed to a single building, they are better financed, thus allowing them to pro-long the inevitable. This will definitely happen, but the question is really to what degree. Residential Housing still has two or three more legs to drop as ARMS reset, so we have just started the foreclosure process, no matter what the government or newspapers say.

4) The USD bubble will obviously be the most devastating. I have talked on this subject in great detail in other posts, therefore I stop myself from sounding like a broken record. But here is the excerpt from one post
"Oh so true, the current environement are the bright and happy days relative to what lies in front of us. Though I have tried to think of all the various ways the dollar could survive after the inflation hits, I have come only to one conclusion: it can't!!. A friend broughht up a great idea to solve the debt problem we have with our creditor nations, but the is insignificant and goes far beyond that issue. Yes we could apease our creditors by selling them government land (which could easily cover the 13+ trillion, but there there is no way to resolve the exponetial increase in the money supply since last oct let alone that enormous increase dated back to 1998.
The most troubling thing is the dramatic increase in deficit spending and the 50T+ of unfunded liabilities we will have in coming the not to distant future. Deficit spending up to date is about 2.9T for 2009 as opposed to 500 billion a year ago. This number is arrived at by adding CBO baseline, Tarp, Stimulus, healthcare, Amt and war (defense).

Past Hyperinflations (Austria, Hungary, Poland, Germany) all had one thing in common: Deficit % of Expenditures hit 50%. These averaged 58% and the next year after crossing this threshold, Inflation averaged 2179%. Guess where we are today? I would have guessed somewhere between 15-20%. Unfortunately as of 2009 we hit 44%!!. Of course I don't expect inflation to hit 1000% next year, mostly due to the preceding countries included exogenous factors. Instead I think this will be identical to pre-revolutionary france, where prices went up at an accelerarating rate for 5 years until hyperinflation. I'm not a soothsayer, so I'm not saying exacly 5 years but expected it to happen around that time period give or take 2 years or so. But hey, maybe the government will stop running the printing presses 24/7, bailing everyone and their grandmother out, stop deficit spending, let banks fail, Get rid of social security, healthcare, abolish the fed and return to hard money. I know there are those who argue for healthcare like it is their god given right but lets breakdown the real costs:
Helathcare costs more than housing making up 16.5% of GDP while housing makes up 10.5%. This was measured in Q3 2006. 2007 saw healthcare rise to 18.8%.. The estimated projections see it rising to 22% by 2011 and 30% between 2018-2022. Thats enough of the healthcare talk, as it is often a touchy subject. Bailouts... that's something most everyone agrees is bad: It has reached 11 trillion if you exclude tarp funds paid back but is more than negated by the money wells fargo and others are asking for and will get without a question.

What is most troubling to me is not just the capital injections of more than 800 billion of total reserves throughout the banking system via the federal reserve, but the amount of excess reserves in the system. Obviously some will be used to cover loan losses (which could be as much as 90% inflationary for those familiar with how banks operate) and the rest for new loans which is the governments strategy to "stimulate" , whatever that means. This will likely be incredibly destructive because any new loans made will have a very high default rate as the economy continues to deepen and more jobs lost.

To show the magnitude of this situation, one needs to look only at the ratio of excess reserves to industrial production. This ratio has been at or under .2 since 1943 and peaking before that in 1938 at .8. This time around, this ratio is 35x times larger than the historical average , currently 7.22.
This is a depressing enough post as it is but I wish to add one more thing. I compile the monetary aggregate (M3) the fed discountinued in 96 (for obvious reasons). As of the first week of April M3= 14.651 Trillion! which excludes the majority of the planned 300 billion dollars worth of Treausry purchases and also assumes those CDS' (1.3 trillion or so) are worth 100% instead of the realistic value of 1%-10%. Is this alot? well in 1990 M3= about 4.2 trillion, So yes I would say so.

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