Pumping Up the Bond Bubble
APRIL 18, 2012
Over the course of the last three decades US Treasuries have witnessed one of the most prolonged debt market rallies in recent history. This substantial appreciation has supported an otherwise withering dollar while simultaneously lowering US government borrowing costs. Yet, this evident bubble in government securities has not come without consequence, increasingly threatening the nation's saver base and retirees who have become unable to retire on traditional low risk interest-bearing securities. The public has now been pressured into riskier assets, contributing to asset inflation, visible in today’s bond and equity prices. Inflation has begun to outstrip yields, threatening investor capital with negative real returns, essentially a confiscation of value. Yet despite what would seem an ideal period for lending, credit availability has diminished, credit conditions are tight, and unemployment remains high. Who are then the prime beneficiaries of this tremendous allocation of capital toward government debt, which seemingly sustains our financial system? The answer lies within operational structure of our monetary system.
To understand the current functional model of our banking system let us take the example of a young boy named Chase and his wealthy father Ben. The boy asks his father “How is it you don’t work and you have so much money?” Ben then answers his son saying, “It’s very simple son, I charge people who want to temporarily use my money. And if you can lend it at a good rate you can do the same with my money”. By the next evening Chase had found a select group of willing friends, including his closest friend Tim. Throughout the next few years Chase becomes fairly wealthy simply by lending his father’s money at virtually no cost and zero risk to himself.
The example above illustrates the lending chain beginning with Chase, representing our feeble banking sector as an undercapitalized participant plagued with non-performing assets and delinquent loans. Chase is brought to profitability by lending with risk-free funding. This lending comes from the FED or Chase’s father Ben who provides lending facilities to banks at today’s near zero discount rate. Chase’s friends represent the select few who enjoy access to this capital. Included among these is the US Treasury or Tim, which through open market operations has become so reliant on this type of funding that it now goes directly to Ben. Through the process known as quantitative easing the FED purchases government debt directly from the Treasury, feeding the government’s capital demands while diminishing the purchasing power of every unit of currency in existence. The government’s capital demands have become so great that Ben sees no alternative to keeping interest rates low but to drop these “helicopter loads” of excessive liquidity.
Every participant seemingly benefits, the FED ultimately keeps the financial system afloat, banks regain profitability, and the Treasury finds a lender. Yet, the general public continues to face high unemployment levels while combating the prolonged inflationary effects of these liquidity measures. The sustainability of these policies is limited and never comes without grave consequences. Remember, “Government should be a referee, not an active player”, once this law of capitalism is violated, the wealth transfer only accelerates.
In Mike’s words “The longer governments and central banks try to cheat the free markets, the greater the pain will be when the correction occurs. Like the precious metals, the free markets always win”. Only by acquiring tangible assets such as gold and silver can we position ourselves on the receiving end of this transfer.
Current policies are certain to bring about more asset bubbles such as today’s bonds, allowing them to pull the wealth transfer in their direction as the FED attempts to master the art of “infinite currency amplification”. History gives this a probability of zero.
Gold and silver remain the only time proven insulation against imprudent monetary policy, effectively storing value in spite of excessive fiscal spending.
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