The Bond Vigilantes Are Back

Who woulda thunk? The bond vigilantes are back. Of course, "bond vigilantes" - negative connotations and all - are just investors with a healthy dislike for being screwed over, even if the Fed promises it will pull out in time. One must wonder if Timmy and the Lords of the Underworld really believe bond investors are about as gullible as girls on prom night. Quote: "The surge in the 10-year note is especially notable because its rate helps to determine mortgage lending rates. The Fed is desperate to keep mortgage rates low to reflate the housing market, and last week it promised to inject hundreds of billions of dollars more in this effort. This week the bond vigilantes are showing what they think of that offer, bidding up yields even higher."

The yield on T-Notes hit 3.7%, while current Wall Street lore says that Timmy and Ben want to keep it near 3% to prop the housing market. Makes perfect sense - who would want a market-clearing price, markets are so passé. We would not want a market to self-correct quickly, much better to keep it deflating for years and avoid those scary pops.

History is also passé. Last time the Fed Funds Rate was kept under 2% for 3 years from Dec 11, 2001 till Nov 10, 2004 (and under 1.5% for 1.5 years from Nov 6, 2002 till Aug 10, 2004) we got... that's right, a huge asset bubble. But, as Sir John Templeton would say, "The four most dangerous words in investing are 'This time it's different." This time, the Fed Funds Rate has been at 0-0.25% since Dec 16, 2008 - the idiots did not even have the cojones to call it 0%, and had to bullshit about targeting a range now, eliciting smirks from professionals who had been watching the bond markets for decades. That's not cheap money - that's free money. Is the expectation that all those who got burned in the CDO implosion are going to think "You know, we were wrong, those things are good, after all, let's pile back into them?" Says Ed Yardeni:"Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever." Bonds normally do well in times of recession with low inflation. For Q1, US GDP tanked at a 5.7% annual rate, and mild deflation was reported, yet bonds are selling off - anyone dare take a guess as to what kind of inflation expectations are baked into this turd cake?

We are being set up for a massive flight from the US dollar and dollar-denominated assets. When that happens (remember the commodity bubble), you get bubbles everywhere, becasue of the sheer size of the outflows. Watch oil, which has just about doubled from the bottom. Watch the commodity currencies - the Canadian and the Australian dollar. I profess lack of trust in and understanding of gold, but watch that too.

Bill Gross Wants In Too

Bil Gross of PIMCO fame (soon to be infamy?) wants in on the gang rape of the American taxpayer, and he even has shaved for the occasion. Quote: "PIMCO would not dispute the need to further capitalize systemically important banks via convertible bonds held by the government, which unfortunately dilute shareholders’ interests. To go further, however, and “haircut” senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk." The much worse news is Bernanke seems to be buying this (badly-)flavored sewage. By now, probably the only entities with exposure to Shittygroup are probably AIG, the Fed, and PIMCO, judging by Gross' Quagmire-ish horny groveling. He deserves not a haircut, not a mustache shave, not a Brazillian bikini wax, but a full-blown beheading, along with anyone dumb enough or cheeky enough to be still exposed. There was plenty of time to pull out, pun very much intended. Yes, I know, a whole lot of pension funds and insurance companies would take a size 16 boot in the crotch (like they have not already!), and the boomers - the richest generation in human history - will be able to spend less on golf and cruises. I am fresh out of sympathy - let them check again when they prove they can behave as adults and vote into office something higher on the evolutionary ladder than toe fungi.

Read also about Gross' "shake hands with Uncle Sam" pickup line, and excuse me while I throw up and take a two-hour shower, which I know will not make me feel any cleaner or less violated.

Understanding Bernanke

At a November 8, 2002 conference to honor Milton Friedman's 90th birthday, Ben Bernanke said: "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." Or... will we?

Mr. Bernanke has an academic and political career to think about, and thus will never emphasize some of the less politically correct points about the Great Depression. He seems to have learned the wrong lessons from the Depression and from Milton Friedman. Here is an excellent essay by Lawrence W. Reed, which gives a great perpective on the business climate FDR created. I have taken the liberty to extract some points.

Herbert Hoover raised top marginal tax rate from 24 to 63%. FDR raised it further to 79%, then later to 90%. According to economic historian Burton Folsom, in 1941, Roosevelt proposed 99.5% marginal tax rate on all incomes over $100,000, and when questioned by an adviser, replied "Why not?". He followed this with an executive order to tax all income over $25,000 at 100%. He also lowered the personal exemption to $600, and hence most US households paid income tax for the first time. Congress rescinded the 100% tax, but went along with the exemption reduction. Furthermore, FDR also tried in 1937 to "pack" the Supreme Court with a proposal to allow the president to appoint an additional justice to the Court for every sitting justice who had reached the age of 70 and did not retire. This failed in Congress, but until it was struck down, added further uncertainty in the investment climate. In his private diary, FDR’s very own Treasury Secretary, Henry Morgenthau, wrote: "We have tried spending money. We are spending more than we have ever spent before and it does not work. . . . We have never made good on our promises. . . . I say after eight years of this Administration we have just as much unemployment as when we started . . . . and an enormous debt to boot!"

Now back to present day, with Mr. Bernanke at the helm of monetary policy. As any macroeconomist, he surely looks at the MV=PQ identity. The perennial clash between monetarists and Keynesians focuses on whether V is stable (monetarists say more-or-less yes, and Keynesians more-or-less no), and whether Q is exogenous (monetairsts say Q is determined by "land, labor, capital, and enterprise", and Keynesians say M can influence Q significanly). Bernanke is observing a credit crunch, i.e. V is tanking. Money is not moving. Even banks with ample liquidity are not lending. His response? Look here. But maybe, just maybe, he ought to re-visit the underlying assumptions for MV=PQ. Among those (not an exhaustive list):
1) Money supply is exogenous.
Well, yes, until is is not. When banks do not lend at any rate (and interests rates cannot get much lower), clearly the bank multiplier is not working right, and the Fed is shooting at a moving target - and one moving way too fast for their lousy shooting skill.
2) The mechanism for injecting money into the economy is not that important in the long run.
Well, no, until it is. The line for federal handouts/bailouts is getting longer by the week - banks, insurance companies, car manufacturers, states/municipalities...

Paulson and Co. let Lehman go under, which sent a chill down the spine of every financial professional in the world. Confidence in one's counterparty's solvency was shattered, and thus V tanked. Everyone and their grandmother is holding on to any cash they have, and will not lend at any rate. Now, I actually think it was right to let Lehman fail, but I also think many others should, and Bernanke is hellbent on not letting them, cost upon the taxpayers and their descendants be damned.

But, let's give Mr. Bernanke the benefit of doubt. Let's say he is desperately working on his part of the MV=PQ, and hoping the government has wisened up, and will not repeat the policy blunders from that 30's. This is probably naive, but at least somewhat defensible. Then logically he should be hoping to be able to mop up this monstrous amount of liquidity pumped into the system when things begin to pick up. When will that be? My pessimistic estimate: just about the time Mr. Obama will be thinking about his re-election prospects. And thus, the Obama administration will probably work feverishly to counter Bernanke's (more likely, his successor's) tightening efforts, which will probably be "too little too late" anyway.

My forecast: inflation will spike around late 2009 to early 2010, and (better, more likely, but still bad scenario) the Fed's efforts to contain it will kill a nascent recovery, or (worse scenario) the Fed will do little, and inflation will rampage at a level the US has not seen yet. I hope I am wrong, but I will be properly positioned short T-bonds and long gold (or any better inflation hedge I may think of).

Scrooge McDuck's Wisdom

Funny cartoon, at about the right level for the average politician, although some may need help with some of the advanced terminology, like definitions of "money" and "inflation".

Via Dale Amon at Samizdata.