Paging Mr. Bond…. Oh Darn, It's BondZilla!


Hoh, hoh…. they say he’s got to go go go BondZilla!

But Ben, you said this wouldn’t happen!  You said you had it all under control.  That rates on the long end would go down, not up….

Never mind that there was never a bit of evidence you were doing anything other than either lying or “wishcasting” – pick one.

Why?  Because the last time Bernanke did “QE”, the so-called “QE1” (now), bond rates actually went up, not down, and now it’s happening again.


I’m not. 

At all.

Why not?  Because there is no exit plan, Bernanke knows it, he’s lying, and the market has figured it out.

Here’s the problem in the main.  Bernanke’s only tool to “tighten” monetary policy means selling bonds into the market and taking in cash from the system.

But what happens if he holds bonds that have all gone down in value?  He gets screwed, that’s what.  In an extreme case The Fed could go “bankrupt.”  Bernanke will avoid this, of course, and he can – but only by not soaking up that liquidity – that is, allowing the cash he printed to remain in the system while the rotting bonds he bought are “absorbed” by The Fed.

The market knows this.  It also knows that the duration of his holdings has gone up a lot and that he cannot pull enough liquidity via short-term roll-off to matter – that is, despite his claim of being “100% confident” he cannot tighten policy – not now and not for many years.

The market thus sees risk – that if the economy improves you get inflation, and lots of it, as Bernanke can’t do anything about it.  If the economy doesn’t improve then the only way for the government to continue spending like crazy, which it clearly is going to do, is to continue to devalue the currency, which means interest rates go up too as commodities will continue to skyrocket (priced in dollars) and this will destroy the tax base upon which government funding rests from the bottom up.

I talk a lot about the tax base, which is best-represented as the labor participation rate.  It sucks, it is not improving, and it cannot improve so long as commodity prices continue to ramp and the currency devaluation continues:

This was the prime error made during The Depression.  Contrary to Bernanke’s claims of being “a student” of The Depression he’s really the Fool-in-Chief of that time.  FDR’s devaluation of the currency trashed the tax base and guaranteed sky-high unemployment for the same reason it’s happening now – devaluation of the currency destroys the finances of the middle class and below as their spending on essential commodities (food, fuel, clothing) is not only more-or-less fixed in volume (which means their cost to those people ramps as price rises) but as a percentage of income this expenditure is much higher than it is for upper-income earners

That in turn suppresses entry-level and lower-wage jobs, which holds down the labor participation rate.  And it is that labor participation rate that drives the ability of government to collect taxes – you can only tax someone who has income, and only people pay taxes – all attempts to tax any other entity, such as corporations, are simply passed through to people.

It is not a coincidence that after stabilizing this chart took a major second leg down when Bernanke initiated QE1 – April of 2009.  It is also not a coincidence that it began to recover when QE1 ended around the beginning of 2010 nor that when Bernanke started to threaten QE2, in the summer of 2010, that it weakened again and continues to weaken.

This is the precise dynamic that played out in the 1930s and Bernanke is causing it, not reacting to it.

Yesterday afternoon Obama made reference to Mitch McConnell and he “not being willing to threaten the sovereign credit of the United States.” 

Mr. President, you, in re-nominating Bernanke and not putting a stop to both the outrageous deficit spending and allowing Bernanke to back himself into this corner without removing him, have destroyed the sovereign credit of the United States.

You may not recognize it yet, and neither has the market in the main, but I assure you that recognition will come, and precisely where the “tipping point” happens to be where you no longer have any meaningful degree of control over the situation is not determinable in advance.

And before you start spouting off about how smart you and Bernanke are, remember that neither Iceland, Greece or Ireland knew where that tipping point was in advance either.

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