At the recent Casey Research conference in Tucson, AZ, Chris sat down with Casey chief economist Bud Conrad to discuss his concerns about the latest and potentially most destructive bubble in danger of popping.
At the conference, Bud stepped up to the podium, reached into his pocket, and pulled out a balloon, which he proceeded to inflate. As it grew, it become clear the word "BONDS" was written across it. For dramatic effect, Bud continued inflating the balloon until it popped. He then looked at the audience and said, "I hope I'm making a point."
Like many critically-thinking analysts today, Bud is watching the growing U.S. debt bubble with alarm. And now that the Fed is monetizing an ever-greater percentage of American debt issuance, he sees no way out for our current policies other than stalling for time until the inevitable happens:
Interest rates are at the lowest they have ever been; that includes the Great Depression.
Our Federal Reserve is buying up all the government debt, as well as buying up the mortgage-backed security debt, such that the buyers and sellers in the bond market have driven all interest rates down. Complicit with that is the advantage that banks get with very low borrowing rates and moderately low, but still higher, other rates. The spread for banks is huge. It is sometimes called “financial repression.” And it has destroyed the income of older folks' fixed income, and given that largesse back to the banks.So, the Federal Reserve’s policy has greatly benefited the large banks and they have done it by stealing from old folks.I also want to get to a little bit about the other beneficiary of low interest rates. That is the government. Who has the biggest debt? They almost cannot survive if rates were to get back to even natural levels. Government debt, $17 trillion; increasing $800 million a year in four years gets you to $20 trillion. Nice round number. Let’s pick 5% as a long-time historical basis for what interest rates probably should be. And I think even you could do the math on that: a trillion dollars a year of interest payment.About $2.5 trillion in round numbers. So it is almost – or getting there – to half the taxable income of the Federal Government.The point is under normal circumstances, without this huge support from the Federal Reserve, our government is very close to bankrupt. And I would say it is easy to put a trajectory. Just add a few more years onto that of compounding that trillion dollars of interest (which then has to be borrowed), to the basis, to you saying you have a completely broke government, and you discount that back to now. These rates should already be well above 5%.We are an empire that I think is weakening, not crashing. But would you want to be confident in the credit-worthiness of the U.S. Government this year as much as you would have 20 years ago? Obviously not. And that is my point about why rates are really under-pricing the risk going forward.
What happens to the 30-year Treasury? It has got to be bought by the Fed. And that means there is no exit policy. Yeah, they could taper to $10 billion a month somewhere, but I suspect the Fed is going to continue marching over the cliff of destroying our currency. And when people wake up to that, that is why interest rates must rise, and why, I suggest, that people should invest in – to protect themselves, maybe gain and prosper from – the fact that interest rates will rise.
When people find that they are losing money [as bond prices fall as rates rise], they say, I don't want these bonds: Sell them. Then the question is, To whom? The Fed is the only answer. So they cannot taper. But where does that lead us to? Worldwide destruction of currencies, often called currency wars. So that is the backside of the bursting of the bubble.
And I will go one step further. We are in the bursting now because interest rates – instead of falling during the last year’s biggest rate of QE – a trillion dollars a year, $85 billion a month (Treasurys and MBS) – that rate rose. It did not fall this year, 2013. As the Federal Reserve increased its purchases and increased its balance sheet, rates tended to go exactly the opposite direction because they are driving them down. They are driving the price of bonds up as they buy them.
This year it went the other way. Now, is that just a fluke or is this it?
My claim is: This is it. We have already passed the bottom of rates.
Click the play button below to listen to Chris' interview with Bud Conrad (34m:50s):
by calm47