Thursday, March 11, 2010

Through the Looking Glass and What Bernanke Found There

Today I am reminded of the book 'Through the Looking-Glass, and What Alice Found There'. Written by Lewis Carroll in 1871, it is the sequel to Alice's Adventures in Wonderland (1865).

Although it makes no reference to the events in the earlier book, the themes and settings of 'Through the Looking-Glass' make it a kind of mirror image of Wonderland including opposites, time running backwards, and so on.

Kinda like the mirror image of rational finances we are currently seeing in the western world.

Reinforcing that imagery is the Monthly Treasury Statement released yesterday. As Tyler Durden of Zero Hedge asks, what's wrong with this picture?

The United States has completed another month in the red. In February, the budget deficit was $220.9 billion, after receipts of just $107.5 billion with vastly surpassed by outlays of $328.4 billion.

That, btw, is a record.

Yet the interest on the public debt was a mere $16.9 billion (page 13 of the MTS report). The reason, as Durden writes, is because in February the interest on public marketable debt (which as of Monday stood at $8.061 trillion) hit an all time low of 2.548%.

In a normal world, the more money you borrow, the greater the associated risk, and the greater the interest payments on this debt. How is it possible that unprecedented debt accumulation can result in ever declining interest rates?

It's a rhetorical question, of course.

We know the answer. The US Federal Reserve, through complete domination of the entire capital market courtesy of ZIRP and Quantitative Easing, have now turned market logic upside down by 180 degrees.

Can we assume that the Fed can forever keep rates on debt at record low levels?

The only way that will happen is if the United States engages in Quantitative Easing to Infinity. If that becomes the only course of action, at some point all that money will have to enter the money supply and - voila! - hyperinflation.

Now we already know that current US Fed chairman Bernanke insists he won't do that. He delivered a blunt warning on U.S. debt and outlined how the stage is set for a Greek-style debt tragedy in the United States if dramatic action isn't taken on the national debt because the Federal Reserve won't monetize the debt with QE to infinity.

Does it look like the politicians heeded Bernanke's warning? Do you see how the United States is racing towards a cliff's edge?

If Bernanke remains true to his word, then you can understand former US Fed chairman Alan Greenspan's concerns when he said that he keeps daily watch on the interest rate on 10-year Treasury notes and 30-year Treasury bonds and calls them the "critical Achilles' heel" of the US economy?

Those spreads are some point are going to spin wildly out of the control at a moment's notice as investors come to full grips with what is looming on the horizon.

The only reason we haven't encountered that scenario is because the QE hasn't ended yet and because no one believes Bernanke won't continue with the policy.

And who can blame them?

Ask youself, what happens if the Fed ends the practice of keeping rates on debt at record low levels?

Currently income from taxes in the United States are plunging. Despite platitudes to the contrary, the economy is not rebounding and incomes are not rising - they're falling. Thus income from taxes are plunging dramatically.

Meanwhile the expenditure side of the ledger has exploded, and not as a function of debt funding: the bulk of outlays have to do with entitlement programs (social security, medicare, etc).

As expenses rise and income falls, it can only mean one thing: more debt.

Recently the debt ceiling was raised to $14.3 trillion which is expected to be hit in less than a year. Observant readers will recall that the previous ceiling of $12.4 trillion was supposed to last the US until the end of March.

Not only was this number passed over a week ago, it is now (less than halfway into the month of March) at $12.5 trillion. Left as it was, the US have broken the debt ceiling far in advance of expectations.

[And remember. This is a debt CEILING... the level goverment won't allow debt to pass!!!]

Obviously this leads us to believe that the $14.3 trillion ceiling will likely have to be raised once again.

Bernanke said the stage is set for a Greek-style debt tragedy in the United States, and he isn't kidding. Consider...
  • Just as recently as September 2007 the interest rate on marketable debt was nearly 5%. It plunged to 2.5% in a year. Even the mere mention of actual tightening will spring rates right back to 5%. What does that mean for actual outlays?
  • If total debt hits $14.3 trillion it will mean the marketable debt will be about $10 trillion, and the incremental 250 bps of interest will mean about $250 billion of additional interest outlays a year, or half a trillion annually.
  • That comes to about $42 billion a month in interest payments alone.

In January 2010, $42 billion dollars represents double the amount of all money collected by the United States in income taxes.

If interest rates are allowed to rise, it will decimate the United States of America.

The bottom line is that either Bernanke will be true to his word and the bond vigilantes will force America into the same brutal debt management as Greece or Bernanke is going to pull the United States permanently to the other side of the Looking Glass and give us quantitative easing to infinity.

Do the math and the conclusions are inescapable.

We are going to have either sky-high interest rates from sovereign debt problems or Bernanke will trigger significant inflation with QE to infinity.

What more do you need to know when discussing the future of real estate in Vancouver and Canada?


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