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The Money Bubble Gets Its Grand Rationalization

Late in the life of every financial bubble, when things have gotten so out of hand that the old ways of judging value or ethics or whatever can no longer be honestly applied, a new idea emerges that, if true, would let the bubble keep inflating forever. During the tech bubble of the late 1990s it was the “infinite Internet.” Soon, we were told, China and India’s billions would enter cyberspace. And after they were happily on-line, the Internet would morph into versions 2.0 and 3.0 and so on, growing and evolving without end. So don’t worry about earnings; this is a land rush and “eyeballs” are the way to measure virtual real estate. Earnings will come later, when the dot-com visionaries cash out and hand the reins to boring professional managers.

During the housing bubble the rationalization for the soaring value of inert lumps of wood and Formica was a model of circular logic: Home prices would keep going up because “home prices always go up.”

Now the current bubble – call it the Money Bubble or the sovereign debt bubble or the fiat currency bubble, they all fit – has finally reached the point where no one operating within a historical or commonsensical framework can accept its validity, and so for it to continue a new lens is needed. And right on schedule, here it comes: Governments with printing presses can create as much currency as they want and use it to hold down interest rates for as long as they want. So financial crises are now voluntary. They only happen if a country decides to stop depressing interest rates – and why would they ever do that? Here’s an article out of the UK that expresses this belief perfectly:

Our debt is no Greek tragedy

“The threat of rising interest rates is a Greek tragedy we must avoid.” This was the title of a 2009 Daily Telegraph piece by George Osborne, pushing massive spending cuts as the only solution to a coming debt crisis. It’s tempting to believe anyone who still makes it is either deliberately disingenuous, or hasn’t been paying attention.

The line of reasoning goes as follows: Britain’s high and rising public debt causes investors to take fright and sell government bonds because the UK might default on those bonds.

Interest rates then spike up because as less people want to hold UK debt, the government has to pay them more for the privilege, so that the cost of borrowing becomes more expensive and things become very, very bad for everyone.

This argument didn’t make sense back in 2009, and certainly doesn’t make sense now. Ultimately this whole Britain-as-Greece argument is disturbing because it makes the austerity project of the last three years look deeply duplicitous.

If you go to any bond desk in the City that trades British sovereign debt, money managers care about one thing – what the Bank of England does or doesn’t do. If Governor Mark Carney says interest rates should fall and looks like he believes it, they fall. End of story.

Why? Because the Bank directly controls the interest rate on short-term government debt, so it can vary it at will in line with any given objective. Interest rates on long-term government debt are governed by what markets expect to happen to short term rates, and so are subject to essentially the same considerations.

It doesn’t matter if investors get scared and dump government bonds because this has no implication for interest rates – it is what the Bank of England wants to happen that counts.

If investors do suddenly decide to flee en masse, the Bank can simply use its various tools to bring interest rates back into line.

The simple point is that since countries like the UK have a free-floating currency, the Bank of England doesn’t have to vary interest rates to keep the exchange rate stable. Therefore it, as an independent central bank, can prevent a debt crisis by controlling the cost of government borrowing directly. Investors understand this, and so don’t flee British government debt in the first place.

Greece and the other troubled Eurozone countries are in a totally different situation. They don’t have their own currency, and have a single central bank, the ECB, which tries to juggle the needs of 17 different member states. This is a central bank dominated by Germany, which apparently isn’t bothered by letting the interest rates of other nations spiral out of control. Investors, knowing this, made it happen during the financial crisis.

On these grounds, the case of Britain and those of the Eurozone countries are not remotely comparable – and basic intuition suggests steep interest rate rises are only possible in the latter.

Britain was never going to enter a sovereign debt crisis. It has everything to do with an independent central bank, and nothing to do with the size of government debt. How well does this explanation stand up given the events of the last few years? Almost perfectly. The US, Japan and the UK are the three major economies with supposed debt troubles not in the Eurozone.

The UK released a plan in 2010 to cut back a lot of spending and raise a little bit of tax money. The US did nothing meaningful about its debt until 2012, and has spent much of the time before and since pretending to be about to default on its bonds. Japan’s debt patterns are, to put it bluntly, screwed – Japan’s debt passed 200 per cent of GDP earlier this year and is rising fast.

But the data shows that none of this matters for interest rates whatsoever. Rates have been low, stable and near-identical in all three countries regardless of whatever their political leaders’ actions.These countries have had vastly different responses to their debt, and markets don’t care at all.

By the same token, the problems of spiking interest rates inside the Eurozone have nothing to do with the prudence or spending of the governments in charge.

Spain and Ireland both had debt of less than 50 per cent of GDP before the crisis and were still punished by markets. France and the holier-than-thou Germany had far higher debt in 2007, and are fine.

The takeaway is that problems with spiking interest rates amongst advanced countries are entirely restricted to the Eurozone, where there is a single central bank, and have no obvious relation to the state of public finances.

So what we have, then, is a disturbingly mendacious line of reasoning . Back in 2010 the Conservative party made a perhaps superficially plausible argument about national debt that was wrong then and is doubly wrong now. They then – sort of – won a mandate to govern based on this, and used it to radically alter the size of the state. The likelihood that somehow this was all done in good faith beggars belief.

Britain has had a far higher proportion of austerity in the form of spending cuts than tax rises relative to any comparator nation. On this basis austerity is a way of reshaping the state in the Conservative image, flying under the false flag of debt crisis-prevention.

If the British public had knowingly and willingly voted for the major changes made under the coalition in how the government taxes, spends and borrows, this wouldn’t be such a great problem.

Instead, they were essentially conned into it by the ridiculous story of Britain as the next Greece.

Some thoughts
What’s great about the above article is that it doesn’t beat around the bush. Without the slightest hint of irony or historical sense, it lays out the bubble rationale, which is that central banks are all-powerful: “If you go to any bond desk in the City that trades British sovereign debt, money managers care about one thing – what the Bank of England does or doesn’t do. If Governor Mark Carney says interest rates should fall and looks like he believes it, they fall. End of story.”

So this is the end of history. Interest rates will stay low and stock prices high and governments will keep on piling up debt with impunity – because they control the financial markets and get to decide which things trade at what price. Breathtaking! Why didn’t humanity discover this financial perpetual motion machine earlier? It would have saved thousands of years of turmoil.

At the risk of looking like a bully, let’s consider another peak-bubble gem:

“The simple point is that since countries like the UK have a free-floating currency, the Bank of England doesn’t have to vary interest rates to keep the exchange rate stable. Therefore it, as an independent central bank, can prevent a debt crisis by controlling the cost of government borrowing directly. Investors understand this, and so don’t flee British government debt in the first place.”

The writer is saying, in effect, that the value of the British pound – and by extension any other fiat currency – can fall without consequence, and that the people who might want to use those currencies in trade or for savings will continue to do so no matter how much the issuer of those pieces of paper owes to others in the market. If holders of pounds decide to switch to dollars or euros or gold, that’s no problem for Britain because it can just buy all the paper thus freed up with new pieces of paper.

This illusion of government omnipotence is no crazier than the infinite Internet or home prices always going up, but it is crazy. Governments couldn’t stop tech stocks from imploding or home prices from crashing, and when the time comes, the Bank of England, the US Fed, and the Bank of Japan won’t be able to stop the markets from dumping their currencies. Nor will they be able to stop the price of energy, food, and most of life’s other necessities from soaring when the global markets lose faith in their promises.

35 thoughts on "The Money Bubble Gets Its Grand Rationalization"

  1. Pingback: The Küle Library
  2. Everyone on this board should be very, very happy that the mainstream believes all this lunacy. With a little patience, we all should be able to buy up their assets fairly soon at an enormous discount. Study the historical precedents, notice the past short-term behaviors of asset prices, and be ready to jump in with cash in hand.

  3. In the past 30 years, after the Friedmanites took control of Washington, it was a case of exponential increase in debt. One man’s debt is another’s asset. With exponential increase in debt, we have exponential increase in wealth. In the earlier years, it was OK when money was put to productive use and generated income. That showed up in the high interest rate that the money is productive money. It was also an era of globalisation and countries were putting money into each other’s countries. The buying of assets went from local demand to international demand. Basic economics says that demand increase, price will increase when supply is limited. So it is a matter of buy, buy, buy and up went the prices of all assets including bonds. Every country is holding some other countries bonds, creating a dam of money. With currency war, this dam of money is getting BIGGER and BIGGER. If I am a sensible Central Banker, I will want to buy insurance on these foreign bonds. This insurance must have no counter party risk. It must be highly liquid and the Chinese and Russians already had the answer, gold. They bought their insurance and they are buying more. We do not know the magic moment when the wind up in asset prices will suddenly snap and wind down commence. Japan will be the first country to trigger the wind down. When the dam breaks, the money will be heading home, US bonds go back to US and Japanese bonds go back to Japan, as asset prices will go down accordingly. Now money is used only to prop up asset prices and that is why we have zero interest rate, unproductive money. Money that does not earn interest is in danger of becoming worthless. Why keep money in the bank when it does not earn interest and have the risk of bail in. People would rather keep cash or invest in high yield stocks. Marginal businesses would have gone bust, should money be earning interest but they are surviving in this zero interest environment. The longer Fed keeps interest rate at zero and with QE, speculators will take advantage of this risk free environment to gear up and make bigger bets. The longer interest rate is kept at zero, the BIGGER the crash. Bonds are risk free only if the printers do not abuse them. Just like CDOs and CDSs were risk free until they were abused by lenders recklessly creating subprime mortgages to NINJAs.

  4. We know the funny money bubble will pop fairly soon. The reason is that governments and their banker buddies have been looking for free lunches for centuries. If it was this simple, they would have figured it out long ago.

    At this point it is just a matter of the right trigger to come along. The Syria situation looked like it had the potential to topple the house of cards, but Obama backed down rather quickly, probably on the orders of whoever it is that he reports to.

    Even with all the bond buying, the yield on 10-year US Treasury Bonds seem too hard to suppress. Up again big today. Some say the intervention is actually more than double the stated $85 billion in bond buying per month. Regardless, whatever the amount, they will have to increase it shortly. I don’t think they want the 10-year yield going north of 3%, and it surged today to 2.8%.

  5. Thank you John Rubino for your ending comments in pointing out the flaw in the arguments of the Keynesian goons and con artists that are keeping the masses, including supposedly “educated” folks on Wall Street down on the “mushroom farm.” I think we could be getting near that point in time when the masses are starting to see the light. Rick Santelli today was talking about how even the Fed may be starting to believe they are losing control of the Treasury markets and thus, in order to retain any credibility at all, they need to “taper.” Whether they can do that at this point, I am doubtful. But it suggests a very painful end game may be much closer than any of us would like, even those of us who have been critical of the Fed.

  6. The interview below posted here on this site with James Galbraith illustrates this point of view perfectly. The Fed can print endlessly, keep interest rates at zero, never default, and deficits don’t matter. As insane as it sounds, I think this is pretty much main stream thinking now. So Mr Rubino, become a hero and explain to us why the Fed can’t do these things. It sure seems that’s exactly what they’ve manged to do the past five years now. Maybe this is what you need for hyperinflation to happen, a complete acknowledgement that it’s all funny money.


    1. I saw this interview when posted before and was baffled and amazed. The comments below it were the most enlightening…people thought this was the most concise and wonderful explanation as to why this could continue forever…it was as if Fission had been solved and free energy was upon us forever.

      Now…your question of why the Fed can’t do these things…..well I pose a question back to you.

      If money can be printed with impunity…..why do we have to pay any taxes at all?

      There should be absolutely NO discussion on tax rates, tax revenues nothing at all. Nor should there be any concern about interest rates.

      It would seem to me if the Fed can print money at the bequest of the Federal Government in unlimited quantities, THEY DON’T NEED OUR TAX DOLLARS to fund whatever they want to do. They could just print what they need and be done with it.

      But alas….when the Fed prints and gives to the Gov…it is a LOAN. And Loans are supposed to be PAID BACK.
      With interest.
      From tax receipts.

      Of course we have recently changes the definition of marriage, so I guess…whats the definition of a loan really mean?

      So this foolishness of “it can go on forever” is only true until the time that someone (Fed Bank) actually wants to get paid back the money it lent the American Drunks. Or the time when the tax receipts no longer cover the monthly payment on the loans.

      Of course my way of thinking is very old school and certainly does not conform with the current “free money forever” thesis put out by these over educated, pompous morons.

      Now on a lighter note…every time I see or hear one of these guys I think of Vizzini in the movie the Princess Bride…as he enters into the battle of wits, he spits out his thoughts into a logical flurry…absolutely sure he is correct in each of his assumptions…until in the end….well, you know what happens.

      1. I think collecting taxes is as much about controlling people as gaining revenue at this point. Yes, it is a nonsensical argument that this can go on forever, but it has gone on for five years now. That’s a long time, especially when it’s been happening world wide in currency after currency. It’s amazing it has not blown up yet. You have to give the powers that be that much credit anyway. I think they are doing this because there are no other options. A reset in the Austrian sense would be too terrible to contemplate and might mean a civilizational collapse. So it’s eat, drink, and be merry for tomorrow we die!

      2. One answer to your question on the need for taxes in an “it can go on forever” world is that taxes must be paid in legal tender, so it is a form of control and forced financial conformity.

        In 2001, crude oil bottomed at $11/bbl. In 2009, in a far more brutal recession, it bottomed at $35/bbl. It is currently at $95/bbl. Hard to say where it will bottom during the next big sell off, but I suspect it will be well north of $35. I believe cheap oil production peaked about 10 years ago. No matter how many dollars they conjure up out of thin air, they aren’t going to find any more giant cheap oil fields. This is one of the constraints they are butting up against.

        1. Yes and the lower the US dollar goes (which is one of the main intents of the Fed’s QE) the higher the price of oil will be, since oil is priced in dollars (because of the “petro oil” agreement). If/when that system breaks down the dollar will fall significantly further causing US oil prices to spike higher.

          1. Ahhh… but when the price of oil goes up, it takes more US dollars to buy the oil, which INCREASES the demand for US dollars. If I have to pay $1million/barrel then I need to acquire $1million US for each barrel. With the increase in demand for oil, this means the demand for US dollars ratchets up as the price of oil increases! Problem solved! Hooray!

          2. Or put in a mathematical formula:
            total demand for US$ = (oil barrel price) X (number of barrels consumed worldwide)
            If either side of equation goes up, the total US$ demand increases.
            With less and less oil on earth and demand skyrocketing both the numbers on the right of the equal sign will keep going up. Only problem is if China, Russia and friends stop using the USD for oil trading. But of course that could never happen, just because…

          3. There is definitely two sides of the issue. However, it is like a security arrangement with the “Mafia”: If you don’t pay for “protection” then things might happen. At some point that arrangement breaks down. Having to buy more dollars may “help” the US dollar system but it still costs the buyers of those dollars more of their own currencies. Basically US dollar devaluation (inflation) is exported and other countries resent that. At some point, when they (e.g., the “BRICS”) think they can handle the repercussions, they will stop trading in dollars in favor of some other means.

          4. US dollars, as in constitutionally legal is not federal reserve dollars, its silver and a bit of copper much like the Spanish pieces of 8 at the time the constitutional was ratified and the term dollar was used before the first coinage act.

  7. Everybody is concerned with money printing but when banks were creating credit nobody cared!
    The velocity of money is falling even with all this money printing, which by the way is a very small part of M2.

  8. No question that this QE/printing/ZIRP cannot continue for ever. Paper money is simply a confetti that people think is pretty — until they don’t. Ahhh, that is the rub, it’s a matter of timing as to when that loss of faith happens. One morning folks will wake up and discover that the central bankster du jour is naked and POOF, we have a reset. Good, intelligent, honest, capable people disagree on when that will happen. Hesler, an economic adviser who published a Pro Timing news letter (now retired) looked at his charts and figured the reset would happen in late 2009. Hussman, on a Sornette Bubble singularity kick, is currently convinced we now have a month, possibly two at the outside before the crash. Grantham’s most recent release has us facing another 25% run-up in the markets over the next year or two and then the crash.

    The crash will happen, it’s only a matter of when. Relax, have another cup of tea, and enjoy the show.


  9. In Silver I Trust, In Banksters I Never Trust !
    Buy Silver Phyzz ! Not bitshit Or Print Money ,
    Gold and Silver are the Real Money Since 5000 year!
    The fed money is trash

    1. why u say that when all them dollars start coming back here then what? in 1973 when fdr took us off the gold standard gold has been at 42.22 it has a statutory price.

      1. what dollars, federal reserve or US?
        If the federal reserve wants to compete it will just have to try and do it without federal government hand holding and legal tender status which it did not have until 1933 anyway, the same year FDR took us off the gold standard and illegally told us we could not own gold.
        The non legal tender federal reserve dollar actually held out pretty good with gold and in 1932 it took the melt value of 5 US Dollars to buy a fsd.
        The melt value of the US Dollar was pretty much worth less than a dollar from the 1880s until 1964.
        Because Congress unconstitutionally declared the coins legal tender, and because not long after the civil war the lobbying of the free silver movement inflationist and the silver mines pushed for a congressional act for the federal government to buy a lot more silver than it needed and pay the inflated price, that pushed the price of silver down.

  10. “…the point where no one operating within a historical or commonsensical framework can accept its validity, and so for it to continue a new lens is needed.”

    I would say “lenses” (plural) because once people’s thinking have gone off the rails there can be many different new myths that one can latch onto to rationalize the status quo.

    Yes, that central banks are all powerful and can control things indefinitely is one such “discovery”, and here are some others that I’ve noticed developing:

    ‘The US is actually in a better situation financially than any other country in the world.’

    ‘Shale oil and a manufacturing renaissance is about to launch the US into a new golden age.’

    ‘Debt doesn’t matter, unfunded liabilities don’t matter, government policies don’t matter, and even monetary policies don’t matter. All that matters is that two-thirds of the world’s population wants a Western middle-class lifestyle.’

    ‘QE will continue indefinitely and we are going to see an explosion in stocks beyond anything ever seen before.’

    ‘All the doom-and-gloomers have been wrong.’

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