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The Nightmare Scenario

It’s safe to say that as this is written at noon EST on Monday the 24th, every economic policymaker in this hemisphere (and a lot of sleepless folks elsewhere) are staring at screens and wondering if this is it. They’ve been playing with fire for such a long time, trying to balance incompatible goals of low interest rates, stable currencies and accelerating growth, that for a while they almost believed that they would get away with it, that the laws of economics could be bent to their will forever.

Now they see that this was hubris, that their sense of control was just an illusion bought with credit on a scale so large that the numbers had become meaningless.

During the night, emerging market stocks tanked again, led, ominously, by China. This morning the carnage has shifted to the US, where stocks are down hard but, more important, interest rates are still rising. 10-year Treasuries, the key to mortgage rates and pretty much everything else, now yield nearly twice what they did a year ago. That means massive losses for a whole world of risk-averse investors who thought they were parking their money in the safest-possible asset. Presumably the rest of their capital is in riskier places like stocks and junk bonds, which means they’re losing big across the board.

10 year treasury june 24 13

This is a global story, since Treasuries have been everyone’s safe haven of choice for decades. But painful as a 40% haircut for the world’s pension funds might be, it pales next to the impact on growth. US interest rates are, with a few notable exceptions like Japan, the base of the global yield curve. Everything else, being riskier, has to have a higher yield. So a doubling of US rates means a commensurate ratcheting up of everyone else’s rates.

Since equities are valued in part in relation to the yield on available bonds, rising interest rates mean lower stock prices – everywhere. And real estate, which is generally leveraged, has just gotten a lot more expensive (which means the other group obsessively staring at screens these days is the new generation of flippers who recently joined the Southern California and Florida bubbles).

This is the nightmare scenario that keeps central bankers and institutional investors up at night because, based on Japan’s experience with hyper-aggressive monetary ease, there might not be a fix. If even easier money is met with dramatically higher bond yields, as in Japan, then there’s nothing left to do but to let the system unravel.

Not that they won’t try one more roll of the dice. It’s just that this time their odds of getting snake eyes have gone way up, and they know it.


42 thoughts on "The Nightmare Scenario"

  1. John, higher interest rates can mean higher stock prices, particularly in industries that have scarce long-term assets (ie: the mining sector), or are heavy leveraged into long-term debt that depreciates in relative value. The Canadian stock market, for these reasons, did remarkably well in the 1970s while the US markets stagnated.

  2. During Greenspan’s years, the method of pumping up the economy at the sign of recession worked because money is required for privatising publicly owned corporations followed by globalisation which expanded affected economies dramatically especially China. The money value started at a low base and money went into real production which generated real income. On the side was the finance industry which expanded even more dramatically, riding on the real economy. Now, the monetary base is so huge and the real production based industries are not growing that rapidly, the finance industry is riding on hot air, pumped up by Fed. All assets have to be supported by real productive industries or more and more money is required to support asset prices. Money is cheapened and the longer it stays cheap, the more courageous risk takers become. More and more assets become over price. Fed can keep printing money and that is why Bernanke thinks that the system will never fail. But he did not take into consideration that the money he prints goes out into the economy and becomes debt. More money more debt. Debt needs productive industries to service it. If the consumers are not able to spend as most money had gone to the top 1%, then the new debts are worth nothing. The only way out is to start growing the wealth of the 99% for the economy to grow vigorously again.

    1. >> All assets have to be supported by real productive industries
      “real productive industries” – the need for this is what ivory tower economists and the wall street crowd just don’t understand, which is why these groups should NOT be making public policy or command decisions for the direction of society.

    1. The FED wrote its own ticket (Fed Reserve Act of 1913) and got the organized crime bosses in Congress to lateral the ball to them; the exclusive U.S. Dollar counterfeiting concession.

      But they didn’t have to force themselves on Congress, who had by 1913 been counterfeiting U.S. money for 51 years, through several very messy depressions.

      It has been win-win for both sides of the organized crime cartel; the politicians have gotten the world’s largest ATM machine, and (in the stupid people’s eyes, anyway) no liability for counterfeiting U.S. money. The FED cartel loves it because they technically are not breaking laws; they were created by, and are defended by, Congress. They have an alibi, but members of Congress don’t.

      So “exposing” the FED will do nothing. What will end the 151-year-old financial crime operation is criminally indicting members of Congress — on STATE criminal charges coinciding with their violating the US Constitution, the public trust, and the credit of the United States.

      See the solution here; uphill all the way, and it will be hugely unpopular unless it is timed *after* the big collapse comes and everyone is screaming for heads to roll. Then, it will be amazingly popular; witless ‘Bobos in Paradise’ (see David Brooks’ eponymous book) will suddenly take interest in enforcing the Constitution’s stipulations for lawful U.S. money.

      That day is coming — and AmericaAgain! is hoping to help a few million American assure that Great Depression II will be the perfect backdrop for recovering all the liberties we have lost since Lincoln’s war, which was the smokescreen for this hijacking in the first place, with Congress’ wholly illegitimate “Legal Tender Act” of 1862.


      1. The 1913 legislation stipulated that the profit of the Fed belonged to the government. The exclusive handling by the FRBNY of the funds and accounting from the auctioning of Treasury secfurities hides $4 billion daily that appears to belong to the government. Hiding money that belongs to the government is embezzlement. These accounts have never been audited or reported to Congresss as required by law. Ref. http://www.scribd.com/doc/101937790/Federal-Reserve-Heist
        http://www.scribd.com/doc/101937790/Federal-Reserve-Heisthttp://www.scribd.com/doc/49040689/RIP-OFF-BY-THE-FEDERAL-RESERVE-Feb-17-2011 http://www.scribd.com/doc/49040689/RIP-OFF-BY-THE-FEDERAL-RESERVE-Feb-17-2011

        All it takes is a congressional committee who understands the Ponzi scheme of the Fed to demand an audit of THESE accounts. No new legislation is required to make a complete audit of the Fed. http://www.scribd.com/doc/101937790/Federal-Reserve-Heist

  3. For years now I’ve been perplexed that mass inflation expectations have been so low despite all of the central banks clearly stating that their intervention efforts were to increase price inflation (i.e., devalue their own currencies). It may be one of the only examples of the financial markets “fighting the Fed” because, perhaps until now, interest rates have stayed so low and even trended downward.

    So none of this should be surprising, and if the central banks do continue their monetizations, and certainly if they increase them, then bond rates are going to rise even faster and higher. It makes no sense to me whatsoever that they would go back down.

    1. Few people seem to invest for the longer term anymore, it’s mostly short-term speculation & gambling now, so unless inflation is going to spike next week nobody seems to care. Use a phrase like “over the next five years” and people’s eyes glaze over. Similarly, folks who know perfectly well that Treasury bonds are a horrific investment could still flock to them one more time yet, if they think that’ll be the right short-term trade during a liquidity crash.

      Short-term thinking is all the more frustrating when you own precious metals. “But those are really down lately,” people say, as if recent price movements somehow negate all of history.

      1. Yes. My father was a stock broker and a lot of his friends were bond brokers. I could almost always tell who was who because of their personalities. The bond traders were more conservative and circumspect in that they tended to invest based upon established facts rather than speculation. In recent years, and perhaps even still, bond traders/investors have taken a wait-and-see approach. It seems they invested traditionally (buying Treasuries as a safe haven, for example) until the facts played out. Well, for 5 years or so interest rates did not rise for whatever reason so they stayed put. Now rates are rising so they’re selling out. I doubt one in a hundred could explain why this happened and they probably don’t care. They just want to preserve their capital and generally bet on the status quo ultimately winning out. After all, the central banks themselves are now heavily invested in the status quo.

        1. Bruce. Don’t you think that this still has a long way to run as yet? Potentially, the Fed could devalue a lot, lot further. For all of the liquidity that has been pumped into the system, this annual 10% inflation rate (that seems to be the number du jour) still appears far from raising the eyebrows of too many Joe Plumbers, as yet. It’s been soaked up, so to speak. Bond yields increasing can well be tamped down, again, and again, and again. International fund managers will pop in and out when it suits. Reap the rewards and continue on. Flying in the face of potential ridicule on here, I believe bonds markets can be handled at a macro level, and levered away from cross border contagion, when it suits. Only when pitch forks are thudding against the very door of the Fed may they actually let it off the leash. It’ll be the proles that will suffer and they’ll have more to worry about than their empty pension funds. Food & Fuel for instance…

          China (and many other Asian countries) dragged their way out of the paddy fields relatively quickly. The US probably has no real rush to hasten it’s plunge into third world status and it appears, to me, that it’s doing a reasonable job of managing the prolonged descent very nicely indeed (42 years and counting).

          1. In a word, no; although “a long way to run” is subjective.

            I don’t think the financial and economic contradictions can be levitated much longer. I think that manifested most clearly in Japan. Evidently it took the kamikaze-like zeal of Abe and the BOJ to finally convince the world that the yen really is going down this time and deflation will finally be defeated once and for all. How or why “he” thought that Japanese bond rates wouldn’t rise in response to that I may never understand. But they did, as they “should” have, and that set off a chain reaction. When our own central bank vows to not let deflation take hold and that inflation is targeted to be 2% then one should expect interest rates to rise in response, and they finally have. When the sovereign debts in Europe continue to increase then one should expect those government bond yields to rise too, and they finally have. When economic data continues to improve then one should expect interest rates to rise in response to that, and they finally have. I’m just surprised that it took so long.

            Right now financial positions all over the world are unwinding and its creating a liquidity shortage because assets are being converted to cash. If investors are as fickle and myopic as we think they are then they very well may jump back into Treasurys as a “safe haven” which would strengthen the US dollar and lower rates again temporarily, but then what? Alternatively, they avoid bonds of all stripes and thus manifest Keyne’s theoretical “liquidity trap” in which cash is hoarded in response to fears of higher interest rates or lower economic demand or war, or expectations of price deflation. Either way, the dichotomy between fiat-based money and gold/silver will become that much more obvious. Ironically, another transformative realization may be when people learn that the “elites” are hoarding gold & silver despite its “bearish” price behavior and propagandized assaults.

  4. Their only fear is that the goys wake from their slumber then rise up and free themselves from Z.O.G.

      1. Hey! I told you once before, I’m in charge of the lazy comments. Remember, you’re in charge of the lazy thinking. Got that?

        1. If you think anyone’s been making money off a fear trade in the past couple of years, you’re clearly the lazy thinker in this crowd.

          1. “Past couple of years?” Are you kidding me? “The Economy is Collapsing! Buy Gold. Buy Silver.” “Hyper-inflation Just Around the Corner. How to Protect Your Wealth By Buying Gold and Silver.” “How to Increase Your Stack and Protect Your Family from the Coming Economic Meltdown.’ “Gold to Hit $5000 an Ounce. Get in While You Can before You Lose Everything.” Etcetera, etcetera, etcetera.” I’ll be the lazy thinker and you can stay in the crowd…of sheep.

          2. Your accusation is that Rubino et al are talking their books as opposed to trying to educate people. I highly doubt it, but even if that were true, it hasn’t worked in quite some time, so what are you complaining about?

            Precious metals owners are a tiny minority; the “herd” are the delusional optimists who think there will never be any repercussions to inflating the money supply and monetizing debt, no matter how fast we print or for how long. Yours is the mainstream view.

            If you’re just here to complain about timing, it sounds like you bought metals for the wrong reasons.

    1. What does a kneeling military industry mercenary have to do with the FED crime? Oh…I get it…yes, you’re right; wars and the FED scam have been linked for a century, true.

      See what whistleblowing constitutionalists in the military industry have been saying for 70 years…war is a RACKET!


      1. Yep. Richard Russell of Dow Theory newsletter has often pointed readers at that artist’s version of the Bob Dylan song when things look particularly dark. The song plus the theme of various world military “involvements” seemed appropriate. I agree that things look particularly dark now and can suggest the two reasons why the US finds itself in this situation, central banksters run amok and military adventurism. We have the some dark times ahead of us, probably not next week or next month, but the simple fact is that every time politicos/banksters get in too far over their collective heads someone starts shooting.

        A hard rain will indeed fall.

        1. Yes, Bill; that tactic has been popular for at least a thousand years in the West. As James Madison put it in the Constitutional Convention…

          “A standing military force, with an overgrown Executive will not long be safe companions to liberty… Among the Romans, it was a standing maxim to excite a war whenever a [domestic] revolt was apprehended…”

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