Bernanke is taking us into uncharted waters.

[girl gone mad]

Low interest rate, permanent bailout policy going amuck..

http://alephblog.com/2009/12/22/uncharted-waters/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+TheAlephBlog+(The+Aleph+Blog)">Uncharted Waters
David Merkel, Aleph Blog

It does not matter how you measure it, the US Treasury yield curve is at its steepest level ever. Away from that, the value for expected five-year inflation, five years from now is at its highest level ever, excluding the noise that we had as our markets crashed in the fourth quarter of 2008.

This concerns me. Anytime we hit new extremes on critical financial variables, it makes me think, “What next?” Treasury yield curve slope and inflation expectations are fundamental. Reaching unprecedented levels is a big thing.

Could the US Government ever face the possibility that it could not meet its obligations? I think so, and a record wide yield curve is one of the things that I would see prior to such troubles.

Last week, I had dinner with my friend Cody Willard. His favorite idea was shorting long bonds. I indicated that I had some leaning that way but could not go all the way on that idea, as the Federal Reserve had the option of inflating during the Great Depression, and did not do so. Cody said something to the effect of “but we have so much less flexibility today.” Can’t argue with that, though I wonder whether politicians and bureaucrats favor foreign claims over domestic claims. Would they bankrupt Americans to pay off foreign claimants? Yes, they might do that. It has happened before.

http://alephblog.com/2009/12/22/uncharted-waters/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+TheAlephBlog+(The+Aleph+Blog)">More...

[FreakinDJ]

1. This CDS trader was saying "Don't Worry" in 2007 as Asian markets crashed

he is exactly the type of trader I do the EXACT OPPOSITE of

http://alephblog.com/2007/02/

Lots of luck following his advice

BTW: I'm over 28% GAIN for the year

[girl gone mad]

2. No one is always right.

This piece is a piece about monetary policy. He is not giving specific investment advice.

[FreakinDJ]

3. Being active in "Short Selling" and CDSs tells me he has a "Vested"

Interest in the economic down turn having "Double Dip". So much so he might as well be advocating for it.

Sorry I just view it as a shallow attempt of advocating doom and gloom to strengthen his "Short" position.

I'm no Wall St. savvy trader, just a working class stiff hoping to retire some day and I even made over 28% on my "Self Directed Portfolio" this year. As George Soros says - "When everyone is timid - be gluttonous, When everyone is in - be worried"

[femrap]

8. George was spouting

'happy days' lately.

He's lying. The 30 year bond vs. the 2 year bond....huge spread. Biggest in years.

And isn't the Fed buying Treasuries? Not just Mortgage bonds. Truly uncharted waters. They've never bought Treasuries before.

[Statistical]

16. Really?

You must not be aware that the Fed has had Treasuries on their balance sheets for nearly 30 years now.

Also of course the 2:30 (even though 2:10 is better metric) spread is extremely high.

The fed has pegged short term interest rates at 0%. They likely won't raise rates anytime soon. I figure maybe 1/4 or 1/2 pt in 2010 and then maybe a point or 2 in 2011. The 2 year is simply reflecting that.

Now as the economy picks up we WILL have inflation. Will we have it in next 2 years? Not likely. Not with trillions in wealth destroyed and 10% unemployment. However will we have it in 5 years? 7 years? 10 years? I think so and so do longer term bond investors.

They are demanding higher yield because retuns AFTER inflation matter.

If you expect 0% inflation over next year or two and at the same time expect high (3%-4%) inflation over longer term (say next 5-7 years after the two year period) then yields are going to reflect that.

[FreakinDJ]

4. BTW: are you in the market at all - 401K / Annuity ??

Maybe I'm old at 52, but I jumped back in "Heavy" when DJIA at 6700

[David Merkel]

5. Thanks for quoting me

I don't know where FreakinDJ got that I have ever traded CDS -- I have never done that once. Further, my call in February 2007 was a short-term call, and proved correct for its period. I am no perma-bull; most people think of me as a bear, though I am an equity investor and economist by trade.

Ad hominem arguments are weak. I only ask that people consider the logic of my position; woe betide any who follow me, or anyone else, blindly.

Again, GGM, thanks for posting my stuff.

PS -- My post today is a little wonky, but helps to explain the yield curve and inflation expectations further, with graphs as well.

http://alephblog.com/2009/12/23/my-tips-treasuries-and-inflation-model/

[Better Today]

7. David, uncharted is scary, I can get that. It bothers me though that

when this country seems to need something akin to a New Deal, folks such as yourself consistently point to the debt and possible inflation which in turn scares the bejeezuz out of folks so they ultimately worry about the national debt without realizing that if we don't get people back to work even if it raises the deficit, we won't be getting the taxes that the nation needs to cover its debts. We are no doubt in a truly scary catch22, but from my historical remembrances, there are times when the fed has pissed the deficit to the wind, and we've been long term the better for it.

Unfortunately your type of scary scenario, will further stall job development and business expansion, guaranteeing that government social service requirements will increase while government tax incomes decrease.

Seems to me the only sensible solution is to tax the rich, but that ain't gonna be happening so posts like this worry me as to their effect on the overall recovery.

All that being said, I don't see anything in your article to disagree with. The stats right now from so many areas are just plain scary, but I hope that fear and presentations like yours don't scare our Congress and President from stepping in and taking even more risk with a kick ass job stimulus bill ASAP.

[A HERETIC I AM]

11. One would hope you realize the majority of readers here don't know the difference between..

a Zero Coupon Bond and a zero sum game.

Welcome to Democratic Underground. Interesting that you joined to comment on this thread.

I've got a couple of questions for you pertaining to the post you linked above;
Do you assume a high likelihood of the US Treasury defaulting on their presently issued long bonds within a 15 year period?
Do you take into account in your predictions the fact that even though the Treasury spread you mention is steep, it still represents a historically low coupon rate?

Does the "FSA" designation mean "Fellow, Society of Actuaries"?

If so, the fact that you hold both the designation of "Chartered Financial Analyst" (CFA) and FSA makes you an incredibly rare breed on DU.

The number of admitted Registered Representatives, not to mention CFA's and FSA's is very low on this board. If your credentials are bona fide, you have my respect and attention.

One thing that does bother me, however. This little line from your "about me & the blog" page;

"All of these goals rely on the help of Jesus Christ and my readers. I thank you for taking the time to read what I write."

Please.

As an atheist and a rationalist, I can only hope that you have a bit more respect for your potential readership than to call on a Bronze Age mythical figure for help while offering financial opinion you hope will be taken seriously.

[westerebus]

14. If the math works?

Who cares were it comes from?

Or who or what helps to get it there?

I did note his disclaimer on following his opinion. Good on him for that. Good on him for posting too. Extra helping of good on GGM too.

Now, excuse me while I google zero coupon bond.

Zero sum game is what happens when I play Scrabble with my nieces.

And if he let's you know we are going to default, and his math works, what ever you do, don't tell anybody. Except me of course.

Does this mean I should buy TIPS and dump my gold? Just kidding!

[TheWatcher]

13. The Ad hominem arguments are all that one you speak of really has.

Very ill, very disturbed person, best ignored or pitied.

Good piece, by the way.

:)

[Kablooie]

6. Do you ever get the feeling that we have lived through the pinnacle of human civilization?

and it will go nowhere but down from here on out.

[roamer65]

9. The Fed's ability to inflate during the major years of the GD was very limited.

From 1929 to 1933 the Federal Reserve was shackled by the gold standard. They could not inflate to any large degree, as the gold backing on Federal Reserve notes had to be maintained.

As my $5 1928A Series FRN states, "Redeemable in gold on demand at the United States Treasury, or in gold or lawful money at any Federal Reserve Bank."

As banks failed, people exercised this redeemability to a much larger degree. One of the big reasons FDR took us off the gold standard was the increasing outward flow of US gold reserves in 1933. People were running away from paper money to gold.

We have much more flexibility now as Bernanke has increased the M1 money supply from around $600B in 2000 to more than $2.1T now. Bernanke can and will inflate much further. Inflation is already running around 8 percent, using the 1980 measurements.

http://www.shadowstats.com

It will go much higher, but they will simply fudge the numbers even further.

[JohnWxy]

10. Jee, I WONDER IF THE DEREGULATION DISASTER 2008 HAD ANYTHING TO DO WITH THIS?

When in a depression and no banks are lending you need to supply liquidity, buying power. In the middle of the Great Depression II - THIS REPUBLICAN DYSTOPIA - inflation is the least of your worries. The big worry is this REPUBLICAN DYSTOPIA GETTING WORSE.


from the article referenced: "All of this is the price for not allowing recessions to be deep — now we have to clear away bad loans bigtime. But who has the courage to do that? Certainly not our government. They avoid all short-term pain, leading to long-term problems."


utter bullshit. It's wise to PREVENT the depression from getting worse because it does cost MORE in the long run, if you let that happen.


The Obama adminstration (and Bernanke) is doing what all rational people recognize as what MUST be done. Banks have frozen credit. The government must try to provide credit while the private banks are not willing to.

[roamer65]

12. I expect Fed quantitative easing to increase greatly as the private banks tighten.

It is how the Federal Reserve gets around private bank monetary tightening. Purchasing Treasury paper on the open market injects liquidity directly into the economy.

[notesdev]

15. Not uncharted

There are at least three historical examples we could be following.

If we're lucky, it's 1990s Japan (plus two decades of stagnation to follow).

If we're unlucky, it's Argentina.

If we're REALLY unlucky, it's Weimar Germany.

[westerebus]

17. I pick door number one.

Japan for one, no, two trillion.

[David Merkel]

18. Again, thanks for reading me

Look, I try not to be controversial just to be controversial. I have no need for fame, and most fame that comes from controversy is bad fame. Some of my views are nonstandard -- I think that the dominant paradigm (neoclassicism) for understanding macroeconomics is wrong, and that the cures it proposes prolongs crises, and makes them more severe. It also leads to cronyism, where favorites can be played by elites. I consistently opposed the bailouts (except for the few times where I said if you had to do it, there were better ways). Best case, you end up with Japan-style malaise. Worst case, severe inflation or depression.

Our government took upon itself the impossible goal of creating permanent prosperity, and instead drove us into a debt bubble, which we are still trying to inflate through the substitution of public debt for private debt. Debt-based systems are inherently inflexible, and tend to break down sharply, as we experienced in the Great Depression, and are experiencing now.

Debts must be reconciled in order for new growth to occur and be solid. That is the opposite of the policy that our government is pursuing. There needs to be a comprehensive compromise of debts that recognizes that we pushed asset values too high through the encouragement of debt-finance. Borrowers and lenders should take their losses, and insolvent lenders should be liquidated.

I encourage all of you to read my blog, if you want to learn more here, and those that are on my blogroll... they are a bright group of non-consensus thinkers.

One final note: one commenter did some digging and noted that I am an evangelical Christian. Well, good. He's the first one after 2+ years of blogging (with 1100 longish posts) to notice that. I would merely encourage anyone to not be a bigot, but read the primary source documents, and give an informed critique of what I believe. 50 years ago, critics of Christians were far more knowledgeable because they had read the Bible and knew it. Today, most critics seem not to have read it, and their critiques sound hollow. As for me, I am no narrow minded man, but have read the Koran, the Tao Te Ching, The Analects, The Book of Mormon, and many other competing theories of what is ultimately true. There is a stereotype of Christians being mindless boobs, when the truth is, they are better educated then the general populace (and that's not saying much).

If you do ever think you want to read the Bible, I have a suggestion for you: do it this way. The Bible is a big book, and too many try to read it cover to cover, and die trying. My method creates more variety, and keeps things moving.

Enough. Again, thanks to all of you for your comments, even those that did not like what I said. Better to talk than keep silent. At least the communication lines are open.

[roamer65]

19. Remember this...Bernanke is taking us in the opposite direction of the late 1920's Fed.

After the very powerful NYFed governor Benjamin Strong died in 1928, the Fed was basically paralyzed by internal fighting. The Fed inaction resulted in a massive constriction of the money supply going into the Crash of '29. What would have been a 1929-1930 recession eventually turned into the Great Depression, due to this continuing monetary constriction.
Bernanke is now experimenting with a massive monetary inflation, basically what he believes should have happened in mid-1930. Let's see where it takes us...

[westerebus]

20. Down the rabbit hole.

Are the banks lending?

Have the toxic wastes been cleaned out of the system?

Does the man or woman on Main Street have a vibrant job market to sell their skills into?

The Market crash of '29 was the opening shot. And was allowed to run its' course. As depressing as
that was.

What they didn't have was the over hanging debt.

" Go ask Alice, I think she knows..."