Treasury Bonds - The next big bubble

A very under reported situation that's looming is the creation of the next big bubble - the t-bond bubble. It's very interesting because I recently attended a party and some folks told me don't worry about the economy because the government will figure out what the next bubble will be. Well they have. When in 2001 the dot-com bubble burst Alan Greenspan gave us the housing bubble by injecting cheap credit into our economy. In 2009 they will save us from the housing bubble by printing money like crazy.

According to Warren Buffet "When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he wrote. "But the U.S. Treasury bond bubble . . . may be regarded as almost equally extraordinary."

Buffett's comments came before the Federal Reserve last week said it would buy $300 billion in long-term U.S. Treasury debt over the next six months.

The government also lifted the ceiling on mortgage-backed securities that Fannie Mae and Freddie Mac can guarantee, up from $500 billion to $1.25 trillion. And the Fed doubled to $200 billion what it might purchase of that debt.

"Never in the U.S. have we had this level of money creation in a short period of time," said Olivier Garret, chief executive of Casey Research in Stowe, Vt. "The scale is such that you could see the printing presses turning red hot."

Interest rates fell sharply and stock markets responded positively to the Fed moves. But critics argue the actions will devalue the U.S. dollar, reduce confidence of foreign buyers and stoke inflation.

"The U.S. dollar is . . . not backed up by anything, only by the fact that the world has confidence the U.S. will be honoring its debts," Garret said.

At some point the debt will be so huge that investors will start to loose confidence in our ability to pay back our debt. This increased risk translates into higher interest to lure investors.

A piece of news that went completely unnoticed this week is that England failed to raise capital to fund their stimulus package. "The impact on the markets of the UK's deepening debt was seen the day after King spoke to the committee. Long-term government bonds, or "gilts," were put up for sale and failed to find enough buyers, the first time this has happened in 13 years."

Higher interest rates at the treasury level means higher cost of capital for businesses (Treasuries are considered in economic terms the risk free instrument, the cost of capital for businesses always has a higher premium, so as treasury interests go up so does cost of capital). Higher cost of capital translates into higher inflation or in this case possibly hyper inflation.

In the mean time the Fed continues to expand their balance sheet (the debit portion) and this will prevent them from taking further action long term. I don't know how they will be able to unwind it, since all the treasuries they are buying won't have any demand in the open market already flooded with treasuries that nobody can buy or wants to buy.

So, our government is taking us down a path that scares the crap out of me. I've said it before and I will say it again, inflation is coming and with a vengeance, the question is how soon?