Quotes from the Book The Everything Bubble

Executive Summary

• The excellent book The Everything Bubble, was so interesting, it was necessary to record some quotes.

Introduction

The US Government statistics are accepted by nearly all for valuing economic indicators and the price of things, a well as the change in the price level over time. However, there are open questions about the true inflation level versus the US government reported level of inflation.

Our References for This Article

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The Largest Wealth Confiscation in US History

In 1933, Franklin Delano Roosevelt began the process of removing the link between the US dollar and gold. First, he closed the banks for four days. During this time, NO ONE could get his or her money out. Then he forbade banks from exporting gold abroad (international banks that stored money in the United States were also asking for their money back in the form of gold). Roosevelt wanted to keep as much gold as possible under the United States’ control. Finally, Roosevelt demanded that all United States citizens turn in their gold to the federal government. Yes, the President of the United States demanded that Americans hand over their personal property to the United States government.

Don’t believe me?

Look up Executive Order 6102, which Roosevelt later issued making gold ownership illegal. Surprisingly or not, academic historians like to defend this action by saying

“he was trying to stop a massive crisis, so the move was justified.”

I’m not so sure about that one. Let’s imagine the financial reality Americans faced during this period. Over 1,000 banks were failing per year going into 1933….and the President was demanding that Americans give the United States government their gold…thereby forcing them to own US dollars…dollars that would almost certainly have to be kept in the banks…that were again, failing at a pace of 3+ per week. FDR passed Executive Order 6102, making it illegal for Americans to privately own gold. Yes, this was an Executive Order…Congress wasn’t involved in it.

This is effect FORCED Americans to store their hard-earned money in US dollars. Not yet finished, the US government then passed The Gold Reserver Act which permitted the government to pay its debts in US dollars, not gold: a move that allowed the government to pay its debt while keeping its gold. Still not finished, Roosevelt then raised the official price of gold from $20.67 to $35.00 per ounce. When Roosevelt raised the price of gold, he was effectively devaluing the US dollar.

There is no relevance to gold backing a fiat currency. A fiat currency obtains its value from being the legal tender of the country and being backed by the full faith and credit of that country.

Nixon’ Biggest Scandal Had Nothing to Do With Watergate

Richard Nixon is the only President to have resigned from office. That alone has resulted in him being the single most vilified President in American History. However, the damage caused by the Watergate scandal pales in comparison to the damage Nixon caused by completely severing the link between the US dollar and gold in 1971. A secondary effect…was that the gold link placed a limit on the amount of debt the US could issue since all US debt would need to be paid back in US dollars…US dollars that could then be exchanged for gold by Central Banks.

Nixon took this limit away. Worst of all, he did this entirely for political reasons: the Nixon tapes reveal that he was personally aware that breaking the US dollar’s link to gold would have disasterous long term effectgs for the US economy. However, in 1971, Nixon wasn’t thinking “long term;” he was thinking about one thing: winning the 1972 Presidential election. And, his reelection bid was facing two major problems:

1. The unemployment rate was rising, having risen to 5.9% from 3.5% when Nixon took office.
2. Despite the rise in unemployment, the Fed was convinced the US economy had exited the recession of the late 1960’s. So the Fed was raising rates. To remedy this, the Nixon administration began putting pressure on then Fed Chair Arthur Burns to ease monetary policy in order to juice the economy and bring down the unemployment rate. Economist Milton Friedman had explicitly told Nixon to his face behind closed dooers that aggressive monetary policy would unleash inflation.

Without gold backing it, the US dollar was now backed by the full faith and credit of the United States government. In simple terms, the US dollar was supported by the belief that the United States would never default on its debts. It had taken 58 years, but the United States financial system had shifted from gold to the US dollar and now to debt as the ultimate storehouse of value for its financial system. Put another way, the backstop for the US financial system had shifted from a hard asset that had stored wealth for 5,000 years (gold), to paper money which had alwasys failed), and finally to a loan made to the same government that had forced Americans to give up their gold in the first place.

This is an oversimplification of why Nixon suspended the convertibility of the dollar into gold for foreign countries. Nixon actually did not have much choice. The US did not have enough gold to meet the requests for gold convertibility. There were other options, but again, this is not relevant. Gold should not be backing fiat currencies. Secondly, there are not examples of gold being effective money. Gold is a commodity and bad money. This is a type of false history.

As for the comment about debt — it is unnecessary for debt to be connected to any money, if the government takes over the money creation function from the private central bank.

Why the US Dollar Evaluated in the 1930s

There is one exception to this trend, that occurred between 1918 and 1933 when the US dollar strengthened in purchasing power. However, this had little to do with the Fed. In the aftermath of WWI, many countries in Europe abandoned any link between their currencies and gold. As soon as they did this, they began printing vast amounts of their currencies. The currency debasement resulted in the British Pound, French Franc, and German Reichsmark losing considerable value against the US dollar. This combined with capital fleeing Europe for the United States, pushed the US dollar higher for a time.

This part about inflation is true, but the reasons provided are not. The quote presumes that currencies should be linked to gold and that delinking them from gold leads to inflation. Furthermore, the quote said many countries began printing vast amounts of their currencies, this is inaccurate. The private central banks produced inflation, not the governments. All of the European governments at this time had private central banks. In the case of Germany, it was the Reichsbank that was producing Reichmarks for speculators.

The Fed Strategy of Creating Repeated Asset Bubbles

..the Fed was concerned wtih only one thing: stopping debt deflation from ever spreading into the US Treasury market.

For this reason, starting in the late 90’s, whenever a major asset class began to suffer a bout of deflation, the Fed quickly dealt with it by creating a financial bubble in an alternate asset class.

Why The Fed Must Deny the Existence of Bubbles

For this reason, Fed leadership cannot accept either of my two definitions of a bubble because doing so would either reveal that the Fed is actually clueless about some of the most important economic developments or is directly responsible for creating asset bubbles. Put simply, if your job is to maintain confidence in the financial systems, the last thing you’re going to do is proclaim your ignorance or culpability in financial disasters.

Greenspan’s True Legacy: Bubbles on Top of More Bubbles

Between 1929 and 1987, the US was effectively asset bubble-free. Stocks, bonds, commodities, real estate, virtually any asset class you can name, had a roughly 60 year period during which their prices never reached levels that were obscenely disconnected from underlying economic realities. Along came Greenspan, and within a span of 16 years, the US had three 1 in 100 year asset bubbles.

What Did Greenspan Do During The 90s Stock Bubble?

Even more astounding is the fact that Greenspan was cutting rates during a period in which he acknowledged that the stock market was exhibiting “irrational exuberance.” He literally knew things were beginning to get out of control.

How the Housing Bubble Was Created

In the early to mid-90s, US Congress launched a concentrated effort to make housing more affordable to more Americans. To that end, in 1992, Congress passed the Housing and Community Development Act. What this bill did, was require certain massive players in the secondary mortgage market to spend at least 30% of their budget buying low quality mortgage loans. In simple terms, what this law did was require Fannie and Freddie to spend 30% of their budget buying mortgages that were made to those who were at or below the median income in their respective communities. This was effectively a giant incentive for local banks to start lending money to people in lower-income brackets.

Banks cannot make housing prices any cheaper. So if banks were to generate more mortgages to low-income individuals, there was only one way to do it: by lowering lending requirements. Historically, banks would avoid granting mortgages to people who had a high probability of not paying the bank back. However, now that Fannie and Freddie were willing to buy these mortgages from banks on the secondary market, banks could lend money to anyone regardless of the risk and then flip the mortgage over to Fannie and Freddie at 100 cents on the dollar. In the 30 years leading up to the House and Community Development Act of 1992, roughly 64% of Americans owned their homes.

Growth of Derivatives

By the time the mid-90s rolled around, the Over the Counter derivatives market had surpassed both the regulated derivatives market…and the United States GDP!

Brooksley Born and OTC

In 1998, soon to be chairperson of the Commodities Futures Trading Commission, Brooksley Born, approached Alan Greenspan, Bob Rubin, and Larry Summers (the three heads of the economic policy for the United States at the time) about the OTC derivatives market.

Born said she thought OTC derivatives should be reined in and regulated because the market was getting too big to contain if a crisis hit. The response from Greenspan and the others was that if she pushed for regulation of OTC derivatives would “implode.”

So Greenspan knew the OTC derivatives issue was a systemic issue as far back as 1998.

This again helps explain why Greenspan chose to address the Tech Crash by creating a housing bubble. By turning a blind eye to Wall Street’s OTC derivatives bonanza and refusing to let bad debts clear through the system via the Tech Crash, Greenspan was setting the stage for an ever bigger crash.

By the time the housing bubble burst in 2008, the US mortgage market was $14 trillion in size. But, thanks to OTC derivatives, the actual risk relates to the US housing market was well worth $175 trillion in size. That was more than TEN TIMES the size of the US GDP at the time.

Bernake Kept It Going

Like his predecessor, Alan Greenspan back in 2001, in 2008 Ben Bernake had a choice. That choice was “do I go down in history as the guy who let the system implode, kicking off another Great Depression…or do I reflate the system with another bubble and pass this mess off to the next person?” Bernake, like Greenspan, chose the second option.

However, by this point, the US Debt Mountain was so massive he would have to engage in even more extreme monetary policy. So Bernake took the very problems that nearly blew up Wall Street (garbage debt, toxic derivatives, and excessive risk taking) and allowed them to spread onto the US Government’s public balance sheet. Put simply, Bernake created a bubble in US sovereign bonds (or Treasuries).

This marked the end of the game for the Fed’s monetary policy in our current financial system. As I’ve explained throughout the first half of the book, US Treasuries are the standard for measuring all risk in the global financial system. In particular, the yield on the 10 year US Treasury is considered the “risk free” rate of return: the rate against which all other risk assets are compared and priced. Stocks, commodities, oil, mortgage rates, home prices, literally everything, is valued based upon its risk level related to this yield. So, if this yield is pushed to abnormally low levels (creating a bubble in bonds forces bond prices up and yields down) the all risk assets in the financial system would adjust accordingly.

Falsely Priced Derivatives

I mentioned before that large banks prefer trading/peddling OTC derivatives as opposed to regular, regulated derivatives. There’s a reason for this: because OTC derivatives are unregulated, they are much more difficult to price. For one thing, the fact that no such securities even existed before means a lack of historical transaction data. And, because these securities are not forced to pass through an exchange where they would be valued by the market, the banks get to value these derivatives using a different type of accounting standard called “mark to model” accounting.

Mark to model accounting means an asset is being valued based on a “model,” in this case, the bank’s own internal “model” of risk and value. After all, asking a bank to accurately value an illiquid asset that is selling (and that no one else can accurately price) is like asking a raging alcoholic to determine his blood alcohol level using his own judgement instead of a Breathalyzer.

Bernake Buys OTC Derivatives

To stop the derivatives market from imploding and taking down the financial system, Bernake had to reinstall investor confidence in the OTC derivatives market and its methods for valuing these securities. The problem was that in the depths of the 2008 crisis, NO ONE wanted to own this garbage, let alone buy it as an investment. So Bernake had the Fed print money and then use this money to buy these assets via a process called Quantitative Easing, or QE. And he didn’t just buy a few other OTC derivatives…he bought $1.35 TRILLION worth of them.

..the notional value of the OTC derivatives market was still well above $700 trillion. So the Fed couldn’t possibly buy all of it. With that in mind, starting in late 2008, the Bernake Fed and other financial regulators lobbied hard for the FASB to suspend mark to market accounting standards for the big banks regarding their mortgage backed securities and other OTC derivatives.

This policy change, the result of pressure from the Bernake Fed, gave the banks the ability to value their assets at whatever level they wanted. Indeed, according to the new rules, banks could even tell their clients “the market value for this asset is wrong, the TRUE value is what we say it is.”

The first policy provided a near endless supply of liquidity to financial institution is. The second gave them the easiest trade in the world: front running the Fed’s bond purchases by buying US Treasuries only to turn around and sell those bonds to the Fed at higher prices.

Remember the yield on the 10 Year Treasury is the “risk free” rate of return, or the rate against which all risk in the US financial system is measured.

Put simply, by pushing interest rates to extraordinary lows via ZIRP and monetary programs like QE, the Fed ws indirectly forcing investors to buy stocks to seek significant returns. In a sense, QE 1 was a kind of backdoor bailout for these firms. The Fed bought their garbage mortgage backed securities from them at 100 cents on the dollar giving them a fresh round of capital.

No More Senior Asset Classes to Bubble

This has brought the Fed to the End Game for Central Bank monetary policy. There is simply no other, more senior asset class the Fed can use to create another bubble when this one bursts. Similarly, the Bond Bubble is too large for the Fed to truly contain when it pops. the US Tech Bubble was $7 trillion in size. The US Housing Bubble was $14 trillion in size. The US Bond Bubble is over $20 trillion in size.

When you include junior debt instruments, it swells to over $60 trillion associated with bond yields, it’s over $124 trillion. Put simply, the Bond Bubble is the largest asset bubble in history, in the senior-most asset class in the financial system. As a result of this, the Fed will be fighting tooth and nail to maintain the bond bubble at all costs. Over the coming months and years, we will experience monetary policies that make even those from the period of 2009 to 2015 look relatively pedestrian.

When Will the Bubble Pop?

Before proceeding, I want to warn you that the bursting of the Bond Bubble will not come quickly, I am not predicting that this process will take a few months. It will take years and possibly even a decade.

Debt Deflation in Europe

From 2010 to 2014, various European member states, specifically the troubled nations of Portugal, Ireland, Italy, Greece, and Spain (the PIIGS) experienced intense episodes of debt deflation.

As a general rule of thumb, when the yield on a given country’s 10-Year Government Bond hit 7%, the country is deemed insolvent. The yields on Italy and Spain’s 10 year Government Bond hit these thresholds in 2011. Now, debt deflation for the sovereign bonds of any nation tends to be catastrophic.

But for members of the EU it was a financial death sentence: only the ECB can print Euros, so when an individual European member state gets into a fiscal mess, it cannot print its way out via currency depreciation.

This is a problematic comparison. These countries gave up their ability to create money for the ECB, and now have no control over their monetary policy, and the EU has tied their arms behind their back.

The Japan Asset Depreciation

As a result of this, Japan now has a sovereign Debt to GDP ratio of well over 230%, and there’s no sign of it stopping any time soon. Indeed, as of 2016, the Bank of Japan was buying up some 50% of Japan’s new debt issuance. As of 2016, the Bank of Japan bought so many stocks that it was the single largest shareholder for one-quarter Japan’s 225 largest publicly traded companies.

Indeed some of the smartest hedge fund managers in the world have gone bust trying to bet on Japan’s collapse. Shorting Japanese Gov Bonds has proven to be so disastrous that this trade is famously called “the widow maker.”

Yes, however, the book does not seem to fully acknowledge why. Japan is not in the EU and not the EU’s punching bag. They control their currency.

How the US Will Be Able To Get Away With This

This is why I believe the Fed will be able to get away with a similar scheme, at least for a time. In fact, because the Fed is in charge of printing the US dollar (the reserve currency in the world), I believe it will be able to get away with even more extreme measures.

However, the Fed has already performed a major balance sheet expansion since 2008. Thanks to QE, the Fed’s balance sheet has grown from a mere 6% of US GDP in 2008 to roughly 27% of US GDP where it stands today.

The Fed will present this situation as a case of it employing extraordinary measures to stop the US financial system from collapsing. However, the reality is that NIRP (Negative Interest Rate Policy) is part of a larger campaign by the Fed and financial regulators to force you and me to move our capital out of cash and into risk assets like stock and bonds, thereby helping to reflate the financial system. The answers to those questions depend on whom you ask. To you or me, cash is money or wealth. To the Fed, cash is a major problem. However, there’s one key difference between cash and every other asset class. When an investor buys the stock, bonds, real estate, commodities, etc.. he or she is helping to inflate the financial system. As we’ve covered extensively, the Fed loves this becuase it means your capital is helping to push these asset prices higher, which helps avert the dreaded debt deflation the Fed wants to avoid at all costs.

This is why when the Fed moves to implement NIRP, it will also be pushed for an actual ban on physical cash.

Fed’s War on Cash

Truth be told, this policy isn’t even that crazy. Technically speaking, the Fed has been engaging in a War on Cash via the “stealth” tax of currency devaluation since it was first created in 1913. Again the goal here is to make sitting on cash so painful that it will force Americans to move their capital into risk assets where the capital will help reflate the collapsing financial system.

The Everything Bubble

As a result of this, the Everything Bubble is in fact on gigantic debt bubble comprised of numerous smaller, individual debt bubbles..bubbles in corporate debt, municipal debt, consumer debt, commercial debt, etc. So while the Fed might be able to prop up the Treasury market via QE programs, there is simply NO WAY it can prop up everything.