History is littered with failed experiments, asset bubbles and economic collapses:

TulipMost commonly referred to as Tulip Mania, this bubble originated in the Netherlands, where tulips quickly gained popularity for its saturated colour. As demand for this commodity grew, so did trade. By 1634, speculators had entered the market, causing prices to skyrocket in a fairly short period of time (at the time, the ‘futures market’ was merely a paper contract that resembled today’s option market [the right to purchase at a later date at a specified price]). The market for tulip bulbs peaked in 1637, when sellers greatly outnumbered buyers and speculation evaporated.


south seaMen made and lost fortunes overnight in South Sea’s stock. The bubble began when insiders spread far-fetched rumors about the company’s future growth prospects in the New World. This created a speculation frenzy, where insiders continued to fan the flames as the stock rose. Once reality set in and speculation collapsed, so did the share price.


BitcoinBitcoin has been called the hedge against fiat currencies (I guess Gold lost its luster). It’s a digital currency that is not backed by a central bank, nor is it regulated. The bubble began around the time Cyprus was thrown into chaos and forced to take a bailout or default. My best guess is that speculation erupted after the Troika demanded that Cyprus tax  its depositors, fueling a panic for safety (the mentality of: “if it could happen there, why not here?”). Add in mass media attention and the herd effect into the equation, and you can see why its price has exploded to the upside. While it is too early to label it as a bubble (prices have to collapse first), I find it hard to believe that this sparks a currency revolution. Reality will eventually return.


Debt vs CBWhich brings me to my final point: aggressive central bank printing and ballooning debt. At what point are their actions going to be considered inflating a massive bubble? Since Washington began focusing on how best to bring down the country’s debt, the US has added several trillions onto its liabilities. And the funny part is that whatever money Washington saves from those scary sequester cuts will go directly to paying interest. In fact, there will still be a huge shortfall (meaning your tax dollars will fill in the rest of the hole). So while Congress and the White House try and work out a bipartisan spending deal and Federal Reserve officials discuss tapering Quantitative Easing, just know that whatever is done will just be a short term solution. The US needs the Federal Reserve to continue to keep borrowing costs down. Not only would higher interest rates negatively affect the economy, but it would make it more costly for the government to (re)finance its debt. 

If there’s one thing the Federal Reserve has taught other central banks it’s the power of the ‘wealth effect’. And that’s exactly what the Bank of Japan is trying to do. However, what Japan is engaged in is extremely dangerous. Shock therapy has proved to be very successful when trying to stabilize a faltering economy. But using it as a tool to create inflation can cause an avalanche that throws the country into chaos. On Friday afternoon, circuit breakers were triggered when Japanese Government Bonds fell to a record low of 32 basis points, but violently reversed to 65 basis points … in the same trading session! Instability and volatility in the second largest bond market is not something to take lightly. Especially when their currency has fallen nearly 20% in the last six months. If that were to accelerate, the Japanese people will be crying for deflation (Japanese 1 year credit default swaps have more doubled in the last four months).


Interest RatesThis downtrend US Treasuries are in will not last forever. Eventually the US will be forced to deal with its debt. Will the Federal government be proactive and prepare for higher rates, or will they be reactive? I’d bet on the latter.


Questions? Comments? Leave me a reply.

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