Why This Time Is Not Different

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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  1. Or what? I mean that in all seriousness, what happens if US debt is not addressed pro actively?

    I hear people taking about it in the media but I don’t hear explicit explanations for the consequences. I know 3 ways to reduce debt: cut expenses, increase revenue & increase inflation.

    But what happens in the real world, what are the spin off consequences?

    Thank you,

    1. Whenever this all happens, it likely loses its reserve currency status and suffers a deep depression. Who’s going to bailout the largest economy in the world? Even if countries came together that wouldn’t be an easy task. How about the creditors take a haircut? Well try returning to the bond market after forcing your creditors to take a massive haircut.

      No one really knows what it would look like. The US is roughly 20% of the world’s GDP, so it would be a massive hit to other countries (also remember the domino effect: even if a country doesn’t directly trade with the US, its trading partners probably do). Domestically, no more pension checks, social services get cut, mass layoffs in the government section, higher borrowing costs for everybody (no idea what would happen to the defense sector). Not only would the federal government default, but state and municipal governments. Just imagine the 1930’s but worse. It would be a disaster that would take decades to fully recover from (if ever, who knows). The wealth effect in reverse is very serious.

      Message me back if I didn’t fully answer something.

      1. It’s not like there is a country strong enough to take over the reserve currency baton. China has its own problems. Hong Kong is a good example of how little these people want to take over the responsibility. Ironically or not, they want stability so they continue to be pegged to USD. Europe? Nope. Japan? Nope. Japan has recently figured out that they too can print their way out of trouble.

        If there is only one thing the central banks would try their best to support, it’s the stock market. That’s what the last 4 years have shown. Poor and middle class getting hit by rising food and gas prices and don’t have money in the casino? Too bad.

      2. I would actually agree on everything, but China. China has its own problems, but it’s no where near as serious as what the US/Japan/EU are facing. They have the largest currency reserves. If they needed to, they could bailout their local governments 300x over. However, in order to become the reserve currency they have A LOT of work to do (open up their economy, maintain a stable banking system, loosen capital controls, etc). I’m not saying this is an event. Most of the time it takes years to chip away at a reserve currency status before it becomes official. Look at the Roman Denari or Pound Sterling. Yes it was an event that officially ended the status of the Roman Denari or Sterling, but years before the Roman Empire collapsed or Bretton Woods, people started to trade using other currencies/gold/silver. My point is that the US is already under fire from Russia, China, Iran, Brazil, etc, about the US Dollar. Even some States have allowed citizens to pay their taxes in gold. Confidence is being chipped away. And if they wish to maintain their special privileges, they better be careful going forward.

      3. The fed is the largest creditor. And they are buying all the debt now. With what? Newly created money. The treasury pays them the interest , then the fed turns around and gives the profits to the treasury. It is a giant circle jerk when the fed monetizes the debt. They could do this for a very long time. Then they could just say “poof” the debt is gone because it took nothing but newly created money to make it. The only down side would be the newly created money ends up in the economy through the government spending and it will cause inflation. But they just lie about real inflation (say its 2% when it is really 6-8%). Rinse and repeat. The doom scenario will not happen.

      4. So the Fed is going to print and buy US Treasuries forever (because the US will be issuing debt for a very long time)? And what happens when foreign buyers start tapering their purchases? The Fed buys their share too? To put that into context, the Federal Reserve would need to quintuple (5x) their current monthly Treasury purchases in order to fund the government.

  2. Why make it difficult?. Once Europe’s economy gets traction, the USA deflates its currency and halves the debt. Crises what crises? What the common man does not understand, It is not businesses problem and neither is it the Governments problem, the only people that will pay this debt is the common man, yes us the 99ers.

    1. I think a lot of people forget that currency depends on confidence. Do you actually believe that countries will allow the US to devalue its currency that aggressively? Money doesn’t make the world go round, it’s confidence. You are confident that when you wake up tomorrow, your dollar will still generally be worth the same as when you went to sleep. You’re confident that you’ll still have a job next week, so you’ll eat out tomorrow night. Almost everything you do that stimulates the economy falls back to confidence. And a reserve currency works the same way. If the US were to do what you suggest, I’d bet this debate for a new reserve currency would intensify. And that’s not something the US wants to play around with.

  3. If the bitcoin rally was the result of decreasing faith in fiat currencies, 30-year bonds in those currencies should be declining, gold should be rising, along with real estate, harder asset stocks.

    It’s an asset with a total of $1-2b outstanding, trades $100-200m on a busy day. When it moves, it says something about the hopes and fears of people in that market, not the overall FX, bond or capital markets.

    1. I think you’re misinterpreting what I said. It only takes, maybe ten thousand to panic and move Bitcoin like it has. That’s why I believe it is in a bubble. Reality will return.

    2. However, I will say that it only takes a few to start a revolution. I have more than 10,000 years of history on my side. Haha, wouldn’t bet it on Bitcoin though.

  4. The US debt chart you use is misleading. That’s not to say I disagree with all the points you make but only going back to 1970 eliminates all the other major increases in US debt as a % of GDP (Civil War, WWI, Great Depression, WWII). In all the previous instances after a major increase, the debt level relative to GDP returned to a normalized level following a period of nominal growth.

    I don’t go so far as to say history will repeat with 100% probability but current debt/GDP levels are not unprecedented.

    1. I see what you’re saying, but the point I was trying to make is that Washington will not be able to cut spending, grow its economy and meaningfully slow the rise of its debt. The Federal government will have to cut back spending, a blow to growth. The Federal Reserve supposedly will taper QE at some point, another blow to growth. Europe is still slowing, China has acknowledged it’s slowing. In fact, global growth has been slowing since 2010. Debt will continue to rise, however, lucky for them, rates are being kept low to spur growth and buy the government time to get its fiscal house in order. When are you expecting nominal growth to return when the US is being squeezed on all fronts?

  5. Vconomics makes a key error when he says the US will default. It will not. It is not Greece, nor Italy, nor any other non-sovereign currency user. It is a sovereign currency issuer whose debts are denominated in the currency that it alone can create. To say there will be no checks, no payments, is, I’m very sorry to say, purveying ignorance. The checks will keep coming, and there will be no default. (The only possible exception to this is if the US made the *political decision* to default, in which case all hell *would* break loose — but this is so unlikely as to be almost ridiculous.) The catch, of course, is what will this created money buy? Inflation, then, is the only constraint, and while it is under control there is no other constraint. Simply put, the US cannot, ever, “run out of money”. The checks will be written, cashed, and spent. And an inflationary explosion that would prevent this game from continuing is highly unlikely as long as the US remains a very highly productive society (and it is). Currency issued by the US represents a claim against assets in one of the most productive societies (if not the absolutely most productive) on Earth. Should the US suffer a massive collapse of production (like, say, Zimbabwe), or lose a war badly (like Germany did in WW I), or borrow or otherwise become indebted in a foreign currency (again, Germany after WW I, which was required to pay war reparations in Francs and Pounds, currencies it could not create at will), then hyperinflation could come. In the meantime, people with seeming agendas to push keep saying that it’s right around the corner, but we never seem to get to the corner. None of this is to say that US finances could not be better, even much better, but it is purely ignorant to claim that the US is about to, or will ever, default on its debt, or stop writing checks to its citizens. This is simply not going to happen.

    1. Why can’t the US default on its debt? People’s argument that it can print is a just a silly excuse. There have been over a hundred cases of defaults around the world. Indonesia can print, yet they defaulted. Poland could have printed, yet they defaulted. In fact, Brazil, Russia, South Africa, Mexico, Chile, India, etc, have all defaulted. And guess what? Most of them are better off. Sure it’s painful at first, but eventually you heal and move on.

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