The Next BubbleThe Next Bubble

Did you ever wonder what a bubble looks like before it is filled?

This is the perfect opportunity to see one. The FED is in talks to sell assets to your mutual fund manager for later repurchase by the FED. If you have money in a mutual fund you are getting ready to buy FED assets in a huge way. Since the number of people and countries willing to buy US debt is falling they have to find some way to continue selling FED securities. In this case in the name of removing an excess of liquidity caused by an excess of ink and paper being FED into a printing press.

Chairman Ben S. Bernanke yesterday charted ways the Fed might withdraw record monetary stimulus pumped into the economy to fight the recession. Among the central bank’s tools are reverse repurchase agreements, in which the Fed sells securities with the intention of repurchasing them at a later date.

The Fed is also considering reverse repurchase agreements with mortgage lenders Fannie Mae and Freddie Mac, said the person familiar with the discussions. Freddie Mac spokeswoman Sharon McHale declined to comment. Fannie Mae spokesman Brian Faith also declined to comment.

“To further increase its capacity to drain reserves through reverse repos,” Bernanke said, the Fed is “in the process of expanding the set of counterparties with which it can transact” beyond primary dealers of government securities.

How will it bubble? If the Mutual Funds are allowed to leverage the purchase of even a 3% interest security can become a 15% return. A 15% return will draw your money and mine. After all in the current market who wouldn’t want that? This return won’t be based on reality it will be based on a false choice of government/FED interest. That means a tremendous amount of the still liquid capital is about to pour into a nonproductive investment. e.g. a government sponsored mal-investment.

By sucking capital out of the productive sector of the economy and placing it into government service it will further exacerbate the Great Recession. Tax revenues will shrink due to a lack of capital formation targeted to productive uses. To cover the shortage government will borrow more from the FED, increasingly its lender of last resort, which will sell more assets into this Mutual Fund scheme. It may even cause a spike in interest rates, as funds tank up on securities, providing a greater paper return and a continuing death spiral as less and less capital is available for productive use.

But it has an ending. Like the housing bubble we may not know the trigger but one day, maybe when the Chinese decide to dump the US debt they own, the dollar will collapse. The paper profits will disappear. You will be a zillionaire, now go buy a taco if you can afford it.

The bubble will do what bubbles do. But only after having sucked the vast majority of the middle class wealth out of the pockets of Americans to spend on political patronage stimulus money. It is the middle class, IRA’s, 401K’s, teachers funds, regular investments accounts, that invest in mutual funds.

Of course the joke will be on the Big Businesses, Unions and Wall Street Bankers. A worthless dollar will be no more valuable to them than us.

It may all seem grim but don’t worry the left does have a plan.

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