Ben Bernanke: Banks, bonds and a big breakdown?

The financial markets were convulsed last week at mere hints the Fed is seeking to kick its $85 billion per month intervention addiction...

If somebody in your household believes in the tooth fairy myth of buying used molars for cash, then you either have a toddler or you’re living with a banker. For many members of the financial firmament who equate the ‘real economy’ with paying their au pair, the past week brought a whole new word to the lexicon which has struck fear into investors’ hearts.

“Tapering” was part of a whispered Fed message that sometime, maybe in the fall, they will start reducing the $85 billion they “Quantitatively Ease” into the US financial system monthly. Given that this money tends to be used to help bankers profit from trading and rarely reaches the real economy, the average citizen yawned. However this 'sotto voce' hint that the crazy fantasy world of easy money could end induced panic amongst dealers. Grown men wept at 10 year Treasury notes yielding a giddy 2.34%. World Markets turned ugly.

Bankers have become so addicted to this tooth fairy-style stimulus that even hinting the party punch bowls might be refilled more slowly provoked an instant attack of trader 'delirium tremens'.

Admittedly to explain the situation, the Fed had to relax their grip pushing the bankers’ heads into said punch bowls for just long enough to let the message sink: this isn’t the end...but last orders could be coming...next summer!

Nobody has actually called last orders, nor has the music stopped at this mammoth party but the markets felt the same terror as children threatened with confiscation of their security blanket. Every month Ben Bernanke buys 85 billion dollars worth of mortgages/bonds/IOUs/old heavy metal albums from banks to grease the wheels of the economy. Instead it just lubricates the banks. Entrepreneurs and small businesses rarely get helped: hence the real economy is moving towards peer to peer lending and crowd funding.

Bankers have grown complacent as the Fed nonchalantly concludes the equivalent of several Eurozone bailouts weekly. The “Bernanke put” as this reckless spending spree has been termed has skewed markets.

Right now all the Fed is threatening to do is, maybe, MAYBE, buy less financial bric-a-brac come the fall. Even then they will still be buying multi-billions of assorted IOUs until summer 2014. The widespread terror in financial markets this week suggests this is tantamount to the Mayan apocalypse.

Incidentally nobody has yet actually suggested the Fed will endeavour to sell the trillions of ‘pick & mix’ quality/questionable IOUs it has accrued in years of binge buying...that really would provoke a meltdown.

So the Fed-fuelled Bond bubble is about to pop sparking global repercussions. When the Fed gave its charges de facto ‘money for nothing’ traders scoured the world for enhanced yields, with a lot of cash inflating mini-bubbles in Asian assets. The Fed whisperings have provoked an emerging markets exodus which will be exacerbated by the Chinese simultaneously reining in their credit bubble. This Sino-US credit contraction pincer movement hurts financial assets. More acutely, lack of credit can severely impact the real economy as lending further dries up. The US may be able to muddle through the storm but Europe is already deep in crisis and Asia is further threatened by the China slowdown. With the Fed cash flood eventually tapering to a few isolated drops, interest rates are likely to head upwards.

The actual rise in interest rates is not the only worrying issue: the competence of traders is a worry here too. A generation of financial markets professionals with anywhere up to 15 years’ experience have never encountered an environment of rising interest rates. That’s why this word “tapering” has led so many traders to suffer a belief-system meltdown as they realised the security of the quantitative easing fairy was just a childish myth.

Meanwhile taxpayers have been left holding a multi-trillion dollar baby (plus ca change...!). The greatest concern is that these trillions of dollars may only have prolonged the economic agony and an inevitable bond market meltdown awaits. Once the punch bowl is finally taken away, markets could be left with a hangover of epic proportions, creating shock waves for global growth. Of course Ben Bernanke will be retired by then earning a crust on the lecture circuit...

The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of RT.