We are baffled by the analysis of the analyst community, some, of which, are not so analytical.  They say that  Europe’s fundamental problem is that it  has a central bank which is unwilling to monetize sizeable debt maturities which bondholders are unwilling to refinance .  They look to the Federal Reserve as a model  and as proof that  the U.S. does not and will not have a sovereign funding crisis.

Maybe that’s why the U.S. Congressional “Super Committee” is having trouble reaching an agreement on a fiscal program.  Talk about the Fed creating moral hazard!

If a sovereign crisis is the result of an intransigent central bank that refuses to print money to refinance maturing bonds that the government can’t afford or is unwilling to pay, why in the world did the Russian government default on its local treasury securities in 1998?

Remember that crisis?  It eventually led to the collapse of Long Term Capital Management and what President Clinton called the greatest economic crisis since the Great Depression.  He was only about ten years early.

Why didn’t the Russian government simply monetize the existing treasury securities, known as GKOs?  Couldn’t they hold rates down to say 10 percent instead of letting them soar to 200 percent?

We don’t know for sure and are too lazy to research it (impossible to prove a counterfactual!) but maybe it was because they  didn’t want to inflict hyperinflation upon the Russian people.    What would Russia be like today if they had monetized?  Ironically, Russia chose to default on its  local currency debt, much of it held by foreigners, including David Tepper, and decided to pay their hard currency Euro bonds.   Go figure.

We’ll also never forget being in the Bulgarian central bank in 1996 just before some very large maturities of treasury bills were coming due.  The market had lost confidence in the government and a high ranking central bank official looked us straight in the eye and said “we will not let the government default.”

We knew instantly a massive amount of liquidity was about to hit the local markets, the demand for the currency was going to collapse, and the country was headed for hyperinflation.   Rioting broke out, the government fell, and the country eventually implemented a currency board, not too dissimilar from  that of the Euro, in order to enforce fiscal discipline upon the government.

Here at the Global Macro Monitor we believe it is one thing to monetize the small debt maturities of Greece and, say, Portugal, but Italy, the third largest debtor in the world, is in a totally different league.   Surprisingly, the markets don’t seem to make the distinction, but, no doubt, German policymakers do.

It doesn’t help that many of Italy’s bondholders are some of Europe’s largest banks who have been recently rewarded by the markets for reducing their sovereign bond holdings.   Some of the French banks, for example, saw their stock prices soar after they announced  sizeable reductions in their European sovereign exposure in the latest earnings releases.  There is no question,  at least in our mind, they’ll continue to be under pressure to sell down their sovereign exposure.

But to whom we ask?   The ECB?    More importantly will the ECB’s “bid of last resort” at a subsidized bond price for the seller result in Italy’s return to full market access at sustainable interest rates?   This is the question Mario Draghi must be asking himself every minute of every day.   The answer will largely depend on Mario Monti’s political ability to motivate Italians to swallow the necessary austerity measures to win back market confidence, which could take some time.

We’re not sure of the economic and political consequences of the monetization of Italy’s debt, but unlike many, we are sure there will be unintended consequences, both economic and political.

We just may be in the midst of the biggest bubble in history.  The complacency that the accumulation of all the ills of the many and massive bubbles that have ripped through the global economy in the past twenty years can simply be resolved by quantitative easing, monetization, printing money or whatever you wish to call it is simply stunning to us.

The loss of confidence, to paraphrase Rudiger Dornbusch, takes longer to happen than you think it should and happens faster than you thought it could.   Governments can finance themselves until they can’t.  Risk free is risk free until it isn’t.

Category: Credit, Federal Reserve, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

31 Responses to “The Biggest Bubble in History?”

  1. ilsm says:

    Hyperinflation as in Iceland.

    The confidence faery is from Vienna.

  2. Libaax says:

    Great article. Just one, minor, red flay, the Euro was introduced in 1999 (as an accounting currency) and then entered circulation on 1 January 2002. So IMHO Russia could not, in 1998, repay their €bonds.

  3. gregheist says:

    You lay out some very interesting and compelling points, but as I get to the end, my question to you is, “So, if this is the biggest bubble in history, what do you recommend investors do to capitalize on this opportunity?”

    Enquiring minds want to know… :-)

  4. JasRas says:

    The biggest bubble in history is China. People just don’t recognize it yet because it hasn’t popped. The good news: most of it’s debt is internal. The bad news: when things go bad in China history suggests they “wall up” for 50 or so years and withdraw from the global playground…

  5. constantnormal says:

    … the defaults, they are a-comin’ … not this year, probably not next year, but after the elections, they will … as leaves in the fall …

  6. constantnormal says:

    Just as a talking point, look at the table of government debts, just absolute levels of debt, independent of the size of the GDP …


    Pay particular attention to Italy …

  7. gregheist,

    you may care to ponder some of..

    London (BullionVault.com) – The world has endured these sorts of crises before. Somehow they come to an end. What happens?

    Sometimes, someone turns up who can prop up the collapsing debt mountain, and they make it grow higher, for a little bit longer. For a short while they are even called brilliant, but they leave a bigger problem than they started with. Eventually the thing comes crashing down and the creditors pay – always.

    Whether the creditor pays through default or rapid inflation, or the mandated acquisition of government bonds by their pension fund, or the sequestration of their deposits, the result is the same: it’s always the creditor who pays.

    And so they should. They lent the money, and they receive interest for taking the risk of lending. It doesn’t work well if they can take the interest without the risk – for which we need only look at the nonsense of naked CDSs! No – as some bondholders are currently finding out, the creditor always pays.

    By and large the creditors in the west are the holders of about $100 trillion worth of currency denominated assets (bonds and deposits) mostly owned by savings institutions which themselves have been pumped up through tax incentives to save. Their owners are the people who are going to pay. That is good news and bad….”

  8. johnhaskell says:

    Global Macro, you are bang on the money.

    The ruble/dollar fell from 6 to 25 and that’s with the GKO’s all frozen. If the CBR had monetized them, Mr Tepper et al would have immediately converted their rubles into USD and taken them out.

    At the end of ’98 Russia’s monetary base as a % of GDP was roughly equivalent to Guinea-Bissau’s. And the CBR had (as did you) the instructive example of Bulgaria, which inflated lev/USD from 80 to 1000 in the course of nine months, followed by riots and the fall of the government.

    Riots and fall of the government or make David Tepper unhappy? Hm, hard choice. Wow, Russia is mysterious isn’t it.

  9. bmz says:

    @ Mark E Hoffer: If what you and all the other gold bugs suggest is true, then shouldn’t we all be investing in real estate? Unlike gold, real estate is not hyperinflated today; and you can finance it at historically low mortgage rates. Moreover, unlike gold, real estate has intrinsic value and can produce income and real wealth.

  10. bmz,

    simply, I am not a ‘Goldbug’..

    though, re: “…real estate is not hyperinflated today…”, care to see some of..


    and, with: “…and you can finance it…”

    note, the Nominal Price of RE is, highly, dependent on the Availability of ‘Financing’, and its Cost..

    but, really, that piece, that I excerpted, was in response to ‘gregheist”s Q: “my question to you is, “So, if this is the biggest bubble in history, what do you recommend investors do to capitalize on this opportunity?”…

    a reminder that ~”there are too many Financial Claims in circulation”…some, of which, will, surely, ‘come acropper’ (go to Zero)..

    past that, how one cares to perceive it, is, at the EOD, on them–as it, always, has been..

  11. [...] is bat-shit crazy — the bubble of reality was never really real. Experts in confusion via The Big Picture: We just may be in the midst of the biggest bubble in history. The complacency that the [...]

  12. AHodge says:

    too much money will be clearly seen
    but the bad money here may not system circulate
    its “lending” to or funding the insolvent–geithner style- leave no bank or bondholder behind
    its also less inflationary because the bondholders wont spend it
    they will just sit on the pile and count it…

  13. dougc says:

    @bmz…. You don’t own real estate, you simply have bought the right to rent it from the State and they can raise the rate you pay (Taxes) and if you don’t pay…. Tough.

  14. Bill Wilson says:

    “The loss of confidence, to paraphrase Rudiger Dornbusch, takes longer to happen than you think it should and happens faster than you thought it could.”

    That’s a great quote. Anyone who thinks that today’s treasury yields are proof that the United States can continue to pile on debt without risk should think again.

  15. GeorgeBurnsWasRight says:

    You note that Clinton’s statement about the 1998 crisis as being “the worst since the Depression” was about 10 years early.

    Personally, I’ll be happy if we’re not saying something similar about the 2008/2009 crisis within my lifetime.

  16. ssc says:

    Not long before the Russian “default”, I remember watching an interview with Julian Petersen, and I always consider it as a humbling cautionary tale. In the interview, Petersen was asked about investing/speculating, his answer was to take well calculated risks. He cited a list of consultants and advisers that his fund used, which included a number of Nobel economists as well as the likes of Margaret Thatcher. Petersen specifically cited Russian as well worth the risk, as with a nuclear arsenal that was second only to US, it was in nobody’s interest to see the country felt into chaos, “as bad as things looked, I think the world will figure something out..”. It made all kind of sense, until it all fell apart..

  17. Tim says:

    Farmland may be the best and safest bet.

  18. Conan says:

    Maybe they are looking at other examples, after all the EU isn’t Russia or Bulgaria. The grandfather of sewing this road is Japan. They now have two lost decades and have been printing money like drunken sailors for sometime now. The next entry in this is the United States who has been at it for like a decade now. So finally it is Europe’s turn???

    All of this is about to pop!! Who is to say where nor how far, but as Barry says a drunk can’t drink himself sober. Nor can any of these three borrow their way out of disaster.

    Lastly who’s is to say that they don’t all pop together or in sufficiently rapid succession that it’s the same anyway? These economies are all so interconnected it is bound to go from bad to worse.

  19. beaufou says:


    We need a new Bretton Woods, simple as that.
    As Mark pointed out, the result will be heavy on creditors.

  20. Finster says:

    Too much of this discussion is focussed on quantitative measures. Monetize so much, hold interest rates down, etc. Qualitative factors matter:

    The underlying economy needs to realign. Governance must improve. Productive investment must be undertaken in productive enterprises or value creating projects. Krugman & Co focus too much on “how much” money should be spent and not “how it should be spent.”
    Our capitalist creed says usually the private sector and the individual know best.

    Europe is forcing countries and governments to restructure and improve. The bond markets are permitted to hold governments at gun point and force them to action. The ECB stands back and lets creative destruction rage and realign the economies. The FED on the other hand is complicit in soothing things over and keeping pressure from Congress. PIMCO failed miserably at trying to play the bond vigilante, because the FED overrode and gagged them, costing them a lot of money in the process.

    I’m a little puzzled by the praise attributed to the U.S. way of action as opposed to the European hard road, especially when I consider who it comes from.

  21. Frwip says:

    Wow. The Pain Caucus seems to be out in full force today…

  22. Bondtrader says:

    There was a simple reason why the Eurobonds ($,DM) were not touched by Russia : They were issued under English and German Law. Any change would have triggered a cross-default and lawsuits across the globe trying to seize russian assets.
    With GKOs Russia just needed to change its own legislation….

  23. phineasq says:

    You know, for those who bother looking the problem in Eurozone isn’t run away inflation. The problem is an idiotic central bank stubbornly refusing to accept its role as the lender of last resort, and instead focusing on inflation. Only inflation. Very soon they won’t have a currency to look after.

    Inflation is a spectrum. It’s not 2% or 1000%. There’s 3%, 4% etc. Furthermore it’s not given that ECB guaranteeing the debts of Eurozone members 100% would lead to inflation. Commitment to purchase bonds may be seen by the bond market as good as actually purchasing them. The rates would go back down to levels they were in before the crisis. In the case of Italy and Spain, this whole mess looks more like a liquidity driven problem than an acute solvency issue anyway.

    This doesn’t mean these countries shouldn’t make reforms and balance their budgets. But they need time to do those changes and we’re running out of time.

    As for Germany and other fiscally sound countries; everybody can’t cut spending at the same time. These countries should take advantage of the low rates and stimulate their economies, which would help the problem countries as well. Unfortunately it looks like the austerity meme is too strong. Just to remind people, it’s debt/GDP. Cut GDP and debt % goes up!

  24. philipat says:

    I’m not sure that the Euro can be described as a “Currency Board”? In the true sense a currency board is where one currency is pegged to another currency and the first currency can ONLY be issued if backed equally by reserves of the second currency, whereas the Euro is a single currency. A currency board essentially emulates a “Gold standard” where “Gold” is a second currency instead of Gold. It has the same impact of the Gold standard and has the effect of discipling the central bank and limiting the scope for “Monetisation/QE etc.”

    An example would be Hong Kong, where the HKD is pegged to the USD. Generally, this has served Hong Kong well over time but recently, with inflation pressures in Asia (And Hong Kong recently reflects China, but with the rule of law) Honk Komg has been suffering from US interest rates. This is inevitable because, in a true currency board, the first currency adopts the central bank policies, and thereby interest rates, of the second currency. This is not all the case with the Euro, where interest rates are wildly different within the single currency area.

  25. bart says:

    Oh my… the very very simple reason that the ECB doesn’t do a bailout or play lender of last resort is that it’s not legal, per their regulations and laws. Their single mandated purpose is to control price inflation. Look it up.
    It’s close to a perfect storm in the EU.

    As far as Russia, to compare them in the late 90s to the ECB or the Fed etc. today displays an awesomely poor understanding of their history and conditions. A comparison against Zimbabwe in recent years would be more appropriate and accurate.

  26. cmurphy9059 says:

    “”Why didn’t the Russian government simply monetize the existing treasury securities, known as GKOs? … maybe it was because they didn’t want to inflict hyperinflation upon the Russian people. ”

    You think it preferable instead to inflict decades of debt peonage upon the people of Italy?

    “We’re not sure of the economic and political consequences of the monetization of Italy’s debt, but unlike many, we are sure there will be unintended consequences, both economic and political.”

    what do you imagine will be the economic and political consequences of the severe deflation and debt peonage you and the rest of the rentier class propose? Any examination of European history in the 1930s will show that the consequences of deflation and depression are far more to be feared than hyperinflation.

    “The answer will largely depend on Mario Monti’s political ability to motivate Italians to swallow the necessary austerity measures to win back market confidence, which could take some time.”

    Italy only needs to appease the confidence fairies, even if the austerity measures imposed to do this drive down government revenues even further and ultimately makes it impossible to servicethe debt.

  27. cmurphy9059 says:

    ssc Says

    I believe you mean Julian Robertson of Tiger funds, not Peterson.

  28. [...] via The Biggest Bubble in History? | The Big Picture. [...]

  29. RW says:

    Found this little gem at http://jugglingdynamite.com/ but had to edit to remove irrelevancies (including some racist code a Canadian would not have recognized) and improve overall applicability and cogency.

    Asset-backed bonds and their derivatives explained:

    Heidi is the proprietor of a bar in Washington DC

    She has some steady customers, including a number of lobbyists, ex-congressmen and military desk jockies (most of whom are borderline alcoholics stuck in the job revolving-door), but has been unable to grow her business until she comes up with a new marketing and business plan that allows her customers to drink now, but pay later.

    Heidi keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi’s “drink now, pay later” strategy and, as a result, increasing numbers of customers flood into Heidi’s bar.

    Soon she has the largest sales volume for any bar in Washington DC. By providing her customers freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices. Consequently, Heidi’s gross sales volume increases massively.

    A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi’s borrowing limit. He sees no reason for any undue concern because he has the debts of her customers as collateral!

    At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS. These “securities” then are bundled, given high bond ratings due based on sophisticated default models and traded on international securities markets.

    Most investors don’t really understand that the securities being sold to them as “AAA Secured Bonds” really are debts of heavy drinkers. Nevertheless, the bond prices continuously climb and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses, so much so that it becomes highly profitable to sell insurance on their continued profitability in the form of derivatives.

    One day, even though the bond prices still are climbing and insurance premiums low, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi’s bar. He so informs Heidi.

    Heidi then demands payment from her patrons but most cannot pay back their drinking debts and the ones who can see no reason to do so because they have nothing at risk. Since Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and Heidi’s 11 employees lose their jobs.

    Overnight, DRINKBOND prices drop by 90%. The collapsed bond asset value destroys the bank’s liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. All the insurance sold on the derivatives suddenly comes due but the insurers don’t have the money to pay the claims so they go belly-up too.

    The suppliers of Heidi’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the DRINKBOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds.

    Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations. Her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers. Her spirituous liquor distributor closes an import warehouse, costing 23 workers their jobs, and the lowered volume cuts the profit margin of a small shipping company who lays off a single dock worker in consequence.

    Fortunately though, the bank, the brokerage houses and their respective executives are bailed out by a multi-billion dollar, no-strings attached cash infusion from the government.

    The funds required for this bailout are obtained by new taxes and bank fees levied on regularly employed, middle-class non-drinkers who have never been in Heidi’s bar.

    Got it?

    PS: The unemployed dock worker developed a taste for single-malt Scotch however and is now looking for a nice place to hang out; if you know of any with a deal like Heidi’s, please let him know.

  30. AtlasRocked says:

    It sure does appear to me that we have a common, systemic problem in all these countries: Too much democracy.

    All these nations need the steady hand of a experts in their ranks, but have none. Instead they vote for policies about which they know not what the secondary effects may be. They vote for the most handsome and eloquent speaker.

    Plato described the failure of Democracy well. “….In their ignorance they tend to vote for politicians who beguile them with appearances and nebulous talk, and they inevitably find themselves at the mercy of administrations and conditions over which they have no control because they do not understand what is happening around them. They are guided by unreliable emotions more than by careful analysis, and they are lured into adventurous wars and victimized by
    costly defeats that could have been entirely avoided.”


    The dominating theme is the citizens in all these countries vote for enriching the benefits-class instead of paying the bills, borrowing more instead of living within means. The politicians are appeasing the rich and corporations by making sure they don’t fail – they provide most of the tax revenue stream. And they appease the middle and low classes with benefits because they provide the vote-stream.

  31. beaufou says:

    “It sure does appear to me that we have a common, systemic problem in all these countries: Too much democracy. ”

    No, we have a fundamentally flawed system which concentrates capital into too few hands.