Ben and the Banker's Big Bubble

You know that screeching sound a balloon makes as it's about to burst?   The world economy is the balloon and  the slew of trillion dollar bailouts over the last two years were of the last bursts of air from a set of exhausted, dollar denominated lungs.


When did this bubble begin?  Some would reach back to the founding of the Fed, the end of the Gold Standard, or the beginning of the 1980’s and Ronald Reagan’s wild spending spree.  This particular bubble began shortly after the last one blew up in our faces.

Robert Schiller maybe considered the ultimate expert in bubbles; he called both the Internet bubble and the housing bubble.  He describes a bubble as,

"a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others' successes and partly through a gambler's excitement."

As Schiller explains it, bubbles occur when people’s common sense is proven wrong by market conditions.  For example, during the housing bubble, imagine a very sensible person is convinced that a property is overvalued; someone buys it and sells it six months later for a 30% profit.  Now he is sure it's overvalued.  The new buyer turns around and sells it again six months later for another 30% gain. The sensible person finally gives up, and being sensible, comes to the conclusion that he missed something, tosses common sense to the wind and joins the buying herd.
In a bubble, money seems to fall from the sky like a gentle rain on fertile fields, something like what is going on with the 'too big too fail banks'.  In the first quarter of 2010, Goldman Sachs, Bank of America, JP Morgan Chase and Morgan Stanley all batted 1.000, that is, none of them lost any money trading for 63 straight days, not one losing day, and over ten billion dollars in trading profits from what are now supposed to be commercial banks.

But bubbles need cash and Mr. Bernanke is supplying it, but at what cost?  Fiat moneys like the dollar and euro are not backed by anything but faith.  Once people lose faith in the integrity of a money, it loses it's status as secure store of value.  The guardians of that faith are the central bankers.  If they abuse the faith by creating too much wealth out of nothing, they will be punished by having their currencies devalued and by paying big interest premuims on their debt obligations. There is a point of no return and Mr. Bernanke is ever so close to reaching it.

How is money created? A few Wall Street types go to a Denny’s in Fort Myers and give ten waitresses $500,000 each to buy houses then take the five million dollars of debt, create a mortgage backed security and sell it along with bets on the girls creditworthiness (credit default swaps).  Our clever New York bankers just created money.  If their bank had a deposit of $500,000 with the Fed, the Fed would have allowed them to borrow ten times that much (leverage) and given them a loan of $5,000,000. This is how fractional reserve banking works, by issuing debt, banks increase the money supply.  The original $500,000 the bank had on deposit became $5,000,000 in the pockets of the home sellers.

Bubbles need irrational exuberance and gobs of cash, which is something The Federal Reserve and Wall Street have plenty of.  Bernanke bought up all of his banker friend's worthless paper and re-stocked them with bailouts to start trading again and in under year they were back buying houses in the Hamptons while millions of Americans were still being foreclosed as a consequence of their last brilliant scheme.

In the new Zeitgeist, the bankers borrow, with levearage from the Fed, at the Fed Funds rate of 0.25% then turn around and buy 30 year Treasuries that pay over 4%.  With leverage, the wafer thin 3% margin becomes a hefty risk free return of more than 20%.  

The clear identifier of a bubble is when commons sense tells you something is wrong.  When banks are basically given 'perfect trades' or when people with no verifiable income or assets are getting loans for $500,000, something is clearly amiss.  But even our most (supposedly) brilliant economists didn't seem to think so.

“I would tell audiences that we were facing not a bubble but a froth — lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.” 

And Bernanke in 2005 said housing prices "largely reflect strong economic fundamentals," 

They not only missed the small picture, they missed the big one.  Global GDP doubled between 2000 and 2006, from about 35 trillion to 70 trillion dollars.  That money was looking for returns, and what better place to find it than in US homeowners.  The rush for more mortgage backed bonds caused the constant decrease in standards which finally collapsed the whole system.  It's very unsettling that Mr. Bernanke didn't see that bubble, and doesn't see the bubble he is creating now (perhaps because he is completely inside it).

History will not be kind to these two gentlemen.  They gloried in their control of inflation and near full employment, when in reality they oversaw the slight of hand that occurred in the 1990's with the introduction of substitution, weighting, and hedonics in the inflation rate and important adjustments to the unemployment rate which shaved significant amounts off both and consequently inflated GDP. Numbers racket: Why the economy is worse than we know  by Kevin P Phillips and published in Harper's gives an excellent description of how this was done.  Using pre-Clinton era calculation methods our inflation rate now would be about 9.5%, unemployment would be 22% and GDP would be -1.5%.  See Shadowstats for a full breakdown.  The graph below shows the difference between current reported CPI (inflation) and what it would be using the pre-Clinton era methodology.

This is tremendously important because it lowers interest rates significantly, as well as Social Security payments and returns for people on fixed incomes and increases GDP.  If the calculation hadn't been 'massaged' the Federal Government would have to pay at least one trillion dollars in interest on the national debt, not the 380 billion it currently pays.  That would be almost half of the little more than 2 billion dollars it brings in, ballooning the deficit even more.  All bubbles are created out of bad math, easy money and the abandonment of common sense.  So where was the inflation from their artificial money?  Hidden in shady math, as well as in the Internet bubble, the real estate bubble, in the Iceland bubble and now in the 'recovery bubble'.


Thomas Jefferson and Alexander Hamilton were probably the two most important men in American history.  Jefferson, founder of what we now call Democratic Party, never wanted a central bank for the United States and believed in states rights, a weak Federal Government and an idyllic rural Republic.  Hamilton, on the other hand, was the consummate business insider, always fighting for a strong Federal Government and a US Central bank.

This healthy fight between States rights and Washington has always been a centerpiece of American politics, but in the end, Hamilton’s side won and we became a Wall Street Republic.   After several attempts at a central bank, and a few speculative panics, particularly the 1907 failed short squeeze on United Cooper Company which needed JP Morgan's massive intervention to contain, The Federal Reserve was created. On December 23, 1913, with much of the Congress home for Christmas, The Federal Reserve Act was passed and signed by President Woodrow Wilson. 

The Federal Reserve is an independent agency, a strange mix between private and public.  The only control the government has over the Fed is to be able to appoint its chairman and board of governors.  The Federal Reserve is owned by its member banks and it is completely independent in its actions.  The Federal Reserve is also the only institution authorized to issue US Currency, or put new money into circulation (except for coins).  Ben Bernanke, while appointed by the President, does not in any way report to the President or the legislative branch.  The Fed is truly the fourth branch of government; Bernanke is responsible only to his conscious and the bankers that are the shareholders of his institution.

William Greider, national editor of Rolling Stone, writes in his book on the Fed Secrets of the Temple,

"Neither Congress nor the White House . . . could affect private lives with the immediacy and universal reach of the Federal Reserve's power, its ability to send instant signals rippling through every family's financial decisions, to change the incentives in virtually every business transaction," Greider continues. "The paradox for democracy was obvious: the Washington institution that was most intimately influential in the lives of ordinary citizens was the one they least understood, the one most securely shielded from popular control."

The only way to put money in to our economy is through the Fed issuing debt.  To create money a bond must be created;  it’s impossible just to increase money supply in a growing economy without creating debt.  The long-term math of this is a bit murky. Interest grows exponentially, the real world doesn’t always do so.  At some future time, simple math tells us that we will be overrun with debt, all new money will just pay the interest on the old.  As the world becomes more and more saddled in debt, we are less productive because we are spending more and more energy paying interest on stored value.

Nathan Martin of  puts it this way.

“In a system in which money is backed by debt, what happens to the supply of money if you decrease the quantity of debt?

We can't pay back our debts without decreasing the supply of debt backed money, and if we do that, then the economy will suffer. But if we continue to pile on debt, then more and more of our money will go to pay interest and our economy will suffer. Those are the choices we are presented within our current Federal Reserve Debt based system.”

As the Fed creates money, it creates debt.  This is fine if our economy is growing at 6% a year and there is no Federal Budget Deficit, but the real budget deficits are outlandish.


Inflation is simply the increase in money supply  without an equal increase in economic output.  If the economy grows by 5%, and money supply grows by 5%, there shouldn’t be any monetary  inflation.  Rising prices are a symptom of inflation, not inflation itself.  Imagine an island with 100 inhabitants, and each has $100 a  month to spend and a bottle of Budweiser costs $2.  If the price of Bud  goes up, something else will go down or less beer will be drunk. If suddenly everyone’s salary is raised to $200, and all other things remain the same, the store owner will eventually wind up raising his prices.  That is inflation.

In a bid to inject liquidity into a stagnant economy and to bail out his shareholders, Bernanke has more than doubled the money supply in less the two years (see graph). So where's the inflation? There is one more variable, velocity. If you double every one's salary on the island, but everyone takes the extra hundred bucks and sticks in under their mattresses, there will be no rise in prices, but inflation is there, lurking like Freddy Kruger under their beds.

As soon as the velocity of money begins to increase, which means it’s being spent, prices will begin to rise.  Bernanke is a deflation hawk; he will do anything in his power to avoid a ‘Japanese syndrome’ of years of deflation and no growth.  Japan had an enormous bubble in the late1980's due to massive trade surpluses and a culture that promoted savings.  Japan's markets peaked in 1989 when the Japanese economy was 70% of the US economy and real-estate prices in some areas of Tokyo reached more than one million dollars a square meter, or $90,000 a square foot.

Japan was the perfect model of a bubble, too much cash floating around and a myth of a new world order led by Japan only drove people to believe more in the higher and higher prices.  The lost decade, the 1990's, saw Japanese real estate prices fall to 10% of their peaks.  The Nikkei closed at 38,915.87 on December 29, 1989, it's around 10,500 now and the Japanese government, once the picture of fiscal responsibility, actually invented quantitative easing (injecting 'printed money' in the market by buying back government debt), and currently has a public debt 192% of GDP and the Japanese economy is now only 35% the size of its US counterpart.

Japan is Bernanke’s nightmare, and so is the difficult recovery from the Great Depression.  In both cases not enough fuel was thrown on the fire fast enough.  Bernanke is not a lunatic.  But what if Ben is wrong?  What if,  in the face of common sense, he creates a hyperinflationary environment?  The consequences will be catastrophic not only for Americans, but for the world. Or will they?


"For the poorest countries (approximately 60), $550 billion has been paid  in both principal and interest over the last three decades, on $540bn  of loans, and yet there is still a $523 billion dollar debt burden."  That is an immense amount of work by the worlds poorest people only to pay bankers.

As for the developed world, the debt is not only overwhelming them, it's growing.  This scenario is completely unsustainable.

The world economy resembles Schrödinger’s cat: half inflationary equities and commodities bubble, and half deflationary recession sucked dry by debt stagnation. The money Bernanke has created has allowed the banks to drive up equities and commodities prices, but nobody really believes the story that things are better.  This is a half bubble.  Lots of funny money but no story.  It's like treating someone with rotten tooth who's in excruciating pain with morphine instead of just pulling the tooth.

The United States public debt is close to 14 trillion dollars, almost 100% of our GDP, and when you begin to add on "unfunded liabilities like Social Security and Medicare, which is a fancy way of saying Uncle Sam owes this money to us and not banks, the total debt is more like 60 trillion dollars.  Total debt in the US, public and private, is the equivalent of $300,000 for every man woman and child.  The world is starting to realize that neither the public debt, nor the private debt, will ever be paid back, and not only just in the US, but in most of the world. 


First the banks blew up, and the central bankers ran to the rescue, pumping in trillions of dollars to save their cohort, but the money isn't working. Every dollar that is created, creates an equivalent debt obligation with interest payments.  There is so much interest to be paid and so much debt that the velocity of money has come to a screeching halt.   The decades of pushing debt on consumers in the form of credit cards, car loans, student loans, consumer loans, and mortgages has finally reached its limit.  The debt is strangling growth.  Now that the public sector has assumed all the responsibility, their ability to pay up is being questioned, the 2010 Greek crisis being the first domino to fall.

China is living a bubble right now that is showing month to month real estate price increases of over 14%, that is annualized to 168% a year, but people still buy. Iceland imploded in a bubble based on selling off the state owned fisheries and banks, then leveraging themselves to the hilt, enjoying a nice ride and finally exploding into the 'neverland' of a useless currency and default. The popping sound is becoming all to common. How long will the austerity plans in Europe remain before the ire of the people  and their power at the ballot box steers countries to abandon the Euro, fiscal austerity and opt out of the international financial ponzi scheme? Austerity plans will not work if there is an easier option, and there is.

The old solution, printing our way out of debt, doesn't work anymore because the total debt amount is too large and the new debt just serves to suck dry more resources than it creates.  The final chapter will be Zimbabwesque;  governments printing to pay the banks and each other in one last mad 'bailout' before the ultimate bust.  Fiat money is based on faith, and we are reaching a monetary 'dark night of the soul'.  The meme that our fiat money is on the path to  worthlessness is close to reaching the tipping point in which case 'the end game' becomes imminent.  It's common knowledge that economic data is 'massaged', and up till now it has not become a big issue.  But once the overall faith in dollar begins to wain, the onslaught of data, lies, and insider scheming will put the final nail in the dollar's coffin.

In many ways we have traded our freedom for the quick pleasure of consumerism and the chains of debt.  Unbridled consumerism, egged on by advertising and a popular culture obsessed with brands and money has left us slaves to mortgages, credit cards and seemingly unending monetary obligations.  How many wouldn't trade in all the consumer gadgets, credits cards, and great FICO score for a good night's sleep without Shylock whispering to them from under the pillow?

Sooner than we think the age of fiat money will end.  It will be a trying and scary time during which long held beliefs about money and government will be tested. Without stable and internationally accepted currencies, international commerce will come to a halt.  Who is going to load an oil tanker or a container full of hard drives if there is no store of value that they can exchange it for?  When all hell breaks loose, and it will, globalization is going to become our biggest nightmare.  Been to a Wall Mart or Auchan lately? Stable currencies pegged to a reserve currency allow those mega-stores to purchase products globally, and our central bankers are dangerously close to blowing the whole game apart.


Nonetheless, we must never lose site of the fact that our money is simply a store of value, it is not the value itself. The coming sovereign debt and monetary crisis will reek havoc on the world for a time, but we are not losing our technology, commodities, culture, property or know-how; we will simply, for a time, lose the possibility of easily transferring them, and because of that, it is very important that the transition to a new system be made as quickly as possible. We should not wait for complete breakdown before we act.

While this may be a trying time, it is also an opportunity to take back our Republic from bankers, paid off politicians and weak kneed journalists.  This could mark a political, economic, cultural and even spiritual renaissance.  We must lay down the conditions for what we want our new financial system to look like, because if we don't, the bankers will gladly do it for us.  End the Federal Reserve System, leveraged banking, budget deficits, debt backed money and the mega banks.  Some kind of amnesty must be made for governments, organizations and people regarding debt loads that are impossible to pay back. Banking needs to become local, logical, and constructive.

The globalized world has become an enormous financial bubble that is about to burst into trillions of pieces of worthless paper.  When common sense returns, and it will,  we will remember that banks can't make money, they can only add value to it once it has been created.  Hopefully this crash will create a new era of both economic and environmental sustainability as the current model is destroying not only our Republic and  currency, but also our planet.

The bankers want their pound of flesh but they ain’t gonna get it.


  1. Why ignore the potential of deflation to reduce the value of all the assets that this debt 'owns'?
    Is this not the only way out & only, say 'natural', way the market will evolve out of the debt bubble.
    This is not money becoming worth less, but debt & the goods it has secured.
    Our actual cash on hand will appreciate in value, while everything we & the banks own with debt will become worth far less.
    This lets the air nicely out of the present bubble & prepares a table with a myriad of options for the next. Kind of like Thanksgiving!

  2. B. Bastiat believerMay 26, 2010 at 4:17 AM

    @bish: I agree with you rather than the author regarding the way out. Deflation is what did it before and I think it will be what does it this time. Eliminating the dollar would not help much although setting a gold backed valuation for it would. Inflating our way out won't work as the people have wised up now.

  3. It is a genuine crisis and the biggest bubble of them all is the 800 pound gorilla in the room called Spain.
    Fitch downgraded its credit rating from AAA to AA+ on Friday and this is threatening to cause a total chaos at the stock market.
    I know not whether the ranking agencies are a good thing or bad.
    What I do know is and have known for 30 months at least is that Spain is in the doo doos in a gigantic way. When a country gains 160,000 public sector workers and loses 1 million workers who actually produce something in one year , that country has big problems. Plus all the problems related to building more properties in 1 year than ,Britain, France, Germany and Italy combined, at a time when the bottom was falling out of the property market.

    A government obsessed with events of nearly 80 years ago and doing nothing about the years 2008, 2009, 2010.

    Banks that have basically rewritten the meaning of creative accountancy , boom time valuations still in 2010 balance sheets when the real price of assets has fallen by 50%.

    The list just goes on, labour laws that prohibit taking on labour. Lack of government incentives to set up new businesses, some help is given but with all the red tape entrepreneurs can´t be bothered.
    A friend of mine moved her office two doors down the road, the paperwork was incredible. She had to employ a "tecnico" to draw up a plan for premises of 65m2, cost 500 euros. I know the town hall must have at least four copies of this plan as each time the premises have a new tenant , a plan has to be presented, no structural changes have taken place, but still a plan must be presented. Umpteen forms had to be presented at the town hall, each one had to be accompanied with a photocopy of ID ,rental contract,etc etc. A good share purchase would be A-4 sheet paper or photopier machine manufacturer.She is carrying on the same business in the same building as before , no structural changes were being made to the new premises. Then the police came two days after she presented the mountain of paperwork to see if she had "committed an infraction". All this really encourages the setting up of new businesses.

    Spain will struggle for 5-10 years at least ,due to EU subsidies, the politicians thought Spain had become a leading economic nation, unfortunately all the subsidies did was paper over the cracks of
    an economy suffering great structural deficiencies.

    As Jesus described in the New Testament, build a house on sand it will collapse at the first storms, a house built on rocks will survive the storms. Unfortunately for Spain, its economy was built neither on sand or rocks bit on quicksands.

  4. Peter George,

    Spain is in a very serious mess indeed. After decades of 'making money' on the former housing bubble, the country has awoken to discover that its prosperity was based on the false premise that property values would go on increasing for ever. Sound familiar? Now Spain has to get back to its roots, sell its real skills and the tourism and yes, suffer reductions in its standard of living because it can't escape from the tight corset of the Eurozone.
    Spain has had the gain (and over E150bn in EU structure subsidies plus the CAP since 1986) and now will feel the pain. Anyone can spend money, it's the earning that's tough in the competitive world of the 21st C. Forget bricks and mortar, that path leads nowhere. Socialism and the consequent greed and inflexibility of socialised labour must be corrected before the problem is solved.
    I'm guessing it won't be.
    Hello depression, and your union brothers don't give a damn about you.
    Don't worry the "leaders" will not pay any price.
    Read the Animal Farm by George Orwell.

  5. We have just entered a deflationary period hundreds of years long. A bit like what happened when Rome bit the dust.