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Still Yawning...


It is essential for the central banks to keep bubbling up asset prices, yet there is no place left to go.


Bennet's piece on the cost of money is essential reading once again. These truly are interesting times for economics, although most economists still yawn at that comment.

We have talked about the unprecedented credit expansion engineered by our friendly central banks, engineered first in stocks and then in houses, then unfortunately in commodities. And now?

It is essential for the central banks to keep bubbling up asset prices, yet there is no place left to go. The consumer has been driven by cash and wealth generated by higher home prices and clever mortgage extraction. That has introduced a new level of leverage in the economy, one never seen before.

The problem is that the impact of the debt is cumulative. The Fed tapped out the U.S. taxpayer as a source of funds, so it had to go to other central banks. Most of the new public debt has been bought by foreign central banks who themselves printed the money to buy it.

And that creates a scenario that, in reading what Bennet said, I put a higher probability to: the Fed does not have the flexibility to lower rates if they need to because foreign central banks may stop buying our debt. That would be a catastrophe.

They can only do it if other central banks are willing to lower theirs as well. Can Japan go lower than zero? It would take monumental printing of dollars, which may not even work, for the Fed to be able to lower rates when Japan cannot. The dollar would crash.

We may see lower long term rates and a very inverted yield curve, but given the current state of things, I see it as very difficult for the Fed to lower short term yields (where other central banks invest) unless other central banks are willing to bet all their power on staying with the Fed.

This is a scenario that needs to be considered.

...and by the way, Fed futures are now pricing in an 80% probability of another Fed hike in August.

That is very different from just last week.

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