Monday, February 1, 2021

How To Bake A Bubble

Bubbles are not random, chance events. They do not materialize out of thin air anymore than pizza bakes itself.  Bubbles are created to convince the gullible masses to suspend their disbelief, to participate and part with their buy assets created, or previously accumulated, by the manipulators. As such,  they are a form of fraudulent wealth transfer from the many to the few. 

It takes just two ingredients to “bake” a bubble.

  1. Lots of liquidity i.e. a pile of cash / easy, cheap credit. That’s mostly provided by the otherwise innocent monetary authorities, but not exclusively.
  2. A "story" which captures the public’s  imagination and transforms cautious, rational individuals into a stampeding herd, a “crowd”. 
Are we in a bubble? Lets look at today’s ingredients:
  1. Money has rained down from the “helicopter”. Governments have distributed trillions, borrowed  from their central banks. As of last week, the additional money created during 2020 by the Fed and ECB amounted to a combined $6.33 trillion, ballooning the banks' balance sheets by an unprecedented 66% (Chart 1).  And it's virtually "free", since interest rates are zero, or negative.


 Chart 1

 2.  Today’s main “story” is firmly connected to (1) above: The Fed and ECB will keep pumping money to support the economy and markets, no matter what. Obviously, it is circuitous logic at its very best: markets can’t go down because there is a lot of money, and there is a lot of money because markets can’t (are not permitted) go down.  

Ok, we have the ingredients and we have the oven (markets/social media).  So, who’s the pizza man? Who is responsible for the manipulation, the pumping up?  The short answer is... there are many.

 In the Credit Bubble of 2006-07 there were those who bought CMO and CDO squared and cubed by the billions, and then there were those who bought CDS on those self same bonds. Very frequently, and certainly not coincidentally, the most laudatory bond sellers/financial engineers were also the buyers of the underlying CDS. Meaning, they knew they were selling junk.

So, in today’s environment it is best to ask the Roman jurist’s question: cui bono, who profits - who really profits - from the insane goings on? The answer is pretty obvious, once you know where to look...


  1. I am still thinking..... Preliminary thoughts.

    I think there is no way to turn off the money printer. I suspect that the cause of all this printing does not even lie in the west.

    Primarily, China needs to print money to cover their bad debts.... And since they cannot stop making bad decisions, they cannot stop the printing....

    This translates into more and more downward price pressure (deflation) in the west... Also known as does anyone want even cheaper Chinese goods?

    Since the west can't do anything about China, they need to print to counteract the deflation.

    I suspect this is the broad pattern and the rest reasons and stories are just fluff.

  2. The China angle on money printing is very intriguing. But I’m not sure I follow how it creates deflation in the West. If they start running a serious monetary inflation domestically, I don’t see how they can prevent “exporting” it in the form of higher prices for their exports. Since their currency is not yet freely exchangeable, they have to raise prices in $ terms.. am I wrong?

  3. Yup, you are right, I mixed two different points when talking.... So I would put it this way.

    China has a huge bubble of bad debt. Left alone, the china system would deflate in RMB terms. Now.. what if the govt prints just the right amount of money, such that it cancels out the deflation.... There is "magically" no RMB deflation but the RMB value goes down (started happening about 2-3 years back)..., with the deflation now exported to the west...

    Now what happens if the west prints enough money such that the RMB does not go down relative to their currencies?

    My hypothesis is this is the mechanics that created our magical world where everyone prints money but everything (except the stock market) stays the same. The question, which is bothering me is... who is being cheated in this system.... Someone must subsidize it... but I can't quite pin it down who....

    1. Ah, I get it. Such a cycle could work for a while, for as long as raw material/commodity prices stay low and don’t push final goods consumer prices up. But once they get going... major oil and foodstuff exporters (Saudi, Argentina, Australia, etc ) are not going to sit idly by as more and more dollars are printed, since they won’t see commensurate benefits on their import side.

    2. Sounds right.... but strangely, I am not that sure about this.....

      over here, the commodity price makes up (I guess) one tenth of the final retail price... maybe less... basically, the commodity price can be whatever it wants to be and there would be little effect on the retail price.