We’re in the midst of history’s greatest and most perilous financial Bubble.  And I am beside myself that nobody in a position of influence seems to care.  We’ve witnessed momentous analytical and policy errors over the years – and these blunders are allowed to repeat themselves without thorough analysis and review.  All this talk about fighting deflation and helping Main Street misses the point – and only feeds the Bubble.  I’m fed up with ideology trumping sound analysis.

Why is there no consensus recognizing that the number one priority must be to protect the soundness of our government debt market – the heart of contemporary “money.”  For me, talk emanating from bond fund managers about how to help the average guy rings hollow.  It is fundamental to our nation’s future that we stabilize the government debt Bubble and secure the integrity of our monetary system.  The chorus of calls for larger deficits and greater Fed monetization is fueling distortions that risk financial calamity. 

The Treasury Department’s conference this week on housing finance overhaul epitomizes the dysfunctional backdrop.  These days, Fannie, Freddie, Ginnie, the FHA, etc. ensure that mortgage borrowing costs are quite low and mortgage Credit reasonably available.  The mortgage market has already essentially been nationalized, and the GSEs are an unmitigated financial black hole.  Enough already.  Yet policy proposals are presented including a massive refinancing of current mortgages to reset at today’s historic low rates.  The idea seems impractical.  Yet such notions – proving that there are no longer any bounds on policy reasonableness or government intrusion – along with the possibility for a tsunamis of mortgage refis throw additional weight upon the Treasury yield collapse, while spurring general market instability (and big profits for those on the right side of the trade). 

The U.S. housing mania was historic - and it’s over.  Mortgage Credit will not provide a meaningful source of system Credit expansion for some years to come.  This post-Bubble reality is misdiagnosed as “deflation.”  As we’ve already witnessed, even enormous fiscal and monetary stimulus does little to incite mortgage borrowing.  Just as post-tech Bubble reflation bypassed the technology sector in favor of inflating mortgage Credit, the MBS marketplace, and housing prices, today’s reflationary forces flow vigorously to government (and related) debt markets. 

I found it interesting that hedge fund legend Stanley Druckenmiller announced his retirement this week, ending an incredible 30-year run in hedge fund management.  And today’s New York Times ran a story highlighting the ongoing difficulties suffered by the “quant” hedge funds.  Massive government stimulus may be benefiting bond fund managers, but it’s certainly not improving the overall functioning of the financial markets.  I would not be surprised if sophisticated market operators such as Mr. Druckenmiller look at the current backdrop and are content to exit the game before the bloody havoc of the next bursting Bubble.  

As the great German economist Dr. Kurt Richebacher was fond of saying, “The only cure for a Bubble is not to allow it to inflate.”  Regrettably, there is little government policymaking can do in the short run to improve the situation.  There is, however, a great deal policymakers are doing to make a bad situation worse.  The current backdrop – certainly impacted by the Greek debt crisis, related market tumult and a faltering U.S. recovery – has created an elevated risk of further policy mistakes. 

A multi-decade Credit Bubble badly distorted our economy’s underlying structure.  The harsh reality is that this structural maladjustment can only be rectified gradually over a period of many years.  There’s just no quick fix.  Ongoing massive fiscal and monetary stimulus only exacerbates our economy’s ills.  Moreover, it risks an inevitable crisis of confidence in our debt markets and monetary system. 

The economy is muddling through right now.  It’s frustrating and discouraging but, under the circumstances, this is about the best we could have hoped for.  I am increasingly troubled by the direction (and tone) of economic analysis and policy discussion.  All the inflationism histrionics, including the notion that the Fed and Congress are committing a dereliction of duties by not stimulating more aggressively, are unhelpful.  Describing fiscal policy as increasingly “austere” is ridiculous.  But mostly, calls for the (un-independent) Federal Reserve to monetize a massive federal spending plan are as irresponsible as they are dangerous.