Bernanke Will Cap Interest Rates, Bond Market Has Not Yet Topped, says Broyhill

July 15, 2011


Broyhill is out with the second part of their 2Q Letter. In part I, Broyhill made the case for a depression era economy, citing similar deleveraging episodes of credit bubbles during the Great Depression and the Japan experiment.

In their latest letter, they mention the same must read Bernanke speech mentioned here several times. Bernanke will seek to cap interest rates as their next move in monetary policy gone wild.  After that, they will seek an outright devaluation vs Gold, using the same speech as a guide. Ben Bernanke (Deflation: Making Sure “It” Doesn’t Happen Here (2002) :

“Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951. Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade . . . The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable . . . Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long- maturity bonds outstanding.”

Unfortunately, their prescription is for more fiscal spending.  In their utopian world, Broyhill believes efficient government spending despite that this has no foundation in history.  A They do not worry about the ramifications on the debt load or higher interest rates, seeing deflation or inflation as binary outcomes, rather than the likeliest outcome of such a path of high powered monetary stimulus, high debt levels, and wasteful spending – stagflation. The end game would be a massive debt load, resulting in debt monetization and dollar devaluation, ending in a hyperinflation crises (granted, not for a long time).  Broyhill sees lower interest rates no matter what fiscal or monetary policy is pursued. There are many flaws in that thesis.

Broyhill goes on to say “History has repeatedly shown that secular bull markets end in a state of euphoria. We see very little evidence that the bond market exhibits any of the classic characteristics of a bubble.

This part I agree with and have mentioned several times. The 30 year bond bull market will end in capitulatory panic buying before the ultimate top is reached. Broyhill does not not mention a trigger, but I will.  Sovereigns will flee to the US Treasury to seek liquidity when there are currency crash(es) in one or more emerging markets. China, Brazil, Turkey, India, are likely candidates, and it could reach Australia or Canada as well. The difference between Broyhill and my own view is we advocate less government spending, which if it comes from government transfer programs and government pensions, will reduce expectations for higher taxes, and boost the economy. This is what history shows.

Bernanke’s Signals New Effort to Destroy Purchasing Power

The Broyhill Letter – Part Duex (Q2-11)

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