US treasury bonds a Ponzi scheme waiting to crash

It is really no secret that US treasuries have become the biggest Ponzi scheme in global financial history. In a Ponzi scheme new buyers’ money is used to pay out redemptions until the new buyers dry up and the whole thing crashes.

For US treasuries the buyers are now waning. The most recent evidence points to the Fed as the main buyer of these bonds last year, with the Chinese second in line and then the banks.

Dollar devaluation

Cash out of US treasuries today and you are paid back in devalued money. Money that is devaluing because the Fed is printing it. But the total amount of money outstanding is so huge that the market would instantly crash if everybody demanded their money back. That is indeed by definition a Ponzi scheme.

Why do the Chinese and banks around the world keep on buying US T-bonds? It is of course a matter of self-interest. If they stopped then the value of their assets held in treasuries would crash in value and the whole financial system tumble. And for US banks buying bonds with free money from the Fed is a money spinner.

If you look back at major financial crises in history then no serious crisis has ever ended without a crash in the bond market. It would therefore be far more surprising if the current global financial crisis avoided a bond crash than if it happened.

Crash timing

The problem is timing the bond market. Recent stock market crashes have generally happened without warning, in fact when the market participants were actually at their most complacent. Nasty things jump out in the night, they are not well advertised in advance.

So the obvious message on bonds ought to be diversification. But into what? Stock markets are also going to take a pummeling when bonds fall because the economic impact will be considerable, and that will upset commodity prices too.

If historical, or perhaps we should say hysterical, precedent is any guide then a bond market crash leads to a massive hike in gold and silver prices in a flight to real assets which may also include property, despite the impact on interest rates.

Cash will also suddenly look mightily attractive as interest rates will shoot up in a real bond crash until the market finds a level at which those who own capital feel secure enough to lend it.

Central bank impotence

It might be unduly alarmist to be talking about a bond market crash in 2010. The Fed and central banks are going to want to indefinitely postpone this event if at all possible. But people are getting far too complacent about the capacity of these authorities to direct markets.

Did they prevent the US housing market crash or the banking crisis or the stock market crash? And how solid is the recovery in 2009 if it rests on a Ponzi scheme? It is certainly a good argument for cautious diversification in asset allocation for 2010.