Three
of the four Fed-created asset bubbles have now burst. Though far from
fully deflated, the dollar, U.S. stocks, and now U.S. bonds are all
in bear markets (with the former two currently enjoying bear market
rallies). The last remaining asset bubble, residential real estate,
still inflating thanks to lax credit standards and adjustable rate
mortgages, is likely to burst at any moment. Efforts by the Fed to “reflate” these
bubbles will fail. The only prices likely to rise in response to future
easings or other “unconventional” actions will be commodities and raw
materials, particularly precious metals and oil, as well as the general
level of consumer and producer prices. In other words, instead of producing
asset “inflation,” Fed monetary policy will simply produce the old
fashioned, much less popular, price “inflation.”

Last week, as reports provided fresh evidence of the nation’s weakening
labor market, Treasury bond futures fell to contract lows and oil futures
rallied to contract highs. If the economy is showing weakness in spite
of soaring real estate prices, record housing and auto sales, repeated
waves of cash-out refinancing, and the lowest mortgage and consumer interest
rates in over 40 years, imagine how weak it will become without all that
added stimulus. In fact, as soaring interest rates turn the housing boom
into the housing bust, home equity, and the consumer spending binge that
it supported, will disappear in a cloud of unemployment, bankruptcy,
and foreclosure. The American dream will become the American nightmare.
Throw oil prices above forty dollars per barrel and run-away federal
and state budget deficits into the mix, and you have a recipe for an
economy that will make the 1970’s look like the roaring twenties by comparison.

Meanwhile, stock market bulls continue dismissing any bad economic numbers
as backward looking, while embracing any minor positive numbers as proof
that the recovery is coming. They have even interpreted the sharp rise
in long term interest rates as being bullish! I’m sure that if long-term
interest rates were still falling, they would be embracing that situation
as being bullish, as well. The ultimate example of their wishful thinking
attitude is that the current bear market stock rally itself is being
touted as the number one sign that a strong economic recovery is imminent.
So the bulls buy stocks because they believe the economy will improve,
which causes stock prices to rise, which is then hailed as proof that
recovery is just around the corner. Some how I just don’t buy this self-serving,
self -perpetuating, argument.