Bernanke's Chinese Fingertrap

I don't know if any of you remember the Chinese finger traps that you could buy when a few decades ago? You stuck a finger in each side and the harder you pulled, the tighter the trap became. For at least 6 months I've been describing Bernanke's policies as leading to the Chinese finger trap.

Late last week China warned the US to protect its debt holders, that wouldn't be the first time, just ask Hilary. However, after seeing the last congressional farce perpetrated by both political parties, including the Republican's who rode the Tea Party wave right into office on fiscal responsibility, the Chinese have a real and credible concern and no one in US policy takes it serious despite the occasional Geithner/ Bernanke warnings. These guys are smarter then this, they know congress isn't making any meaningful cuts to reduce the budget deficit. The last proposal was quickly unravelled to show what it really was, a few hundred million-far less then the billions they were touting.

So the debt ceiling will have to be raised by summer (or before) or else we default on debt service, but it's already a done deal. So a few short days later, the Chinese are now talking about reducing their exposure to US debt by 60+%. I've talked in the past about the nightmare scenario in which demand for US debt dries up, followed by wholesale liquidation by China. It's simple supply/demand economics. If you can't sell debt now, which we've had a hard time doing for quite some time, thus the Fed is monetizing the debt, despite Bernanke's promise before Congress not to do so, then how much worse does it get when you have China selling our debt as well?

Japan isn't saving the day, they've got bigger fish to fry and China seems to be more interested in buying PIIGS debt then even holding US debt and unfortunately for Spain, the Chinese real estate bubble and swarming inflation are likely to end that arrangement leaving Portugal wondering if they'll get a bailout as Finland looks likely to veto it, and Spain and Italy seeing the last of the EU bailout funds spent rescuing Portugal. The political will to increase the bailout mechanism in the EU isn't there as evidenced by the recent German and Finnish elections.

When you can't sell U.S. debt and the market is flooded with additional sources of US debt for sale to the tune of $3 trillion dollars, what's the answer? One the Fed can't stop buying debt, so some sort of QE 3 in some form is looking more likely. Secondly to sell whatever is possible ( and the Fed can't buy it without the Primary Dealers buying it from the Treasury, which until now has been a risk free handout of billions of dollars to the PD's) even the Primary Dealers now are going to want a higher rate of interest as the holding period which has been a few weeks typically before the Fed monetizes it, is no longer a risk free assumption. So I'm willing to bet that the yield is going way up in the very near term, especially if China makes good on the threats they're making now, even if they turn out to be only a fraction of the reported amount.

Where does that lead us, higher costs for everything. A housing market that will be so dead that the banks will be better off bulldozing foreclosures. Of course consumer credit will drop off the very low cliff it's on now, small businesses will fail and investment in technology (about the only thing the US has left after debasing our manufacturing sector) will drop off. The jobless rate will soon hit the double digits on the much manipulated U3 data. The U6 data will most likely surpass the great depression at 25+% and the US will enter one of the worst periods of stagflation in the western world. I can't wait to see what the new $10,000 US greenbacks look like, you'll probably need one to fill your gas tank.

This is Bernanke's Chinese finger trap. QE and risk free/free money to the Primary dealers have driven inflation up, that's a trend likely to get worse. Forget the term "margin squeeze" when it comes to EPS, there won't be any margin left. So just run the math real quick, rapidly appreciating prices, higher interest rates and greater unemployment=stagflation.With the rest of the word, including China, entering in to the next worldwide recession, I don't think I even have the imagination to paint a picture of the consequences, but even worse (as with all Fed policy) are the unintended, unforeseen consequences.

Bernanke created what I've been calling a Chinese Finger Trap and isn't it ironic that it's precisely the Chinese that are likely to escalate this situation from an unbelievable mess to an unimaginable mess.

Hawaii Premium Gas Hits $4.078 a Gallon

And here is sunny Florida, an Orlando gas station is now charging $5.69 a gallon for REGULAR!  

Meanwhile as you may have heard, the two nastiest words in Chinese politics "Social Unrest" have developed into protests throughout the transportation industry because of high gas prices and pay related issues; could it be the start of the Jasmine Revolution? I doubt it, but it's a sign of the times and it won't be helpful for the world economy or political leaders.

Meanwhile the Saudis are cutting back production, saying the market is saturated. I have to wonder if this is in some way connected to the Libyan export on/export off scenario that's developed the last few weeks. Italy depends on Libyan crude, the Saudi crude is a poor replacement. The Italian refineries need to buy 3 barrels of Saudi to get 1 barrel of Libyan because of the high sulfur content in Saudi Crude.

One also has to wonder if the Saudis are about to pull out another cash drop to keep the peasantry from rebelling and contrary to popular belief, they aren't as well financed as you'd think. Higher Crude prices may be a political necessity for the Saudis to escape the wrath of revolutions spreading across MENA like wildfire.