Return to Paradox: Another “Flight to Treasuries” Scenario...

We begin today with a paradox: Treasuries — and the U.S. dollars they’re good for — are doomed. But if you’ve got ’em, hold ’em.

Since taper terror swept the markets, the dollar has rallied to two-week highs. Only today has it started to cool off.

Objectively, the greenback is gaining on mayhem and some optimistic growth projections. Has unemployment come down? Has growth picked up full steam? Has the Fed stopped printing billions or the government started to spend what it takes in?

Uhh, no.

Recall September 2008: Just six weeks after we released I.O.U.S.A., Lehman Bros. declared bankruptcy… stimulus packages got rammed through Congress. “Too big to fail” banks were bailed out by the dozen. What did the dollar do? It rallied by 22%. Yield on Treasuries dropped negative. No one gave one hoot about the ballooning deficit or exploding national debt.

The Panic of ’08, in effect, helped the dollar reassert itself as the world’s reserve currency– the safe haven for investors. Hold that thought.

The Chinese equity markets continued taking a beating overnight — down 20% since February — and all eyes are on the People’s Bank of China (PBoC) as worries over out-of-control lending mount.

The PBoC tried to stem worries by pledging to print more money if need be. But that won’t help them. The Chinese have already puffed $11 trillion into the system over the past five years, bringing their total credit-to-GDP ratio to 200%, and they aren’t growing as fast.

Who’s surprised lending’s getting out of hand?

According to Fitch, the shadow banking sector in China has grown to nearly $6 trillion — almost 69% of Chinese GDP — doubling in the last two years alone. Remember shadow banks? Well, their lending practices are just as sketchy as their U.S. counterparts were.

Allow the sense of deja vu pass over you. “The Ponzi scheme is going on with retail investors,” our friend and author of Currency Wars, Jim Rickards, told Yahoo’s Daily Ticker this morning. “They don’t want 1% or 2% in the bank or even less. So the quasi banks come along and say, ‘We’ll give you 6%-7%-8%.’ They take the money, invest in these assets that are completely nonproductive [with] no way to be able to pay off the debt.”

“They never sell the assets,” he says. “They just sell [new] products and use that money to pay off the old guys.”

If history rhymes, that means there will be an equally grand flight back into the Treasury market. Bonds are selling off today, but so what? Yields haven’t crept up to 2.58%, because creditors think the U.S. will default — a new mad rush into Treasuries would prove it. The mother of all financial bubbles is still destined for a sticky end… but not before it’s given a few more puffs. Mostly because so many others are in worse shape.


Pete Coyne
for The Daily Reckoning

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