We've all seen several prominent asset bubbles and their collapses in the last decade.  The collapse of the stock market in 2000 and again in the last year, the ongoing "housing bubble" bursting, a less talked about but no less spectacular recent collapse in the commodities and corporate debt markets.  A bubble is usually used to refer to a boom that gets so far away from fundamentals and often purely driven by psychology or artificial attempts to keeps the good times rolling.  Boom and busts are a natural economic cycle, where the principal "The bigger they are, the harder they fall" rules the day.

While, bubbles in across so many assets have burst during the past year, one mountainess asset bubble continues to bulge over the horizon, the US treasuries market, the mechanism which with the US government funds itself.  This market exhibits almost all the typical classic signs of an asset bubble, a disconnect from fundamentals and artificial influence like todays announcement of the FED buying long term US treasuries to attempt to prop it up.

Lets say the following person came to you and asked for what amounts to an unsecured loan.

• They currently have debt in excess of 4x their annual income.
• They have spent more money than they've made nearly every year for the last decade.
• They project to spend 72% more than they'll make in the during year with similar losses stretching off into the horizon.
• Their estimated future liabilities are several times their hard assets.

Does this profile look like a person that over the long term is going to be able to make due on that loan?  Would you give them a long term loan?  Yet, the world keeps loaning this person (The US Government) massive amounts of money at what is currently a 2.5% interest rate for a 10 year term.  Need anymore proof the US treasury market is not running off fundamentals?

It's a very similar situation to GM, for which ironically there is this saying, "as GM goes so goes the country".  For several years anyone that looked at GM's balance sheet knew that failure was inevitable.  The only reason they kept operating is that for years people kept loaning them money at insanely low interest rates.  But then in the last year something changed, due to credit market troubles people began questioning whether GM really could fail, the cheap loans dried up and GM was forced back into financial reality.

So why do people loan the US gov. money at 2.5%?  Well it all comes down to safety and the idea that if anyone can make good on their loans, well just because the can.  The fundamentals don't support it, they say failure to pay back these loans in inevitable, it's just a question of when.

But, but the US gov. has a printing press

Oh, we're forgetting one thing, these loans are payable in US currency and the US gov. has this handy machine called a printing press, so they can just print up more money to pay their debt.  Now here's the problem, the US gov prints money, US currency become worse less, inflation goes up and you have to get more interest on your loan or you are loosing money.  So, isn't this just another fundamental disconnect suggesting a growing asset bubble?

When does it pop?

It's notoriously hard to determine the peak of an asset bubble.  Many correctly saw the real estate bubble and predicted it's immanent collapse, several years before it did.  But there are a few common signs, that asset bubbles are nearing their end.

One of them is a peak in "irrational exuberance", that is people believing the bubble will continue for the foreseeable future.  In 2000, the stock market crashed at the same time surveys were showing the highest percentage of people were bullish on the stock market.  What is now seen as the peak of the real estate bubble coincides with surveys showing a similar insane bullishness of real estate.  Same with the recent commodities bubble.  Sentiment in the US treasury market seems to be reaching that same irrational peak with nearly everyone expecting long term treasury rates to stay depressed for the foreseeable future.

Also near peaks you begin to see increasing amounts of artificial manipulation to keep the party going.  Manipulation of earnings statements in 2000, increasingly inventive lending schemes in 05-06.  This is how I view todays announcement by the FED that they will begin buying long-term US treasuries in order to hold down interest rates.  It's an artificial attempt to keep the US treasury bubble inflated, and I take it as a sign this last asset bubble may in fact be nearing it's peak.

So what would the bubble bursting mean?

Well to put it in four words, "Much higher interest rates" and a true funding crisis for the US Government.  Just like with GM, the US government would be rudely jolted out of a financial stupor.  The forced contraction of government spending almost overnight would be rather shocking to put it lightly.