The sub-prime housing bubble of 2008 was a classic bubble.  It almost brought down the world financial system and did cause a recession in the United States that spread to most of the developed world.  But just two years earlier in 2006 almost nobody was predicting that the housing bubble would burst and how much apparent equity would be lost.  One of the things about a financial bubble is that while it lasts it is good for almost everyone involved, so nobody wants it to end and everyone is generally unwilling to look at the underlying faulty assumptions.  So far I’ve written nothing new.  You can read all of this in much more detail in many books on the housing bubble or if you want a historic perspective in Charles MacKay’s classic Extraordinary Popular Delusions and The Madness of Crowds.

Now we get to the new part.  In late November 2012 a headline in the WSJ reported that Mongolia was able to issue $1.5 billion worth of bonds at less than five percent.  If you read the article you found out that Mongolia has defaulted on its debt five times in the last 22 years and yet it was still able to sell new bonds at relatively low interest rates.  It suddenly dawned on me there is a new bubble going on and it is being fueled by the US Federal Reserve.  If Mongolia can borrow at less than five percent based on their record then the financial markets are being distorted.  We are in a government spending bubble.

The Fed, to avoid the deflation that Keynesians say caused the Great Depression, has been increasing the money supply and suppressing interest rates in an unprecedented way for a remarkably long time. Banks are being allowed to hold sovereign debt without reserves and governments are deficit spending without a hope of ever being able to pay it back especially if interest rates rise.  Like in previous bubbles everybody has benefited.  Politicians can spend money without raising taxes, Bankers have access to almost free money and financiers make massive fees for lending money to borrowers, like Mongolia.  This is the sub-prime housing bubble on steroids.

To personalize the horror of this vision.  What should someone with a modest amount of assets now invested in the stock market do to avoid the havoc that will be caused by the government spending bubble bursting?  And is there anything that the same someone can do to benefit from it?  Help.