I'll start 2009 with a bold prediction: within 1-5 years the bond market will crash (by crash I mean at least a 25% fall).

Over Christmas I have had a look at previous FED history since the crash in 1987. I’m no fan of the central banking system of printing money out of thin air. As far as I can see Bernanke is now on his way of creating the mother of all bubbles: the bond market.  

In 1990-92, in response to a recession, the Fed slashed rates. As far as I can see this created a bubble in the bond market by encouraging leverage. In 1994 this “bubble” burst. In 1995, in response to a financial crisis in Mexico, the Fed bailed out a bunch of investors. This created more  moral hazard and helped contribute to a bubble and the subseqeunt meltdown in emerging markets, and later the LTCM disaster in 1998. The Fed slashed rates again, and this might have caused tech stocks to go into an even bigger bubble, exacerbated by further injections of liquidity in anticipation of the Y2K "problem" (it turned out to be a non-problem). This caused the greatest stock bubble in US market history. Now, 9 years later, Nasdaq is still more than 50% lower. Later this was exacerbated by the terror in 2001. When World Trade Center crashed, Greenspan slashed rates to 1% and kept them there for over 2 years after the “recession" ended. This caused the biggest real estate bubble since WWII, which in turn caused our current financial crisis. The falling interest rates since the beginning of the 90s have created too much leverage and too little saving. Greenspan's policies caused huge leveraged investment in artificially strong assets, particularly real estate and equities, since low interest rates prevent savings and encourage leveraging capital as credit is cheap. This caused America to issue massive debt, but used this to finance further consumption rather than production or industry. This led to the formation of a debt bubble, as the United States entered a cycle of consuming foreign exports, issuing debt to its trade partners, and using the debt to consume more of their exports.

As far as I can see, the central bank is the main culprit behind all these bubbles. Of course, there are a lot of factors, but the Fed artificially and needlessly causes bubble after bubble by printing money, which causes bust after bust, which in turn responds to more bubble inflating.

Now the Fed has taken rates to 0-0.25%, and they are now talking about purchasing long-dated Treasuries. This will create a huge bubble in the bond market, perhaps the mother of all bubbles.

As we have seen with prior bubbles, their creation leads to huge market distortion and misallocation of capital for years, followed by an incredibly destructive (eventual) crash. There is no reason to think this pattern will be any different. Treasuries will go to absurdly low yields (10 years treasuries is at 2.1% at this date), become hideously overvalued, suck in lots of savings and investment capital - and later crash.

At sufficiently low yields, the risk of capital loss on Treasuries becomes enormous. 30 year bonds can easily fall 40-50% in a year if the yield gets low enough, say 1%, and then the market crashes. Imagine what a 30-40% hit to bond prices would do to the average retirement portfolio or pension plan. It would be absolute carnage. Worst of all, it would hit the most risk-averse savers, since government bonds are traditionally viewed as a safe investment. However, as we all know, a sufficiently excessive price can turn any investment into an extremely risky one.

The Fed is following its typical behaviour of wreaking utter havoc in the markets and the economy. By trying to fight the last bubble (which it partly created) it is inflating the next. A bubble in the bond market could be even more devastating, once it finally hits, than the real estate bubble. Remember the last serious bond bear market in the late 60s and 1970s - that was a lost decade of inflation, recession, and total annihilation of savings. Many widows and pensioners were put into penury as their retirement funds collapsed due to soaring yields and inflation. A whole generation was effectively wiped out financially. The Fed continually says they will do whatever to avoid a recession – another form of saying printing enough money to inflate the whole problem. Bernanke studied the depression in the 30s and concluded it was due to contraction in the money supply. Now he he is printing all he can to make sure the money supply does not contract. If things stabilizes further down the road, think about the carnage if yields then have to increase.

This latest bubble, and its consequences, are going to cause the greatest financial crime of the 21st century in the western world. Later generations are going to get pounded, and the younger generation are going to end up footing the bill with increased welfare payments. Savings will be close to worthless. All of this because the Fed created 5 bubbles in 15 years and no one did a damn thing to stop them creating thr 6^th (the bond market). Bernanke will go down as the worst Fed chairman since the Great Depression. He will fight the last war, doing way too much to stimulate the economy, and his legacy will be a bubble and bust in the bond market that people will still be writing about in 100 years time!