I think his point is that if Bernanke interferes in the Bond market then you ultimately see a total collapse in the credit markets. The result of this would be mass bankruptcies as businesses are unable to roll over loans. The would certainly represent a very strong deflationary force. However, his argument to that conclusion is a little thin. He makes some good points though - let's try to sort them out.
1) If Bernanke buys treasuries then he'll become the only buyer.
The evidence for this is that buyers dried up in the commercial paper markets when the fed intervened there. But this isn't true. Commercial paper markets froze when Lehmen Brothers collapsed out of fear they wouldn't get their money back. The fed stepped in to supply credit in this case to prevent massive bankruptcies. The idea was to keep money flowing to these companies who rely on short term credit until markets returned to normal a little bit - and the fear factor had ameliorated. So there already were no buyers when the fed stepped in.
The test is to see whether buyers will step back in now that the fed has begun to withdraw (which it is starting to do now). There is about 230 billion worth of fed owned commercial paper expiring this friday apparently. The question will be whether the issuers return to the market or seek to roll it over with the fed. Until this test is completed (and others) we don't actually know what effect on the market the fed's intervention will have had.
Secondly... Denninger ignores the vested interests of state holders of US treasuries. They can't exit out of their positions on a whim - nor would they want to. They wish to protect these assets. This has clearly been China's policy in particular who has continued to buy treasuries.
2)Everyone will sell to the fed...
Not likely - the private investors sure... but again, state holders don't want their assets to evaporate - which they surely would if they even announced an intention to sell.
In fact - when the fed last hinted they were going to buy treasuries the bond market went up in anticipation. Since the fed's presence acts as a guarantee that there will be a buyer at the higher price. As far as I know - no actual purchases by the fed occurred and as a result the bond market is declining again as the market begins to suspect that bernanke is just yanking their chains. He's hit the wire to hint again that he is going to purchase... but note that he has repeatedly said in speeches that all the fed has to do is hint that they will purchase to keep rates low - and the market does all the rest.
Even once this game gets stale and the fed does actually have start buying treasuries - it doesn't mean that they will have to buy all of them. All Bernanke has to do is say - I'll buy at X - and the market will push bonds up to that level. The fed can then buy some treasuries at that point to make good on the promise and let the market fall once again. But it doesn't mean it will tank immediately. Once the price of treasuries have dipped somewhat, you can imagine holders will wait to see if the fed will step in later on to drive prices up again. As such - they'll hold on to get the better prices, preventing a total slide. The hint hint game of the fed can then continue for a while until the market gets impatient again.
This can continue to play for as long as it takes for the government to issue its debt and get its stimulus into place. But if the stimulus fails (as I think it will) and government has to come back to the trough - then both them and the fed will be completely boned.
So I agree with denninger that the end game is coming - but not just yet. We have to wait for the stimulus to fail. If it succeeds, then you can imagine that credit markets will gain confidence and some degree of normalcy will be restored.
3) Fed purchases of gov debt will cause a collapse in the commercial paper market
Largely his argument here is that there will be no point of reference. Well - there will be a point of reference - it'll just be fixed by the fed. Whether or not it is a fair point of reference is another question entirely. Price controls certainly don't lead to efficient and dynamic economies, but they don't immediately lead to collapse either.
Conclusion:
I have previously thought that a collapse in treasuries was imminent - until I saw the effect of the fed hinting. I also thought that this collapse would be inflationary as that money which rushed out of debt would have to rush into 'stuff'. But now I'm not so sure. A swift collapse would see a lot of bond holders wiped out. If the bond market is valued at X trillion... you can't ever take X trillion out of it in the form of cash all at once, because there won't be that many buyers at that price, and what's more there isn't that much cash.
But with the fed interfering what you might see instead is a slow collapse. Each time treasuries drop, then fed will have to step in - printing a little bit of money each time. This might over the long run allow more people to get out of treasuries at a higher price than if a swift collapse eventuated - pumping more money directly into stuff. As inflationary effects will be slow to show - the fed will feel tempted each time to print.. thinking that the extra amounts won't hurt until they realise they crossed the line long ago.
Secondly - a slow collapse would mean that later on down the track, the fed wouldn't be able to sell its treasuries and reduce the money supply. That's when the hyperinflation would presumably kick in...
Whew! this turned out longer than I thought it would.
