Over-Extension of the Risk (Bubble Bonds)

The Fed has managed to keep money cheap and readily available. So how come it has downgraded the economy?

Low yields (high bond prices) indicate a deflationary trend (a declining rate of profit). Since the rate of profit indicates the probability of growth (investment that exceeds the low yield), the Fed sees a low probability for organic growth.

Cash being horded by large, economy-of-scale firms will be used for inorganic growth, which causes a further extension of the risk. Over-extension of the risk not only consolidates market share (alpha risk), but renders small firms less creditworthy.

While inorganic growth reduces risk for big firms (rendering them "too big to fail"), it extends the risk to the rest of the economy. Anything not too big to fail is stuck with maximum risk and minimal reward. Conversely, the reward is maximized by big economy-of-scale firms over-extending the risk.

The extent of the risk is measured by the rate of interest. The risk is scored against the ability to pay (creditworthiness). The less creditworthy, the more interest paid, if you can get it.

When credit extends to match the over-extension of risk, a bubble forms. Thus, the bond rally (the so-called flight to security) is a bubble.

Bubble bonds are secure only because they are backed by the federal government (The Federal Reserve). It measures the risk over-extended into a gamma (crisis) proportion.

In order to avoid the crisis dimension, risk cannot be allowed to extend without the full measure of the reward; and budget deficits, rather than filling the deficit of reward, just extends the risk and bonds it into a bubble that cannot be repaid without the extension of credit--over-extending the risk.