The Coming Derivatives Panic That Will Destroy Global Financial Markets

When financial markets in the United States crash, so does the U.S. economy. Just remember what happened back in 2008. The financial markets crashed, the credit markets froze up, and suddenly the economy went into cardiac arrest. Well, there are very few things that could cause the financial markets to crash harder or farther than a derivatives panic. Sadly, most Americans don't even understand what derivatives are. Unlike stocks and bonds, a derivative is not an investment in anything real. Rather, a derivative is a legal bet on the future value or performance of something else. Just like you can go to Las Vegas and bet on who will win the football games this weekend, bankers on Wall Street make trillions of dollars of bets about how interest rates will perform in the future and about what credit instruments are likely to default. Wall Street has been transformed into a gigantic casino where people are betting on just about anything that you can imagine. This works fine as long as there are not any wild swings in the economy and risk is managed with strict discipline, but as we have seen, there have been times when derivatives have caused massive problems in recent years. For example, do you know why the largest insurance company in the world, AIG, crashed back in 2008 and required a government bailout? It was because of derivatives. Bad derivatives trades also caused the failure of MF Global, and the 6 billion dollar loss that JPMorgan Chase recently suffered because of derivatives made headlines all over the globe. But all of those incidents were just warm up acts for the coming derivatives panic that will destroy global financial markets. The largest casino in the history of the world is going to go "bust" and the economic fallout from the financial crash that will happen as a result will be absolutely horrific. There is a reason why Warren Buffett once referred to derivatives as "financial weapons of mass destruction". Nobody really knows the total value of all the derivatives that are floating around out there, but estimates place the notional value of the global derivatives market anywhere from 600 trillion dollars all the way up to 1.5 quadrillion dollars. Keep in mind that global GDP is somewhere around 70 trillion dollars for an entire year. So we are talking about an amount of money that is absolutely mind blowing. So who is buying and selling all of these derivatives? Well, would it surprise you to learn that it is mostly the biggest banks? According to the federal government, four very large U.S. banks "represent 93% of the total banking industry notional amounts and 81% of industry net current credit exposure." These four banks have an overwhelming share of the derivatives market in the United States. You might not be very fond of "the too big to fail banks", but keep in mind that if a derivatives crisis were to cause them to crash and burn it would almost certainly cause the entire U.S. economy to crash and burn. Just remember what we saw back in 2008. What is coming is going to be even worse. It would have been really nice if we had not allowed these banks to get so large and if we had not allowed them to make trillions of dollars of reckless bets. But we stood aside and let it happen. Now these banks are so important to our economic system that their destruction would also destroy the U.S. economy. It is kind of like when cancer becomes so advanced that killing the cancer would also kill the patient. That is essentially the situation that we are facing with these banks. It would be hard to overstate the recklessness of these banks. The numbers that you are about to see are absolutely jaw-dropping. According to the Comptroller of the Currency, four of the largest U.S. banks are walking a tightrope of risk, leverage and debt when it comes to derivatives. Just check out how exposed they are... JPMorgan Chase Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars) Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars) Citibank Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars) Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars) Bank Of America Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars) Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars) Goldman Sachs Total Assets: $114,693,000,000 (a bit more than 114 billion dollars - yes, you read that correctly) Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars) That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets. To get a better idea of the massive amounts of money that we are talking about, just check out this excellent infographic. How in the world could we let this happen? And what is our financial system going to look like when this pyramid of risk comes falling down? Our politicians put in a few new rules for derivatives, but as usual they only made things even worse. According to Nasdaq.com, beginning next year new regulations will require derivatives traders to put up trillions of dollars to satisfy new margin requirements. Swaps that will be allowed to remain outside clearinghouses when new rules take effect in 2013 will require traders to post $1.7 trillion to $10.2 trillion in margin, according to a report by an industry group. The analysis from the International Swaps and Derivatives Association, using data sent in anonymously by banks, says the trillions of dollars in cash or securities will be needed in the form of so-called "initial margin." Margin is the collateral that traders need to put up to back their positions, and initial margin is money backing trades on day one, as opposed to variation margin posted over the life of a trade as it fluctuates in value. So where in the world will all of this money come from? Total U.S. GDP was just a shade over 15 trillion dollars last year. Could these rules cause a sudden mass exodus that would destabilize the marketplace? Let's hope not. But things are definitely changing. According to Reuters, some of the big banks are actually urging their clients to avoid new U.S. rules by funneling trades through the overseas divisions of their banks... Wall Street banks are looking to help offshore clients sidestep new U.S. rules designed to safeguard the world's $640 trillion over-the-counter derivatives market, taking advantage of an exemption that risks undermining U.S. regulators' efforts. U.S. banks such as Morgan Stanley (MS.N) and Goldman Sachs (GS.N) have been explaining to their foreign customers that they can for now avoid the new rules, due to take effect next month, by routing trades via the banks' overseas units, according to industry sources and presentation materials obtained by Reuters. Unfortunately, no matter how banks respond to the new rules, it isn't going to prevent the coming derivatives panic. At some point the music is going to stop and some big financial players are going to be completely and totally exposed. When that happens, it might not be just the big banks that lose money. Just take a look at what happened with MF Global. MF Global has confessed that it "diverted money" from customer accounts that were supposed to be segregated. A lot of customers may never get back any of the money that they invested with those crooks. The following comes from a Huffington Post article about the MF Global debacle, and it might just be a preview of what other investors will go through in the future when a derivatives crash destroys the firms that they had their money parked with... Last week when customers asked for excess cash from their accounts, MF Global stalled. According to a commodity fund manager I spoke with, MF Global's first stall tactic was to claim it lost wire transfer instructions. Then instead of sending an overnight check, it sent the money snail mail, including checks for hundreds of thousands of dollars. The checks bounced. After the checks bounced, the amounts were still debited from customer accounts and no one at MF Global could or would reverse the check entries. The manager has had to intervene to get MF Global to correct this. How would you respond if your investment account suddenly went to "zero" because the firm you were investing with "diverted" customer funds for company use and now you have no way of recovering your money? Keep an eye on the large Wall Street banks. In a previous article, I quoted a New York Times article entitled "A Secretive Banking Elite Rules Trading in Derivatives" which described how these banks dominate the trading of derivatives... On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan. The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential. According to the article, the following large banks are represented at these meetings: JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup. When the casino finally goes "bust", you will know who to blame. Without a doubt, a derivatives panic is coming. It will cause the financial markets to crash. Several of the "too big to fail" banks will likely crash and burn and require bailouts. As a result of all this, credit markets will become paralyzed by fear and freeze up. Once again, we will see the U.S. economy go into cardiac arrest, only this time it will not be so easy to fix. Do you agree with this analysis, or do you find it overly pessimistic? Please feel free to post a comment with your thoughts below... Source

Yuan Reserve? We're not Betting on It

How the Yuan Could Take the Dollar's Crown ... China could eclipse the United States sooner than many think as the yuan (renminbi) becomes a major player on the word stage that could put the dollar in the shade. – CNBC

Dominant Social Theme: China is a super power waiting to take over the world.

Free-Market Analysis: CNBC tells us that the Chinese yuan could soon overtake the dollar as the world's reserve currency. It's a common perception because China has expanded so rapidly over the past 40 years.

China has truly experienced a great leap forward, though we're on record as questioning how much is due to expansive monetary policy and how much is due to the innate healthiness of the socio-political, entrepreneurial and economic system. (We've often stated we think central bank monopoly money has a lot to do with China's Greatest Leap Forward.)

In a sense this issue about the yuan reserve currency is a kind of shorthand meme for the progress of China itself. The power elite wants to make clear how formidable a competitor China is to the West. The yuan provides a platform for a subdominant social theme: Even the Red Dragon's money could topple King Dollar. How powerful is that!

In fact, we don't see it. We've been expecting a "landing" that is harder rather than softer because of the immense amount of currency that has been pumped into the Chinese system. So we don't see it. The dollar may topple from its perch but not because the yuan displaces it. Reserve currencies don't work that way.
It's true that China has considerable heft on the world stage. China is now the world's second biggest economy and its currency is similarly enhanced. The yuan – also called the renminbi for international purposes – is being positioned several ways from an international perspective.

First, Chinese officials are using it for trade-settlements purposes, then for investing and, finally, they are trying to encourage other countries to use it as a reserve.

The Chinese have created swap deals agreed with Australia, Russia, Japan and Brazil, according to the article. The Japanese yen is exchangeable, as well. And the dominant economic power in Asia is no longer Japan but China.

Here's some more from the article:

In 2009 China allowed its currency to be partially convertible outside the country, setting up the offshore deliverable-CNY market for Hong Kong (the CNH) which will likely spread to other jurisdictions. RBS reports that from a basis of nearly zero four years ago CNH-denominated deposits now total some 500 billion.

"Economic prowess has clearly shifted from Japan to China," analysts at Citi said in a research note. "Hence policymakers in Asia are more wary of relative strength of their currencies versus China than Japan."

Simon Derrick, chief currency strategist for BNY Mellon, has been tracking the foreign currency reserves China holds and has kept a keen eye on policy announcements by the country's politburo.
He highlights a marked decrease in growth of foreign currency reserves the country holds. September's third quarter figure showed foreign exchange growth of 2.76 percent year-on-year. Last year the same figure showed 20.9 percent growth."

... All this suggests that the first quarter of next year could prove an interesting one. Although further clues (one way or another) will likely surface through January and February, the most likely point for an announcement will come on or around March 14," he said, adding that the date was significant as it coincides with the National People's Congress in Beijing.

There are other views, however. Larry Edelson, financial analyst at Weiss Research is quoted as saying, "The world is headed toward a new reserve currency, either backed by the IMF SDRs (special drawing rights), or some other neutral basket."

We would tend to agree with this.

The next step is not a reserve Chinese currency but a global currency.

Setting up another country reserve system is probably not going to happen. Special circumstances contributed to the dollar reserve in the first place.

The US dollar reserve system is based on the Saud family declaring to the world that oil is to be priced in dollars. For this reason, countries have had to hold dollars.

That system is eroding now. But there is still no compelling reason for the countries of the world to hold Chinese currency. It is not, strictly speaking, a "reserve."

Conclusion: Next stop, a global SDR basket of currencies?

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New Rules For Life Insurers – “Future Generations Have To Deal With The Financial Carnage”

Yves here. Most people don’t think much about the life insurance industry, precisely because it has managed to be what financial services should be: boring and safe. Insurance is particularly prone to abuse, since customers pay money up front and submit claims (or in the case of investment products, get payouts) much later.

As Wolf Richter warns us, the insurance industry just approved new rules which will allow them to keep lower reserves, which is that industry’s analogue to bank capital. And the aim of this change is to allow insurers to engage in more speculation. Nothing like choosing to rely on the playbook that gave us the global financial crisis, now is there?

By Wolf Richter, San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.

During the off-hours on Sunday, when few people were willing to ruin whatever remained of their weekend, when even astute observers weren’t supposed to pay attention, the National Association of Insurance Commissioners approved new rules that would allow life insurance companies to lower their reserves for future claims.

Executives claimed that they could put that capital to “more productive uses,” such as blowing it on stock buybacks and acquisitions or plowing it into subprime-based CDOs or Greek sovereign debt, or whatever, to goose their paper returns—having already forgotten all about the financial crisis.

“The insurance industry weathered the financial crisis well precisely because of the careful reserving state regulators have historically required,” said Benjamin Lawsky, superintendent of the New York Department of Financial Services. “To ignore the lessons of the financial crisis and deregulate the industry, allowing them to keep less in reserves, is unwise.”

Others were less sanguine. Joseph Belth, Insurance Forum editor and professor emeritus of insurance at Indiana University, worried that “future generations of executives, regulators, and consumers will have to deal with the financial carnage.”

There are salient precedents. The Glass-Steagall Act, after decades of being reinterpreted and watered down—and finally gutted by Citibank’s foray into investment banking and insurance—was repealed in 1999. The business of finance boomed, banks ballooned, Wall Street printed paper profits, and bonuses skyrocketed. Less than a decade later, the financial crisis laid waste to the world economy. Before it, there was the S&L crisis, brought on by a series of challenges that culminated in the deeply troubled industry’s deregulation in the early 1980s. With disastrous consequences.

The Insurance industry had lobbied for the change for almost a decade. The existing rules used formulas that were “far too conservative,” life insurers maintained, according to the Wall Street Journal. Instead, the industry would implement a “principles-based” system that would use computer models—algos and “fat fingers” come to mind—to figure out how large the reserves would have to be; or rather, just how small they could be. Because rationalizing “lower reserves in the aggregate”—as Lawsky’s deputy Robert Easton called it—had after all been the goal of the lobbying campaign.
California Insurance Commissioner Dave Jones fretted about the “very complicated black-box models”—that their mathematics might be impenetrable for state regulators who then would not be capable of overseeing that “principles-based” system. Whether or not that was one of the underlying motivations for the industry remains to be seen.

Granted, it’s been tough for life insurers. Their investment returns have gotten hammered by the evil twins of a lumpy economy and the Fed’s Zero Interest Rate Policy. Initially classified as “exceptional,” ZIRP has now been in effect for four years, and its expiration date keeps getting kicked further into the future. It has brought down bond yields across the spectrum to where returns on all but junk are negligible, a process that has been draining the reserves of life insurers—just like it has been fleecing the Social Security trust fund and savers. So the thinking went, with lower reserve requirements, insurers could divert some capital to speculate in riskier assets that might offer a greater return. It would dope their paper profits and make Wall Street smile. For a while. We’ve seen this movie before.

But it’s not yet a done deal. The National Association of Insurance Commissioners, which is composed of state regulators, sets solvency standards that states may then adopt in regulating insurers. The idea is to come up with a common set of standards for all 50 states. However, states don’t have to follow the decision. And it’s unlikely that all of them will. Of the 56 members, 43 voted to approve this change. Regulators in California and New York voted against it. And in states where lawmakers refuse to adopt the new reserving requirements, life insurers would establish subsidiaries whose reserves would conform to the rules of that state.

While some life insurers might continue to be conservative under the new rules, others will venture out towards the thin end of the limb to chase paper profits from quarter to quarter. And they’re doing it just when the industry is staring at an unprecedented and brutal demographic reality: insured baby boomers aren’t going to live forever, and life-insurance payouts are going to jump to historic records.
The temptation is huge to tweak the math of the “black-box models”—as California Insurance Commissioner Dave Jones called it—to bury that reality until the bitter end. It took Wall Street less than a decade to explode, counting from the repeal of the Glass-Steagall Act. Home many years will it take the life-insurance industry after the new rules go into effect? One thing we know already: when it explodes, no one will be held responsible. Because everyone followed the rules.

Every country in the Eurozone has its own set of big fat lies that politicians and eurocrats have served up to make the euro and subsequent bailouts or austerity measures less unappetizing. Like in 1999: “Can Germany be held liable for the debts of other countries? A very clear No!” said the CDU, the party of Chancellor Angela Merkel. Read…. Ten Big Fat Lies To Keep The Euro Dream Alive.

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Next Up For A "Recovering" Europe: A 30-50% Collapse In Wages In Spain, Italy And... France

Several weeks ago Europe officially entered a double dip recession, and based on various secondary economic indicators, even Europe’s primary economic powerhouse, Germany, is on the verge of negative economic growth. The reasons for Europe’s woeful macroeconomic state are numerous, but boil down to two primary ones: i) massive external imbalances among Eurozone nations (think soaring peripheral debt) coupled with the inability to devalue the common currency as that would mean a failure and collapse of the joint currency union, ii) a desperate need for the periphery to regain price competitiveness (via wages and labor costs) with Germany in order to arrest and collapse an unemployment rate (general, but especially youth) that not even the most optimistic pundits dare claim is sustainable.

Said otherwise, most European countries (including France) face a desperate need for external devaluation, which is impossible under a monetary union, leaving only internal devaluation as an option. This is where the much maligned concept of austerity comes in:  from a macroeconomic perspective, austerity is not so much an exercise at moderating the pace of debt increase (as neither Spain nor Italy have reduced their rate of debt issuance), but of gradually becoming more price competitive with Germany: a key outcome that will be needed for the Eurozone to have any chance of survival, i.e., lowering sticky unemployment rates from levels that virtually assure social "disturbances" in the months and years ahead.

And herein lies the rub: because while protests against “austerity” (which as we observed recently has still not been truly implemented in Europe, and certainly not in Portugal or Spain) are a daily event in most PIIGS nations, “you ain’t seen nothing yet.“ The reason: to achieve the unavoidable macroeconomic rebalancing, and to collapse the spread between soaring labor costs in the periphery and those of Germany (see chart below), the bulk of European countries will need to see wages collapse by anywhere between 30% and 50% to compensate for the lack of state-level currency devaluation optionality. And yes, this includes France.

Goldman’s Huw Pill explains the scary future facing peripheral European workers:

We ask the following question: For the Euro area countries of interest, how big a real exchange rate depreciation (which (to recall) in monetary union means (to a first approximation) a relative wage cut) is required in order to establish a sustainable external position .…

The results of our exercise are shown below. They demonstrate that relying solely on internal devaluations to correct existing imbalances implies a need for very large wage and cost adjustments. For the small and vulnerable peripheral countries (Greece and Portugal), we would need to see wages fall by at least 50% relative to Germany (from their level at the start of 2011) if this mechanism alone were to re-establish external sustainability. And even for larger and richer countries such as Spain and France, relative wage reductions (on a comparable basis) of 30%+ are needed.

Which begs the question: how will the long-suffering workers of Greece, Spain, and Italy (and also France), who are confident they have gone to the 9th circle of hell in the past 4 years, react when they realize that none of the needed internal devaluation has actually taken place yet?

In other words, what happens when Spanish wages tumble by another 30%, as they must if the EUR, and the Eurozone, is to survive? Alternatively, if there are no labor cost cuts, how many more years and months of 1%/month unemployment increases will the unemployed in the periphery suffer before it realizes that chronic 25%+ unemployment is here to stay, as is the European Depression. What is most sad is that the economic reality is that regardless of the “all clear” that central-bank-manipulated market indicators tell us, the European imbalances continue deteriorating at a rapid pace.

And the paradox is that as long as market indicators aren’t flashing red, no politician has the urge to enact the critical laws needed to fix the underlying problem, as that same fix will lead to an immediate end of said politician’s career.  

Needless to say, not even Goldman thinks that kindly asking for Greek and Spanish workers to take another 30-50% pay cut is feasible and would lead to anything short of revolution (and the alternative: asking Germany to adopt a wage increase and watch German inflation surge is just as ludicrous):

We view relative wage cuts of this magnitude as unfeasible: it is difficult to imagine France accepting a one-third fall in living standards relative to Germany. Of course, one could rely on Germany to raise wages, so as to redress the competitiveness gap from the other side. But ultimately such an approach would imply Germany accepting much higher rates of inflation, say above 4% pa for a decade or more, assuming the ECB met its target of keeping area-wide inflation close to 2%. We doubt the German public would countenance such an eventuality….

So does this mean that despite all best efforts to the contrary, when one looks beyond the daily hollow rhetoric emanating from Brussels and focuses on the simple economics of it all, that the Eurozone is doomed? While our pessimistic opinion on the viability of the failed European project is well-known, not even Goldman can bring much words of encouragement:

To answer that question, we need to explore the implications of relaxing some of the assumptions that underlie the exercise described above. First, we could implement the necessary relative wage adjustment through resort to nominal exchange rate changes. But allowing exchange rates to vary implies exit from the Euro area and reintroduction of national currencies. Relying on this mechanism implies recognising the impracticality of the euro, rather than describing how it can be saved.

Second, uncompetitive economies could suppress domestic demand to contain imports and run with mass unemployment on an ongoing basis. In our view, this is not politically feasible. British experience in the late 1920s (following Winston Churchill’s decision to put Britain back on the Gold Standard at its pre-first World War parity) demonstrates as much. High unemployment, recessionary conditions and lost export markets were the precursors to abandoning gold rather than mechanisms for sustaining British adherence to it. One would expect as much for the Euro area periphery: if mass unemployment become endemic and permanent, it would eventually precipitate euro exit.

Third, uncompetitive peripheral countries could be subsidised on an ongoing basis by the more competitive surplus countries, i.e., a system of fiscal transfers from north to south could close the current account deficit and eliminate the existing imbalances. Such mechanisms are quite normal in continental monetary unions: witness the transfers from wealthy New York to poorer West Virginia via the federal government in the United States.

But the institutional mechanisms and political support for such area-wide redistribution are (as yet, still) lacking in the Euro area.

It is worth pointing out that the ad hoc and very much informal (after all Merkel’s reelection chances are much lower if the German people understand what is really happening in Europe) transfer union has worked so far primarily because it funded the relatively modest economy of Greece. Yet even ordinary Germans understand that the Bundesbank’s TARGET2 claims are nothing more than Germany’s implicit fiscal transfer mechanism to the rest of Europe (one which happens to benefit German exporters: i.e., a public to private transfer scheme), one which is soaring by tens of billions each month.

To be sure all such indefinite ad hoc attempts to delay the day of “labor-cost equivalency”-reckoning using piecemeal and incomplete fiscal transfers from Germany to everyone else, will one day fail, when surging nationalist parties across Europe just say “nein” to ceding sovereignty to Germany which will eventually demand all Europe bow down to it in exchange for a full-blown fiscal union and Eurobond initiative in which Germany officially bears the cost of “temporary-to-permanent” Current Account imbalances, by shifting from TARGET2 to a wholesale German-funded fiscal union. This “unthinkable scenario” is quite thinkable by most, especially Europe, but in this case certainly Goldman:

A number of the options listed above are feasible for the smaller peripheral countries. Since the magnitude of structural change required to make them sustainable is so large (and the institutional capacity to implement those changes open to question), it is likely that we will see a prolonged period of both mass unemployment and subsidisation if they are to remain within the Euro area. This has been the experience thus far. Indeed, recent discussions over the terms of financial support for Greece in Brussels can be seen as a codification of how the subsidies will be provided in that case.

At the same time, we should not ignore the possibility of exit: were the rest of the Euro area to develop sufficient robustness to manage the transition, one could easily imagine a Euro without Greece or Cyprus.

But for the larger countries, options are much more limited. It is unthinkable to have a Euro area without France; at that point, it would become little more than a greater Deutsch mark zone. The politics of perpetual mass unemployment are equally infeasible as in the small peripheral countries. And France and Spain are simply too large to subsidise on an ongoing basis. So there is no alternative but to implement a restructuring of the economies to reduce the needed real depreciation to a plausible level. But the nature of the restructuring needs to be tailor-made for the country concerned.

The only good news to date, if one may call it so, is that Spain has already taken some modest steps to address its internal devaluation. However that former AAA-stalwart, and now bastion of resurgent socialism, France has not. And it is here that those who took offense to that recent edition of The Economist with the ticking time baguette cover should be paying attention.

Spain’s economy is weak and vulnerable at present. But while of little comfort to those unemployed, there is a silver lining to that weakness: it is associated with a necessary restructuring that offers hope of a more balanced and competitive Spanish economy in the future.

Unfortunately, there are reasons for greater caution with regard to developments in France. Like Spain, France also needs to shift resources into the tradable sector in order to reduce its chronic and deteriorating current account deficit. But France’s problem is not a bias towards the construction sector as in Spain, but rather a bloated public sector. Public expenditure in France is 56% of GDP, compared with 47% in Germany: the inherently domestic-oriented nature of government spending implies that France produces too few tradable goods relative to Germany.

In Spain, a largely spontaneous bursting of the housing bubble initiated the necessary restructuring of the economy. But in France a conscious political decision to shrink the state is needed to achieve the restructuring. And the political obstacles to that decision are high. While the French authorities increasingly recognise the need to improve French competitiveness, developing an understanding that this implies a deep restructuring of the economy remains elusive, at least at the political level, as recent discussion of industrial policy attests.

And then there is that other wildcard: the UK. As CLSA’s Chris Wood writes in his latest edition of Fear and Greed:

Europe, the path ahead for the Eurozone was made crystal clear with a plan unveiled by European Commission President Jose Manuel Barroso on Wednesday, outlining the need for an overhaul of Eurozone institutions to pave the way for the collective issuance of debt. This fits GREED & fear’s base case; namely that the Eurozone is moving towards “debt mutualisation”, a  process which will ultimately lead to fiscal union. This week’s “deal” on Greece, with its extension of maturities and lowering of interest rates, is a further indication of the political determination to keep the Eurozone going in its present form and the unwillingness to contemplate the stresses of a Greek exit.

The above is also why the real political tension triggered by the direction in which the Eurozone has now embarked will turn out to be in Britain, not Spain or Greece. This is because there is real antagonism towards the Eurozone in Britain whereas in Greece and Spain the majority of people continue not to blame the euro for their problems. This is why it is possible that the Eurozone can make a deflationary adjustment, as indicated by the periphery countries’ improving current accounts. It is also why Britain’s fresh-faced Prime Minister, David Cameron,has a political problem.

All of the above is correct: the true European fulcrum nations have now shifted from the PIIGS to France and the UK, but it will take some time for this to become evident. What is unclear is the question of timing. And with Europe hell bent on actually addressing the real underlying causes for its persistent recessionary state instead of merely attacking the symptoms (soaring yield spreads, plunging equity markets, diving EUR FX rate), one can be sure nothing will change as long as the ECB gives the impression that European imbalances are under control, courtesy of a bond purchase backstop, which sooner or later will be activated at which point this too threat will become reality, and like QEternity, will lose all potency.

It is only then that Europe will have some hope of finally addressing that which is the true basis for its unsustainability: the internal imbalances which in the absence of currency adjustments can only be addressed through collapsing labor costs, and wages.

Yet telling a continent, which in its desperation is hopeful and confident that the worst is behind it (as its lying politicians take every opportunity to note) that the most acute of standard of living collapses is yet to come, is borderline cruel and unusual. So we will just keep our mouths shut and let Europe’s politicians bring this depressing message to their people. We are confident the reaction will be more than dignified.

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Gold: The Solution To The Banking Crisis?

The Basel Committee on Banking Supervision is an exclusive and somewhat mysterious entity that issues banking guidelines for the world’s largest financial institutions. It is part of the Bank of International Settlements (BIS) and is often referred to as the Central Banks’ central bank. Ever since the financial meltdown four years ago, the Basel Committee has been hard at work devising new international regulatory rules designed to minimize the potential for another large-scale financial meltdown. The Committee’s latest ‘framework’, as they call it, is referred to as “Basel III”, and involves tougher capital rules that will force all banks to more than triple the amount of core capital they hold from 2% to 7% in order to avoid future taxpayer bailouts. It doesn’t sound like much of an increase, and according to the Basel group’s own survey, the 100 largest global banks will only require approximately €370 billion in additional reserves to comply with the new regulations by 2019. Given that the Spanish banks alone are believed to need well over €100 billion today simply to keep their capital ratios in check, it is hard to believe €370 billion will be enough protect the world’s “too-big-to-fail” banks from future crises, but it is indeed a step in the right direction.

Initial implementation of Basel III’s capital rules was expected to come into effect on January 1, 2013, but US banking regulators issued a press release on November 9th stating that they wouldn’t meet the deadline, citing a large volume of letters (ie. complaints) received from bank participants and a “wide range of views expressed during the comment period”. It has also been revealed that smaller US regional banks are loath to adopt the new rules, which they view as overly complicated and potentially devastating to their bottom lines. The Independent Community Bankers of America has even requested a Basel III exemption for all banks with less than $50 billion in assets,“in order to avoid large-scale industry concentration that would curtail credit for consumers and business borrowers, especially in small communities.” The long-term implementation period for all Basel III measures actually extends to 2019, so the delays are not necessarily meaningful news, but they do illustrate the growing rift between the US banking cartel and its European counterpart regarding the Basel III framework. JP Morgan’s CEO Jamie Dimon is on record having referred to Basel III regulations as “un-American” for their favourable treatment of European covered bonds over US mortgage-backed securities. Readers may also remember when Dimon was caught yelling at Mark Carney, Canada’s (soon to be former) Central Bank Governor and head of the Financial Stability Board, during a meeting in Washington to discuss the same topic. More recently, Deutsche Bank’s co-chief executive Juergen Fitschen suggested that the US regulators’ delay was “hurting trans-Atlantic relations” and creating distrust... stating, “when the whole thing is called un-American, I can only say in disbelief, who can still believe in this day and age that there can be purely European or American rules.” Suffice it to say that Basel III implementation has not gone as smoothly as planned.

One of the more relevant aspects of Basel III for our portfolios is its treatment of gold as an asset class. Documents posted by the Bank of International Settlements (which houses the Basel Committee) and the United States FDIC have both referenced gold as a “zero percent risk-weighted item” in their proposed frameworks, which has launched spirited rumours within the gold community that Basel III may define gold as a “Tier 1” asset, along with cash and AAA-government securities. We have discovered in delving further that gold’s treatment in Basel III is far more complicated than the rumours suggest, and is still, for all intents and purposes, very much undecided. Without burdening our readers with the turgid details, it turns out that the reference to gold as a “zero-percent risk-weighted item” only relates to its treatment in specific Basel III regulation related to the liquidity of bank assets vs. its liabilities. (For a more comprehensive explanation of Basel III’s treatment of gold, please see the Appendix). But what the Basel III proposals do confirm is the regulators’ desire for banks to improve their liquidity position by holding a larger amount of “high-quality”, liquid assets in order to improve their overall solvency in the event of another crisis.

Herein lies the problem, however: the Basel III regulators have stubbornly held to the view that AAA-government securities constitute the bulk of those high quality assets, even as the rest of the financial world increasingly realizes they are anything but that. As banks move forward in their Basel III compliance efforts, they will be forced to buy ever-increasing amounts of AAA-rated government bonds to meet post Basel III-compliant liquidity and capital ratios. As we discussed in our August newsletter entitled, “NIRP: The Financial System’s Death Knell”, the problem with all this regulation-induced buying is that it ultimately pushes government bond yields into negative territory - as banks buy more and more of them not because they want to but because they have to in order to meet the new regulations. Although we have no doubt in the ability of governments’ issue more and more debt to satiate that demand, the captive purchases by the world’s largest banks may turn out to be surprisingly high. Add to this the additional demand for bonds from governments themselves through various Quantitative Easing programs… AND the new Dodd Frank rules, which will require more government bonds to be held on top of what’s required under Basel III, and we may soon have a situation where government bond yields are so low that they simply make no sense to hold at all. This is where gold comes into play.

If the Basel Committee decides to grant gold a favourable liquidity profile under its proposed Basel III framework, it will open the door for gold to compete with cash and government bonds on bank balance sheets – and provide banks with an asset that actually has the chance to appreciate. Given that US Treasury bonds pay little to no yield today, if offered the choice between the “liquidity trifecta” of cash, government bonds or gold to meet Basel III liquidity requirements, why wouldn’t a bank choose gold? From a purely ‘opportunity cost’ perspective, it makes much more sense for a bank to improve its balance sheet liquidity profile through the addition of gold than it does by holding more cash or government bonds – if the banks are given the freedom to choose.

The world’s non-Western central banks have already embraced this concept with their foreign exchange reserves, which are vulnerable to erosion from ‘Central Planning’ printing programs. This is why non-Western central banks are on track to buy at least 500 tonnes of net new physical gold this year, adding to the 440 tonnes they collectively purchased in 2011. In the un-regulated world of central banking, gold has already been accepted as the de-facto forex diversifier of choice, so why shouldn’t the regulated commercial banks be taking note and following suit with their balance sheets? Gold is, after all, one of the only assets they can all own simultaneously that will actually benefit from their respective participation through pure price appreciation. If banks all bought gold as the non-Western central banks have, it is likely that they would all profit while simultaneously improving their liquidity ratios. If they all acted in concert, gold could become the salvation of the banking system. (Highly unlikely… but just a thought).

So far there have only been two banking jurisdictions that have openly incorporated gold into their capital structures. The first, which may surprise you, is Turkey. In an unconventional effort to increase the country’s savings rate and propel loan growth, Turkish Central Bank Governor Erdem Basci has enacted new policies to promote gold within the Turkish banking system. He recently raised the proportion of reserves Turkish banks can keep in gold from 25 percent to 30 percent in an effort to attract more bullion into Turkish bank accounts. Turkiye Garanti Bankasi AS, Turkey’s largest lender, now offers gold-backed loans, where “customers can bring jewelry or coins to the bank and take out loans against their value.” The same bank will also soon “enable customers to withdraw their savings in gold, instead of Turkish lira or foreign exchange.” Basci’s policies have produced dramatic results for the Turkish banks, which have attracted US$8.3 billion in new deposits through gold programs over the past 12 months - which they can now extend for credit. Governor Basci has even stated he may make adjusting the banks’ gold ratio his main monetary policy tool.

The other banking jurisdiction is of course that of China, which has long encouraged its citizens to own physical gold. Recent reports indicate that the Shanghai Gold Exchange is planning to launch an interbank gold market in early December that will “pilot with Chinese banks and eventually be open to all.” Xie Duo, general director of the financial market department of the People’s Bank of China has stated that, “[China] should actively create conditions for the gold market to become integrated with the international gold market,” which suggests that the Chinese authorities have plans to capitalize on their growing gold stockpile.

It is also interesting to note that China, of all countries, has been adamant that its 16 largest banks will meet the Basel III deadline on January 1, 2013. We can’t help but wonder if there is any connection between that effort and China’s recent increase in physical gold imports. Could China be positioning itself for the day Western banks finally realize they’d prefer gold over Treasuries? Possibly – and by the time banks figure it out, China may have already cornered most of the world’s physical gold supply.

If global banks’ are realistically going to improve their balance sheet diversification and liquidity profiles, gold will have to be part of that process. It is ludicrous to expect the global banking system to regain a sure footing through the increased ownership of government securities. If anything, we are now at a time when banks should do their utmost to diversify away from them, before the biggest “crowded trade” of all time begins to unravel itself. Basel III liquidity rules may be the start of gold’s re-emergence into mainstream commercial banking, although it is still not guaranteed that the US banking cartel will adopt all of the Basel III measures, and they still have years to hammer out the details. If regulators hold firm in applying stricter liquidity rules, however, gold is the only financial asset that can satisfy those liquidity requirements while freeing banks from the constraints of negative-yielding government bonds. And while it strikes us as somewhat ironic that the banking system may be forced to turn to gold out of sheer regulatory necessity, that’s where we see the potential in Basel III. After all – if the banks are ultimately interested in restoring stability and confidence, they could do worse than holding an asset that has gone up by an average of 17% per year for the last 12 years and represented ‘sound money’ throughout history.
Appendix: Gold’s treatment in Basel III

Basel III is a much more complex “framework” than Basel I or II, although we do not claim to be experts on either. It should also be mentioned that Basel II only came into effect in early 2008, and wasn’t even adopted by the US banks on its launch. Post-meltdown, Basel III is the Basel Committee’s attempt to get it right once and for all, and is designed to provide an all-encompassing, international set of banking regulations designed to avoid future bailouts of the “too-big to fail” banks in the event of another financial crisis.

Without going into cumbersome details, under the older Basel framework (Basel I), the lower the “risk weighting” regulators applied to an asset class, the less capital the banks had to set aside in order to hold it. CNBC’s John Carney writes, “The earlier round of capital regulations… government-rated bonds rated BBB were given 50 percent riskweightings. A-rated bonds were given 20 percent risk weightings. Double A and Triple A were given zero risk weightings — meaning banks did not have to set aside any capital at all for the government bonds they held.” Critics of Basel I argued that the risk-weighting system compelled banks to overweight their exposure to assets that had the lowest riskweightings, which created a herd-like move into same assets. This was most evident in their gradual overexposure to European sovereign debt and mortgage-backed securities, which the regulators had erroneously defined as “low-risk” before the meltdown proved them to be otherwise. The banks and governments learned that lesson the hard way.

Basel III (and Basel II) takes the same idea and complicates it further by dividing bank assets into two risk categories (credit and market risk) and risk-weighting them depending on their attributes. Just like Basel I, the higher the “riskweight” applied to an asset class, the more capital the bank is required to hold to offset them.

It is our understanding that gold’s reference as a “zero percent risk-weighted asset” in the FDIC and BIS literature only applies to gold’s “credit risk” - which makes perfect sense given that gold isn’t anyone’s counterparty and cannot default in any way. Gold still has “market-risk” however, which stems from its price fluctuations, and this results in the bank having to set aside capital in order to hold it. So for banks who hold physical gold on their balance sheet (and we don’t know of any who do, other than the bullion dealers), the gold would not be treated the same as cash or AAA-bonds for the purposes of calculating their Tier 1 ratio. This is where the gold community’s conjecture on gold as a “Tier 1” asset has been misleading. There really isn’t such a thing as a “Tier 1” asset under Basel III. Instead, “Tier 1” is merely the ratio that reflects the capital supporting a bank’s risk-weighted assets.

HOWEVER, Basel III will also be adding an entirely new layer of regulation concerning the relative liquidity of the bank’s assets and liabilities. This will be reflected in two new ratios banks must calculate starting in 2015: the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).

Just as Basel III requires risk-weights for the asset side of a bank’s balance sheet (based on credit risk and market risk), Basel III will also soon require the application of risk-weights to be applied to the LIQUIDITY profile of both the assets and liabilities held by the bank. The idea here is to address the liquidity constraints that arose during the 2008 meltdown, when banks suffered widespread deposit withdrawals just as their access to wholesale funding dried up.

This is where gold’s Basel III treatment becomes more interesting. Under the proposed LIQUIDITY component of Basel III, gold is currently labeled with a 50% liquidity “haircut”, which is the same haircut that is applied to equities and bonds. This implicitly assumes that gold cannot be easily converted into cash in a stressed period, which is exactly the opposite of what we observed during the crisis. It also requires the bank to maintain a much more stable source of funding in order to hold gold as an asset on its balance sheet. Fortunately, there is a strong chance that this liquidity definition for gold may be changed. The World Gold Council has in fact been lobbying the Basel Committee, the Federal Reserve and the FDIC on this issue as far back as 2009, and published a paper arguing that gold should enjoy the same liquidity profile as cash or AAA-government securities when calculating Basel III’s LCR and NSFR ratios. And as it turns out, the liquidity definitions that will guide banks’ LCR and NSFR calculations have not yet been finalized by the Basel Committee. The Basel III comment period that ended on October 22nd resulted in the deadline being pushed back to January 1, 2013, and given the recent delays with the US bank regulators, will likely be postponed even further next year. Of specific interest to us is how the Basel Committee will treat gold from a liquidity-risk perspective, and whether they decide to lower gold’s liquidity “haircut” from 50% to something more reasonable, given gold’s obvious liquidity superiority over that of equities and bonds.

The only hint we’ve heard thus far has come from the World Gold Council itself, which suggested in an April 2012 research paper, and re-iterated on a recent conference call, that gold will be given a 15% liquidity “haircut”, but we have not been able to confirm this with either the Basel Committee or the FDIC. In fact, all inquiries regarding gold’s treatment made to those groups by ourselves, and by other parties that we have spoken with, have been met with silence. We get the sense that the regulators have no interest in stirring the pot by mentioning anything related to gold out of turn. Given our discussion above, we can understand why they may be hesitant to address the issue, and only time will tell if gold gets the proper liquidity treatment it deserves.

Goldman Wins Again As European Union Court Rules To Keep ECB Involvement In Greek Debt Fudging A Secret

Three years ago, a hard fought landmark FOIA lawsuit was won by the great Bloomberg reporter, the late Mark Pittman, in which the Fed was forced to disclose a plethora of previously secret bailout information, which in turn spurred the movement to "audit the Fed" and include a variety of largely watered down provisions in the Frank-Dodd bill. This victory came despite extensive objections by the Fed and the threat that the case may even escalate to the highly politicized Supreme Court, which lately has demonstrated conclusively that not only is justice not blind, but goes to the highest ideological bidder. Moments ago, Europe just learned that when it comes to secrecy of its supreme monetary leaders, in this case all originating from Goldman Sachs and defending data highly sensitive to the same Goldman Sachs, the European central bank's secrecy is not only matched by that of the Fed, but even more engrained in the "judicial" system of the Eurozone, after the European Union General Court in Luxembourg just announced that the European Central Bank will be allowed to refuse access to secret files showing how Greece used derivatives to hide its debt. Why? Simple: recall that it was Goldman Sachs who was the primary "advisor" on a decade worth of FX swaps-related deals which allowed Greece to outright lie about both its fiscal deficit and its total debt levels, and that it was a Goldman alum who became head of the same Greek debt office just before the country imploded. And certainly the ECB was involved and knew very all about the Greek behind the scenes shennanigans. And who happens to be head of the ECB? Why yet another former Goldman worker, of course. Mario Draghi.

And with yet another ex-Goldmanite taking over the BOE, any hopes of bank transparency in the UK have just been crushed as well. Goldman is taking over the world one central bank, and Supreme Court at a time, and leaving not a trace behind, even as it manages to create ever more debt out of thin air to keep the population occupied chasing trinkets, gadgets, and other unneeded stuff, while the real wealth plunder by Goldman et al enters its terminal phase.

From Bloomberg:

“Disclosure of those documents would have undermined the protection of the public interest so far as concerns the economic policy of the EU and Greece,” the European Union General Court in Luxembourg said today, rejecting a challenge by Bloomberg News. The news organization initially sought the documents in August 2010.

The same excuse always and forever: the common man should not know what is truly going on behind the scenes, as the truth would "undermine protection of the public interest" - just leave it to the smart men in tweed suits to fret about the details; it is best if the general ignorant herd remains in the dark, or else its "protection" may be impaired...

Today’s ruling by three judges denies European taxpayers, on the hook for the cost of Greece’s 240 billion-euro ($311.5 billion) bailout, the opportunity to see whether EU officials knew of irregularities in Greece’s public accounts before they became public in 2009.

The decision underscores the lack of accountability at the ECB as it expands its powers to become the region’s lender of last resort and chief banking regulator. The central bank, which puts greater limits on its disclosures about its decision making than its British and U.S. equivalents, is under pressure from policy makers including governing council member Erkki Liikanen to boost transparency. ECB President Mario Draghi last month defended the Frankfurt-based bank, telling reporters it was already a “very transparent” institution.

Bloomberg News sought two internal papers drafted for the central bank’s six-member Executive Board. The first document is entitled “The impact on government deficit and debt from off- market swaps: the Greek case.” The second reviews Titlos Plc, a structure that allowed National Bank of Greece SA (ETE), the country’s biggest lender, to borrow from the ECB by creating collateral.

And just to complete the farce, perhaps the Fed will tell us how its own investigation launched in February of 2010(!) looking at Goldman's behind the scenes involvement in faking the Greek debt numbers for a decade, is going. Recall: "We are looking into a number of questions related to Goldman Sachs and other companies and their derivatives arrangements with Greece," Bernanke said in testimony before the Senate Banking Committee. It is now nearly three years later and still nothing...

Naturally, we won't hold our breath.

Sadly, little can be added here: Goldman wins again, and justice for the common man is long dead.

Source

The Giant Currency Superstorm That Is Coming To The Shores Of America When The Dollar Dies

By recklessly printing, borrowing and spending money, our authorities are absolutely shredding confidence in the U.S. dollar. The rest of the world is watching this nonsense, and at some point they are going to give up on the U.S. dollar and throw their hands up in the air. When that happens, it is going to be absolutely catastrophic for the U.S. economy. Right now, we export a lot of our inflation. Each year, we buy far more from the rest of the world than they buy from us, and so the rest of the world ends up with giant piles of U.S. dollars. This works out pretty well for them, because the U.S. dollar is the primary reserve currency of the world and is used in international trade far more than any other currency is. Back in 1999, the percentage of foreign exchange reserves in U.S. dollars peaked at 71 percent, and since then it has slid back to 62.2 percent. But that is still an overwhelming amount. We can print, borrow and spend like crazy because the rest of the world is there to soak up our excess dollars because they need them to trade with one another. But what will happen someday if the rest of the world decides to reject the U.S. dollar? At that point we would see a tsunami of U.S. dollars come flooding back to this country. Just take a moment and think of the worst superstorm that you can possibly imagine, and then replace every drop of rain with a dollar bill. The giant currency superstorm that will eventually hit this nation will be far worse than that.

Most Americans don't realize that there are far more dollars in use in the rest of the world than in the United States itself. The following is from a scholarly article by Linda Goldberg...

The dollar is a major form of cash currency around the world. The majority of dollar banknotes are estimated to be held outside the US. More than 70% of hundred-dollar notes and nearly 60% of twenty- and fifty-dollar notes are held abroad, while two-thirds of all US banknotes have been in circulation outside the country since 1990

For decades we have been exporting gigantic quantities of our currency.

So what would happen if that process suddenly reversed and massive piles of dollars started coming back into the country?

It is frightening to think about.

Well, I guess the key is to get the rest of the world to continue to have confidence in the U.S. dollar so that will never happen, right?

Unfortunately, there are lots of signs that the rest of the world is accelerating their move away from the U.S. dollar.

For example, it was recently announced that the BRICS countries are developing their own version of the World Bank...

The BRICS (Brazil, Russia, India, China and South Africa) bloc has begun planning its own development bank and a new bailout fund which would be created by pooling together an estimated $240 billion in foreign exchange reserves, according to diplomatic sources. To get a sense of how significant the proposed fund would be, the fund would be larger than the combined Gross Domestic Product (GDP) of about 150 countries, according to Russia and India Report.

And as I noted in a previous article, over the past few years there have been a whole host of new international currency agreements that encourage the use of national currencies over the U.S. dollar. The following are just a few examples...

1. China and Germany (See Here)

2. China and Russia (See Here)

3. China and Brazil (See Here)

4. China and Australia (See Here)

5. China and Japan (See Here)

6. India and Japan (See Here)

7. Iran and Russia (See Here)

8. China and Chile (See Here)

9. China and the United Arab Emirates (See Here)

10. China, Brazil, Russia, India and South Africa (See Here)

Will this movement soon become a stampede away from the U.S. dollar?

That is a very important question.

But you don't hear anything about this in the U.S. media and our politicians are not talking about this at all.

Meanwhile, our "leaders" seem to be doing everything that they can to destroy confidence in the U.S. dollar. The Federal Reserve is printing money like there is no tomorrow, and the federal government continues to run up trillion dollar deficits year after year.

They do not seem to understand that they are systematically destroying the U.S. financial system.

Other world leaders get it. For example, Russian President Vladimir Putin once said the following...

"Unreasonable expansion of the budget deficit, accumulation of the national debt – are as destructive as an adventurous stock market game.

During the time of the Soviet Union the role of the state in economy was made absolute, which eventually lead to the total non-competitiveness of the economy. That lesson cost us very dearly. I am sure no one would want history to repeat itself.”

Wow.

Why can't most of our politicians see how destructive debt is?

What the federal government continues to do is absolutely insane. The national debt increased by more than 24 billion dollars on the day after Thanksgiving this year. But utter disaster has not struck yet, and most Americans are not really that concerned about the debt. So things just keep rolling along.

And of course our national debt of $16,309,738,056,362.44 is nothing when compared to the future liabilities that our federal government is facing. Just check out what a recent article in the Wall Street Journal had to say about all this...

The actual liabilities of the federal government—including Social Security, Medicare, and federal employees' future retirement benefits—already exceed $86.8 trillion, or 550% of GDP. For the year ending Dec. 31, 2011, the annual accrued expense of Medicare and Social Security was $7 trillion. Nothing like that figure is used in calculating the deficit. In reality, the reported budget deficit is less than one-fifth of the more accurate figure.

Other economists paint an even gloomier picture. According to economist Niall Ferguson, the U.S. government is facing future unfunded liabilities of 238 trillion dollars.

So where are we going to get all that money?

Well, why don't we just print more money than ever before so that the U.S. government can borrow and spend more money than ever before?

Don't laugh. That is actually what some of the top economists in the country are actually recommending.

The most famous economic journalist in the entire country, Paul Krugman of the New York Times, is boldly proclaiming that the solution to all of our problems is to print, borrow and spend a lot more money. He insists that there is no reason to fear that the giant mountain of debt that we are accumulating will someday collapse the system...

For we have our own currency — and almost all of our debt, both private and public, is denominated in dollars. So our government, unlike the Greek government, literally can’t run out of money. After all, it can print the stuff. So there’s almost no risk that America will default on its debt — I’d say no risk at all if it weren’t for the possibility that Republicans would once again try to hold the nation hostage over the debt ceiling.
But if the U.S. government prints money to pay its bills, won’t that lead to inflation? No, not if the economy is still depressed.

Now, it’s true that investors might start to expect higher inflation some years down the road. They might also push down the value of the dollar. Both of these things, however, would actually help rather than hurt the U.S. economy right now: expected inflation would discourage corporations and families from sitting on cash, while a weaker dollar would make our exports more competitive.

Of course what he is prescribing is complete and utter madness.

At some point this con game is going to collapse and the rest of the world is going to say a big, fat, resounding "NO" to the U.S. dollar.

Why should they continue to use a currency that is becoming extremely unstable and that is constantly being manipulated?

And when the rest of the world rejects the U.S. dollar, the value of the dollar will drop like a rock because there will be far less global demand for it.

In addition, if the rest of the world is not using the U.S. dollar for trade any longer, other nations will cease to soak up our excess currency and huge mountains of our currency that are floating around out there will start flooding back to our shores.

At that point we will be looking at inflation unlike anything we have ever seen before. The era of cheap imports will be over and we will pay far more for everything from oil to the foreign-made plastic trinkets that we buy at Wal-Mart.

Most Americans don't even know what a "reserve currency" is, but when the U.S. dollar loses reserve currency status it is going to unleash a nightmare that most economists cannot even imagine.

So enjoy this holiday season while you can. There are still lots and lots of cheap imports filling the shelves of our stores.

Once the coming giant currency superstorm strikes, we will dearly wish for the good old days of 2012.

Yes, the U.S. dollar is alive and ticking for now. But at the pace that our authorities are abusing it, I would not say that things are looking good for a long and healthy lifespan.

Source

Ex-Goldman Sachs banker appointed as new governor at Bank of England

Today the chancellor confirmed that there will be no real change at the Bank of England. There will be no change to the Treasury and Bank of England’s obsession with inflation targeting and “price stability”. Above all, he confirmed that there will be no reining-in of the banks; that banks will not be re-structured – to separate the retail and investment arms, and ensure that banks are no longer too big to fail.

He confirmed this by appointing an ex-Goldman Sachs banker, Mark Carney, as governor of the Bank of England.

The FT was right when in January this year it described Carney as [FT paywall] ”the leading example of a new breed of ambitious, internationally focused central bankers who view regulatory and monetary policy issues through a more market-based lens”. He favours an “open and resilient financial system” – code for giving the banks free rein in global capital markets. And like many of his peers he believes that the key to recovery lies in all western economies “capitalising on the immense opportunity that emerging markets in general and China in particular represent”. Like others, he prefers exports over the expansion and strengthening of domestic markets.

So be very afraid. Business-as-usual will prevail. And nothing will be done to constrain the City, and therefore to prevent the next collapse of the financial system.

Carney is a central banker steeped in the culture and practices of Goldman Sachs’s investment banking arm. Before becoming Canada’s central bank governor, he spent 13 years with Goldman Sachs in its London, Tokyo, New York and Toronto offices. He held a range of senior positions. The most significant was as managing director of investment banking.

In a speech made recently Carney made the right noises. He complained of ”a system that privatises gains and socialises losses” and endorsed the approach that sets capital and leverage ratios for banks. He’s even commended the Occupy movement for being “constructive”.

But there is nothing in his speeches that indicates that he will help give Britain’s real economy the protection it needs from its over-mighty – and still very dangerous – banking sector. Nothing, in other words, that indicates the real economy – the productive sector – will be given priority over the City’s preference for reckless global speculation.

Instead like many others who adopt a “market-based” approach to regulation, Carney prefers to tinker – retrospectively – with the capital ratios of banks. This is because he and many others in central bank circles know that most of the Britain’s banks are very highly leveraged. That without the support of the Bank of England’s quantitative easing programme, and its very low lending rates – all effectively backed by British taxpayers – Britain’s banks would effectively be insolvent.

And so Carney will continue with quantitative easing – which has provided British banks with the liquidity needed to indulge in speculative activity both at home and abroad, speculative activity that bears a scary resemblance to that undertaken before the crisis.

He is unlikely to pressure his friends in the City’s commercial banks to lend at low sustainable rates to Britain’s productive sector. He is therefore most unlikely to reverse the most bizarre and historically unprecedented aspect of today’s British banking system: the fact that those of us in the real economy are lending to banks. Their original mission – of lending into the real economy – has been turned on its head. Today Britain’s banks are recipients of loans (deposits) from those active in the real economy – and subsidies from taxpayers.

Source

On Artificial Interest Rates And The Forfeiture Of Growth For Dividends

Diapason Commodities' Sean Corrigan provides an insightful introduction to the critical importance of a market-set rate of interest and central banks' manipulated effect on the factors of production.

"Fixated with using their illusory ‘wealth effect’ to avoid a full realization of the losses we have all suffered in a boom very much of those same central bankers’ creation - or else cynically trying to achieve the same denial of reality by driving the income-poor into accepting utterly inappropriate levels of financial risk - they are destroying both the integrity and the signalling ability of those same capital markets which are the sine qua non of a free society."

As Ron Paul also confirms in the clip below "with artificial interest rates, we get an artificial economy driven by mal-investment leading to the inevitable bubbles" and while central banks hope for this 'created credit/money' to flow into productive means (Capex), instead it has (in today's case where QE is no longer working) created an investor-class demand for yield - implicitly driving management to forfeit growth-and-investment for buybacks-and-dividends.

Ron Paul's interview with Laisses Faire outlines the impact an artificial interest rate has on the economy...



and Sean Corrigan of Diapason Commodities provides a more in-depth look at the process by which a manipulated interest rate impacts the factors-of-production (or the risks and rewards of the real business cycle)...

What is not to be overlooked is that the applicable rate of interest is not some abstract entity, utterly variable according to the whim of the banking system, but rather is one of the fundamental ratios prevailing in the vast, interconnected topology of exchange - in this case, between the value put on goods available at once and on those only accessible at some future date...

Take the act of deciding upon the launch of a new or expanded line of business. Obviously the entrepreneur will make his best guess as to the stream of revenues he may gather and will set these off against his estimates of what it will cost him to achieve them. Thus it is, of course, that a lowering of the rate of generally accepted rate of interest makes his challenge seem a less daunting one: our man will not only have less to pay out on any hired capital he requires, but the possibility of earning a greater return in some other fashion...Yet - whether he recognises this or no - his reckoning is intimately bound up with the information which the interest rate is conveying with regard to the likely relative abundance of his inputs and the relative demand for his outputs over the entire investment horizon of his project...

It should be all too apparent by now that if we are to enjoy conditions which are favourable to both the greatest degree of co-ordination between the market’s multitude of actors; if we are to remove all impediments to the early recognition of such lapses from that co-ordination as must inevitably occur in a shifting world of imperfect knowledge and changing tastes, then any interference with the spontaneous, holistic formation of prices is not to be countenanced, much less embraced as a tool of dirigisme.

Rather, it is vital that the myriad interactions between buyer and seller, producer and consumer, saver and spender, employer and employee should be allowed to make its due contribution to the universal field of prices thence to reveal how best to marshal our limited resources in order to deliver more of what appears to be the more urgently required and to expend fewer efforts on the less. This is not true only in the here and now, but also over time.

Clearly, we have no gold standard to impose discipline on either the ruling elite or the bankers who are their political symbionts... granted, we have a wider range of non?bank and other credit instruments to confuse the issue; but none of them alter the fact that investment is best undertaken when both the money and the means corresponding to that money have been voluntarily set aside to finance it, or that, conversely, investment is worst entered upon when it is launched on a soon cresting wave of counterfeit capital, conjured up by the banks or the government printing press.

which leads to the current remarkably non-traditional text-book situation that Citi describes - where equities are now the yield-providing asset as management is punished for spending capital on growth or investment and is praised for buybacks and dividends as the Fed's artificial premise in which we live has created a monster...

Policy-makers have adopted aggressive methods to push interest rates and bond yields down to unprecedented levels. It is hoped that these low rates will trigger a stronger recovery in corporate capex and jobs. Evidence of this remains sketchy...

We think that QE may be having the opposite impact to that intended. Instead of encouraging capex and job creation, ultra low interest rates are bringing yield-starved capital into the global equity market. These investors are more interested in dividends and share buybacks than corporate expansion. Those CEOs who give them what they want should be rewarded by share price outperformance. Those who do not may find themselves replaced.
If we are to salvage any residue of our liberty, restore any semblance of our prosperity, and again secure to ourselves the right to enjoy our property, this [manipulation] must be ended before it consumes our capital...

If all this means that we have fewer projects underway at any one time, so be it: we will waste far less of what we hold scarce and end up holding fewer things as scarce as we do now.

The Garden of Eden may well be denied us, but that does not mean the only remaining choices are the debtor’s gaol or the soft totalitarianism of de Tocqueville’s worst imaginings...

...it is saving that makes us rich, not spending, and it is only by saving – not through authoritarian fiat ? that a naturally lowered interest rate confers a lasting aid to capital formation.

If policymakers hope that listed companies can help drive down current high levels of unemployment then it could be a long wait. Corporate expansion plans are likely to remain constrained by uncertainties about the global economy and a shareholder base that is more interested in share buybacks and dividends than capex and job creation.

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Goldman Sachs's "Porous Safety Net"

Goldman Sachs is something else. It tries to revise history; it makes ridiculous suggestions; it makes horrific predictions; it should be ashamed of itself.

The following excerpt is from a Forbes article quoting Goldman Sachs:

Why did household formation collapse? Goldman’s research team suggests the headship rate, or the percentage of people that are heads of a household, broke down as immigration flows to the U.S. slowed and young people either stayed with their parents for longer or “doubled up” with relatives and roommates.

Such revisionism brings to mind 1984 and Winston Smith's "job to re-write past newspaper articles so that the historical record always supports the current party line." In the present instance, it is the banks' line that they had nothing to do with creating the sub-prime mortgage and securitization frauds that brought down the financial system, that foreclosed on millions of people who were sold inappropriate mortgages so that the banks could earn substantial profits, which in turn gave the executives huge salaries and munificent bonuses based on their egregious unearned profits. Unemployment caused foreclosures during the financial crisis that Goldman helped create. But Goldman recalls its own bad deeds as "the heads of a household" breaking down as immigration flows slowed! How nice to revise history in your own favor or more accurately, of putting your past into a "memory hole." The two histories, the one that no longer exists for Goldman and the one that it re-writes above, are excellent examples of "doublethink."

Then as to Mr. Blankfein's ridiculous suggestions, those can be found on the CBS blog by Scott Pelley;

Here Blankfein says that the people should not expect to get the entitlements of Social Security, Medicare and Medicaid. He wants people to lower their expectations for retirement and health benefits that should be "slowed down and contained" because the government can no longer afford them.

It is ridiculous to say that the government cannot afford Social Security. Any sovereign government that has its own currency can afford to pay whatever it chooses to pay for!

Here's what Joe Firestone says:

– Social Security has no solvency or “running out of money” problems. The SS crisis is a phoney one. No solution to this “fiscal crisis,” bipartisan or partisan, is needed. What is needed is a solution to the political problem of getting SS’s funding guaranteed in perpetuity by Congress, just the way it guarantees funding for Medicare Parts B and D.

– The same applies to the so-called Medicare crisis. It too is phoney, and can be solved easily by Congress guaranteeing funding in perpetuity to Medicare Parts A and C.

– More generally, there is no entitlement funding crisis in the United States, except a political crisis where US politicians are determined to ignore their constituents and cut back on an already inadequate safety net either because they believe in, or want others to believe in false ideas about fiscal responsibility and nature of the Government as a giant household. (from an article in New Economics Perspectives by Joe Firestone)

Finally, Blankfein makes a horrific prediction for the future of others: that society should be one where "the safety net would be more porous and lower to the ground."

And for him I would wish that his safety net be high and porous: no more taxpayer bailouts; no more huge unearned salaries; no more big bonuses; no more bets against the economy and finally, full prosecution under the law for accounting control fraud--soon.

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They Are Going To Make It Nearly Impossible To Pass On A Farm Or A Business To Your Children

If you have a farm or a small business, would you like to pass it on to your children when you die?  Well, unless Congress does something, it is going to become much, much harder to do that starting next year.  Right now, there is a 5 million dollar estate tax exemption and anything above that is taxed at 35 percent.  But on January 1st, the exemption will go down to 1 million dollars and the tax rate will go up to 55 percent.  A lot of liberals are very excited about this, because they believe that the government will be soaking wealthy people like Warren Buffett and Bill Gates.  But the truth is that a lot of farms, ranches and small businesses will be absolutely devastated by this change in the tax law.  There are many farmers and ranchers out there today that do not make much money but are sitting on tracts of land that are worth millions of dollars.  According to the American Farm Bureau, approximately 97 percent of all farms and ranches in the United States would be subject to the estate tax if the exemption was reduced to just a million dollars.  That means that the children of these farmers and ranchers would be faced with a very cruel choice when it is time to inherit these farms and ranches.  Either they come up with enough money to pay the government about half of what the farm or ranch is worth, or they sell the farm or ranch that may have been in their family for generations.  Needless to say, most farm and ranch families do not have that kind of cash lying around.  Most of them are just barely making it from year to year.  So this change in the tax law is going to greatly accelerate the death of the family farm in America.  This is also going to devastate many family-owned small businesses.  Many small businesses don't make much money, but they have buildings or land or assets worth millions of dollars.  Children that may have wanted to continue the family legacy will be forced to sell because of the massive tax bill that they get from Uncle Sam.  This is an insidious cruelty, and it shows just how broken our system has become.

The desire to leave the wealth that you have worked so hard to accumulate all your life to your children is something that is common to virtually all human societies.  We want to know that future generations will be taken care of.

It is simply immoral for the federal government to swoop in and tax farms, ranches and small businesses that were intended to be passed down from parents to their children at a 55 percent tax rate.

A lot of the people that are going to be affected by this change are not "wealthy" at all.  A recent Fox News report examined what this change in the law is going to mean for rancher Kevin Kester and his family...

Rancher Kevin Kester works dawn to dusk, drives a 12-year-old pick-up truck and earns less than a typical bureaucrat in Washington D.C., yet the federal government considers him rich enough to pay the estate tax -- also known as the "death tax."

Kester told Fox News that he has no doubt that his ranch will have to be sold when he dies just to pay the tax bill...

"There is no way financially my kids can pay what the IRS is going to demand from them nine months after death and keep this ranch intact for their generation and future generations," said Kester, of the Bear Valley Ranch in Central California.
Two decades ago, Kester paid the IRS $2 million when he inherited a 22,000-acre cattle ranch from his grandfather. Come January, the tax burden on his children will be more than $13 million.

Reading that should make you angry.  Every single year, thousands upon thousands of farms, ranches and small businesses are going to be lost to the federal tax monster.

It is almost as if the federal government does not want income-producing assets to remain in the hands of the "little guy".

What in the world are we supposed to do?

It isn't as if all of those farmers and ranchers can go off to the big cities and find good jobs.  As I wrote about yesterday, our politicians are standing aside as millions of our good jobs are shipped out of the country.

The cold, hard truth is that our system does not work for average Americans any longer.  Those that roll out of bed every morning, work hard and never complain always seem to get the short end of the stick.
The people that are the backbone of America are the ones that the government is always the hardest on.
Unfortunately, we have gotten to a point where the government is searching for more "revenue" from anywhere it can because it desperately needs more money.  U.S. government finances are a complete and total mess and we are drowning in the biggest ocean of debt the world has ever seen.

We are more than 16 trillion dollars in debt and there are more than 100 million Americans that are enrolled in at least one welfare program.

Someday has to pay for all this.

Middle class Americans are already hit with dozens of different taxes each year, and you can be certain that our politicians will continue to invent ways to extract even more "revenue" out of us.

And of course our politicians will never stop their wild spending.  Despite all of the negotiations that have taken place over the past couple of years, our spending problems just continue to grow.  For example, the federal budget deficit for the month of October was $120 billion, which was more than 20 percent larger than the federal budget deficit for October 2011 was.

So what is the solution?

Well, Treasury Secretary Timothy Geithner now says that he wants to eliminate the debt ceiling entirely.  He says that we should just have no limit and that the federal government should just be able to go into debt as much as it wants.

In the end, all of this debt is going to absolutely crush us.  We have literally destroyed the future of America, and yet most of the country still seems clueless about all of this.  The blind are leading the blind, and we are headed straight for complete and utter disaster.

One day, when people look back on this period in American history, what do you think people are going to say about us?

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