Saturday, October 24, 2009

100 and Counting

To celebrate the 100th bank failure this year Sheila Blair took a few minutes to comfort the American public and let them know that they have nothing to fear moving forward.



Quick reminder on what is actually happening in the real world:

The FDIC just recently ran out of money, and they have opened up their $500 billion credit line from the United States Treasury.

The United States Treasury currently has no money. It now owes over $100 trillion in total liabilities, and it runs a deficit every year over $1 trillion. (Obama has promised at least a deficit this high through 2019. The actual yearly deficit will be much, much, higher as social security and medicare enter bankruptcy.)

The Treasury now gets their money from the Federal Reserve who is purchasing the majority of all new debt entering the market.

The Federal Reserve gets their money from an electronic printing press.

Sheila Blair is telling Americans the absolute truth in this video. Depositors will be made whole across the board in every single bank failure moving forward. They will receive 100% of the insured dollars they held at the banks.

Unfortunately she forgot to mention that the value of those dollars received will be close to nothing, and this will ultimately lead to civil unrest.

Happy Halloween everyone, the scary stuff is coming soon.

The Warning

Understanding Everything

I'd like to welcome aboard my foreign/non-US viewership that has grown significantly over the past six months. Also, before getting started I would like to thank Jim Puplava of the PFS Group for a lot of the information presented in this segment.

My goal with this web page, which I hope I have accomplished, is to take somewhat complex topics and discuss them in a way that is easy to understand.

One of my main focus points has been the next major shift in the global financial markets, which is the fall of the United States currency.

However, there are many, many, aspects to the financial system other than currency trends and how they effect the markets.

I would like to take a step back now and try to bring some of the market cross currents full circle by looking at where we've come from, where we are today, and where we are headed. I will be taking new aspects into view such as market cycles and derivatives. To help you understand some of the topics here, I would advise starting with the documentary above titled "The Warning." It was developed by Frontline, and presents a fantastic behind the scenes look at the origins of the derivatives monster.

If this gets a little complicated, I apologize, but I think the information is important as we move forward. With that said, lets begin.......

In 1985 there was an event held called the Paris Accord, and a few weeks later at the G7 (a gathering of global leaders) it was determined that the dollar's value was too high and hurting global markets. Actions were taken to change this course, and in the Summer of 1987 this caused a mini run on the dollar and it began to plunge. To counter this, the Federal Reserve raised interest rates to 10%.

This rate raise caused some turmoil in the markets, and many believe it was one of the determining factors that led to the October, 1987 stock market crash. Forever known as Black Monday, the stock market crashed 22% in a single day. To help you visualize that type of decline, it would be the equivalent of the market falling 2,200 points today, in one day.

Two weeks before the 1987 stock market crash, a new Federal Reserve Chairman had been crowned. His name was Alan Greenspan, and he would take the markets in a brand new direction that the world had never seen before.

To counter the market crash in 1987, Greenspan dropped interest rates and unleashed an ocean of liquidity into the market. Throughout the 1990's, every time there was a set back, mini-crisis, or recession, Greenspan did the same thing; lowered interest rates, and flooded the market with money. There are consequences for these actions.

In the 1990's we saw the greatest stock market run in world history, as Greenspan brought the market to unimaginable heights. In the mid-90's an instrument known as derivatives began to grow off banks' balance sheets. It started very small and began to grown exponentially. The Frontline documentary above discusses this period in detail. They end the program around the 2000 period and that is where I want to pick up from there.

After Long Term Capital Management collapsed, our regulators had a chance to reign in the derivatives growth and protect the financial markets from "systemic failure." As seen in the film, they did everything in their power to prevent regulation.

In 1999 they repealed the Glass Steagall Act. This act originated during the great depression creating a wall between the banking and investment banking portion of these large banks. This meant that banks in charge of protecting the public's money could now take endless risk with that money.

In 2001 they created the Commodities Futures Modernization Act. This completely removed derivative securities and credit default swaps (a form of derivatives) from Federal oversight. The market had officially become the Wild West.

In 2004, regulators removed the leverage ceiling that banks had to maintain. Up to that point, banks could only leverage at 12 to 1, meaning if they had $1 in assets they could borrow $12 more. Once this was removed leverage exploded and in some cases reached 40 to 1. (As seen in Bear Stearns before their collapse.)

These three acts opened the door to a derivatives explosion, but while this dark market began to grow, Alan Greenspan continued dumping gasoline on the fire with his free money policy.

In 2001, in response to the stock market crash, he lowered interest rates down to 1% to try and get overleveraged Americans out the door to borrow and spend.

This is where things become very important. Greenspan had created a period of boom and bust cycles with his reckless free money policy. What is important to understand is that each time we experience a boom bust cycle it takes a different form than the last.

When the stock market exploded in 2000 the cheap money that Greenspan brought into the system found its way into the real estate market. Everyone knows the story from here.....the cheap money allowed loans to be sold, packaged, securitized, and sold all around this world. This created the real estate bubble that blew into 2006.

What was not seen, however, was the off balance sheet derivatives growth centered around the housing bubble. As these loans were being created and insured by lenders such as AIG, there was another market that was taking "side bets" on whether these loans would default. These side bets were known as credit default swaps. At the peak, the credit default swap market approached $60 trillion in size, three times larger than the entire housing market.

During last fall, you repeatedly heard that banks were being bailed out to avoid systemic risk. The systemic risk did not come from the actual loan defaults, but from the off balance sheet bets made on the mortgages. AIG was not only insuring the actual mortgages, but they were insuring the gambling off balance sheet arena in the dark derivatives world. If one institution could not pay out on its derivatives position, every institution would simultaneously fail down the line.

So this brings us to the present. Last fall, just as we did in the year 2000, we had a major crash. Just as we did in 2000, the Federal Reserve has rushed in and dropped interest rates to zero and flooded the market with liquidity. The size and scope of the bailouts today are far, far, greater than the previous two times:

In 1990: Bailout was in Millions $$
In 2000: Bailout was in Billions $$
In 2008: Bailout was in Trillion $$

Before I discuss where we go from here, it important to understand that during this entire process one thing has remained constant: The derivatives market has continued to grow in size.

In 2001 the entire United States derivatives market was $60 trillion.

Today this market now stands at $204 trillion.

The entire global derivatives market has just crossed over $600 trillion in size.

During the crisis last fall you would have expected this market to shrink considerably right? No chance, it has not missed a beat. The market grew 1% last year during the crisis, and it grew over 1.5% last quarter in size.

Looking at the major banks today:

J.P. Morgan has $1.7 trillion in total assets.
Their derivatives position: $80 trillion.

Goldman Sacs has $120 billion in total assets.
Their derivatives position: $41 trillion.

Bank of America has $1.5 trillion in assets.
Their derivatives position: $39 trillion.

Citi has $1.1 trillion in assets.
Their derivatives position: $32 trillion.

These four banks account for 95% of all derivatives trading. It is also clear to see that just a small loss in their derivatives positions wipes away their entire net worth completely.

Alright, quick recap:

1990 recession Greenspan floods liquidity creating boom in stock market.
2000 stock market bust, Greenspan floods liquidity creating boom in real estate.
2008 real estate bust, Bernanke flooding liquidity as we speak.

Today we are living the reflationary boom as the stock market is now reflecting that reflation. As I've said, each boom/bust cycle takes a different form, so the important question is, what happens from here? Here is how I see it playing out:

The boom from the most recent liquidity injection is going to move toward the emerging markets and commodities creating the next bubble in these two markets. The bulk of the liquidity will not go back into US stocks and real estate. (This process has already started as foreign markets and commodities have far outpaced US stock and real estate gains this year)

The next crisis or bust, which may be two or three years away, is going to come from the dollar.

(For reasons why we are approaching a dollar crisis you can read essentially every other post on this website. It is dedicated to making that point crystal clear.)

Now here is how it all ties together:

As the dollar begins to fall, interest rates are going to rise across the board as investors demand a higher return to offset the currency risk. Even the Federal Reserve will have to raise rates to try and stem the inflation.

In the $600 trillion derivatives off balance sheet black hole, 95% of the financial instruments are tied to interest rates, they are known as Interest Rate Swaps.

As the interest rates begin to move violently upward, it will cause chaos in this swap market, similar to what was seen on the insurance purchased on subprime real estate.

It is only a matter of time before this market detonates.

This is the reason Bernanke is doing everything in his power to keep interest rates low. He is buying treasuries, buying mortgage securities, and he has the Fed Funds rate set at 0%. This strategy, however, has a perverse effect on the value of our currency and combined with Obama's mission to bankrupt the nation, foreign investors are heading for the exits.

The bailout for the next bust will be in the quadrillions, not trillions. The question is, can you save dollars faster than Bernanke can print them? I don't know anyone on this earth who can.

Friday, October 23, 2009

Option 3: Disintegration

The United States Empire has started its long decline to a third world nation. The route we take to get there is being determined daily by government decisions.

By watching from the sidelines it is becoming clear that we will not move through a slow decline, a steep collapse, but will experience full disintegration.

The Wall Street Journal reported this morning that bank reserves have now reached $1 trillion. That is a trillion in cash sitting on their balance sheets, awaiting deployment.

The Fed has stated all along that as part of their exit strategy, they would remove the excess liquidity as their short term lending programs ended. As these programs have unwound, the excess reserves have risen from $2 billion to $1 trillion.

A lot of the banks' money is also working its way into the bond market. When banks can borrow from the Fed at 0%, they can then reinvest that money back into the treasury bond market at X%. Anything above zero is a profit. The money is free.

We are working our way closer to the point of D Day for Mr. Ben Bernanke. As the dollar continues to crater off a cliff, he will have to decide whether he will try to protect the currency or save everything else.

As of right now the Fed has become the mortgage market. He is printing endless amounts of money to buy new and old mortgages and he has once again pushed back the dates these programs will end. This buying is the only support the housing market has from complete collapse. There are currently estimates of over 10 million in "defaulted" homes the banks are holding off the market to prevent the losses on their balance sheets.

This stealth inventory continues to build month after month as more and more homeowners stop making payments. If this inventory were to hit the market, and it will eventually, I don't have to tell you what it will do to home prices.

The commercial mortgage is in far worse shape. The market's destiny now lays in the hands of Bernanke. If he develops a program to purchase commercial debt on a large scale, it will keep the market artificially propped up. If they do not, it will be total annihilation.

It is estimated that the Fed is now purchasing over 50% of the treasury debt issued. They do this in multiple ways. The first is direct purchases at auctions. (The $300 billion they have announced and purchased this year) The second is buying toxic mortgages from foreign central banks, which then take that cash and buy treasuries. The third is purchasing the debt from one of the 16 major treasury dealers about 4 to 5 weeks after an auction. The second two options allow it to be kept hidden from the public. These purchases finance Obama's endless, reckless, spending.

We are in full monetization mode now. All debt is being papered over with freshly printed bills.

The Fed has two choices:

1. Let the dollar fall and protect every market
2. Protect the dollar and allow the economy to completely collapse

So far they have only chosen option one, and the world markets have taken notice.

Money Supply Growth:
Gold's Secular Bull Market In Progress:


The markets follow a general pattern today that when the stock market rises the dollar falls and vice versa. It is a trade of risk against safety and has been the same since the financial crisis erupted in September of 2008.

The question is, will this trend continue moving forward?

In the fall of 2008, most of the world was caught off guard by the financial crisis and in their fear they ran toward what they perceived as safety in treasuries and the US dollar. This caused a short term massive rally in those markets.

Now that people have had a chance to collect themselves and understand the reasons for the financial crisis, I believe they will not make the same mistake and rush toward the fire as the United States heads toward disintegration.

At some point I believe we will see the stock market, the bond market, AND the US dollar all move down in harmony. This is the normal correlation between markets looking back throughout history.

The question of course as with everything is.....when?

Could investors make the same mistake again? Possibly, but to bet on that outcome is to bet against market history. The markets have already begun to diverge and as they continue it will only cause more money to flow toward other investments such as foreign currencies, foreign markets, commodities, and precious metals.