Collapse At Hand
Ever since the beginning of the financial crisis and quantitative
easing, the question has been before us: How can the Federal Reserve
maintain zero interest rates for banks and negative real interest rates
for savers and bond holders when the US government is adding $1.5
trillion to the national debt every year via its budget deficits? Not
long ago the Fed announced that it was going to continue this policy for
another 2 or 3 years. Indeed, the Fed is locked into the policy.
Without the artificially low interest rates, the debt service on the
national debt would be so large that it would raise questions about the
US Treasury’s credit rating and the viability of the dollar, and the
trillions of dollars in Interest Rate Swaps and other derivatives would
come unglued.
In other words, financial deregulation leading to Wall Street’s
gambles, the US government’s decision to bail out the banks and to keep
them afloat, and the Federal Reserve’s zero interest rate policy have
put the economic future of the US and its currency in an untenable and
dangerous position. It will not be possible to continue to flood the
bond markets with $1.5 trillion in new issues each year when the
interest rate on the bonds is less than the rate of inflation. Everyone
who purchases a Treasury bond is purchasing a depreciating asset.
Moreover, the capital risk of investing in Treasuries is very high. The
low interest rate means that the price paid for the bond is very high. A
rise in interest rates, which must come sooner or later, will collapse
the price of the bonds and inflict capital losses on bond holders, both
domestic and foreign.
The question is: when is sooner or later? The purpose of this article is to examine that question.
Let us begin by answering the question: how has such an untenable policy managed to last this long?
A number of factors are contributing to the stability of the dollar
and the bond market. A very important factor is the situation in Europe.
There are real problems there as well, and the financial press keeps
our focus on Greece, Europe, and the euro. Will Greece exit the European
Union or be kicked out? Will the sovereign debt problem spread to
Spain, Italy, and essentially everywhere except for Germany and the
Netherlands?
Will it be the end of the EU and the euro? These are all very
dramatic questions that keep focus off the American situation, which is
probably even worse.
The Treasury bond market is also helped by the fear individual
investors have of the equity market, which has been turned into a
gambling casino by high-frequency trading.
High-frequency trading is electronic trading based on mathematical
models that make the decisions. Investment firms compete on the basis of
speed, capturing gains on a fraction of a penny, and perhaps holding
positions for only a few seconds. These are not long-term investors.
Content with their daily earnings, they close out all positions at the
end of each day.
High-frequency trades now account for 70-80% of all equity trades.
The result is major heartburn for traditional investors, who are leaving
the equity market. They end up in Treasuries, because they are unsure
of the solvency of banks who pay next to nothing for deposits, whereas
10-year Treasuries will pay about 2% nominal, which means, using the
official Consumer Price Index, that they are losing 1% of their capital
each year. Using John Williams’ (
shadowstats.com)
correct measure of inflation, they are losing far more. Still, the
loss is about 2 percentage points less than being in a bank, and unlike
banks, the Treasury can have the Federal Reserve print the money to pay
off its bonds. Therefore, bond investment at least returns the nominal
amount of the investment, even if its real value is much lower. (For a
description of High-frequency trading, see:
http://en.wikipedia.org/wiki/High_frequency_trading )
The presstitute financial media tells us that flight from European
sovereign debt, from the doomed euro, and from the continuing real
estate disaster into US Treasuries provides funding for Washington’s
$1.5 trillion annual deficits. Investors influenced by the financial
press might be responding in this way. Another explanation for the
stability of the Fed’s untenable policy is collusion between Washington,
the Fed, and Wall Street. We will be looking at this as we progress.
Unlike Japan, whose national debt is the largest of all, Americans do
not own their own public debt. Much of US debt is owned abroad,
especially by China, Japan, and OPEC, the oil exporting countries. This
places the US economy in foreign hands. If China, for example, were to
find itself unduly provoked by Washington, China could dump up to $2
trillion in US dollar-dominated assets on world markets. All sorts of
prices would collapse, and the Fed would have to rapidly create the
money to buy up the Chinese dumping of dollar-denominated financial
instruments.
The dollars printed to purchase the dumped Chinese holdings of US
dollar assets would expand the supply of dollars in currency markets
and drive down the dollar exchange rate. The Fed, lacking foreign
currencies with which to buy up the dollars would have to appeal for
currency swaps to sovereign debt troubled Europe for euros, to Russia,
surrounded by the US missile system, for rubles, to Japan, a country
over its head in American commitment, for yen, in order to buy up the
dollars with euros, rubles, and yen.
These currency swaps would be on the books, unredeemable and making
additional use of such swaps problematical. In other words, even if the
US government can pressure its allies and puppets to swap their harder
currencies for a depreciating US currency, it would not be a repeatable
process. The components of the American Empire don’t want to be in
dollars any more than do the
BRICS.
However, for China, for example, to dump its dollar holdings all at
once would be costly as the value of the dollar-denominated assets would
decline as they dumped them. Unless China is faced with US military
attack and needs to defang the aggressor, China as a rational economic
actor would prefer to slowly exit the US dollar. Neither do Japan,
Europe, nor OPEC wish to destroy their own accumulated wealth from
America’s trade deficits by dumping dollars, but the indications are
that they all wish to exit their dollar holdings.
Unlike the US financial press, the foreigners who hold dollar assets
look at the annual US budget and trade deficits, look at the sinking US
economy, look at Wall Street’s uncovered gambling bets, look at the war
plans of the delusional hegemon and conclude: “I’ve got to carefully get
out of this.”
US banks also have a strong interest in preserving the status quo.
They are holders of US Treasuries and potentially even larger holders.
They can borrow from the Federal Reserve at zero interest rates and
purchase 10-year Treasuries at 2%, thus earning a nominal profit of 2%
to offset derivative losses. The banks can borrow dollars from the Fed
for free and leverage them in derivative transactions. As Nomi Prins
puts it, the US banks don’t want to trade against themselves and their
free source of funding by selling their bond holdings. Moreover, in the
event of foreign flight from dollars, the Fed could boost the foreign
demand for dollars by requiring foreign banks that want to operate in
the US to increase their reserve amounts, which are dollar based.
I could go on, but I believe this is enough to show that even actors
in the process who could terminate it have themselves a big stake in not
rocking the boat and prefer to quietly and slowly sneak out of dollars
before the crisis hits. This is not possible indefinitely as the
process of gradual withdrawal from the dollar would result in continuous
small declines in dollar values that would end in a rush to exit, but
Americans are not the only delusional people.
The very process of slowly getting out can bring the American house
down. The BRICS–Brazil, the largest economy in South America, Russia,
the nuclear armed and energy independent economy on which Western
Europe (Washington’s NATO puppets) are dependent for energy, India,
nuclear armed and one of Asia’s two rising giants, China, nuclear armed,
Washington’s largest creditor (except for the Fed), supplier of
America’s manufactured and advanced technology products, and the new
bogyman for the military-security complex’s next profitable cold war,
and South Africa, the largest economy in Africa–are in the process of
forming a new bank. The new bank will permit the five large economies to
conduct their trade without use of the US dollar.
In addition, Japan, an American puppet state since WWII, is on the
verge of entering into an agreement with China in which the Japanese yen
and the Chinese yuan will be directly exchanged. The trade between the
two Asian countries would be conducted in their own currencies without
the use of the US dollar. This reduces the cost of foreign trade between
the two countries, because it eliminates payments for foreign exchange
commissions to convert from yen and yuan into dollars and back into yen
and yuan.
Moreover, this official explanation for the new direct relationship
avoiding the US dollar is simply diplomacy speaking. The Japanese are
hoping, like the Chinese, to get out of the practice of accumulating
ever more dollars by having to park their trade surpluses in US
Treasuries. The Japanese US puppet government hopes that the Washington
hegemon does not require the Japanese government to nix the deal with
China.
Now we have arrived at the nitty and gritty. The small percentage of
Americans who are aware and informed are puzzled why the banksters have
escaped with their financial crimes without prosecution. The answer
might be that the banks “too big to fail” are adjuncts of Washington and
the Federal Reserve in maintaining the stability of the dollar and
Treasury bond markets in the face of an untenable Fed policy.
Let us first look at how the big banks can keep the interest rates on
Treasuries low, below the rate of inflation, despite the constant
increase in US debt as a percent of GDP–thus preserving the Treasury’s
ability to service the debt.
The imperiled banks too big to fail have a huge stake in low interest
rates and the success of the Fed’s policy. The big banks are positioned
to make the Fed’s policy a success. JPMorgan Chase and other
giant-sized banks can drive down Treasury interest rates and, thereby,
drive up the prices of bonds, producing a rally, by selling Interest
Rate Swaps (IRSwaps).
A financial company that sells IRSwaps is selling an agreement to pay
floating interest rates for fixed interest rates. The buyer is
purchasing an agreement that requires him to pay a fixed rate of
interest in exchange for receiving a floating rate.
The reason for a seller to take the short side of the IRSwap, that
is, to pay a floating rate for a fixed rate, is his belief that rates
are going to fall. Short-selling can make the rates fall, and thus drive
up the prices of Treasuries. When this happens, as these
charts
illustrate, there is a rally in the Treasury bond market that the
presstitute financial media attributes to “flight to the safe haven of
the US dollar and Treasury bonds.” In fact, the circumstantial evidence
(see the charts in the link above) is that the swaps are sold by Wall
Street whenever the Federal Reserve needs to prevent a rise in interest
rates in order to protect its otherwise untenable policy. The swap
sales create the impression of a flight to the dollar, but no actual
flight occurs. As the IRSwaps require no exchange of any principal or
real asset, and are only a bet on interest rate movements, there is no
limit to the volume of IRSwaps.
This apparent collusion suggests to some observers that the reason
the Wall Street banksters have not been prosecuted for their crimes is
that they are an essential part of the Federal Reserve’s policy to
preserve the US dollar as world currency. Possibly the collusion between
the Federal Reserve and the banks is organized, but it doesn’t have to
be. The banks are beneficiaries of the Fed’s zero interest rate policy.
It is in the banks’ interest to support it. Organized collusion is not
required.
Let us now turn to gold and silver bullion. Based on sound analysis,
Gerald Celente and other gifted seers predicted that the price of gold
would be $2000 per ounce by the end of last year. Gold and silver
bullion continued during 2011 their ten-year rise, but in 2012 the price
of gold and silver have been knocked down, with gold being $350 per
ounce off its $1900 high.
In view of the analysis that I have presented, what is the
explanation for the reversal in bullion prices? The answer again is
shorting. Some knowledgeable people within the financial sector believe
that the Federal Reserve (and perhaps also the European Central Bank)
places short sales of bullion through the investment banks, guaranteeing
any losses by pushing a key on the computer keyboard, as central banks
can create money out of thin air.
Insiders inform me that as a tiny percent of those on the buy side of
short sells actually want to take delivery on the gold or silver
bullion, and are content with the financial money settlement, there is
no limit to short selling of gold and silver. Short selling can actually
exceed the known quantity of gold and silver.
Some who have been watching the process for years believe that
government-directed short-selling has been going on for a long time.
Even without government participation, banks can control the volume of
paper trading in gold and profit on the swings that they create.
Recently short selling is so aggressive that it not merely slows the
rise in bullion prices but drives the price down. Is this
aggressiveness a sign that the rigged system is on the verge of
becoming unglued?
In other words, “our government,” which allegedly represents us,
rather than the powerful private interests who elect “our government”
with their multi-million dollar campaign contributions, now legitimized
by the Republican Supreme Court, is doing its best to deprive us mere
citizens, slaves, indentured servants, and “domestic extremists” from
protecting ourselves and our remaining wealth from the currency
debauchery policy of the Federal Reserve. Naked short selling prevents
the rising demand for physical bullion from raising bullion’s price.
Jeff Nielson explains another way that banks can sell bullion shorts when they own no bullion. (See,
http://www.gold-eagle.com/editorials_08/nielson102411.html)
Nielson says that JP Morgan is the custodian for the largest long
silver fund while being the largest short-seller of silver. Whenever the
silver fund adds to its bullion holdings, JP Morgan shorts an equal
amount. The short selling offsets the rise in price that would result
from the increase in demand for physical silver. Nielson also reports
that bullion prices can be suppressed by raising margin requirements on
those who purchase bullion with leverage. The conclusion is that
bullion markets can be manipulated just as can the Treasury bond market
and interest rates.
How long can the manipulations continue? When will the proverbial hit the fan?
If we knew precisely the date, we would be the next mega-billionaires.
Here are some of the catalysts waiting to ignite the conflagration that burns up the Treasury bond market and the US dollar:
A war, demanded by the Israeli government, with Iran, beginning with
Syria, that disrupts the oil flow and thereby the stability of the
Western economies or brings the US and its weak NATO puppets into armed
conflict with Russia and China. The oil spikes would degrade further the
US and EU economies, but Wall Street would make money on the trades.
An unfavorable economic statistic that wakes up investors as to the
true state of the US economy, a statistic that the presstitute media
cannot deflect.
An affront to China, whose government decides that knocking the US
down a few pegs into third world status is worth a trillion dollars.
More derivative mistakes, such as JPMorgan Chase’s recent one, that
send the US financial system again reeling and reminds us that nothing
has changed.
The list is long. There is a limit to how many stupid mistakes and
corrupt financial policies the rest of the world is willing to accept
from the US. When that limit is reached, it is all over for “the
world’s sole superpower” and for holders of dollar-denominated
instruments.
Financial deregulation converted the financial system, which formerly
served businesses and consumers, into a gambling casino where bets are
not covered. These uncovered bets, together with the Fed’s zero interest
rate policy, have exposed Americans’ living standard and wealth to
large declines. Retired people living on their savings and investments,
IRAs and 401(k)s can earn nothing on their money and are forced to
consume their capital, thereby depriving heirs of inheritance.
Accumulated wealth is consumed.
As a result of jobs offshoring, the US has become an import-dependent
country, dependent on foreign made manufactured goods, clothing, and
shoes. When the dollar exchange rate falls, domestic US prices will
rise, and US real consumption will take a big hit. Americans will
consume less, and their standard of living will fall dramatically.
The serious consequences of the enormous mistakes made in Washington,
on Wall Street, and in corporate offices are being held at bay by an
untenable policy of low interest rates and a corrupt financial press,
while debt rapidly builds. The Fed has been through this experience once
before. During WW II the Federal Reserve kept interest rates low in
order to aid the Treasury’s war finance by minimizing the interest
burden of the war debt. The Fed kept the interest rates low by buying
the debt issues. The postwar inflation that resulted led to the Federal
Reserve-Treasury Accord in 1951, in which agreement was reached that the
Federal Reserve would cease monetizing the debt and permit interest
rates to rise.
Fed chairman Bernanke has spoken of an “exit strategy” and said that
when inflation threatens, he can prevent the inflation by taking the
money back out of the banking system. However, he can do that only by
selling Treasury bonds, which means interest rates would rise. A rise in
interest rates would threaten the derivative structure, cause bond
losses, and raise the cost of both private and public debt service. In
other words, to prevent inflation from debt monetization would bring on
more immediate problems than inflation. Rather than collapse the system,
wouldn’t the Fed be more likely to inflate away the massive debts?
Eventually, inflation would erode the dollar’s purchasing power and
use as the reserve currency, and the US government’s credit worthiness
would waste away. However, the Fed, the politicians, and the financial
gangsters would prefer a crisis later rather than sooner. Passing the
sinking ship on to the next watch is preferable to going down with the
ship oneself. As long as interest rate swaps can be used to boost
Treasury bond prices, and as long as naked shorts of bullion can be used
to keep silver and gold from rising in price, the false image of the US
as a safe haven for investors can be perpetrated.
However, the $230,000,000,000,000 in derivative bets by US banks
might bring its own surprises. JPMorgan Chase has had to admit that its
recently announced derivative loss of $2 billion is more than that. How
much more remains to be seen. According to the Comptroller of the
Currency
http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf
the five largest banks hold 95.7% of all derivatives. The five banks
holding $226 trillion in derivative bets are highly leveraged gamblers.
For example, JPMorgan Chase has total assets of $1.8 trillion but holds
$70 trillion in derivative bets, a ratio of $39 in derivative bets for
every dollar of assets. Such a bank doesn’t have to lose very many bets
before it is busted.
Assets, of course, are not risk-based capital. According to the
Comptroller of the Currency report, as of December 31, 2011, JPMorgan
Chase held $70.2 trillion in derivatives and only $136 billion in
risk-based capital. In other words, the bank’s derivative bets are 516
times larger than the capital that covers the bets.
It is difficult to imagine a more reckless and unstable position for a
bank to place itself in, but Goldman Sachs takes the cake. That bank’s
$44 trillion in derivative bets is covered by only $19 billion in
risk-based capital, resulting in bets 2,295 times larger than the
capital that covers them.
Bets on interest rates comprise 81% of all derivatives. These are the
derivatives that support high US Treasury bond prices despite massive
increases in US debt and its monetization.
US banks’ derivative bets of $230 trillion, concentrated in five
banks, are 15.3 times larger than the US GDP. A failed political system
that allows unregulated banks to place uncovered bets 15 times larger
than the US economy is a system that is headed for catastrophic failure.
As the word spreads of the fantastic lack of judgment in the American
political and financial systems, the catastrophe in waiting will become a
reality.
Everyone wants a solution, so I will provide one. The US government
should simply cancel the $230 trillion in derivative bets, declaring
them null and void. As no real assets are involved, merely gambling on
notional values, the only major effect of closing out or netting all
the swaps (mostly over-the-counter contracts between counter-parties)
would be to take $230 trillion of leveraged risk out of the financial
system. The financial gangsters who want to continue enjoying betting
gains while the public underwrites their losses would scream and yell
about the sanctity of contracts. However, a government that can murder
its own citizens or throw them into dungeons without due process can
abolish all the contracts it wants in the name of national security.
And most certainly, unlike the war on terror, purging the financial
system of the gambling derivatives would vastly improve national
security.
