September 10, 2008
The Hidden Bailout Of $1.4 Trillion In Fannie / Freddie Credit-Default Swaps
by Daniel Amerman
Something extraordinary happened on Monday, September the 8th, 2008. The government takeover of Fannie Mae and Freddie Mac triggered the pending settlement of $1.4 trillion in credit-default swaps. This single event could have led to a cascading series of failures that might have bankrupted Wall Street – and much of the rest of the financial world – by the end of the week. That isn’t happening, and indeed, the media is treating this as something close to a non-event. However, a very real $1.4 trillion event happened – whose resolution effectively constitutes one of the largest government bailouts in history. Nobody noticed, for even though this is occurring in “plain sight”, the simple fact is that few people outside of the financial industry understand the $600 trillion derivative securities market. In this article, written the day after the event, we will briefly explain why this hidden, massive bailout – not of Fannie and Freddie but of the financial derivatives industry – is hugely significant, with potentially profound – and arbitragable – implications for the dollar, the markets and your personal financial future.
What Did NOT Happen
(These first several paragraphs in italics do not describe what did happen, but rather what could have happened in an alternate universe in which we actually had a free market that functioned without massive government interventions.)
The financial news of the day was that Fannie Mae and Freddie Mac were both unable to make debt payments and had defaulted on $5 trillion in bonds and mortgage-backed securities. With the US real estate market having fallen $4 trillion in the previous two years (non inflation-adjusted), it should have been no surprise that these two highly leveraged companies were not able to absorb the staggering losses. As this became clear to the markets, Fannie and Freddie lost the ability to borrow – which their survival was based upon – and actual default followed soon after. This default immediately triggered settlements on $1.4 trillion in credit-default swaps (credit derivatives), which had been entered into by major financial firms who had promised – in exchange for lucrative fee income – that if Fannie Mae or Freddie Mac were to default, these guarantor firms would make good on the defaulted bonds.
As the value of Fannie Mae and Freddie Mac debt plunged to 30 cents on the dollar, this meant that there was a 70% loss on the bonds (if one could find a buyer at all). This then triggered a call for settlement on the $1.4 trillion in credit-default swaps outstanding. Because the debt of the two former titans of the financial world was trading at a 70% discount compared to par value, this meant that total credit losses were $1 trillion ($1.4 trillion X 70% = $1 trillion). This meant $1 trillion worth of payments was due from the companies that had guaranteed the value of this debt, through their entering into credit-default swaps.
Settlement was triggered, but as the credit-default swap beneficiaries soon found out, collecting their settlements was an entirely different matter. The financial institutions around the world who had guaranteed Fannie and Freddie in exchange for lucrative corporate fee income (and multi-million dollar individual bonuses) were all highly leveraged themselves (indeed, weaker than the companies they were guaranteeing), and absolutely reliant on the day to day availability of large lines of credit and general borrowing capacity. As the creditors of these financial giants realized that a trillion dollar hit was barreling straight at them, they pulled their financing. Having to repay or replace these loans, without being able to sell massive portfolios of illiquid assets in a market suddenly devoid of buyers, left nearly every major investment bank and commercial bank in the United States and Europe unable to meet their obligations – even before settlement of their trillion dollar credit-default swap losses.
The failure of the major financial firms triggered another massive round of credit-default swap events, with amounts well over $10 trillion by Thursday, and over $20 trillion by Friday. By that time, however, no one was naïve enough to expect actual payment on those swaps, as Wall Street and the rest of the world’s financial hubs had all been insolvent since Wednesday. When the markets eventually opened for business again more than two months later, the official drop in the Dow Jones Industrial Average was over 10,000 points, meaning the index was trading at a level in the 1,000 – 1,500 range.
What Did Happen
“They say there are no atheists in a foxhole. Well, there are no libertarians in a financial crisis, either.”
Jeffrey Frankel, Harvard economist
The above scenario is what might have happened if we took the naïve perspective that markets actually function on their own without government intervention, and that corporations take the consequences for their own bad decisions, in exchange for the profits that come from their good decisions. That is of course a hypothetical world that has little to do with current global financial markets.
If you want a glimpse of the real world future, and what is happening as the same flawed business model that destroyed the $1.2 trillion subprime mortgage derivative securities market now threatens the over $60 trillion credit derivatives market, then we need to look no further than what actually happened with the $1.4 trillion worth of Fannie Mae and Freddie Mac credit default swaps. The companies were taken into conservatorship on September 6th. They have effectively failed even if legally there are some different ways of phrasing it. As reported by Bloomberg on September 8th, that led to a unanimous agreement by 13 Wall Street firms on Monday, September 7, 2008, that settlement of $1.4 trillion in credit default swaps had been triggered.
If Fannie Mae and Freddie Mac had actually failed to make payments on their debt – the consequences would have quite likely destroyed Wall Street right there. As illustrated in the scenario above, there simply isn’t a big enough capital base on Wall Street to absorb a trillion dollars in losses in a week, particularly once your creditors catch on to what is happening. Much smaller losses from subprime mortgage derivatives incrementally dribbling out over the course of the year, still might have taken down Wall Street, had it not been for the ability to hide losses in Tier Three assets (with the full complicity of the government), as well as the reassurances that the Federal Reserve provided by so swiftly bailing out Bear Stearns via JP Morgan, when a creditor driven bankruptcy (as described above) threatened to take down a major player.
Of course, the hypothetical collapse did not happen. The meltdown was averted because the federal government proactively and aggressively intervened to keep a financial disaster from taking down Wall Street (just as it did with Bear Stearns, and Long Term Capital Management the decade before). When the situation started to get bad, the federal government stepped in and – even if they still are hedging a bit legally – effectively guaranteed the debt of Fannie Mae and Freddie Mac.
Which means that they also – and this is crucial – bailed out the firms who had guaranteed the $1.4 trillion in credit derivatives. There may very well be losses, perhaps significant losses, but there would be no catastrophic loss there, that would threaten the viability of the financial system. Because what has really happened is that you have replaced a credit default swap on a quasi-governmental agency, that being Fannie Mae or Freddie Mac, with a credit default swap on the full faith and credit of the United States government. If the US guarantee had not been substituted then it would be a catastrophic failure. But because the US guarantee was substituted, it’s seemingly not a big deal, though much remains to be worked out.
In other words, the biggest beneficiaries of the $1.4 trillion Fannie and Freddie bailout were not Fannie or Freddie at all, but the Wall Street firms whose senior officers just happen to be major political contributors to both political parties – with some of those senior officers also running the Treasury Department on a revolving door basis.
How the ending valuation of the credit default swaps for settlement purposes will work out is a fascinating question. Arguably you could say that the value of Fannie and Freddie debt just rose, not only in comparison to prices during the recent financial turmoil, but also compared to par value. After all, we have just gone from quasi-governmental debt to something that is much closer to being explicitly a full faith and credit obligation of the United States Government, which means we should be losing part of the small spread that Fannie and Freddie traded at as quasi-governmental debt over direct governmental debt yields. From this perspective, one could say that the United States stepping in and taking over actually improves credit quality and the value of the bonds, so there is no loss at all – but a gain.
However there still remains a level of uncertainty, as the debt has not explicitly been made full faith and credit of the United States government. There’s a taint involved, and there could be liquidity issues – as investors typically are not too fond of even small uncertainties. So there’s a good chance the ending value will end up somewhere in the 90s – perhaps very close to par or perhaps a little bit further away. Wherever the ultimate settlement prices, however, it will not be a massive loss, because what has really happened is that a swap has indeed taken place, and the United States government bailed Wall Street out of self-inflicted credit swap-driven destruction, through preemptively swapping its guarantee for the guarantees by Fannie Mae and Freddie Mac.
The real implication of this then is that there is no danger from credit default swaps directly taking down Wall Street, so long as the federal government is willing to aggressively intervene every time there is a potential failure. I think we can see a clear path to the future here.
Where Did That Trillion Come From?
Before going any further, let’s stop and ask a simple question.
Where did the money for the bailout come from?
How did a strapped federal government come up with the trillions (if need be) to make good on all of Fannie Mae and Freddie Mac’s obligations?
How did a government that is already running over a $400 billion deficit so smoothly and easily come up with an extra trillion dollars or two, if needed? (With the $400 billion being based upon government accounting standards whose usage would get an individual or private firm thrown in prison. The deficit is far, far higher when unfunded retirement obligations are taken into account.)
And, for that matter, now that we’re on the subject – where did the government come up with the money for the $170 billion “tax rebate”?
How about that $59 trillion number for unfunded retirement related government obligations that keeps being bandied around? (The real number is a good bit higher as I cover in my article “The $2 Million Opportunity.”)
Where does the government come up with all that money, anyway?
The answer is simple – there is an unlimited supply of dollars. When you issue your own currency, and you are sufficiently determined, then there is an infinite supply of money available. Which could be a very good thing(?), for the Fannie Mae and Freddie Mac credit-default swaps are only one small part of a much larger market – and much larger risk. As we will discuss later in the article, however, while the supply of money is infinite, the value of that money is a different matter.
Taking Full Advantage Of Implicit Government Guarantees
Once you understand that the supplyof money is effectively infinite for a sufficiently grave emergency, then you are ready for the next step in understanding some recent events which might otherwise seem indecipherable. From some perspectives, this near catastrophe which could have so easily taken down all of Wall Street (had the federal government not intervened), was not a catastrophe at all. It was instead a highly successful experiment. For the many firms which purportedly took on the risk in creating $1.4 trillion of credit-default swaps for Fannie Mae and Freddie Mac did not do so for the fun of it or out of the goodness of their hearts. They did so because they got paid enormous sums of money for purportedly taking on all those risks. With much of that money quite directly passing through to the already wealthy individuals involved.
If Fannie and Freddie had not run into problems then the guarantor financial firms would have just pocketed all of their fees, ultimately as pure profit. Instead of that, a worst case scenario occurred that arguably should have destroyed every one of the firms involved in this business – and would have likely done so if there had genuinely been a free market involved.
What the experiment proved was that as long as the risk that you take is big enough, then the federal government and your former coworkers down at the Treasury Department can be absolutely relied upon to bail you out. Now, Wall Street felt this was likely already the case. It was kind of a shame to lose a firm like Bear Stearns, but the good part about it was it proved that a major derivatives market failure wouldn’t be allowed to occur, as was remarked upon in the article from last month quoted below:
“Government intervention has saved the $62 trillion credit derivatives market from facing the nightmare of counterparty failure during the credit crisis of the past year…
After the government backed rescue of Bear Stearns, the market views other major derivative counterparties as also “too big to fail”, and this implicit support… means the credit derivatives market will likely be spared the ultimate test.”
Reuters (Karen Brettell), August 7, 2008
With the takeover of Fannie Mae and Freddie Mac, the markets have been shown to be correct, and the reliability of the government bailout occurring has now been proven on a much larger scale. If the dollar amount is great enough, then no individual firm has to go down. Instead the United States Treasury and/or Federal Reserve will preemptively step in, and effectively make every one whole (or close thereto), perhaps without even affecting Wall Street bonuses.
The principle is very simple. Take huge risks that you know cannot possibly pay out if you lose. In fact – that’s the key to the whole transaction. The risks have to be so large that you cannot afford to lose, and the economy and markets cannot afford for you to lose. Then one of two things happens. Either the risk event does not come about and you make an extraordinary amount of money as an individual and as a firm for having taken on this huge amount of risk. Or the risk happens and you have to pay out. Except you really don’t, because you can’t afford to pay out and you have effectively blackmailed the rest of the population through being too big to fail. Then the government steps in and bails you out. Except it’s not really the government, because the government can’t truly do that, it is the rest of the population which bails you out.
Situations like this are sometimes referred to as “moral hazard” – a weak and theoretical sounding term for an insider’s game of global economic blackmail that is growing at a rate much faster than the overall global economy. The cozy relationship between Wall Street and regulators is crucial, and much of the massive, hidden derivatives bailout that just occurred can be explained by looking at just who the chief “cop” is. US Treasury Secretary Henry Paulson built his half billion dollar personal fortune as the former head of Goldman Sachs, meaning he was chief executive of one of the world’s leading derivatives players.
Making Sense Of The Irrational
It is only when you understand the game that is being played, that the actions of Wall Street and much of the rest of the financial world after the subprime mortgage crisis becomes clear.
The subprime mortgage derivates experiment failed spectacularly. The firms that were creating these derivative securities and the rating firms who were rating them were making numerous and obvious mistakes. Yet once the fundamentally flawed business model was disproven – the world did not move away from derivative securities. Oh, they stopped creating new subprime mortgage derivatives, but when we look at the arguably much riskier credit derivatives market (this greater risk is explored in my article “Credit Derivatives Dangers In 2008 & Beyond – A Primer”), the market grew from $35 trillion in outstanding credit derivatives in July 2007 — the same time it was becoming clear that something was going very badly wrong in the subprime mortgage derivatives market — to a current level of about $62 trillion. In other words the market reacted to the real world proof that these things don’t actually work, by almost doubling the amount in existence in one year. Indeed, the amount of credit derivatives outstanding grew at an annual rate that was about twice the size of the entire United States economy.
Now if you are an academic modeling a hypothetical world of free markets and rational behavior by sophisticated investors keeping the markets safe and fairly valued for all involved, this would make no sense whatsoever. Rational investment firms ought to be fleeing markets like credit derivatives – not doubling up on an already failed experiment.
The reason? It’s the best game in town. Take a huge amount of risk, be paid exceedingly well for it and if you screw up — you have absolute proof that the government will come in and bail you out at the expense of the rest of the population (who did not share in your profits in the first place).
Investing For The Bailout, Not The Crisis
Once we recognize that what is happening here is not a massive credit default, but a monetization by the US government of those losses on a potentially multi-trillion dollar scale, then our investment strategy changes dramatically. We are no longer investing for the crisis – but for the bailout. The combination of this bailout and the Federal Reserves unprecedented actions in forcing interest rates so far below the rate of inflation creates a “target-rich environment” for the execution of arbitrage strategies by both corporate and individual investors.
The federal government is not going to let the financial system fail. It will create however much money needs to be created to bail out the institutions and attempt to bailout the economy, as it has already shown in real world test after test, from the so-called “tax rebate”, to Bear Stearns, to Fannie Mae and Freddie Mac. Which means that the government is prepared to destroy the dollar, and is not just prepared to, but is currently actively destroying the value of the dollar rather than let those firms fail. So the way you invest for the failure of an out of control derivatives market is to invest for the destruction of the dollar. Which means taking on new tools for a new time.
Four Steps To Creating Wealth From Catastrophe
The first step in creating wealth in an unfair world – is to avoid getting cheated. If you are investing money at short term rates of 1%, 2% or even 5%, while the value of your money is eroding at 9% a year, then you are being deliberately played for a sucker, and cheated out of the value of your money by the Federal Reserve.
Not that secret meetings are being held and an explicit agreement is being made to “get the little guys”. It’s just that sacrifices have to be made for the greater good to try to avert a catastrophic market meltdown, and that means that trusting individual investors get paid a negative interest rate on their money (after adjusting for inflation), while paying taxes on (economically) non-existent income for the privilege. Keep in mind as well that one of the purposes in destroying the value of your money is to keep the prices on financial assets propped above where they would otherwise be, if genuine market forces were setting short term interest rates. Which means that you are systematically overpaying for financial assets compared to actual fundamental values, and are getting played for a sucker there as well, to the extent that you are not being subsidized with below (real) market rates like the banks, investment banks and hedge funds. (See my article “Fed Manipulations Subsidize Wall Street & Cheat Investors” for more on this.)
The second step to turning financial catastrophe into personal wealth requires understanding one simple thing – which most investors do not. Inflation does not destroy real wealth, at least not directly. Inflation redistributes real wealth. Indeed, inflation can be used by individuals to quite directly take real wealth from both financial institutions and other individuals, as I illustrate in my (slightly twisted) morality tale “Inflation Pickpocket”. (To add insult to injury, those doing the pocket picking can often do so tax-free, even while their victims pay real taxes on illusory income.)
The third step is to understand that wealth redistribution on a massive scale creates personal opportunity on a massive scale. John Paulson (no relation to Treasury Secretary Henry Paulson) saw the crisis that was coming in subprime mortgages, researched and educated himself on this area (which had not been his field of expertise), and he turned the crisis into a $3-$4 billion personal payday in 2007. If you’re not a hedge fund manager like John Paulson, you may not have the tools that he used to turn a market crisis into personal billions. That’s OK, because Paulson didn’t start with the tools either. He started with educating himself and learning about a new area, until he came up with a novel way to profit from disaster. A method that wasn’t in the financial textbooks, and that he didn’t find by reading a financial columnist in the paper.
Next you need to understand that you personally may have more tools than you may think, some of which may surprise you. Tools which can give you the opportunity to turn financial disaster into personal net worth. There are ways you can use those tools to turn the destruction of the currency into perhaps the greatest real wealth-building opportunity of your life, on a long-term and tax-advantaged basis. But, if you want this to happen –you will need to start with learning. That is the irreplaceable fourth step. You are going to have to educate yourself, and work to not just understand, but to master some of the financial forces and methods in play here. You will have to learn how to turn the destruction of paper wealth into real wealth. With Turning Inflation Into Wealth being the key to this next step. My best wishes to you for turning this challenge into an extraordinary personal opportunity.
Where are the insider admissions about gold Manipulation? Right here
By : Chris Powell
Secretary / Treasurer
Gold Anti-Trust Action Committee
Dear Friend of GATA and Gold:
People like Mike Shedlock of Sitka Pacific Capital Management in Edmonds, Washington, who writes Mish’s Global Economic Trend Analysis letter, will never debate a GATA representative about manipulation of the gold market even as they aggressively misrepresent GATA’s work, as Shedlock did again this week in his essay, “Conspiracy Theory Psychology”:..
Shedlock wrote, as if it is GATA’s position: “Theory 1: The U.S. government, foreign governments, central banks, various broker-dealers, and a consortium of 10 large U.S. banks are all acting together in some massive conspiracy to suppress the price of precious metals for 15 years running, and not a single insider has stepped up to expose the fraud even though housing fraud stories from insiders are being disclosed at a rapid pace, and government, CIA, and other intelligence leaks have been running rampant throughout that entire timeframe.”..
Actually, of course, GATA’s position is that quite a few insiders have testified to the gold price suppression scheme. Though Shedlock purports not to notice it, GATA has been publicizing their admissions for years. It would be decent of Shedlock and those who share his views to familiarize themselves with and respond to these admissions, particularly:..
January 1995: The Federal Reserve’s general counsel, J. Virgil Mattingly, told the Federal Open Market Committee, according to the committee’s minutes, that the U.S. Treasury Department’s Exchange Stabilization Fund had undertaken “gold swaps.” Central banks have only one purpose for “gold swaps”: market intervention. The January 1995 FOMC minutes with Mattingly’s statement are posted at the Fed’s Internet site here:..
July 1998: Federal Reserve Chairman Alan Greenspan told Congress, “Central banks stand ready to lease gold in increasing quantities should the price rise.” That is, Greenspan himself contradicted the usual central bank explanation for leasing gold — supposedly to earn a little interest on a dead asset — and admitted that gold leasing was all about suppressing the price. Greenspan’s admission about the gold price suppression scheme is posted at the Fed’s Internet site here:..
September 1999: The Washington Agreement on Gold, made by the European central banks in 1999, was a proclamation that Western central banks were working together to control the gold price. The central banks in the Washington Agreement claimed that, by restricting their gold sales and leasing, they meant to prevent the gold price from falling too hard. But even if you believed that explanation, it was still collusive intervention in the gold market. The Washington Agreement can be found at the World Gold Council’s Internet site here:..
February 2003: Barrick Gold confessed to the gold price suppression scheme in U.S. District Court in New Orleans when it filed a motion to dismiss Blanchard & Co.’s anti-trust lawsuit against Barrick and its bullion banker, JPMorganChase, for rigging the gold market. Barrick’s motion said that in borrowing gold from central banks and selling it, the company had become the agent of the central banks in the gold market, and, as the agent of the central banks, Barrick should share their sovereign immunity and be exempt from suit. Barrick’s confession can be found here:..
September 2003: The Reserve Bank of Australia confessed to the gold price suppression scheme in its annual report for 2003. “Foreign currency reserve assets and gold,” the RBA’s report said, “are held primarily to support intervention in the foreign exchange market.” The RBA’s report is posted at the central bank’s site here:..
June 2005: Maybe the most brazen admission of the Western central bank scheme to suppress the gold price was made by the head of the monetary and economic department of the Bank for International Settlements, William S. White, in a speech to a BIS conference in Basel, Switzerland. There are five main purposes of central bank cooperation, White announced, and one of them is “the provision of international credits and joint efforts to influence asset prices (especially gold and foreign exchange) in circumstances where this might be thought useful.” White’s speech is posted at GATA’s Internet site here:..
Further, government manipulation of the gold price is only the unanimously accepted history of the world prior to the period about which GATA is complaining. That’s what the gold standard was about, fixing the price of gold to certain amounts of government currencies. That’s what the London Gold Pool was about, the effort of the U.S. and British governments, abandoned in 1968 amid extraordinary demand for the metal, to hold the gold price at $35 per ounce..
Shedlock does acknowledge government’s propensity for market manipulation. He writes:..
“Of course there are conspiracies and manipulations. I have listed many of them..
“– Term Auction Facility..
“– Primary Dealer Credit Facility..
“– Term Securities Lending Facility..
“– SEC rule changes options expiration week..
“– Selective enforcement of naked shorting rules..
“– Discount window changes in options expiration week..
“– Shotgun marriages arranged by the Fed.
“– The bailout of JPMorgan/Bear Stearns.”..
So Shedlock’s position seems to be that government is trying to rig almost every market except the one government used to rig openly. What strange and sublime faith he must have!
Despite the misrepresentation of GATA’s work by Shedlock and others, we’re actually in fairly respectable company in maintaining that the gold market is manipulated. Some big investment houses have said the same thing..
Sprott Asset Management:..
The Cheuvreux brokerage house of the French bank Credit Agricole:
There’s a lot of admission and documentation above, which, it seems, is why Shedlock, Kitco’s Jon Nadler, the World Gold Council, and others who disparage complaints of manipulation of the gold market refuse to debate the issue, where they might be compelled to address the evidence specifically. But GATA remains ready, any time these folks or others on their side work up the honesty and courage.
Join GATA here:
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Secretary / Treasurer
Gold Anti-Trust Action Committee
GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.GATA.org. GATA is grateful for financial contributions, which are federally tax-deductible in the United States.
The Lessons of a Lifetime
SILVER WEEKLY COMMENTARY..
August 18, 2008..
By : Theodore Butler..
TED BUTLER’S ARCHIVES..
In order to understand where you may be going, it is important to understand where you have been. Nowhere is this more true than in silver. The historic price sell-off, coupled with the obvious shortages in almost all forms of retail physical silver present the lessons of a lifetime. I believe that how we learn from this lesson will determine our future financial situation, good or bad..
The drastic sell-off in silver (and gold) is further proof of an ongoing manipulation to the downside. My advice to own real silver on a fully paid for basis, has been borne out. Real pain exists among those who held silver or gold on margin. Many leveraged investors have lost their positions because they couldn’t meet margin calls. Meanwhile, no fully paid up investors sold because they had to come up with more margin money. That’s lesson number one..
The Anatomy of a Crime..
What we just witnessed in the historic sell-off in silver and gold was a crime. That’s not a crybaby complaint. There were no supply or demand developments that could account for the severity of the sell-off. The proof that this sell-off was criminal lies in public data provided in the Commitment of Traders Report (COT) and a basic understanding of how the futures market works. This has been the most extreme sell-off in the recent history of silver and gold. We are farther below the moving averages than at any point since I have been writing about silver. Price movements this severe are likely to be intentional and not accidental..
Every criminal act must have a motive and an opportunity to commit the crime. By the simple process of elimination, those responsible for this crime are the concentrated commercial shorts on the COMEX. No one else fits the profile. They had the means (through their dominant and monopolistic position), the profit motive and the skill to cause the sell-off..
I can’t identify the concentrated shorts by name, as commodity law protects their identity. But the regulators certainly know who they are and continue to choose to do nothing about them. (They also knew the identity of the SemGroup, which appears responsible for the recent run up and collapse of crude oil prices.) While I can’t identify the perpetrators by name, I can label senior management of the NYMEX/COMEX , as well as the commissioners and other high ranking employees at the CFTC as being complicit and involved in the manipulation. Incompetence can no longer be considered an explanation or excuse for them not enforcing the law. (While not the purpose of this article, I will list the e-mail addresses of the regulators at the end of this article, for those who want to make their feelings known.)..
I am not writing this article in anger. I understand how many could feel angry, particularly if leveraged silver or gold positions were liquidated as a result of this sell-off. Not only does this episode confirm that these markets have been manipulated, it also strengthens my conviction that the termination of this manipulation is a certainty. The commercials know better than anyone how the markets function mechanically. This is their full-time business. They know when the markets are least liquid and when many traders are absent. Perhaps the most illiquid times, with few traders present, are in the overnight sessions. The most illiquid time is around 8 PM EST. On Thursday evening, right at that time, the price of silver suddenly plummeted by almost $1.50. It had never before fell by that amount so quickly in any overnight session..
So, how did the concentrated shorts pull that off? They waited until the most opportune time and threw in some relatively small, but aggressively placed sell orders. These sell orders caused the price to fall, touching off further sell orders from under-margined longs, which further caused prices to fall. The analogy I like to use is that it is similar to rolling a small snowball down a hill and watching it pick up size and momentum. As the sell orders began to snowball more and more, guess who was buying after prices dropped? Correct, the concentrated shorts..
How is it possible that the commercials could buy back short positions on thousands of contracts at times of steep sell-offs, without triggering a rise in price? There is only one possible and plausible explanation – through discipline and collusion. The commercials know the price levels that tech funds and other large speculators are likely to sell at on the way down. In addition, some of those large commercials do the clearing for these speculative traders. In that position, they know the finances of the large long silver traders better than anyone. The commercials know, in advance, the sell points and vulnerability levels of the longs as well as the longs themselves. So all the commercials have to do is trigger low enough prices at illiquid times in the market to manufacture an avalanche of selling. Then they sit back with low priced buy orders and wait for the desperate sellers to come to them. Previously, I have referred to the behavior of the commercials as a wolf pack. It is shocking that the regulators can permit this..
To those who claim that these are normal market games, and the commercials are market makers, let me point out that commodity law does not allow for market making. The markets are supposed to operate as an open outcry (now electronic) auction, not as a specialist system. Even assuming that the commercials operate as self-appointed market makers, what kind of legitimate market maker only caps price rises by increasing short selling. Then they create disorderly moves to the downside. That’s why all silver price rallies are contained and orderly and why we get vicious, out of control sell-offs. The commercials make markets only for their own financial benefit. Some market makers..
I promise you that I could prove this if I were privy to the trading records rather than just the CFTC and the exchange, whose mission is to look the other way. But that is impossible, so I have to prove it with public data. While the data for this Thursday-Friday sell-off won’t be available until the next COT, the last few COTs provide ample evidence to prove what I allege..
The most recent COT, for positions held as of 8/12, confirm that the commercials have been on a buying binge for the past month. In other words, they have rigged the sell-offs in silver and gold over the past month and used those sell-offs to collusively buy as many contracts as possible. The numbers are impressive. Since the COT of 7/15, the commercials have bought back and reduced their total net silver futures short position by more than 20,000 contracts (100 million ounces) In gold the commercials have bought back, as a group, more than 90,000 futures contracts, reducing their net short position by 9 million ounces. Undoubtedly, more contracts have been bought by the commercials in the current week..
In addition to this buying on the COMEX, I believe that the naked short position in shares of the silver ETF, SLV, have been bought back, either entirely or in large part over the past month. This was the plan..
However, the percentage of net buying by the concentrated shorts in COMEX silver and gold has decidedly lagged the overall pace of commercial net buying. In silver, the big 4 concentrated shorts only bought back 10%, or 2000 of the 20,000 silver contracts bought, while the raptors (the 9+ smaller commercials) bought 12,000 and the 5 thru 8 largest traders bought a bit more than the 6000 contract balance. In gold the big 4 only bought back 22%, or 20,000 of the 90,000 net contracts bought, with the raptors buying 40,000 contracts and the 5 thru 8 largest traders buying 30,000 contracts..
What this tells us, for sure, is that the concentrated short position of the big 4 in silver and gold, while somewhat reduced in total contracts over the past month, has grown more concentrated and manipulative. The big 4 in gold and silver have grown more and more isolated from the rest of the commercials and, therefore, more desperate. This fully explains the disorderly nature of the recent sell-off and will explain any further disorderliness. The very small amount of short covering by the big 4 increases the likelihood that they may be trapped in these short positions..
Remember, concentration and manipulation go hand in hand, and the more concentrated the short position becomes in silver and gold the clearer the proof of manipulation. Only those that refuse to analyze the public data and reject the very idea that silver and gold could possibly be manipulated can conclude that we are witnessing free market behavior and not a rig job. With the growing evidence of a retail investment shortage in silver, those who deny manipulation are about to look very silly..
The Retail Silver Investment Shortage..
The growing and persistent retail silver investment shortage is becoming increasingly obvious. This segment makes up a small part of the total silver market on a daily basis. However, due to the large number of participants, on both the buy and sell side, the demographics elevate this segment to a more reliable barometer than daily volumes might suggest. With some 5,000 US retail dealers and perhaps 100,000 customers, there is much to learn from in this retail market..
What is happening is nothing short of astounding. For the first time in our lifetime, there is not enough silver to go around. Just about everywhere you look, dealers are sold out or low on inventories, throughout the entire supply chain. Delays in deliveries, the clearest definition of a commodity shortage, are commonplace. This is unprecedented. That this is occurring precisely at the same time of a sharp sell-off in the price of silver, should make your head spin..
I would suggest, if you have college-age children or that you borrow any basic economics textbooks they have. What you will read, is what you already know. The most basic law of supply and demand dictates that low and falling prices must be an indication of growing supplies or falling demand. You will find no suggestion that the price of anything could fall sharply with record demand, especially with the unavailability of supply. At least, not in any free market system..
Then I would suggest that you consider the only plausible explanation to silver investment shortages amid plummeting prices. That explanation is that there must be something wrong with the price of silver, not with supply or demand. After all, the actual supply or demand can’t possibly be “wrong.” They are what they are. Only the price could possibly be wrong. To be exact, the price of silver is manipulated, something that I have maintained for more than two decades. The growing retail silver shortage confirms this manipulation..
I recognize that even if the true Prophet of any or all religions descended from the Heavens and certified that the price of silver (and gold) was manipulated, there would still be many who doubted it. That’s because one of the most powerful forces on the face of the earth, is the inability to admit that they may have been wrong. If that error is about something as basic as a market being free or manipulated, then the denial is likely to be more obstinate. In fact, as the evidence becomes more apparent, it’s actually quite humorous to read and listen to why the shortage doesn’t matter..
As regular readers know, the inevitability of a silver shortage (as a direct result of the long-tern manipulation) has been at the center of my message. If there is one thing upon which I have agreed with my good friend and mentor, Izzy, it is the coming shortage of silver. This has been an issue on which we have agreed for more than 20 years. But it is only recently that I have come to appreciate his true take on what shortage will mean to the price of silver. He has a perspective that few of us have, including me..
By way of review, the silver retail investment shortage emerged some six months ago, shortly after Izzy’s article extolling the advantage of buying US Silver Eagles..
There is not the slightest doubt in my mind that his article jump started the huge demand for Silver Eagles and as a result the US Mint could not keep up with demand. They still can’t. Already, the Mint has sold more Silver Eagles in the first seven and a half months of this year than it sold in any full year in the 22 year history of the Eagle program. And we still have four and a half months. Clearly, Silver Eagle sales would have been higher were the Mint able to keep up with demand. I believe the demand for Silver Eagles subsequently generated sales for all retail silver investment products. Those not able to buy Eagles bought other forms that were available, until demand exceeded supply for other silver products..
Now many may doubt that a retired grandfather could write a single article that could launch a shortage of retail silver for the very first time in history, but I know better. I know that is exactly what happened. And the reason I know it is because I knew that was Izzy’s intent beforehand. Everything he wrote about the benefits of owning silver was the gospel truth. But, he also intended and set out to highlight just how tight silver supply had become by forcing the Mint into a position where they could not meet demand. He knew that the Mint couldn’t hide a shortage of Silver Eagles. There’s no way that someone sets out to accomplish such a specific objective and then achieves it by accident..
The reason I am recounting Izzy’s remarkable accomplishment is to give you a sense of the true meaning of his thoughts on the coming silver shortage. Even I raise my eyes when he offers his seemingly outrageous price projections, although I know better to dismiss anything he says. But there is something unique in his experience and background that gives him a perspective unlike most. In fact, it is a perspective one can achieve only through first hand experience..
Izzy has experienced the kind of shortages of basic goods only witnessed during war. He was present during communist take over in his native Romania. He has related to me how people would pay any price for a loaf of bread, a chicken, even a tool. You and I can’t conceive of such shortages because we have never experienced them first hand..
Perhaps you can mentally transport yourself to imagine such shortages, where price becomes secondary to availability,. If so, you may get a brief glimpse of Izzy’s vision and “crazy” price targets for silver in a time of true shortage. I can only do it for the shortest of times, before my imagination shuts down. If this persistent and growing retail shortage of silver develops into a true full-blown wholesale and industrial shortage (as I believe we may already be in), we will not be able to judge what price is truly crazy. Those most likely to gauge price correctly in a shortage may only be those who have been there and done that..
Lessons For Everyone..
I realize I am running long here, but I ask your indulgence. This article is about the important lessons before us. Let me summarize the lessons to different segments of the silver market..
For investors, don’t let this opportunity slip by. I realize you are seeing something with your own eyes that you have never seen before, namely, shortages and low and sharply declining prices. This is contrary to everything you have learned and experienced. It is nothing short of extraordinary. You must rely on your common sense. Something has to give, either prices or supply. This can’t last for long. Continued low prices won’t increase supply. The only solution for shortage is higher prices. In the case of silver, sharply higher prices. Don’t hesitate in buying silver now..
Recently, I wrote that I thought silver was exceptionally low-risk, since it had fallen sharply. The price then went lower than I thought it would or could. But my basic premise is still intact, namely that the lower the price goes, the lower the remaining risk..
For those investors capable of switching gold owned into silver, this is a particularly opportune time to switch, as silver prices have been manipulated much lower than gold prices. Silver is cheaper, compared to gold, than it has been in a long time. That can’t last. Yes, gold looks cheap here and appears to be also tight on a retail supply basis, but the big difference is this; due to silver’s industrial consumption nature and deeply depleted world inventories, higher prices for silver will not cure a shortage for a long time..
Investors should recognize that the manipulative sell-off may have created the very springboard that will cause the price of silver to soar. This is not about some academic discussion on whether silver is manipulated or not. This is about identifying and taking advantage of a potential price explosion. It has been my long-held premise that before we took off to the upside, we were likely to get a super smash to the downside. I think this was the super smash..
For industrial consumers of silver, the lessons are even more compelling than for investors. That‘s because, investors don’t have to buy silver. They have the choice to buy or not buy. Users don’t have that choice, they must buy. Their only choice is when, how much, and at what price to buy silver. A few weeks ago, users were paying more than $19 an oz for silver. Since then, the price dropped more than $6. Users will not consume less silver just because the price declined..
If you know you must consume an item, price declines are the time to stock up. This is not complicated. If you consume a favorite type of coffee, when it goes on sale for 30% off, the reaction is to take advantage and buy more than you normally would. Likewise, some industrial consumers of silver will do the same. It’s called legitimate hedging, which is the economic justification of the futures markets..
A special note to users. For the past ten years or so, hedging has been a disaster for the producers who sold future production at too low of a price. But if there was one shining example of a good hedge, it was on the buy side by a user. I am speaking of Southwest Airlines, and their magnificent buy hedge of fuel. As a result of locking in low prices, those responsible for the fuel hedge are placed upon a pedestal at the company, and rightly so. Someday soon, there will be some great success stories about those users who locked in silver at current prices..
For mine producers of silver, the current sell-off presents unique risks and opportunities. Obviously, the low price presents danger to your shareholders. I don’t know of a primary miner that can operate at a profit at current silver prices. Producers can and should do something about it. At a minimum, producers should speak up about the sell-off and question its cause. They might threaten to withhold production. Such actions would meet with strong approval from shareholders. It would be a public relations bonanza. Shareholders don’t want to hear producers say everything is fine in the silver market, because they know otherwise..
A few years ago, a silver mining company, Silver Standard, appeared to take my public advice to buy some silver. The results were spectacular. Not only did the company and its CEO, Robert Quartermain, reap shareholder goodwill, it achieved a profit of roughly $25 million, when it sold the silver earlier this year above $20. I would suggest that this company (and others) take advantage of the sell-off and do it again. If they do, I think the results, both from a public relations and profit standpoint, will be even better..
Finally, the lessons to the regulators from this sell-off may be the most important of all. This year we have witnessed disorderly pricing in many markets. In oil and cotton, the disorderly markets were caused by speculator shorts, masquerading as commercials, who ran into trouble and had to buy back their short positions. While the concentrated shorts in silver and gold have not yet lost control, given the growing physical shortage in silver, it would appear to be only a matter of time..
In the meantime, the regulators are permitting a crime to remain in progress. This is shameful. Worse, I believe that their denial of the existence of a silver manipulation has, effectively, given a green light to the concentrated shorts to continue the manipulation. In other words, the CFTC is directly responsible for the recent silver and gold sell-off. That’s beyond shameful..
Any pretense that the concentrated short position in silver was somehow a legitimate hedge went out the window the minute that the price cracked below the cost of production and shortages started to develop. After all, who legitimately hedges to lock in a loss or hedges against nonexistent inventory?..
Here are the e-mail addresses for the regulators. If you want to give someone a piece of your mind about the manipulation, this is a good place to start. While it may or may not do any good, it is the right thing to do, especially if you are disturbed by this manipulation, as you should be..
Has the Government Looted the Gold at Fort Knox?
George Washington’s Blog
Saturday, June 7, 2008
A group called the Gold Anti-Trust Action Committee claims that the U.S. government has defrauded the American people out of the nation’s wealth. Specifically, the group claims that the U.S. has secretly sold, leased or otherwise frittered away half of its entire gold reserves to pay for past military adventures abroad and other ill-conceived actions. Furthermore, the group claims that the government has intentionally covered up this loss of gold reserves through accounting fraud.
Are they right?
Well, as described by Darryl Robert Schoon in his book “How to Survive the Crisis and Prosper in the Process”:
Frank Veneroso is the author of the Gold Book Annual, probably the most comprehensive study and analysis of gold markets available today. One of the world’s foremost financial analysts, Veneroso’s clients have included the World Bank, the Organization of American States, sovereign nations and global money managers.
Frank Veneroso is also chief investment strategist for RCM Global Investors, the equity investment arm of Allianz Dresdner, the giant German insurance conglomerate which also owns the PIMCO bond funds, the bailiwick of Bill Gross.
It was in compiling the statistics on gold markets that Veneroso discovered that the Central Banks were hiding the vast majority of their gold loans from public view. Veneroso estimated that by the late 1990s, the highly lucrative and still hidden gold-carry trade amounted to 10,000 to 15,000 tonnes of gold.
The Central Banks pointed to their books which showed receipts showing large amounts of gold on deposit. What Veneroso suspected and found to be true, however, was that the gold wasn’t there. Ten to fifteen thousand tonnes of gold, an amount far larger than the Central Banks would admit, had been loaned to the investment banks in order to suppress the price of gold and now, in Veneroso’s opinion, were never coming back.
Veneroso noted that the amount of physical gold lent, 10,000-15,000 tonnes, is far too large for investment banks to repurchase without causing the price of gold to explosively rise, the very result the Central Banks had set out to prevent.
The success of the gold-carry trade had led to its failure. Now, at the cost of almost half of their gold reserves, the Central Banks are left only with promissory notes from investment banks instead of the tons of physical gold they had once possessed.
Whereas someone you know, perhaps even yourself, may in the very near future be forced out of their foreclosed home by bank order, rest assured that the investment banks will suffer no consequence for not repaying the gold they borrowed from Central Banks, gold that belonged to the nations that lent it, not its Central Bankers. In matters of finance, especially, the “even hand of justice” is reserved primarily for those that cannot afford it. It is estimated that in the past, Central Banks’ holdings of gold totaled 32,000 tonnes; and Veneroso’s figures show that perhaps 50 % of that is gone. This newly-discovered charade of Central Bank bookkeeping is as fraudulent as Enron’s; and as with Enron, the bookkeepers were complicit in the deception.
See also this.
Are Veneroso and GATA right? I don’t know.
But given that the wealth and stability of our nation is at stake, we should support their attempts to find out. The group has launched a campaign and filed a freedom of information act request to uncover the truth.
If you don’t have any background in the history of gold, here is a very brief history:
* The world’s leading currencies (or “reserve currencies”) have traditionally been backed by gold, at least since the days that shells were the preferred trading standard
* At the end of World War II, it was agreed by the wealthiest nations through the Bretton Woods agreement that the U.S. would be the world’s reserve currency, but that the U.S. dollar would be backed by physical gold (the “gold standard”)
* Because of huge over-spending on foreign military adventures, the U.S. had a gold deficit and was on the verge of economic disaster, and so in 1971 Richard Nixon suspended the gold standard (i.e. he de-linked the dollar from its gold backing)
* GATA and others allege that the U.S. and other wealthy nations have since intentionally suppressed the price of gold so as to make their non-gold backed currencies seem more valuable, and to hide the true level of inflation effecting paper money
* Part of this suppression has allegedly included dumping gold from Fort Knox and foreign gold repositories onto the gold market whenever the price of gold has drifted upward too much for their liking
THE SHELL GAME
Modern economics is not rocket science. In fact, it’s not science at all. It’s a game, a confidence game. Once paper passed for money, economics became an elaborate shell game designed to hide the fact paper had been substituted for silver and gold. Debt ratings are an attempt to quantify confidence in paper assets and are an essential part of the game. The shell game is called “Where’s The Money?” The answer is simple, it’s not there.
The question “where did the money go during the Great Depression?” has now been answered to my satisfaction. During the Great Depression, money essentially disappeared and, as a consequence, consumer and business demand collapsed as did prices, beginning a downward coreolis-like spiral that was to suck the global economy into an economic black hole.
My study of the Great Depression began in the 1990s and the subsequent collapse of the dot.com bubble provided a real-time corroboration of assumptions about the connection between loose credit, excessive speculation, and financial bubbles; and, now, in 2008, one of my most troubling questions about the depression has been answered—where did the money go during the Great Depression?
Plunge In US Commercial Property, an article by Daniel Pimlott posted on FT.com (Financial Times) May 21, 2008 provided a critical clue:
Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago as sources of finance for deals has dried up, according to data from Standard & Poor’s out yesterday.
The value of commercial buildings fell 1.03 percent between January and February, the largest monthly decline since at least 1993, when the industry was just emerging from a deep slump.
The fall in national property prices comes as banks have retrenched on lending due to credit crisis and the slowing economy, causing the volume of deals to slow sharply. The market for commercial mortgage-backed securities, which until last August was a major route to cheaper borrowing, has largely ground to a halt.
Sales of commercial properties were down 71 per cent in the first quarter compared with a year earlier, according to data from Real Capital Analytics.
The fact that sales of US commercial real estate fell an astounding 71 % from 1st quarter 2007 to 1st quarter 2008 is shocking and the implications are quite serious. The cause of the slowdown, however, provided the very clue I was seeking.
Commercial property prices in the US…saw their sharpest decline…as sources of finance for deals has dried up… as banks have retrenched on lending due to credit crisis…
DURING THE GREAT DEPRESSION
MONEY DID NOT DISAPPEAR
The answer to: Where did the money go in the Great Depression? is found in the metaphor of the shell game. It is now clear that money didn’t disappear during the Great Depression, credit disappeared.
The money was never there in the first place. Money had been replaced by credit in the shell game introduced by the Federal Reserve in 1913 when the Federal Reserve began issuing credit-based Federal Reserve notes in place of the savings-based money from the US Treasury.
For details on how the shell game is run, Professor Antal E. Fekete’s description of the check kiting scheme between the US Treasury and Federal Reserve provides crucial information for those perhaps wishing themselves to live off the earnings of others.
It is epitomized by an elaborate check-kiting conspiracy between the U.S: Treasury and the Federal Reserve. Treasury bonds, contrary to appearances, are no more redeemable than Federal Reserve notes. It’s all very neat: the notes are backed by the bonds, and the bonds are redeemable by the notes. Therefore each is valued in terms of itself, rather than by an independent outside asset. Each is an irredeemable liability of the U.S: government. The whole scheme boils down to a farce. It is check-kiting at the highest level. At maturity the bonds are replaced by another with a more distant maturity date, or they are ostensibly paid in the form of irredeemable currency. The issuer of either type of debt is usurping a privilege without accepting the countervailing duty. They issue obligations without taking any further responsibility for their fate or for the effect they have on the economy. Moreover, a double standard of justice is involved. Check-kiting is a crime under the Criminal Code. That is, provided that it is perpetrated by private individuals. Practiced at the highest level, check-kiting is the corner-stone of the monetary system.
GOTTERDÄMMERUNG The Twilight of Irredeemable Debt, Antal E. Fekete, April 28, 2008
THE STUDY OF MODERN ECONOMICS IS SIMILAR
TO THE STUDY OF RELIGION IN A TIME OF IDOLATRY
In the shell game of modern economics, credit replaces money and when credit gives rise to speculative bubbles, the collapse of those bubbles leads to the defaulting of debt which causes credit to disappear and the economy to collapse.
The credit based shell game, however, is nearing its end. The historic credit contraction that began in August 2007 is still in progress. Despite the efforts of central bankers, credit is still disappearing and, just as in the Great Depression, the credit contraction is continuing to spread causing more and more debt to default.
Credit, the fertilizer of human debt, when no longer available effectively spells the end of the legalized shell game masquerading as modern economics; but the kreditmeisters, their global confidence game now damaged by an unexpected lack of confidence on the part of the marks, sic investors, however, will not give up their scam easily.
THE CONUNDRUM OF THE KREDITMEISTERS
Those running the shell game, the central bankers and their codependent brethren, investment bankers, are terrified of losing their day jobs, They have lived well for three hundred years (since the establishment of the Bank of England in 1694) leveraging the productivity of others and we can be assured they will do everything in their considerable power to keep their lifestyle intact..
At this time the central bankers are collectively engaged in financial triage as they attempt to replace the credit that is rapidly being withdrawn in the face of ever increasing amounts of defaulting debt.
Following the same play book they used in the aftermath of the dot.com collapse, the Fed has quickly cut rates from 5.25 % to 2 % but this time they will not ignite a housing bubble as they did the last time. This time, they will do worse. This time, they will burn down the house.
BURNING DOWN THE HOUSE
In the long run, there is no short run
In retrospect it will all be clear, the mistakes, the reasons, the excuses, the results. Now, however, in the beginning of the collapse, events appear more problematic, the outcome still unknown. Nonetheless, even in the fog of unexpected events, certain things can be known and safely predicted; and, one of them is that we are now on the road to hyperinflation.
Appointing “Helicopter Ben” Bernanke to head the Federal Reserve now is akin to sending Sammy the Bull, the mafia hit-man, to negotiate with the Palestinians and Israelis; and when the news comes back that Sammy the Bull shot and killed the Palestinians and Israelis at the negotiating table, we should not be surprised—just as we should not be surprised that Ben “the printing press” Bernanke is erring on the side of excess in the current economic crisis by providing even more credit, by shoving even more debt based paper into now a burning house.
WHEN A HOUSE OF PAPER MONEY BURNS
Hyperinflation is to inflation like pneumonia is to a cold. Though similar, the former is much more consequential; and whereas pneumonia can sometimes kill, hyperinflation is a veritable death sentence. Hyperinflation always ends in the total destruction of paper money. In hyperinflation, the value of paper money reverts to its mean—ZERO.
The past is indeed prologue when it comes to humanity, printing presses, and the recurrent desire of governments to turn paper into gold; which through the alchemy of central banking is possible—though only for a limited time.
While central bankers and governments do not intend to cause hyperinflation anymore than drunk drivers intend to crash, they are nonetheless responsible for the decisions that lead to hyperinflation and deflationary depressions.
The United States has experienced high rates of inflation in the past and appears to be running the same type of fiscal policies that engendered hyperinflations in 20 countries over the past century.
Professor Laurance Kotlikoff, Federal Reserve Bank Review St Louis July/Aug 2006
The US is the largest economy in the world and the US dollar is the world’s reserve currency. Its central bank, the Federal Reserve, is the most influential, and Ben “the printing press” Bernanke is its chairman. We should not be surprised at what is now going to happen to the US, the US dollar and the world economy.
As the Fed is busy bailing out international investment banks with America’s money, we should be more concerned with what is going to happen to us; because when the US dollar goes up in smoke, the US economy will go down in flames and the world economy will stumble badly, if not collapse completely.
Hyperinflation will destroy both the US dollar and the US economy and the world will not be unaffected. Professor Kotlikoff’s warning about a US hyperinflation was published in 2006; and, now in 2008, US printing presses under Fed chairman Ben Bernanke are running faster than they’ve ever been run before.
HYPERINFLATION IS LIKE STEPPING OFF A CLIFF.
YOU ONLY EXPERIENCE IT AFTER YOU’VE GONE TOO FAR
Friedrich Kessler, a law professor at Harvard and at Boalt Hall UC Berkeley described the onset of hyperinflation during the Weimar Republic in Germany.
It was horrible. Horrible! Like lightening it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.
From Fiat Paper Money, The History And Evolution of Our Currency $28.50 by Ralph T. Foster, email@example.com (510) 845-3015 This book, a primer on the end game, is everything you wanted to know about fiat paper money and were too afraid to ask.
At Session III of Professor Fekete’s Gold Standard University Live in February, I discussed the possibility of a sequential or simultaneous hyperinflationary deflationary depression, the economic equivalent of having both a severe heart condition and a possibly fatal cancer at the same time. Such is not impossible; in fact, it is increasingly likely.
I highly recommend the thorough and studied analysis of hyperinflation and concurrent possibilities in John Williams’ Hyperinflation Special Report, Shadow Government Statistics, Series Issue No. 41, April 8, 2008, http://www.shadowstats.com/article/292. John Williams also references and recommends Ralph T. Foster’s Fiat Paper Money, The History And Evolution of Our Currency noted above.
The critical question should now be asked: What can we do?
THE PARACHUTE OF GOLD AND SILVER
JUMPING OUT OF UNCLE BEN’S SPUTTERING HELIPCOPTER
The following is from The Nightmare German Inflation, Scientific Market Analysis, 1970, which describes the extreme hyperinflationary conditions during the Weimar Republic in the 1920s:
The ones who fared best were the small minority who had the foresight to exchange marks into foreign money or gold very early, before new laws made this difficult and before the mark lost too much value.
The difference between 1920s Germany and today is that there are no longer any currencies convertible to precious metals. In the 1920s, when hyperinflation destroyed the German mark, other currencies were still tied to gold. Today, this is no longer the case. Today, only gold and silver will offer guaranteed monetary refuge during the coming crisis.
A hyperinflation is a monetary phenomena caused by the rapid printing of money not convertible to gold or silver. The inflation of the paper money supply happens gradually, but hyperinflation is itself a sudden-onset phenomena. Suddenly and unexpectedly, inflation becomes hyperinflation and unless you are already prepared, it is already too late.
Today, we are moving closer to the end game, the resolution of past monetary sins when the banker’s shell game is exposed for what it is—a monetary abomination, a parasite on the economic body that over time kills the host on which it feeds.
Be aware. Be careful. Be safe.
Note I: I now have a blog, Moving Through The Maelstom with Darryl Robert Schoon. My first blog discusses the underlying reasons for our increasing series of crises.
Note II: I will be speaking at Professor Antal E. Fekete’s Session IV of Gold Standard University Live (GSUL) July 3-6, 2008 in Szombathely , Hungary. If you are interested in monetary matters and gold, the opportunity to hear Professor Fekete should not be missed. A perusal of Professor Fekete’s topics may convince you to attend (see http://www.professorfekete.com/gsul.asp ). Professor Fekete, in my opinion, is a giant in a time of small men.
Darryl Robert Schoon
|December 06, 2007Credit ‘Crunch’ – or Credit Collapse?
by Alex Wallenwein
How can you protect yourself during the worsening credit crunch?
To figure that out, we first need to understand what this ‘credit crunch’ really is, from the most fundamental perspective possible. For, it’s root cause is not the sub-prime mortgage default crisis as financial pundits like to claim. It goes far, far deeper than that.We all know by now that the entire world financial structure is dependent on one thing, and one thing only. That one thing is the very brick from which the splendid looking but dangerously tilting edifice is constructed:
Fundamentally, however, that term is nothing more than a dressed up word for:
The world’s financial system is held up and powered by banks, and banks are in the business of loaning money, which means they are in the business of getting individuals, companies, and governments into debt.
That would be okay if there was a way to retire this debt, but unfortunately the very ‘money’ we all use is itself a creature of debt and consists of nothing but debt.
How is that possible?
It is possible because the very definition of money (i.e., “M1” or the most liquid form of a country’s total money supply) includes bank deposits – and bank deposits are created when someone borrows money from a bank.
When you loan your neighbor a cup of sugar, you go and get some of yours and give it to him, hoping he will return the favor some day. As a normal human being, you cannot loan what you don’t have. That’s pretty obvious.
A bank, however, is a special creature. It is legally authorized to create what it loans you right then and there on the spot. Any funds credited to your loan account by the bank are immediately counted as part of your country’s money supply.
In other words, the bank parts with nothing of its own – but you now legally “owe” the bank the amount money you just borrowed.
Neat, isn’t it?
The bank now has a legal right to your future productivity as either an individual or business earning money in return for what is essentially – nothing. That means the money you just borrowed has no real existence, no real value, other than your promise to “repay”. That promise is what the bank now carries on its books as an “asset.”
There is another way to look at this.
The “money” that circulates throughout individual countries and the is a legal fiction, backed up only by the issuing government’s license to the banks allowing them to create it in this fashion while at the same time giving banks the legal right to enforce your promise to repay against you in a court of law.
Physical cash (i.e., coins and central bank notes) circulating only constitutes a very small fraction of the total money supply, usually about five to ten percent. Most money circulates in electronic form, transferred by checks or EFT technology.
Now, guess what the issuing government receives as its consideration (a legal term for counter-promise) in this bargain?
The issuing government essentially gets a perpetual blank check from the central bank.
The central banks get authority to operate by promising the government in question that they will loan the government whatever “money” it needs to pay its ever-rising bills (at interest, of course).
That way, the banks make both us as individuals as well as our national government their debtors.
You and I, on the other hand, are promised by our government that we will be able to spend this debt. They do this by passing and enforcing a law that requires anyone to whom we offer this debt-money in payment for any debt to accept it – or else the debt is wiped out. The legal term for our offer is called a tender of payment (not “payment” itself). Hence the phrase “legal tender”.
Debt – as payment for other debt.
This system has its own tricky checks and balances consisting of bank reserve requirements and “money multipliers” etc., but there is no need to go into these right now to understand what the true origin of this so-called “credit crunch” is.
The True Nature of the Credit Crunch
Mortgages are really nothing more than another type of promise to repay.
When you take out a mortgage, the bank clerk types a number into the bank’s computer that shows up in the system as a “credit” on your account. This is done in return for your promise to “repay” the bank. That way, the bank gives you a legal fiction and your government backs up the bank’s claim against you, in case you default, with the banks right to sue you in court.
In essence, it is you – not your government – that backs up your country’s money supply. In truth, it is your future productivity that creates the money that “makes the world go “round” as the popular ditti says.
You are Atlas holding up the financial world, and the banks are riding on your shoulders.
The banks, though, have now finally shot themselves in the foot.
Their quintessential need to get more and more people into debt so that the banks themselves can prosper, has led them to generate more and more creative ways of finding more and more potential borrowers.
Their last resort was to make loans to home buyers who really didn’t qualify for a mortgage. They felt constrained to loan to people who really didn’t demonstrate the requisite future productive power they could pledge in return for the “credit” the bank created on their accounts.
So, when times eventually got a little tougher as interest rates rose, they began to default on their mortgages – in growing numbers.
Those borrowers didn’t have much to lose. They got their homes for zero or near-zero down payments, based on fictitious “stated income” figures which the mortgage brokers were encouraged to dream up for them in order to make it look on paper as if the loan was justified. The loan broker’s supervisor closed both eyes, issued the loan, and bagged his bank-sponsored bonus vacation for having found yet another sucker who would go for this gambit, and the world kept spinning.
These mortgages are now the epicenter of the so-called credit crunch.
But they are no different in nature than the very “money” that everybody earns and spends, the very money that governments, banks, and businesses now fear may one day stop flowing as abundantly as it has so far.
The sad truth is that both the mortgages and they money they are supposed to be repaid with are nothing more than – debt.
When Banks Don’t Trust Banks …
Normally, banks fear that individual or business borrowers won’t be able to repay them in time. Now, they are afraid of each other because no single bank knows what the other’s real exposure to the credit crunch really is.
You have read about the gragantuan losses of the biggest financial houses in the world. Some of these losses go into the tens of billions of dollars. Smaller banks have similar problems albeit on a smaller scale.
Knowing this, and knowing that these losses stem from banks’ exposure to disappearing mortgage assets, no bank in its right mind would loan to the other money that the lending bank itself sorely needs to fund its own operations.
That little problem has made the interest rate at which banks loan each other money shoot straight up.
By now, not only subprime mortgages are at risk, but even prime borrowers with sterling credit are defaulting. Their mortgages (debt) were sold by the originating lenders to other outfits called “SIVs” or ‘specialized investment vehicles’ – a fancy term for what boils down to sham corporations set up to buy the mortgages.
Remember that mortgages constituting promises to repay are “assets” in the debt economy. The originating banks sold these to investment funds like hedge funds and to SIVs so the mortgages wouldn’t appear on the originating bank’s .
That, in turn, was important so that the banks could make more money by making even more loans. A bank is required to keep a certain “reserve to loan ratio”. When it originates a loan and keeps servicing it, the loan show up on its books as both an asset (the right to receive future payments from the borrower) and a liability (money loaned out). Assuming the ratio is one to nine, for each $100,000 of reserves, the bank is “only” allowed to make $900,000 in new loans.
By selling the loans to other entities, a bank can turn the formerly balancing asset-liability pair into a pure asset. Once it receives payment for the mortgage (at a discount, of course), its “reserves” increase by that amount.
The bank can then go and loan out up to nine times of that new reserve amount.
That’s how the original mortgage mushroomed into the financial equivalent of nine other mortgages, each for nearly the same amount. Take this process and repeat it thousands of times, every day, throughout the entire US economy, and you have a pretty good picture of the amount of default risk that has been created in the process.
The really big problem is, however, that many banks gave the buyers of their mortgages an open line of credit on which the buyers can call if they run into financial trouble. These backdoor agreements are now being called in by the buyers of these mortgages who are not receiving what they bargained for. The reason: the mortgage-“assets” they bought are being defaulted upon by under-qualified homeowners.
It is this exposure that now makes banks very, very leery of each other.
Banks regularly loan each other low-interest money to finance their daily operations. Without these loans, they cannot operate profitably. Without them, they must either use their reserves to pay for expenses or pay higher interest on their day to day operating cash. Both of these options shrink the amount of new loans they are allowed to make,
That is the truly devastating effect of the credit crunch.
When banks can’t make loans, borrowers who need to borrow can’t get what they need, so they can’t spend it, so that flow of money is not available to the economy, so the economy eventually slows and then shrinks when gross domestic product goes negative – and that’s what we call a recession.
The Mutant Recession
Just as viruses mutate to become resistant to lower level antibiotics, we are now seeing new types of recessions brewing that will no longer respond to the usually prescribed “treatment” of lower interest rates.
Under normal circumstances, recessions can be temporarily alleviated and even turned into another boom by injecting more “credit” (debt) into the economy. This is done by lowering interest rates, and central banks have a number of ways of achieving that.
But when banks don’t trust each other and stop loaning money to each other, that’s when you have a real problem on your hands.
If they don’t trust each other, you can bet that they trust their customers less. We are already seeing mortgage lending standards tightening up – and that is happening even though interest rates have been lowered 75 basis points since the credit crunch hit this past summer, and further significant rate cuts are expected.
This puts banks in a bind: They can’t trust borrowers to pay their loans back as they did in the past, but making loans is the primary way for them to make money. The result: They end up making fewer loans.
Fewer loans mean they make less money.
Fewer loans also mean that the rate at which credit (the money supply) grows begins to shrink.
When this gets to a point where not only the growth rate of credit shrinks, but where the total amount of outstanding credit shrinks, we have a full-blown credit contraction in the making – and the name we usually pin on credit contractions is “Deflation.”
The only ‘solution’ to this dilemma is for the Fed to inject more money (debt) into the system.
That is the root cause of the entire problem.
Debt must be created in order for money to even exist. To repay that debt, more money must be created, and that requires even more debt. Debt piled on debt, and then more debt piled on top of that. It’s an inverted pyramid of debt creation, and you know that structures like that cannot stand on their own. They must be propped up – but the system is rigged in such a fashion that only more debt can prop it up, which only exacerbates the entire problem.
You, as a business owner, private citizen, father, mother, employer, or whatever, are carrying this inverted pyramid. Picture Atlas himself, carrying an inverted pyramid on his back,except that Atlas’ size is about the same in proportion to the pyramid he carries as your size to the great pyramid of Cheops.
That’s you, functioning in this economy.
How do you get out of this situation? Is it all gloom and doom? No. There are ways to escape this crushing load – but that’s the subject of the next installment of this mini-series.
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