Over the centuries there have been many stories, some based on loose facts, others based on hearsay, conjecture, speculation and outright lies, about groups of people who “control the world.” Some of these are partially accurate, others are wildly hyperbolic, but when it comes to the historic record, nothing comes closer to the stereotypical, secretive group determining the fate of over 7 billion people, than the Bank of International Settlements, which hides in such plain sight, that few have ever paid much attention.
This is their story.
First unofficial meeting of the BIS Board of Directors in Basel, April 1930
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The following is an excerpt from TOWER OF BASEL: The Shadowy History of the Secret Bank that Runs the World by Adam LeBor. Reprinted with permission from PublicAffairs.
The world’s most exclusive club has eighteen members. They gather every other month on a Sunday evening at 7 p.m. in conference room E in a circular tower block whose tinted windows overlook the central Basel railway station. Their discussion lasts for one hour, perhaps an hour and a half. Some of those present bring a colleague with them, but the aides rarely speak during this most confidential of conclaves. The meeting closes, the aides leave, and those remaining retire for dinner in the dining room on the eighteenth floor, rightly confident that the food and the wine will be superb. The meal, which continues until 11 p.m. or midnight, is where the real work is done. The protocol and hospitality, honed for more than eight decades, are faultless. Anything said at the dining table, it is understood, is not to be repeated elsewhere.
Few, if any, of those enjoying their haute cuisine and grand cru wines— some of the best Switzerland can offer—would be recognized by passers-by, but they include a good number of the most powerful people in the world. These men—they are almost all men—are central bankers. They have come to Basel to attend the Economic Consultative Committee (ECC) of the Bank for International Settlements (BIS), which is the bank for central banks. Its current members [ZH: as of 2013] include Ben Bernanke, the chairman of the US Federal Reserve; Sir Mervyn King, the governor of the Bank of England; Mario Draghi, of the European Central Bank; Zhou Xiaochuan of the Bank of China; and the central bank governors of Germany, France, Italy, Sweden, Canada, India, and Brazil. Jaime Caruana, a former governor of the Bank of Spain, the BIS’s general manager, joins them.
In early 2013, when this book went to press, King, who is due to step down as governor of the Bank of England in June 2013, chaired the ECC. The ECC, which used to be known as the G-10 governors’ meeting, is the most influential of the BIS’s numerous gatherings, open only to a small, select group of central bankers from advanced economies. The ECC makes recommendations on the membership and organization of the three BIS committees that deal with the global financial system, payments systems, and international markets. The committee also prepares proposals for the Global Economy Meeting and guides its agenda.
That meeting starts at 9:30 a.m. on Monday morning, in room B and lasts for three hours. There King presides over the central bank governors of the thirty countries judged the most important to the global economy. In addition to those who were present at the Sunday evening dinner, Monday’s meeting will include representatives from, for example, Indonesia, Poland, South Africa, Spain, and Turkey. Governors from fifteen smaller countries, such as Hungary, Israel, and New Zealand are allowed to sit in as observers, but do not usually speak. Governors from the third tier of member banks, such as Macedonia and Slovakia, are not allowed to attend. Instead they must forage for scraps of information at coffee and meal breaks.
The governors of all sixty BIS member banks then enjoy a buffet lunch in the eighteenth-floor dining room. Designed by Herzog & de Meuron, the Swiss architectural firm which built the “Bird’s Nest” Stadium for the Beijing Olympics, the dining room has white walls, a black ceiling and spectacular views over three countries: Switzerland, France, and Germany. At 2 p.m. the central bankers and their aides return to room B for the governors’ meeting to discuss matters of interest, until the gathering ends at 5.
King takes a very different approach than his predecessor, Jean-Claude Trichet, the former president of the European Central Bank, in chairing the Global Economy Meeting. Trichet, according to one former central banker, was notably Gallic in his style: a stickler for protocol who called the central bankers to speak in order of importance, starting with the governors of the Federal Reserve, the Bank of England, and the Bundesbank, and then progressing down the hierarchy. King, in contrast, adopts a more thematic and egalitarian approach: throwing open the meetings for discussion and inviting contributions from all present.
The governors’ conclaves have played a crucial role in determining the world’s response to the global financial crisis. “The BIS has been a very important meeting point for central bankers during the crisis, and the rationale for its existence has expanded,” said King. “We have had to face challenges that we have never seen before. We had to work out what was going on, what instruments do we use when interest rates are close to zero, how do we communicate policy. We discuss this at home with our staff, but it is very valuable for the governors themselves to get together and talk among themselves.”
Those discussions, say central bankers, must be confidential. “When you are at the top in the number one post, it can be pretty lonely at times. It is helpful to be able to meet other number ones and say, ‘This is my problem, how do you deal with it?’” King continued. “Being able to talk informally and openly about our experiences has been immensely valuable. We are not speaking in a public forum. We can say what we really think and believe, and we can ask questions and benefit from others.”
The BIS management works hard to ensure that the atmosphere is friendly and clubbable throughout the weekend, and it seems they succeed. The bank arranges a fleet of limousines to pick up the governors at Zürich airport and bring them to Basel. Separate breakfasts, lunches, and dinners are organized for the governors of national banks who oversee different types and sizes of national economies, so no one feels excluded. “The central bankers were more at home and relaxed with their fellow central bankers than with their own governments,” recalled Paul Volcker, the former chairman of the US Federal Reserve, who at- tended the Basel weekends. The superb quality of the food and wine made for an easy camaraderie, said Peter Akos Bod, a former governor of the National Bank of Hungary. “The main topics of discussion were the quality of the wine and the stupidity of finance ministers. If you had no knowledge of wine you could not join in the conversation.”
And the conversation is usually stimulating and enjoyable, say central bankers. The contrast between the Federal Open Markets Committee at the US Federal Reserve, and the Sunday evening G-10 governors’ dinners was notable, recalled Laurence Meyer, who served as a member of the Board of Governors of the Federal Reserve from 1996 until 2002. The chairman of the Federal Reserve did not always represent the bank at the Basel meetings, so Meyer occasionally attended. The BIS discussions were always lively, focused and thought provoking. “At FMOC meetings, while I was at the Fed, almost all the Committee members read statements which had been prepared in advance. They very rarely referred to statements by other Committee members and there was almost never an exchange between two members or an ongoing discussion about the outlook or policy options. At BIS dinners people actually talk to each other and the discussions are always stimulating and interactive focused on the serious issues facing the global economy.”
All the governors present at the two-day gathering are assured of total confidentiality, discretion, and the highest levels of security. The meetings take place on several floors that are usually used only when the governors are in attendance. The governors are provided with a dedicated office and the necessary support and secretarial staff. The Swiss authorities have no juridisdiction over the BIS premises. Founded by an international treaty, and further protected by the 1987 Headquarters Agreement with the Swiss government, the BIS enjoys similar protections to those granted to the headquarters of the United Nations, the International Monetary Fund (IMF) and diplomatic embassies. The Swiss authorities need the permission of the BIS management to enter the bank’s buildings, which are described as “inviolable.”
The BIS has the right to communicate in code and to send and receive correspondence in bags covered by the same protection as embassies, meaning they cannot be opened. The BIS is exempt from Swiss taxes. Its employees do not have to pay income tax on their salaries, which are usually generous, designed to compete with the private sector. The general man- ager’s salary in 2011 was 763,930 Swiss francs, while head of departments were paid 587,640 per annum, plus generous allowances. The bank’s extraordinary legal privileges also extend to its staff and directors. Senior managers enjoy a special status, similar to that of diplomats, while carrying out their duties in Switzerland, which means their bags cannot be searched (unless there is evidence of a blatant criminal act), and their papers are inviolable. The central bank governors traveling to Basel for the bimonthly meetings enjoy the same status while in Switzerland. All bank officials are immune under Swiss law, for life, for all the acts carried out during the discharge of their duties. The bank is a popular place to work and not just because of the salaries. Around six hundred staff come from over fifty countries. The atmosphere is multi-national and cosmopolitan, albeit very Swiss, emphasizing the bank’s hierarchy. Like many of those working for the UN or the IMF, some of the staff of the BIS, especially senior management, are driven by a sense of mission, that they are working for a higher, even celestial purpose and so are immune from normal considerations of accountability and transparency.
The bank’s management has tried to plan for every eventuality so that the Swiss police need never be called. The BIS headquarters has high-tech sprinkler systems with multiple back-ups, in-house medical facilities, and its own bomb shelter in the event of a terrorist attack or armed conflagration. The BIS’s assets are not subject to civil claims under Swiss law and can never be seized.
The BIS strictly guards the bankers’ secrecy. The minutes, agenda, and actual attendance list of the Global Economy Meeting or the ECC are not released in any form. This is because no official minutes are taken, although the bankers sometimes scribble their own notes. Sometimes there will be a brief press conference or bland statement afterwards but never anything detailed. This tradition of privileged confidentiality reaches back to the bank’s foundation.
“The quietness of Basel and its absolutely nonpolitical character provide a perfect setting for those equally quiet and nonpolitical gatherings,” wrote one American official in 1935. “The regularity of the meetings and their al- most unbroken attendance by practically every member of the Board make them such they rarely attract any but the most meager notice in the press.”8 Forty years on, little had changed. Charles Coombs, a former foreign exchange chief of the New York Federal Reserve, attended governors’ meetings from 1960 to 1975. The bankers who were allowed inside the inner sanctum of the governors’ meetings trusted each other absolutely, he recalled in his memoirs. “However much money was involved, no agreements were ever signed nor memoranda of understanding ever initialized. The word of each official was sufficient, and there were never any disappointments.”
What, then, does this matter to the rest of us? Bankers have been gathering confidentially since money was first invented. Central bankers like to view themselves as the high priests of finance, as technocrats overseeing arcane monetary rituals and a financial liturgy understood only by a small, self-selecting elite.
But the governors who meet in Basel every other month are public servants. Their salaries, airplane tickets, hotel bills, and lucrative pensions when they retire are paid out of the public purse. The national reserves held by central banks are public money, the wealth of nations. The central bankers’ discussions at the BIS, the information that they share, the policies that are evaluated, the opinions that are exchanged, and the subsequent decisions that are taken, are profoundly political. Central bankers, whose independence is constitutionally protected, control monetary policy in the developed world. They manage the supply of money to national economies. They set interest rates, thus deciding the value of our savings and investments. They decide whether to focus on austerity or growth. Their decisions shape our lives.
The BIS’s tradition of secrecy reaches back through the decades. During the 1960s, for example, the bank hosted the London Gold Pool. Eight countries pledged to manipulate the gold market to keep the price at around thirty-five dollars per ounce, in line with the provisions of the Bretton Woods Accord that governed the post–World War II international financial system. Although the London Gold Pool no longer exists, its successor is the BIS Markets Committee, which meets every other month on the occasion of the governors’ meetings to discuss trends in the financial markets. Officials from twenty-one central banks attend. The committee releases occasional papers, but its agenda and discussions remain secret.
Nowadays the countries represented at the Global Economy Meetings together account for around four-fifths of global gross domestic product (GDP)— most of the produced wealth of the world—according to the BIS’s own statistics. Central bankers now “seem more powerful than politicians,” wrote The Economist newspaper, “holding the destiny of the global economy in their hands.” How did this happen? The BIS, the world’s most secretive global financial institution, can claim much of the credit. From its first day of existence, the BIS has dedicated itself to furthering the interests of central banks and building the new architecture of transnational finance. In doing so, it has spawned a new class of close-knit global technocrats whose members glide between highly-paid positions at the BIS, the IMF, and central and commercial banks.
The founder of the technocrats’ cabal was Per Jacobssen, the Swedish economist who served as the BIS’s economic adviser from 1931 to 1956. The bland title belied his power and reach. Enormously influential, well connected, and highly regarded by his peers, Jacobssen wrote the first BIS annual reports, which were—and remain—essential reading throughout the world’s treasuries. Jacobssen was an early supporter of European federalism. He argued relentlessly against inflation, excessive government spending, and state intervention in the economy. Jacobssen left the BIS in 1956 to take over the IMF. His legacy still shapes our world. The consequences of his mix of economic liberalism, price obsession, and dismantling of national sovereignty play out nightly in the European news bulletins on our television screens.
The BIS’s defenders deny that the organization is secretive. The bank’s archives are open and researchers may consult most documents that are more than thirty years old. The BIS archivists are indeed cordial, helpful, and professional. The bank’s website includes all its annual reports, which are downloadable, as well as numerous policy papers produced by the bank’s highly regarded research department. The BIS publishes detailed accounts of the securities and derivatives markets, and international banking statistics. But these are largely compilations and analyses of information already in the public domain. The details of the bank’s own core activities, including much of its banking operations for its customers, central banks, and international organizations, remain secret. The Global Economy Meetings and the other crucial financial gatherings that take place at Basel, such as the Markets Committee, remain closed to outsiders. Private individuals may not hold an account at BIS, unless they work for the bank. The bank’s opacity, lack of accountability, and ever-increasing influence raises profound questions— not just about monetary policy but transparency, accountability, and how power is exercised in our democracies.
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WHEN I EXPLAINED to friends and acquaintances that I was writing a book about the Bank for International Settlements, the usual response was a puzzled look, followed by a question: “The bank for what?” My interlocutors were intelligent people, who follow current affairs. Many had some interest in and understanding of the global economy and financial crisis. Yet only a handful had heard of the BIS. This was strange, as the BIS is the most important bank in the world and predates both the IMF and the World Bank. For decades it has stood at the center of a global network of money, power, and covert global influence.
The BIS was founded in 1930. It was ostensibly set up as part of the Young Plan to administer German reparations payments for the First World War. The bank’s key architects were Montagu Norman, who was the governor of the Bank of England, and Hjalmar Schacht, the president of the Reichsbank who described the BIS as “my” bank. The BIS’s founding members were the central banks of Britain, France, Germany, Italy, Belgium, and a consortium of Japanese banks. Shares were also offered to the Federal Reserve, but the United States, suspicious of anything that might infringe on its national sovereignty, refused its allocation. Instead a consortium of commercial banks took up the shares: J. P. Morgan, the First National Bank of New York, and the First National Bank of Chicago.
The real purpose of the BIS was detailed in its statutes: to “promote the cooperation of central banks and to provide additional facilities for international financial operations.” It was the culmination of the central bankers’ decades-old dream, to have their own bank—powerful, independent, and free from interfering politicians and nosy reporters. Most felicitous of all, the BIS was self-financing and would be in perpetuity. Its clients were its own founders and shareholders— the central banks. During the 1930s, the BIS was the central meeting place for a cabal of central bankers, dominated by Norman and Schacht. This group helped rebuild Germany. The New York Times described Schacht, widely acknowledged as the genius behind the resurgent German economy, as “The Iron-Willed Pilot of Nazi Finance.” During the war, the BIS became a de-facto arm of the Reichsbank, accepting looted Nazi gold and carrying out foreign exchange deals for Nazi Germany.
The bank’s alliance with Berlin was known in Washington, DC, and London. But the need for the BIS to keep functioning, to keep the new channels of transnational finance open, was about the only thing all sides agreed on. Basel was the perfect location, as it is perched on the northern edge of Switzerland and sits al- most on the French and German borders. A few miles away, Nazi and Allied soldiers were fighting and dying. None of that mattered at the BIS. Board meetings were suspended, but relations between the BIS staff of the belligerent nations remained cordial, professional, and productive. Nationalities were irrelevant. The overriding loyalty was to international finance. The president, Thomas McKittrick, was an American. Roger Auboin, the general manager, was French. Paul Hechler, the assistant general manager, was a member of the Nazi party and signed his correspondence “Heil Hitler.” Rafaelle Pilotti, the secretary general, was Italian. Per Jacobssen, the bank’s influential economic adviser, was Swedish. His and Pilotti’s deputies were British.
After 1945, five BIS directors, including Hjalmar Schacht, were charged with war crimes. Germany lost the war but won the economic peace, in large part thanks to the BIS. The international stage, contacts, banking networks, and legitimacy the BIS provided, first to the Reichsbank and then to its successor banks, has helped ensure the continuity of immensely powerful financial and economic interests from the Nazi era to the present day.
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FOR THE FIRST forty-seven years of its existence, from 1930 to 1977, the BIS was based in a former hotel, near the Basel central railway station. The bank’s entrance was tucked away by a chocolate shop, and only a small notice confirmed that the narrow doorway opened into the BIS. The bank’s managers believed that those who needed to know where the BIS was would find it, and the rest of the world certainly did not need to know. The inside of the building changed little over the decades, recalled Charles Coombs. The BIS provided the “the spartan accommodations of a former Victorian-style hotel whose single and double bedrooms had been transformed into offices simply by removing the beds and installing desks.”
The bank moved into its current headquarters, at 2, Centralbahnplatz, in 1977. It did not go far and now overlooks the Basel central station. Nowadays the BIS’s main mission, in its own words, is threefold: “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in these areas, and to act as a bank for central banks.” The BIS also hosts much of the practical and technical infrastructure that the global network of central banks and their commercial counterparts need to function smoothly. It has two linked trading rooms: at the Basel headquarters and Hong Kong regional office. The BIS buys and sells gold and foreign exchange for its clients. It provides asset management and arranges short-term credit to central banks when needed.
The BIS is a unique institution: an international organization, an extremely profitable bank and a research institute founded, and protected, by international treaties. The BIS is accountable to its customers and shareholders—the central banks—but also guides their operations. The main tasks of a central bank, the BIS argues, are to control the flow of credit and the volume of currency in circulation, which will ensure a stable business climate, and to keep exchange rates within manageable bands to ensure the value of a currency and so smooth international trade and capital movements. This is crucial, especially in a globalized economy, where markets react in microseconds and perceptions of economic stability and value are almost as important as reality itself.
The BIS also helps to supervise commercial banks, although it has no legal powers over them. The Basel Committee on Banking Supervision, based at the BIS, regulates commercial banks’ capital and liquidity requirements. It requires banks to have a minimum capital of eight percent of risk-weighted assets when lending, meaning that if a bank has risk-weighted assets of $100 million it must maintain at least $8 million capital. The committee has no powers of enforcement, but it does have enormous moral authority. “This regulation is so powerful that the eight percent principle has been set into national laws,” said Peter Akos Bod. “It’s like voltage. Voltage has been set at 220. You may decide on ninety-five volts, but it would not work.” In theory, sensible housekeeping and mutual cooperation, overseen by the BIS, will keep the global financial system functioning smoothly. In theory.
The reality is that we have moved beyond recession into a deep structural crisis, one fueled by the banks’ greed and rapacity, which threatens all of our financial security. Just as in the 1930s, parts of Europe face economic collapse. The Bundesbank and the European Central Bank, two of the most powerful members of the BIS, have driven the mania for austerity that has already forced one European country, Greece, to the edge, aided by the venality and corruption of the country’s ruling class. Others may soon follow. The old order is creaking, its political and financial institutions corroding from within. From Oslo to Athens, the far right is resurgent, fed in part by soaring poverty and unemployment. Anger and cynicism are corroding citizens’ faith in democracy and the rule of law. Once again, the value of property and assets is vaporizing before their owners’ eyes. The European currency is threatened with breakdown, while those with money seek safe haven in Swiss francs or gold. The young, the talented, and the mobile are again fleeing their home countries for new lives abroad. The powerful forces of international capital that brought the BIS into being, and which granted the bank its power and influence, are again triumphant.
The BIS sits at the apex of an international financial system that is falling apart at the seams, but its officials argue that it does not have the power to act as an international financial regulator. Yet the BIS cannot escape its responsibility for the Euro-zone crisis. From the first agreements in the late 1940s on multilateral payments to the establishment of the Europe Central Bank in 1998, the BIS has been at the heart of the European integration project, providing technical expertise and the financial mechanisms for currency harmonization. During the 1950s, it managed the European Payments Union, which internationalized the continent’s payment system. The BIS hosted the Governors’ Committee of European Economic Community central bankers, set up in 1964, which coordinated trans-European monetary policy. During the 1970s, the BIS ran the “Snake,” the mechanism by which European currencies were held in exchange rate bands. During the 1980s the BIS hosted the Delors Committee, whose report in 1988 laid out the path to European Monetary Union and the adoption of a single currency. The BIS midwifed the European Monetary Institute (EMI), the precursor of the European Central Bank. The EMI’s president was Alexandre Lamfalussy, one of the world’s most influential economists, known as the “Father of the euro.” Before joining the EMI in 1994, Lamfalussy had worked at the BIS for seventeen years, first as economic adviser, then as the bank’s general manager.
For a staid, secretive organization, the BIS has proved surprisingly nimble. It survived the first global depression, the end of reparations payments and the gold standard (two of its main reasons for existence), the rise of Nazism, the Second World War, the Bretton Woods Accord, the Cold War, the financial crises of the 1980s and 1990s, the birth of the IMF and World Bank, and the end of Communism. As Malcolm Knight, manager from 2003–2008, noted, “It is encouraging to see that—by remaining small, flexible, and free from political interference—the Bank has, throughout its history, succeeded remarkably well in adapting itself to evolving circumstances.”
The bank has made itself a central pillar of the global financial system. As well as the Global Economy Meetings, the BIS hosts four of the most important international committees dealing with global banking: the Basel Committee on Banking Supervision, the Committee on the Global Financial System, the Committee on Payment and Settlement Systems, and the Irving Fisher Committee, which deals with central banking statistics. The bank also hosts three independent organizations: two groups dealing with insurance and the Financial Stability Board (FSB). The FSB, which coordinates national financial authorities and regulatory policies, is already being spoken of as the fourth pillar of the global financial system, after the BIS, the IMF and the commercial banks.
The BIS is now the world’s thirtieth-largest holder of gold reserves, with 119 metric tons—more than Qatar, Brazil, or Canada. Membership of the BIS remains a privilege rather than a right. The board of directors is responsible for admitting central banks judged to “make a substantial contribution to international monetary cooperation and to the Bank’s activities.” China, India, Russia, and Saudi Arabia joined only in 1996. The bank has opened offices in Mexico City and Hong Kong but remains very Eurocentric. Estonia, Latvia, Lithuania, Macedonia, Slovenia, and Slovakia (total population 16.2 million) have been admitted, while Pakistan (population 169 million) has not. Nor has Kazakhstan, which is a powerhouse of Central Asia. In Africa only Algeria and South Africa are members—Nigeria, which has the continent’s second-largest economy, has not been admitted. (The BIS’s defenders say that it demands high governance standards from new members and when the national banks of countries such as Nigeria and Pakistan reach those standards, they will be considered for membership.)
Considering the BIS’s pivotal role in the transnational economy, its low profile is remarkable. Back in 1930 a New York Times reporter noted that the culture of secrecy at the BIS was so strong that he was not permitted to look inside the boardroom, even after the directors had left. Little has changed. Journalists are not allowed inside the headquarters while the Global Economy Meeting is underway. BIS officials speak rarely on the record, and reluctantly, to members of the press. The strategy seems to work. The Occupy Wall Street movement, the anti-globalizers, the social network protesters have ignored the BIS. Centralbahnplatz 2, Basel, is quiet and tranquil. There are no demonstrators gathered outside the BIS’s headquarters, no protestors camped out in the nearby park, no lively reception committees for the world’s central bankers.
As the world’s economy lurches from crisis to crisis, financial institutions are scrutinized as never before. Legions of reporters, bloggers, and investigative journalists scour the banks’ every move. Yet somehow, apart from brief mentions on the financial pages, the BIS has largely managed to avoid critical scrutiny. Until now.
by Roger Blitz
A visitor to Mexico City’s Bellas Artes Museum walks between two Andy Warhol “Dollar Sign” paintings August 24. The two paintings are part of the first ever Andy Warhol exhibition in Latin America. Warhol’s art is back in fashion, according to museum director Agustin Arteaga, as similar retrospective exhibitions are being held this year in several cities around the world.
“Export growth has weakened,” said the central bank, in a veiled reference to how the sustained appreciation of the currency since last summer has weighed on the economy.
Although the Fed rarely chooses to discuss the currency, Janet Yellen, chairwoman, also referred to dollar strength during her press conference after the statement was published.
That one-two punch drove the dollar sharply lower on Wednesday, with the euro, which has depreciated 13 per cent since the start of the year, on track for its best weekly gain since October 2011.
A 25 per cent rise in the dollar over the past year may well give way to a period of far choppier trading that challenges investors, especially those betting on further gains for the greenback. With the US central bank voicing its worries about a strong dollar and signalling that this could delay monetary tightening, investors are likely to face a tougher trading environment in the currency market.
The strength of the dollar and ramifications for Fed policy have been bubbling away for a while. When ex-Fed chairman Ben Bernanke was guest of honour at a recent private investment forum hosted at Pimco, the bond fund management firm’s staff peppered him with questions about the central bank’s likely approach to the strengthening dollar.
Surging dollar appreciation globally has triggered growing unease among US equity investors as numerous multinational companies have revealed lower profits from their foreign operations.
That became apparent during this week’s Fed press conference. In addition to worries about exports, Ms Yellen said import prices had restrained inflation, and “in light of the recent appreciation of the dollar, will likely continue to do so in the months ahead”.
Rich Clarida, global strategic adviser at Pimco, says: “Until now, with markets romancing the idea of quantitative easing in Europe and Japan, you have had a one-way move in the dollar. The new element is that this is the first time the Fed, through its jawboning, has signalled that the currency move is on its radar.”
While the Fed statement and Ms Yellen played down the prospect of a rate rise in June, dollar bulls quickly capitalised on a knee-jerk bout of weakness.
After falling 2.5 per cent against the euro on Wednesday, the dollar roared back 24 hours later, reversing those losses. This whipsaw trading between the dollar and euro highlights how volatility is picking up across the currency market.
“You have to go back a long time to get to anything like that level of volatility,” says Simon Derrick, strategist at BNY Mellon. “To go from $1.06 to $1.10 [in one session] — that was ‘wow’.”
Marc Chandler, global currency strategist at Brown Brothers Harriman and a long-time dollar bull, says it was an opportunity that long-dollar advocates could not pass up.
“Long and medium-term dollar investors are still very dollar bullish,” he says. “Whether the Fed raises [rates] in June or September is not such a big deal.”
But some long-dollar traders have begun shifting their strategy and on Friday the euro was rising fast. Ugo Lancioni of asset manager Neuberger Berman says the group has been long on the dollar since last year but has become more neutral.
One reason, he says, is that divergence is now priced into the greenback. “Investors jumped on the dollar story on the back of expecting divergence, which is a powerful story, but which has played out,” he says.
“Given that the dollar is doing some of the tightening for the Fed, will that momentum of the divergence story continue?”
That view is shared by longstanding dollar-bull proponents at HSBC who say the dollar rally is nearing its end.
“Tell me something I don’t know,” says Daragh Maher of HSBC about the divergence argument. “There’s no one out there who isn’t aware the Fed wants to raise rates. We are in the autopilot phase.”
There are other reasons to believe that the dollar bull case has run its course, says HSBC.
The dollar has already moved a long way, more than in other historical dollar rallies; the dollar is the world’s second most overvalued currency (behind the Swiss franc); the markets are ignoring both disappointing US economic data and surprisingly good numbers from eurozone economies; positioning is so stretched that there appears no resistance to dollar bulls; and historically the dollar tends to fall after the US raises interest rates.
Mr Chandler disagrees. In dollar rallies of the 1980s and 1990s, the euro or its equivalent halved, he says.
History will repeat itself, he says. “It peaked at $1.60 back in 2008 and ever since that peak my technical models and fundamental views became much more dollar-bullish.
“It has been a long slog since then . . . but I’m convinced that the euro is going back down to test those historic lows at about half the value of its peak.”
by Charles Hugh-Smith
Borrowing in USD was risk-on; buying USD is risk-off.
There is a lively debate about the global demand for U.S. dollars:
Global finance faces $9 trillion stress test as dollar soars (Telegraph.co.uk)The Dollar Squeeze – How Problematic Is It? (Acting Man)The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different” (Zero Hedge), which references a Bank for International Settlements (BIS) paper: Global dollar credit: links to US monetary policy and leverage.
Thank you, Mark, for the detailed analysis. Here are my initial thoughts:
By Bill Holter
We have watched, even marveled at how the U.S. dollar has strengthened since last September. All sorts of theories have been put forth as to “why”. Some have proffered the dollar is the cleanest dirty shirt of the bunch. Others believe the interest rate differential is kicking in where dollars at least have a positive interest rate versus negative rates elsewhere.
Another theory and one which I have written about in the past and believe to be the main reason for dollar strength is the “margin call” aspect. In other words, the “carry trade” which was used to leverage all sorts of trades is unwinding and dollars are needed to pay back the loans. A synthetic dollar short being covered in other words.
Looking back to my writing yesterday regarding the impossibility in my mind of the Fed actually raising rates, the strong dollar also supports this argument. If the Fed were to raise rates, wouldn’t this exacerbate an already immense currency cross problem with (for) the rest of the world? Wouldn’t higher U.S. rates explode the dollar higher (short term) versus foreign currencies? The answer of course is yes, but with a stronger dollar comes other obvious problems.
The two biggest problems are
A. we still have a trade deficit of close to $500 billion per year, a stronger dollar will only exacerbate this AND destroy what little manufacturing we have left.
B. the very problems we just saw with a soaring Swiss franc will be seen in many multiples throughout the dollar lending market.
I might add, as the dollar moves higher and foreign currencies drop, more and much stronger inflation gets exported to foreign soil. High and rising inflation and its effects on living standards and the human psyche will create massive unrest across Europe and elsewhere.
This last point is an important one, foreigners who have borrowed in dollars have already seen their “loan balance” expand because the dollars cost more to pay back. Higher U.S. interest rates will only make matters worse. The strong dollar has had the effect of slowing the global economy as companies (and individuals) are cutting back (employment and consumption) to make ends meet.
The above is only half of the equation, the other half is described by Alan Greenspan himself. I personally watched Mr. Greenspan speak in New Orleans last October. He used the word “tinder” http://www.zerohedge.com/news/2015-03-09/alan-greenspan-warns-explosive-inflation-tinderbox-looking-spark for a coming inflation several times and spoke of the money supply and reserves of dollars that have been created and parked away on bank balance sheets. I could only think back to the Texas wildfire as he spoke of “tinder”. The amount of dollars created is like some nutcase piling dry leaves, branches and dead trees in a huge pile, then pouring gasoline on it …and thinking to himself, “this will keep me warm in winter”. In other words, the “fuel” is there and has already been created for a bonfire of inflation and the financial system blowing up on itself. But don’t worry, it will never catch fire?
Tying these two phenomena together, not enough dollars, yet too many, here is the likely scenario I can see unfolding.
The stronger dollar is putting pressure on the financial system all over the world, something (someone), somewhere is going to “fail”. Our financial system is so interconnected and over levered, it will only take one strategic institution’s failure to break the derivatives daisy chain.
Let’s call this the “spark”. This spark causes further failures which I am convinced will circle the globe in less than two days. The forest (economy and financial system) is very dry (weak, fragile), any spark (failure) will create an out of control forest fire which will not be put out until all the fuel is burned and blackened.
Please remember this, the dollar (and Treasuries) are now “backed” by the full faith and credit of the United States. This was not the case back in the 1930′s, dollars were backed by gold. The Treasury did not have enough gold to back all of the dollars but for a very large percentage of those outstanding. This is not even close to the case today. It remains to be seen if there is any gold at all left but, assuming the gold is left untouched, gold would need to be priced at $100,000+ per ounce to cover our debt and money supply. I bring this up because ”gold will still be gold” no matter what happens financially. Hold this thought, it ties in with the final logic.
The stronger dollar is beginning to cause stress both financially and economically. It is not “official” yet but even with bogus reporting, the West is already in recession while the East is markedly slowing down. This brings up a few questions. With a slowing or declining economy, will the Treasury have the tax revenues to pay total interest and support all of the other largesse?
Of course not, we will just borrow whatever is necessary to keep going on down the road.
What about higher interest rates, will this exacerbate the problem?
Of course. Tax revenues will drop, “benefits” or spending will rise as will the deficit…and now the federal debt is almost double what it was last time around in 2008. Do you see where this leads? Is the “issuer” of dollars stronger, or weaker than it was in 2008? It’s OK, you can admit it. Weaker. In this scenario where a higher dollar (the spark) puts so much pressure on financial counterparties who are short the dollar, what will be the Feds reaction to derivatives or other sovereign currency crises? Does the Fed have to quintuple their balance sheet again? Or the federal debt double again? Or will another secret $16 trillion or a multiple thereof be lent out all over the world by necessity?
Looking at this in the real world, there have already been many markets thrown into upheaval. The two most important being the FOREX crosses and the oil market. Oil without a doubt is the largest and most all encompassing market on the planet with the exception of dollars themselves. Oil has crashed well over 50% in less than 6 months, dollars have risen 25% over this time frame.
Do you think that these percentages when applied to $10′s of trillions might add up to a tad more than a tidy sum? Remember, derivatives is a zero sum game so anything “won” is also “lost”. I believe the spark has already created a fire behind the scenes and some have already been consumed and are dead, but hidden. Can I know this for sure? No, but common sense and the amounts involved tell me this is 100% dead on! And there you have it folks, there are too may dollars outstanding …which were created by too much borrowing of dollars … This pushed asset values higher until the world reached debt saturation and led to assets being sold to pay back the debt, asset prices dropped which is causing a global margin call…this synthetic short has created dollar demand to pay these dollars back. In essence creating a dollar shortage. Are you still with me after that long and horrible string of sentences?
If you are, then here we are …facing the global margin call which can ONLY be met by central banks printing more dollars, euros, yen etc. because liquidity is again drying up. The alternative of course is to let the margin call run its course and take all banks, brokers and insurance companies down. Oh yes, don’t forget the sovereign treasuries and central banks themselves. It is the solvency of these institution that will ultimately be challenged.
And no, I didn’t forget I told you to “hold that thought” for the end. What I have described to you is the world running around and fetching as much wood and pouring as much gasoline on the pile as possible. The thought is this, without a spark this is harmless right? Without going into static electricity, spontaneous combustion, a “gun” or even a BIC lighter for that matter, is it even sane? Gold and silver do not and will not burn.
Whether it be a wildfire, a derivatives core meltdown, or even a central bank (like the Fed) or a sovereign treasury going upside down, gold will remain money and remain the benchmark against which currencies are measured. Fiat currencies by definition are “terminal” at their inception. The “deflation/inflation” debate is a moot point unless argued in terms of real money.
Secret ‘Triangle’ Doc Strips NY Fed Power: “Reserve Bank Doesn’t Breathe without Asking Washington if It Can Inhale”
by Mac Slavo
A secret agreement that was enacted five years ago at the Federal Reserve has just come to light. Known as the ‘Triangle Document,’ it purports to take away regulatory power from the New York Fed branch – long known as the most important outpost for the private quasi-government institution – and put it in the hands of the Fed’s Board of Governors in Washington, D.C.
Until 2010, when the document was produced, the big banks essentially enjoyed self-regulation, with significant power over the board.
Class A and Class B NY Fed board members are elected directly by member banks, with Class C members in turn elected by the board (not much different, really). JPMorgan Chase CEO Jamie Dimon – intricately involved in the post-2008 bailout controversy – was the Class A director for the New York Fed board for six years until his term expired in 2013.
For Big Banks and the Federal Reserve, it was a sweetheart fox-guarding-the-henhouse arrangement that the public was never meant to fully understand.
The Wall Street Journal’s Jon Hilsenrath broke the story:
The Federal Reserve Bank of New York, once the most feared banking regulator on Wall Street, has lost power in a behind-the-scenes reorganization at the nation’s central bank.
The Fed’s center of regulatory authority is now a little-known committee run by Fed governor Daniel Tarullo , which is calling the shots in oversight of banking titans such as Goldman Sachs Group Inc. and Citigroup Inc.
The new structure was enshrined in a previously undisclosed paper written in 2010 known as the Triangle Document. Under the new system, Washington is at the center of bank supervision, exercising control over the Fed’s 12 reserve banks, much as the State Department exerts control over embassies….
The lengthy WSJ article details a rather dramatic power struggle between Wall Street’s top banking interests and Washington bureaucrats for control over the institution that has taken control of the world.
During discussions the same year over what became the Triangle Document, New York Fed bank examiners, led by supervisor William Rutledge, fought for more representation on committees but lost, according to people who took part. Mr. Rutledge, now at Promontory Financial Group, which advises firms on dealing with regulators, said he supported the reorganization…
Nine of the Federal Reserve Board’s members are on the 16-person committee; the New York Fed has three representatives, and they answer to Washington. Mr. Dudley isn’t on it.
“This reserve bank doesn’t breathe any more without asking Washington if it can inhale or exhale,” said one person prominent in the banking community.
The move, in theory, is one towards greater accountability towards the public, as the Fed’s Board of Governors in Washington are federal employees and subject to FOIA requests and greater scrutiny.
However, those gains are negated by the fact that the public didn’t even find out about this reorganization – set in 2010 – until five years later.
Nevertheless, the Triangle document reorients power Washington, likely a good thing for those who’ve been considered about the power granted the New York Fed, who have long established cozy ties with Wall Street.
This is partially a result of the Dodd-Frank Act and the creation of the Financial Stability Oversight Council.
As Naked Capitalism wrote:
This is a major win for Fed governor Dan Tarullo, who has emerged as one of the toughest critics of big financial firms at the Fed in the wake of the crisis. It is also a loss for the banks, since the New York Fed is widely recognized as close to Wall Street. Moreover, the Board of Governors is more accountable to citizens (its governors are Federal employees, the Board of Governors is subject to FOIA,
And while there is some good news in moving the power center directly away from Wall Street, it is obviously enough that Washington, D.C. hasn’t been much better for the interests of the people.
All in all, the significance of this move may be overstated – as it is now being made public – at a time when the Federal Reserve is trying to appear more accountable and transparent to the public, while also maintaining the appearance that life could not go on without its significant interventions.
Via Naked Capitalism:
Thus while this is generally a step in the right direction, the open question is whether these steps are adequate. As one can see from its monetary policy, which has worked out swell for the top 1%, the central bank is far too tied into orthodox, meaning elite, views of what its priorities should be. The Fed, for instance, appears to have no concern about the fact that the economy is overfinancialized and reducing the size and profitability of that sector should be a high priority. However, that point of view is anathema to the Board of Governors’ general counsel Scott Alvarez, who is unapologetic about how the deregulation over which he presided produced the financial crisis and continues to exercise outsized influence over regulatory policy.
As we’ve regularly argued, large banks get so much support from the state that they cannot properly be considered to be private entities. They now represent the worst form of socialism for the rich. They should be regulated like utilities. Having utility-like profits and pay would mean that real economy rather than casino economy jobs would look more attractive to ambitious, highly-educated candidates.
Thus the Board of Governors move, while salutary, is likely to turn out to be what the Japanese call “a height competition among peanuts,” where the changes look significant to insiders but are recognized as trivial to more objective observers.
Too little, too late is definitely a fair criticism. Will these regulatory changes amount to any significant reform?
by Patrick Barron
We refer to the dollar as a “reserve currency” when referring to its use by other countries when settling their international trade accounts. For example, if Canada buys goods from China, China may prefer to be paid in US dollars rather than Canadian dollars. The US dollar is the more “marketable” money internationally, meaning that most countries will accept it in payment, so China can use its dollars to buy goods from other countries, not solely the US. Such might not be the case with the Canadian dollar, and China would have to hold its Canadian dollars until it found something to buy from Canada. Multiply this scenario by all the countries of the world who print their own money and one can see that without a currency accepted widely in the world, international trade would slow down and become more expensive. In some ways, its effect would be similar to that of erecting trade barriers, such as the infamous Smoot-Hawley Tariff of 1930 that contributed to the Great Depression.
There are many who draw a link between the collapse of international trade and war. The great French economist Frédéric Bastiat said that “when goods do not cross borders, soldiers will.” No nation can achieve a decent standard of living with a completely autarkic economy, meaning completely self-sufficient in all things. If it cannot trade for the goods that it needs, it feels forced to invade its neighbors to steal them. Thus, a near-universally-accepted currency can be as vital to world peace as it is to world prosperity.
What “Reserve Currency” Really Means
However, the foundation from which the term “reserve currency” originated no longer exists. Originally, the term “reserve” referred to the promise that the currency was backed by and could be redeemed for a commodity, usually gold, at a promised exchange ratio. The first truly global reserve currency was the British pound sterling. Because the Pound was “good as gold,” many countries found it more convenient to hold pounds rather than gold itself during the age of the gold standard. The world’s great trading nations settled their trade in gold, but they might accept pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. Toward the end of World War II, the US dollar was given this status by treaty following the Bretton Woods Agreement. The US accumulated the lion’s share of the world’s gold as the “arsenal of democracy” for the allies even before we entered the war. (The US still owns more gold than any other country by a wide margin, with 8,133.5 tons compared to number two Germany with 3,384.2 tons.)
The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve’s commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce. Thusly, countries had confidence that their dollars held for trading purposes were as “good as gold,” as had been the British pound at one time.
The Advent of the Fiat Reserve Currency
However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce. During the 1960s, the US funded the War in Vietnam and President Lyndon Johnson’s War on Poverty with printed money. The volume of outstanding dollars exceeded the US’s store of gold at $35 per ounce. The Fed was called to account in the late 1960s first by the Bank of France and then by others.
Central banks around the world, who had been content to hold dollars instead of gold, grew concerned that the US had sufficient gold reserves to honor its redemption promise. During the 1960s the run on the Fed, led by France, caused the US’s gold stock to shrink dramatically from over 20,000 tons in 1958 to just over 8,000 tons in 1970. At the accelerating rate that these redemptions were occurring, the US had no choice but to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely. To its everlasting shame, the US chose the latter and “went off the gold standard” in September 1971. (I have calculated that in 1971 the US would have needed to devalue the dollar from $35 per ounce to $400 per ounce in order to have sufficient gold stock to redeem all its currency for gold.) Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts. There was no other currency that could match the dollar, despite the fact that it was “delinked” from gold.
Why the Dollar Continued To Be a Reserve Currency
There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value over time. These two factors create a demand for holding a currency in reserve. Although the dollar was being inflated by the Fed, thus losing its value vis-à-vis other commodities over time, there was no real competition. The German Deutsche mark held its value better, but the German economy and its trade was a fraction that of the US, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US. So demand for the mark was lower than demand for the dollar. Of course, psychological factors entered the demand for dollars, too, since the US was the military protector of all the Western nations against the communist countries.
Today we are seeing the beginnings of a change. The Fed has been inflating the dollar massively, reducing its purchasing power and creating an opportunity for the world’s great trading nations to use other, better monies. This is important, because a loss of demand for holding the US dollar as a reserve currency would mean that trillions of dollars held overseas could flow back into the US, causing either inflation, recession, or both. For example, the US dollar global share of central bank holdings currently is 62 percent, mostly in the form of US Treasury debt. (Central banks hold interest-bearing Treasury debt rather than the dollars themselves.) Foreign holdings of US debt is currently $6.154 trillion. Compare this to the US monetary base of $3.839 trillion.
Should foreign demand to hold US dollar denominated assets diminish, the Treasury could fund their redemption in only three ways. One, the US could increase taxes in order to redeem its foreign held debt. Two, it could raise interest rates to refinance its foreign held debt. Or, three, it could simply print money. Of course, it could use all three to varying degrees. If the US refused to raise taxes or increase the interest rate and relied upon money printing (the most likely scenario, barring a complete repudiation of Keynesian doctrine and an embrace of Austrian economics), the monetary base would rise by the amount of the redemptions. For example, should demand to hold US dollar denominated assets fall by 50 percent ($3.077 trillion) the US monetary base would increase by 75 percent, which undoubtedly would lead to very high price inflation and dramatically hurt us here at home. Our standard of living is at stake here.
So we see that it is in the interest of many that the dollar remain in high demand around the world as a unit of trade settlement. It is necessary in order to prevent price inflation and to prevent American business from being saddled with increased costs that would come from being forced to settle their import/export accounts in a currency other than the dollar.
Threats To the Dollar as Reserve Currency
The causes of this threat to the dollar as a reserve currency are the policies of the Fed itself. There is no conspiracy to “attack” the dollar by other countries, in my opinion. There is, however, a rising realization by the rest of the world that the US is weakening the dollar through its ZIRP and QE programs. Consequently, other countries are aware that they may need to seek a better means of settling world trade accounts than using the US dollar. One factor that has helped the dollar retain its reserve currency demand in the short run, despite the Fed’s inflationist policies, is that the other currencies have been inflated, too.
For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency. Now even the European Central Bank will proceed with a form of QE, apparently despite Germany’s objections. All the world’s central banks seem to subscribe to the fallacious belief that increasing the money supply will bring prosperity without the threat of inflation. This defies economic law and economic reality. They cannot print their way to recovery or prosperity. Increasing the money supply does not and cannot ever create prosperity for all. What is more, this mistaken belief compounds a second mistake; i.e., that savings is not the foundation of prosperity, but rather spending is the key. This mistake puts the cart before the horse.
A third mistake is believing that driving their currencies’ exchange rate lower vis-à-vis other currencies will lead to an export-driven recovery or some mysteriously generated shot in the arm that will lead to a sustainable recovery. Such is not the case. Without delving too deeply into Austrian economic and capital theory, just let me point out that money printing disrupts the structure of production by fraudulently changing the “price discovery process” of capitalism. When this happens, capital is allocated to projects that will never be profitably completed. Bubbles get created and collapse and businesses are suddenly damaged en masse, thus, destroying scarce capital.
Possible Future Scenarios
Because of this money-printing philosophy, the dollar is very susceptible to losing its vaunted reserve currency position to the first major trading country that stops inflating its currency. There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China. Should the world’s second largest economy and one of the world’s greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease overnight.
Or, the long festering crisis in Europe may drive Germany to leave the eurozone and reinstate the Deutsch mark. I have long advocated that Germany do just this, which undoubtedly would reveal the rot embodied in the euro, the commonly held currency that has been plundered by half the nations of the continent to finance their unsustainable welfare states. The European continent outside the UK could become a mostly Deutsch mark zone, and the mark might eventually supplant the dollar as the world’s premier reserve currency.
The underlying problem, though, lies in the ability of all central banks to print fiat money; i.e., money that is backed by nothing other than the coercive power of the state via its legal tender laws. Central banks are really little more than legal counterfeiters of their own currencies. The pressure to print money comes from the political establishment that desires both warfare and welfare. Both are strictly capital consumption activities; they are not “investments” that can pay a return.
In a sound money environment, where the money supply cannot be inflated, the true nature of warfare and welfare spending is revealed, providing a natural check on the amount of funds a society is willing to devote to each. But in a fiat money environment both war and welfare spending can expand unchecked in the short run, because their adverse consequences are felt later and the link between consumptive spending and its harm to the economy is poorly understood. Thus, both can be expanded beyond the recuperative and sustainable powers of the economy.
The best antidote is to abolish central banks altogether and allow private institutions to engage in money production subject only to normal commercial law. Sound money would be backed 100 percent by commodities of intrinsic value — gold, silver, etc. Any money producer issuing money certificates or book entry accounts (checking accounts) in excess of their promised exchange ratio to the underlying commodity would be guilty of fraud and punished as such by both the commercial and criminal law, just as we currently punish counterfeiters. Legal tender laws, which prohibit the use (in many cases) of any currency other than the one endorsed by the state, would be abolished and competing currencies would be encouraged. The market would discover the better monies and drive out less marketable ones; i.e., better monies would drive out the bad or less-good monies.
We need to look at the concept of a reserve currency differently, because it is important. We need to look at it as a privilege and a responsibility and not as a weapon we can use against the rest of the world. If we abolish, or even lessen, legal tender laws and allow the process of price discovery to reveal the best sound money, if we allow our US dollar to become the best money it can — a truly sound money — then the chances of our personal and collective prosperity are greatly enhanced.
by Charles Hugh Smith
When we look back from 2025, it will be painfully obvious that central bank policies exacerbated the systemic crises that brought down the global financialization machine.
What with all the praise being heaped on central banks for “saving” the world from economic doomsday in 2008, it’s only natural to ask which structural problems their unprecedented policies solved in the past 6 years. After all, “saving” the world from financial collapse was relatively quick work; so what problems beyond imminent implosion did the central banks policies solve in the past 6 years?
Answer: none. zip, zero, nada. The truth is central bank policies of zero-interest rates and free money for financiers have made many structural problems worse.
Did central bank policies resolve the structural problem of unfunded pension and retiree healthcare liabilities? No, they made it worse, as zero-interest rates have reduced the yields on pension funds, 401Ks and IRAs to mere pittances. This destruction of safe yields has driven pension funds into risky investments in junk bonds and stocks, leaving them vulnerable to devastating losses when the current credit bubble bursts.
Did central bank policies resolve the structural problem of corporate wealth buying political influence? No, they made it worse, by encouraging corporations to borrow vast sums to use on whatever they fancied–for example, lobbying and share buybacks.
Did central bank policies resolve the structural problem of rising dependence on credit for weak “growth”? No, they made it worse, as cheap money enabled the re-emergence of subprime loans to marginal borrowers. The deterioration of credit quality guarantees a credit crisis and bubble pop as marginal borrowers default.
Did central bank policies resolve the structural problem of low investment in new assets that boost productivity, enabling widespread advances in wealth? No, they made it worse, as near-zero interest rates for financiers and corporations and limitless liquidity have incentivized debt-based speculation and highly leveraged bets on completely unproductive projects such as share buybacks, which boost the value of corporate insiders’ stock options while producing no new goods or services.
Did central bank policies resolve the structural problem of rising wealth/income inequality? No, they made it worse, by boosting the value of assets owned by the super-wealthy .01% and to a lesser degree, the top 5%.
Did central bank policies resolve the structural problem of moral hazard, the separation of financial risk from consequence? No, they made it worse, as monetary policies were designed not to help Main Street but to recapitalize Wall Street banks by diverting tens of billions of dollars that were once paid in interest to depositors straight into the banks’ coffers.
Nothing has changed: private banks are free to make risky bets, knowing that if the bets go sour the state or central bank will make good their losses.
Did central bank policies resolve the structural problem of sovereign debt, i.e. central states overborrowing and saddling future generations with crushing debt loads? No, they made it worse, as zero-interest rate policies have enabled central states to borrow gargantuan sums without the interest due on the debt squeezing out other spending.
When credit is nearly free, there’s no need to make hard choices or face the costs of systemic corruption, waste, fraud, cronyism and inefficiency; just borrow another trillion dollars, yen, euros or yuan to prop up parasitic elites and vested interests.
When we look back from 2025, it will be painfully obvious that central bank policies exacerbated the systemic crises that brought down the global financialization machine. Extend and pretend only increases the power and amplitude of the crises that will eventually burst forth from the monetary dysfunctions and distortions that are currently praised as financial genius.
Of Two Minds
by Charles Hugh Smith
We are witnessing a profound secular sea-change: the failure of expanding debt and leverage to lift the real economy of wages and household income.
Despite ending the month with a whimper, after Fed vice-chairman’s hawkish words spooked the market on Friday afternoon, February was the best month for equities in over three years – since October of 2011 – driven by a 7% Nasdaq surge on the back of a gigantic move higher in Apple. And yet, as we have shown time and again, none of this reflects the “decoupling” US underlying economy, which if anything has rapidly recoupled with the rest of the world following 38 data “misses” and only 6 “beats”- the worst “surprise” index in 12 months…
… a world which as Goldman recently showed is now in outright contraction for the first time since 2012.
It also certainly wasn’t earnings: February was the first month in which we showed that as a result of plunging revenue and EPS guidance and deteriorating sales and profitability, 2015 will be the first year since Lehman when there will be a full year decline in year-over-year sales.
So if not the economy or fundamentals, and if not the Fed, which as we know is still on sabbatical after its massive QE1-2-Twist-3 $3 trillion liquidity injection, just what has pushed stocks up to jawdropping all time highs?
Here, courtesy of Deutsche Bank, is the answer:
In case it is unclear just what the chart above shows, here is DB’s explanation: “buyback announcements have surged with February ($98bn) posting the largest monthly tally on record. The pace of actual buybacks tends to closely follow that of announcements.“
And there you have it: the highest number of monthly buyback announcements in history, which for a market that may be broken but can still discount what companies will do (now that they have committed to buybacks) is merely frontrunning the most cost-insensitive buyer in the world: corporate management teams themselves.
It should thus come as no surprise why the S&P500 soared to record highs at a time when US economic data tumbled at the fastest pace in years. It should also explain the relentless buying of AAPL stock (among others), which pushed the Nasdaq to just why of 5000: recall that it was less than 3 weeks ago that AAPL announced it would proceed with merely its latest debt-funded share buyback.
It also explains why, in the absence of the Fed, stocks continue to rise as if QE was still taking place: simply said, bondholders – starved for any yield in an increasingly NIRP world – have taken the place of the Federal Reserve, and are willing to throw any money at companies who promise even the tiniest of returns over Treasuries, oblivious if all the proceeds will be used immediately to buyback stock, thus pushing equity prices even higher, but benefiting not only shareholders but management teams who equity-linked compensation has likewise never been higher.
To be sure, this theater of financial engineering – because stocks are not going up on any resemblance of fundamental reasons but simply due to expanding balance sheet leverage – will continue only until it can no longer continue.
What do we mean by that? Two things:
First, we have previously shown the case studies of Herbalife…
… both of which soared as long as they could lever up, and issue debt which it would promptly be used to repurchase stock which in an already massively illiquid market, meant soaring stock prices. However, once net debt got prohibitively large and creditors would no longer lend, the company had no choice but to halt the buybacks:
We know what has happened to both companies’ stock prices since.
The second issue is even more troubling. Recall also from one month ago that according to Goldman’s calculations, the biggest source of net inflows, i.e., buyer of stocks, in 2015, will be companies themsleves. Aka: lots and lots of buybacks…. but apparently not enough.
According to Goldman, in 2015 buybacks will amount to a near record $450 billion, making corporations by far the biggest source of equity buying in the US stock market (at least until the Fed returns with QE4). In fact, corporations are now using the generous funds of creditors to offset a little over $400 billion in equity withdrawals (i.e., sales) by both households and pensions, which is also understandable: with Millennials now a lost generations courtesy of an economy that just refuses to recover (aside for the S&P500 of course), the retiring baby boomers who are liquidating ever greater amount of stocks as they retire in droves, are not being offset by a new generation of stock inflows.
For now, corporate buybacks are offsetting this record demand by an ever-older population to cash out of the market and do whatever retirees do in this day and age.
But once the debt levels of corporations, already at record high levels…
… starts becoming a concern to even the most desperate of fixed income managers of “other people’s money”, and even “Investment Grade” companies rapidly approach Herbalife’s leverage levels – now that median EBITDA levels are the lowest relative to total market enterprise value in history – just who will step into a market that has already soaked up every last source of possible stock buying, and become the buyer of last, and only, resort?
by Mac Slavo
The Fed has no mandate outside the 50 states, but it unofficially determines foreign debt and currency markets across the globe in a big way anyway.
Now, chairwoman Janet Yellen has testified before Congress that the Federal Reserve is looking to increase interest rates, on the pretext of low inflation. The rate increase represents an enormous price fixing mechanism that will alter the course of investments for everyone.
The ground shakes when the Fed takes a step. Never mind if it should be this way:
Federal Reserve Chair Janet Yellen said Wednesday that the central bank could raise interest rates before inflation picks up as long as it foresees price increases accelerating and the job market continues to advance. (Source)
Jim Grant, publisher of the Grant’s Interest Rate Observer, has been calling out currency manipulation and interest rate manipulation for some time.
The main driver of these manipulations, from the shadows and out of the mind of the public, are the actions of the Federal Reserve, which affects other central bank actions and much of the global market.
Watch what Grant said on NBC News:
Grant called the Fed’s interventions a “virus of radical monetary policy.” And according to Grant, there’s no going back… their actions are pivotal to the entire marketplace. With below zero interest rates under QE1-3, that amounts to free money for the biggest banks and massive worldwide economic manipulation:
“To me, the substantive fact about the Fed is that is has been involved in the greatest protracted experiment in price control in modern times. Interest rates are prices that have been suppressed and manipulated and generally federally man-handled. And the consequences of the distortion of these critical prices called interest rates, these distortions are at every hand. But we can’t know the final consequences, but we can be pretty sure they will not be wholesome.”
“And to me, this virus of radical monetary policy is now coursing through the political bloodstream. There’s no going back, at least not for the medium term. The world has come to expect that the central bank will be there in force, in unprecedented ways, with the greatest improvisations come times of trouble. There will be trouble coming up, of course there always are.”
Incredibly, Grant points out that some 83% of the entire global stock market is based upon the 0% rates set by the Federal Reserve. When those rates change, for better or worse, there will be global echoes.
Citing a Merill Lynch book titled “The Longest Picture”, Grant states that:
“83% of the world’s stock market capitalization is under the shadow of zero percent interest rates. And something in excess of $4 Trillion of sovereign debt yields nothing, or a little less. So, we can’t know exactly what valuations will be in the absence of these most extraordinary interventions, but I think we’d have a very different financial landscape.”
The great experiment in price controls set by the Federal Reserve has undoubtedly resulted less freedom and less economic stability for the average person. The last of the middle class is being vacuumed up by the post-2008 economic crisis interventions.
There is no understanding their impact.
Markets based upon zero interest rate free money are hooked, as a junkie is, on Federal Reserve interventions, artificial liquidity and de facto price controls.
Here’s an earlier video where Jim Grant discusses the “virus” that is the Federal Reserve policy:
The American Dream
by Michael Snyder
Janet Yellen is very alarmed that some members of Congress want to conduct a comprehensive audit of the Federal Reserve for the first time since it was created. If the Fed is doing everything correctly, why should Yellen be alarmed? What does she have to hide? During testimony before Congress on Tuesday, she made “central bank independence” sound like it was the holy grail. Even though every other government function is debated politically in this country, Yellen insists that what the Federal Reserve does is “too important” to be influenced by the American people. Does any other government agency ever dare to make that claim? But of course the Federal Reserve is not a government agency. It is a private banking cartel that has far more power over our money and our economy than anyone else does. And later on in this article I am going to share with you dozens of reasons why Congress should shut it down.
The immense power wielded by the Federal Reserve is clearly demonstrated whenever Janet Yellen speaks publicly. On Tuesday, her comments about interest rates sent stocks to brand new record highs…
Yellen, in her semi-annual testimony before the Senate banking committee, used a word familiar to investors when she reiterated that the central bank will be “patient” on raising interest rates for the first time since the 2008 financial crisis. Traders took that as a sign that interest rates would remain unchanged until autumn.
The Dow Jones Industrial Average rose 92.35 points (0.5%) to 18,209.19, while the Standard & Poors 500 gained 5.82 points (0.3%) to 2,115.48, both eclipsing Friday’s record closes.
But Yellen was also unusually defensive on Tuesday. The “Audit the Fed” bill that is being sponsored by Rand Paul (among others) has her really freaked out. The following comes from the Hill…
Appearing before the Senate Banking Committee, Yellen was on the defensive, as Republicans questioned how the Fed conducts monetary policy and Democrats put forward ideas for getting tougher on Wall Street.
In the midst of all of it, Yellen generally argued the Fed was designed as an independent entity for a reason — and it would be best not to change it.
“Central bank independence in conducting monetary policy is considered a best practice for central banks around the world,” she said. “Academic studies, I think, establish beyond the shadow of a doubt that independent central banks perform better.”
In fact, she went so far as to mention the “Audit the Fed” bill by name…
A GOP-controlled Congress has given the bill its best chances yet of passage, and that renewed interest led Yellen to deliver her most spirited opposition yet.
“I want to be completely clear,” she said. “I strongly oppose Audit the Fed.”
Yellen argued the audit measure would allow politicians to second-guess the Fed’s decisions, which, in turn, would weaken the central bank. And the ultimate victim of that process, she said, would be the U.S. economy.
So what is she so concerned about?
We are all accountable to someone.
What is so wrong about the Federal Reserve being accountable to Congress?
Why can’t we find out what is really going on inside the Fed?
And of course it isn’t just Yellen that is freaking out. Just consider these comments from Richard Fisher, the president of the Federal Reserve Bank of Dallas…
“It is always politically convenient to make something sound mysterious, if not malevolent, by claiming it is opaque,” Fisher said in a speech to the Economic Club of New York that is part of an effort by Fed officials to fight the legislation.
“My suspicion is that many of those in Congress calling for ‘auditing’ the Fed are really sheep in wolves’ clothing,” he said. “Having proven themselves unable to cobble together with colleagues a working fiscal policy or to construct a regulatory regime that incentivizes rather than discourages investment and job creation — in other words, failed at their own job — they simply find it convenient to create a bogeyman out of an entity that does its job efficiently.”
Obviously this is a very, very touchy subject over at the Fed.
It is quite clear that they do not want the rest of us to be able to see what they are really up to.
And the truth is that if the American people really did know how the Federal Reserve works and what it has been doing behind closed doors, most Americans would want it shut down tomorrow.
At the end of the day, the reality of the matter is that we don’t even need a Federal Reserve. I really like how David Stockman made this point the other day…
At the end of the day, American capitalism does not need recycled political hacks like Jerome H. Powell or clueless school marms like Janet Yellen to thrive. If we need a Fed at all, it is the one designed by Carter Glass 100 years ago. That is, a “bankers bank” that was intended to provide standby liquidity at a penalty spread above the free market interest rate in consideration for good collateral originating from inventory and receivables in the real economy.
Under that arrangement, there would be no monetary central planning or pointless attempts to manage the level of GDP, the number of new jobs, the rate of housing starts, the fluctuations of the CPI or the amplitudes of the business cycle. There would also be no pegging of the money market rate, no helping hand for Wall Street gamblers, no cheap debt to enable profligate politicians to kick-the-can down the road indefinitely.
In short, what the nation really needs is not an “independent” Fed, but one that is shackled to a narrow and market-driven liquidity function. The rest of its current remit is nothing more than the self-serving aggrandizement of the apparatchiks who run it; and who have now managed to turn the nation’s vital money and capital markets into dangerous, unstable casinos, and the nations savers into indentured servants of a bloated and wasteful banking system.
The Federal Reserve has been around for just over a hundred years, and it has done an absolutely abysmal job for the American people.
I want to share with you some facts and figures that I have shared before, but they bear repeating. Please share this list of 100 reasons why the Federal Reserve should be shut down with everyone that you know…
#1 We like to think that we have a government “of the people, by the people, for the people”, but the truth is that an unelected, unaccountable group of central planners has far more power over our economy than anyone else in our society does.
#2 The Federal Reserve is actually “independent” of the government. In fact, the Federal Reserve has argued vehemently in federal court that it is “not an agency” of the federal government and therefore not subject to the Freedom of Information Act.
#3 The Federal Reserve openly admits that the 12 regional Federal Reserve banks are organized “much like private corporations“.
#4 The regional Federal Reserve banks issue shares of stock to the “member banks” that own them.
#5 100% of the shareholders of the Federal Reserve are private banks. The U.S. government owns zero shares.
#6 The Federal Reserve is not an agency of the federal government, but it has been given power to regulate our banks and financial institutions. This should not be happening.
#7 According to Article I, Section 8 of the U.S. Constitution, the U.S. Congress is the one that is supposed to have the authority to “coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”. So why is the Federal Reserve doing it?
#8 If you look at a “U.S. dollar”, it actually says “Federal Reserve note” at the top. In the financial world, a “note” is an instrument of debt.
#9 In 1963, President John F. Kennedy issued Executive Order 11110 which authorized the U.S. Treasury to issue “United States notes” which were created by the U.S. government directly and not by the Federal Reserve. He was assassinated shortly thereafter.
#10 Many of the debt-free United States notes issued under President Kennedy are still in circulation today.
#11 The Federal Reserve determines what levels some of the most important interest rates in our system are going to be set at. In a free market system, the free market would determine those interest rates.
#12 The Federal Reserve has become so powerful that it is now known as “the fourth branch of government“.
#13 The greatest period of economic growth in U.S. history was when there was no central bank.
#14 The Federal Reserve was designed to be a perpetual debt machine. The bankers that designed it intended to trap the U.S. government in a perpetual debt spiral from which it could never possibly escape. Since the Federal Reserve was established 100 years ago, the U.S. national debt has gotten more than 5000 times larger.
#15 A permanent federal income tax was established the exact same year that the Federal Reserve was created. This was not a coincidence. In order to pay for all of the government debt that the Federal Reserve would create, a federal income tax was necessary. The whole idea was to transfer wealth from our pockets to the federal government and from the federal government to the bankers.
#16 The period prior to 1913 (when there was no income tax) was the greatest period of economic growth in U.S. history.
#17 Today, the U.S. tax code is about 13 miles long.
#18 From the time that the Federal Reserve was created until now, the U.S. dollar has lost 98 percent of its value.
#19 From the time that President Nixon took us off the gold standard until now, the U.S. dollar has lost 83 percent of its value.
#20 During the 100 years before the Federal Reserve was created, the U.S. economy rarely had any problems with inflation. But since the Federal Reserve was established, the U.S. economy has experienced constant and never ending inflation.
#21 In the century before the Federal Reserve was created, the average annual rate of inflation was about half a percent. In the century since the Federal Reserve was created, the average annual rate of inflation has been about 3.5 percent.
#22 The Federal Reserve has stripped the middle class of trillions of dollars of wealth through the hidden tax of inflation.
#23 The size of M1 has nearly doubled since 2008 thanks to the reckless money printing that the Federal Reserve has been doing.
#24 The Federal Reserve has been starting to behave like the Weimar Republic, and we all remember how that ended.
#25 The Federal Reserve has been consistently lying to us about the level of inflation in our economy. If the inflation rate was still calculated the same way that it was back when Jimmy Carter was president, the official rate of inflation would be somewhere between 8 and 10 percent today.
#26 Since the Federal Reserve was created, there have been 18 distinct recessions or depressions: 1918, 1920, 1923, 1926, 1929, 1937, 1945, 1949, 1953, 1958, 1960, 1969, 1973, 1980, 1981, 1990, 2001, 2008.
#27 Within 20 years of the creation of the Federal Reserve, the U.S. economy was plunged into the Great Depression.
#28 The Federal Reserve created the conditions that caused the stock market crash of 1929, and even Ben Bernanke admits that the response by the Fed to that crisis made the Great Depression even worse than it should have been.
#29 The “easy money” policies of former Fed Chairman Alan Greenspan set the stage for the great financial crisis of 2008.
#30 Without the Federal Reserve, the “subprime mortgage meltdown” would probably never have happened.
#31 If you can believe it, there have been 10 different economic recessions since 1950. The Federal Reserve created the “dotcom bubble”, the Federal Reserve created the “housing bubble” and now it has created the largest bond bubble in the history of the planet.
#32 According to an official government report, the Federal Reserve made 16.1 trillion dollars in secret loans to the big banks during the last financial crisis. The following is a list of loan recipients that was taken directly from page 131 of the report…
Citigroup – $2.513 trillion
Morgan Stanley – $2.041 trillion
Merrill Lynch – $1.949 trillion
Bank of America – $1.344 trillion
Barclays PLC – $868 billion
Bear Sterns – $853 billion
Goldman Sachs – $814 billion
Royal Bank of Scotland – $541 billion
JP Morgan Chase – $391 billion
Deutsche Bank – $354 billion
UBS – $287 billion
Credit Suisse – $262 billion
Lehman Brothers – $183 billion
Bank of Scotland – $181 billion
BNP Paribas – $175 billion
Wells Fargo – $159 billion
Dexia – $159 billion
Wachovia – $142 billion
Dresdner Bank – $135 billion
Societe Generale – $124 billion
“All Other Borrowers” – $2.639 trillion
#33 The Federal Reserve also paid those big banks $659.4 million in “fees” to help “administer” those secret loans.
#34 During the last financial crisis, big European banks were allowed to borrow an “unlimited” amount of money from the Federal Reserve at ultra-low interest rates.
#35 The “easy money” policies of Federal Reserve Chairman Ben Bernanke have created the largest financial bubble this nation has ever seen, and this has set the stage for the great financial crisis that we are rapidly approaching.
#36 Since late 2008, the size of the Federal Reserve balance sheet has grown from less than a trillion dollars to more than 4 trillion dollars. This is complete and utter insanity.
#37 During the quantitative easing era, the value of the financial securities that the Fed has accumulated is greater than the total amount of publicly held debt that the U.S. government accumulated from the presidency of George Washington through the end of the presidency of Bill Clinton.
#38 Overall, the Federal Reserve now holds more than 32 percent of all 10 year equivalents.
#39 Quantitative easing creates financial bubbles, and when quantitative easing ends those bubbles tend to deflate rapidly.
#40 Most of the new money created by quantitative easing has ended up in the hands of the very wealthy.
#41 According to a prominent Federal Reserve insider, quantitative easing has been one giant “subsidy” for Wall Street banks.
#42 As one CNBC article stated, we are seeing absolutely rampant inflation in “stocks and bonds and art and Ferraris“.
#43 Donald Trump once made the following statement about quantitative easing: “People like me will benefit from this.”
#44 Most people have never heard about this, but a very interesting study conducted for the Bank of England shows that quantitative easing actually increases the gap between the wealthy and the poor.
#45 The gap between the top one percent and the rest of the country is now the greatest that it has been since the 1920s.
#46 The mainstream media has sold quantitative easing to the American public as an “economic stimulus program”, but the truth is that the percentage of Americans that have a job has actually gone down since quantitative easing first began.
#47 The Federal Reserve is supposed to be able to guide the nation toward “full employment”, but the reality of the matter is that an all-time record 102 million working age Americans do not have a job right now. That number has risen by about 27 million since the year 2000.
#48 For years, the projections of economic growth by the Federal Reserve have consistently overstated the strength of the U.S. economy. But every single time, the mainstream media continues to report that these numbers are “reliable” even though all they actually represent is wishful thinking.
#49 The Federal Reserve system fuels the growth of government, and the growth of government fuels the growth of the Federal Reserve system. Since 1970, federal spending has grown nearly 12 times as rapidly as median household income has.
#50 The Federal Reserve is supposed to look out for the health of all U.S. banks, but the truth is that they only seem to be concerned about the big ones. In 1985, there were more than 18,000 banks in the United States. Today, there are only 6,891 left.
#51 The six largest banks in the United States (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) have collectively gotten 37 percent larger over the past five years.
#52 The U.S. banking system has 14.4 trillion dollars in total assets. The six largest banks now account for 67 percent of those assets and all of the other banks account for only 33 percent of those assets.
#53 The five largest banks now account for 42 percent of all loans in the United States.
#54 We were told that the purpose of quantitative easing is to help “stimulate the economy”, but today the Federal Reserve is actually paying the big banks not to lend out 1.8 trillion dollars in “excess reserves” that they have parked at the Fed.
#55 The Federal Reserve has allowed an absolutely gigantic derivatives bubble to inflate which could destroy our financial system at any moment. Right now, four of the “too big to fail” banks each have total exposure to derivatives that is well in excess of 40 trillion dollars.
#56 The total exposure that Goldman Sachs has to derivatives contracts is more than 381 times greater than their total assets.
#57 Federal Reserve Chairman Ben Bernanke has a track record of failure that would make the Chicago Cubs look good.
#58 The secret November 1910 gathering at Jekyll Island, Georgia during which the plan for the Federal Reserve was hatched was attended by U.S. Senator Nelson W. Aldrich, Assistant Secretary of the Treasury Department A.P. Andrews and a whole host of representatives from the upper crust of the Wall Street banking establishment.
#59 The Federal Reserve was created by the big Wall Street banks and for the benefit of the big Wall Street banks.
#60 In 1913, Congress was promised that if the Federal Reserve Act was passed that it would eliminate the business cycle.
#61 There has never been a true comprehensive audit of the Federal Reserve since it was created back in 1913.
#62 The Federal Reserve system has been described as “the biggest Ponzi scheme in the history of the world“.
#63 The following comes directly from the Fed’s official mission statement: “To provide the nation with a safer, more flexible, and more stable monetary and financial system.” Without a doubt, the Federal Reserve has failed in those tasks dramatically.
#64 The Fed decides what the target rate of inflation should be, what the target rate of unemployment should be and what the size of the money supply is going to be. This is quite similar to the “central planning” that goes on in communist nations, but very few people in our government seem upset by this.
#65 A couple of years ago, Federal Reserve officials walked into one bank in Oklahoma and demanded that they take down all the Bible verses and all the Christmas buttons that the bank had been displaying.
#66 The Federal Reserve has taken some other very frightening steps in recent years. For example, back in 2011 the Federal Reserve announced plans to identify “key bloggers” and to monitor “billions of conversations” about the Fed on Facebook, Twitter, forums and blogs. Someone at the Fed will almost certainly end up reading this article.
#67 Thanks to this endless debt spiral that we are trapped in, a massive amount of money is transferred out of our pockets and into the pockets of the ultra-wealthy each year. Incredibly, the U.S. government spent more than 415 billion dollars just on interest on the national debt in 2013.
#68 In January 2000, the average rate of interest on the government’s marketable debt was 6.620 percent. If we got back to that level today, we would be paying more than a trillion dollars a year just in interest on the national debt and it would collapse our entire financial system.
#69 The American people are being killed by compound interest but most of them don’t even understand what it is. Albert Einstein once made the following statement about compound interest…
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
#70 Most Americans have absolutely no idea where money comes from. The truth is that the Federal Reserve just creates it out of thin air. The following is how I have previously described how money is normally created by the Fed in our system…
When the U.S. government decides that it wants to spend another billion dollars that it does not have, it does not print up a billion dollars.
Rather, the U.S. government creates a bunch of U.S. Treasury bonds (debt) and takes them over to the Federal Reserve.
The Federal Reserve creates a billion dollars out of thin air and exchanges them for the U.S. Treasury bonds.
#71 What does the Federal Reserve do with those U.S. Treasury bonds? They end up getting auctioned off to the highest bidder. But this entire process actually creates more debt than it does money…
The U.S. Treasury bonds that the Federal Reserve receives in exchange for the money it has created out of nothing are auctioned off through the Federal Reserve system.
There is a problem.
Because the U.S. government must pay interest on the Treasury bonds, the amount of debt that has been created by this transaction is greater than the amount of money that has been created.
So where will the U.S. government get the money to pay that debt?
Well, the theory is that we can get money to circulate through the economy really, really fast and tax it at a high enough rate that the government will be able to collect enough taxes to pay the debt.
But that never actually happens, does it?
And the creators of the Federal Reserve understood this as well. They understood that the U.S. government would not have enough money to both run the government and service the national debt. They knew that the U.S. government would have to keep borrowing even more money in an attempt to keep up with the game.
#72 Of course the U.S. government could actually create money and spend it directly into the economy without the Federal Reserve being involved at all. But then we wouldn’t be 17 trillion dollars in debt and that wouldn’t serve the interests of the bankers at all.
#73 The following is what Thomas Edison once had to say about our absolutely insane debt-based financial system…
That is to say, under the old way any time we wish to add to the national wealth we are compelled to add to the national debt.
Now, that is what Henry Ford wants to prevent. He thinks it is stupid, and so do I, that for the loan of $30,000,000 of their own money the people of the United States should be compelled to pay $66,000,000 — that is what it amounts to, with interest. People who will not turn a shovelful of dirt nor contribute a pound of material will collect more money from the United States than will the people who supply the material and do the work. That is the terrible thing about interest. In all our great bond issues the interest is always greater than the principal. All of the great public works cost more than twice the actual cost, on that account. Under the present system of doing business we simply add 120 to 150 per cent, to the stated cost.
But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good.
#74 The United States now has the largest national debt in the history of the world, and we are stealing roughly 100 million dollars from our children and our grandchildren every single hour of every single day in a desperate attempt to keep the debt spiral going.
#75 Thomas Jefferson once stated that if he could add just one more amendment to the U.S. Constitution it would be a ban on all government borrowing…
I wish it were possible to obtain a single amendment to our Constitution. I would be willing to depend on that alone for the reduction of the administration of our government to the genuine principles of its Constitution; I mean an additional article, taking from the federal government the power of borrowing.
#76 At this moment, the U.S. national debt is sitting at $18,141,409,083,212.36. If we had followed the advice of Thomas Jefferson, it would be sitting at zero.
#77 When the Federal Reserve was first established, the U.S. national debt was sitting at about 2.9 billion dollars. On average, we have been adding more than that to the national debt every single day since Obama has been in the White House.
#78 We are on pace to accumulate more new debt under the 8 years of the Obama administration than we did under all of the other presidents in all of U.S. history combined.
#79 If all of the new debt that has been accumulated since John Boehner became Speaker of the House had been given directly to the American people instead, every household in America would have been able to buy a new truck.
#81 Since 2007, the U.S. debt to GDP ratio has increased from 66.6 percent to 101.6 percent.
#82 According to the U.S. Treasury, foreigners hold approximately 5.6 trillion dollars of our debt.
#83 The amount of U.S. government debt held by foreigners is about 5 times larger than it was just a decade ago.
#85 If Bill Gates gave every single penny of his entire fortune to the U.S. government, it would only cover the U.S. budget deficit for 15 days.
#86 Sometimes we forget just how much money a trillion dollars is. If you were alive when Jesus Christ was born and you spent one million dollars every single day since that point, you still would not have spent one trillion dollars by now.
#87 If right this moment you went out and started spending one dollar every single second, it would take you more than 31,000 years to spend one trillion dollars.
#88 In addition to all of our debt, the U.S. government has also accumulated more than 200 trillion dollars in unfunded liabilities. So where in the world will all of that money come from?
#89 The greatest damage that quantitative easing has been causing to our economy is the fact that it is destroying worldwide faith in the U.S. dollar and in U.S. debt. If the rest of the world stops using our dollars and stops buying our debt, we are going to be in a massive amount of trouble.
#90 Over the past several years, the Federal Reserve has been monetizing a staggering amount of U.S. government debt even though Ben Bernanke once promised that he would never do this.
#91 China recently announced that they are going to quit stockpiling more U.S. dollars. If the Federal Reserve was not recklessly printing money, this would probably not have happened.
#92 Most Americans have no idea that one of our most famous presidents was absolutely obsessed with getting rid of central banking in the United States. The following is a February 1834 quote by President Andrew Jackson about the evils of central banking…
I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the Bank. You tell me that if I take the deposits from the Bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out and, by the Eternal, (bringing his fist down on the table) I will rout you out.
#93 There are plenty of possible alternative financial systems, but at this point all 187 nations that belong to the IMF have a central bank. Are we supposed to believe that this is just some sort of a bizarre coincidence?
#94 The capstone of the global central banking system is an organization known as the Bank for International Settlements. The following is how I described this organization in a previous article…
An immensely powerful international organization that most people have never even heard of secretly controls the money supply of the entire globe. It is called the Bank for International Settlements, and it is the central bank of central banks. It is located in Basel, Switzerland, but it also has branches in Hong Kong and Mexico City. It is essentially an unelected, unaccountable central bank of the world that has complete immunity from taxation and from national laws. Even Wikipedia admits that “it is not accountable to any single national government.” The Bank for International Settlements was used to launder money for the Nazis during World War II, but these days the main purpose of the BIS is to guide and direct the centrally-planned global financial system. Today, 58 global central banks belong to the BIS, and it has far more power over how the U.S. economy (or any other economy for that matter) will perform over the course of the next year than any politician does. Every two months, the central bankers of the world gather in Basel for another “Global Economy Meeting”. During those meetings, decisions are made which affect every man, woman and child on the planet, and yet none of us have any say in what goes on. The Bank for International Settlements is an organization that was founded by the global elite and it operates for the benefit of the global elite, and it is intended to be one of the key cornerstones of the emerging one world economic system.
#95 The borrower is the servant of the lender, and the Federal Reserve has turned all of us into debt slaves.
#96 Debt is a form of social control, and the global elite use all of this debt to dominate all the rest of us. 40 years ago, the total amount of debt in our system (all government debt, all business debt, all consumer debt, etc.) was sitting at about 2 trillion dollars. Today, the grand total exceeds 56 trillion dollars.
#97 Unless something dramatic is done, our children and our grandchildren will be debt slaves for their entire lives as they service our debts and pay for our mistakes.
#98 Now that you know this information, you are responsible for doing something about it.
#99 Congress has the power to shut down the Federal Reserve any time that it would like. But right now most of our politicians fully endorse the current system, and nothing is ever going to happen until the American people start demanding change.
#100 The design of the Federal Reserve system was flawed from the very beginning. If something is not done very rapidly, it is inevitable that our entire financial system is going to suffer an absolutely nightmarish collapse.
Federal Reserve Insider Alan Greenspan Warns: There Will Be a “Significant Market Event… Something Big Is Going To Happen”
by Mac Slavo
With the Federal Reserve printing trillions upon trillions of dollars to keep the economic system afloat, many investors and financial pundits have surmised that the fundamental economic problems facing the United States during the crash of 2008 have been resolved. Stocks are, after all, at historic highs.
But the insiders know different. And if there’s any single person out there who understands U.S. monetary policy and its long-term effects on domestic and global affairs it’s former Federal Reserve chairman Alan Greenspan. As the head of the world’s most powerful central bank for nearly two decades he’s privy to the insider conversations and government machinations that have brought us to where we are today.
Greenspan recently joined veteran resource analyst Brien Lundin at the New Orleans Investment Conference to share some of his thoughts. According to Lundin, the former Fed chairman made it clear that the central bank is facing a serious problem and one that will have significant ramifications in the future.
We asked him where he thought the gold price will be in five years and he said “measurably higher.”
In private conversation I asked him about the outstanding debts… and that the debt load in the U.S. had gotten so great that there has to be some monetary depreciation. Specially he said that the era of quantitative easing and zero-interest rate policies by the Fed… we really cannot exit this without some significant market event… By that I interpret it being either a stock market crash or a prolonged recession, which would then engender another round of monetary reflation by the Fed.
He thinks something big is going to happen that we can’t get out of this era of money printing without some repercussions – and pretty severe ones – that gold will benefit from.
Watch the full interview:
(Watch at Future Money Trends)
If we are in fact staring a major market event in the face as Alan Greenspan proposes then wealth preservation should be a key tenet of any preparedness strategy going forward. Greenspan himself, somewhat ironically, was a gold bug and proponent of sound money prior to his appointment as the chairman of the Fed. And though he didn’t discuss it much during his tenure, he is now actively saying that we can expect to see gold markedly higher within the next five years.
His assessment is likely based on concerns over the U.S. dollar which will, as Lundin notes, more than likely suffer a currency devaluation at some point in the future.
The end has to come at some point… If you look at a chart of the U.S. dollar index it has gone nearly parabolic in the last few months… In any market that is so one sided, that is accelerating so rapidly, that trend will end… it will most likely end in a fairly violent fashion.
And if gold rises as a result, so too will other resource assets in the energy and mining sectors. What it boils down to is that the assets that are necessary to keep our system operating will always have value, and that is especially true in a situation where the U.S. dollar happens to be crashing. Uranium , for example, powers one in five American homes, which means that it will always be a necessary resource, regardless of what the dollar does or doesn’t do. Lundin’s assessment is echoed by Uranium Energy Corp CEO Amir Adnani, who recently said we may well see a “resurgence” in the price of this and natural resources like gold.
The same can be said for oil and agriculture resources.
They will always have value, regardless of whether the dollar is strong or violently collapses under its own weight.
Thus, when we consider ways to preserve wealth and insulate ourselves from the coming destruction of our currency one must consider holding physical assets. For some that means stockpiling food and other supplies in anticipation of Greenspan’s market event that could adversely affect credit flows and delivery of essential goods. For others who may currently hold stocks, U.S. Treasurys, or cash, diversifying your portfolio with well managed resource-based companies will not only preserve wealth during currency volatility, but build it as the value of real, physical assets rises.
The man who is essentially the architect responsible for domestic monetary policy under four U.S. Presidents has now said that a significant market event will take place when the Fed is eventually forced to exit their monetary easing and zero-interest rate policies.
Are you prepared for that day?
The Common Sense Show
by Dave Hodges
Disturbingly, George Soros has repeatedly demonstrated that he has had both accurate and advanced knowledge of stock market and banking crashes in the past. In fact Soros has a history of causing economic collapses with his preplanned money movements (e.g. Arab Spring). Subsequently, savvy investors keep a very close eye on Soros’ money movements and resulting holdings as Soros is the proverbial “Canary in the mine”. He is the world’s ultimate economic hit man and both bankers and politicians watch his every move with fear and apprehension. If you want to know what money venues to avoid, or embrace, tracking George Soros is your best bet.
Monkey See Monkey Do
With regard to one’s personal investments, a prudent steward of one’s own resources would want to not be where George Soros’ isn’t and to imitate Soros’ money movement with regard where George Soros does place his bets. Why? Because Soros is one of the principals that determines the “rules” for the rigged game of investments across the planet.
Soros’ money movements are significant for several reasons. First, he is now betting against both the U.S. Stock Market and three major U.S. domestic banks. Second, Soros has obtained a sizable gold portfolio which is something one would want to do if one were expecting, or causing a crash of paper currency (i.e. the dollar) to occur. Finally, and most significantly, Soros is betting against the solvency of the Federal Reserve by running from the three of the major investors (i.e. the three major banks) in the Federal Reserve.
According to a 2014 filing with the Securities and Exchange Commission, it was revealed that Soros sold his holdings in Citigroup, J.P. Morgan and Bank of America. Soros subsequently moved his money and took up new positions in gold and tech stocks associated with Chinese money movement. Soros has moved his money to RF Micro Devices, Nuance Communications, Marvel Technology Group, Nokia Corp., and Cypress Semiconductor. Soros also boosted his stake in Herbalife and took up a new position in Yamana Gold and AuRico Gold, and New Gold Inc. This sent shockwaves among aware investors in the banking and stock market arena.
The Chinese and the Federal Reserve Will Eventually Die Together
It is interesting to note that JP Morgan Chase, earlier in 2014, has sold their property located at One Chase Manhattan Plaza skyscraper to Fosun International, a Chinese investment firm, for the bargain basement price of $725 million. This is only the latest in a series of New York real estate purchases by Chinese investors for properties formerly reserved for Federal Reserve members. This is a highly significant event that received only a couple of days of attention, but quickly faded from the front pages of the mainstream media. In a future article, I will go into more detail how Soros is setting a trap for both the Chinese and the Federal Reserve. For now, let’s suffice it to say that his actions are helping to set the course for World War III because war is something that desperate nations engage in when they have no other financial options. America, China, Russia and their military allies are quickly approaching this moment.
Collaborating Data: Why It Is Becoming Difficult to Gain Access to Your Bank Account
The Soros money movement strategies are purposeful and ominous. A wise investor from the House of Soros, would liquidate all of their current economic positions and quickly get liquid so they could invest in future winners. Unfortunately, you cannot access your money and “get liquid” with the ease of a George Soros. The banks are building in safeguards to help prevent flight from the banks. However, when it does come down to where one should put their discretionary income, there is a crystal clear pattern on what all Americans should be doing with their money.
Prior to establishing the George Soros investment watch list, it is somewhat reassuring, but not comforting, to note that the actions of the G20 and the British and American banking establishment clearly demonstrate why Soros has fled the American banking system and Stock Market. On November 16, 2014, it was revealed that the G20 nations passed a joint resolution to get their nation’s central banking system to declare that your bank account was not defined as money. This was done because the G20 central banks are approaching insolvency. This put your assets at the bottom of the list for FDIC compensation in the event a bank failure. every “common citizen” should see this as an inevitable sign that their bank is going to fail and that they are not going to get their money back. Further, the U.S. and Britain practiced for widespread bank failures on November 10, 2o14, in a drill facilitated by the FDIC. This is so highly significant because this is occurring at a time when the Federal Reserve gave permission to various Chinese interests (i.e. all controlled by the Chinese military) to purchase sizable positions in American banking which serves to underwrite and partially fund the Federal Reserve.
The fact that these two events happened in close proximity to each other is not surprising when one considers that an economic collapse is right around the corner. However, it is surprising that these two events (i.e. the 11/10/2014 bank failure drill and the 11/16/2014 G20 declaration) happened in such close proximity to each other presents clear signs that the banking industry is preparing to hold on to your money in attempt to stave off financial ruin.
In a future article, I will discuss strategies on how to separate your money from the banks, before the banks can separate you from your money.
Georgy’s List of Winners and Losers
By using Soros’ money movements over the past year as the blueprint on what to do and not do prior to the economic collapse, one should keep in mind the results of the Soros list of do’s and don’ts and then act accordingly,
George Soros List of Don’ts
1. Avoid the Stock Market like the plague. If your 401K or other retirement plans are tied to the Stock Market, you would be better off, in the long run, to liquidate your position and take the 50% hit from the Federal government for doing so before the age of 59.5. Half a loaf, is better than no loaf at all.
2. Get your money out the Federal Reserve banks (all banks). The obvious question is what to do with your money once you have obtained possession. This is covered in the next session under “Do’s” with regard to your discretionary income.
3. Avoid American real estate investments. Let’s not forget that the Federal Reserve, until recently, was purchasing $40 billion dollars of mortgage backed securities every single month. Then the Federal suddenly stopped the practice after they realized the error of their ways. George Soros is not investing in American real estate.
George Soros List of Do’s
1. Buy gold and lost of it!
2. Buy some silver, but realize that silver is historically unstable. Therefore, all portfolios should be heavily invested in gold over other precious metals.
3. Find a way to pay off your mortgage, because after an economic collapse, you will have no means to do so and MERS will there be waiting. If you are unwilling to do this, then you should sell your home and rent because you are throwing away your current mortgage payments.
4. At least in the near term, invest in Chinese hi tech stocks associated with their money movement. There are two very trouble considerations with this move. First, the Chinese would obviously move their money away from troubled American investments prior to the collapse of the dollar. Soros move to follow this pattern signals the end of the dollar. On a more ominous note, Soros could be telling you who is going to lose World War III. If the U.S. was slated to win World War III, would Soros invest in Chinese money movement over the U.S. dollar and the American Stock Market?
When in Rome, do as the Romans do. In this case, one should be doing what George Soros is doing. To continue to invest in American real estate, the Stock Market and retirement accounts is like buying hair restoring tonic from a bald barber.
Future articles will cover how to get as liquid as possible along with how to invest in yourself.
Three months ago, we wrote “How The Petrodollar Quietly Died, And Nobody Noticed“, in which we explained in painful detail why far from the simple macroeconomic dogma which immediately prompted the macro tourists to scream that “oil prices dropping are good for US consumers“, the collapse in the price of crude is not only a disaster for oil exporting nations – one which will lead to a series of violent “Arab Springs” across the oil-producing developed world – but far more importantly, have a massive impact on capital markets as a result of the plunge in the most financialized commodity in history.
On the death of the Petrodollar we commented that unlike previously, when petrodollar recycling funneled the proceeds from oil-exports into financial markets, helping to boost asset prices and keep the cost of borrowing down, henceforth “oil producers will effectively import capital amounting to $7.6 billion.” We added that “oil exporters are now pulling liquidity out of financial markets rather than putting money in. That could result in higher borrowing costs for governments, companies, and ultimately, consumers as money becomes scarcer.”
The conclusion was simple: “net capital flows will be negative for EM, representing the first net inflow of capital (USD8bn) for the first time in eighteen years. This compares with USD60bn last year, which itself was down from USD248bn in 2012. At its peak, recycled EM petro dollars amounted to USD511bn back in 2006. The declines seen since 2006 not only reflect the changed global environment, but also the propensity of underlying exporters to begin investing the money domestically rather than save. The implications for financial markets liquidity – not to mention related downward pressure on US Treasury yields – is negative.“
In retrospect, it probably was not “simple enough”, because even three months ago everyone was confident that both higher yields and an increase in market liquidity are imminent. Since then not only has the yield on the 10 Year plunged to near record low levels (while 16% of global government debt now trades at negative yields), but judging by the absolute liquidity devastation in the E-Mini, in Trasurys and virtually every other asset class, few actually grasped the implications of what plunging oil really means in a world in which this most financialized of commodities plays a massive role in both the global economy and capital markets, not to mention in geopolitics, with implications far, far greater than the amateurish “yes, but gas is now cheaper” retort.
So, three months later, we are happy to report that somebody finally noticed that the Petrodollar has indeed finally died, and more importantly, has attempted to put together an analysis of what we said in early November, reaching the conclusion that plunging oil just may not be all that financial comedy TV has it cracked up to be.
Did we say somebody? We meant everyone!
Below are extensive, in-depth, and long overdue questions on petrodollar recycling, or rather its halt, and its implications from virtually every single Bank of America economist and strategist who after months of stalling, have finally been forced to confront this most critical of topics head on.
From Bank of America
Q&A on petrodollar recycling
- We explore the economic, financial, and geopolitical implications that will result from the collapse in oil prices and the reduction in petro-dollar flows.
- We see a limited impact on UST yields or the USD. In recent years, the UK, Euro area and EEMEA have benefitted from reserve diversification away from the USD. A drying-out of petrodollar flows will reduce funding availability for current account deficit countries, particularly the UK, and may hurt London’s real estate sector.
- Venezuela’s debtors such as Cuba, which benefitted from Petrocaribe loans, as well as left-leaning regimes in LatAm, will feel the pressure. Russia could lose regional influence, although Ukraine’s dependence on its gas is still very high. Lower oil prices should diminish the ability of Iran to project regional power. Growth model limitations could eventually accentuate GCC social pressures, in our view.
The oil market outlook
Alberto Ades, co-head of Global Economics: Sabine, the natural starting point to a discussion of petrodollar recycling is an assessment of the oil market. What is your reading of OPEC’s policy shift?
Sabine Schels, commodity strategist: Before the recent oil rebound, Brent crude oil prices came off almost in a straight line from $115 to $50/bbl, making three very brief stops at $85, $80 and $60. That marks the second steepest six-month decline in the oil market’s history. In a dramatic policy shift, OPEC supply has kept increasing in recent quarters despite falling prices, as Saudi Arabia seems intent on increasing its market share, irrespective of the impact on price. Saudi Arabia has pledged not to take out supply even if the price drops to $40, $30 or even $20 per barrel, suggesting curtailments will have to come from high cost non-OPEC producers.
The sharp price decline is delivering a windfall-tax to consumers globally while giving a major blow to producers. For GCC alone, it is equivalent to $440bn in foregone revenues. In our view, OPEC’s decision to give up on its traditional role of keeping supply and demand in check will have far-reaching consequences across all asset classes as the flow of OPEC petrodollars is drying up. In the absence of a quick and sharp rebound in oil prices, this may drain liquidity from global asset markets, at least for the remainder of 2015.
Alberto Ades: Recently, you cut your oil price forecasts significantly. What drives your bearish view on oil prices for the next few months?
Sabine Schels: Basically, supply keeps running above demand. The term structure of Brent, which preceded the collapse in prices, continues to weaken across the next 12 months as inventories are building at an alarming speed, setting the stage for lower, not higher prices.
Inventories typically build because supply exceeds demand in any given market. But in some markets, like oil or gas, storage capacity is a finite number and price declines can accelerate as inventories build. In previous oil price downturns, OPEC would reduce supply as stocks built up to prevent a collapse in the term structure of prices. After all, when the price of storage soars, storage operators benefit and oil producers suffer
However, this new OPEC policy will likely create a large inventory overhang, suggesting further downside risks to oil prices. In fact, we see floating storage coming into play over the coming months with roughly 55 million barrels building on ships by the end of 2Q15 as land-based inventories across North America, Europe and Asia fill up. But even floating storage is limited by its very nature. If crude vessels fill up, shipping rates will spike; and that is unlikely to help any oil producer in the world.
Alberto Ades: Given this new OPEC policy, couldn’t non-OPEC producers simply turn off supply to stabilize prices? Are these producers large enough to influence the market significantly?
Sabine Schels: To restore equilibrium in the oil market, we would need a sizeable supply cut of at least 1 million b/d. In our view, it is not reasonable to expect non-cartelized production to shut down immediately as prices fall because many producers are well hedged, face very low cash costs, are partially protected by falling domestic currencies or tax breaks, or are notoriously slow to react. According to our estimates, with the exception of shale oil, which is cash flow intensive and thus dependent on price (current or forward), non-cartelized crude oil output in many parts of the world is not price sensitive at all, particularly in the first 12 months.
In the absence of a moderating agent like Saudi Arabia, this means prices have to fall below operating cash costs (non-shale) or well below cash flow breakevens (shale) for marginal producers. In our view, non-OPEC oil supply cuts will not come easy in the short run, as operating cash costs sit below $40/bbl. True, investments will be put on hold as some of the world’s output is challenged below $70/bbl in the long run. However, production guidance continues to point up in 2015 for most listed companies. Unless production guidance for 2015 goes negative or Saudi Arabia changes its policy, the market could become more disorderly as oil prices find a floor around operating cash costs.
As a result, we now expect oil prices to spiral down toward the end of 1Q and target Brent at $31/bbl and WTI at $32/bbl.
Alberto Ades: Since you expect no significant price bounce in the near future, do you see a risk of the flow of petrodollars drying up in the longer term?
Sabine Schels: We have argued that once spending cuts by non-OPEC producers, most likely US shale oil, are in place, Brent crude prices should start to recover. This will likely happen in the second half of this year, to a year-end target of $57/bbl. For 2016, we forecast Brent crude oil prices averaging $58/bbl. All else equal, this should increase the flow of petrodollars to the global economy, though to levels much lower than when oil was in the $100+/bbl environment. However, there is a risk to our base case. This assumption relies heavily on Saudi Arabian production staying at around the current level of 9.7 million b/d. While the kingdom pledges not to cut output to prevent prices from falling, this new OPEC policy could imply raising output, thus cutting into effective spare capacity. If this occurs, oil prices may stay low for longer, depressing the flow of petrodollars for years to come. This would allow them to increase their market share as oil prices recover, rather than allow shale producers in the US to reenter the market.
In this context, it is important to note that Saudi production is close to a record high in terms of total output, but not in terms of its share of the global market. So the question remains whether the Saudis want to put their spare capacity to work in coming years and increase output beyond 12 million b/d as oil prices start to recover. In that scenario, we estimate the fiscal budget breakeven price for the Kingdom would fall quickly, by $22/bbl from $94/bbl currently, meaning much-trumpeted reserves would last even longer to sustain this new policy.
Alberto Ades: Could a rebound in global economic activity support an oil price recovery, even under the new OPEC policy?
Sabine Schels: Our models suggest a six-month lag before lower prices start to impact consumption positively. Assuming the lower prices create no spiraling effect in emerging markets, this means global consumption should accelerate meaningfully in the second half of this year and into 2016.
Global oil demand is driven by net oil importing countries and large oil producers. Incrementally, we still expect China and India to deliver the bulk of the global consumption increase in 2015, although we do not expect China’s oil demand to grow nearly as fast as it did between 2004 and 2010, given domestic housing woes and an expensive currency.
While large importing countries like the US, China and India will likely see a bounce in consumption in 2015 and 2016, demand in oil-producing countries could be meaningfully slower next year as recession bites in Russia and lower oil prices negatively impact Middle East economies. After all, many oil producers had
their cake and ate it too for years as oil prices rose.
As a result, we remain very concerned that slower demand from oil-producing countries could come back to haunt the market. We estimate 50% of the growth in demand in the last 10 years has come from oil-producing countries, a clear downside risk to prices, and the flow of petrodollars, from here.
GCC: a possible tectonic shift in petrodollar recycling
Alberto Ades: Jean-Michel, let’s turn to the regional impact of the petrodollar recycling dry-up for the countries in the Gulf Cooperation Council (GCC). How did these countries recycle petrodollars during the oil boom years?
Jean-Michel Saliba, Middle East and North Africa economist: GCC oil export earnings totaled roughly US$1.04tn in 2014, for a cumulative US$10.8tn since 1970. These revenues have been recycled through two main channels, the absorption and financial account channels. The former refers to the use of oil export receipts to finance imports of goods and services. Through the second channel, current account surpluses translate into net financial investments in the rest of the world. The split in these flows comes from the sovereign’s intertemporal allocation decision between spending under the absorption channel and saving under the financial account channel. The latter also involves an asset allocation decision.
Alberto Ades: Let’s first discuss the absorption channel. How has it evolved since the 1970s?
Jean-Michel Saliba: GCC absorption capacity has increased steadily with the launch of large diversification and infrastructure spending programs. We estimate that around half of the GCC oil export earnings were spent and recycled through imports between 2003 and 2014. In comparison, during the oil boom of the 1970s and 1980s, the ratio of imports to exports increased rapidly from 0.3 to 0.6 on average in the 1980s and then remained fairly elevated on large domestic development plans and declining oil prices. After peaking at 0.8 in 1986, the ratio has declined gradually after the spending drop of the 1990s. This suggests the absorption channel has diminished in importance for GCC this time around.
Also, in the past, higher GCC imports lent support to global demand and mitigated the widening of DM current account deficits due to higher oil prices. In other words, imports were sourced back from developed markets. Over time, this channel has become somewhat USD-negative as trade links with the US decreased at the expense of the rise in the share of Asia.
Alberto Ades: Is it safe then to conclude that the financial account channel has recently gained importance for the GCC?
Jean-Michel Saliba: Yes, and this is probably the reason why this is the channel people tend to focus on when speaking of petrodollar recycling. Current account data suggest the GCC has accumulated $2.7tn in net foreign assets since the 1970s1, $2.4tn of which has likely come during the most recent oil boom that started in 2004
Saving GCC petrodollars in the form of foreign assets held abroad has occurred largely through the official sector. In turn, the GCC official sector’s outward investment has helped sterilize oil receipts. This has shielded the domestic economies from excessive or volatile liquidity, albeit only incompletely given the presence of currency pegs and robust fiscal expansion.
Over time, the role of the GCC monetary authorities, except for the Saudi Arabia Monetary Agency (SAMA), has been eclipsed by the rise of sovereign wealth funds. This likely implies a less risk-averse asset allocation by GCC.
Alberto Ades: You bring up an important new player, namely the SWFs. Their relative size and influence over global markets has increased sharply since the
1980s. What are the implications of this?
Jean-Michel Saliba: For one thing, the growing relevance of the financial account channel and the rise of SWFs have made it more difficult to track the flows accurately. Through our work, we have been able to account for the geographical destination of only about 50% of the accumulated GCC net foreign investment.
Previously, tracking was simpler because the bulk of financial flows passed through DM banks or DM securities markets. The GCC current account surpluses could broadly be explained by increases in FX reserves and bank deposits in the US and Bank of International Settlements (BIS) reporting countries. For example, between 1974 and 1979, 47% of total identified investments were deposited in bank accounts in developed economies or used to purchase UK or US money market instruments. The rest were simply used for long-term lending, mainly to developing economies through international banks. These patterns actually planted the seeds of the 1980s debt crises when flows dried out.
This time, financial account flows appear to have gained in sophistication, with diversification across a larger set of asset classes and geographies, including regional and domestic ones. This likely implies a potentially less risk averse asset allocation by the GCC countries
Alberto Ades: Of what you have been able to track, what are the geographical destinations of GCC petrodollar investment flows?
Jean-Michel Saliba: We believe the bulk of petrodollars recycled through the financial channel ended, either directly or indirectly, in the deep and liquid US financial markets. After all, the rise in the GCC current account surpluses was mirrored by the widening of the US current account deficit, whereas Emerging Asia has run surpluses and the Eurozone has kept relatively flat external balances. Therefore, these flows ended up financing the US, for the most part. Petrodollars may have funded an increase in domestic and regional investment on a relative basis as well, but this remains hard to quantify. That said, the Abu Dhabi Investment Authority (ADIA) allocation could be used as a very rough guide on investment flows. Long-term neutral EM benchmark exposure for ADIA consists of between 15% and 25% of assets under management. This contrasts with 35-50% for North America, 20-35% for Europe and 10-20% for Developed Asia. Note that around 75% of ADIA’s assets are managed externally and some 55% of ADIA’s assets are invested in index-replicating strategies.
In terms of the cumulative stock of identified GCC foreign asset holdings, most of it is concentrated in foreign direct investments in Europe, Asia, and the US, BIS offshore bank deposits and US equities
Alberto Ades: What would be the main implications of the dry-up in petrodollar recycling likely to happen in a lower oil price environment?
Jean-Michel Saliba: Lower oil prices for longer should imply material shifts in the size and direction of petrodollar recycling flows. Every $10/bbl drop in oil prices shaves off 4.2% of GDP from GCC current account balances. The move in oil prices between US$115/bbl and US$52/bbl would therefore shave off US$440bn in export revenues annually. The GCC external current account breakeven oil price is at approximately $65/bbl, which would only make the region a net external creditor if oil prices rebound sharply this year. The regional fiscal breakeven oil price is at $85/bbl, suggesting the GCC is set to run a fiscal deficit on aggregate, the bulk of which is likely to be financed through a drawdown of foreign assets currently held abroad.
History suggests GCC’s fiscal adjustment occurs with a lag. This would imply a sticky absorption channel through still elevated imports in the near term. During the first year or so of low oil prices, a country such as Saudi Arabia would draw down its official reserves to finance the balance of payments gap. These assets are most likely invested in foreign deposits and liquid US securities, which would take a hit. Later, financial account flows, which in the era of high oil prices were invested abroad to sterilize oil receipts, would likely reverse their direction. This would leave a more manageable drawdown of official central bank assets. Petrodollar shifts could reshape the geopolitical landscape
Alberto Ades: Jean-Michel, let’s conclude by discussing the changing geopolitics. What impact do you expect for the Middle Eastern conflicts?
Jean-Michel Saliba: Over a longer time frame, we would expect lower financial support to regional proxy armed groups to weaken some of the geopolitical dynamics on the ground. However, this can be moderated by various factors. First, in the local press, the Iranian leadership has expressed its belief that the new Saudi oil policy regime has clear geopolitical motives. The closest analogy is perhaps the 1985 Saudi oil policy regime shift, which sent oil prices tumbling and weighed on the conduct of the Iran-Iraq war. Iranian Foreign Minister Zarif recently suggested that lower oil prices diminish the possible gains of the Iranian regime concluding a nuclear deal with the P5+1 countries. Also, we note the Iranian macro adjustment could make the threat of further sanctions less potent.
Second, the resurgent Houthi military gains in Yemen, continued engagement in the Syrian conflict and recent Hezbollah-Israeli hostilities suggest Iranian regional ideological involvement is unlikely to alter course materially in the near term given the elevated stakes. In addition, a number of regional proxy armed groups were founded in the mid-1980s and appear to have developed alternative financing mechanisms.
Finally, in some instances, lower oil prices could accentuate sectarian conflicts in the Middle East. We suggested a risk to the colonial Sykes-Picot borders in Iraq, which has been addressed imperfectly through US external intervention and the recent budgetary agreement between Baghdad and the Kurdistan Regional Government. However, low oil prices challenge the economics of the deal and deepen Iraq’s fiscal strains and liquidity crunch.
Alberto Ades: Venezuela is another oil exporter that will also be directly impacted. Francisco, how did Venezuela recycle petrodollars during the previous oil boom? I get the sense that geopolitical trends in the region can’t be understood without a reference to Venezuela and the “grants” it distributed to countries with shared political affinities. Is this correct?
Francisco Rodríguez, Andean economist: Definitely. High oil prices in recent years allowed Venezuela to expand its influence in the region. The cost of this was very large for the country. We estimate the stock of loans to regional allies currently outstanding totals $25bn. This is larger than the current Venezuelan international reserves. In other words, the opportunity cost of Venezuelan foreign policy was not building a stabilization fund that would have enabled it to smooth out the adjustment during periods of declining oil prices.
These policies are unsustainable at current oil prices. In fact, the data already show a notable decline in trade credits and other public sector investment assets, two capital account items that essentially capture the change of liabilities of other countries with Venezuela generated as a result of Petrocaribe and other cooperation agreements. Net lending to other countries, as captured by the sum of these lines, fell to $1.9bn in the first three quarters of 2014 from $5.9bn and $11.2bn for comparable periods in 2013 and 2012, respectively.
Alberto Ades: And are we already seeing some of the effects of these drying out?
Francisco Rodríguez: Absolutely, the restoration of full diplomatic relations between the United States and Cuba is an important byproduct of this decline in Venezuela’s influence. From Cuba’s vantage point, the need to change its sources of external income is evident. As of 2013, it received oil shipments from Venezuela totaling 98mbd. In our view, the implications of this important announcement reach beyond Cuba’s borders, as it can help reshape the relationships between the US and Latin America, a region where a large fraction of governments is headed by leftist parties.
Alberto Ades: We cannot discuss geopolitics of oil without discussing Russia. Every day we hear that Russia will not only be affected economically but also politically, and even socially. Vladimir, overall, how important is oil for Russia?
Vladimir Osakovskiy, Russia and CIS economist: We believe the impact of oil prices goes well beyond the economy and deeper into Russian society. This dependence goes all the way back to the late 1970s, when the then USSR became one of the major energy exporters and an important player on the global energy markets. In periods of relatively high oil prices, the abundant inflow of capital tended to create strong momentum in the economy, which also coincided with periods of a very assertive foreign and domestic policy
For example, historically high oil prices between the late 1970s and early 1980s correlated with the peak of the tensions between the US and the USSR in various parts of the world. More recently, record high oil prices in mid-2008 and between 2011 and early 2014 coincided with a brief war with Georgia in August 2008 and the political crisis in Ukraine. On the contrary, periods of low and falling oil prices have coincided with times when Russia’s relations with the West tended to improve. We can say that with respect to the entire Perestroika in 1987 and the US-Russia reset in early 2009.
Also, there are numerous ways in which such high oil revenues have been converted into political capital. Obviously, more abundant capital gave the government a greater ability to increase spending on such a political item as defense, which gave it more tools for an independent foreign policy on the international agenda. Russia’s defense spending reached peaks in the mid-1980s and in 2014.
Similar to what Francisco described for Venezuela, abundant and expansive energy resources also provide a lot of “soft power” that can be converted easily into political benefits through discounted gas shipments, direct financial support to loyal governments, etc. Over the past 5-10 years Russia has been quite active in supporting loyal governments in Belarus, Armenia and Ukraine. However, the capacity for such soft power is declining with lower oil prices and, even more importantly, the value of energy concessions that Russia can offer is falling as well.
Alberto Ades: Vadim, with all this background that Vladimir outlined, can we expect easing of the geopolitical tensions in Ukraine as a result?
Vadim Khramov, Ukraine and CEE economist: From the geopolitical standpoint, there is an argument that Russia would have to take a softer stance on Ukraine, as falling oil prices and western sanctions hurt the Russian economy. For now, the conflict in eastern Ukraine is still ongoing and at the end of 2014, there was even some escalation of tensions. Therefore, it is hard to say that Russia is taking a softer stance on Ukraine for now. However, we do not know the counterfactual on the situation had oil prices stayed high.
One major issue is related to Ukraine energy imports from Russia. As you know, Ukraine is an energy importer. According to our estimates, the recent drop in oil prices will allow it to save about $4bn on the imported gas bill as well as $3-4bn on petroleum-related imports. Also, Ukraine’s energy dependence on Russia has reduced not only in price but also in volume terms. This limits Russia’s ability to add more pressures on Ukraine.
That being said, our estimates show that Ukraine still will have to buy almost half of its gas imports from Russia in the next few years, as large gas substitution from Europe is unlikely. Therefore, even under a situation with low energy prices, Russia can add pressure on Ukraine along the energy lines. For this reason, in my view, the short-term impact of low energy prices on the Ukraine conflict overall is still limited.
Alberto Ades: Let’s briefly discuss potential impacts on domestic policies in Russia. Vladimir, are these affected as much as foreign policies?
Vladimir Osakovskiy: Sure. In the past, discussions about reforms in Russia have occurred during periods of low oil prices. For example, the USSR started democratization and its move away from the planned economy in the late 1980s when it was facing massive resource constraints due to a sharp decline in oil prices. After oil prices dipped below $10/bbl, Russia was pushed to accept the IMF program in 1998, even though it did not help to avert the default.
Conversely, the intensity of Russia’s reforms fell quickly and the government increased its assertive control over society as oil prices started to rise at the beginning of the century. The reformist and democratic agenda had a tentative recovery in 2009 when the oil price dropped below $30/bbl. However, this period faded quickly, just as oil prices recovered quickly.
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Strategy impact will be larger for FX than for rates
Alberto Ades: Gustavo, let’s switch away from regional geopolitics and back into global economics and strategy. As petrodollar recycling dries out, will this hit global liquidity conditions?
Gustavo Reis, global economist: Jean-Michel noted petrodollar flows likely ended up in liquid US financial markets; therefore, a consequent effect would be diminished support for US asset prices. There are other adjustments that can override this, however. Unlike in the 1970s, when oil revenues were mostly recycled through banking channels, the ongoing adjustment in global rates and exchange rates is key to understanding how petrodollar flows will ultimately affect overall financial conditions.
Our Global Liquidity Tracker shows the recent oil price drop coincides with a moderate tightening in global liquidity conditions. The higher market volatility and diminished risk appetite have offset the drop in global bond yields. Much of this reflects global growth concerns, which have also been weighing on oil prices. Moreover, monetary policy in the Euro area and Japan will probably deviate from the playbook of looking through oil price changes by responding assertively to increased deflation risks.
Despite the uncertainty on recycling routes, my view is that petrodollar flows will be of second-order importance to global liquidity in 2015. Estimating the impact of petrodollar flows on global market conditions a decade ago, the International Monetary Fund found them to be limited. A more patient Federal Reserve, additional easing by the European Central Bank and Bank of Japan, as well as the decline in long-term global inflation expectations, will likely dominate. This suggests a contained potential impact of petrodollar flows over and above the market gyrations associated with the oil price plunge.
Alberto Ades: Shyam, in terms of strategy, given the GCC’s sizable holdings of US fixed income assets, what will be the impact on US rates? Should we expect a sell-off of US Treasuries?
Shyam Rajan, rates strategist: As Jean-Michel mentioned, there is definitely a risk that countries like Saudi Arabia will draw down liquid US securities to finance any balance of payments gap. After all, according to the latest TIC holdings data, OPEC nations hold about $280bn of UST, with another $200bn held by Russia and Norway.
However, we are less concerned about the impact of this flow on the rates market for two reasons. First, corporate bond and stock holdings of Middle East oil-exporting
nations have increased by almost twice that of UST over the last four years (up about $70bn since 2010). This increased preference for higher-yielding and higher-risk assets likely explains why the relationship between UST flows from this region and oil prices has weakened substantially recently. This is consistent with Jean-Michel’s intuition that the emergence of SWFs has probably led to a less risk averse allocation by GCC.
Second, sales by these countries are usually more than offset by other flows. It is important to remember that the top four oil importers excluding the US (China, Japan, India and South Korea) own five times the amount of UST held by the oil exporters. Increased buying from these countries could therefore easily offset any sales. In addition, a further drop in oil prices as envisioned by Sabine would probably increase risk aversion and safe haven flows into the UST market.
Alberto Ades: Talk of UST yields and inflation may have implications for Fed action. Mike, could the shift in petrodollar recycling influence the Fed’s monetary policy during 2015?
Michael Hanson, United States economist: Not in my view. For the Fed, the decision on when to begin the tightening cycle will depend on how it assesses the progress toward maximum employment and price stability in the dual mandate. But as the January FOMC statement revealed, financial and international developments will also play a role. If the shedding of US assets by oil-exporting economies results in an appreciable tightening of US financial conditions, the Fed may move later or more gradually in its exit strategy.
* * *
In other words, from irrelevant, to “unambiguously good” if only for those who have zero understanding of what it means, suddenly the end of the Petrodollar recycling chain is said to impact everything from Russian geopolitics, to global capital market liquidity, to safe-haven demand for Treasurys, to social tensions in developing nations, to the Fed’s exit strategy.
Or said otherwise, we now know why the Fed felt like adding the word “international developments” in its latest statement.
by Mac Slavo
In financial circles, it is widely acknowledged that the Federal Reserve was about to raise interest rates, but has since changed course and decided to hold firm.
Why? Because currencies are tanking all across the globe, and a stronger U.S. dollar – a double-edged sword – is making export goods more expensive and hurting international business.
Welcome to 2015, the year of the currency wars. Things are about to get volatile, so hold on.
Wall Street bears are warning that a crisis is near, according to CNN Money:
The bears build their case that a crisis is near [based] on four factors: falling oil prices, stagnant wages, the “two-edged sword” of a strong US dollar and big trouble abroad.
“Earnings and economic activity are actually weakening, not strengthening,” says James Abate, chief investment officer at Centre Asset Management, which manages over $8 billion. “The growth outlook, to us, is deteriorating.”
Only a short time ago, the Swiss decoupled from the Euro, signalling trouble ahead and sending markets spiraling. Now Greece is back in debt trouble, and several other European nations are vulnerable. This will spread further. The damage could be severe, depending upon what plays out.
Growth in China is slowing. The Swiss National Bank ignited a “currency war” this month after a surprise move. The European Central Bank is throwing a life raft to its nations drowning in deflation, and Japan is already deflating.
On top of that, Greece just elected a leader almost certain to cause tension with other European leaders and tensions are flaring up again between Russia and the Ukraine.
“Everyone seems to be falling or faltering in some way,” abroad, says Matt Kerkhoff, research director at Dow Theory Letters, an online newsletter. The American economy, “cannot really outperform while all the rest are in shambles.”
Remember, everything is, and has been for decades, interconnected. As SHTF quoted earlier this week,
“At a basic level, all markets are increasingly integrated — if Wall Street sneezes, New Zealand is likely to catch a financial cold.”
Now it figures that if Wall Street catches the flu, the world might catch the plague. And so, Federal Reserve monetary policy is hinging on international conditions during a time of stormy seas.
Cue Russia, Mexico, Brazil and OPEC nations being tested by devastatingly low oil prices.
Right now, the Mexican Peso and Brazilian Real are at the tipping point, with the peso at its lowest point since 2009 and the real at the lowest point in 10 years!
Meanwhile, economic experts are debating whether or not the euro can still be saved, or is doomed to collapse as European states are internalizing control of their economies and repatriating gold to weather the storm should the entire continent be consumed in the swell.
Motley Fool highlighted the plaguing issues:
Since last July, the value of the dollar has soared by 15% versus the world’s major currencies, making U.S. exports less competitive in global markets.
The dollar’s strength is being fueled by multiple factors. Lower oil prices have caused currencies in Russia, Mexico, and other energy-dependent economies to fall precipitously. Since the middle of last year, for instance, the Russian ruble has lost roughly half of its value versus the dollar.
Monetary policy by the European Central Bank is also playing a role. In an effort to jump-start the continent’s ailing economies, the ECB announced earlier this week that it would follow in the Federal Reserve’s footsteps by buying 60 billion euros in government bonds each month over the next year and a half. Because this expands the number of euros in circulation, anticipation of the news pushed the euro’s value to its lowest point vis-a-vis the dollar in more than a decade.
Finally, actions by central banks in Canada, Singapore, Japan, and other countries suggest a deliberate attempt to manipulate exchange rates in a broadening currency war. Most recently, Canada cut its benchmark interest rate last week by a quarter of a point, and the Monetary Authority of Singapore said this week that it would take measures to slow the appreciation of the Singapore dollar.
The net result is that the Federal Reserve has little choice but to delay an increase in interest rates. Doing otherwise would only further drive up the value of the U.S. dollar given that higher rates would attract international capital, and thereby boost the demand (and thus price) for dollars.
The combination of the returning European debt crisis and the crash of oil prices is serious enough, again, that it is determining Federal Reserve policy.
Things are that bad.
Earlier today, Michael Snyder warned that “if the price of oil stays at this level throughout 2015, We’re going to have a total financial nightmare.”
Now, the currency wars are reaching “hot” levels, and casualties are about to begin.
With the oil crisis undermining many economies and destroying well-paying job, the Euro is becoming the primary front, though the wars are being fought all across the globe.
As usual, any remaining national sovereignty and wealth among the population – and their bank accounts – will be the first to be sacrificed to stave off the crisis.
Already, Mario Draghi, the head of the European Central Bank, has told the world he will do “whatever it takes” to save the euro. According to GoldSeek.com, that means:
Draghi is willing to…
1) Confiscate wealth by cutting interest rates to negative.
2) Permit regulators to seize bank accounts to “bail-in” banks.
3) Verbally intervene every time possible provided it pushes yields on EU nation sovereign bonds lower.
4) Buy EU sovereign bonds despite the fact that this clearly violates the Maastricht Treaty (the treaty that formed the Eurozone).
However, what Draghi is NOT wiling to do is restructure ANY EU sovereign nation’s debt.
Time to chain down anything you don’t want them to take.
by Mac Slavo
The Davos World Economic Summit has long been a parade for the insider agenda, putting the power players’ plans for the world’s economies on display as a preview to their playing out for the rest of the year.
But so far, the 2015 elite retreat in the Swiss Alps has proven to be full of apprehension, and even horror… with many of its own members expressing regret at the world they have built.
The Guardian reported:
The billionaires and corporate oligarchs meeting in Davos this week are getting worried about inequality… even the architects of the crisis-ridden international economic order are starting to see the dangers. It’s not just the maverick hedge-funder George Soros, who likes to describe himself as a class traitor. Paul Polman, Unilever chief executive, frets about the “capitalist threat to capitalism”. Christine Lagarde, the IMF managing director, fears capitalism might indeed carry Marx’s “seeds of its own destruction” and warns that something needs to be done.
The scale of the crisis has been laid out for them by the charity Oxfam. Just 80 individuals now have the same net wealth as 3.5 billion people – half the entire global population. Last year, the best-off 1% owned 48% of the world’s wealth, up from 44% five years ago. On current trends, the richest 1% will have pocketed more than the other 99% put together next year. The 0.1% have been doing even better, quadrupling their share of US income since the 1980s.
These billionaires are not concerned with a fair or truly equitable world, of course. But they may well be concerned about having pushed the system beyond the brink, and triggering global collapse or unrest as a result of things gone way too far.
On top of a bloated super-surveillance police state that is still expanding in the age of Big Data and continuing terrorism, it is a “wealth grab on a grotesque scale” that has stood out the most in 2015.
In 2015, it has become obvious that inequality has become just plain cynical, unsettling and, perhaps, downright revolutionary… and even the insulated, egocentric billionaires have taken notice.
Meanwhile, the Telegraph compiled a set of compelling reasons to think the world has fallen back into crisis, with a global economic meltdown perhaps looming overhead.
Charts compiled from 2014 data showed gloomy numbers in everything from stunted growth, mounting deflation, collapsing oil prices (and with it a collapsing Russian economy), conspicuously low central bank interest rates, mounting debt in Europe and the UK, new waves of the Euro-crises in Greece, Italy and Spain, and shortcomings in previous forecasts for growth by the IMF.
In short… well, things are not looking so great.
Along with the other factors mentioned above, this chart, published by the London Telegraph, shows what has happened to Americans as they struggled to tread water and keep afloat after 2008. For the United States, there have been some signs of improvement, but mostly for those already on top. And the general decline in the global rankings of economic freedom and civil liberties does not complement the widening inequality, either.
It illustrates the dramatic shift from the post World War II years of economic expansion to where we stand now…
As Neil Irwin reported for the NY Times:
Who benefits from rising incomes in an expansion has changed drastically over the last 60 years. Pavlina R. Tcherneva, an economist at Bard College, created a chart that vividly shows how.
Back in the 1940s, ’50s and ’60s, most of the income gains experienced during expansions — the periods from the trough of one recession until the onset of another — accrued to most of the people. That is to say, the bottom 90 percent of earners captured at least a majority of the rise in income.
With each expansion in sequence, however, the bottom 90 percent captured a smaller share of income gains and the top 10 percent captured more.
Post-WWII and the Burgeoning Middle Class
It’s not that things were ever perfect, but… here’s a glimpse into how most Americans – the “average” American in the middle or lower class was doing, overall, half a century or so ago. With a strong manufacturing and industrial sector, many had the opportunity for a good paying job, a home and some semblance of upward mobility. Not all was rosy, but by the numbers, things were on an even enough keel.
In short, the chart begins in 1949, when the income growth for most Americans outweighed that of the top 10% by a factor of four to one.
The trend gradually declined, moving from 80% of income growth in the bottom 90% in 1949-1953 to just 55% in the years 1975-79.
During those years, most Americans steadily enjoyed relatively high wages and general prosperity.
Energy Crisis and Stagflation of the 1970s
The 1970s represented a turning point, however, with several stages of the oil crisis hitting in 1973 and 1979. Foreign policy led to OPEC hiking energy prices; Americans in turn saw rationing and a rise in the cost of living; middle class wealth and job opportunity took a dive.
The beginning of deindustrialization meant that, more and more, Americans weren’t producing actual goods; manufacturing was in decline, and many good jobs were soon shipped over seas.
Meanwhile, wealth on a global stage flowed through the petrodollar, which was, in turn, recycled on Wall Street, making speculators and banking houses – not good and production – the center of the economic universe.
Deregulation and Unfettered Speculation in the 1980s and 1990s
Thus, the increases in income as wealth changed dramatically in the following decades, starting in the year 1982 and continuing to 2000 and the end of the century.
During the presidencies of Republicans Ronald Reagan and George Bush and Democrat Bill Clinton, income growth patterns flipped from their post-war patterns, with the top 10% suddenly outpacing everyone nearly 3-to-1, and regular folks seeing a noticeable decrease in their earnings.
In short, the middle class in decline. And things were getting even worse for those at the bottom.
The deregulation atmosphere of the 80s represented a complete upheaval of the post-war middle class boom.
As Wall Street’s predatory capitalism became the law of the land, a full 80% of income growth went to those at the top, while middle and lower class wealth suddenly staggered to a 29% share.
The 90s continued this trend, with income growth for the bottom 90% dropping to 27%.
This fast-paced era of “free market” (crony) capitalism – as defined and enhanced by Wall Street – only set the stage for what was to come, however.
The Walls Come Down: End of Glass Steagall and Rise of Derivatives Intro 21st Century
For those looking back after the 2008 financial collapse, these are the years in which the Glass Steagall Act, which had separated commercial and investment banking since the 1930s, was repealed with the handiwork of Clinton’s Treasury Secretary Robert Rubin and Larry Summers, Rubin’s deputy and successor.
Meanwhile, since the mid-90s, the derivatives market was opened up for big business, despite the warnings of such regulators as Brooksley Born, then head of the Commodity Futures Trading Commission (CFTC).
Under these important developments, the cynical years of the George W. Bush presidency – initiated by a Supreme Court decision, and not by the electoral process – became even worse.
Income growth for most people ground to a halt, with the total income growth for the lower and middle classes reaching only 2% (meaning most had no meaningful rise in income at all).
Meanwhile, income growth for the top 10% soared to 98% of all increases. America’s richest took it straight to the bank, in an era of massive speculation during a huge housing bubble that would soon come crashing down.
Much has been said about the 2008 financial crisis, but the “too big to fail” banks were signposts for an opportunistic class of Americans who had profited by their own rules when opportunity was dwindling for most people.
After the brink, when taxpayers bailed out the banks, things became even worse for average Americans who found themselves in the so-called “bottom 90%.”
During the Obama years, when many Americans perceived America’s first black president as redistributing vast amounts of wealth to the lower classes, income dropped sharply, with negative growth for 90% of Americans for the first time since World War II.
There was no such leveling out, but a sharpening of the growing disparity nationwide. Obama is a corporatist, not a socialist.
During the period since 2009, when most Americans saw an average drop of 16% in income, the top 10% increased their wealth by a mind-boggling 116%. Their earnings more than doubled, while the average population struggled with less and less. Things reached a point of total us vs. them…
The Occupy Wall Street crowd called it the 1%, but it is much worse than that. The issue is a tiny, tiny few (numbering only a few thousand) who now effectively own it all.
They make the rules, they break the rules, and, well, they just rule. Period.
Could the picture be any clearer?
This video shows how America’s perception of the wealth gap underplays the reality, and compounds the problems, and further reveals that in reality, the bottom 40% in the United States have, well, next to nothing to show for themselves in terms of economic wealth:
As for the Middle Class – currently dead, in limbo or alternately M.I.A., columnist Harold Meyerson argues:
The extinction of a large and vibrant American middle class isn’t ordained by the laws of either economics or physics. Many of the impediments to creating anew a broadly prosperous America are ultimately political creations that are susceptible to political remedy. Amassing the power to secure those remedies will require an extraordinary, sustained, and heroic political mobilization. Americans will have to transform their anxiety into indignation and direct that indignation to the task of reclaiming their stake in the nation’s future.
Perhaps that means the Middle Class could be once again revived, if ever sanity reentered the picture, if the bums were kicked out and those guilty of outright treason in the financial and political arenas were finally rounded up and held accountable.
But don’t hold your breath… just hold onto what you’ve got, if you can.
The Economic Collapse
by Michael Snyder
The absolutely stunning decision by the Swiss National Bank to decouple from the euro has triggered billions of dollars worth of losses all over the globe. Citigroup and Deutsche Bank both say that their losses were somewhere in the neighborhood of 150 million dollars, a major hedge fund that had 830 million dollars in assets at the end of December has been forced to shut down, and several major global currency trading firms have announced that they are now insolvent. And these are just the losses that we know about so far. It will be many months before the full scope of the financial devastation caused by the Swiss National Bank is fully revealed. But of course the same thing could be said about the crash in the price of oil that we have witnessed in recent weeks. These two “black swan events” have set financial dominoes in motion all over the globe. At this point we can only guess how bad the financial devastation will ultimately be.
But everyone agrees that it will be bad. For example, one financial expert at Boston University says that he believes the losses caused by the Swiss National Bank decision will be in the billions of dollars…
“The losses will be in the billions — they are still being tallied,” said Mark T. Williams, an executive-in-residence at Boston University specializing in risk management. “They will range from large banks, brokers, hedge funds, mutual funds to currency speculators. There will be ripple effects throughout the financial system.”
Citigroup, the world’s biggest currencies dealer, lost more than $150 million at its trading desks, a person with knowledge of the matter said last week. Deutsche Bank lost $150 million and Barclays less than $100 million, people familiar with the events said, after the Swiss National Bank scrapped a three-year-old policy of capping its currency against the euro and the franc soared as much as 41 percent that day versus the euro. Spokesmen for the three banks declined to comment.
And actually, if the total losses from this crisis are only limited to the “billions” I think that we will be extremely fortunate.
As I mentioned above, a hedge fund that had 830 million dollars in assets at the end of December just completely imploded. Everest Capital’s Global Fund had heavily bet against the Swiss franc, and as a result it now has lost “virtually all its money”…
Marko Dimitrijevic, the hedge fund manager who survived at least five emerging market debt crises, is closing his largest hedge fund after losing virtually all its money this week when the Swiss National Bank unexpectedly let the franc trade freely against the euro, according to a person familiar with the firm.
Everest Capital’s Global Fund had about $830 million in assets as of the end of December, according to a client report. The Miami-based firm, which specializes in emerging markets, still manages seven funds with about $2.2 billion in assets. The global fund, the firm’s oldest, was betting the Swiss franc would decline, said the person, who asked not to be named because the information is private.
This is how fast things can move in the financial marketplace when things start getting crazy.
It can seem like you are on top of the world one day, but just a short while later you can be filing for bankruptcy.
Consider what just happened to FXCM. It is one of the largest retail currency trading firms on the entire planet, and the decision by the Swiss National Bank instantly created a 200 million dollar hole in the company that desperately needed to be filled…
The magnitude of the crisis for U.S. currency traders became clear Friday when New York-based FXCM, a publicly traded U.S. currency broker, and the largest so far to announce it was in financial trouble after suffering a 90-percent drop in the firm’s stock price, reported the firm would need a $200-$300 million bailout to prevent capital requirements from being breached. Highly leveraged currency traders, including retail customers, were unable to come up with sufficient capital to cover the losses suffered in their currency trading accounts when the Swiss franc surged.
Currency traders worldwide allowed to leverage their accounts 100:1, meaning the customer can bet $100 in the currency exchange markets for every $1.00 the customer has on deposit in its account, can result in huge gains from unexpected currency price fluctuations or massive and devastating losses, should the customer bet wrong.
Fortunately for FXCM, another company called Leucadia came riding to the rescue with a 300 million dollar loan.
But other currency trading firms were not so lucky.
For example, Alpari has already announced that it is going into insolvency…
Retail broker Alpari UK filed for insolvency on Friday.
The move “caused by the SNB’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity,” Alpari, the shirt sponsor of English Premier League soccer club West Ham, said in a statement.
“This has resulted in the majority of clients sustaining losses which exceeded their account equity. Where a client cannot cover this loss, it is passed on to us. This has forced Alpari (UK) Limited to confirm that it has entered into insolvency.”
And Alpari is far from alone. Quite a few other smaller currency trading firms all over the world are in the exact same boat.
Unfortunately, this could potentially just be the beginning of the currency chaos.
All eyes are on the European Central Bank right now. If a major round of quantitative easing is announced, that could unleash yet another wave of crippling losses for financial institutions. The following is from a recent CNBC article…
One of Europe’s most influential economists has warned that the quantitative easing measures seen being unveiled by the European Central Bank (ECB) this week could create deep market volatility, akin to what was seen after the Swiss National Bank abandoned its currency peg.
“There was so much capital flight in anticipation of the QE to Switzerland, that the Swiss central bank was unable to stem the tide, and there will be more effects of that sort,” the President of Germany’s Ifo Institute for Economic Research, Hans-Werner Sinn, told CNBC on Monday.
As I have written about previously, we are moving into a time of greatly increased financial volatility. And when we start to see tremendous ups and downs in the financial world, that is a sign that a great crash is coming. We witnessed this prior to the financial crisis of 2008, and now we are watching it happen again.
And this is not just happening in the United States. Just check out what happened in China on Monday…
Chinese shares plunged about 8% Monday after the country’s securities regulator imposed margin trading curbs on several major brokerages, a sign that authorities are trying to rein in the market’s big gains. It was China’s largest drop in six years.
Sadly, most Americans have absolutely no idea what is coming.
They just trust that Barack Obama, Congress and the “experts” at the Federal Reserve have it all figured out.
So when the next great financial crisis does arrive, most people are going to be absolutely blindsided by it, even though anyone that is willing to look at the facts honestly should be able to see it steamrolling directly toward us.
Over the past couple of years, we have been blessed to experience a period of relative stability.
But that period of relative stability is now ending.
I hope that you are getting ready for what comes next.
by Claudio Grass
Looking Back at 2014
2014 was quite an eventful year for global markets: Janet Yellen became the new Chairman of the Federal Reserve; we were on the brink of war in Crimea, and Germany won its fourth world cup title. Many countries around the world held elections, the Scotts and the Swiss had referendums and both of them decided to maintain the status quo, whether it was against Scottish independence or the Gold initiative.
I wouldn’t describe this year as a tough one for gold, considering that it is ending the year close to where it left off end-2013. While some may perceive this negatively and against the rationale for holding physical gold, I find it more relevant than ever, like I said last year. The main reason why gold did not move against the tide this year is, in my opinion, because appearances have a stronger influence on the minds of the people than the facts presented by reality.
Image credit: Glenna Goodacre
The global debt situation is much worse than a few years ago and real economic growth is near zero. Income inequality is rising faster than ever before. The Federal Reserve’s balance sheet expanded from about USD 890 billion to more than USD 4.5 trillion since end-2007 and the only outcome so far has been an artificial spike in different asset classes and an expansion of the welfare-warfare state. The fact is that a fiat-money system always results in massive centralization, in terms of the economic landscape, “wealth-accumulation” and an ever-expanding state apparatus. The accumulation of debt is part and parcel of this mechanism. No necessary reforms or structural changes have taken place, which would allow a more positive outlook for 2015.
The vast expansion in the Fed’s balance sheet – click to enlarge.
More and more people feel that something is going completely wrong because they understand that it is not possible to fight over-indebtedness by piling up even more and more debt. The majority of the public, I believe, understands they need to sacrifice the present for the future. However, they suppress their conclusion. Most of them want to believe in a miracle and live in the hope that only others will be affected by the negative consequences of today’s system, which my friend Prof. Dr. Thorsten Polleit calls a system of “collective corruption”.
Men refuse to think about the rational outcome of our unsustainable system and prefer to believe in the lie they have been told a hundred times rather than a new truth which is based on the facts. However, we can’t hide from the future or as Herbert Stein used to say: “if something cannot go on forever, it will stop”. The Soviet Union did not collapse because ist citizens finally changed their minds and opposed communism; the USSR collapsed because it could no longer be funded.
The only achievement since the global financial crisis is that central banks purchased time financed by “money” that we simply don’t have. According to the Bank of International Settlements, total non-financial debt in advanced economies rose by 37 percentage points to 279% of GDP since the global financial crisis! Even emerging markets, which managed to somehow resist the pileup of debt in the past, have now reached a debt level of 157% of GDP. Instead of cutting the cord and putting an end to this dependence on additional credit, the western economies seek to solve their problems by printing more money and accumulating more debt! Mario Draghi believes that the way out is for the ECB to buy corporate bonds and asset-backed securities amongst other assets, dreaming of increasing the ECB balance sheet by EUR 1 trillion to reach around EUR 3 trillion!
The ECB plans to expand its balance sheet back to the highs of 2012 – click to enlarge.
Also Japan, which has been in a QE mindset for years plans to address any prospect of a recession with even more asset purchases! How valuable can money be if all central banks just want to print more of it? Money is no longer a property title, instead it became an I-owe-something, the Dollar and every other paper money we hold today are simply IOUs. Due to this debt-based system, we need more and more money so that the system does not collapse, because as we all know, loans need to be repaid with interest. This constant increase in the money supply reduces its purchasing power. As long as governments and central banks can redistribute wealth from the middle class, they will continue to do so – the outcome of which will be impoverishment on a wide scale and the destruction of our society.
BoJ assets: QE in overdrive – click to enlarge.
Let’s have a closer look on what has been going on in the physical gold market. Physical demand is very strong and the refineries are again working 24 hours straight to meet demand but mining supply as well as scrap gold seems to be tightening. The Swiss Customs released import/export data showing another strong month of gold exports in November. Exports totaled 232 tons, stronger than the already good month of October with 200.8 tons. India was the main export destination with 77 tons, followed by 34.7 tons to China, 34.2 tons to Hong Kong, 22.8 tons to Turkey and 16.4 tons to Singapore. The Gold Offered Forward Rate (GOFO) has recently turned negative. When the GOFO rate becomes negative, it implies that the demand for physical gold in the spot market is high and market participants are willing to pay a premium to get immediate delivery of gold. The last time we saw such a development was back in 2009 when we witnessed a substantial increase in gold prices for several years. So, in this situation particularly with a shortening in the physical supply, we just don’t feel that comfortable about the future.
Gold over the past year, in dollar and euro terms. In euro terms a new bull market seems to be underway already – click to enlarge.
Paper Money Destroys the Values Allowing us to Coexist Peacefully
With low or even negative interest rates associated with the debasement of the purchasing power of money itself, every saver appears to be a fool. This process has a strong impact on us, because saving does not make sense and therefore people end up buying things they don’t need or they even can’t afford. This imbalance in which consumption and debt carry bigger weight compared to savings leads to the moral degeneration of society. Excessive consumerism stands for absolute contemporary fixation – a devil-may-care attitude. Because money becomes worth less and less, people start running after yields to compensate for the loss of purchasing power. The ways we think and act adjust according to our short-term problems and goals, ignoring the long-term ramifications.
I believe that as a result of this, we lack time to reflect, to discuss, to care for the family but also to think about the values and ideals of our society. State activism and an inflationary monetary system are destroying our understanding of a “traditional family”. It loosens the ties between parents, reduces the attraction to bring children into the world and particularly to rear children in the best proper way so as to pass on these values to future generations.
It is therefore that I firmly believe that state activism undermines the respect for all non-state authorities and is therefore destructive to our cultural and traditional values. Wilhelm Röpke, a German economist, once said in this regards, that “Self-discipline, a sense of justice, honesty, fairness, chivalry, moderation, public spirit, respect for human dignity, firm ethical norms — all of these are things which people must possess before they go to market and compete with each other. These are the indispensable supports which preserve both market and competition from degeneration.”
In our Las Vegas conference back in September I expressed my strong opinion how liberty has been slowly dying since 9/11. Governments have expanded their infrastructures to increase their infiltration into societies and intensify their control to curb civil liberty, ironically, in the name of protecting liberty. I particularly like to share a quote by Henry Hazlitt from an article he wrote back in 1956, saying “that the greatest threat to American liberty today comes from within. It is the treat of a growing and spreading totalitarian ideology.”
There are three ways or tenets whereby a society drifts into totalitarianism, but it all starts with increasing government regulation of every sphere of life, whether social, economic or cultural – you constantly have to ask the government for permission. The more the government spends the more far-reaching the government intervention becomes. I also believe the increase in government regulation is indicative of a lack of trust the elites have towards individuals.
The government doesn’t trust us with our choices, but how can we be confident that the government will make the right choice for us? It is evident that the political and economic spheres of government reinforce each other towards this objective, and in the end it is our liberty that we lose. Here in Switzerland, an already established state endorsing deregulation of government, I was optimistic that the Gold Initiative would pass. And though it didn’t, I am convinced it succeeded in making the public question the system that regulates their financial and economic interests. And therefore I am optimistic we will have interesting discussions to witness in Switzerland.
The East knows better!
The ongoing geopolitical power shift from West to East has become crystal clear this year. History has shown us that currencies rise and fall with the rise and fall of their empires. It is obvious that the current currency system is at war. Demographics in the western world are unfavorable. The East, as we all know, is highly motivated to increase their productivity and aim for better standards of living and quality of life. At the same time they don’t have a gigantic welfare-state in place and their hunger for gold is unstoppable. They know all too well that the tides will turn at some point and they want to make sure they have the support to protect them from the damage that we’ll see when the system breaks down.
Whom can we trust?
We cannot take the media at face value. With about six companies in the US controlling the media landscape – how can we guarantee objectivity or that there isn’t a certain bias or agenda at play? Edward Bernays, the father of propaganda, once said, “[t]he conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in a democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government, which is the true ruling power of our country [… ] we are dominated by the relatively small number of persons […] who understand the mental processes and social patterns of the masses. It is they who pull the wires which control the public mind”.
And though there is a strong force promoting government agendas I believe there is an opposing current in the Internet questioning the media and the ideas they are promoting. I would like to take this opportunity to ask you to read the article written by my friend Marco Ricca that explains how the Internet is helping to make the world a freer place (please refer to the abstract and link in this Outlook). The exponential growth rate that for example the Austrian School and its proponents are witnessing, particularly since the crisis in 2007, is a strong indicator of this.
Nothing can Protect You Better than Gold
If we review the events of 2014, it seems the situation has intensified: governments are still overwhelmed with debt, our fiat money system is unsupported, our central banks insist on accumulating debt and making money valueless. It doesn’t look all too good. Or does it? Will someone realize we have to pull the plug? And when we do, because it will happen whether we want it or not, how can we hedge against the damage that we will all be exposed to? I am a strong advocate of physical gold and can’t stress enough the importance of owning physical precious metals stored outside the banking system. It is a proven and essential form of monetary insurance against the uncertainties and negative surprises we see in our world today.
Let me close with the freedom train metaphor for building a movement that I heard from Jeff Deist, President of the Mises Institute, a few weeks ago. “If you want more freedom, join us. Get on the train. You can get off whenever you like. Maybe you favor 60 percent of our ideas, or 80 percent or 90 percent, or whatever. Just join us and go as far as you like, get off when you like. As I said earlier, we are so far from what we could consider a free society that we hardly should concern ourselves about it now. Let’s just get the train moving in the right direction!”
Great change has always come from the bottom upward and not the other way round. I recall the words of Mahatma Gandhi: “Be the change that you wish to see in the world.” Like Gandhi, I firmly believe change stems from the individual – but the individual needs to believe in his power and potential to create it.
The Economic Collapse
by Michael Snyder
Is this the start of the next major financial crisis? The nightmarish collapse of the price of oil is creating panic in financial markets all over the planet. On June 16th, U.S. oil was trading at a price of $107.52. Since then, it has fallen by almost 50 dollars in less than 6 months. This has only happened one other time in our history. In the summer of 2008, the price of oil utterly collapsed and we all remember what happened after that. Well, the same patterns that we witnessed back in 2008 are happening again. As the price of oil crashed in 2008, so did prices for a whole host of other commodities. That is happening again. Once commodities started crashing, the market for junk bonds started to implode. That is also happening again. Finally, toward the end of 2008, we witnessed a horrifying stock market crash. Could we be on the verge of another major one? Last week was the worst week for the Dow in more than three years, and stock markets all over the world are crashing right now. Bad financial news continues to roll in from the four corners of the globe on an almost hourly basis. Have we finally reached the “tipping point” that so many have been warning about?
- WTI’s 2nd worst week in over 3 years (down 10 of last 11 weeks)
- Dow’s worst worst week in 3 years
- Financials worst week in 2 months
- Materials worst week since Sept 2011
- VIX’s Biggest week since Sept 2011
- Gold’s best week in 6 months
- Silver’s last 2 weeks are best in 6 months
- HY Credit’s worst 2 weeks since May 2012
- IG Credit’s worst week in 2 months
- 10Y Yield’s best week since June 2012
- US Oil Rig Count worst week in 2 years
- The USDollar’s worst week since July 2013
- USDJPY’s worst week since June 2013
- Portugal Bonds worst week since July 2011
- Greek stocks worst week since 1987
The stock market meltdown in Greece is particularly noteworthy. After peaking in March, the Greek stock market is down 40 percent since then. That includes a 20 percent implosion in just the past three trading days.
And it isn’t just Greece. Financial markets all over Europe are in turmoil right now. In addition to crashing oil prices, there is also renewed concern about the fundamental stability of the eurozone. Many believe that it is inevitable that it is headed for a break up. As a result of all of this fear, European stocks also had their worst week in over three years…
European stock markets closed sharply lower on Friday, posting their biggest weekly loss since August 2011, as commodity prices continued to fall and and shares in oil-related firms came under renewed pressure from the weak price for crude.
The pan-European FTSEurofirst 300 unofficially ended 2.6 percent lower, down 5.9 percent on the week as the energy sector once again weighed heavily on wider benchmarks, falling over 3 percent.
But despite all of the carnage that we witnessed in the U.S. and in Europe last week, things are actually far worse for financial markets in the Middle East.
Just check out what happened on the other side of the planet on Sunday…
Stock markets in the Persian Gulf got drilled Sunday as worries about further price declines grew. The Dubai stock index fell 7.6% Sunday, the equivalent of a 1,313-point plunge in the Dow Jones industrial average. The Saudi Arabian market fell 3.3%.
Like I said, this is turning out to be a truly global financial panic.
Another region to keep an eye on is South America. Argentina is a financial basket case, the Brazilian stock market is tanking big time, and the implied probability of default on Venezuelan debt is now up to 93 percent…
Swaps traders are almost certain that Venezuela will default as the rout in oil prices pressures government finances and sends bond prices to a 16-year low.
Benchmark notes due 2027 dropped to 43.75 cents on the dollar as of 11:35 a.m. in New York, the lowest since September 1998, as crude extended a bear market decline. The upfront cost of contracts to insure Venezuelan debt against non-payment for five years is at 59 percent, bringing the implied probability of default to 93 percent, the highest in the world.
So what does all of this mean for the future?
Are we experiencing a repeat of 2008?
Could what is ahead be even worse than that?
Or could this just be a temporary setback?
Recently, Howard Hill shared a few things that he looks for to determine whether a major financial crisis is upon us or not…
The first condition is a serious market sector correction.
According to some participants in the market for energy company bonds and loans, such a correction is already underway and heading toward a meltdown (the second condition). Others are more sanguine, and expect a recovery soon.
That smaller energy companies have issued more junk-rated debt than their relative size in the economy isn’t under debate. Of a total junk bond market estimated around $1.2 trillion, about 18% ($216 billion, according to a Bloomberg estimate) has been issued by energy-related companies. Yet those companies represent a far smaller share of the economy or stock market capitalization among the universe of junk-rated companies.
If the beaten-down prices for junk energy bonds don’t stabilize or recover a bit, we might see the second condition: a spiral of distressed sales of bonds and loans. This could happen if junk bond mutual funds or other large holders sell into an unfriendly market at low prices, and then other holders of those bonds succumb to the pressure of fund redemptions or margin calls and sell at even lower prices.
The third condition, which we can’t determine directly, would be pressure on Credit Default Swap dealers or hedge funds to make deposits as the prices of the CDS move against them. AIG was taken down when collateral demands were made to support existing CDS agreements, and nobody knew it until they were going under. There simply isn’t a way to know whether banks or dealers are struggling until the effect is already metastasizing.
I think that he makes some really good points.
In particular, I think that watching how junk bonds perform over the next few weeks will be extremely telling.
Last week was truly a bloodbath for high yield debt.
But perhaps things will stabilize this week.
Let’s hope so, because this is the closest that we have been to another major financial crisis since 2008.