Saturday, December 31, 2011
MF Global - Beginning of the End?
On Halloween weekend, there was a primary dealer that went bankrupt. It's been in the news for a while, maybe you've heard of it, maybe not. It's MF Global, a commodity futures brokerage firm, kind of like TD Ameritrade/Scottrade/Fidelity, only for commodity futures, options and derivatives.
http://en.wikipedia.org/wiki/MF_Global
One thing I've learned from this bankruptcy is that it shows our system of everything is braking, and it may be beyond repair, but we'll see.
But let's back track a little to 2008 during the financial crisis. Back then, if a company went bankrupt, (i.e. Bear Sterns, Lehman Brothers) the parts of the company would be sold off if possible to other competitiors, customer's money/assets were made whole and transferred to the new company, the remaining assets were divided up to the next stakeholders in line. These companies going bankrupt damaged the financial system as I've mentioned before leading to the government (tax-payers) bailing out AIG, and a whole bunch of banks from the counter party risk they had with each other. Most of these banks were foreign banks in Europe if you recall. So private companies went bankrupt because they were stupid and were betting on highly leveraged collateralized debt obligations (CDO) and mortgage backed securities (MBS) based on sub-prime mortgages (rated AAA for some reason). The private companies after getting bought out by Barclays and JP Morgan, then had to sell their unsaleable products (CDO and MBS) to the government in the form of the Federal Reserve purchasing these toxic assets (CDO and MBS) and bailing out companies.
How did the government fund this? Through the sale of it's own bonds to raise the money needed. They just called it "providing liquidity to the system" or some garbage like that. (This raised the debt ceiling, and our national debt.)
So that was the first financial crisis where by private sector companies went bankrupt and the burden fell onto the government to fix the problem. There's a lot of issues involved with the whole financial crisis in 2008, but I'll stop there.
That was then...this is now.
Think of MF Global as a smaller version of what happened in 2008 because, they were smaller, and they didn't have their hands in everything like Bear Sterns and Lehman Brothers. They weren't investment bankers and securities brokers to that level, but they were similar in their own industry of commodity futures and options.
Now MF Global went bankrupt because they were doing similar things as Bear Sterns and Lehman Brothers by highly leveraging investments in sovereign debt of European countries, instead of CDO's and MBS's. The thing to take away is that MF Global leveraged (40-1) the amount of their actual assets to purchase the debt of European countries. This is similar to how a bank can leverage 9-1 (or more) the money you put into the bank to loan to other people, businesses, etc. (This is why bank runs are bad, they only have a small % of the actual assets in the bank, the rest are tied up in other things. Again, think It's a Wonderful Life). MF Global did this by borrowing money (very cheap right now w/ historically low rates) and then using that money to purchase government bonds. Thereby borrowing money at a lower interest rate than the bonds were paying back in interest to create basically free money. The loans were collateralized by the bonds. So the only thing that needed to happen, was MF Global needed to maintain their minimum margin (down payment % in a way) to carry the loans. They couldn't.
That's how the MF Global bankruptcy got started. But it's after it was started that things started to go really badly...potentially for everyone.
One of the first things that came out was that MF Global had missing customer money. First it was $633 million that was found to be missing by Interactive Brokers who tried to acquire the company on October 30, 2011 and made the deal fall through. But now it could be $1.2 billion or more. This money has still not been "found."
Here's a great link to the MF Global bankruptcy.
http://www.btrtrading.com/Legal/MF%20Global%20White%20Paper%20Revised%20-%2012-1-11.pdf
Well, there's been a lot of talk about this "missing money" and where it went, etc. The consensus I've seen is that it was rehypothecated. http://en.wikipedia.org/wiki/Hypothecation Basically, since MF Global didn't have the collateral to maintain the margins on the loans, they pledged their customer's money from the segregated accounts. This is obviously not a good situation as if you had an account with MF Global to trade in commodities, that was your money you were trading, so you have a claim to that. Well MF Global used that money as collateral, so JP Morgan (who loaned them the money) also had claim to a portion of the customer's money ($633 million - $1.2 billion+) when they filed bankruptcy.
This is where things start to show why our system is breaking, if not already broken.
When MF Global filed for bankruptcy Chapter 7, they were not listed under Sub Chapter IV (Commodity Broker Liquidation). They were listed under Sub Chapter III (Stockbroker Liquidation). When that happened, that basically put the customers way down the list of stakeholders, and put JP Morgan to the top of the list. Why this was done, I could only guess. The fact is, MF Global was a Commodity Broker with $5.4 billion in assets on over 50,000 accounts for commodities, vs. $100 million and 400 or so contracts for securities. http://uscode.house.gov/download/pls/11C7.txt
But the point is, that decision has just changed our legal system, and puts into question it's viability. This also should put questions about our financial system's viability if JP Morgan had to steal (with the help of the legal system and bankruptcy courts) $600 million to potentially over $1.2 billion of customer's money. If they didn't do that, would JP Morgan have gone bankrupt due to leverage on their own books? Would that have collapsed the whole financial system in a worse way than 2008? I don't know for sure, but it's definitely unprecedented actions that have taken place during this bankruptcy. So I would have to imagine there would have been unprecedented re-actions if things did not happen this way.
So what does all of this mean?
Some would say that nobody's money is safe...any where. After all, it was because of this bankruptcy that Ann Barnhardt closed her commodity futures brokerage company. She said she could no longer guarantee her customer's funds. Maybe she's a little nutty, but she had her own company in this industry, and that's more than anyone I know has. http://www.zerohedge.com/news/entire-system-has-been-utterly-destroyed-mf-global-collapse-presenting-first-mf-global-casualty
But what's the difference between some commodity brokerage's company with their accounts and say TD Ameritrade and a stock trading account, Fidelity and a 401k/IRA, Charles Schwab investments, Insurance annuities, or your bank account even? Well, that's up to you to decide. It could be that everything is different and if something happened to the company the accounts would be made whole. Or maybe nothing is different and your money could be stolen as well at any time, and replaced with 65% of what you originally had.
The one thing I can guarantee, the problems that caused this situation are similar. Companies, governments, banks, individuals all leveraging their assets (your home is a leveraged asset when you made your down payment of 3-20%, and you leveraged the other amount in a loan to actually purchase the house). These are being collateralized as well, mostly by the assets backing the leveraged loans. But more importantly, banks are also collateralizing leverage of assets with customer money (just like MF Global did)...see Bank of America. They are currently leveraging and collateralizing the $53 Trillion of derivatives with $1 Trillion of customer bank accounts. Luckily, those are FDIC insured, up to $250k. But the actions are the same, and the result could potentially be the same, so be forewarned.
http://www.bloomberg.com/news/2011-10-18/bofa-said-to-split-regulators-over-moving-merrill-derivatives-to-bank-unit.html
http://www.zerohedge.com/news/bank-america-forces-depositors-backstop-its-53-trillion-derivative-book-prevent-few-clients-dep
So, is this the beginning of the end? Who knows? Maybe the next financial crisis like 2008 started with MF Global on Halloween. Maybe instead of the governments bailing out the banks and putting it on your shoulders, they'll just take your money directly instead. One way or the other, your money is being taken from you. Whether it's through direct stealing like with MF Global, or Government inflation...all of the debt has to be paid, one way or another. And it doesn't help when the national debt just keeps getting larger. It's already clear that companies will steal your money. And at some point, inflation won't be an option for governments to increase and pay their debts. So the question is, then what?
A couple other good articles to read from which I have gained knowledge about this bankruptcy and have included in the above...
http://gonzalolira.blogspot.com/2011/12/run-on-global-banking-systemhow-close.html
http://www.washingtonpost.com/the-systemic-risk-revealed-by-mf-globals-collapse/2011/12/14/gIQAtrTI1O_story.html
Wednesday, December 21, 2011
Iran
Well, I can't say I'm thrilled about reading this...
http://www.telegraph.co.uk/news/worldnews/northamerica/usa/8969551/US-military-ready-to-engage-in-a-conflict-with-Iran.html
Since missles, planes, ships, and military personnel don't pay for themselves, there's only one option...raise the debt ceiling and print more money.
In case you wanted an updated chart...nothing has really changed too much. Still have the dome shape. Although the POMO's (Federal Reserve's "Primary Open Market Operations") have slowed things a bit. It's possible there's a reversal of this, we won't know until 2012 though without some kind of news.
http://www.telegraph.co.uk/news/worldnews/northamerica/usa/8969551/US-military-ready-to-engage-in-a-conflict-with-Iran.html
Since missles, planes, ships, and military personnel don't pay for themselves, there's only one option...raise the debt ceiling and print more money.
In case you wanted an updated chart...nothing has really changed too much. Still have the dome shape. Although the POMO's (Federal Reserve's "Primary Open Market Operations") have slowed things a bit. It's possible there's a reversal of this, we won't know until 2012 though without some kind of news.
Thursday, December 15, 2011
Updated Charts (again)
So it's been about a week (in trading days) and the Dow has finally broken lower out of that sideways trading that was going on. Honestly, I would have thought that there would be some huge selling off after the Federal Reserve announcement of basically nothing the other day. Instead, things have been slowly working their way down.
If I break out the handy eraser in MS Paint, we can get rid of that quick drop and rebound from the opening of liquidity to European banks through the Federal Reserve Swaps from a couple weeks ago, and here you can see what's happening.
As you can see, there's definitely a pattern here of a rounded top.
A Rounded Top is considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.
http://www.trending123.com/patterns/rounded_top.html
So pretty much, back to where we were a couple weeks ago almost where the bottom dropped out and it looked like a very dire situation developing. Well, this is where again, the government will have to step in and provide more "liquidity" for the new "double dip recession" to not continue developing.
Ok, shifting gears...
Eventually I will have a specific post on the developing Currency War that's going on. But when you hear talk of the government being upset with China (or anyone else) for "currency manipulation" and tariffs or sanctions or anything else along those lines to "boost" the economy, that is a new battle in the Currency War. Currency Wars aren't good for anybody. It's just more government intervention directed to get extremely short term gains on some chart or statistic. In the long run, these are bad and hurt the economy.
http://news.yahoo.com/china-gets-revenge-obama-tariff-u-autos-213747820.html
Here's an article discussing China's actions or (response) to a previous battle the U.S. initiated. Obviously this is going to be very bad for the automakers and the companies that are selling these vehicles into China. They will immediately have a 20% price increase. That will change people's minds about purchasing these specific vehicles, and buy something domestic instead. Not too dissimilar to what has taken place here in the past 3 years.
So there's two things to think about. More later.
If I break out the handy eraser in MS Paint, we can get rid of that quick drop and rebound from the opening of liquidity to European banks through the Federal Reserve Swaps from a couple weeks ago, and here you can see what's happening.
As you can see, there's definitely a pattern here of a rounded top.
Implication
A Rounded Top is considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.
Description
A Rounded Top is dome-shaped, and is sometimes referred to as an inverted bowl or a saucer top. The pattern is confirmed when the price breaks down below its moving average.
http://www.trending123.com/patterns/rounded_top.html
So pretty much, back to where we were a couple weeks ago almost where the bottom dropped out and it looked like a very dire situation developing. Well, this is where again, the government will have to step in and provide more "liquidity" for the new "double dip recession" to not continue developing.
Ok, shifting gears...
Eventually I will have a specific post on the developing Currency War that's going on. But when you hear talk of the government being upset with China (or anyone else) for "currency manipulation" and tariffs or sanctions or anything else along those lines to "boost" the economy, that is a new battle in the Currency War. Currency Wars aren't good for anybody. It's just more government intervention directed to get extremely short term gains on some chart or statistic. In the long run, these are bad and hurt the economy.
http://news.yahoo.com/china-gets-revenge-obama-tariff-u-autos-213747820.html
Here's an article discussing China's actions or (response) to a previous battle the U.S. initiated. Obviously this is going to be very bad for the automakers and the companies that are selling these vehicles into China. They will immediately have a 20% price increase. That will change people's minds about purchasing these specific vehicles, and buy something domestic instead. Not too dissimilar to what has taken place here in the past 3 years.
So there's two things to think about. More later.
Sunday, December 11, 2011
Financial Repression
A couple weeks ago I posted this ( http://playwithmonopolymoney.blogspot.com/2011/11/banks-making-moneystill-through.html ), which discusses how the banks have been making money still through obtaining very cheap money through the Federal Reserve discount window, buying government bonds and taking the profit. I explained how this is a major reason for the artificially low interest rates, mortgage rates, etc. So that's the how.
If that's the how, "Financial Repression" and this post is the combination of the how and the why.
First, a definition...
How I would translate...Financial Repression is a collection of ways that governments use to manipulate the costs of borrowing money for themselves, paying back the borrowed money, and directing money that they need toward themselves.
So why is this important? Well, we all know that governments around the globe have run massive trade deficits and increased their debt by huge amounts. Specifically in the U.S., there was all of the news about raising the debt ceiling over the summer. Specifically in Europe they are going through a crisis again just like in 2010 with multiple countries having Debt to GDP ratios that are too high and unsustainable that could even collapse the Euro currency.
Here is a chart showing the Debt to GDP Ratio from a great summary of a great study done on Financial Repression. The study focused on how governments reduced the amount of debt they carried after WWII. As you can see, we are back to those levels.
From the article link above...summary of the financial repression in the study
The specifics of financial repression took somewhat different forms in each of the advanced economies, but they shared four characteristics: 1) inflation; 2) governmental control of interest rates to guarantee negative real rates of return; 3) compulsory funding of government debt by financial institutions; and 4) capital controls.
If that's the how, "Financial Repression" and this post is the combination of the how and the why.
First, a definition...
A term that describes measures by which governments channel funds to themselves as a form of debt reduction. This concept was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon. Financial repression can include such measures as directed lending to the government, caps on interest rates, regulation of capital movement between countries and a tighter association between government and banks.
Read more: http://www.investopedia.com/terms/f/financial-repression.asp#ixzz1gI5wfkvU
Read more: http://www.investopedia.com/terms/f/financial-repression.asp#ixzz1gI5wfkvU
From wikipedia's definition...bold and underline mine
These measures allow governments to issue debt at lower interest rates than would otherwise be possible. A low nominal interest rate can help governments reduce debt servicing costs, while a high incidence of negative real interest rates liquidates or erodes the real value of government debt.[3] Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation, and it can be considered a form of taxation.[4]"
Definition link...
Here is a chart showing the Debt to GDP Ratio from a great summary of a great study done on Financial Repression. The study focused on how governments reduced the amount of debt they carried after WWII. As you can see, we are back to those levels.
Study of Financial Repression...very technical, long and boring, I haven't gone through it yet, but some good research is in there.
http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf
Summary article...I encourage you to read this
The specifics of financial repression took somewhat different forms in each of the advanced economies, but they shared four characteristics: 1) inflation; 2) governmental control of interest rates to guarantee negative real rates of return; 3) compulsory funding of government debt by financial institutions; and 4) capital controls.
So let's get into how Financial Repression affects you...
#1 is inflation. In order for the government have this work for them, they need inflation as I've said before. Inflation makes the money they borrow cheaper, while making everything else more expensive for us when we purchase something.
#2 is control of the interest rates to guarantee negative real rates of return...
When I took my finance classes, we were taught that whatever we invested in, we needed to focus on Real Rates of Return. A Real Rate of Return = (Nominal Rate of Return - Inflation)...let's just ignore taxes and fees for now, although taxes and other fees would also be subtracted.
So let's say you can invest your money in a money market account and get a 3% a year return (interest) on that money. This would be the Nominal Rate of Return (3%). But if inflation is 3% a year, your Real Rate of Return is actually 0%.
But right now, you probably couldn't get 3% on a money market account because the government has manipulated the bond markets through this Financial Repression #1 (capping interest rates very low). So maybe you could get lucky and find 1% right now. Well inflation right now is say 4% (I believe it to be much higher). So your real rate of return right now if you leave your money invested in a money market account is -3%. So you are thinking that you're actually making money, 1% by keeping your money in the money market account, but really, the government is inflating the currency and taking 4% of your money in the future when you buy something with that money, so you're left with losing 3%. This is how the countries paid back the debt they incurred from WWII through the bond market.
Some countries had higher inflation, some had lower, but it just took more or less time to pay of the debts. I believe the United States officially paid of WWII under Bill Clinton in the 1990's (so 50 years). Not every year were there negative real rates of return from bonds, but the study showed quite a few.
So one would hopefully wonder why anyone would invest in treasury bonds at such low interest rates (.12% for a 1 yr T-Bill) and inflation around 3.5% (officially)?
Well, most people usually don't, some investors do to get a "risk-free rate of return" and offset the risks of buying stocks right now. But as I explained in my previous post, banks will. They'll buy a ton, because they can borrow the money for even cheaper from the Federal Reserve. They still get to book their spread as profit so they can keep making their money, and the government gets a guaranteed way to inflate the currency, and keep real rates of return negative (therefore helping to pay off their debt more cheaply).
#3 Compulsory funding of government debt by financial institutions.
Here we're talking about either the government forcing mutual funds, teacher retirement accounts, pensions, and banks to purchase government bonds, or making it highly desirable to so. Right now with the stock market and the world economy the way that it is, many are investing in government bonds for safety reasons, even if it is a negative return, because the alternative is the riskiness of stocks with the potential to lose even more money. Also, as mentioned earlier, the Federal Reserve is making it VERY attractive to borrow nearly free money to purchase government bonds. As long as people have confidence that the government will be able to make their interest payments to keep interest rates low, this will continue. When it doesn't, you can look at Greece, Ireland, Italy as examples.
One thing to keep an eye on is the mandatory purchase of government bonds as "safe assets". Most likely you see this in teacher retirement accounts, pensions, etc where there is more concern about loss of wealth vs. the preservation of wealth. If you see that happening all over, you'll know for sure that there are no longer the number of buyers the government needs to continue funding their massive spending, so either interest rates would have to rise (which is undesirable for governments to owe more on their interest), or they would have to force the purchase of bonds by other parties.
I also think about WWII when there was advertisements to "Buy War Bonds". It wasn't mandatory, but man would you have been un-patriotic if you didn't take a negative real rate of return on your "investment."
#4 Capital Controls.
This is where the government puts controls on the flow of money in and out of the country and usually impacts the exchange rates. I haven't seen too many examples of this recently, so we're not really to this stage yet. If we were to this point, it's basically as if the government locks you into only investing within the country and the dollar. I would think we'd have to be in pretty bad shape for this to happen, but you never know. If the first three aren't working and people are sending their money to China, South America, etc at very high rates to escape the inflation, negative interest rates and near mandatory purchasing of government bonds, I could see it happening. I would imagine they would also sell this as a "do it for your country" type thing first though.
So when you're saving your money, you'll want to have a real rate of return at 0% or better. Otherwise, think of anything else as a donation to the government to pay down the debt and finance their excessive, and mostly idiotic spending. And this is on top of the taxes you already pay.
I found these articles/threads useful.
- http://www.bloomberg.com/news/2011-05-16/pimco-sees-financial-repression-in-u-s-amid-deteriorating-debt-dynamics-.html
- http://seekingalpha.com/article/269022-protecting-against-financial-repression
- http://www.pimco.com/EN/Insights/Pages/The-Caine-Mutiny-Part-2.aspx
- http://www.tfmetalsreport.com/forum/2793/financial-repression-watchtower
- http://www.reuters.com/article/2011/11/18/uk-financial-repression-forces-savers-in-idUSLNE7AH01J20111118
Updated Chart for next week
Real quick as there's something more important I wanted to post about today.
Well, last week sure looked like there would be some direction didn't it? Well, not so much. Initially the chart went into a corner and broke down like I thought it might with all of the bad news, then popped back up later that day, then went down on Wed and Thursday, but Friday popped back up again. Oh the markets, so fun to watch.
Eventually, there will be decisions that will turn this one way or the other from the governments of the world. What are they going to do though? Something, or nothing. Until we hear that, I think we're going to be stuck in this sideways pattern. There may be some very serious underlying problems in the shadow banking side of things that are forcing the buying of time (not allowing the market to correct down) right now. I mean, who really wants another crisis like 2008? I sure don't. But they aren't really coming out and saying we're going to print a bunch more money to offset it either.
I guess we'll see next week what could happen.
Well, last week sure looked like there would be some direction didn't it? Well, not so much. Initially the chart went into a corner and broke down like I thought it might with all of the bad news, then popped back up later that day, then went down on Wed and Thursday, but Friday popped back up again. Oh the markets, so fun to watch.
Eventually, there will be decisions that will turn this one way or the other from the governments of the world. What are they going to do though? Something, or nothing. Until we hear that, I think we're going to be stuck in this sideways pattern. There may be some very serious underlying problems in the shadow banking side of things that are forcing the buying of time (not allowing the market to correct down) right now. I mean, who really wants another crisis like 2008? I sure don't. But they aren't really coming out and saying we're going to print a bunch more money to offset it either.
I guess we'll see next week what could happen.
Thursday, December 8, 2011
Counterparty Risk
So what is Counterparty Risk and why would I talk about it? Let's start with some definitions.
What Does Counterparty Risk Mean?
Investopedia explains Counterparty Risk
Also read...
Counterparty risk. Counterparty risk is the risk that the person or institution with whom you have entered a financial contract -- who is a counterparty to the contract -- will default on the obligation and fail to fulfill that side of the contractual agreement.
In other words, counterparty risk is a type of credit risk. Counterparty risk is the greatest in contracts drawn up directly between two parties and least in contracts where an intermediary acts as counterparty.
For example, in the listed derivatives market, the industry's or the exchange's clearinghouse is the counterparty to every purchase or sale of an options or futures contract. That eliminates the possibility that the buyer or seller won't make good on the transaction.
The clearinghouse, in turn, protects itself from risk by requiring market participants to meet margin requirements. In contrast, there is no such protection in the unlisted derivatives market where forwards and swaps are arranged.
So how I understand Counterparty Risk is this, there's a risk that one entity will default on their end of a promise. I could come up with an example like this....
I loan my car to a friend for a week, and in return they promise to give it back to me in the same condition, and with a full tank of gas. They also promise to give me an extra $100 (like a rental fee) for the use of my car. We are both taking on risk in this situation called Counterparty Risk. I risk that my friend will damage my car, bring it back with less than a full tank of gas, not bring it back in a week, or not give me the $100. My friend risks the fact that I could need my car back in less than a week and take it back.
If either of us default on our promise, we open up a whole new can of worms on determining what the repercussions would be. If I need to take my car back in 3 days, but my friend went to Las Vegas, we have a new problem because I can't get my car back. So I need to "default" on my friend, but by defaulting, I create many more problems that need a resolution.
In the same way, if my friend takes my car and either damages it or doesn't bring it back in a week, we have problems again that need to be resolved. I need a new car, we need to work out an arrangement for damages or loss of use, etc. Sometimes what happens can be easily resolved, other times it can't and it's much more complicated. So the lesson on Counterparty Risk is, it's always there when you make an agreement for things. You expect that the agreement will be kept as is and nothing will come up to change that agreement. But inevitably things always could come up.
So I want to take this one step further as it'll help some explanation later. Let's say that I make an agreement with my friend as stated above. As far as I know, he's driving the car for a week. Well what if my friend borrows my car that's a Ferrari. It's a sweet ride and it's the envy of all of his friends. They also want to borrow the car for a day during the week. Well my friend then lends out my Ferrari to 3 other people on different days at a higher lending rate and makes the money to easily cover the cost of the gas and the $100 he owes me and turns a profit. Then on each day his friends also lend the car to some of their friends for an hour each day to help cover the cost of them borrowing the car. I would call this leveraging, and it greatly increases the Counterparty Risk because now there's not just me and my friend, but now three of his friends borrowing the car for a day (5 friends) and three of their friends borrowing the car for an hour each day (11 people involved in total). Each friend is leveraging the one car to 11 people. And each friend now has created additional Counterparty Risk. If any of those people default on their agreement, we could have a Systemic Risk of all of our agreements failing and tons of things needing to be sorted out among all of us.
So what does this have to do with money?
Well, this is the situation that has occurred over the past 3 years, but on a much larger scale involving our entire financial system. In 2008, when Bear Sterns went bankrupt, it was as if there was a default in me loaning my car to my friend. We were able to resolve it just like Bear Sterns went bankrupt and got bought out by JP Morgan, and all was well. Then Lehman Brothers went bankrupt a few months later. Let's compare their bankruptcy to my friend lending my car to one of his 3 other friends for a day. If that default happens, the solution is a lot more complicated. The same was when Lehman Brothers went bankrupt, it created a whole bunch of more problems. It brought in AIG into the mix as the insurer.
This would be the equivalent of say my friend buying insurance to protect himself in case of his friends defaulting on their daily agreement causing great problems for himself and our weekly agreement. In this sense, in the financial world, I would call it a Credit Default Swap. Only in the financial world, they are lending money, not cars. And it was this that caused AIG to almost go bankrupt because they had to pay back all of the defaults that Lehman Brothers among others were causing during the 2008 crises.
Hopefully now you are beginning to see the much bigger problem in the financial world. Things are developing every single day to further us down the path. The problem is, when you're dealing with money in the financial world, Credit Default Swaps, Derivatives, leverage of assets, lending of securities and the mass amounts of Counterparty Risk between all involved, it becomes a Systemic Risk of the entire financial system collapsing.
2008 was about one part of the financial system, namely the real estate market and mortgages causing problems. The original agreements caused a chain reaction through out our system as the bank who lent money to people for homes started to default, causing the banks to sell and remove liquidity from the leveraged system, causing more deleveraging of other companies until one couldn't get the liquidity it needed and failed (Bear Sterns, Lehman Brothers).
So liquidity is a big concern right again right about now. It was the reasoning, I think, behind the reduction in the swap lending rates last week that took us out of the dire situation we were in and bought a week or so until this week. But things are brewing again just like in 2008, only the situation is a whole lot bigger this time. The Dow Jones and the rest of the market are just outward reflections of the liquidity and money flows around the world. When there's issues, like what's going on in Europe right now with liquidity, it gets reflected in the stock market. So when I post a chart like the Dow that I've been following for the past month, and all of the other charts look the same way, there's underlying problems. Problems like 2008's credit crisis don't happen very often. So to compare a chart to 2008 is saying a lot, because that crisis brought the US and the rest of the world to it's knees for a couple weeks.
But think of right now as if all of the friends have bought insurance against something happening as far as loaning the car to each other because now they learned from the first time they had problems. So they are all insured and have somewhat of a game plan in case one of the friends defaults on their agreement, only this time there's no longer a problem with the loaning of the car among friends, there's a problem with the car itself. That's where I think we are today and why the similarities are there just like 2008, only much different.
More later...
Because A is a counterparty to B and B is a counterparty to A both are exposed to this risk. For example if Joe agrees to lends funds to Mike up to a certain amount, there is an expectation that Joe will provide the cash, and Mike will pay those funds back. There is still the counterparty risk assumed by them both. Mike might default on the loan and not pay Joe back or Joe might stop providing the agreed upon funds.
In most financial contracts, counterparty risk is also known as "default risk".
The risk to each party of a contract that the counterparty will not live up to its contractual obligations. Counterparty risk as a risk to both parties and should be considered when evaluating a contract.
Tuesday, December 6, 2011
China's Ghost Towns
Here's something else that I've been watching and these videos are short, and pretty good. When we purchase all of our products from China, they get a huge influx of cash, US Dollars. Well, they have to trade their Yuan for our Dollars anyhow. Now, the entire world has been buying Chinese products for years. Normally, the Chinese currency would appreciate in this scenario versus all other currencies (i.e. they would be able to purchase more with their Yuan vs. our Dollar, Euro, etc as the Yuan would become stronger). But a strange thing has happened, they decide to print more Yuan to maintain an equal exchange rate (mostly due to pressure from the buying countries as they don't want to spend more to purchase the items). When they do this, they are printing money to give out, as loans, government programs, whatever they want really.
What would you think they would use all of this new money for, the same things we used the money for from 2001-2007, building new houses of course. I mean, real estate is the ever appreciating asset right? Yes and no. It depends on what causes the appreciation.
In China, it's inflation from a stronger currency being purposely weakened to maintain a target exchange rate.
Well, this is the kind of thing that happens when you have too much supply and not enough demand, but people choose to build anyway, it's nearly free money. Then this happens, just like in the U.S. housing prices start to plummet, and quickly.
But here's the interesting thing. Most countries and governments use GDP (Gross Domestic Product) as their measuring stick of economic activity. Well, cheap or free money gets converted into loans to build, build and build some more. Always increasing the GDP of China with these new construction projects and jobs, jobs and more jobs. But if there's nobody there to purchase these at the inflated prices, prices have to go down drastically until there is buyers. If there isn't buyers, it stays as a ghost town, all of the loans and capital used to build the towns and housing goes to waste. This is what is called Economic Prosperity by the government and on the news. Many economists may even talk about how great China is and all of it's glory of state planning and the communist system. But none of that matters. If a government is going to give away cheap and/or free money by printing it, whether it's the U.S., China, England, Germany, where ever, you will see "investments" in bubbles like these homes in China, Dot Com companies, Education (College and higher), Sovereign Debt, anything that will get a great return, even if it's only a return long enough to make a quick buck and leave someone else holding the bag. All the while the news is that the country is growing, we're doing great and just like the guy in the video thinks, prosperity will never end.
These are the dangers of inflation. These are the dangers of government intervention in the marketplace. And you absolutely don't want to be holding the bag when the bubble disappears. This kind of prosperity does end. It ends terribly because it shouldn't have started in the first place (i.e. there is no demand for it). The result is "bad deflation" or monetary deflation. It's as unnecessary as these Chinese Ghost Towns.
It'll Be Interesting Tomorrow (Updated)
So it really looks like tomorrow is going to be a very interesting day. Will there be some kind of Central Bank action to propel the markets above key resistance, or will the previous recession looking chart come back into form? Only time will tell. We may even know by tomorrow morning when we wake up as Europe will probably determine this one.
 |
| Three times in the past week 12,200 held. |
 |
| It looks like 6 times 12,200 held as the ceiling since the end of October. |
This holds true dating back to a month ago when this same level needed to be taken out if the deep recesses of the abyss were to be avoided. Right now is about the time at the one week mark that the swap happened. It looks like we will be in for a rough rest of this week, but who knows what Uncle Sam, Bernanke and the rest of the banks and media have in store for us.
It may just be a Festivus miracle.
But it sure doesn't look like it.
UPDATE: 12/7/11 9:00
And there you have it...it tried overnight to get over and stay at about 3-5am over in Europe, but it didn't last. Now to see how far it drops until there's more intervention or another recession (or continuing depression if you want to call it that).
Here's some news about that topic this morning.
http://www.ft.com/intl/cms/s/0/3d23a05c-20cc-11e1-816d-00144feabdc0.html#axzz1frYhv8Yj
http://uk.reuters.com/article/2011/12/07/uk-britain-manufacturing-idUKLNE7B601120111207
http://www.reuters.com/article/2011/12/07/italy-output-idUSL5E7N71KZ20111207
And here's a nicely done chart from Zero Hedge showing exactly why they had to drop the swap rate last week...because it was needed by somebody quickly.
http://www.zerohedge.com/news/we-just-had-rerun-bear-stearns-when-lehman-coming
UPDATE: 12/7/11 9:00
And there you have it...it tried overnight to get over and stay at about 3-5am over in Europe, but it didn't last. Now to see how far it drops until there's more intervention or another recession (or continuing depression if you want to call it that).
Here's some news about that topic this morning.
http://www.ft.com/intl/cms/s/0/3d23a05c-20cc-11e1-816d-00144feabdc0.html#axzz1frYhv8Yj
http://uk.reuters.com/article/2011/12/07/uk-britain-manufacturing-idUKLNE7B601120111207
http://www.reuters.com/article/2011/12/07/italy-output-idUSL5E7N71KZ20111207
And here's a nicely done chart from Zero Hedge showing exactly why they had to drop the swap rate last week...because it was needed by somebody quickly.
http://www.zerohedge.com/news/we-just-had-rerun-bear-stearns-when-lehman-coming
Overdraft Fees
This was just a little something that I saw on Zero Hedge, linked from the Pew Charitable Trusts that everybody should be aware of if you keep low balances and are in danger of overdraft fees. I don't know if Wells Fargo still does this, I don't know if other banks have or will do this. But you should probably be aware as it's happened in the past to other people. Don't assume that just because you purchase something at different times, that those transactions clear the bank in that order. Think of it like writing a check, who knows when that check will be taken out of your account. Just make sure you don't spend more than you have.
http://www.pewtrusts.org/our_work_report_detail.aspx?id=85899364999
http://www.pewtrusts.org/our_work_report_detail.aspx?id=85899364999
Friday, December 2, 2011
Unemployment down?
This has only an indirect relation to money, but it is WHY we all work, and HOW we get our money, so it's important to follow.
Here's the headlines today...
JOBLESS RATE DROPS TO 8.6%
http://finance.yahoo.com/news/jobless-rate-drops-8-6-133402269.html
http://www.marketwatch.com/story/us-jobless-rate-falls-to-86120000-jobs-added-2011-12-02
We can all bask in the glory of an economy getting better! Hooray! Markets are all up this morning. Everything is great again.
Well, not quite. The BLS numbers mean very little. These are the charts and numbers you want to look at, not the headline unemployment rate. So you can ignore everything you hear about unemployment on TV, newspapers, news sites.
You just need to know it's not good, and it's not getting better. And when a bunch of people you know are still out of work, or can't find a job, or a good job, you can think about these charts and understand why what you hear in the headlines doesn't match what you see in reality.
All courtesy of...
http://www.zerohedge.com/news/key-charts-nfp-report-records-jobless-duration-and-people-who-want-job-civilian-labor-force-plu
So until these charts change, don't expect anything else to significantly change out there.
Here's the headlines today...
JOBLESS RATE DROPS TO 8.6%
http://finance.yahoo.com/news/jobless-rate-drops-8-6-133402269.html
http://www.marketwatch.com/story/us-jobless-rate-falls-to-86120000-jobs-added-2011-12-02
We can all bask in the glory of an economy getting better! Hooray! Markets are all up this morning. Everything is great again.
Well, not quite. The BLS numbers mean very little. These are the charts and numbers you want to look at, not the headline unemployment rate. So you can ignore everything you hear about unemployment on TV, newspapers, news sites.
You just need to know it's not good, and it's not getting better. And when a bunch of people you know are still out of work, or can't find a job, or a good job, you can think about these charts and understand why what you hear in the headlines doesn't match what you see in reality.
All courtesy of...
http://www.zerohedge.com/news/key-charts-nfp-report-records-jobless-duration-and-people-who-want-job-civilian-labor-force-plu
So until these charts change, don't expect anything else to significantly change out there.
Wednesday, November 30, 2011
Game Change?
In my last post I explained how there's two options, inflation or deflation. Print more money, sell more bonds, or stop and reverse course causing deflation and a depression. According to my chart I drew almost 3 weeks ago now pointed to deflation/depression.
Well today we had quite the day in the markets. Why? Inflation.
http://www.zerohedge.com/news/here-comes-global-liquidity-bail-out
As you could see in the article, the Federal Reserve released this note at 8:00am EST along with Central Banks throughout the world coordinating a decrease of US liquidity swap rates. On the chart below you can see at 8:00am EST the DOW went up $200 in 5 min. This is one of the main ways inflation looks on a chart. Instantaneous rises on news.
So the next question is, does that change the picture of my previous chart here?
For the time being, yes. There was a nice rally today of almost $500 from the previous close that busted the similarities of this chart. So where do we go from here...well let's check out some other posts.
http://www.zerohedge.com/news/did-fed-just-buy-europe-week
http://www.zerohedge.com/news/risk-rally-real
http://www.zerohedge.com/news/here-what-happened-after-last-global-coordinated-central-bank-intervention
So according to these three, nothing has fundamentally changed all that much. There's other's that say this is great for the precious metals and show that risk is "on." I am very tempered in my optimism. I would tend to think this alone will only keep things up for a week, maybe a little longer depending on what news comes out, but maybe just the idea of breaking the very scary looking chart above will give enough people the idea that the economy is better.
If you couple that with a lot of fundamental upbeat news items today with the ADP payroll report being way higher than expected, the Chicago Purchasing Manager survey was much higher than expected and home sales as well, you begin to see how things could keep that chart from continuing it's decline. I'm skeptical of these "fundamental" numbers until I see a couple weeks or months more of similar data, but it all added up for a great day. But when the goal of the federal government, the mainstream media and the Federal Reserve is the Management of Perceptions to control economics, you can see why they would want everyone to believe that chart was busted and everything looks good. Because in their world, the proper functioning of the economy is all about spending, even if they print money to give to you to spend. As long as we're all spending, there's no problems, no matter the actual problems. See they could care less that unemployment is 9% (by their numbers) as long as the government or everyone else makes up that spending decrease. I'll get into all this some other time.
So one other thing I wanted to discuss is what's going on in the Middle East. There's definitely growing "tensions" to put it mildly between Iran and pretty much everyone else in the area, including the US. Turd Ferguson over at TF Metals Report has been all over this.
Here's a post with a lot of info.
http://www.tfmetalsreport.com/blog/3051/war-drums
Then today I see this...
http://www.zerohedge.com/news/china-will-not-hesitate-protect-iran-even-third-world-war
Needless to say, whatever is happening over there is nothing good. Let's just hope our idiots in Washington don't do more stupid things to instigate Iran or anyone else to start a fight. This would obviously be the biggest game changer imaginable. It should definitely be watched closely.
Well today we had quite the day in the markets. Why? Inflation.
http://www.zerohedge.com/news/here-comes-global-liquidity-bail-out
As you could see in the article, the Federal Reserve released this note at 8:00am EST along with Central Banks throughout the world coordinating a decrease of US liquidity swap rates. On the chart below you can see at 8:00am EST the DOW went up $200 in 5 min. This is one of the main ways inflation looks on a chart. Instantaneous rises on news.
 |
| 5 minute chart showing a $200 rise right at the 8am release of the Federal Reserve notice. |
So the next question is, does that change the picture of my previous chart here?
For the time being, yes. There was a nice rally today of almost $500 from the previous close that busted the similarities of this chart. So where do we go from here...well let's check out some other posts.
http://www.zerohedge.com/news/did-fed-just-buy-europe-week
http://www.zerohedge.com/news/risk-rally-real
http://www.zerohedge.com/news/here-what-happened-after-last-global-coordinated-central-bank-intervention
So according to these three, nothing has fundamentally changed all that much. There's other's that say this is great for the precious metals and show that risk is "on." I am very tempered in my optimism. I would tend to think this alone will only keep things up for a week, maybe a little longer depending on what news comes out, but maybe just the idea of breaking the very scary looking chart above will give enough people the idea that the economy is better.
If you couple that with a lot of fundamental upbeat news items today with the ADP payroll report being way higher than expected, the Chicago Purchasing Manager survey was much higher than expected and home sales as well, you begin to see how things could keep that chart from continuing it's decline. I'm skeptical of these "fundamental" numbers until I see a couple weeks or months more of similar data, but it all added up for a great day. But when the goal of the federal government, the mainstream media and the Federal Reserve is the Management of Perceptions to control economics, you can see why they would want everyone to believe that chart was busted and everything looks good. Because in their world, the proper functioning of the economy is all about spending, even if they print money to give to you to spend. As long as we're all spending, there's no problems, no matter the actual problems. See they could care less that unemployment is 9% (by their numbers) as long as the government or everyone else makes up that spending decrease. I'll get into all this some other time.
So one other thing I wanted to discuss is what's going on in the Middle East. There's definitely growing "tensions" to put it mildly between Iran and pretty much everyone else in the area, including the US. Turd Ferguson over at TF Metals Report has been all over this.
Here's a post with a lot of info.
http://www.tfmetalsreport.com/blog/3051/war-drums
Then today I see this...
http://www.zerohedge.com/news/china-will-not-hesitate-protect-iran-even-third-world-war
Needless to say, whatever is happening over there is nothing good. Let's just hope our idiots in Washington don't do more stupid things to instigate Iran or anyone else to start a fight. This would obviously be the biggest game changer imaginable. It should definitely be watched closely.
Monday, November 28, 2011
Banks Making Money...still (through inflation)
I was planning on building to this post through history and slowly explaining things, etc. But I just read an article and a post on TF Metals Report that make me want to skip ahead as this is very important for everyone to understand why things are the way they are, even if it doesn't make sense.
While everyone was upset about the $700 Billion in TARP money that the federal government gave multiple different banks in 2008 to "stay afloat" and "not collapse the system," one has to wonder, how in the world have the banks been making money for 3 years? At least I would hope one would think that.
Well, that's all a part of the system we have set up now. See, $15 Trillion of debt that the U.S. government owes doesn't get just printed by the Treasury department and the US Mint in $10, $20, $50, $100 bills. It's much more subtle than that. So in order for the federal government to continue to fund deficits and more spending, they need to raise capital (money). They do this by selling treasury bonds of differing length of time and differing yields (% returns) in return for money right here and now.
Whenever the government sells these bonds to get the money to fund spending over the amount of tax revenues (deficit spending), two things need to happen...
1.) There needs to be buyers. These buyers could be you, me, companies, banks, governments, whoever.
2.) The bonds need to be priced attractively enough that the return you get back is worth it vs. the amount of time and risk you take.
In essence, whoever buys government bonds, is investing in the government.
With government bonds, the risk of them defaulting (not paying you interest or your principal) is generally very low. So low, I was taught in school that this is the "risk-free rate." I don't believe that, but many still do. The other aspect is the amount of interest you receive. This is supposed to be determined by market factors where the buyers just won't buy the bonds if they don't get a high enough % return. Right now, those %'s are very, very low. Historically low. Which is also the reason you can get a 30 year mortgage for 4.2%, a 15 year mortgage for 3.25% and interest on your bank account of 0.02% (or whatever ridiculously low amount you get).
In order for %'s of bonds to be so low, the price of those bonds should be really high. Well, they are. Higher than they've ever been.
So 48.4% is foreign bondholders (people/banks/mutual funds/governments in foreign countries) and that leaves 51.6% as being domestically owned. So we still "own" or owe ourselves (people/banks/mutual funds/government in the US).
But maybe you're thinking, what does that have to do with inflation? Well, everything.
See, when the government sells these bonds, they're sold amongst those buyers I listed. People, banks, mutual funds, government entities, etc, both foreign and domestic, but the amount that any one of those individual groups purchase changes constantly. Since 2008, primary dealers (21 major banking and institutional investment houses that are approved vendors by the Federal Reserve) have been purchasing a large quantity of these.
http://newyorkfed.org/markets/pridealers_current.html
Why them?
Because they have access to the Federal Reserve's discount window (almost unlimited). The Fed Funds rate is currently between 0-0.25 basis points (.0025% - Maximum). So basically free money. These primary dealers borrow money from the Federal Reserve for next to nothing, then purchase Treasury bonds which yield them much more in interest received. Example, borrow money at 0% interest, purchase 30 year Treasury Bills that yields 2.93%. Thus providing themselves an income spread that they book as profit each year, and pay bonuses, etc.
So how much money has these primary dealers borrowed with the Fed discount window? According to the Bloomberg article below, $7.77 Trillion. So while everyone gets all up tight about $700 Billion, you should get up tight about 11x that amount of nearly FREE money that the Federal Reserve loans both foreign and domestic banks. This is how the banks have made money. Not to mention they also use this money to make "investment" gains in the stock market and works hand in hand with the government to supply them extremely low interest rates to service the $15+ Trillion in debt.
This money has been artificially driving down the government bond rates, which in turn have artificially driven down mortgage rates, interest rates on education loans, car loans, etc, and interest on checking and savings accounts. It's a great time to borrow money. Just like it was from 2002-2007. So in 2008, we had a huge bubble that burst in the housing market due to low interest rates and loose lending practices, and put us in our current financial crises. What's the solution to this? Why creating even more borrowing with even lower rates and putting more money into the financial system (inflation).
One solution to this problem the last time we were in a similar situation was in the 1970's and Paul Volcker raised interest rates to 15-20%. This caused a terrible recession, stagflation, shortages (because of government price caps), etc. Well, the problem is, the US as a country was a net exporter in the 1970's (i.e. they had a trade surplus), so the pain really wasn't that bad back then because they had money still coming into the country from selling excess goods. Now, the US is a net importer (we have massive trade deficits w/ Asia - money flowing out of the country). Not only that, but we now owe $15+ Trillion. If we increased interest rates to 15-20%, it may make the debt servicing (i.e. the amount of interest on $15+ Trillion) unservicable and lead to a default. If we dont, we have massive inflation.
So that's the choices. Neither are good. Which do you think the government will choose?
Print more money by selling cheap bonds to the primary dealers and simulaneously inflating the $15+ Trillion away while paying 2-3% interest and providing Wall Street with access to free money and profits until there's hyper-inflation and a complete destruction of the dollar?
Or increasing interest rates, bankrupting said primary dealers who need free money to stay in business, cutting spending by trillions to stop the inflation, causing deflation and a depression the likes nobody has seen ever, with no government support for the newly found poor and unemployed?
I know what they will do, but not that they should.
One thing should become quite clear to all at this point. There is a very real and very tight connection between the Federal Government, Federal Reserve and Wall Street. At this point, none can survive without the others. At the head of this three headed monster is the Federal Reserve.
http://www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html
This is a good article and summary from about a year ago.
http://tfmetalsreport.blogspot.com/2010/11/tipping-point.html
This is a similar summary from today.
http://www.tfmetalsreport.com/blog/3036/great-ponzi
While everyone was upset about the $700 Billion in TARP money that the federal government gave multiple different banks in 2008 to "stay afloat" and "not collapse the system," one has to wonder, how in the world have the banks been making money for 3 years? At least I would hope one would think that.
Well, that's all a part of the system we have set up now. See, $15 Trillion of debt that the U.S. government owes doesn't get just printed by the Treasury department and the US Mint in $10, $20, $50, $100 bills. It's much more subtle than that. So in order for the federal government to continue to fund deficits and more spending, they need to raise capital (money). They do this by selling treasury bonds of differing length of time and differing yields (% returns) in return for money right here and now.
Whenever the government sells these bonds to get the money to fund spending over the amount of tax revenues (deficit spending), two things need to happen...
1.) There needs to be buyers. These buyers could be you, me, companies, banks, governments, whoever.
2.) The bonds need to be priced attractively enough that the return you get back is worth it vs. the amount of time and risk you take.
In essence, whoever buys government bonds, is investing in the government.
With government bonds, the risk of them defaulting (not paying you interest or your principal) is generally very low. So low, I was taught in school that this is the "risk-free rate." I don't believe that, but many still do. The other aspect is the amount of interest you receive. This is supposed to be determined by market factors where the buyers just won't buy the bonds if they don't get a high enough % return. Right now, those %'s are very, very low. Historically low. Which is also the reason you can get a 30 year mortgage for 4.2%, a 15 year mortgage for 3.25% and interest on your bank account of 0.02% (or whatever ridiculously low amount you get).
In order for %'s of bonds to be so low, the price of those bonds should be really high. Well, they are. Higher than they've ever been.
In order for this to happen, there needs to be a substantial amount of buyers willing to purchase bonds at these high prices (low %'s). Most people know that China is one of those main buyers. I hear all the time that China owns us, and we owe China. Well, it's true for the most part as they are the largest foreign bond purchaser of government bonds. But they don't own us per se.
"Overall, foreign holdings of Treasuries rose 1.9 percent in September to a record $4.66 trillion, U.S. government data show. Foreigners held 48.4 percent of the $9.62 trillion of outstanding public Treasury debt, the most since May. "
But maybe you're thinking, what does that have to do with inflation? Well, everything.
See, when the government sells these bonds, they're sold amongst those buyers I listed. People, banks, mutual funds, government entities, etc, both foreign and domestic, but the amount that any one of those individual groups purchase changes constantly. Since 2008, primary dealers (21 major banking and institutional investment houses that are approved vendors by the Federal Reserve) have been purchasing a large quantity of these.
http://newyorkfed.org/markets/pridealers_current.html
(MF Global was a primary dealer up until their bankruptcy 10/31/11.)
Why them?
Because they have access to the Federal Reserve's discount window (almost unlimited). The Fed Funds rate is currently between 0-0.25 basis points (.0025% - Maximum). So basically free money. These primary dealers borrow money from the Federal Reserve for next to nothing, then purchase Treasury bonds which yield them much more in interest received. Example, borrow money at 0% interest, purchase 30 year Treasury Bills that yields 2.93%. Thus providing themselves an income spread that they book as profit each year, and pay bonuses, etc.
So how much money has these primary dealers borrowed with the Fed discount window? According to the Bloomberg article below, $7.77 Trillion. So while everyone gets all up tight about $700 Billion, you should get up tight about 11x that amount of nearly FREE money that the Federal Reserve loans both foreign and domestic banks. This is how the banks have made money. Not to mention they also use this money to make "investment" gains in the stock market and works hand in hand with the government to supply them extremely low interest rates to service the $15+ Trillion in debt.
This money has been artificially driving down the government bond rates, which in turn have artificially driven down mortgage rates, interest rates on education loans, car loans, etc, and interest on checking and savings accounts. It's a great time to borrow money. Just like it was from 2002-2007. So in 2008, we had a huge bubble that burst in the housing market due to low interest rates and loose lending practices, and put us in our current financial crises. What's the solution to this? Why creating even more borrowing with even lower rates and putting more money into the financial system (inflation).
One solution to this problem the last time we were in a similar situation was in the 1970's and Paul Volcker raised interest rates to 15-20%. This caused a terrible recession, stagflation, shortages (because of government price caps), etc. Well, the problem is, the US as a country was a net exporter in the 1970's (i.e. they had a trade surplus), so the pain really wasn't that bad back then because they had money still coming into the country from selling excess goods. Now, the US is a net importer (we have massive trade deficits w/ Asia - money flowing out of the country). Not only that, but we now owe $15+ Trillion. If we increased interest rates to 15-20%, it may make the debt servicing (i.e. the amount of interest on $15+ Trillion) unservicable and lead to a default. If we dont, we have massive inflation.
So that's the choices. Neither are good. Which do you think the government will choose?
Print more money by selling cheap bonds to the primary dealers and simulaneously inflating the $15+ Trillion away while paying 2-3% interest and providing Wall Street with access to free money and profits until there's hyper-inflation and a complete destruction of the dollar?
Or increasing interest rates, bankrupting said primary dealers who need free money to stay in business, cutting spending by trillions to stop the inflation, causing deflation and a depression the likes nobody has seen ever, with no government support for the newly found poor and unemployed?
I know what they will do, but not that they should.
One thing should become quite clear to all at this point. There is a very real and very tight connection between the Federal Government, Federal Reserve and Wall Street. At this point, none can survive without the others. At the head of this three headed monster is the Federal Reserve.
http://www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html
This is a good article and summary from about a year ago.
http://tfmetalsreport.blogspot.com/2010/11/tipping-point.html
This is a similar summary from today.
http://www.tfmetalsreport.com/blog/3036/great-ponzi
Friday, November 25, 2011
Banking and Government Debt
Banking on a consumer side of things is very simple to understand. You deposit your money into your bank, they hold it for you, and give you interest for it. You can withdraw cash at anytime and almost anywhere now through ATM's, write checks against your bank account, get traveler's checks for international use, use your debit card, and now even do online bill payment and banking (instead of paper statements). All very convenient things that have evolved from technological innovations to make it simple and easy for the end user of money. The 21st Century Act which legalized the acceptance of duplicate (copies) of checks, and even scanned checks greatly facilitated the rising use of technology involved with banking. The reason you can scan a check on your phone, and through your mobile phone deposit that money into your bank is from this act.
As convenient as that is, it's even better as a money saver for the banks themselves as they no longer have to employ people to do all of that work of taking a check, sending it to the Federal Reserve (clearing house), which then sends it to the original bank of the check writer. It's all done electronically, in the same day.
Banking on the inside isn't as easy to understand. In fact, through years of college, I never fully understood it as my college classes focused on the different laws, interest rates, clearing system, markets and products of those markets. Basically, to teach me what the different banking products/services are, and how to sell them, not really understand them and where they came from.
This book changed all of that. It stripped away all of the details on the modern system to start, and went straight to uncovering the "Mystery of Banking" from the beginning. As it really was a mystery to me even after being "educated" on it in college. Read all, some, whatever you feel like to get a basic understanding of how banking evolved. The topic is much larger than I could explain in a post but I'll summarize below. http://mises.org/Books/mysteryofbanking.pdf
Banking itself is linked more to money changers of ancient history. Greeks and Romans had the first kind of banks where they changed currency from one to another, they were involved heavily in business transactions and lending. The Knights Templars used a system of storage in their vaults and transfer through writing deposits on paper and allowing the depositor to withdraw similar items and wealth at any Templar location. This was useful as theft while traveling was common. Then we get to the more common banks in Italy with the Peruzzi and Bardi families with their double entry accounting system and gold florins (The World Reserve Currency of the day). This is where I can find the first big lending to governments for the Hundred Years War where the two family lent England 1.5M florins. There were many other loans to governments, but this was notable because the default caused the wealthy families to go bankrupt. Other banking started up. Here is a brief history. http://www.historyworld.net/wrldhis/PlainTextHistories.asp?groupid=2450&HistoryID=ac19>rack=pthc
Briefly, I explained fractional-reserve banking at the end of this post. In the 17th and 18th centuries, goldsmiths began to pop up as banking became the new business to get into. The beginning is summarized in the first paragraph well here and goes on to describe the first goldsmiths conversion into banking and their lending to the government of England. Merchants also got into banking from their international trading and storage of wealth in these goldsmith vaults. http://heritagearchives.rbs.com/wiki/Edward_Backwell,_London,_1653-82
These goldsmiths/bankers transitioned into some of the first national banks like the Bank of Scotland and the Bank of England. These banks are private institutions. The Bank of Scotland was very different than the Bank of England at the beginning though. The Bank of Scotland primarily lent money to businesses in Scotland. The Bank of England however was set up to be the primary lenders to the government to finance England's war with France. As the wealthy new bankers found out, it was much more lucrative to lend to governments that always had a flow of taxes to pay interest on loans than businesses. You just had to make sure they would always pay the interest as if the government defaulted, they would immediately go bankrupt. Many of them did.
These loans, just like the goldsmith loans were backed by either gold or silver that was on deposit at the bank. Only this time, it wasn't the gold or silver that the government owed, but from the goldsmiths and the merchants who stored their money there, who funded the Bank of England. The Bank of England is important because it became the model for all Central Banks that were created after.
The United States has a long history of battles with banks. It is the U.S. Constitution, Article 1, Section 10 that states only gold and silver coin is legal tender of payments, and no state shall coin money. This allowed for the creation of a government bank to unify all of the currencies used throughout the colonies at the time, as well as set the legal payments of the country and it's citizens linked to a gold or silver coin.
As Madison states in The Federalist Papers, No. 44...
I bring this up because this is exactly what is happening in the European Union right now after ignoring the fiat currency issues. The idea was to use the Euro as one currency to build a stronger European Union. The rules of the Euro are supposed to be that each country uses fiscal prudence in their own country to support the greater Euro currency and European Union. But the problem is that Portugal, Ireland, Italy, Greece and Spain (PIIGS as it's referred to) basically borrowed money from the more productive countries of France and Germany to fund their own social debt spending which is causing great concern and "animosities" between the countries. Eventually, something will have to be done to rectify the situation. Either the debtor countries will have to leave, or the stronger German and France countries will have to continue to loan money. Either way, it doesn't end well in my opinion which I will get into later.
The same is what is happening in the United States right now, it's just we don't discuss it as the US dollar is the World Reserve Currency and no State has caused any other to visibly suffer, or discredit the dollar. But I guarantee that it will happen here as it is in Europe now. California and Illinois will be at the forefront. California by all practical purposes has defaulted and needs constant new bonds to fund the state. Illinois is also in a similar boat. Only California is the equivalent in GDP size as Italy, and Illinois the size of Turkey, so eventually, the light will be shining on the U.S and it's problems.
http://www.economist.com/blogs/dailychart/2011/01/us_equivalents
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)
Next I will discuss the history of money in the U.S., it's national banks, and the development of the Federal Reserve. As well as the changes that have occurred in our own currency.
As convenient as that is, it's even better as a money saver for the banks themselves as they no longer have to employ people to do all of that work of taking a check, sending it to the Federal Reserve (clearing house), which then sends it to the original bank of the check writer. It's all done electronically, in the same day.
Side Note....
The rise in consumers doing the work that would have otherwise been done by the business itself by paying employees, is rapidly racing into our economy. No longer is there people to pump your gas (except in NJ), check out your groceries at the store (with the auto checkouts), etc. This is due to inflation and also the minimum wage laws, and also a reason that the unemployment of people ages 16-24 is around 45-50%. Here's a great article that discusses this unpaid labor (Shadow Labor/Work) that we all do and references another article from the NY Times below that.
Banking on the inside isn't as easy to understand. In fact, through years of college, I never fully understood it as my college classes focused on the different laws, interest rates, clearing system, markets and products of those markets. Basically, to teach me what the different banking products/services are, and how to sell them, not really understand them and where they came from.
This book changed all of that. It stripped away all of the details on the modern system to start, and went straight to uncovering the "Mystery of Banking" from the beginning. As it really was a mystery to me even after being "educated" on it in college. Read all, some, whatever you feel like to get a basic understanding of how banking evolved. The topic is much larger than I could explain in a post but I'll summarize below. http://mises.org/Books/mysteryofbanking.pdf
Banking itself is linked more to money changers of ancient history. Greeks and Romans had the first kind of banks where they changed currency from one to another, they were involved heavily in business transactions and lending. The Knights Templars used a system of storage in their vaults and transfer through writing deposits on paper and allowing the depositor to withdraw similar items and wealth at any Templar location. This was useful as theft while traveling was common. Then we get to the more common banks in Italy with the Peruzzi and Bardi families with their double entry accounting system and gold florins (The World Reserve Currency of the day). This is where I can find the first big lending to governments for the Hundred Years War where the two family lent England 1.5M florins. There were many other loans to governments, but this was notable because the default caused the wealthy families to go bankrupt. Other banking started up. Here is a brief history. http://www.historyworld.net/wrldhis/PlainTextHistories.asp?groupid=2450&HistoryID=ac19>rack=pthc
Briefly, I explained fractional-reserve banking at the end of this post. In the 17th and 18th centuries, goldsmiths began to pop up as banking became the new business to get into. The beginning is summarized in the first paragraph well here and goes on to describe the first goldsmiths conversion into banking and their lending to the government of England. Merchants also got into banking from their international trading and storage of wealth in these goldsmith vaults. http://heritagearchives.rbs.com/wiki/Edward_Backwell,_London,_1653-82
These goldsmiths/bankers transitioned into some of the first national banks like the Bank of Scotland and the Bank of England. These banks are private institutions. The Bank of Scotland was very different than the Bank of England at the beginning though. The Bank of Scotland primarily lent money to businesses in Scotland. The Bank of England however was set up to be the primary lenders to the government to finance England's war with France. As the wealthy new bankers found out, it was much more lucrative to lend to governments that always had a flow of taxes to pay interest on loans than businesses. You just had to make sure they would always pay the interest as if the government defaulted, they would immediately go bankrupt. Many of them did.
Side Note...
It was war that depleted England's reserves. It was Charles I (in 1640) that first confiscated the private gold at the Royal Mint for a forced loan to the government to pay for his wars. This action put into question the Royal Mint as the safest place to store money. It was the goldsmiths that benefited from this as people preferred to deposit their money with them. It was the goldsmiths that had financed Oliver Cromwell in the English Civil War to overthrow, try and execute Charles I. It's the financing of wars that first created the Bank of England.
The United States has a long history of battles with banks. It is the U.S. Constitution, Article 1, Section 10 that states only gold and silver coin is legal tender of payments, and no state shall coin money. This allowed for the creation of a government bank to unify all of the currencies used throughout the colonies at the time, as well as set the legal payments of the country and it's citizens linked to a gold or silver coin.
"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."
As Madison states in The Federalist Papers, No. 44...
"Had every State a right to regulate the value of its coin, there might be as many different currencies as States; and thus intercourse among them would be impeded; retrospective alterations in its value might be made, and thus the citizens of others States be injured; and animosities be kindled among the States themselves. The subjects of foreign powers might suffer from the same cause, and hence the Union be discredited and embroiled by the indiscretion of a single member."
I bring this up because this is exactly what is happening in the European Union right now after ignoring the fiat currency issues. The idea was to use the Euro as one currency to build a stronger European Union. The rules of the Euro are supposed to be that each country uses fiscal prudence in their own country to support the greater Euro currency and European Union. But the problem is that Portugal, Ireland, Italy, Greece and Spain (PIIGS as it's referred to) basically borrowed money from the more productive countries of France and Germany to fund their own social debt spending which is causing great concern and "animosities" between the countries. Eventually, something will have to be done to rectify the situation. Either the debtor countries will have to leave, or the stronger German and France countries will have to continue to loan money. Either way, it doesn't end well in my opinion which I will get into later.
The same is what is happening in the United States right now, it's just we don't discuss it as the US dollar is the World Reserve Currency and no State has caused any other to visibly suffer, or discredit the dollar. But I guarantee that it will happen here as it is in Europe now. California and Illinois will be at the forefront. California by all practical purposes has defaulted and needs constant new bonds to fund the state. Illinois is also in a similar boat. Only California is the equivalent in GDP size as Italy, and Illinois the size of Turkey, so eventually, the light will be shining on the U.S and it's problems.
http://www.economist.com/blogs/dailychart/2011/01/us_equivalents
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)
Next I will discuss the history of money in the U.S., it's national banks, and the development of the Federal Reserve. As well as the changes that have occurred in our own currency.
Sunday, November 20, 2011
Government and Currency
Government has always had a hand in every currency of the land. The reasoning is quite simple. There's only a couple ways for a government to raise funds to pay for itself and programs that it implements. In a barter system like I originally created for Islandia and Rockton, a government would only be able to seize actual products and goods to consume or trade with. Another option that governments use is taxation, which is the main way we all know of. The third way governments can fund itself is through debasement of metal currency or inflation of paper currency.
When I think about the different ways that governments obtain money through seizure and taxation, I think of it like the old Disney cartoon Robin Hood where the Sheriff basically walks into the house with a bunch of children in it and takes the one gold coin the child received for his birthday. That's what tax collecting was like for thousands of years. People always hated the tax collector. It was generally the tax collectors who were more rich within the village. Maybe a little due to the fact they were paid so much by the governments to collect their money, but also because some stole money from people and kept it for themselves. The Bible even talks about Zacchaeus, the tax collector, who wanted to find Jesus and promised to give back 4 times the amount that he unlawfully took from the citizens and to be forgiven.
Basically, the point is, taxation was always a very personal and unpopular affair for the people involved. Revolutions are generally started through over-taxation whenever you look throughout history.
http://en.wikipedia.org/wiki/History_of_tax_resistance
Governments needed a better way to collect taxes and also raise extra revenue for more spending that wouldn't incite riots and revolutions.
One very successful way was the development of the Tally Stick in England that revolutionized the way taxes were paid and accounted for. Also with the Talley Sticks, the government didn't want to wait until people paid for their taxes the two times a year they collected (at Easter and Michaelmas), so they sold the Talley Sticks at a discount (since interest was not allowed per the Church law). Since they sold the Talley Sticks at a discount, the government raised funds immediately to spend, for the right to the total money at time of collection. These Talley Sticks had value since it was a claim on the taxes owed and traded in a similar fashion as government bonds do today. The Tally Stick system worked so well due to the fact it was backed by the gold coins that the taxpayers owed for taxes, and it allowed the government to spend in excess of actual current tax receipts as well as ease the pressure for the government to debase it's coins/currency to fund more spending. It was a win-win for both sides and it lasted for 726 years until the Bank of England ended their use.
http://www.arraydev.com/commerce/jibc/9811-11.htm
http://www.bus.lsu.edu/accounting/faculty/lcrumbley/tally%20stick%20article.pdf
http://www.garynorth.com/public/6916.cfm
The main way that governments get more funds historically is through the debasement of coins and inflation of paper currency. Most people don't even realize it's going on. If the government takes a gold coin from taxes, melts it down, adds some base metals to it and re-distributes it, nobody is the wiser. Think if you went and bought an 18k gold necklace. Could you tell the difference between an 18k and the 14k necklace a store gave you when you paid for an 18k gold one unless someone told you at the store or it was listed? Same thing back in the day, so they created ways to determine it's purity.
Real World Application...Skip if you want...
So why do governments even need to debase the coins or inflate paper currency? Mainly due to financing wars, and more recently, to finance social programs (medicare, social security, education, etc). Historically, the only time a government would need to borrow money or inflate/debase the currency on a large scale was to fund a war. Just like the Romans who had a world-wide empire to fund soldiers everywhere, the U.S. today operates on-going wars and funds soldiers across the globe to be the world's police. As I write this, the government is looking to institute a no fly zone over Syria and either start a war with them, or provoke Iran to do something. Why? Who knows. But one thing is certain, it will cost a lot of money. Money we don't have and will have to sell Treasury Bonds to borrow the money to fund any activity.
Next I will discuss the current banking set up, and how it relates to the government financing of debt.
When I think about the different ways that governments obtain money through seizure and taxation, I think of it like the old Disney cartoon Robin Hood where the Sheriff basically walks into the house with a bunch of children in it and takes the one gold coin the child received for his birthday. That's what tax collecting was like for thousands of years. People always hated the tax collector. It was generally the tax collectors who were more rich within the village. Maybe a little due to the fact they were paid so much by the governments to collect their money, but also because some stole money from people and kept it for themselves. The Bible even talks about Zacchaeus, the tax collector, who wanted to find Jesus and promised to give back 4 times the amount that he unlawfully took from the citizens and to be forgiven.
Basically, the point is, taxation was always a very personal and unpopular affair for the people involved. Revolutions are generally started through over-taxation whenever you look throughout history.
http://en.wikipedia.org/wiki/History_of_tax_resistance
Governments needed a better way to collect taxes and also raise extra revenue for more spending that wouldn't incite riots and revolutions.
One very successful way was the development of the Tally Stick in England that revolutionized the way taxes were paid and accounted for. Also with the Talley Sticks, the government didn't want to wait until people paid for their taxes the two times a year they collected (at Easter and Michaelmas), so they sold the Talley Sticks at a discount (since interest was not allowed per the Church law). Since they sold the Talley Sticks at a discount, the government raised funds immediately to spend, for the right to the total money at time of collection. These Talley Sticks had value since it was a claim on the taxes owed and traded in a similar fashion as government bonds do today. The Tally Stick system worked so well due to the fact it was backed by the gold coins that the taxpayers owed for taxes, and it allowed the government to spend in excess of actual current tax receipts as well as ease the pressure for the government to debase it's coins/currency to fund more spending. It was a win-win for both sides and it lasted for 726 years until the Bank of England ended their use.
http://www.arraydev.com/commerce/jibc/9811-11.htm
http://www.bus.lsu.edu/accounting/faculty/lcrumbley/tally%20stick%20article.pdf
http://www.garynorth.com/public/6916.cfm
The main way that governments get more funds historically is through the debasement of coins and inflation of paper currency. Most people don't even realize it's going on. If the government takes a gold coin from taxes, melts it down, adds some base metals to it and re-distributes it, nobody is the wiser. Think if you went and bought an 18k gold necklace. Could you tell the difference between an 18k and the 14k necklace a store gave you when you paid for an 18k gold one unless someone told you at the store or it was listed? Same thing back in the day, so they created ways to determine it's purity.
Real World Application...Skip if you want...
In the current day, even though we have paper currency, the coins we have are also debased at the same time. Quarters from 1932-1964 are made of 90% silver and are worth about $5.75/each...for now. War Nickels that are from 1942-1945 are worth closer to $1.75 each because of the silver content. This is the same as Pennies from 1982 or earlier are made of mostly copper (worth about $.025) vs. the pennies today made of mostly zinc and worth a lot less. This is similar to a 1 oz American Eagle Gold coin having a face value of $50 if you were to buy something with it at the store (it's legal tender), but it's actual metal value is around $1,685 today.
This is what debasement looks like currently for coins, but really, who uses coins any more to pay for anything or keep them? Most people use one of four things, cash, checks, debit cards, or credit cards. Only cash is an actual tangible item, although intrinsically a dollar is only worth the piece of paper it's printed on. Kind of like a coupon. A coupon could be $10 off if you purchase an item at JC Penney, or Macy's...but if you wanted to trade that coupon w/ JC Penney for $10 cash, they say no, it's not worth but 1/20 of $.01. A dollar is the same thing, only it's every person saying, I'll accept that $1 bill for $1 worth of xxx. That $1 will NEVER be worth more than $1 and whatever that could purchase. 10 years ago, $1 could purchase a gallon of gas. Today, $1 could buy you 1/3 a gallon (or less). 10 years ago, $1 could buy you 3 cheeseburgers from McDonald's, now it could buy 1. That's inflation. So unlike a coin which contains metals that are needed and traded in production of goods (intrinsic value) and could eventually go up in value, a dollar is a dollar, no matter what that can buy, because the paper itself is really not worth anything.
Checks are like the warehouse receipts that the goldsmiths would give to people depositing coins in their vault. The checks entitle you to withdraw or pay for items with money stored in the bank's vault. With checks though, there's always float time between when the check is written, given to the store, deposited at their bank, and funds transferred from your bank to the store's bank. In a lot of ways, writing a check is similar to writing a letter to your bank and telling them to transfer your money to another bank. If you don't have the money in your account, the check will bounce back to you and the bank will charge you a $25 NSF fee. If you want to prevent that from happening, you can pay a little fee and get over-draft protection where the bank will then give you money (a temporary loan) to cover the check until you put more money into the bank. Again, the check itself isn't worth anything but the paper, just like a $1 bill. It just tells the store that you promise to pay.
So where does that leave debit and credit cards? With a debit card, you're really trading computer code that's linked to your checking account. Technically, the bank is really the intermediary in the transaction as they are the ones that pay the merchant the money (plus a 1% fee) when you buy something. If they go to take the funds out of your checking account and it's not there, boom, finance charge of $35 over-drafting, plus the amount of the item you purchased. Where does the bank get the money then? They either take it from somebody else as a short term loan, or they give you a "loan" where they print the money out of nothing, and charge you $35 for the overdraft fee. They probably just pay it by creating it out of thin air. The money doesn't have to exist because of fractional reserve banking. As long as somebody has 10% of the amount you purchased the item for, they are good. Maybe someone that works in a bank could discuss this and explain that situation and where the money really comes from. Credit cards are a loan from the bank. It's a open credit line (up to your limit) the same as if you had a home equity loan. If you pay with a credit card, the bank is creating that money out of thin air through fractional reserve banking (plus charging a 1.5-3% fee to the merchant to take your card payment). All of these things are inflationary in nature because there's nothing real backing that paper, debit card payment, or credit card payment. Just the promise to work and pay it later.
So why do governments even need to debase the coins or inflate paper currency? Mainly due to financing wars, and more recently, to finance social programs (medicare, social security, education, etc). Historically, the only time a government would need to borrow money or inflate/debase the currency on a large scale was to fund a war. Just like the Romans who had a world-wide empire to fund soldiers everywhere, the U.S. today operates on-going wars and funds soldiers across the globe to be the world's police. As I write this, the government is looking to institute a no fly zone over Syria and either start a war with them, or provoke Iran to do something. Why? Who knows. But one thing is certain, it will cost a lot of money. Money we don't have and will have to sell Treasury Bonds to borrow the money to fund any activity.
Next I will discuss the current banking set up, and how it relates to the government financing of debt.
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