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.

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.

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.

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. "

http://www.bloomberg.com/news/2011-11-16/china-s-holdings-of-longer-term-treasuries-increase-most-since-march-2010.html

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

(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

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.

   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. 

http://mises.org/daily/5813   

http://www.nytimes.com/2011/10/30/opinion/sunday/our-unpaid-extra-shadow-work.html?pagewanted=all

http://bls.gov/news.release/youth.t01.htm

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&gtrack=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.

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.

"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.

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...

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.

Europe and Today

Last night I wanted to discuss a little about Europe, but with the happenings of the market direction, I felt the updated charts would be more beneficial.  So I'm going to make a quick post about Europe now.

What's happening over there is not good.  I'm not talking about companies going bankrupt and laying people off bad.  I'm talking governments nearing default, interest rates rising rapidly and governments getting replaced.

Gonzalo Lira talked about today being the day that would start a liquidity run on European debt without the ECB massively purchasing bonds.  Well, guess what, they did.  So that will be postponed for later, but one of the things that has been very interesting and very big news lately is the Italian and Greek prime ministers resigning and being replaced.

George Papandreou and Silvio Berlusconi were forced to resign in the past two weeks for not getting their fiscal house in order and putting the entire European Union at risk of collapse.  This will not end in my opinion until every country's head of state has been considered "friendly" in helping the EU and the European Central Bank do whatever it is they are trying to do.

The replacement of Berlusconi with Mario Monti is just what I am talking about here.  A politician being replaced by a banker.  The problem with this is that Monti will force the fiscal house to get in order.  What's wrong with that, sounds like that's what they need, right?  Sure, if they want more taxpayer funded bailouts of banks, increased retirement ages, lower social programs, etc.  Banks who should be bankrupt already.  Banks who pay their CEO's millions of dollars (or Euros) to run an already failing business into the ground with more taxpayer funded "loans."  This is what is constituting an "answer" to the problem.  This is no solution, only more problems.


So I also just quickly wanted to point out this...

Ann Barnhardt shut down Barnhardt Capital Management today with these words.

"The reason for my decision to pull the plug was excruciatingly simple: I could no longer tell my clients that their monies and positions were safe in the futures and options markets – because they are not. And this goes not just for my clients, but for every futures and options account in the United States. The entire system has been utterly destroyed by the MF Global collapse. Given this sad reality, I could not in good conscience take one more step as a commodity broker, soliciting trades that I knew were unsafe or holding funds that I knew to be in jeopardy."


She goes on to say...


"Finally, I will not, under any circumstance, consider reforming and re-opening Barnhardt Capital Management, or any other iteration of a brokerage business, until Barack Obama has been removed from office AND the government of the United States has been sufficiently reformed and repopulated so as to engender my total and complete confidence in the government, its adherence to and enforcement of the rule of law, and in its competent and just regulatory oversight of any commodities markets that may reform. So long as the government remains criminal, it would serve no purpose whatsoever to attempt to rebuild the futures industry or my firm, because in a lawless environment, the same thievery and fraud would simply happen again, and the criminals would go unpunished, sheltered by the criminal oligarchy."

She was referencing the MF Global bankruptcy where money went "missing" to never be found.  People lost money...a lot of money.  The guess is that MF Global took client money to pay for company losses to bets on European debt.  She is right, that is criminal.

What gets me is this is so very eerily similar to what happens in the book Atlas Shrugged.  I mean, who shuts down a company off of principals like this?  People that would rather quit the game that's being played, than be involved in the game.  That's what happens when the game is rigged.

Here is the entire letter from Ann Barnhardt...
http://www.zerohedge.com/news/entire-system-has-been-utterly-destroyed-mf-global-collapse-presenting-first-mf-global-casualty

Updated charts

I'm going take a history break and focus back on the here and now.  Why?  Because it's not looking so good.  Here's the chart again that I posted almost two weeks ago on 11/4.

Nothing has changed on the chart except we're further along and the market is getting very close to last call.

As you can see, a drop below this line takes us into that last support area between the two lines from the above chart.  A drop below what looks like 11,600 or so, and it could be a bumpy ride down to 10,500.  Below that number and your guess is as good as mine where it stops.

The fundamentals and the news have not been good at all, so a holding of this support in unlikely without some kind of government support of the price.

This is basically the same as the above charts, only the S&P 500, and a lot nicer write up with technical analysis.
http://www.oftwominds.com/blognov11/assume-crash-positions11-11.html

But here was the eye opener for today. We'll see if he's right.  My guess is no and that the European Central Bank will enter the market and purchase whatever bonds need to be purchased to eliminate the chance of a a run.  At least for now.
http://gonzalolira.blogspot.com/2011/11/were-in-middle-of-run-on-europeand-its.html

That's it for now...back to history tomorrow unless something drastically changes in the sleeping hours while Europe trades and we sleep.


UPDATED TODAY....SEE COMMENT #1.

Historical Currency

In the made up world with the islands of Islandia and Rockton, sticks and metal were the individual currencies of each island.  When the two islands wanted to trade with each other, it worked for a while, but then one currency eventually dominated.  That currency was the metal because it was valuable to everyone.  So just like how the sticks came about as the currency for Islandia, the people found the most common acceptable medium of exchange for the whole world (the two islands) through the open market system was shiny metal.  There were no governments or laws written to create the currency, it developed naturally through the barter market and the varied products it offered.

Throughout most of modern history, it was metals that was accepted as currency.  The first metal to be used as currency, gold and silver bars, were around 4000 BC in Egypt and Mesopotamia.  By around 650 BC, gold was the first used in it's modern circle form in Lydia (Turkey).
  

Later in the 6th century BC, Greece minted silver coins.


Throughout this period, the amount of gold and silver were limited by mining activities.  Whenever a country would find a large deposit, they had a boom to their economy with the increase in currency, but at the same time, the boom also created inflation (higher prices of all other products) which hurt those people that stored their wealth in these coins, but it also made it easier to earn more by the selling of their own products.

The governments that controlled the minting and distribution of coins, as well as the collection of taxes, had an advantage that nobody else had.  Governments throughout history have deployed tactics of debasement and devaluation.  Some governments collected the coins through taxes and clipped or shaved each coin, thereby being able to melt down the shavings and re-mint new coins thereby increasing the governments ability to pay their bills.  Other governments melted down all of the metal coins and mixed other metals into the coins, thereby diluting the purity of the coins and minting additional coins.  This also created inflation as the new amount of currency in the system became more known and questioned. But since this debasement was done without public knowledge, the prices didn't rise as quickly as if a new deposit of gold or silver was found, therefore the governments were able to purchase more with their currency than anyone else.

By the 16th and 17th centuries, Goldsmith's who would form the precious metals into jewelry started to get people asking if they could use their vaults to store their own gold/silver coins as it was becoming unsafe through theft to store mass quantities at their own homes.  The goldsmith's would do it and charge those patrons a small storage fee.  The patron would get a receipt of this deposit in order to claim their gold/silver at any time.  Some depositors allowed the Goldsmith to even loan out their coins and charge interest to worthy borrowers, in exchange for the waiving of the depositors storage fee.  This way, the Goldsmith could make extra money by finding worth borrowers that would repay timely and in full, and be able to collect some interest on those loans for pure profit.

Eventually, the Goldsmith's vaults became a very common place for everyone to store their coins.  Since almost everyone's coins were in the local Goldsmith's vault, people actually began trading their vault receipts instead of withdrawing the coins and taking them back to pay for their goods or services.  These paper receipts were so much more convenient than carrying around a bag or pocket full of coins.

18th Century Goldsmith bank receipt

The Goldsmith's used this activity to their advantage.  The smarter Goldsmith's first figured out that not everyone came back to withdraw their coins.  In fact, a small percentage of people did.  And if they did, they really didn't care if it was their exact coins that they received, just similar quantity and quality.  The Goldsmith's used this opportunity to lend out more vault receipts than the amount of deposited coins in the vault.  This created more "money" in the economy because the receipts that he loaned to borrowers was then used to purchase whatever the borrower needed.  In the same way the governments debased or devalued the coin currency, Goldsmith's did the same thing by loaning additional receipts that were not backed by an actual deposit.  If this sounds like fraud to you, it's because it is.  In essence, the Goldsmith's created money out of thin air, by just writing up another receipt.  This was the beginning of our modern day fractional reserve banking system.

It's called a fractional reserve banking system because there's a fraction of the deposits on hand in the bank vs. the amount of money they loan out.  For most of history, there was a fear by the Goldsmith's and later the bankers, that at any moment, their depositors would come in to withdraw their coins (a bank run).  If more people came in to withdraw coins than they had on hand, they would instantly go bankrupt and be out of business.  (Think "It's a Wonderful Life" where Jimmy Stewart explains to the people he doesn't have their money, Fred and Ethel have it for their car or house.  Then he's over-joyed at closing time because he was able to keep $2 and stay in business)

Therefore, this fear kept them in line to only lend out a modest amount over their deposits. In modern times, this fear was eliminated with the creation of Central Banks, and even FDIC insured deposits, as it took away the wanting of those depositors to make a run on the banks (in theory).  But that's for another time.

Next we will backtrack a little bit and discuss the Government's role in currency in a little bit more detail throughout history.

What is Money and Currency?

In the last post I posed some questions.  What is currency?  What is money?  What is a world reserve currency? Each of these are different and I will discuss them as we go.

First, we'll go with the most broad...Money.

From wikipedia (http://en.wikipedia.org/wiki/Money) -
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context.  The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past, a standard of deferred payment.


So basically, anything could be money as long as it fits the requirements of being generally accepted.  Throughout history, many things have been called money...salt, rocks, sticks, tobacco, cotton, cattle, metal coins, paper...you name it, it's probably been money at some point in history.  Again, the important thing is that it is generally accepted.

So how does money come about?  Every single item that was ever considered money came about through the barter system.  People would trade their labor or products for other products or labor.

Here's an example...

Joe Farmer lives in a remote location of the world called Islandia.  His family lives with him and they all farm their land.  In fact, they are so good at it, that they can grow enough food to not only feed their own family, but they can take their extra food miles into town to trade for other goods they need like shoes, wood, etc.  Joe Farmer finds a nice pair of shoes at the local shoe smith named Eric Nike that is so good at making shoes, his family has all the shoes they need, but doesn't have a lot of food.  So Joe approaches Eric and wants to trade some of his food for some shoes.  They work out a deal to trade 20 ears of corn for 1 pair of shoes. (This is called barter).  Everyone is happy and they move on.

Now Eric Nike needs to get some leather to make another pair of shoes.  He goes down to Fred Rancher and asks him for some leather.  Fred has plenty of rawhide from all of his cattle.  Eric proposed a trade of a pair of shoes for 3 rawhides.  Fred declines as he doesn't need shoes.  So Eric proposes another trade, 15 ears of corn for 2 rawhides.  Fred declines again as he doesn't really like corn, he's more of a potato kind of guy.  Eric is upset because without rawhide, he can't make any more shoes.  He now has to find out from Fred what he is willing to trade some rawhide for.  Fred tells him that he really wants those potatoes.  Eric now has to go and try to barter with Vince Farmer who grows potatoes.

As you can see, this would become a very tiresome affair just to get some rawhide.  What if Vince doesn't want shoes or corn?  He then has to find out what Vince would want to get potatoes, to get the rawhide he needs.  This problem is called the "double coincidence of wants."  This problem is how money is created within an economy.  What they needed was a "medium of exchange."  Something that is generally accepted by everyone so they can easily trade their products and labor with one another.

In Islandia, the group of people in their village all decided that they would go with the one item that is small, lightweight and portable, easily divisible, and something that is acceptable to all.  They decided on 12 inch sticks because it fits all of the previous requirements, and it's a harder item to acquire on their remote island that doesn't have a forest nearby.  Another key part of the stick was that it was used to build their huts.  So not only did it fit the criteria, but it was also a valuable product in itself.

Since the institution of the 12 inch stick as a medium of exchange (Currency), people were able to sell their products and labor for the stick (or a part of the stick) and get any product they wanted.  Then people started to go on adventures to find more sticks.  It took a lot hard work, risks, building of boats, savings of food, etc.  When these adventures came back after finding a large island with a rain forest, they brought a huge amount of sticks with them that were very valuable.  This is what helped grow the economy even more as new sticks were brought into Islandia.

As Islandia's adventurers went out to find more sticks, people from another island came to Islandia.  One group from the island of Rockton was looking for more mountain islands.  What they had was a lot of shiny metals that the people of Islandia have never seen before that they thought they could wear as jewelry.  Rockton was also on an adventure, they were wanting to find more shiny metals for their island, as that was the medium of exchange (Currency) in Rockton because it was so hard to find and dig up.  The people of Rockton didn't find a mountain on Islandia, but instead found that they loved the corn and potatoes that they had never seen before, so they traded.

This was great, both economies were able to get new products they wanted and never had before.  Up until Rockton didn't want corn and potatoes any more.  They also didn't want any sticks (Islandia's currency) as there were plenty of those in their own mountains.  They needed another medium of exchange.  Since the shiny metal was valuable to both Rockton and Islandia, they decided that all trade between the two islands must be done in shiny metals.  This is what I would call a World Reserve Currency.

Next we will take this example and apply it to the real world.

Intro

So I've decided that this would be the best way to convey my thoughts on what's happening in the world today.  Hopefully someone will get some benefit out of it and pass the word around.  If I thought things would just correct themselves, or that what's happening right now in the financial world was no big deal, I wouldn't bother doing this blog.  I also wouldn't bother trying to spread the word of my interpretation of events from my own thoughts or through sharing of the thoughts of other smart people out there who's opinions I value.  But the devil is always in the details, and the details are pointing to something much larger than the world going through a recession.

Never in the history of the known, recorded world, has there ever been a more inter-connected world economy than right now.  Never in the history of the known world has there been the world economy using fiat currency (basically Monopoly money).

The fiat currencies across the globe have been debased/devalued for years now.  Even historically strong currencies who pegged to hard assets (think Swiss Francs) are starting to devalue their currency and peg to other currencies.  This has and will lead to inflation of the world currencies, and a lot of it.  

So what is Currency?  Currency is what we call money.  But what is money?  Is it a Dollar, Euro, Peso or is it something more?  What determines it's value?  What's the world reserve currency?  What does that even mean?  These are the topics I will cover in my next post and how that affects all of us.