31 August 2008

Ponzi Finance Dynamics Still at Play:

Ponzi Finance Dynamics Still at Play:

Second quarter GDP expanded at a 3.3% pace, the strongest since Q3 2007’s 4.8%. Durable Goods Orders, Existing Home Sales, and the Chicago Purchasing Managers' index were all reported “stronger-than-expected”. And with commodity prices almost 20% off July highs – and crude oil notably unimpressive this week in the face of a major Gulf hurricane – the markets seem to lend support to the waning inflation viewpoint. The dollar rallied further this week. Meanwhile, despite today’s downdraft, Freddie Mac gained 60% this week and Fannie Mae advanced 37%. Monoline insures MBIA and Ambac surged 59% and 35%, respectively. MBIA saw its stock price more than double during August, to surpass $16. The Bank index jumped 3.1% this week and the Broker/Dealers rallied 4.0%. Homebuilding stocks were up 9%.

Investors are increasingly willing to accept that the worst of the Credit crisis has passed. Talk that the nation’s housing markets are bottoming becomes louder each week. And every day market participants seem more receptive to the “economic resiliency” thesis.

First of all, I am certainly of the view that the economy is much weaker than the headline 3.3% growth rate. At the minimum, I am skeptical that the 1.2% annualized increase in the GDP price index accurately captures what I believe is a significant inflationary component in current “output”. It is worth noting that the favored inflation gauge of Greenspan and the Fed, the PCE Deflator, was up 4.5% from a year earlier, the strongest year-over-year increase since 1991.

There is bountiful wishful thinking when it comes to our nation’s mortgage and housing crises. Granted, many of the burst Bubble markets – including some spectacular busts throughout California, Florida, Nevada, and Arizona – have in some cases seemingly reached somewhat of a “clearing price”. Transaction volumes are up significantly in many of the locations with the greatest y-o-y price declines. I’ll suggest, however, that it is unwise to extrapolate trading dynamics in these burst markets to national housing trends more generally. I believe the vast majority of markets around the country are more aptly described as Bubbles leaking air, as opposed to the collapsed markets that garner the greatest media attention.

I’ll turn more constructive on home prices and housing markets generally when mortgage Credit Availability begins to loosen. It remains my view that Credit continues in a tightening dynamic. Notably, the growth in Fannie and Freddie’s Combined Books of Business slowed sharply to a 3.7% rate during July, the slowest pace in two years. And while there is nothing really in the works to compare to the abrupt Credit tightening that emanated from collapsing subprime and Alt-A securitization markets, I’ll argue today’s tighter Credit is a more subtle dynamic resulting from various types of lending institutions restricting, on the margin, loans to even prime Credits.

From the Wall Street firms down to the small community banks, tighter lending terms are leading to higher downpayments and less flexible payment terms for even high quality borrowers. And while the nature of this dynamic specifically does not lead to collapses for the relatively stable housing markets around the country, it nonetheless will definitely continue to pressure prices. And downward home prices will, over time, lead to only more lender nervousness and restraint.

And despite the lull, vulnerable housing markets remain acutely susceptible to any worsening in the GSE crisis. With MBS spreads having tightened somewhat during August, I’ll assume Fannie and Freddie resumed aggressive mortgage purchases in the marketplace after somewhat slowing their buying during July. Importantly, overall marketplace liquidity has deteriorated to the point where the GSEs must expand aggressively in order to forestall another major leg down in the ongoing housing crisis. As such, the marketplace of late is involved in a dangerous game of “chicken” with both the GSEs and Treasury. These days, any time the GSEs slow their marketplace buying of mortgage paper (back away from their “backstop bid”), spreads widen sharply and fears of a liquidity crisis – and forced Treasury bailout – intensify. So, I’ll assume the GSEs have resorted again to ballooning their exposure aggressively - recklessly.

There has been a lot of talk about the GSEs being “privatized.” As the thinking goes, Fannie and Freddie should be temporarily “nationalized,” recapitalized, split up and then released as responsible participants in the free marketplace – Credit providers no longer posing a risk to the American taxpayer. This all sounds wonderful in theory – yet is completely impractical in reality. I fully expect the GSEs to be nationalized. But I suspect the federal government will be running – and recapitalizing - these institutions for many years to come.

The private mortgage marketplace self-destructed, and now the entire “prime” mortgage/housing market is dependent upon ongoing cheap mortgage finance available only through American taxpayer backing and subsidies. The private sector simply cannot today – or at any time in the foreseeable future - provide the hundreds of billions of cheap ongoing new mortgage Credit necessary to forestall a systemic housing/economic/financial collapse. There will be no happy “recapitalize and privatize” ending to this saga. The bill to the taxpayer is now growing rapidly – along with GSE exposure – and will balloon into the trillions over the coming years and decades. And for how long the holders of GSE debt and MBS will be allowed such handsome returns at taxpayer expense is a quite intriguing question.

I also read and hear too much about the continued need for “Keynesian” stimulus. Regrettably, the system has been in non-stop government (fiscal and monetary) stimulus mode for years now. It may have been indirect at the time, but it is now apparent that GSE obligations should be included today right along with debt owed directly by the Treasury. And before all is said and done, the taxpayer will also be on the hook for enormous losses from various federal guarantees of deposits, student loans, pensions, and the like. The bottom line is that a whole range of direct and indirect federal guarantees – especially since the 2001/02 recession – have played an integral role in spurring Credit and Economic Bubbles. “Keynesian” ammunition - fired way too early and freely in order to sustain multiple Bubbles – has definitely buoyed the U.S. Bubble Economy, although such measures will have only limited effect down the road when they’re sorely needed.

Returning back to my initial paragraph, these days the economy and markets don’t appear all that bad - certainly nothing as nasty as we dour prognosticators have been forecasting. I’ll warn, however, that there are some very dangerous “Ponzi Finance” Dynamics Still very much At Play. The most obvious resides with the GSEs. And there are closely related Bubbles throughout the agency and Treasury bond arena. Meanwhile, a view has gained adherents that the U.S. economy is actually in much better shape than Europe and elsewhere. The reality that Europe is not buoyed by their own government-sponsored mortgage behemoths and that their economies are more manufacturing based (and thus vulnerable to cyclical downturns) are only short-term relative disadvantages.

29 August 2008

Lehman To Be Acquired by Tooth Fairy, Tinkerbell and a Crocodile

The market responded with enthusiasm to reports that the Tooth Fairy has agreed to acquire Lehman. The purchase price has not yet been determined and will be set by Dick Fuld wishing upon a star, clicking his heels three times, and being transported back to that magical place where Lehman still sells for over $70 per share.

In related news, Lehman has agreed to sell all of its level III capital, including CDOs, ABSs, pet rocks, baseball cards, slightly used condoms, and credit default swaps written by MBIA and Ambac. Lehman's level III capital will be acquired for 150% of its face value by Tinkerbell, who will carry it off to Neverland to be fed to a crocodile.

Lehman is financing 90% of the acquisition at an interest rate that has not been announced; Tinkerbell's up-front payment consists of a handful of pixie dust, three crickets, and a bullfrog. Analyst Dick Bove estimates that the bullfrog could eventually be transformed into three princes and a pumpkin coach.

The deal gives Lehman no recourse to any of Tinkerbell's assets other than the Level III capital. If Tinkerbell defaults, Lehman's successor entity will stick its hand down the crocodile's throat and attempt to get it to regurgitate. The firm's historical value-at-risk analysis shows that sticking your hand down a crocodile's throat is completely safe.

Treasury Secretary Hank Paulson issued a statement: “I am delighted that SWFs (Sovereign Wealth Fairies) continue to express confidence in the terrific values represented by American financial institutions. As I have been saying since August of 2007, this shows that the crisis is now over.”

Meanwhile, the SEC has announced an investigation of mean, evil, bad short-seller David Einhorn. While out for a beer with a friend, Einhorn reportedly suggested that the Tooth Fairy does not exist and that wishing upon a star is not a wholly reliable price discovery mechanism.

Christopher Cox, chairman of the SEC, said, “Vicious rumors attacking the Tooth Fairy will not be tolerated. Our entire financial system and indeed the American way of life depend on the Tooth Fairy and wishing upon a star. How else could one value level III capital appropriately?” The SEC is reportedly planning to set up re-education camps for short-sellers

Gold makes glittering comeback

MUMBAI: Gold is enjoying a modern-day renaissance in the country. From retail sales of 300-400 kgs of gold bar per day at the start of 2008, demand has surged to 3,000 to 4,000 kgs per day.

Barring the slight rise in price at the start of this week, most counters registered an unprecedented sale. Gold's dip below Rs 12,000 per 10 grams early this month has sparked off widespread buying. From a high of Rs 13,900 for 10 grams around a month and half ago, the price of the yellow metal slipped to Rs 11,850 on Wednesday, ensuring droves of customers.

The demand for the metal has skyrocketed to such an extent that imports for the month of August alone are set to cross 100 tonne. Last August, the country imported 69 tonne of gold.

"Ten days ago, the price was Rs 11,300 and retail outlets recorded consumer demand many times higher than that witnessed during 'Dhanteras', the first day of Diwali, or 'Akshaya Tritiya', when buying gold is considered auspicious," said Suresh Hundia of the Bombay Bullion Association.

India, the world's biggest buyer of bullion, is also set to increase its gold imports for the first time in nearly 12 months, analysts told TOI. Given that the first half of 2008 saw volatile gold prices driving down demand, the last few weeks have witnessed a sudden rush of imports.

The country imported 750 tonne of the yellow metal in 2006. This dropped to 449 tonne in 2007, as a consequence of the rise in price. Traders who spoke to TOI said India imported 122 tonne between January to July 2008. The corresponding period of 2007 saw 269 tonne of the metal coming into the country.

Incidentally, the rise in demand is being attributed by traders to the next festival after 'Raksha Bandhan', which is Ganesh Chaturthi, which falls on September 3. Traders maintain that many consumers, particularly in South India, normally buy idols or jewellery in gold to bedeck their favourite God and the rush to retail stores ensures that the line-up to the festival has already started.

Gold generally moves in tandem with crude oil as the latter signals inflation. The fall in price in the international market has ensured a slump back home.

Gold makes glittering comeback

MUMBAI: Gold is enjoying a modern-day renaissance in the country. From retail sales of 300-400 kgs of gold bar per day at the start of 2008, demand has surged to 3,000 to 4,000 kgs per day.

Barring the slight rise in price at the start of this week, most counters registered an unprecedented sale. Gold's dip below Rs 12,000 per 10 grams early this month has sparked off widespread buying. From a high of Rs 13,900 for 10 grams around a month and half ago, the price of the yellow metal slipped to Rs 11,850 on Wednesday, ensuring droves of customers.

The demand for the metal has skyrocketed to such an extent that imports for the month of August alone are set to cross 100 tonne. Last August, the country imported 69 tonne of gold.

"Ten days ago, the price was Rs 11,300 and retail outlets recorded consumer demand many times higher than that witnessed during 'Dhanteras', the first day of Diwali, or 'Akshaya Tritiya', when buying gold is considered auspicious," said Suresh Hundia of the Bombay Bullion Association.

India, the world's biggest buyer of bullion, is also set to increase its gold imports for the first time in nearly 12 months, analysts told TOI. Given that the first half of 2008 saw volatile gold prices driving down demand, the last few weeks have witnessed a sudden rush of imports.

The country imported 750 tonne of the yellow metal in 2006. This dropped to 449 tonne in 2007, as a consequence of the rise in price. Traders who spoke to TOI said India imported 122 tonne between January to July 2008. The corresponding period of 2007 saw 269 tonne of the metal coming into the country.

Incidentally, the rise in demand is being attributed by traders to the next festival after 'Raksha Bandhan', which is Ganesh Chaturthi, which falls on September 3. Traders maintain that many consumers, particularly in South India, normally buy idols or jewellery in gold to bedeck their favourite God and the rush to retail stores ensures that the line-up to the festival has already started.

Gold generally moves in tandem with crude oil as the latter signals inflation. The fall in price in the international market has ensured a slump back home.

Gold makes glittering comeback

MUMBAI: Gold is enjoying a modern-day renaissance in the country. From retail sales of 300-400 kgs of gold bar per day at the start of 2008, demand has surged to 3,000 to 4,000 kgs per day.

Barring the slight rise in price at the start of this week, most counters registered an unprecedented sale. Gold's dip below Rs 12,000 per 10 grams early this month has sparked off widespread buying. From a high of Rs 13,900 for 10 grams around a month and half ago, the price of the yellow metal slipped to Rs 11,850 on Wednesday, ensuring droves of customers.

The demand for the metal has skyrocketed to such an extent that imports for the month of August alone are set to cross 100 tonne. Last August, the country imported 69 tonne of gold.

"Ten days ago, the price was Rs 11,300 and retail outlets recorded consumer demand many times higher than that witnessed during 'Dhanteras', the first day of Diwali, or 'Akshaya Tritiya', when buying gold is considered auspicious," said Suresh Hundia of the Bombay Bullion Association.

India, the world's biggest buyer of bullion, is also set to increase its gold imports for the first time in nearly 12 months, analysts told TOI. Given that the first half of 2008 saw volatile gold prices driving down demand, the last few weeks have witnessed a sudden rush of imports.

The country imported 750 tonne of the yellow metal in 2006. This dropped to 449 tonne in 2007, as a consequence of the rise in price. Traders who spoke to TOI said India imported 122 tonne between January to July 2008. The corresponding period of 2007 saw 269 tonne of the metal coming into the country.

Incidentally, the rise in demand is being attributed by traders to the next festival after 'Raksha Bandhan', which is Ganesh Chaturthi, which falls on September 3. Traders maintain that many consumers, particularly in South India, normally buy idols or jewellery in gold to bedeck their favourite God and the rush to retail stores ensures that the line-up to the festival has already started.

Gold generally moves in tandem with crude oil as the latter signals inflation. The fall in price in the international market has ensured a slump back home.

27 August 2008

Looming Financial Catastrophe: A Real Inconvenient Truth

“Sometimes I wonder whether the world is being run by smart people who are putting us on….or by imbeciles who really mean it.” – Mark Twain

The United States of America is about as far from united as we’ve been since the Civil War. The two major parties agree on virtually no major issues. The only time they agree is when it involves tax rebates and pork projects for their constituents. They have no problem spending our grandchildren’s money to get re-elected in November. No politician is willing to tell the American people the blunt truth that we have an epic financial crisis that must be addressed in the next 10 years. When I watch the Republicans and Democrats respond to these issues by spinning them to make the other side seem evil, it infuriates me. We are wasting precious time. If you take a poll of Americans and ask them if they want make sacrifices for future generations, I can guarantee you that 85% would say no. Our society is dominated by present self interest to the detriment of the best interests of our future generations. We need leaders who are willing to speak the truth and convince the country to change course before it is too late.

Our fiscal crisis is complex, multi-faceted and dangerous to our long-term future. The major issues that we need to confront include the current fiscal situation, the colossal amount of unfunded liabilities that our politicians have obligated us to pay, our dependence on foreign oil, our education system, and a dearth of leadership and political courage. These issues are intertwined and cannot be addressed individually. To successfully solve these issues we need to ignore political affiliations and choose the best solutions. It seems strange to me that the best ideas for dealing with our crisis come mostly from billionaires. The people that we should believe in my opinion are: David Walker, Pete Peterson, Warren Buffett, Ross Perot, T. Boone Pickens, Matt Simmons, Bill Gates, and Ron Paul.

These men have put aside partisan politics and name calling to work together to save our country. They have an extremely difficult task. There are different challenges they must overcome. The largest hurdle is getting the attention of the majority of Americans who are apathetic towards the entire political process. These are the 71 million voting age citizens who decided not to vote in the last presidential election. If they don’t care enough to vote in the presidential election, they certainly won’t care about future unfunded liabilities. I think the only thing that will get the attention of this group is a major recession that negatively impacts their quality of life. There are millions of Americans living lives of silent desperation. They are living on the edge and the debt contraction that is underway is pushing many over that edge. The anger that is building will hopefully eliminate the apathy.

“The punishment of wise men who refuse to take part in the affairs of government is to live under the government of unwise men.” - Plato

The next obstacle is what I call the Great Deniers. They deny that there are any problems in America. They ignore the hard facts and spout rhetoric like: “We are the greatest country in the history of the world; There is nothing that's going to occur to our economy except a continuance of the great economic success our great nation has always enjoyed; The sun is not setting on our great nation, it is rising!; It is morning in America.” It is difficult to have a logical discussion with these shills. They are disciples of the Ben Stein School of ignoring facts and figures. They are cheerleaders for America, when what we need are wide eyed realists. Many of these people have secure well paying comfortable positions in our society and fear a change in the status quo.

Using a baseball analogy is the best way I can describe our current situation. When I hear the denial gang speak, I see America as a baseball team on par with the NY Yankees dynasty. They have been the dominant team in baseball for decades, with 26 World Series championships in 39 World Series appearances. Their payroll is bigger than any other team. They start to read their press clippings, rely on their reputation and allow their minor league system to deteriorate. Their star players are getting long in the tooth, no longer in their prime. Changing managers (Presidents) hasn’t worked. They are still good, but the competition is younger, talented, and has greater desire to succeed. The upstart Devil Rays (Emerging Market Countries) and the reviled Red Sox (China) have moved past them. It is late August and they are 10 games out of 1st place. It is time to trade the aging veterans for young minor leaguers and begin the rebuilding process. This is where America stands today. We are at a crossroads. We can continue on our current course and be in the middle of the pack in the future, or we can completely retool to compete in this 21st Century world.

By far, the greatest challenge that our selfless patriots must overcome is the entrenched ruling elite that run this country. The ruling elite includes the crooked politicians in Washington, the lifetime bureaucrats who run the various governmental agencies, the paid lobbyists who write the laws for Congress, obscenely overpaid short-term profit driven corporate CEOs, media conglomerates, and the privileged Wall Street aristocracy. These privileged few are surrounded by leeches and parasites (media consultants, pollsters, spin artists, and PR agencies) that attack anyone who threatens their position of power. The only way to overturn their comfortable world is an uprising among the masses. An educated population would not allow them to herd us like the sheep they think we are.

Congress consists of 100 Senators and 435 Representatives. Based on the data below there are 32 lobbyists for every member in Congress. They spend $5.3 million per member of Congress every year. Lobbyists will spend $3 billion this year to persuade our noble politician leaders. PACs and 527 Plans will spend hundreds of millions of dollars pushing their agendas. Who is looking out for my senior citizen parents? Certainly not their Congressman or Senator. They are earning a pitiful 2% on their IRA money market fund because JP Morgan, General Electric and Fannie Mae have lobbyists to fight for their rights. When our government has to use your tax dollars in the next few months to take over Fannie Mae and Freddie Mac, it should warm your heart knowing that these two quasi-governmental entities have spent $175 million in the last 10 years lobbying Congress. Not much has really changed in the last hundred years. Will Rogers pegged politicians back in the 1920’s.

Dollar Bulls Meet Prof. Robert Triffin

Jeff Poppenhagen
August 26, 2008

I believe that it is time for us all to become (re)acquainted with Robert Triffin. Triffin was an economics professor at Yale University in 1960, when he exposed a gaping flaw in the Bretton-Woods monetary system:

If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.

If the U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits (dollar glut) would erode confidence in the value of the U.S. dollar, it would no longer be accepted as the world’s reserve currency. The fixed exchange rate system could break down, leading to instability.

Robert Triffin


Triffin was referring to the dilemma (later referred to as the Triffin Dilemma) that the U.S., as the issuer of the world’s reserve currency, was always going to be required to run a current account deficit to ward off a global contractionary spiral, but constantly running such a deficit would lead to an undermining of the dollar itself, also setting off global economic instability. In short, there was no way for the Bretton-Woods system to find any way to sustain itself in the long-run.

As most know, Bretton-Woods was a fixed rate monetary system where countries held dollars as the reserve currency and the U.S. promised to exchange those foreign held dollars at the fixed rate of one ounce of gold per $35. As the U.S. ran current account deficits, dollars began to pile up in the vaults of foreign central banks. By 1960, when Triffin recognized the dilemma, foreign central banks held nearly $19 billion in short-term dollar based assets. The U.S. gold stock at the time, valued at $35 per ounce, was worth just under $18 billion. Speculators quickly recognized the problem and gold began trading at a premium to this $35 per ounce price. By 1971, the charade of $35 gold could no longer be maintained by the U.S., and Bretton-Woods died, replaced by the fiat dollar standard. Currencies would be allowed to float in value, while the fiat U.S. dollar would be adopted as the world’s reserve currency.

This adoption of the fiat U.S. dollar as the reserve currency was a grave error. The one lesson that should have been learned from the failure of Bretton-Woods is that any monetary system that adopts the currency of a single country (or region) as the reserve currency is doomed to fail. Adoption as the reserve means that demand to hold that currency is very high outside the country or region of issue. This strong demand pushes the value of that currency higher relative to the currency of other countries, making businesses in the issuing country uncompetitive on the global stage. Unless the reserve issuing country is willing to live with the attendant economic weakness and unemployment engendered by the high valuation of its currency (and the U.S. never is), the issuing country will be tempted to meet the high demand for its currency by issuing large amounts of debt denominated in its currency for goods until demand is satisfied, the value of the currency falls and economic weakness is arrested. This will lead to trade and current account deficits.

Differences between the Fiat Dollar Standard and Bretton-Woods

What made Bretton-Woods unique was that dollars were worth more to foreigners than they were to Americans. Foreigners could exchange their dollars for goods and services that were denominated in dollars or they could acquire gold from the Federal Reserve at $35 per ounce. The latter option was not open to Americans. The option to acquire gold at $35 per ounce made it simple calculate whether the dollar was over or undervalued in the market since it was easy to see how many dollar based assets foreigners were carrying compared with the value of the gold stock held by the U.S.

Today, no such simple calculation can help us with the dollar’s value in the marketplace. Instead, we first need to understand what all of these dollar based assets really are. Certainly the majority of dollar based asset holders retain their paper because they expect to be able to exchange it for as many, or more, goods and services in the future as they could exchange it for today. The question then becomes, is this expectation a valid one?

Without question, holding dollar based assets is a “sucker’s bet.” If we look at the Fed’s Z.1 report, which is a summation of debt outstanding and its rate of growth, we can see that non-financial debt in the U.S. has been growing at more than $2 trillion per year since 2005, and for 2007 and through the first quarter of 2008 that figure has been closer to $2.3 trillion per year. All of this debt represents a claim on output in the U.S. If we were to balance that figure against normalized output growth (real GDP growth) plus savings we might come up with about $600-700 billion dollars (we include savings here because saved output that is lent out is not inflationary as the debt created by this lending process is backed up by the saved output itself). That is, claims against output and savings are growing more than 3X faster than output and savings itself. Why investors are willing to accept low coupon U.S. dollar based debt in exchange for their own output and savings is beyond me, but this is clearly a situation that cannot go on forever. Dollar based debt issuance of this magnitude constitutes a glut and will erode confidence in the dollar per Triffin.

Unfortunately, slowing down the rate of credit growth isn’t much of an option either. Clearly, new credit growth of more than the recent run rate of credit growth is required in order to keep the system solvent. Debts of the magnitude of those racked up in the U.S. over the years clearly cannot be serviced out of GDP and require fresh credit growth to service the old debt (in short, a Ponzi scheme). Slowing credit growth in the U.S. now will lead to a massive recession and the wiping out of most of the equity in the global financial system. For instance, if credit growth were to slow to the rate of GDP growth plus savings so that those accepting dollars could feel confident in not losing purchasing power, we would see credit growth collapse some $1.6 trillion per year. At an interest rate of 6.5%, this would require wiping out about $25 trillion in net worth somewhere. Given that the banking system itself has only slightly more than $1 trillion of equity I think that we could safely assume that there would be precious few survivors. Again, Triffin’s insight into our present dilemma was rather prescient.


Just as Triffin correctly identified the end of the Bretton-Woods system long before its collapse, I think that it is now fairly obvious that the dollar is going to fail as the reserve currency of the world. Any reserve currency issued by a single country or region is doomed to fail. Protecting the currency requires economic pain of a magnitude that is not tolerable in the issuing country while meeting demand for the reserve currency undermines the currency itself as issuance will dwarf the issuers output of goods and services. Today, we are clearly staring at the dilemma that Triffin warned about nearly fifty years ago while many remain “bullish” on the dollar. This is folly.

25 August 2008

Credit Seizing Up

By Liz Capo McCormick and Gavin Finch

Aug. 25 (Bloomberg) -- Most of the bond strategists and salesmen that Resolution Investment Management Ltd.'s Stuart Thomson talked to last August expected the credit crunch to be long over by now. Instead, money markets show there's no end in sight, and it may even worsen.

''It's like an ongoing nightmare and no one is sure when we're going to wake up,'' said Thomson, a money manager in Glasgow at Resolution, which oversees $46 billion in bonds. ''Things are going to get worse before they get better.''

In a replay of the last four months of 2007, interest-rate derivatives imply that banks are becoming more hesitant to lend on speculation credit losses will increase as the global economic slowdown deepens. Binit Patel, an economist in London at Goldman Sachs Group Inc., said in an Aug. 21 report that nations accounting for half of the world's economy face a recession.

The premium banks charge for lending short-term cash may approach the record levels set last year, based on trading in the forward markets, where financial instruments are sold for future delivery. Back then, concern about the health of the banking system led investors to shun all but the safest government debt, sparking the biggest end-of-year rally for Treasuries since 2000.

''These problems going into year-end are likely to be worse this time round because of the amount banks have to refinance in December,'' Thomson said, citing a figure of $88 billion. ''The suspicion is that banks are still hiding losses. The banking system relies on trust and at the minute there quite simply isn't any.''

Rate Spreads

Banks are charging each other a premium of 77 basis points over what traders predict the Federal Reserve's daily effective federal funds rate will average over the next three months to lend cash. The spread is up from about 24 basis points in January, and may widen to 85 basis points, or 0.85 percentage point, by mid-December, prices in the forwards market show.

Former Fed Chairman Alan Greenspan said in June that this spread, which is the difference between the three-month London interbank offered rate for dollars and the overnight indexed swap rate, should serve as a measure for telling when markets have returned to normal.

A narrowing to 25 basis points in the so-called Libor-OIS spread would be viewed as a positive, he said. Forward markets signal that won't happen until sometime after June 2010. The premium averaged 11 basis points, or 0.11 percentage point, in the 10 years prior to August 2007.

Another 2007

Increased turmoil in the money markets may again serve as a catalyst for a surprise year-end rally in Treasuries like the one in 2007.

''The trade to do in December will be to get back into the most liquid thing you can find,'' such as Treasury bills or notes, said David Keeble, head of fixed-income strategy in London at Calyon, a unit of Credit Agricole SA, France's second- largest bank by assets. ''We are having a period now of a second round of pressures on banks. It's weak economic growth which is now piling the pain onto the banks.''

A year ago, 10-year note yields fell about half a percentage point to 4 percent between September and December, even though the median estimate of 65 economists surveyed by Bloomberg was for a rise to 5 percent. Treasuries returned 3.98 percent, versus 1.92 percent for company debt and a loss of 3.82 percent in the Standard & Poor's 500 Index, according to Merrill Lynch & Co.

And just like last year, economists and strategists are again calling for an increase in yields. The median of 52 estimates in a Bloomberg survey between Aug. 1 and Aug. 8 was for 10-year Treasury yields to rise to 4 percent by the end of 2008.

Flow of Cash

The yield on the benchmark 4 percent note due in August 2018 closed at 3.87 percent last week, rising from 3.31 percent after the Fed engineered the bailout of Bear Stearns Cos. in March and inflation accelerated to the highest level in 17 years.

''The credit crunch remains the centerpiece of our bond strategy,'' said Resolution's Thomas. He said he's bullish on Treasuries maturing in five years or less.

Banks began to hoard their cash when rising defaults on subprime mortgages led two Bear Stearns hedge funds to seek bankruptcy protection on July 31, 2007, as creditors forced them to liquidate at least $4 billion of securities tied to the loans.

Then on Aug. 9, 2007, Paris-based BNP Paribas SA halted withdrawals from three investment funds because it couldn't ''fairly'' value their subprime debt holdings and the European Central Bank took the unprecedented action of offering to pump unlimited cash into the banking system. The BNP funds had about 1.6 billion euros ($2.2 billion) of assets.

'Systemic' Problems

Losses and writedowns on securities related to home loans to people with poor credit now exceed $504 billion at financial institutions. Last month Treasury Secretary Henry Paulson was forced to seek congressional authority to inject unlimited capital into Fannie Mae and Freddie Mac, which are responsible for about 42 percent of the $12 trillion U.S. home loan market, after their shares tumbled about 90 percent, wiping out some $54 billion of stock market value.

Trust among banks remains low even after the Fed cut its target rate for overnight loans to 2 percent from 5.25 percent in September and created three emergency lending programs, including the Term Auction Facility, or TAF. In total, the Fed has provided almost $1 trillion of emergency loans.

The Fed's most recent lending survey released Aug. 11 said that more banks tightened credit standards for consumers and business borrowers since April as defaults and delinquencies on home loans climbed.

Libor Validity

''The problem is much more systemic than was widely anticipated a year ago,'' said Michael Darda, chief economist for MKM Partners LLC in Greenwich, Connecticut. ''Not only bank balance sheets but home balance sheets are under pressure due to falling house prices.''

The seizure in the credit markets and rise in short-term borrowing costs this year triggered questions over the validity of Libor, a benchmark administered by the London-based British Bankers' Association and used to calculate rates on $360 trillion of financial products worldwide.

The Bank for International Settlements in Basel, Switzerland, said in March some members of the BBA may have understated their borrowing costs to avoid being seen as having difficulty raising financing.

''Libor markets aren't reflective of the entire banking system but of three or four major banks that continue to have pressure on liquidity,'' said Saumil Parikh, a money manager who helps oversee $688 billion at Pacific Investment Management Co., in Newport Beach, California. ''That spreads to the entire system because you are not really sure who you are going to end up lending to through the Libor market.''

'Not Over'

Restrictive lending makes it harder for growth to accelerate in U.S. economy, where gross domestic product may slow to 1.5 percent this year, according to the median forecast of 76 contributors in a Bloomberg survey that puts a greater weighting on most recent estimates.

Meanwhile, Europe's GDP unexpectedly fell 0.2 percent in the second quarter, while Japan's economy shrank at an annual rate of 2.4 percent in the same period.

The crisis is ''not over and I'm not exactly sure when it's going to end,'' Nobel Prize-winning economist Myron Scholes said Aug. 21 at a conference in Lindau, Germany, featuring 14 Nobel laureates in economics.

Silver short facts

These facts speak for themselves. Here are the facts. As of July 1, 2008, two U.S. banks were short 6,199 contracts of COMEX silver (30,995,000 ounces). As of August 5, 2008, two U.S. banks were short 33,805 contracts of COMEX silver (169,025,000 ounces), an increase of more than five-fold. This is the largest such position by U.S. banks I can find in the data, ever. Between July 14 and August 15th, the price of COMEX silver declined from a peak high of $19.55 (basis September) to a low of $12.22 for a decline of 38%.

For gold, 3 U.S. banks held a short position of 7,787 contracts (778,700 ounces) in July, and 3 U.S. banks held a short position of 86,398 contracts (8,639,800 ounces) in August, an eleven-fold increase and coinciding with a gold price decline of more than $150 per ounce. As was the case with silver, this is the largest short position ever by US banks in the data listed on the CFTC’s site. This was put on as one massive position just before the market collapsed in price.

This data suggests other questions should be answered by banking regulators, the CFTC, or by those analysts who still doubt this market is rigged. Is there a connection between 2 U.S. banks selling an additional 27,606 silver futures contracts (138 million ounces) in a month, followed shortly thereafter by a severe decline in the price of silver? That’s equal to 20% of annual world mine production or the entire COMEX warehouse stockpile, the second largest inventory in the world. How could the concentrated sale of such quantities in such a short time not influence the price?

Is there a connection between 3 U.S. banks selling an additional 78,611 gold futures contracts (7,861,100 ounces) in a month, followed shortly by a severe price decline in gold? That’s equal to 10% of annual world production and amounts to more than $7 billion worth of gold futures being sold by 3 U.S. banks in a month. How can this extraordinary concentrated trading size not be manipulative?

Because prices fell so sharply after the short sales were taken (with the appropriate dirty tricks as I have previously explained) holders of known physical silver in the world suffered a decline in value of more than $2.5 billion and long COMEX silver futures holders suffered a similar $2.5 billion decline in the value of their contracts. In gold, because the dollar value held is much greater than silver, investor losses were much greater, on the order of hundreds of billions of dollars on their physical holdings. Declines in the value of mining shares adds many billions more. Was this loss of value caused by the concentrated short selling of 2 or 3 U.S. banks?

What real legitimate business do 2 or 3 U.S. banks suddenly have for selling short such quantities of speculative instruments over a brief time period? Do we want banks to be engaging in this type of activity? If the manipulation was not successful, would U.S. taxpayers be called on to bail out yet another bank speculation gone bad?

Do the traders who lost money in the recent price collapse of silver have a reason to believe that their money is now in the pockets of these two or three U.S. banks? If so, do they have recourse?

The data in the Bank Participation report is clear and compelling. that it is hard to conclude anything but manipulation. It is beyond credulity to conclude other than two or three banks caused one of the most severe price collapses in precious metals history. The CFTC has a lot to answer for as the regulatory agency responsible for preventing this type of blatant manipulation.

24 August 2008

The Real Cost of a Full Bailout

Don A. Rich | Posted on 8/22/2008

A recent study from the Congressional Budget Office (CBO) has zero credibility. It pegged likely taxpayer losses in the Fannie Mae and Freddie Mac bailouts at $25 billion. For those with a sense of history, it is worth remembering that the S&L bailout had a $160 billion price tag. The numbers diverge so far from reality as to be laugh-out-loud funny. Funny, that is, except that the CBO estimate demonstrates a willful disconnect with the actual consequences of federal government actions.

As demonstrated below, the real cost of the bailouts will easily exceed $1.3 trillion. In fact, the real cost is likely to range between $1.3 trillion to $1.6 trillion, and is not unlikely to reach $2.5 trillion.

Between 2001 and 2007, Fannie and Freddie purchased or guaranteed $700 billion of Alt-A and subprime loans. Given the default rates on these loans — and the fact that the price of the housing that is the ultimate security of the loans will, for reasons demonstrated below, fall by at least thirty percent — this alone implies a loss for Fannie and Freddie on the order of $210 billion.

Fannie and Freddie acknowledge already-impaired loans on the balance sheet of $19 billion, which they have used creative accounting to avoid deleting from the shareholder equity account. This means that Fannie and Freddie have a maximum of $64 billion in capital remaining.

Given the inevitable losses on the Alt-A/subprime portion of their portfolio, it must be the case that if the federal government, as it is doing, guarantees Fannie and Freddie's solvency, the difference between the loss and the capital to be made up by the government (i.e., the taxpayers) must equal, not $25 billion but $147 billion.

That alone would mean that the CBO is blowing smoke with their estimated cost figures, and if you think back to the S&L cost of $160 billion, this is not a surprising result. The real picture is so much worse that it is pretty obvious the CBO is flat out inventing figures just to get the politicians through November.

The real story is simple. We have witnessed the largest asset-price bubble in US history, making the tech-stock bubble seem like an overdone weekly rally.

When you look at the graph of the Case-Shiller residential real-estate index, an index dating from 1890 to the present and an index which measures the cost of housing in comparison to other goods, the first thing you see is that the 2001 to 2006 bubble stands out like a fifty foot saguaro cactus in a patch of daisies. There simply has never been anything like it before.

When you know what you are looking at — the biggest bubble in history — it is scary.

To be precise, the Case-Shiller Index in its entire 110-year history had never crossed 140 until the recent bubble. In 2006, it reached 210. Every single real-estate bubble in the past has at best been followed by a fall back to at least the 110 level in the postwar era, although the bubble preceding the Great Depression witnessed a fall to 60.

What this means is that in the best-case scenario, real-estate prices have to fall in the medium to long run by almost half.

Now consider Fannie and Freddie. Just looking at their portfolios on the balance sheet without the guarantees, let us accept (for no particular reason other than a desire that the reader sleep better at night) that real-estate prices only fall by thirty percent.

Well, since Uncle Sam is now committed to "doing whatever it takes," that is a loss right there of $1 trillion. This committment to keep financial markets open as usual is made in spite of the overwhelming evidence that what we have been taught is usual is in fact delusional, given that Fannie and Freddie own $3 trillion and change of mortgages.

The CBO is not fence-post stupid, so obviously just as in the S&L fiasco in 1988, they are outright inventing figures so that the politicians can slither into November and then announce, Whoops! our numbers were a little low.

The more realistic scenario is actually worse. Fannie and Freddie own and guarantee a total of more than $5 trillion in mortgages.

Given the long-run historically plausible equilibrium values of residential real estate as embodied in the Case-Shiller Index, that means that the taxpayer loss definitely reaches $1.3 trillion, easily ranging up to $1.6 trillion.

Unfortunately, that is the good news. The bad news is that if real-estate prices were to replicate the Great Depression (as would surely occur in the case that hedging instruments of Fannie and Freddie were to catastrophically fail due to counterparty failure — and given the absurdly low risk premiums on credit-default swaps at the height of the bubble, such an event cannot be considered unlikely) the Case-Shiller Index tells us that the loss to the taxpayers could exceed $2.5 trillion dollars.

I don't know what those people in Washington are taking to sleep at night after all their electorally driven accounting and finance exercises, but I can tell you what they will be doing to keep the government open for business: printing a whole lot of money.

Chairman Bernanke has the discount window open to any collateralization not worth the paper it is written on, so in effect he has the helicopters ready to drop hundred-dollar bills over Wall Street — as he once famously described the ultimate policy instrument of a fiat-money system.
$10 $7

The Creature from Jekyll Island

Of course, if he does that, we will have to change his nickname from Helicopter Ben to Hyperinflation Ben, which answers the question of who picks up the tab of bailing out Fannie and Freddie: anyone owning dollars.

Produce a lot of something, and it becomes worth less. And given the losses at Fannie and Freddie, the taxpayer guarantee, and the ongoing initiation of Boomer retirement, only the inflation tax will work to pay for keeping Fannie and Freddie afloat.

Like it or not, we are about to enter interesting times, and it is too bad our supposed professional civil servants at the Congressional Budget Office have failed to tell the emperor the truth: that he is buck-naked bankrupt and getting ready to take a lot of people with him.

Our only hope is to (1) accept up front a twenty-percent fall in American living standards for a people living beyond their means for the past twenty-five years on the delusions made possible by fiat money, and (2) simultaneously discipline the creature from Jekyll Island, a.k.a. the Federal Reserve System, not to create new money just to prop up asset-price bubbles.

Peak Credit

Peak Oil!! Peak Inflation ?!? Peak Credit??
Does Peak Credit inevitably follow piqued credit? Well if you're my age, and you thought so and positioned accordingly, you'd have been bankrupted a very long time ago - possibly as early as the late 1980s. And if you were a glutton for punishment, you'd have been toasted again in 1994, another time in 1998, yet again in 2002, and rubbing one's nose in it, perhaps every year after that until midsummer two-thousand-and-seven. Dog days indeed for those bearish on the ability of the financial system to manufacture, distribute, and service debt, whether in real or nominal terms, or in relation to any measure of the economy or change in the growth thereof.

Yet as pessimistic on its sustainability (and wrong!!) as one would have been in the past, one should now be as optimistic one's assessment that this is The Big One, that we've smacked head-first into the boundary of the maximum amount of debt that can be assumed by households, corporates and governments in our economy and be reasonably sustained with the fruits of our labour, and investment. Actually, I would posit that we long-ago pierced any reasonably sustainable threshold, and only through sheer inertia and the fortuitiousness of pulling of rabbits-out-of-hats have we lasted this long. But it is the anchoring of popular belief in faith and absent solvency from days long passed combined with the extrapolation a series of non-extrapolatable macro income streams which could cause any sensible human being believe or have believed that the boundary lay somewhere in front of us and not far behind us.

Culpability is not singular. Stern-Stewart, investor short-termism and systemic mono-focus, along with greedy managers replete with agent/principal dilemmas must assume blame on the corporate side. Selfish American Voters repeatedly demanding representatives requite incongruous financial goals with cynically lame and unsustainable fiscal policies, along with a near complete detachment from reality in regards to present consumptive desires in relation to both incomes and longer-term savings requirements are just as at fault as the monetary wrecktitude resulting from an unwillingness to accept mild deflation and cyclical recessions where required for reasons that - to this day remain inexplicable given that Continental Europeans seemingly had little difficulty distinguishing a bubble or accepting that both taxes and economic brush-fires are not inherently bad in The Big Picture.

So IF what we are currently witnessing, commonly termed as The Credit Crunch, is in fact, an expression of what I will term Hubbert's financial equivalent - "Peak Credit" phenomena , and IF as I posit, we long ago untethered the financial wagon from the real economic train, what does this mean?

Many things, but first and foremost, that we are at a major and painful inflection that will impose a real Kunstleresque austerity upon Americans converging their desires with their means. In a word, this means "revulsion", a somewhat arcane and long-forgotten term for large-scale write-downs and/or economy-wide elimination of outstanding debt(s). For this reflects the implausibility of servicing, let alone paying off obligations, and the consequences to those whose capital and assets were/are/will be vaporized. It will, undoubtedly, be fought by authorities, with certain costs borne by the state and socialized upon unwitting voters. Japan wallowed in their own debt-shite for more than decade, and in the US it is (in present political climate of denial) even more natural that attempts to band-aid and stave off the inevitable reality will likewise be tried. In another time and another place, natural growth and demographics might have met inflation somewhere in the middle and the cycle would resume again without massive dislocation. But this time it is different. This time, the encumbrances are too large. This time, there is competition for markets, and their value propositions are surpassing Americas. This time the patient is too soft, obese, relatively uneducated, faux-faithful, weak, politically compromised, and cronily corrupt. This time, the business cycle is turning dramatically for the worse, wealth effects are only beginning to bite, oil has peaked with a generation of adjustment between any remotely plausibly cost-effective replacement. And competition is even heating up in the emerging world for the remaining high-margin business. This does not sound like an environment that will assist households or government to rebuild balance sheets and make good on obligations without great sacrifice from ordinary people and even greater sacrifices from the monied class. This sounds like an environment where creditors and debtors will be required to sit down and negotiate what can and might plausibly be paid, or converted into equity, or stretch maturity with lower rates - anything to keep it as an "asset" and a performing one.

"Peak Credit", like Peak Oil, thus forlornly reflects the necessity of increasing demand for credit from borrowers to sustain the unsustainable, at precisely the time when supply is constrained and shrinking, for suppliers are squarely confronting the reality that new sources are limited, and in any event, the demanders (even if supplied) have diminishing hope in the current environment of returning what was lent.

Some will think that these ruminations border on the insane. And I will admit that when I walk out of my office door to the local trendy coffee bar, there is scant evidence where I live that Peak Credit is anything but a financial phenomena - limited to the flippers in Vegas or the spec developers in Fla. or CA. But perhaps that's because the most insidious aspect of Peak Credit is its disruption to the chain of dependencies that bore its hallmark over the past two-and-one-half decades. So inexorable and complete has the rise of credit been in its permeation of every crevice of life that no one blinks when multi-trillion dollar GSE balance sheets are supported by but the thinnest veneer of equity - even AFTER large potentially (no, probably) impermanent increases in underlying asset values; when dogs receive pre-approved credit cards by mail; that its sheer ubiquity produces persistently negative rates of saving; when corporates use leverage in lieu of a margin of balance-sheet safety on the enterprises they are meant to steward in order to conform and placate the markets' twisted short-sighted ideal of optimal capital structure leaving them woefully exposed to cyclical fluctuations; where data-mined models themselves based on limited data replace good common sense; where leaders defer to unsustainable plebeian notions of what constitutes prudent fiscal policy producing errors in judgment that make the trench warfare of the first world war appear sane. If this is what God's country resembles, imagine the financial horror in hell...

"Peak Credit" will wreak as monumental changes upon American consumptive life as Peak Oil, and these cannot help but exert a massive deflationary pull - at least until such time as the parties agree to squarely face reality that confronts them, and in an interconnected world, everyone else.

"Leveraged Beyond Comprehension"

The world financial system is leveraged beyond comprehension. It's estimated that $500-700 TRILLION of derivatives are outstanding. Compare this with total economic activity (GDP) of the world, which is around $50 Trillion, and you can see that even a 5% drop in value of the derivatives is beyond the rescue capability of the world's central banks. --- Bert Dohmen (of Wellington Letter, and author of Prelude to Meltdown)

Two very interesting discussions are featured in this week's audio reports, one from Don Coxe , the other Don McAlvany. Incidentally, Coxe's site now carries the following warning: Links to Don Coxe's conference call webcasts are for the exclusive use of BMO Financial Group clients and are not to be distributed or posted for public access. What it means, I don't know. However, this is the last time I will publicly link to his site.

Coxe's discussion isn't very long. Aside from some his usual interesting tidbits, it was the Q&A that mostly caught my attention. First time I had ever heard mention of "synthetic money". This was Coxe's term to address that all money metrics, M1, 2,3, etc, not very helpful in determining what's going on today. Instead, Coxe thinks real interest rates are the key factors to look at.

Clearly, on the basis of this discussion, and the McAlvany interview with Bert Dohmen, the question about the current environment being deflationary becomes absurd. In fact, Dohmen's argument is so convincing that, well, you'll just have to hear it for yourself.

The key, of course is that the Fed, et al are waging an all out fight aimed at countering the collapse, which is so devastating that, well, again, you just have to hear it for yourself. The current recession is SO DEEP, SO PERVASIVE, that the world is on the verge of going down. No place to hide, 'cept maybe in "real money", meaning metal. Such is what the market is saying.

Highlights from both discussions: (sorry, not in any particular order)

Synthetic, or Neomoney: Negative real rates are being sustained, which leads to inflation. Printing or not printing" money, based on the Ms, is not the real focus, though argued back and forth practically everywhere. What should be matter of interest is that, so long as negative real rates prevail, bad lending will continue to be stimulated and savers will keep losing money as bad allocations of capital continue to be subsidized at savers expense. So long as savers continue to lose money central bank policy should be understood as supporting mal-investment. Implications should be obvious. Inflationary pressures remain in short term. As for the Dollar, trend will remain downward until BKX has risen 80%.

Dohmen sees a 30-yr inflationary cycle (which began in early 2000) underway. What it means is that we're now in secular bear market. Way too early to go bargain hunting. Government fudging numbers, big time. GDP is negative, at least to the tune of 4-5%, which means we're in midst of sharp contraction. Japan, Europe, US - all in recession, and bound to go much deeper. All currencies of the world are destined to decline relative to gold. Be clear, this is the strongest bear market since the 1930s. And it's at the end of a recession when you get deflation. All this is totally contrary to what you hear from the media, especially CNBC, specialists in bringing on analysts who chatter about US not being in bear market. It is a gross deception.

The kitty is empty, banks have run out of capital. Banking system is in dire straits. Key focus, going forward, is liquidity and credit. When credit contracts the market must go down. Rates will have to move in direction of zero. Tens of trillions of dollars are just going up in smoke and CBs can't accommodate enough. The problem is not that Fed is creating too much money.

We've not yet arrived at the recognition stage. Unemployment hasn't surged yet, primarily because so much labor had been outsourced. Emerging economies, therefore, will get hit. No place to hide. The world is in the process of going down. Civil unrest will become the biggest problem in emerging economies, and this is one of China's biggest fears. There could be 200 million unemployed Chinese, having moved from countryside into cities and fully out of work. China is NOT BLOOMING. Their market is already down 58%, which means they're signaling awareness of the problem.

Best investment over next several years will be shorting the emerging markets. It's a worldwide recession that we're in, emphasis being placed on global downturn. Three hundred point rallies never occur in bull markets, check history an you won't find it. Such rallies are the hallmark of a recession.

Scary thought

Are we safe, knowing at the helm of our federal reserve is an academic specialist on depressions? Consider the case of Robert Mugabe. Mugabe, according to Dohmen and McAlvany, has 3 PhDs and other multiple degrees, some coming from Oxford no less. I checked around the Net and did find records showing a master's degree in economics, a bachelor's degree in administration, and two law degrees — to go with the three bachelor's degrees he already possessed, in economics, education, and history and literature. Guess certificates don't necessarily mean dip. Fade 'em.

Dohmen Capital Research - excellent bookmark candidate.

Excerpt from the WELLINGTON LETTER, August 5, 2008

.....................Bridgewater Associates' recent estimate of losses from mortgage-related securities in the financial institutions is $1.6 trillion. If you look at the leverage ratios of these firms, they seem to average around 25 to 1. That means each dollar of capital supports $25 of assets. If $1.6 trillion has gone up in smoke, than we multiply that times 25, and get a reduction in lending capacity of $40 trillion.

The world's economic product (similar to a country's GDP) is around $55 trillion. So we can see that the reduction in lending capacity is 80% of what the world produces each year. However, we also have to consider how many institutions, banks or financial firms, have severely cut their lending voluntarily just to be more cautious.

And then we have Wall Street's incredible money machine, which pooled loans of all types and resold them via certificates, coming to a screeching halt. In fact, that was one of the largest contributors to worldwide liquidity creation. European banks also participated in such techniques. This involved trillions of dollars.

The result is that money will be very tough to borrow over the next many years. The bad stuff has to be liquidated first before new credit can be created. And when money creation flips from creating tens of trillions of dollars to liquidating similar amounts, you have a drastic change in liquidity. And that can only result in a serious, long-term recession, globally.

People ask me, why haven't we seen the U.S. economy plunge into a deep recession? There are several reasons...

Excerpt from the WELLINGTON LETTER, July 16, 2008.

Banks and finance firms worldwide have so far reported losses of about $410 billion in writedowns and losses. There is much more to come, but they can't do it all at once, as they have to raise new capital every time they take more writedowns. Ray Dalio, founder of the huge hedge fund, Bridgewater, estimates losses of $1.6 TRILLION. My estimate for the next 10 years is much higher.

Think of the implications: Where will these financial firms find the capital to compensate for these losses? Are there any investment firms or Sovereign Wealth funds willing to provide such capital, especially those who were too early at the end of last year, and now are sitting on multi-billion dollar losses on these investments? Bankruptcies, or "shotgun weddings," are inevitable. In fact, last year I predicted that some of the major U.S. financial institutions would eventually be controlled by foreign entities. Guess what: now legislation is being considered which would give a blessing to foreign firms wanting to own more than 25% of such institutions. The groundwork for the inevitable is being laid.

from Prelude to Meltdown (excerpt)

"While everyone on Wall Street talked about the huge amount of "liquidity," Bert pointed out that genuine liquidity is cash, and that Wall Street confused liquidity with "credit" which could disappear overnight. And that's exactly what has happened.

It's estimated that $500-700 TRILLION of derivatives are outstanding. Compare this with total economic activity (GDP) of the world, which is around $50 Trillion, and you can see that even a 5% drop in value of the derivatives is beyond the rescue capability of the world's central banks."

21 August 2008

Evolutionary Fitness: the diet that really works

Bryan Appleyard thinks he has found a diet that really works: it took him three weeks to shed 14lb with healthy ease. But he had to go back 5,000 years to discover the science behind it

A half-naked 71-year-old with 8% body fat and the testosterone levels of a boy of 18 greets me at the door of a large house overlooking a golf course near St George, Utah. He has the physique of a very fit young man and the springy, energetic demeanour of somebody who has cracked most of life’s outstanding problems. I am calling on him because, ever since I heard of him, I have begun to look uncannily well.

Two weeks earlier I had strolled into the office of the editor of this organ.

“You look 10 years younger. Why?” he barked, as editors do.

I was 11lb lighter than the last time he’d seen me. But he said “younger”, note, not just thinner.

Is functional exercise better than the gym?
Our writer tries out the new fitness craze that's sweeping America and finds it is demanding, but not impossible

“Arthur De Vany,” I reply, “he’s this guy…”

“Well, you’d better go and see him, then,” he growled, as editors do.

And so here I am in the red desert of Utah saying hello to Superman’s slightly fitter grandad. Now, I know all you men will be wanting to know the secret of Arthur’s testosterone trick. I’ll come to that – it couldn’t be simpler. But first a word of explanation.

Feeling bloated and absurd after seven weeks in America, most lethally Texas, where the steaks are bigger than your head, I went on a diet. I do this periodically and lose up to 20lb over three months or so. Then, slowly, I put them all on again. I console myself with the thought that this inflate-deflate regime has kept me from the more severe middle-aged inflations I see around me. Many of my contemporaries are beginning to look like Sylvia Plath in pregnancy – melons “strolling on two tendrils”.

My usual diet is simplicity itself: eat too little and lay off the booze. All other dietary schemes struck me as over-elaborations or, in many cases, cunning excuses to keep eating. Calories in, calories out was, I thought, the only rational basis on which to lose weight. The body is a bag that gets lighter if you take out more than you put in. This time, however, I had a more sophisticated plan – Arthur’s – and boy, did it work.

I adopted the Arthur plan because the last time I was in America I had encountered Nassim Nicholas Taleb. He wrote a brilliant book called The Black Swan, superficially about risk in financial markets but, in fact, about life. He couldn’t stop talking about the Arthur diet. Nassim embarked on his regime after someone told him he looked like the writer Umberto Eco, a fatty. He had lost 20lb in three months after getting hooked on Arthur via his website (arthurdevany.com ). Nassim still looks a bit like Umberto, but not fat.

Now, as I say, I have never believed in smart diets. But for the first time, Nassim gave me a justification for a diet that made sense. (I’ll come back to that just before I get back to the testosterone.) And so here I am in Utah, now 13lb lighter, confronted by a half-naked Arthur.

I am early – I am always early, it’s a curse – and he has just got out of the shower. Unlike most 71-year-olds he feels no need – and has no reason – to cover his body. A good thing too. It’s 103 degrees and I, fully clad, am sweating like a thinnish pig. But it’s cool, tranquil and immaculate inside the house. The only signs of familial chaos are the bits of wire botched together in the garden to keep in their Yorkshire terriers, Django and Bela. Otherwise, Arthur’s world is disciplined and active. He listens to jazz on a stratospherically expensive Krell hi-fi, he has motorbikes and push-bikes in the garage, also a Range Rover that I assume is brand new, but which is in fact a couple of years old; he just looks after it. Arthur’s stuff, like Arthur’s body, is the best there is and all very carefully maintained.

He was always an athlete, but he has been on his regime – it’s called Evolutionary Fitness – since 1984. The first benefit is that he is never ill.

“I’m not on any medication. I had a fair number of colds before I began this programme but I’ve only had two episodes of food poisoning since then – both were in high-end restaurants – and that’s it since 1984. My insulin is unmeasurably low; insulin is the ageing hormone – it tells you to go ahead, reproduce and die. My HDL is enormously high, my triglycerides are way down, my blood pressure is perfect, scans of my carotid artery show there are no lesions there, no build-up of plaque, so my brain is getting lots of nourishment. I was just motorcycle-riding with a gang of guys in Elba, riding all over the hills. I play softball; I was the only guy in the seniors to hit them over the fence. I can hit a golf ball 340 yards. I’m fast as heck, I’m very strong…”

And the testosterone? “We do have a lot of sex for a 70-year-old couple. I had to close the door the other night, she was screaming so loud – she sings!” Perhaps luckily, his wife, Carmela, is not around to be embarrassed by this: she is in Las Vegas for the day. But on the other hand, she probably wouldn’t mind. She went on Arthur’s diet after they married and dropped six dress sizes. “You don’t see many 70-year-olds who are a size four and have such a cute, petite figure.”

This bouncy, clear-eyed, low-insulin, horny rebuke to unfit fat slobs everywhere was born in Davenport, Iowa, but his home town is really LA, where he finished high school and was signed to a minor-league baseball team. He was always fit but his sight wasn’t good enough for pro baseball. He started working out – primarily weightlifting – at 16 and has done so ever since.

Is functional exercise better than the gym?
Our writer tries out the new fitness craze that's sweeping America and finds it is demanding, but not impossible

Ah, you’re thinking, he’s a fitness freak – no hinterland, no brain, all biceps; we may be slobs, but we’re smart. Sorry. Arthur studied economics at the University of California, Los Angeles, and now, in retirement, he is professor emeritus of economics at the Institute for Mathematical Behavioral Sciences at the University of California, Irvine. He has written the most important works on the economics of the movie industry and he worked out the best ways of privatising the electromagnetic spectrum: broadcast frequencies. “It was the template for the establishment of spectrum markets throughout the world,” he says with charming egotism. “I am told I am a legend in Guatemala, for example.”

This isn’t just background, it is essential to an understanding of Arthur’s approach to diet and fitness. It is very rigorous and thoughtful – which is why Nassim’s advocacy got me on the diet. The first point is that economics happens inside the body as well as outside. His work is all about the dynamics of complex, adaptive systems; he calls himself a complexity scientist. Central to this is the overthrow of old statistical models. Basically, we have all been taught that events – human wealth, earthquakes, blockbuster movies – cluster round an average forming a graph in the shape of a bell curve. This is an illusion and the concept of the average leads to fatal errors.

In reality, almost all events of significance follow what are known as “power laws”. This means, to simplify, that what are thought of as rare events are, in fact, more important than any average. We think of bank crises, like the present one, as rare and the rest of the time the banks go on making money. In fact, they don’t. Bank crashes are so devastating that they wipe out all the investment profits of the banking system. Look at the average and you don’t see this; apply power laws and you do.

“The average,” says Arthur, “is always misleading and may not exist.”

The obsession with the bell curve and the average has corrupted us. We tend to think of stable models not just of the human world but also of the human body. Almost all dietary and fitness regimes are based on a homeostatic view of the body – meaning it is a self-regulating system that maintains itself in a continuous, stable condition. The average is the ideal. So we are told to eat regular meals consisting of a balance of the food groups and to take regular exercise, dominated by steady aerobic activity like cycling or jogging. This is all wrong.

But though Arthur’s economics feed into his Evolutionary Fitness regime, that’s not how he got there. He married his first wife, Bonnie, in 1957. They had three children, two of them adopted. Their biological son, Brandon, was diagnosed with type-1 diabetes at the age of two. “I went down to the Chicago University bookstore and bought everything I could on metabolism, including the big, thick textbooks, and I started ploughing through all that stuff.”

Some years later, Bonnie received the same diagnosis. By now, Arthur had decided most of what they were being told by doctors was wrong. “We had to neglect a lot of advice from doctors.”

He began experimenting with diets. Prolonged high blood sugar is fatal to diabetics.

It is lowered by insulin injections. But, Arthur reasoned, why not keep the blood sugar low in the first place? “I was frustrated with the doctors. We were having reactions day after day. So I decided to start testing. Something was driving her blood sugars up, so I started systematically eliminating foods that drove them up. Beans – something as simple as beans sent her blood sugar sky-high. Pasta was disastrous. There was something wrong here, this can’t be the case, you’re shooting her blood sugar up like this.”

It was clear that carbohydrates were the problem. By removing them from the diet, Bonnie and Brandon’s need for injected insulin dropped dramatically – so dramatically that one doctor refused to believe Bonnie had diabetes. But it wasn’t enough for her. She developed a rare complication – systemic vasculitis – that was eventually to kill her. Brandon, though lapsing from the low-carb diet, has done well.

Arthur asked himself what was going on here – and, basically, decided almost everything we thought we knew about diet and metabolism was wrong. There is a parallel with his work on the economics of movies. Hollywood producers sit around in meeting rooms telling each other stories about why a film succeeds or fails – the stars, the directors, the trailers, anything. Marketing men join them and tell them more tall tales. And everybody feels good about themselves. “The stories give them the illusion of control, they reinforce prejudices and biases, and they all like to feel important.”

But the stories are all false. The reality, as Arthur discovered, is that 5% of movies pay for the other 95%, and success or failure is unpredictable. The best the studios can hope to do is find contractual mechanisms that back success after it happens and thus leverage their profits. This was what they had with distributors and cinemas, and it worked. They just didn’t realise it was these deals and almost nothing else that was paying for their Cohiba cigars. The movie industry was what Arthur loves best: “a complex, adaptive, decentralised system”. Exactly like the human body.

Is functional exercise better than the gym?
Our writer tries out the new fitness craze that's sweeping America and finds it is demanding, but not impossible

The trick is to look at what happens in the real world and not listen to stories –producers’ tales or medical theories. Similarly false stories are told about diet and metabolism, the big two concerning homeostasis and the diet heavy in hydrates and low in saturated fats. It didn’t matter what stories the producers told – they went on making money. But, with homeostasis and high-carb/low-fat diets, the stories mattered because they affected the behaviour and health of ordinary people. Bombarded with the fat bad/carbs good (FBCG) advice, they just kept on getting fatter and sicker.

But why are carbs such a problem? The very persuasive answer to this is why I went on the diet. Humans evolved over millions of years, probably on the African savanna. We were, for almost all our existence, hunter-gatherers – agriculture and settlement began only 10,000 years ago. Both sides of the dietary debate agree that this means we are omnivorous – hunter-gatherers have to be – and that because of our massive brains we have unusual energy requirements. Both sides also agree that settlement and civilisation changed our diet and living conditions radically. We may live longer because we are better protected from predatory beasts and all the other traumas that would have afflicted early man, but we also have new diseases, new miseries.

“We live,” says Arthur, “like lab rats. A lab rat has a life expectancy three times that of a wild rat because it is protected from accidents or disasters… But it doesn’t live better.”

Advocates of FBCG believed that the big dietary change behind our new miseries was increased consumption of animal fats on the basis that, for early man, there were lots of vegetables and fruit lying around, but a good kill would be rare. Recent research, however, suggests that kills could be very large and our ancestors did not, as we do, carve out the best bits; they ate the whole animal. Their fat intake was, in fact, much higher than we thought.

The truth is that the big dietary change was not fat but carbohydrate consumption. Agricultural settlement resulted in the cultivation of cereals and root vegetables. Bread, potatoes and rice became the staffs of life. The FBCG people didn’t think they were a problem: pound for pound, they contained fewer calories than meat. But what carbohydrates do is stop you burning fat, so the fat you do consume gets laid down in your arteries and on your stomach. It’s not the burger that bloats, it’s the bun.

Furthermore, carbs become sugar in the body. In the case of refined carbs – white flour or sugar – the effect is instantaneous. “Some of these starches, as soon as they hit the saliva in your mouth, become sugars. Pasta is a bowl of sugar, briefly deferred.”

This produces blood-sugar spikes that stress the pancreas and put millions in a pre-diabetic condition. They develop metabolic syndrome in which fat accumulates about the midriff and fundamentally alters body chemistry. This, it is thought, may well be either a primary or secondary cause of the diseases of modernity: cancers, heart attacks, strokes and, of course, all the woes that flow from obesity.

Arthur is not alone in understanding the lethality of carbs. The whole FBCG ideology is now on the run. One very successful book, The Diet Delusion by Gary Taubes, exposed how threadbare the science behind the ideology actually was. A recent study in The New England Journal of Medicine seemed to show conclusively that a low-carb diet was a better way of losing weight than either a low-fat or a Mediterranean diet. It also showed it reduced bad cholesterol – a clear refutation of most orthodox dietary advice. The Palaeolithic diet, meanwhile, a regime based on the diet of early man, was first advocated in 1975. And, of course, there was the most famous low-carb regime of all: the Atkins diet.

But what’s different about Arthur is, first, he is not selling anything, except for subscriptions to his website. He has long thought about writing his Evolutionary Fitness book, but he has never got round to it. In fact, until I interviewed him he wasn’t even thinking about it. He is much more interested in a financial instrument he’s invented and is now selling through a firm called Extremal Securities. He reckons it will transform, among other things, the mortgage market, which, let’s face it, needs transformation.

Secondly, he puts much more stress on vegetables, fruit and exercise than Atkins, and is convinced that, though carbs are the main problem, massive intakes of saturated fats are, at least, unwise. Thirdly, he is very smart. His reasoning is immaculate and he knows a lot more than your average doctor or nutritionist. Fourth, Evolutionary Fitness is not just a focus on weight. I feel better, not just lighter. And, fifth, as I say, he looks like Superman’s fitter grandad.

The trick he is trying to pull off is to find a way of combining the Palaeolithic and the modern lifestyles; to free us from being lab rats. People in the wild – isolated tribes – do not get fat and neither do other omnivores and predators. But, of course, they die younger. We can’t drop the comforts and protection of modernity. But we can fight its sugary seductions. So how do you live the Arthur life?

First, you free yourself of the homeostatic delusion. We are not made to eat regular meals or take regular exercise, nor are we meant to suffer chronic stress in an office. Our ancestors ate when they could and kept moving. Most of their life was stress-free, but occasionally they would be subject to acute stress in the form of an attack by a predator. So Arthur e-mailed me these recommendations. “Don’t eat three square meals a day. Skip meals now and then. Work towards an extended overnight period of no eating. This means eat sometime before you sleep and don’t be in a hurry to eat breakfast… Do not fear hunger. Nothing but good will come of it, but it must be episodic, not chronic.”

Is functional exercise better than the gym?
Our writer tries out the new fitness craze that's sweeping America and finds it is demanding, but not impossible

And on exercise: “First, everybody over-trains. Don’t do it. Don’t trudge away on a treadmill, count sets or repetitions, or work out according to a top-down Soviet model. You will hate it and it does not produce results. You must let it happen. You must have a playful, intermittent form of exercise. And you must exercise. The benefits are profound… Make it fun, intense according to your own fitness and goals, and brief. The goal of an exercise session is to promote growth-hormone release, to build muscle, and to elevate insulin sensitivity. Brevity and intensity are keys. Intensity means a little burn in the muscle, not heaving and straining. Brevity means you do not release stress hormones. So, you are favourably altering your hormone profile.” Superman's grandad, it turns out, gets by on no more than 45 minutes in the gym and only when he feels like it.

Getting the food right is hard work. Arthur shops only on the outer edges of the supermarket, where they keep the fresh stuff. And cutting carbs completely, as I did, results in a few days of hell – raging hunger and gloom. On the fourth day I woke up so depressed I could barely move. Then I ate a peach and I was fine and I’ve stayed fine, more or less, ever since.

I’d suffered an enormous drop in blood sugar, which the peach instantly corrected.

Breakfast is hell at first – no cereals or bread – but you can have almost everything else. Arthur sent me an example of his breakfast: “Four thin pork chops, well trimmed and browned in a bit of oil with rosemary and pieces of fresh apple. Some canteloupe melon with it.” Trust me, after a month or so, the spectacle of toast or a bowl of cornflakes will revolt you.

In the end, I am not qualified to say that Arthur is right. But I am qualified to say that it works for him and for me – 20lb lighter at the time of writing – and that he is the most articulate definer of a paradigm shift in our thinking about the human metabolism that is still in progress. Carbs, not fats, are modernity’s most deadly assassins. And, even if they don’t kill you, they make you feel worse. I sleep better without them and I seem to have become a nicer person; what with that and the weight loss, my friends – or were they enemies? – barely recognise me.

Arthur drives me down to the golf club in his perfect Range Rover. It is still blindingly hot; the red desert is shimmering. We sit down for lunch. I stare critically at the menu.

“The turkey wrap’s good,” says Arthur.

“Wrap! Are you mad? It’s carbs.”

“You’ve got to live in the real world, Bryan.”

We end up with salads. Mine arrives with a cigar-shaped toasted bun on top.

“He doesn’t eat bread,” says Arthur, whipping it off and handing it back to the waitress.

He’s right, I don’t. I am early man, hunting and gathering, fighting lions, treading the outer reaches of the supermarket, spear in hand, picking up armfuls of celery. Celery? Yep, that’s what I meant to tell you – it works wonders for the testosterone.

Is functional exercise better than the gym?
Our writer tries out the new fitness craze that's sweeping America and finds it is demanding, but not impossible

The good, the bad and the tasty

The fundamentals of Arthur De Vany’s diet: bin the carbs and packaged food, and delight in lean meat and at least two veg meals

- Cook by colour and texture so that meals look beautiful. If busy, skip meals with little worry. You don’t have to have three square meals a day. Snack on nuts or celery. Drink plenty of water. I also drink tea, coffee and a little wine.

Avoid bread, muffins, bagels, pasta, rice, potatoes, cereals, vegetable oils, beans or anything in a package — empty, high-calorie foods with a high carbohydrate content.

Spice up your food with fresh ingredients such as basil, garlic, parsley, rosemary, spring onions, avocados and nuts, and use various oils, such as olive oil, for flavour.

Celery adds texture (and is good for testosterone too).

Fresh fruits of all sorts are good; I focus on melon and red grapes. Fruit juice is out. I have one or two fruits with most breakfasts; now and then a piece with other meals.

Eat lots of fresh raw, steamed, sauteed or grilled vegetables. I never use frozen, canned or packaged vegetables.

Eat plenty of meat, such as ribs, steak, bacon, pork loin, turkey and chicken, but trim fat from the edges. Fish, seafood and eggs are also good choices.

I tend to eat last night’s leftovers: turkey with jarlsberg cheese and fruit, bacon with red grapes, omelettes with rosemary, olives and spring onions.

Usually salads, with red cabbage, romaine lettuce, spring onions, garlic, kale, broccoli or cauliflower, with salmon, tuna, turkey, chicken, pork or steak.

I sometimes eat a whole rack of ribs with salad and vegetables. Or a large steak, trimmed of fat. Almost always there is a beautiful salad and vegetables.

The real story on Gold imo

There is a huge demand for both gold and silver right now in India and North America. North American shops are completely bare of silver. Indian shops are empty of both silver and gold. Even the Indian banks don't have any gold or silver. The big western bullion banks, based in New York and London, control both the gold and silver trade. Reports from India are that they are refusing to extend Indian bank lines of credit, forcing the small banks to deliver to clients, collect money, and pay down lines of credit, before being allowed to take delivery of another gold or silver shipment. This is very abnormal. Normally, if a banker’s bank knows that its customer-bank has firm orders, it would extend the smaller bank a bigger line of credit. Not now.

By refusing to extend lines of credit, the big bullion banks are essentially rationing a very thin supply. Most physical silver, for example, is being reserved for industrial and fabrication use, and investors are simply not able to get any, without waiting for months. Investor oriented shops are bare, and the U.S. Mint has suspended coin production. All available supply seems to be reserved for industrial users. You cannot substitute paper claims for real silver, in industrial use, because paper doesn’t have the physical properties of silver. So, it seems that all available supply is being diverted to industrial users, and, to a lesser extent, aside from the squeeze on lines of credit, also to jewelry fabricators. But, investors are left out in the cold. They can accept paper claims, or nothing. The most interesting mistake that the manipulators have made is in not supplying the U.S. Mint, which has run out of silver, proving that there is a severe shortage.

Meanwhile, by refusing to extend Indian bank lines of credit, Indian jewelry demand for both gold and silver is being stymied. India is not being allowed to drain away precious metals, in the amounts that are warranted, given the low prices and the numbers of unfilled orders that are sitting on desks in India. World bullion banks, in other words, are managing deliveries of physical gold and silver to artificially reduce the quantities delivered, under the excuse that the “Indians have run down their credit lines.”

The happiest fact of bullion bankers’ lives is that western markets are, with the exception of some fabrication and industrial demand, almost 90% paper based. The huge COMEX futures market almost never sees an ounce of real silver or gold ever change hands. It is all paper, shuffled back and forth. These paper markets are being flooded with paper based "claims" to alleged gold and silver, supposedly being held in big bank vaults in London and New York City. The market is overwhelmed with paper claims, and the big bullion banks (maybe, with the Federal Reserve providing the money?) are paying big bucks to secondary derivatives dealers to get them to lease this artificially created “gold and silver.” In a normal market, one who leases a thing of value must pay for it. But, now, derivatives dealers are being paid to lease both gold and silver. Then again, it may not be a thing of value, if it is fake…

That being said, the paper claims may have a lot of value, whether or not they are fake. Derivatives dealers can write futures contracts, options, etc., according to CFTC rules, because paper "claims" to vault-stored silver and gold can be used as the legally mandated "cover" for futures contracts. To understand the nature of paper claims, we must travel back in time, for a moment, to a class action against Morgan Stanley (MS). According to the complaint, Morgan Stanley claimed that it bought physical silver, on behalf of various clients, and was storing it, in safe-keeping, in its vault in New York. Allegedly, Morgan Stanley defrauded its clients from Feb. 19, 1986, and Jan. 10, 2007. According to the complaint, it never bought any silver, but, all the while, continued to charge clients big fees for storing the imaginary metal. Morgan Stanley is one of the biggest investment banks in the world. It is one of the major players in precious metals. Yet, according to the lawsuit, the paper claims to vaulted silver it issued to clients was nothing more than a lie. One of Morgan Stanley’s defenses, interestingly enough, was that everything it did simply followed “standard industry practices.” For more information, see here.

Apparently, it is standard Wall Street industry practice to send people monthly statements promising that the firm is storing physical precious metals in a vault, charge for the storage, but really never buy or store any real metal. Morgan Stanley eventually settled the case for many millions of dollars in damages, rather than going to trial. That tends to indicate that they were guilty, as charged. I believe, with good reason, as you shall soon see, that most of the paper claims to silver and gold, now floating about, and collapsing prices, are cousins to the Morgan Stanley silver claims.

Logic tells us that the so-called metal must be imaginary, and I will soon tell you why. Yet, for some reason, in spite of class actions like the one described above, no one demands to see it. The majority assumes that banks, like Morgan Stanley, are honest, and would not issue fake paper claims. But, if they did it before, they are probably doing it again. That could be the key to precious metal market manipulation.

If you are a huge bank, with hundreds of billions of dollars worth of short positions, and you know the price is going to explode, you can do one of two things. You can be honest, like most individual and institutional short sellers must be, and cover your short position by buying back at market prices even though you may take losses to do so. Or, you can be dishonest. The majority of banks and hedge funds don’t have the option of being dishonest, even if they want to be.

However, what if you happen to be a primary dealer of the Federal Reserve, or the ECB, or the Bank of England, or all three? If you are, then you happen to have overwhelming knowledge and control of the marketplace, because your divisions are deeply enmeshed in the global financial trading system, and your powerful computers allow you to analyze all markets in a matter of minutes or even seconds. You have an ownership stake in all the big markets like the New York Stock Exchange, Nasdaq, COMEX, NYMEX, and the London Metals Exchange.

Unlike a small or medium sized institutional investor, you are in a position to be dishonest, if you choose to be, and in a position to profit from your dishonesty. Because all orders flow, at one point or another, through your firm or one of a handful of other big wire houses, you will know where the stop-loss triggers of non-affiliated long and short sellers are. With this in hand, you are ready to manipulate any market, especially small commodity markets like gold and silver.

The first thing you need to do is issue large numbers of false paper claims to allegedly stored gold and silver in your vault. This gold and silver really doesn’t exist, but it doesn’t matter because you are a big prestigious bank, and no one questions you when you say it is in your vault. You offer these claims for “lease” to any secondary dealer willing to take you up on it. You don’t want to sell them outright, because then you might eventually be faced with a demand for the real metal, as Morgan Stanley was. You don’t actually have enough real metal to cover these claims, so, you want to make sure that the operation takes place in a limited time frame. That’s why you “lease” the claims for a term of months. If you find that small dealers are afraid to lease such claims, you encourage them by subsidizing the leases with a negative interest rate. In other words, you pay them to accept your alleged gold and silver.

This is exactly what is happening in the precious metals market, right now. Gold and, especially, silver leases are being subsidized. As of a week ago, if you are a dealer, and you lease gold or silver, from the bullion banks, incredibly enough, THEY WILL PAY YOU! At the end of this article, I have attached a chart, showing the current negative lease rates for the various metals. Dealers who lease claims to fake metal, are able to issue futures contracts and other derivatives. The fact that they hold contractual claims to metal means they will have fulfilled the “cover” requirement imposed by their federal regulator, CFTC. The CFTC has never bothered to audit a vault to see if the gold or silver is really there, so you’ve got nothing to worry about. You’re a big bank! You say it is there. Everyone believes you, just like Morgan Stanley’s customers believed them. You might even be Morgan Stanley.

At any rate, you initially issue a lot of claims to fake metal, and so many futures contracts are written, in a very short time period, that they flood the market on exchanges like COMEX and the London Metals Exchange, where almost all the transactions are on paper, and real metal rarely changes hands. Meanwhile, if you are the big bullion bank, you know what you are doing. You issue just enough subsidized precious metal paper to automatically trigger stop-loss orders. The price starts going down as the sell orders are filled. That triggers yet more stop-loss orders, and the process becomes one of dominos, falling one after another, until the price collapses. If the operation is successful, and the collapse is big enough, market confidence is destroyed, on a wide scale.

The destruction of market sentiment won’t last forever. You can’t fool all the people all of the time. But, temporarily, having been burned badly, investors refuse to buy. Buying may still be happening on the real market, as it is, in both America and India, in gold shops. True physical metal will still be in severe shortage, so the metal will disappear quickly, as the price goes down below where true market forces should be bringing it to reach equilibrium between supply and demand. But, real market buyers look to the COMEX and the London Metals Exchange, because they think they are honest exchanges, even though they may not be.

Prices on those exchanges will determine prices charged in shops, and when the price goes down deeply, there isn’t enough product to go around, because everyone buys it. In other words, supply and demand go into disequilibrium, there isn’t enough supply to meet the demand at such low price points, so delays in delivery, as well as outright shortages result. That is what is happening, right now, in the physical gold and silver market. Not only to retail investors, but, also, even to the U.S. Mint, which has suspended production of gold coins, and is rationing silver coins.

At any rate, when market confidence is damaged sufficiently, we can move in. We unwind our new short positions in the futures market, by buying back huge number of long positions at very low prices on the COMEX. We also unwind an exponentially larger number of positions inside the shadow world of "dark pools", which are little known secretive private exchanges, controlled by the big banks. It ended up costing us some money, but not a lot compared to the money we’ve avoided losing. We’ve paid subsidies on the leases, but we’ve never actually had to buy the gold or silver, because there isn’t any available, and none in our vault. This is the way that a group of big bullion banks could induce a price collapse to unwind hundreds of billions of dollars worth of potential losses, or position themselves to go long on hundreds of billions of dollars worth of potential profits.

Contrary to the pundits at CNBC, Bloomberg, etc., the price of gold really has nothing to do with the value of the dollar or the value of oil. It doesn’t matter what the dollar is worth, in relation to euros, pounds sterling or Zimbabwee money. It only matters what supply and demand factors exist for gold. Yes, the demand will fall a bit if the price goes up, for example, in euros, because the euro has depreciated. But, what really counts is not what the euro, yen or dollar price is, but, rather, whether or not there is enough demand to soak up the available supply.

Gold is priced in dollars, but, so long as people holding either dollars, euros, yen, yuan or Zimbabwean money, are willing to pay whatever price gold is selling for, in an honest market, the price should rise. Obviously, enough people are willing to pay for gold and silver, at the previous $978 and $19.50 per troy ounce price, because the U.S. Mint could not source enough metal at those price, and had to suspend coin production.

This proves that people are more than willing to fork over, in whatever currency they are using, the previous prices for gold and silver, in such quantities, that a shortage was already existing, before the price collapse, especially in the silver market. It is true that people in poorer countries like India, might have back on their consumption.

But, while they were cutting back, demand and consumption of gold in North America, including Canada and the USA, was soaring. For example, before it suspended production of bullion coins, due to shortages, the U.S. Mint’s statistics show that it was printing 2.5 times as many gold coins, and almost 4 times as many silver bullion coins, this year, compared to last year. Gold and silver bullion, in bar form, was also flying off North American retail shelves.

Bottom line: Enough people were buying, when the price was high, to exhaust the supply. Basic economics says that, in a free market, this means the price must rise.

But we don’t live in a world of free markets. Instead, we are living in an Orwellian 1984 double-speak world. Welcome to the world of Fed/PPT, where 2+2=5, blue is yellow, and black is white. All things are as they say they are, rather than as they really must be. Welcome to the world of a controlled business media, where the pundits will do anything and say everything to convince you to forget your math, and your eyesight. No, they tell you. It really isn’t so. What you’re seeing isn’t the way it is. Believe, instead, what we tell you. We can do it! We have special skills. There is a new world order. We can make 2+2=5. Just give us your money, and we’ll show you how!

But, let’s return to reality. Right now, virtually no North American precious metals dealer can give you a firm delivery date on large quantities of silver. They have no stock to sell. This means demand is robust. On Friday, as the COMEX gold price was collapsing, the U.S. Mint suspended gold bullion coin production because it cannot source enough gold bullion! That could not happen if bullion banks were selling claims to real physical metal into the marketplace. Indeed, the Mint began rationing silver bullion coins two months ago, when it started having trouble sourcing silver bullion. Word from the Perth Mint in Australia is that it is taking weeks or months to take physical delivery of gold and silver, even though investors are already supposed to own that metal. Supposedly, it is simply being kept in the Mint's vault for safe storage. But, it is getting harder to take it out of “storage”. Meanwhile, as previously stated, Indian gold and silver dealers, wholesalers and banks all have empty vaults. None of this can happen if demand is down, and supply is abundant.

We have a disconnect between reality markets and fantasy markets. The COMEX and London Metals Exchange are fantasy markets controlled by the big bullion banks. They must be engaged in market manipulation, because nothing can explain a big price collapse, in the midst of widespread shortages and robust demand. A group of big financial institutions, deeply enmeshed in the global trading system, and heavily involved in the gold and silver market, must be deliberately inducing temporary panic, for their own purposes. These malevolent characters will eventually be able to buy back their short positions at low prices, and, possibly, also, even collect a significant long position. The process is a continuing one, and hasn’t stopped yet. On Friday, for example, the subsidy for leasing gold and silver was raised to very high levels.

It is obvious what they are doing. More important, however, is why? What does it mean? Well, the PPT bank executives are generally “people in the know” about financial events, before they actually happen, sue to close relations with regulators like the Federal Reserve, and FDIC. They folks are so desperate to cover short positions, that they are willing to spend a billion or so dollars, subsidize precious metal leases, to collapse the market, and destroy investor confidence. But, why? We know that the Federal Reserve, like other central banks, sees gold as a rival to the dollar. But, that’s not enough, because they’ve never attacked precious metals with such ferocity as now, and, if the Fed were directly involved, they could probably supply real metal.

If something terrible is about to happen in the financial world, the losses that big banks would take on their precious metal short positions would put most of them into bankruptcy. Remember the words of Warren Buffett. Derivatives are the financial world’s weapons of mass destruction. Precious metals futures short positions are highly leveraged transactions that could cost hundreds of billions if the price of gold were to suddenly explode.

We can guess that the main players here are big powerful Wall Street and/or High Street investment banks who work closely with the Federal Reserve, the ECB, and the Bank of England. These people are privy to the information needed to carry out a massive manipulation as described above. No one else is. Since most of the collapse happens on the COMEX, we can assume that most of the manipulation is being done by New York based investment banks.

Wall Street’s investment banks control most of the world's gold and silver markets. They are also entrenched in the overall mesh of all financial markets. Making matters worse, because of the 1987 President’s Executive Order on Working Markets, they are authorized to work together, and in conjunction with the U.S. Treasury and the Federal Reserve, to manipulate markets without fear of criminal prosecution. They know exactly where the stop-loss orders are, and how much flooding of paper claims for gold and silver would be needed to trigger them. They are, therefore, perfectly positioned to carry out the nefarious scheme I have outlines. The ultimate aim, of course, would be to destroy investor confidence, by collapsing the price for a few weeks. This would allow them to unload their own exposure at a very low cost, while the majority of market participants are temporarily shell-shocked, and in retreat.

As noted above, they are not using real gold or silver to do this. That implies that this particular attack on gold was not authorized by the Federal Reserve. They’ve never had any real silver and have used paper claims for years to manipulate that market. But, gold has often been supplied out of the U.S. hoards at Fort Knox, West Point, or the NY Fed. I suspect all three have had their gold hoard so heavily loaned and swapped out, that there is little or no physical gold left to play with. That’s why the Federal Reserve has been pushing for the IMF gold sales. The vaults are probably already filled with IOUs from the likes of Goldman Sachs, JP Morgan, etc. Perhaps, that is why the Treasury Department lists total U.S. gold holdings as "gold and gold swaps", and refuses to disclose details how much consists of real gold and how much consists of swap IOUs (loaned out gold). But, anyway, the lack of physical gold probably implies that the Federal Reserve is not involved directly, because they probably still have enough to flood the market for a week or two.

But, it’s not cheap to manipulate markets. It will probably cost over a billion dollars to subsidize the negative lease rates. The only logical reason to spend such a huge amount of money, is if you are going to get an even bigger benefit from doing so. They must be very worried about losing far more. Once again, that implies that some VERY bad economic news is about to be released. Skeptical? How much worse can the economy get? It can get much worse! So, what’s in store? A series of huge bank failures, maybe? IndyMac collapsed two weeks ago. Are we going to see the collapse of Washington Mutual (WM)? National City Bank (NCC)? Someone else?

I don’t know. But, I do know this. The FDIC will not have enough cash to make good on its insurance pledges, if they fail. The FDIC only has $37 billion left in its trust fund, after paying off IndyMac depositors. Between its two major divisions, WaMu has total deposits of about $204 billion. National City has about $101 billion. Could FDIC turn to the Federal Reserve for a quick loan? Not a chance! The Fed has its own problems. It has already polluted its balance sheet with some $450 billion in low value and absolutely worthless mortgage paper that its client banks wanted to get rid of.

Depositors might wait months for their money, while Congress is petitioned to approve the sale of more Treasury bills. This delay would be likely to cause other depositors to make a run on other banks, creating a domino effect. Then, more banks might fail. More bank failures will require yet more dollars, and cause more delays in making depositors whole. At the very least, the sudden issuance of $300 billion new dollars would stimulate massive inflation. Under such circumstances, gold could be expected to explode to the $2 - $3,000 per troy ounce range, within a matter of a few weeks or months.