Wednesday, November 30, 2011

Wed Post #2: Inevitable - Part Deux

Back on March 8, 2010 we posted that the swirling economic ill winds continue to blow strong in Europe and we ignore what is going there at our own peril.

We wrote that there was an inevitable shift occurring in the great economic crisis of 2008 - 2010 (now 2011).

The first wave caused individual people and companies to face bankruptcy. The looming second wave now threatens entire governments.

Sovereign Debt is the key issue of this decade.

And unlike the Russian financial crisis of 1998, in which Russia was allowed to default on their debt, or the Argentine economic crisis of 1999-2002, when Argentina declared default in 2002, the main players in the European Debt Crisis - the PIIGS nations - will not be allowed to default.

The reason that European Sovereign Debt cannot be allowed to fail and default is because the five largest US banks hold trillions of dollars of credit default swap Over The Counter (OTC) derivatives guaranteeing that garbage debt against failure.

If European Debt is allowed to fail, the Western financial world implodes.

Ergo... Sovereign Debt cannot be allowed to fail.

That is why this blog has been such a staunch proponent of precious metals. The only way to stop the implosion of the Western financial world is to engage in Quantative Easing to infinity.

Today is seems we can now clearly see the inevitable starting to play out.

Early this morning Forbes wondered aloud if a big European bank come close to failing last night?

European banks, especially French banks, rely heavily on funding in the wholesale money markets. Did a major bank have difficulty funding its immediate liquidity needs?

The question was asked because last night The US Federal Reserve, the Bank of England, European Central Bank, the Bank of Japan, the Swiss National Bank, and the Bank of Canada moved in a coordinated action to provide liquidity to the global financial system.

Peter Schiff summarized what these actions mean:

Today’s unprecedented announcement by the world’s most powerful central banks was a loud and clear bell ringing to buy precious metals. The move, disguised as an attempt to help the fragile state of the global economy, is in reality a move to prop up failing banks in Europe and the US.

By reducing interest rates paid for dollar swaps, central bankers are in effect increasing the quantity of global dollars in circulation.

This is the pure definition of inflation: increasing the money supply. And today it was increased profoundly.

Schiff contends this may be one of the most important economic events of the year.

As Goldman Sachs made all too clear today, this is merely the beginning as more and more inflationary actions have to be undertaken by central banks to save banks from being crushed by untenable debt loads.

Whether they succeed in overturning the deflationary tsunami is unknown. What is certain is that they will bring fiat currencies to the verge of viability (and beyond) in trying.

Q.E. to infinity has begun.

Sovereign Debt cannot be allowed to fail as the US dollar will weaken, inflation will rise, and Gold/Silver will soar.

It is as inevitable as the fate of this mouse...


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Wed Post #1: An interesting proposal for Silver Miners by Eric Sprott

Eric Sprott, and Sprott Asset Management, had an intriguing message for Silver mining companies in his latest update.

Since we focus on Silver investing on the blog, you might find it it worthwhile reading.

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Silver Producers:
A Call to Action
By: Eric Sprott and David Baker

As we approach the end of 2011, the silver spot price has admittedly endured a tougher road than we would have expected. And let’s be honest – what investment firm on earth has pounded the table on silver harder than we have? After the orchestrated silver sell-off in May 2011, silver promptly rose back to US$40/oz where it consolidated nicely, only to drop back below US$30 within a two week span in late September.

The September sell-off was partly due to the market’s disappointment over Bernanke’s Operation Twist, which sounded interesting but didn’t involve any real money printing. Like the May sell-off before it, however, it was also exacerbated by a seemingly needless 21% margin rate hike by the CME on September 23rd, followed by a 20% margin hike by the Shanghai Gold Exchange – the CME’s counterpart in China, three days later.

The paper markets still dictate the spot market for physical gold and silver. When we talk about the "paper market", we’re referring to any paper contract that claims to have an underlying link to the price of gold or silver, and we’re referring to contracts that are almost always levered.

It’s highly questionable today whether the paper market has any true link to the physical market for gold and silver, and the futures market is the most obvious and influential "paper market" offender.

When the futures exchanges like the CME hike margin rates unexpectedly, it’s usually under the pretense of protecting the "integrity of the exchange" by increasing the collateral (money) required to hold a position, both for the long (future buyer) and the short (future seller). When they unexpectedly raise margin requirements two days after silver has already declined by 22%, however, who do you think that margin increase hurts the most?

The long buyer, or the short seller?

By raising the margin requirement at the very moment the long contracts have already received an initial margin call (because the price of silver has dropped), they end up doubling the longs’ pain – essentially forcing them to sell their contracts. This in turn creates even more downward price pressure, and ends up exacerbating the very risks the margin hikes were allegedly designed to address.

When reviewing the performance of silver this year, it’s important to acknowledge that nothing fundamentally changed in the physical silver market during the sell-offs in May or mid-September. In both instances, the sell-offs were intensified by unexpected margin rate hikes on the heels of an initial price decline. It should also come as no surprise to readers that the "shorts" took advantage of the September sell-off by significantly reducing their silver short positions.

Should physical silver be priced off these futures contracts?

Absolutely not. That they have any relationship at all is somewhat laughable at this point. But futures contracts continue to heavily influence spot prices all the same, and as long as the "longs" settle futures contracts in cash, which they almost always do, the futures market-induced whipsawing will likely continue. It also serves to note that the class action lawsuits launched against two major banks for silver manipulation remain unresolved today, as does the ongoing CFTC investigation into silver manipulation which has yet to bear any discernible results.

Meanwhile, despite the needless volatility triggered by the paper market, the physical market for silver has never been stronger. If the September sell-off proved anything, it’s the simple fact that PHYSICAL buyers of silver are not frightened by volatility. They view dips as buying opportunities, and they buy in size.

During the month of September, the US Mint reported the second highest sales of physical silver coins in its history, with the majority of sales made in the last two weeks of the month.

Reports from India in early October indicated that physical silver demand had created short-term supply issues for physical delivery due to problems with airline capacity.

In China, which reportedly imported 264.69 tons (7.7 million oz) of silver in September alone, the volume of silver forward contracts on the Shanghai Gold Exchange was more than six times higher than the same period in 2010.6.

It was clear to anyone following the silver market that the physical demand for the metal actually increased during the paper price decline. And why shouldn’t it? Have you been following Europe lately? Do the politicians and bureaucrats there give you confidence? Gold and silver are the most rational financial assets to own in this type of environment because they are no one’s liability. They are perfectly designed to protect us during these periods of extreme financial turmoil.

And wouldn’t you know it, despite the volatility, gold and silver have continued to do their job in 2011.

As we write this, in Canadian dollars, gold is up 23.4% on the year and silver’s up 6.8%. Meanwhile, the S&P/TSX is down -12.3%, the S&P 500 is down -5.1% and the DJIA is up a mere +0.26%.

So here’s the question: we think we understand the value and great potential in silver today, and we know that the buyers who bought in late September most definitely understand it,… but do silver mining companies appreciate how exciting the prospects for silver are?

Do the companies that actually mine the metal out of the ground understand the demand fundamentals driving the price of their underlying product?

Perhaps even more importantly, do the miners understand the significant influence they could potentially have on that demand equation if they embraced their product as a currency?

According to the CPM Group, the total silver supply in 2011, including mine supply and secondary supply (scrap, recycling, etc.), will total 1.03 billion ounces.

Of that, mine supply is expected to represent approximately 767 million ounces.

Multiplied against the current spot price of US$31/oz, we’re talking about a total silver supply of roughly US$32 billion in value today. To put this number in perspective, it’s less than the cost of JP Morgan’s WaMu mortgage write downs in 2008.

According to the Silver Institute, 777.4 million ounces of silver were used up in industrial applications, photography, jewelry and silverware in 2010.

If we assume, given a weaker global economy, that this number drops to a flat 700 million ounces in 2011, it implies a surplus of roughly 300 million ounces of silver available for investment demand this year.

At today’s silver spot price – we’re talking about roughly US$9 billion in value.

This is where the miners can make an impact.

If the largest pure play silver producers simply adopted the practice of holding 25% of their 2011 cash reserves in physical silver, they would account for almost 10% of that US$9 billion. If this practice we’re applied to the expected 2012 free cash flow of the same companies, the proportion of investable silver taken out of circulation could potentially be enormous.

Expressed another way, consider that the majority of silver miners today can mine silver for less than US$15 per ounce in operating costs. At US$30 silver, most companies will earn a pre-tax profit of at least US$15 per ounce this year. If we broadly assume an average tax rate of 33%, we’re looking at roughly US$10 of after-tax profit per ounce across the industry.

If GFMS’s mining supply forecast proves accurate, it will mean that silver mine production will account for roughly 74% of the total silver supply this year.

If silver miners were therefore to reinvest 25% of their 2011 earnings back into physical silver, they could potentially account for 21% of the approximate 300 million ounces (~$9 billion) available for investment in 2011.

If they were to reinvest all their earnings back into silver, it would shrink available 2011 investment supply by 82%. This is a purely hypothetical exercise of course, but can you imagine the impact this practice would have on silver prices?

Silver miners need to acknowledge that investors buy their shares because they believe the price of silver is going higher. We certainly do, and we are extremely active in the silver equity space. We would never buy these stocks if we didn’t. Nothing would please us more than to see these companies begin to hold a portion of their cash reserves in the very metal they produce. Silver is just another form of currency today, after all, and a superior one at that.

To take this idea further, instead of selling all their silver for cash and depositing that cash in a levered bank, silver miners should seriously consider storing a portion of their reserves in physical silver OUTSIDE OF THE BANKING SYSTEM.

Why take on all the risks of the bank when you can hold hard cash through the very metal that you mine? Given the current environment, we see much greater risk holding cash in a bank than we do in holding precious metals. And it serves to remember that thanks to 0% interest rates, banks don’t pay their customers to take on those risks today.
None of this should seem far-fetched. One of the key reasons investors have purchased physical gold and silver is to store some of their wealth outside of a financial system that looks increasingly broken.

The European banking system is a living model of that breakdown. Recent reports have revealed that more than €80-billion was pulled out of Italian banks in August and September alone. In Greece, depositors have taken almost €50-billion out their banks since the beginning of 2010.13 Greek banks are now completely reliant on ECB funding to stay afloat. The situation has deteriorated to the point where over two thirds of the roughly 500 billion euros that banks have borrowed from the ECB are now being deposited back at the central bank.

Why? Because they don’t trust other banks to stay afloat long enough to get their money back.

Silver miners shouldn’t feel any safer banking in the United States. Fitch Ratings recently warned that the US banks may face severe losses from their exposures to European debt if the contagion escalates.

There’s very little at this point to suggest that it won’t. The roots of the 2008 meltdown live on in today’s crisis. We are still facing the same problems imposed by over-leverage in the financial system, and by postponing the proper solutions we’ve only increased those risks.

We don’t expect the silver miners to corner the physical silver market, and we know the paper games will probably continue, but the silver miners must make a better effort to understand the inherent value of their product.

Gold and silver are not traditional commodities, they are money.

Their value lies in their ability to retain wealth in environments marked by
  • negative real interest rates,
  • government intervention,
  • severe economic uncertainty,
  • and vulnerable banking institutions.
Silver’s demand profile is heightened by its use in industrial applications, but it is the metal’s investment demand that will drive its future performance.

The risk of keeping all of one’s excess cash in a bank is, in our opinion, considerably more than holding it in the more enduring form of money that silver represents. It’s time for silver producers to embrace their product in the same manner their shareholders already have.


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Tuesday, November 29, 2011

Tues Post #2: Metro Vancouver Real Estate achieves a 'New Paradigm'

If you have followed the topic of real estate bubbles, you have seen the above graph (click image to enlarge).

Titled 'The Main Stages of a Bubble', it is a representation of the stages that all bubbles (real estate or otherwise) travel through.

As we watch our Real Estate bubble in Vancouver, one has to wonder if we are now approaching the end of the third stage of the bubble process; the Mania Stage.

The Mania Stage has four basic phases: Enthusiasm, Greed, Delusion and New Paradigm.

Many real estate bears, salivating in 2008/2009 that the bubble might have been bursting, thought we had seen the end of the Mania Phase.

But watching events over the past 18 months, many will surely say the current market qualifies as delusion bordering on a new paradigm.

Have we indeed made that transformation?

How else to describe the belief by some economist's that the 'threat' of a bubble forming in Metro Vancouver has dissipated?

A Conference Board of Canada report released today quotes senior economist Robin Wiebe as saying not only has “the threat of a bubble largely dissipated” in Metro Vancouver “but, really, there never was one.”

See? There never was a bubble. Our market has achieved a New Paradigm.

Perhaps this explains why, in the current mania, we see the asking price of this Shaughnessy Mansion almost double from $17 million to $31 million.

Or why we see this downtown Penthouse condominium, which sold last year for $18.1 million recently relisted for a stunning $28.8 million (click on image below to enlarge MLS screenshot of listing).

The chutzpah for these types of increases is emboldened by the belief we have achieved that 'New Paradigm'. And the new paradigm viewpoint has been further reinforced with the proliferation of articles, like this one, explaining why the influx of Chinese money won't dissipate.

For those who study Bubbles, it has always been difficult to truly appreciate how pervasive and engulfing the Mania Phase can be.

People still look back at Holland's tulip mania in the 1600's with a sense of bewilderment. Long considered the first recorded speculative bubble, the peak of tulip mania saw single tulip bulbs selling for more than 10 times the annual income of a skilled craftsman.

Peering back across the gossamer waves of time, it's often difficult to comprehend how the enthusiasm for tulip bulbs could beget the all-consuming greed that leads to the delusional prices which then entrap a nation into believing that somehow a new paradigm could be created in the price of tulips.

By the time our current situation bursts, residents of the Village on the Edge of the Rainforest will be experts on just how a inexplicable Mania can completely grip a populace.

People will say "it's just real estate" the same way we now look at them as "just tulip bulbs."


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Tues Post #1: In Australia they've started blaming the buyers for "unrealistic expectations"

When we hear or see auctioneering we always think of insolvency.

But in Australia it is commonplace to put your home up for auction before giving a mandate to estate agents. The auction of houses and land is not considered as a last resort.

In the Land of Oz, over 85% of real estate is sold by auction.

And no day is more important on the Auction calandar than the last Saturday at the end of November - the last weekend of spring in the Southern Hemisphere and traditionally the most popular day to buy and sell real estate via auction.

Known as 'Super Saturday', this particular day is considered the high point of the real estate sales year and is significantly hyped.

Anticipation was keen for this year's 'Super Saturday' as property owners and real estate agents had hoped the lead-up hype would jolt what has been a lifeless market so far this year into action.

But it wasn't just property owners and real estate agents who were looking forward to 'Super Saturday'. Those hunting for real estate 'deals' were out in force.

But 'deals' of desperation were not forthcoming as the slumping Australian market is not quite at that point yet.

With clearance rates for residential properties in Sydney and Melbourne way below expectations, buyers kept a tight grip on their wallets and only about half of all homes being put to auction sold under the hammer.

It lead the Australian news to proclaim Super slow sales on real estate market's 'Super Saturday'

It shouldn't come as a surprise. With articles proclaiming that many current homeowners are facing a problem of negative equity as a result of declining Aussie real estate values, potential buyers have become vultures. Who wants to catch a falling knife?

And an interesting dynamic is developing.

The failure of last weekends 'Super Saturday' is prompting auctioneer's to blame the potential buyers.
"Buyers were being unrealistic about property prices, auctioneer Damien Cooley of Cooley Auctions said. "We're seeing a lot of cases where an agent may quote a price such as mid to high $400,000s and buyers are turning up expecting to pay in the low $400,000s. A year ago buyers would have automatically felt they had to pay five to 10% more than what was being quoted."
Oh the horror!!

But buyer aprehension is justified.

According to SQM Research, an independent property advisory and forecasting research house which specialises in providing accurate property related advice, research and data to financial institutions, property developers and real estate investors, the Aussie real estate contraction is far from over.

"The tide hasn't turned," SQM Research director Louis Christopher said. "The worst is still in front of us. There is a huge overhang of stock for the market to work through and it is going to get worse before it gets better."

I wonder how long it will take the Real Estate industry here to blame 'unrealistic buyers' when our market turns and the bidding wars become a distant memory?


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Monday, November 28, 2011

Mon Post #2: Ron Paul explains how America shifted away from 'debt' money after the Civil War and can do it again

Ron Paul continues to lay out his platform calling for the end of the Federal Reserve and returning America to sound monetary policy.
"We know what to do - we did it once after the Civil War period, we went from a paper standard back to the gold standard, and the event wasn't that dramatic. But today the big problem is that both the conservatives and liberals have an big apetite for big government for different reasons, therefore they need the Fed to tie them over and monetize the debt. So if you don't get rid of that appetite it's going to be more difficult, but the transition isn't that difficult. You have to get your house in order; you have to balance the budget, you have to not run up debt, and you have to promise not to print any more money..."

"I am quite convinced that the system we have will not be maintained - that's what these last 4 years was all about, and that's what the turmoil in Europe is all about. The question is are they going to move toward a constitutional form of money. or are we going to go another step further into international money - instead of having an international gold standard based on the market, are we going to go toward a UN, IMF standard where they are going to control with the use of force another fiat standard. I consider that a very, very dangerous move."
Paul's comments come a day after more secret Fed bailouts were publicized.

Bloomberg reported yesterday that Secret Fed Loans Gave Banks $13 Billion.
The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.

Saved by the bailout, bankers lobbied against government regulations, a job made easier by the Fed, which never disclosed the details of the rescue to lawmakers even as Congress doled out more money and debated new rules aimed at preventing the next collapse.

A fresh narrative of the financial crisis of 2007 to 2009 emerges from 29,000 pages of Fed documents obtained under the Freedom of Information Act and central bank records of more than 21,000 transactions. While Fed officials say that almost all of the loans were repaid and there have been no losses, details suggest taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger.

Is there anyone who still really believes we shouldn’t be taking a closer look at the Federal Reserve’s activities?


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Mon Post #1: Events in Europe, QE and Gold/Silver

To say that we live in interesting times is nothing short of an understatement.

Sovereign Debt will be the issue of this decade and the situation with the PIIGS (Portugal, Ireland, Italy, Greece, Spain) in Europe dominates the headlines again this past weekend.

A stunning article appreared in the UK newspaper, The Telegraph, which reported that Britain's Foreign Office has given instructions to embassies and consulates to begin contingency planning to help expats should the crushing debt of the PIIGS collapse the Euro.

Even more incredibly, a senior minister has revealed that Britain is now planning on the basis that a Euro collapse is not just a possibility, but that it is only a matter of time.
A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time. “It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.
Meanwhile Société Générale (SocGen), a large European Bank and a major Financial Services company that has a substantial global presence, has come out its Multi Asset Portfolio Scenario/Strategy guide wherein the French bank makes the simple case that the worse things get, the stronger the response by global central banks will be.
"A major liquidity crisis should not occur this time, as we think we are on the eve of major QE in the UK, US and (a bit) later on in the EZ."
How big will QE3 be?

According to SocGen, the Fed will preannounce it in the January 2012 FOMC statement and that the monetization will last from March 2012 until the end of the year and will buy a total of $600 billion.

Many analysts believe the actual total will be well greater, probably in the $1.5 trillion range as the Fed will finally say "enough" to piecemeal solutions and grab the bull by the horns.

What really stands out is SocGen's investment advice:
"Buy gold ahead of QE3 as money creation has a strong impact on prices... Gold is highly sensitive to US QE, as every dollar of QE goes into M0, triggering the debasement of the USD."
SocGen sees Gold going to $8,500/oz so as...
"to catch up with the increase in the monetary base since 1920 (as it did in the early 80s)."
Older readers will recall that was a time when Gold went from $35/oz to $850/oz.


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Friday, November 25, 2011

What we cannot seem to see

I read a great quote today:

"Many of the world’s financial and economic woes since 2008 began with the bursting of the biggest bubble in history. Never before had house prices risen so fast, for so long, in so many countries..."

That's how a recent Economist article, 'House of Horrors 2: The bursting of the housing bubble is only half over', begins. And it makes a statement that few in Vancouver truly understand. It bares repeating:

"Never before had house prices risen so fast, for so long, in so many countries"

Vancouver's house prices are not a reflection of inherent value. They are a by-product of a world-wide debt phenomena that was deliberately created. Click the image below to enlarge and read a critical quote uttered by economist Paul Krugman on August 2, 2002:

In America, US President George Bush almost singlehandedly, through cheap rates, lax regulation, government housing subsidies, presidential boosterism and financial engineering, managed to get the home ownership rate to 70% as part of a deliberate strategy in expand the economy. A bubble was created BY DESIGN.

In Canada, Prime Minister Stephen Harper added fuel to the bonfire.

In the last six years we’ve had more pro-real estate initiatives than in the quarter-century prior to that.

We've had the zero down, forty year mortgage. The ability to raid the RRSP fund for down payments. The Home Reno Tax Credit. Emergency interest rates. First-time buyer’s closing cost credit. Regulations that permit liar loans. Regulations that permit zero-down payments with cash back from mortgage lenders. And most significantly, CMHC absorbing all lender risk.

Cheap credit, artificially supressed interest rates and government policy have fuelled this real estate boom.

You must understand this... our sky-high real estate prices are not a reflection of real value but a by-product of a deliberate strategy to create a bubble and inflate the economy.

In many countries the bust of the boom created by these policies have started. But as the Economist notes:

"The bust has been much less widespread than the boom. Home prices tumbled by 34% in America from 2006 to their low point earlier this year; in Ireland they plunged by an even more painful 45% from their peak in 2007; and prices have fallen by around 15% in Spain and Denmark. But in most other countries they have dipped by less than 10%, as in Britain and Italy. In some countries, such as Australia and Canada, prices wobbled but then surged to new highs. As a result, many property markets are still looking uncomfortably overvalued."

Many here think that because our bubble has not burst yet that we are not really in a bubble and that our housing prices are not artificially inflated, but are a reflection of 'true value'.

They are wrong. We ARE in a credit inflated bubble, a bubble that is part of a world wide phenomena. And that bubble is unsustainable.

As the Economist concludes, the worldwide housing bust is only half over and the full impact is yet to begin in many countries.

Canada is one of those countries.

We are, as the Economist notes, "more overvalued than America was at it's peak."

Unfortunatly most of us cannot seem to see that.


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Thursday, November 24, 2011

Who will bail out the US Federal Reserve?

Came across an interesting editorial by James Rickards, senior managing director of Tangent Capital and author of the book 'Currency Wars'. Rickards asks some interesting questions about how the US Federal Reserve funds itself.

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From Occupy Wall Street to the halls of Congress there is anger at bailouts orchestrated by the U.S. Federal Reserve. These bailouts have not been limited to banks but include brokers, money market funds and foreign corporations. The Fed has released details grudgingly and some disclosures were forced by the Dodd-Frank legislation. Gradually the bailouts have been revealed as if a veil were slowly being drawn to display a densely formed mosaic. The bailouts have enriched stockholders, bondholders and CEO’s while unemployment remains at depression levels and forty-six million Americans survive on food stamps.

But what if the Fed itself needed to be bailed-out? The Fed may be a central bank, but it is still a bank with a balance sheet and capital. A balance sheet has two sides consisting of assets and liabilities. The Fed’s assets are mostly government securities it buys and its liabilities are mostly the money it prints to buy them. Capital consists of the assets minus the liabilities.

The Fed has capital of about $60 billion and assets approaching $3 trillion. If the Fed’s assets declined in value by just 2 percent, that decline applied to $3 trillion in assets produces a $60 billion loss—enough to wipe out the Fed’s capital. A 2 percent decline is not unusual in today’s volatile markets.

The Fed is well aware of this problem. In 2008, the Fed met with Congress to discuss propping up its balance sheet by issuing its own bonds as the Treasury does now. By getting permission from Congress to issue new Fed Bonds, the Federal Reserve could tighten monetary conditions when the time came without having to sell the bonds on its books and realize losses. Sales of the new Fed Bonds would replace sales of the old Treasury bonds to reduce the money supply. This way, the losses on the old Treasury bonds would stay hidden.

In 2009, Janet Yellen, now a member of the Fed board, went public with this request in a New York speech. Regarding the power to issue new Fed Bonds, Yellen said, “I would feel happier having it now.” Yellen seemed eager to get the program under way, and with good reason. The Fed’s looming insolvency was becoming more apparent by the day as it piled more leverage on its capital base.

This bond scam was shot down on Capitol Hill, and once it failed, the Fed needed another solution quickly. The answer was a deal struck between Treasury and the Fed that did not require approval from Congress.

The Fed earns huge profits every year on the interest received on Treasury bonds the Fed owns. The Fed normally pays these profits back to the Treasury. Behind closed doors, the Fed and Treasury agreed that the Fed could suspend the repayments and keep the cash. The amount the Fed would usually pay to the Treasury would be set up as an IOU.

Now as losses on future bond sales arise, the Fed does not reduce capital, as would normally occur, instead they increase the amount of the IOU to the Treasury. In effect, the Fed is issuing private IOUs to the Treasury and using the cash to avoid appearing insolvent. As long as the Fed can keep issuing these IOUs, its capital will not be wiped out by losses on its bonds. Corporate executives who played these kinds of accounting games would be sent to jail. Americans might be outraged to know that the Treasury is a public institution while the Fed is privately owned by banks, so this accounting sham is another example of bilking the taxpayers to enrich the banks.

The United States now has a system in which the Treasury runs huge deficits and sells bonds to keep from going broke. The Fed prints money to buy those bonds and loses money owning them. Then the Treasury takes IOUs back from the Fed to keep the Fed from going broke. This arrangement resembles two drunks leaning on each other so neither one falls down. Today, with its 50-to-1 leverage and investment in volatile securities, the Fed looks more like a poorly run hedge fund than a central bank.

Even this Treasury lifeline to the Fed may not be enough in the long run. If the Fed begins a new round of money printing and the Treasury continues with trillion-dollar plus deficits, there may come a time when even the credit of the Treasury and Fed are called into question and the money printing circus grinds to a halt. At that point the Fed could “phone a friend” at the IMF and be bailed out by a kind of IMF funny money called “special drawing rights” or SDR’s, or the Fed could use its nuclear option and go back to the gold standard using the gold in Fort Knox. Given the limited amount of gold and the huge amount of paper money that would have to be backstopped, the new gold price would be $7,000 per ounce or higher. These kinds of spikes in the price of gold during money crises have happened before – in 1930’s and the 1970’s. Those crises were forty years apart and the last one was forty years ago so a new crisis in the near future would be right on time.


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To our American friends...


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Tuesday, November 22, 2011

Ron Paul on the US Federal Reserve: "It is immoral"

Congressman Ron Paul (and candidate for the US Republican 2011 presidential nomination) delivered a speech for the National Association of Home Builders at the 29th Annual Cato Monetary Conference yesterday.

The key topics were the US monetary policy and the US Federal Reserve.
"I think there is no doubt that the Federal Reserve is immoral, it's unconstitutional, it's a disaster and we don't need it... The Federal Reserve is an institution that was created by the Congress and the Congress has been totally derelict in their duties as far as oversight of the Federal Reserve."
In the middle of an election campaign, here you have a man who is speaking consistently with everything he has said about monetary policy for the last 30 years. He refuses to pander to the electorate and change his opinions to garner votes. Ron Paul tells you exactly how it is in this excellent speech.

This is the man who 'should' be the next president of the United States.


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If at first your house doesn't sell... double the asking price!

Time for another tale from the Bubble Zone.

As noted last week in the Vancouver Sun newspaper, a house has just gone on the market at 3390 The Crescent for $31.9 million.

The Crescent lies at the heart of one of Vancouver's most upscale neighbourhood's: Shaughnessy. The street itself is a  circular road with a lovely park in the middle. And 3390 is a palatial white house that sits on an acre sized lot where The Crescent meets Osler Street.

The house itself contains 10,516 sq. ft of space spread over three storeys. There are six bedrooms, eight bathrooms and five fireplaces, along with a wine cellar, a games room, a gym and staff quarters.

With a backyard pool, a koi pond, a greenhouse, and large, beautifully landscaped grounds; the home is 'palatial' in every sense of the word.

But what makes this mansion stand out is it's selling history. The current owners bought the home in April 2004 for $6 million.

Last year the home was listed for sale for $17.9 million, but there were no takers at that 'bargain' price.

And we say 'bargain' price because after looking at the high prices mansions are commanding in Shaughnessy (a house that sold last year on Angus Drive for $5.7 million was recently assessed at $9 million), the owners decided to raise the asking price from $17.9 million to $31.9 million.

That's right... the home failed to sell so they doubled the asking price.

Who says there's a disconnect in our real estate market?


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Saturday, November 19, 2011

Steve Forbes: The Dollar Will Be Re-Linked To Gold within 5 years

Steve Forbes makes a number of very good points about monetary policy, what he terms “the most boring subject in the world” and goes on to predict that, within the next five years, the U.S. dollar will again be linked to gold.

His discussion of time and money and how the government shouldn’t be in the business of manipulating either is particularly intriguing.


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Friday, November 18, 2011

Time to bail on Gold and Silver... right?

It's been interesting to watch the mainstream media coverage of Gold and Silver the last few months.

Every time gold undergoes a significant correction, the gold bears come out of the woodwork to proclaim that the gold 'bubble' has finally burst and we're about to see a massive sell-off.

The viewpoint is propagated despite the fact that the global debt crisis goes hand in hand with monetary inflationism. Governments faced with either significantly cutting bloated spending levels and raising taxes always choose  currency debasement as the easy way out.

The notion that Gold and Silver are in a bubble, either from a fundamental or technical perspective, simply does not stand to reason.

And one only has to look at what Central Banks around the world are doing to frame those assertions properly.

As noted in yesterday's Globe and Mail newspaper, Central Banks are going on a Gold Rush.

Official net purchases of Gold by Central Banks exploded in the recently completed third quarter of 2011. Central Banks purchased 148.8 tonnes of Gold, more than double the entire amount of government buying in 2010 according to a report by the World Gold Council, a London-based industry association.

The surge is startling to some because until last year, Central Banks had been net sellers of gold for two decades. But this year they are adding to stockpiles at what the Gold Council reckons is a record pace, reflecting deep concern about the longer-term viability of the U.S. dollar and the euro as stores of value.

“We are seeing what now looks like unprecedented levels of central bank buying,” said Marcus Grubb, managing director, investment, at the Gold Council. “We do believe this is a long-term trend. This is not just short-term, tactical buying.”

Do you think they would be buying if Gold and Silver were in bubbles perched on highs that were about to plunge dramatically?

Of course this news came yesterday which happened to be a day when both Gold and Silver plunged dramatically.  Silver was down over $2.00 and has left some scratching their heads in bewilderment.

The blog, The Golden Truth, made note of Silver's steep decline yesterday and pointed the finger at one culprit: JP Morgan.

As faithful readers of this blog know all too well, JP Morgan is is hopelessly short COMEX silver futures and by the explicit admission of one of the CFTC directors, JP Morgan manipulates the silver market illegally.

And Silver watchers this week have seen some stunning developments occurring in the COMEX markets.

Two days ago, in a move which raised eyebrows throughout the precious metals trading community, JP Morgan moved 1.1 million ounces of silver from the the "eligible" bin and into the "registered" bin. This amount represents nearly 50% of JPM's "eligible" silver

(The COMEX inventory of gold and silver is reported on a daily basis and breaks out the inventory between "eligible," which is metal being "safekept" at the COMEX by investors who have taken delivery, and "registered," which is the metal that has been certified by the COMEX to meet its delivery standards and is being held for the purposes of delivery.)

The author of The Golden Truth, having studied the COMEX open interest and inventories for nearly 10 years, believes that the outright size of this inventory move by JP Morgan is unusually large and would suggest that JP Morgan is anticipating the probability of having to deliver a lot of silver for the December delivery month (of which JP Morgan is likely short at least 17k of the current 34k open interest, or 85 million ounces.)

Many analysts, seeing these developments, have been bracing themselves for another smackdown of the precious metals.

This is because, with 9 trading days left until the "first notice" day (November 30th) for December silver deliveries, the open interest for December remains extraordinarily high.

In order for the December open interest to get down to a level which represents just the total amount of registered silver - roughly 33 million ounces - the December open interest will have to bleed down to 6600 contracts. This is a big liquidation in just 9 days.

When you combine this with JP Morgan's recent inventory behavior, the implication is that delivery supply could get very tight this month.

To drive down the open interest, it is crucial that the spot price of Silver comes down precipitously. 

As The Golden Truth notes:
The key here is to understand that the action between now and first notice day for December delivery has nothing to do with market fundamentals or outright global demand for silver and everything to do with JP Morgan's ability to try and force the silver market lower to protect its short position AND the unwillingness of our Government to enforce the laws in place to prevent this kind of market manipulation. Furthermore, the key to trading and investing in silver when the market goes through phases like this is to either hold what you got and don't watch the intra-day volatility or buy the down-spikes aggressively and take some profits on the rebound, but make sure you take full advantage of this market inefficiency and wealth-enhancing opportunity and increase your overall holdings.
Look at what is happening in Europe right now. Do the fundamentals suggest flight from the precious metals?

Yes, liquidity issues are prompting a sell off in the only assets that are performing well (Gold/Silver) in order to access cash, and that is part of the reason for the sell-off, But close inspection of the sell-off times and amounts have got JP Morgan's manipulation fingerprints and style M.O. all over them.

The Golden Truth makes a keen observation:
One of these days the market is going to blow up in JP Morgan's face because they won't have enough physical supply of silver to meet delivery demands and we'll be reading about JP Morgan the same way we are reading about MF Global, only it will be many multiples more severe. It will potentially be catastrophic to the U.S. dollar and any remaining faith thereof. You want to make sure you have as much of your paper money moved into gold and silver because when the market does blow up like that, the end-game will be near and gold and silver will undergo a breathtaking move higher. I would suggest that behavior like we are seeing by JP Morgan this week indicates that the "blow up" event is getting closer.
And that is all you need to know about what you should be doing with your investment funds right now.


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Thursday, November 17, 2011

What's wrong with this picture?

Did you ever play Monopoly as a kid and, as the designated banker, succumb to the temptation to simply remove some money for yourself if you were strapped for cash?

Wouldn't it be great if you could do that in real life?  Solve your money problems by simply creating more cash for yourself?

That's basically what the United States is doing.

As notes, at the close of business on Tuesday the debt of the US federal government exceeded $15 trillion for the first time - with the largest single owner of the publicly held portion of that debt being the US Federal Reserve.

Over the past year, as the Federal Reserve massively increased its holdings of U.S. Treasury securities and entities in China marginally decreased theirs, the Fed surpassed the Chinese as the top owner of publicly held U.S. government debt.

In its latest monthly report, the US Federal Reserve said that as of Sept. 28, it owned $1.665 trillion in U.S. Treasury securities. That was more than double the $812 billion in U.S. Treasury securities the Fed said it owned as of Sept. 29, 2010.

Meanwhile, as of the end of this September, entities in mainland China owned $1.1483 trillion in U.S. Treasury securities, according to data published today by the U.S. Treasury Department. That was down slightly from the $1.1519 trillion in U.S. Treasury securities the Chinese owned as of the end of September 2010, according to the same Treasury Department report.

Thus, at the end of September 2010, the Chinese owned about $339.9 billion more in U.S. Treasury securities than the Fed owned at that time. By the end of September 2011, the Fed owned about $516.7 billion more in U.S. Treasury securities than the Chinese owned.

Perhaps the most astonishing statistic is that since Barack Obama has been President, the US debt has gone from $10,626,877,048,913 on January 20, 2009 to $15,033,607,255,920 as of yesterday. That's a stunning increase of 41.5%, or $4.4 trillion.

No wonder the US Federal Reserve is now the largest holder of debt.  Who else, besides the ones who are printing the currency, is there to buy it?


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Wednesday, November 16, 2011

Keeping the balls in the air

The email inbox overflows from yesterday's posting on the political attack video about Vancouver's Mayor Moonbeam, clearly striking a nerve on various sides of the civic political spectrum.

Today, however, we switch gears and go back to world's debt problems.

As we have commented before, debt will be the issue of this coming decade... specifically Sovereign Debt. 

The ticking time bomb in this mess is the financial product known as 'derivatives', vehicles which Warren Buffet labeled as "financial weapons of mass destruction".

I am fond of saying that what we experienced in 2008 was a deep, financial earthquake - the repercussions of which we do not fully appreciate nor understand.

I maintain that viewpoint even today.

The chain of events set into motion in 2008 still has a long way to play out. A massive amount of private and public debt  has accumulated and the system needs to allow this debt to unwind, no matter how painful this process will be (and it will be painful).

We cannot have meaningful recovery until this happens.

But Western governments have not allowed this to happen. They have intervened to prevent the pain.

The slate needs to be wiped clean but the problem is eliminating all these debts, deficits and unfunded social entitilements will trigger the gorilla in the room: the $600 trillion of derivatives created by the banks.

This is why the Euro zone and the PIIGS is such an important topic.

Bloomberg hilighted this today by reporting that JP Morgan and Goldman Sachs have disclosed to shareholders those two banks alone have have sold protection on more than $5 trillion of debt globally (much of it dependant on the debt of Greece, Italy and Spain).

Bloomberg notes, "as concerns mount that those countries may not be creditworthy, investors are being kept in the dark about how much risk U.S. banks face from a default. Firms including Goldman Sachs and JPMorgan don’t provide a full picture of potential losses and gains in such a scenario, giving only net numbers or excluding some derivatives altogether."

The banking system has enabled the creation of an unsustainable mountain of debt.

What we have watched since 2008 has been nothing more than a complex juggling act that has - so far - failed to deal with the root of the problem: eliminating the debt.

The crisis that looms on the horizion will be the biggest event in our lives and understanding/preparing for it will be the most important step you will ever take.

Future generations will look back upon the 25-year period after 2008 in a way that dwarfs the 25-year period that followed 1929.


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Tuesday, November 15, 2011

Mayor Moonbeam

For those who don't live in British Columbia, the cities and municipalities of our fair Province will be heading to the polls this coming Saturday for civic elections.

And while this blog doesn't support any party or individual, we had to chuckle at this creative youtube vid about the current Vancouver civic election issues and it's Mayor, Gregor Robertson (who has been dubbed 'Mayor Moonbeam' for many of his policies).


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CNBC announces Ron Paul 'surges' into tie for lead in Iowa Republican Presidential Race



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Sunday, November 13, 2011

Sunday Post #2: The European Debt Crisis Explained

Blogger Gonzalo Lira has produced an excellent post trying to make the European Debt Crisis understandable for the average joe.

It also succinctly explains why more Quantitative Easing is almost assured.

The European Debt Crisis: This is what happened

In 1999, the Europeans implemented a common currency, the euro. They did it in order to improve trade between the eurozone nations, and thus bind the European countries closer together.

This new currency was centrally managed—that is, there was a single issuer of this new currency. Which of course makes sense: In the United States, you don’t have 50 states issuing currency—you just have the Federal Reserve, issuing dollars for the entire country.

Same with Europe: Thus the eurozone - the zone of countries that had the euro as their currency. This new currency was managed by the European Central Bank - the ECB - out in Frankfurt, Germany. The ECB’s primary concern - like all central banks - was making sure that the currency it was supervising did not lose value. That is, it made sure that inflation stayed below 2% per year.

However, just like in the U.S., though there was a central bank - in this case the ECB -each of the member states of this European Money Union (from where we get the acronym “EMU”) - could issue its own debt.

So far, so good: The euro was printed and managed by the ECB in Frankfurt. The individual countries - pain, France, Germany, Holland - could each issue their own debt, and of course manage their own government budgets.

Now, the strongest economy in Europe is Germany’s. For our purposes, the reasons why of this don’t matter. What matters is, Germany’s cost of borrowing was the lowest of the eurozone.

This makes sense: If I make a million bucks a year, and borrow $10,000 for expenses and stuff, I’m going to get a pretty good interest rate from my credit card company or my bank. You know how lenders are: They lend you an umbrella when it’s sunny, then take it away when it rains. Since I don’t need to borrow the ten grand, all the lenders will trip over themselves to lend me money at extremely low rates, because they know I’m good for it. I won’t default on the debt.

Same with nations - and same with Germany: German debt was always cheap, in the 1%–3% range, because Germany was good for it. After all, it’s the fifth largest economy in the world, and the biggest within the eurozone, racking trade- and fiscal budget surpluses year after year. So who wouldn’t feel comfortable lending money to the Germans? Nobody - ‘cause see the Germans? They pay up - always.

But here comes the problem: Banks felt very comfortable lending money cheaply to Germany. Germany was a member of the eurozone. Therefore, lenders assumed that the other countries in the eurozone were going to be as good a credit risk as Germany.

So the banks lent money to the other, weaker countries in the eurozone at the same rates of interest as they lent to Germany.

Imagine you have a great credit rating - so the bank gives your kid a $100,000 consumer line of credit, just because he happens to live in the same house as you do. The bank lends your kid the money because it says there’s a “tacit promise” that if your kid doesn’t pay back the money, you will.

Crazy, right? Right - but that is the core problem: Countries like Portugal, Italy, Ireland, Greece and Spain - countries whose initials spell out the acronym “PIIGS” - could go into debt at the same rates of interest as Germany, just because they shared the euro as a currency.

The economies of the PIIGS were not as sound as Germany’s - but the lenders treated them as if they were. Not only that, the lenders assumed that, if any country got into trouble - i.e., if any one of the PIIGS couldn’t pay back their loans - the eurozone as a whole would be good for the debt.

This was great for the PIIGS. Because it meant cheap and plentiful loans, with which they could go out and buy stuff.

So they did: The PIIGS went into debt - too much debt  - while the banks gave them all the slack they needed. Which makes complete sense: If before 1999, these countries were borrowing at (say) 6% or more, and all of a sudden their cost of borrowing drops in half, what will they do? Go into debt!

Which is what they did - massively.

And what did these countries do with the debt? Create a false sense of prosperity!

This in a nutshell is what happened between 1999 and 2010, when the Greek crisis first erupted: During those “boom” years (which were really no more than junior going crazy with the credit card), the various countries of the eurozone went into massive debt, in order to both fund a social safety net, and cut taxes on their citizens.

In other words, something for nothing, bought and paid for with cheap debt. Kind of like America. 

Though they now don’t want to admit it, the Germans encouraged this over-indebtedness, by the way - as did the French. Why? Because with this false sense of prosperity, the over-indebted nations bought German and French goods and services. German and French banks were at the forefront of lending money to the PIIGS - which essentially made the whole scheme nothing more than vendor financing on a massive scale: I lend you money so that you can buy my products.

Just like a junkie setting up an addict, or a predatory credit card company giving you teaser rates, the Germans and the French - via their banks and government institutions—gave the weaker economies all the incentive in the world to go into massive debt, and then go out and buy German and French products.

It was bound to end in tears. As is happening now. It all goes to the issue that all these countries are over-indebted. And that overindebtedness is being reflected in the sovereign bond markets.

Let’s take a slight detour, to explain what this means.

What Are Bonds? What Are Yields? And Why Do They Matter?

A bond is a bit of paper that is traded, just like stocks. But unlike a stock, which is a piece of ownership in a company, a bond is essentially a promissory note: You lend me money, and I give you this piece of paper where I promise to pay you back. The bond has a face value, and an interest rate. The person who buys the bond at the market price collects the interest, and receives the principal of the bond on maturation. A person can own a bond, or sell it to someone else, just like a stock.

Corporations issue bonds, in order to finance factories, expansion, whathaveyou. And governments issue bonds, in order to finance various infrastructure projects, as well as their deficit spending.

With all bonds, there are three pieces you have to understand: There is the face-value of the bond, there is the interest that the bond pays, and then there’s the effective return-on-investment of the bond—which is known as the yield.

The yield of a bond is what everyone pays attention to. The yield on a bond is a percentage value: It is the interest rate of the bond, times the face value of the bond, divided by the current price of the bond. The yield is inversely affected by the price of the bond: The higher the price of the bond, the lower the yield, and vice versa.

So you see, it’s a seesaw: When the yield of the bond is going up, then the price of the bond is going down. When the yield is going down, then the price of the bond is going up.

Let’s see an example: Say I sell you a bond for €1,000, paying 5% interest per year. The bond is trading in the open markets at €900. So 5% times €1,000, divided by €900, equals 5.55%—the yield has widened, as they say in the biz. That is, the yield has gone up, since the price of the bond has gone down.

But say instead that the bond has risen in value, which of course can happen: Say the price is up to €1,100 per bond. So 5% (the original interest) time €1,000 (the face value), divided by €1,100 (the current price, gives us a yield of 4.54%. The bond’s yield is said to be narrowing.

Since bonds all have different conditions insofar as maturation, interest rate, etc., it is simpler and quicker to speak of changes in yield only: “The yield is rising” means that the price of the bond is going down.

Why is the price of a bond going down? Because investors think that the person who owes the debt—the bond issuer—is not necessarily good for the debt. That is, they think the debtor might default. So the owners of the bond sell it at a lower price, because they don’t want to have the risk of a default.

Why does a bond go up in price? Because the debtor might show signs that it won’t default—so the high yield makes it attractive for a buyer to pay more for the bond, thereby driving up the price, thus paradoxically lowering the yield of the bond.

So what does this mean for countries?

Well, when the yield of a government bond rises, it means that people are selling that country’s bonds. Take the above example of €1,000 bonds paying 5%. If the bonds are now at €900, the yield is at 5.55%, as per the above example.

Now, if the yield on that bond rises to 7%, what does that mean? It means that the bond is trading at distressed levels. Because for a €1,000 bond paying 5% interest to be yielding 7%, then the bond is trading in the €715 range. (The face-value price of €1,000 times 5% divided by a current price of €715 yields 7%.)

So say you’re a government, and you have to fund €1 billion for a bridge. You will issue bonds to finance the bridge, bonds that will pay an interest of 5% a year. In order to raise those billion euros, you have to sell not a million €1,000 bonds—you have to sell 1,400,000 bonds with a face value of €1,000.

And therefore, you have to pay interest on 1,400,000 bonds, instead of 1,000,000 bonds. And when these bonds mature—that is, when they have to be paid off in full—the government won’t be paying out €1 billion in principal: They’ll be paying out €1.4 billion in principal, on what was supposed to be a €1 billion bridge. Because bonds are paid full face value on maturation.

Thus a government’s cost of borrowing has risen. And it’s all expressed in the yield.

That’s why yields matter. And unfortunately, rising yields is what’s been going on with European debt: They have risen massively—because investors think there is a less likelihood that the bonds will be paid back in full.

Why does this matter? Because these nations are all relying on deficit spending: They spend more money than they bring in. So they need to issue more debt, in order to pay off their obligations, such as salaries, pensions, medical care, not to mention pay off the interest on the previous bonds they’ve already issued.

So in this situation, a country can get to the point where its bonds are selling at such a discounted value that it cannot issue enough bonds to simultaneously pay off their obligations and allow them to continue to function at their current level.

That is, countries can get to the point of bankruptcy—depending on how high the yields on their bonds rise.

Now, About Greece

This is what happened to Greece: Its cost of borrowing rose so much that they no longer had the ability to raise the cash to pay off all their obligations.

So starting in April of 2010, the so-called Troika—the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC, the executive arm of the European Union)—structured a bailout package, which was eventually passed through in June.

The bailout package of course had some conditions, which the Greeks agreed to in order to get the money—and which they then promptly failed to live up to.

The details aren’t that important for the purposes of this discussion. What matters about the Greek Drama is two-fold:
    • One, Greece is a small economy within the EMU—about 2% of the eurozone’s GDP—so therefore its debts, while massive, were all-in-all manageable.
    • Two, the bailout of Greece was supposed to be swift and decisive, and act as a signal to the markets that the Troika would defend the eurozone, and not allow any of its members to go bankrupt. In other words, Greece was a firewall, to protect the other economies.

But the problem was, the Troika dithered.

Why did they dither? Because it became immediately clear that the only way to fix the Greek situation was by debt haircuts—and haircuts were impossible, because they would bankrupt the European banks. And the American ones too.

Fear of a Credit Event

Part of any debt restructuring—be it a poor man’s bankruptcy, or the bankruptcy of a large corporation—is debt haircuts: That is, lenders get less than the 100% of the debt that they are owed.

Say I owe $10,000 to a car dealership for a new car I bought last year, and I go bankrupt. The dealer will get a percentage of the money I have left after everything (including the car) is liquidated. But they won’t get the full $10,000 that I owe them, obviously, because I’m bankrupt: I owe more than I have.

Same with nations: Greece owed more than they had—so Greece’s lenders were going to have to take a haircut. That is, they would have to take less money than they were owed.

This is what’s known as a “credit event”.

This was a problem.

If there was a haircut on Greek debt—a credit event—then the banks and insurance companies which held the debt (predominantly German and French banks) would have to write a loss on those loans. Huge losses. Losses bigger than their capital.

Thus these banks would go bankrupt, if there was a credit event in Greek debt.

Even if they didn’t go bankrupt, these financial institutions would have to sell off other bonds, in order to raise the cash to stave off bankruptcy.

This massive sell-off of sovereign bonds would have a contagion effect: In order to cover their Greek bond losses, banks would have to sell their Italian, Spanish and French bonds—at a loss—so as to raise the cash to stay solvent, which would in turn make Italian, Spanish and French debt toxic.

In other words, a domino effect.

Furthermore, American banks—which don’t own much in the way of PIIGS debt directly—have written a lot of insurance on those sovereign bonds: The famed credit default swaps (CDS). Bank of America especially has made a lot of money selling CDS’s on those debts in 2008, 2009 and 2010, as has JPMorgan.

If those sovereign bonds defaulted, those American banks would have to pay off these CDS’s—

—and thus they would go bankrupt too!

Everything is connected: A credit event in Greek bonds would trigger credit events in Italian, Spanish and eventually French bonds, which would bankrupt European banks as well as American banks—

—basically, a repeat of the 2008 Global Financial Crisis, only bigger, and without the happy ending.

This is why the Troika dithered. They talked tough, and they even put the gun to Greece’s head: Pass these austerity measures, or else no bailout money. But they never pulled the trigger and let Greece fail—because if they did, the European and American banking sector would collapse.

Since the Greek financial hole grew bigger between 2010 and 2011—because the Greek’s didn’t live up to most of their promises—a second bailout package had to be created.

Again—more dithering. This time, the dithering was because the Germans in particular feel that they are propping up spendthrift countries—and nobody likes to feel like the chump who’s paying for other people’s good times.

There is enormous political pressure on Merkel to not save Greece. The people pressuring Merkel don’t realize what will happen if Greece collapses.

So then last October 28, the Troika plus German Chancellor Angela Merkel and French President Nicolas Sarkozy finally came up with a “solution” to the Greek Drama.

“Solution” is used in the loosest possible sense of the word: In the weeks previous to the Oct. 28 announcement, the Europeans had been going around the world, hat in hand, asking emerging markets—especially China—to fund their bailout facility. They had been politely refused—because they’re not stupid: They saw that the bailout facility—the famed European Financial Stability Facility (EFSF)—was just a lot of smoke and mirrors, essentially throwing good money after bad.

Through some clever accounting tricks and some not-so-clever baldfaced lies involving accounting standards, the Europeans managed to cobble together a workable EFSF which could give Greece and potentially one of the other PIIGS a lifeline.

But in order to show that they were “serious”, the Troika and Merkel and Sarkozy insisted that the Greeks agree to a serious of painful austerity measures.

The big news, however, was that this second bailout of Greece included haircuts on Greek debt. The advertised number on the Greek haircuts was fifty percent! (Though when you looked more closely at the details, it was more like 20%.) The Oct. 28 deal stipulated that the haircuts on the Greek debt would be voluntary—“voluntary” as opposed to “forced”, which would have triggered a credit event)—

—but then on the following Monday, Georgios Papandreou, the Prime Minister of Greece, threw a monkey wrench into the Rube Goldberg contraption that is the Second Greek Bailout Package:

G-Pap called for a popular referendum of the bailout!

All hell broke loose.

The eurocrats famously do not like going to the public to ask for their support—they like to dictate instead. Why? Because they consistently lose the popular vote, to the point where they no longer bother putting things up for a vote.

For Papandreou to put the austerity package to a popular referendum meant that it would likely not pass—because no citizenry likes to be asked if they want their government to give them less services and entitlements (duh!).

Therefore, the Troika suspended the €8 billion tranche of the first bailout package that the Greeks were supposed to get in November.

Without that tranche, Greece goes bankrupt on December 15.

So Papandreou backtracked on Thursday, November 3, and said that there would be no referendum.

But the damage was done: The bond markets got so freaked out that they started looking at the next weak link in the European chain.

Enter Italy

In mid October, Italian debt was yielding about 3.5%—very respectable. Italy, furthermore, has a very large debt, but it is far from insolvent: In fact its government regularly meets its budget with a bit of a surplus. Balance of trade is okay, growth is low but in line with the rest of Europe. And aside from periodice sex scandals, the Berlusconi government is fairly competent and efficient.

Overall, Italy is in pretty good shape.

But it needs more debt to pay off previous debts, and to shore up its economy, which is in a recession much like the rest of the world’s. It’s debt load is growing, but strictly because its government is spending to prop up the sagging Italian economy.

Nevertheless, after the Greek fiasco, the bond markets turned on Italy.

On the Monday after the Greek Week (Nov. 7), Italian yields rose from their 5% level—then spiked on Wednesday to above 7.6%, which is potentially catastrophic. Why catastrophic? Because at those levels, no advanced economy can finance itself—not to mention the fact that certain derivatives require that yields stay below certain thresholds. If they remain above certain yield numbers for a set period of time, they are considered credit events—which triggers CDS’s, which lead to bank bankruptcies.

So those yields have to go down now—fast.

This crisis in Italy has led Silvio Berlusconi to resign, once austerity measures are passed. His resignation will likely calm the markets—for a bit.

What is striking is the inanity of the eurocrats’ response. They come up with vague and flimsy packages, and a lot of flowery rhetoric—you should have just heard Sarkozy, after the Oct. 28 deal, going all French Literature on the thing.

But the Europeans don’t seem to understand that they have a nuclear weapon at their disposal—which they refuse to use.

And that nuclear weapon in the European Central Bank.

Fear of Monetization

The easiest way to fix this entire debt situation would be for the European Central Bank to simply print up money, and go out and buy enough Greek and Italian debt to bring down their yields.

It wouldn’t even have to be very much—a mere €50 billion would do the trick. The fear that the markets would have of being caught on the wrong side of a trade against the ECB would be enough to keep the markets docile and quiet.

And this is where more QE is almost assured.

 You have to stabilize the patient, before you give him the treatment—not operate him for liver cancer while he’s still bleeding from a gunshot wound to the leg.

Having the ECB come in and decisely calm the markets—like the Swiss National Bank did a month ago—would be the best way to get the European house in order, and then implement the structural reforms and austerity measures that everyone agrees need to be implemented.

But the ECB isn’t stabilizing the patient. Why? Because the Germans are greedy.

If the ECB does a European version of Quantitative Easing, the Germans are afraid that their currency will weaken—which they do not want, because they are a creditor nation. If the euro’s value erodes, then Germany will have lost some purchasing power.

They are so afraid of the euro weakening—and thus the Germans losing a bit of their surplus—that they are making the other economies in the eurozone crash.

The Germans do not seem to understand that, if the nations of Europe go down, there will be no buyers for their goods and services—so they will suffer too.

Thus the ECB sits there, while this Greek problem becomes now an Italian problem—

—and soon a French problem: The yields of French bonds are rising precipitously, and already one French bank, Credit Agricole, is in trouble over the Greek Drama. It’s only a matter of time before the big French banks start tumbling—and then France itself—unless the bond markets are calmed.

So What’s Going To Happen?

At some point the Germans are going to come to their senses, and the ECB will start buying up European sovereign debt, calming the markets. Greece and a couple of other small and/or weak eurozone countries exit the European Monetary Union, go back to local currencies, devalue, and then rebuild their economies; say Greece, Portugal, Spain and maybe Italy. And finally, austerity measures are imposed, fiscal budgets are put on a sounder footing, and things right themselves in a few years.


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