Will the economic world end in 2012?
I agree with Martin Hutchinson (below) that the present financial situation in Europe, the UK and the USA is headed for disaster but I have a somewhat different view of what governments will do about it. All three are already hurtling down the path of Weimar Germany, with big money-printing operations happening sporadically. There will be a lot more of that -- as it is the only way all the debts can be paid. The debts will be paid with freshly-created money.
Because the supply of goods and services will remain fairly constant while the amount of money representing those goods and services expands greatly, each dollar will soon buy a lot less and could easily drop to the point where it needs a hundred dollars to buy what one dollar now buys. All savings will buy so little that they become virtually worthless. So our "betters" will rob everybody's savings to pay for their extravagance
So if savers get a knockout blow, what will happen to others? Holders of blue-chip company shares will be OK; Real Estate owners will probably gain; debtors will be laughing; Gold bugs will finally have their day and China will be right royally stiffed. They hold trillions of U.S. dollars which are set to lose most of their value. They might even drop a big one on San Francisco "accidentally" to show their displeasure.
I'm glad I live in Australia, which has very little Federal debt and a good relationship with China -- JR
According to the Mayan calendar, the Great Cycle will end on December 21, 2012, at which point the current Fourth World founded on August 11, 3114 BC will come to an end, leading us into a Fifth World of greater enlightenment. Economically, this is beginning to seem like a remarkably accurate prediction. There are a number of signs in today’s market that a world-changing crisis is approaching, after which our economic environment will never be the same.
The approach of a market apocalypse can be gauged by considering the relative valuations the market is currently putting on assets. Considered rationally, the most attractive asset today should be equity participations in the world’s fastest growing economy, China – yet Chinese equities are at 33-month lows, and many small Chinese companies are trading on earnings multiples not seen since the Great Depression. Considered rationally, among the least attractive assets today should be the long-term debt of two countries with unsustainable budget deficits and governments that have made very little effort to close them – yet British and U.S. government bonds are trading at yields close to all-time historic lows and far below the rates of inflation in their respective countries.
Extreme market irrationality of this kind is a pretty good warning signal of coming market collapse. Just as the Emperor’s Palace grounds being worth more than the state of California signaled the end of Japan’s real estate bubble in 1989, so current valuations of British and U.S. government debt signal that we are very close to a massive reversal, in which probably for several decades it becomes impossible for those governments to sell new debt except at very high cost. Bank balance sheets worldwide, which have loaded up on government debt because of the foolish Basel banking regulations and the attractiveness of “gapping” income between short-term and long-term rates, will collapse into insolvency. The early part of this collapse will be marked by a rapid reversal of “mark-to-market” regulations, so that banks are not forced to mark down their debt holdings to deflated market prices, but even if this accounting chicanery works in the short run, it will prove no solution in the long run, as short term rates rise above the meager long term yields on their government bond portfolios.
The First Pennsylvania Bank failed in 1980 through precisely this problem, at a time when there was thought to be no risk whatever of a U.S. government default or delay in payment. Adding the default possibility into the equation will simply make the problem all the more insoluble. Banks will attempt to hedge themselves through interest rate swaps and credit default swaps, but that will only cause a collapse in swap markets as well; the depth of those markets will prove completely inadequate to solve their problems. Naturally as in 2008 there will be a few sharp operators, like John Paulson and Goldman Sachs in that year, who make money out of the collapse, but their ability to do so will merely worsen the burden on the rest of the system and the costs of any attempted rescues.
There is thus considerable danger, probably in the latter half of 2012 as the Mayans predicted, of a banking system collapse dwarfing that of 2008. Value distortions such as those prevalent currently are necessarily of short duration. The eurozone problem seems certain either to find a solution or to cause a major upheaval in 2012, with the balance of probability being on the latter outcome. In the United States also, 2012 seems the period of maximum near-term danger for the budgetary problem; solutions are impossible in an election year and exacerbation of the problem by foolish handouts only too likely. Maybe the U.S. budget mess can avoid collapsing before 2013, but any market shock, for example from Europe, is likely to push it over the edge. Japan, too, is nearing the point at which its government debt to GDP ratio moves above the level at which it is unsustainable; again a market shock in 2012 could push it over the edge. To use a chemical analogy, the market solution is super-saturated, and any tiny crystal dropped into it will cause precipitation. A trivial event, such as a repetition of May 2010’s stock market “flash crash,” could be the trigger for a market collapse.
Given the extent to which banks have loaded up on “risk-free” government debt, a collapse of the government debt market will cause a collapse of the banking system. I have written before how the world economy would work rather better if government debt were not considered the universal risk-free investment, and were instead considered the doubtfully solid security it actually is. However there is no question that the transition, with the collapse of global government debt markets and banking systems, will be extremely painful. Since government debt market collapse will cause banking system collapse, there will be no rescue available.
Central banks worldwide will of course attempt to alleviate (or rather, postpone) the problem, by an endless array of gimcrack money-printing schemes. Since their credibility, already dented, will be at an all-time low as evidence of world systemic collapse emerges, they will doubtless attempt to devise money-printing schemes with a populist appeal. Thus Ben Bernanke, whose 2002 “thought experiment” of dropping $100 bills from helicopters was intended as a snobbish academic joke against the bourgeoisie, will end up doing just this. TV cameras will be lined up, the world’s financial bloggers will be prepared, and a Bernanke-bearing helicopter will appear hovering over some carefully chosen demographically balanced slum, dropping roll after roll of greenbacks to a Secret Service-prescreened crowd of adoring populace. Of course the real money will still zip by wire transfer to the vaults of the nation’s largest banks and embezzling government securities dealers, but the production values of a benign Bernanke rewarding a faithful underclass will be thought well worth creating.
It won’t work. Far from obeying Walter Bagehot’s famous advice for a financial crisis, of lending freely against top quality security at very high rates, Bernanke and his chums will as in 2008 throw money around like confetti, taking little account of the quality of the security nominally tendered, and lending it at rates that allow the banks to make yet more illicit billions by on-lending their subsidized finance. The European Central Bank’s handout last week, where it lent $600 billion of 3-year money to the banks at 1%, in the hope that they would re-lend it to tottering Eurozone governments at a spread of some 500-600 basis points, is typical of current central bank thinking.
Lend money to the banking system by all means, if you think there is a liquidity problem, and lend it for 3 years if you want to stabilize their financial position. However the money should be lent at a stiff interest rate of around 7%. At that rate, only those banks that really needed the money would have borrowed it, so the bailout would have been limited to $100 billion or so. The remainder of the rescue of banks’ balance sheets would have been achieved by them rushing to sell all their assets that yielded less than 7%. This would notably not include consumer loans and productive small-business loans, which generally yield considerably more than 7%, but it would include all the miscellaneous government junk with which the banks had been playing “gapping” games, hoping to borrow at short term rates and lend at long-term rates, capturing the spread between short-term and long-term interest rates. With their marginal funding cost 7% for 3 years, this would no longer be profitable.
Of course, many Eurozone banks, a simple lot, have not incorporated marginal pricing into their Treasury operations, so will happily borrow at 7% and lend through a different department at 3%, puzzling why their profits are less than they were. But frankly, a little Darwinian selection against stupidity in the European banking system would do no harm at all!
The chance of a system-destroying financial breakdown in 2012 is thus substantial, and December 21 is as good a day as any other on which it might occur. With government credit and banks both collapsing, the old financial world as we have known it since the Bank of England’s foundation in 1694 would indeed have ended. The good news is that this would not shove us back to 1694’s living standards. As for my Great-Aunt Nan, who put her savings in British government War Loan when she retired in 1947 and found inflation and interest rate rises eroded more than 90% of their value before she died in 1974, the disappearance of government bonds, bank stocks and many bank deposits from our assets would cause great hardship. However the central function of banks as a payment mechanism would not disappear and commercial, manufacturing and service-providing activity would continue.
The disruption would be huge, but human civilization would carry on, even the affluent Western civilization many of us have grown used to. It would not be necessary to invest our assets in gold, canned goods and a shotgun; those of us with our savings in non-financial sector stocks would find their long-term value would recover, after what would doubtless be the mother of all stock market crashes.
There would be a Fifth World for us as the Mayans predicted. In it we will finally have achieved enlightenment – about the folly of fiat money, over-powerful central banks and “risk-free” government paper. Achieving this enlightenment will be painful, but it will be worth it!
The Federal Reserve's Covert Bailout of Europe
America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here.
The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.
Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.
The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.
The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks — which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.
The Fed's support is in addition to the ECB's €489 billion ($638 billion) low-interest loans to 523 euro-zone banks last week. And if 2008 is any guide, the dollar swaps will again balloon to supplement the ECB's euro lending.
This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter Allgemeine Zeitung noted on its website that European banks took three-month credits worth $33 billion, which was financed by a swap between the ECB and the Fed. When it first came out in 2009 that the Greek government was much more heavily indebted than previously known, currency swaps reportedly arranged by Goldman Sachs were one subterfuge employed to hide its debts.
The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)
No matter the legalistic interpretation, the Fed is, working through the ECB, bailing out European banks and, indirectly, spendthrift European governments. It is difficult to count the number of things wrong with this arrangement.
First, the Fed has no authority for a bailout of Europe. My source for that judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14 to brief them on the European situation. After the meeting, Sen. Lindsey Graham told reporters that Mr. Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe. The week Mr. Bernanke promised no bailout, however, the size of the swap lines to the ECB ballooned by around $52 billion.
Second, these Federal Reserve swap arrangements foster the moral hazards and distortions that government credit allocation entails. Allowing the ECB to do the initial credit allocation — to favored banks and then, some hope, through further lending to spendthrift EU governments — does not make the problem better.
Third, the nontransparency of the swap arrangements is troublesome in a democracy. To his credit, Mr. Bernanke has promised more openness and better communication of the Fed's monetary policy goals. The swap arrangements are at odds with his promise. It is time for the Fed chairman to provide an honest accounting to Congress of what is going on.
Pentagon: US Navy will remain in Persian Gulf: "The Pentagon on Tuesday answered an Iranian warning to keep U.S. aircraft carriers out of the Persian Gulf by declaring that American warships will continue regularly scheduled deployments to the strategic waterway. George Little, the Pentagon press secretary, said the Navy operates in the Gulf in accordance with international law and to maintain 'a constant state of high vigilance' to ensure the flow of sea commerce"
We are all evil un-American terrorists now: "According to government officials, you may be a terrorist if you: are a Tea Party activist, an Occupy activist, store seven days of food, have missing fingers, buy flashlights, pay cash at hotels, are a Ron Paul supporter, are a libertarian, believe in conspiracies, own precious metals, guns and ammo. It's getting very difficult to keep up with."
Obama has learned nothing from mortgage meltdown mess: "Just days before Christmas, the Obama administration gave Bank of America a big lump of coal, levying a hefty $335 million dollar fine on the company for discriminating against minorities in its lending practices. Supposedly Countrywide, a mortgage company bought by Bank of America in 2008, had not given out enough low interest rate loans to minorities from 2004 to 2008. What the large fine reveals is that President Obama hasn’t learned anything from the recent financial crisis."
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