Destruction of economy by parasitic governments and financial institutions

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The destruction of our economy by parasitic governments and financial institutions

Present

Most countries’ financial centers and governments are currently in the process of expanding the supply of world currencies and cheap credit, in order to boost their own budgets, salaries and political power and to avoid recessions.   One of the effects of this policy is the protection of their own personal wealth consisting of paper assets such as bond and stock funds that would otherwise have collapsed.

Past

A similar expansion of the monetary supply has historically led to the de-industrialization of  entire regions or countries that followed such policies for a sustainable period of time, typically over several generations.   On the surface, the mechanism of such de-industrialization seems to work by inflating the costs of doing business faster than the price inflation of manufactured goods and services produced by affected companies, thus destroying profitability, especially when a vast supply of goods is available from peripheral provinces or from other countries.  One such example was the 5th century Roman Empire (see Fall Of Empire essay), the other one is 16th century Spain under Philip II.

“Nuts and bolts”

Industrial companies that may initially enjoy the cheap credit, use it to expand production facilities or other business assets, which then leads to excess production or excess supply of services and inevitably destroys profitability.   Decreasing profitability reduces investment yield, the Return On Investment (ROI) but it also serves to restrain the inflationary pressure fuelled by the financial expansion.   The reduced inflationary pressure due to collapsing profitability allows the central banks and governments to maintain the low inter-banking lending interest rate which in turn facilitates the issuance of even more credit, including borrowing by the governments for virtually limitless spending on themselves.

Risk management, CDS and leverage

The issuance of more and more credit to an expanding circle of corporate and other borrowers at a time of falling yields would have normally been stopped at some level by the rising risk premium preventing a further reduction of interest rates.  Rising loan risk would have acted as a negative feedback preventing the currently observed unprecedented drop in interest rates and related bond yields.  It would have ultimately prevented excessive credit generation.   The negative risk-mediated feedback has been sabotaged by the use of a special form of financial credit insurance called “Credit Default Swaps” (CDS).   CDS allowed the lending institutions to exceed the lending limits imposed by the normal risk avoidance standards (and by common sense) , by allowing them to profitably lend, giving very low and falling loan interest rates.   In this low interest rate environment, it was necessary to lower the required capital reserve for banks and financial institutions such as hedge funds in order to maintain the expected profitability.  Until recently, this required capital reserve was decreed to be 1:11 (capital-to-total loans), which was recently further reduced by the “Basel 3” agreement to 1:30 bringing the world banks to similar “standards” as hedge  funds which “enjoyed”  the 30:1 leverage even before the 2008 crash  (Leverage is the inverse of the capital requirement).

Positive feedback loop of destruction

Apart from destroying industrial profits, the excessive credit also creates bubbles in selected investment sectors such as stock, futures and bonds.  Rising bond prices are further depressing  the yields and interest rates which further accelerated the lending.  This situation is described in science and engineering by the term “positive feedback loop”. This means that even a small input stimulus is amplified by the system and fed back to an input, amplifying itself further until the system reaches some very large deviation from an equilibrium, and saturates or the system breaks down.

Eventually financial companies flee the market where interest rates and Return On Investment (ROI) has been depressed, moving most of their investment capital off-shore to countries where the ROI is still high.   The process is repeated until all manufacturing economies end up eventually running unprofitable industries, subsidized at first by the investment capital influx, later by government subsidies to maintain employment and to prevent the paper assets backed by industry from crashing.   Subsidized manufacturing in poorer countries floods the world market with underpriced industrial goods allowing prices of industrial goods to remain stagnant (deflation) in spite of the rapid expansion of the financial system and money.
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I saw the future...
   
The last stage of this economic destruction is the breakdown of the unprofitable manufacturing, resources and agricultural sectors when the subsidies run out or when the employees refuse to work under the austere conditions imposed upon them by the profit squeeze. This process, like the credit growth itself, is also governed by the positive feedback law.   Once started, it will accelerate, fuelling itself like a cancer or fire.  This will happen specifically, when food prices and the cost of living overtake the wages paid by unprofitable manufacturing companies causing industrial disruption due to strikes and closures, leading to further increases in the cost of living and so on.   

The impact of this upon the developed countries that almost totally depend upon the subsidized under-priced production from the developing countries, will be equally severe.  A decline of the subsidized imports of industrial and consumer goods will cause the supply chain to break down in the developed economies, leading to explosive inflation of all prices for manufactured goods, commodities, food and services.  The ensuing inflation will put an upward pressure on interest rates which government will no longer be able to obfuscate or manipulate using financial techniques alone.

Aftermath

The  inflation-induced jump in interest rates and yields will crash the bond market (bond values are inverse to their yields).  Old bonds will drop in value destroying most of the pension funds and probably most of the financial institutions, given that it may trigger an avalanche of CDS claims (another positive feedback) which will accelerate the institutional and systemic collapse.  At the same time, the new bonds will become very expensive for borrowers to issue, thereby derailing the “gravy train” enjoyed by governments and large corporations the world over.  It may even make the refinancing or rollover of old debt impossible.

The break-down of the government bond market will cause currency exchange rates to vary wildly and may cause some currencies to crash and disappear, beginning with those countries that will default on their government bonds first and ending with probably all presently known paper currencies disappearing and being replaced by something else.  

Science, technology and ideas (including business ideas) are unlimited.   Completely new industrial companies, technologies and services will be created, filling in the present business vacuum, using new-old forms of self-financing and capital-rising that are more robust and do not depend on large financial institutions and governments.  This will happen in the countries that  provide a legal framework effective in protecting private ownership and civil order yet not stifled by any excessive legislation or taxation.

The good news is that that which worked in the past, will work in the future, and what didn’t work in the past will not work in the future either.

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Definition of money and the time-symmetry

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A few thoughts:

1) Gold Money = Past Work.

A money system that is 100% backed by tangible products such as gold or by some real consummer produce such as food, cars, seashells etc is the symbol or equivalent substitute of work done in the past. A found pot of Roman gold coins represents work done by some people 2000 years ago. To create a monetary system like that you first have to mine out and accumulate some gold, copper etc or make some products and then you can have a "money" backed by it. It is mildly deflationary (in a harmless way, probably) since the amount of goods and products generally accumulates faster than gold.

A monetary system based on the assets produced in the past is inherently stable for the same reason that the automation control systems based on the "feed-forward" principle (as opposed to "feed-back") have to be. That is because past products are inherently more solid that the promise of future products! (I was just about to write "because the Past is Immutable" but on the second thought decided not to).

It's downside (or perhaps an advantage?) is the fact that it is very difficult to generate new investment credit and lend money very quickly for large projects, other then through a slow process of accumulation of capital. In particular, it is very difficult for governments and large corporations to obtain large amounts of capital without direct taxation or outright confiscation of capital from productive business entities. Such activity cannot be easily concealed by authorities and if attempted, it would be declared illegal as well as incompatible with the democratic principles. This type of monetary system probably enforces honesty and encourages work-oriented culture (if backed by the effective legal system). This is probably the main reason why the gold backed monetary system was first subverted and finally abolished by most governments.

2) Debt Money = Future Work.

Money based exclusively on debt is the present equivalent substitute of a work promised, a work that will be done in the future. Other than this difference, the system works (initially) the same way as #1! It is typically mildly inflationary because it is always easier to borrow more and generate excessive debt. The system tends to generate more of the debt-backed money, than can be reasonably predicted to be covered by the productive work in the future. In addition to the inherently poor money issuance control, unpredictable disasters or business failures tend to undermine a balance tilting it towards inflation.

When the future comes and some debt proves to be defaulted, then the equivalent amount of debt-backed money must by law be destroyed. This 'must' NEVER happens! It's a Keynesian's fallacy, for example that a government is supposed to be counter-cyclical, restraining its spending during a boom. In theory it must be done but never gets done! At least, not when the big governments run by incompetent collectivists have their way! :)

Eventually, excessive unbacked phantom money keeps accumulating because nobody is destroying it! Nobody likes becoming the first one to burn their paper banknotes, admit that their bonds (held or issued) are worthless etc. In the event of mass defaults, business closures or just corporate downsizing, the debt-backed monetary system seems to give all players an incentive to maintain a fiction and pretend that the paper assets backed by the defunct debt still have some value. It encourages the players to cheat, and punishes honesty. This honesty disincentive is also compounded by massive leverage through banking lending multiplier (it's name is '33') and derrivatives (I think the system would probably still remain inherently unstable even without the multipliers and derrivatives).

The main advantage (or perhaps its main fault) is the fact that it is very easy to generate additional credit to finance some urgent projects or startups. It's main alure is probably the fact that the very large players such as governments and some very large corporations, may generate and use gigantic amounts of new credit/money without actually producing anything useful co-measurate with the amount of resources they are appropriating. They can do all that in plain view without breaking any law, and without breaking principles of democracy.

3) Present Time Money

Can Present Money be defined as the average of #1 and #2?  One can envisage a 50%-50% mixture (or similar ratio) of both forms of money-backing asset classes (hard assets from the past or gold,  plus debt counted as an asset), but it is not really equivalent to any product being produced in the present! The 50-50 money backing scheme has no relation to the current work being done in the present time! Such monetary systems have been used in the past and are called "fractional reserve gold backed currency". It is like standing on two boats with one foot in each.

I think, the nearest equivalent of a "money" system that reflects a work being done in the present time is barter - which in fact uses no money at all! Such a system did work in the past, but only in a very primeval economy. Could such a system have worked in an industrialized economy such as during the Industrial Revolution in the last 200 years? Absolutely not! Would such a system work in the future information based economy? Perhaps, I don't know but I would not exclude a possibility that it may work!  We have to get used to a habit of challenging the old "wisdoms" because the new ways of global information access make certain formerly impractical ideas possible, for example a direct democracy! I have a gut feeling that this could be the key point behind the future economic revival!

I think, that kind of systemic classification based on the symmetry patterns is always helpful in science, it may even have some predictive power.
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Why does Canadian gov...

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... steal less?  Less than other governments! Hope you will enjoy this refreshing point of view, and appologies for straying away from the main blog topics.  (feel free to click that box on the right, it's OK.  8-:) )

This discussion begun with Gavin Hewitt's BBC article

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Stan "Dozent" P. wrote:

You were right, the British papers are much more interesting and honest then North American, BUT...

Quote:

"That is one of the key conclusions of the paper. Since adopting the euro Greece, Ireland, Italy, Portugal and Spain have become increasingly uncompetitive. That and the slowdown in productivity is the heart of the crisis in the eurozone, rather than debt. Debt is a symptom."

No, It is not, pure and simple. Uncompetitiveness is a symptom. Debt is the result of the disease. The Euro is a facilitator, not the root cause. The cause of the cancer is rooted deeper, much deeper. It is true that without the conversion to Euro the massive theft ( or misallocation of capital  8-)  ) in Greece and Ireland would not have happened.  But a similar story has happened in USA and it is hard to blame it on adopting a dollar. Iceland is in the worse situation then Greece or Ireland yet it does NOT use the Euro! One can not blame it on the Mediterranean culture either. Iceland is a country of tough, hard working people yet it is screwed up just as well.

The root cause is that western elites and governments are indolent and corrupt to the bone. Give the mouse a piece of cheese, he will ask for a glass of milk.

20 years ago Argentina and Brasil went bankrupt. Their liabilities were about 100 Billion. Their popolation 100 million Who the heck lent 120 Billion to Iceland, a country of 300,000 people? Who lent 600 billion to Ireland, the country of 3 million? Greeks did what Bernie Madoff would do if he was a state! Cheated, falsified numbers, and paid bills with new phony money. Who the heck packaged all these Alabama Ninja mortgages into "AAA" securities. Who sold this crap to Icelandic banks? Where did they got the money to pay for it? When you look at it closely, Iceland was used to launder money and they got a commission for doing it.

The establishment, the governments and their paid journalists will invent one reason after another why this crisis happened and continues.  This will change nothing Thanks God our Canadian Prime Minister took a bribe of $300,000.  He thought it is BIG MONEY.  Thanks God another Prime Minister got involved in his friend Golf Course.  It cost taxpayers 0.5 million.  Thanks to these crooks, our government was paralyzed for 20 years and missed the greatest thieving opportunity of their lives.  Thank to them, we can calmly wait until this economic bomb explodes SOMEWHERE ELSE.  Explode it will! A few hundred crooks cannot stop 6 billion people who want to live decent lives.  Someone, somewhere, sometimes will default on their "obligations" and this whole house of cards will fall apart.

Stan P.

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Money matters

I am glad to present another interesting essay written by Dozent (Stan P.), this is a continuation on the subject of Baby Boomers culture (that we fondly refer to as "Monkeys"), this time discussed in the context of economy and money.  I hope you will enjoy it.

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Stan (Heretic) wrote Re:

I found that being too "business"-obsessed in the sense of seeing monetary rewards in everything is also a sign of a "monkey".   The reverse is probably also true. Real people want to be paid real money but they (we) are not too obsessed with it. Playing games with monetary reward, that is withholding it when due and rewarding arbitrarily when it is not warranted, is _their_ signature.

Stan,


I always knew it and I have acted upon it.


What is money (I mean real-money) ? It is equivalent of work or in other terms a rechargeable work-battery   :-)


I like to work. It is normal. Why should I be obsessed with WORK.  If you can not make money then you do work nobody wants.  But the problem is: you NEVER KNOW what will sell.


A few years ago I found your "marketing research.on your sensors a little funny, but "harmless" so I said nothing.  Simply estimating the potential size of the market is a good thing.  But that as far as I would go.


I know "if the product WORKS for me then it will most likely work for others".   I veered off topic. "Monkeys" are obsessed with money because they can not do any useful work. For them money is NOT an equivalent of work. No wonder they print it - they can not not see the equivalence. They either "hustle" money or receive it for being loyal to the boss.  They can not earn it on the open work market because they have no marketable skills.  They can not make things other people need.  They are obsessed wit it because it is their constant problem.

Mind you, this definition automatically defines who is a "human" [in our sense] and who is a "monkey" [figuratively, not literally, in a cultural sense, S.B.].    The critical words are "what people need".


It means that a singer like lady Gaga is a human being because she creates something "people need" and are willing to pay for.   It means she is working for her money. It is a kind of work you and me do not understand, but we can not be Astronauts either.


The definition of "useful work" is that is has a "monetary value" on the market. Loyalty and arse kissing does not have a monetary value on the market though it does have value to the Top Monkey and is rewarded accordingly. However, nothing has been created neither by loyal followers nor the boss.  The money, being an equivalent of work must be stolen by a form of "taxation" or simple extortion.

This defines instantly the role of the government.   What government creates ?   Services ?   What services ? No, the only "product" government "creates" is SECURITY.   Mind you, it is a marketable product and people are willing to pay for it.   Providing security is a full time job.
Now what is a value of a well equipped army.  That depends.  If you are facing Hitler or Genghis Khan, nothing else matters.   The problem is a professional army could not stop Hitler.  If fact, it was wiped out and proved completely useless.   In the end a few million of regular folks had to leave their stores, their factories, their fields, they had to learn to fight and they kicked ass.


So the security it is not worth 50% of MY EARNINGS.   If it is, it is time to make weapons and go to war.

There is a reason why the "monkeys" do not understand the connection between work and money.   For them, there isn't any. No matter how hard they "work" ie talk, go to meetings, make noise and other efforts nothing happens.


There is no product, no buyer, no sale and no money.

Now we can go back and create some definitions.  

[Goods and Services]

To state the obvious: people need things.  In order to survive people need goods and services like food, shelter, clothing, tools etc...     These goods have to be made. For the sake of efficiency and quality work specialization is required so most of the goods we need is made by other people.  By definition services are provided by other people.  Primeval societies "found" things they needed. There was a very high "intrinsic" component in goods.  We hunted land animals and fish, collected nuts, dug roots, used wood, bone, native gold, obsidian and flint.  With few exceptions like fish we have exhausted the available supply of  things we could find.  Now ALL the goods have to be made by human labor.

[Trade and Economy]

The second factor is an economy of scale. It was difficult to kill an animal to catch a fish or to make a bow. It was even more difficult to produce "high tech" product like a bronze axe or a gold ear-rings. It required a skill and a know how.  Once the smith made first good axe, it was easy to make 10 or 20 more.  Then one could trade them for some beautiful sea shells    :-)      You know I am serious there. Trade is as old as humankind.   What was the first trade?   Well, the Bible is probably right: a woman exchanging sex for food though a Snake had nothing to do with it!

[Money, Value, Currency and Fake Value ]

Trade started as barter. Money was invented later to facilitate the exchange.   Money is a concept. It is a measure of "value" humans attach to goods and services.   Value is the desire of humans to "own" or "consume" goods and services.   However, money has an weakness. It needs a medium to be implement in practice.  A medium like sea shells, iron bars or gold and silver.   The medium has to be convenient to carry, indestructible, difficult and expensive to produce,  impossible to fake, easily recognizable and uniform (that is why diamonds are not money).    It has to have value to humans but it can not have any utility value so it will not be destroyed.    It has to be rare and expensive but not too rare nor too expensive.


The only medium of exchange that survived the centuries is gold and silver.   Over time, gold and silver has become money though it does not have any use and little utilitarian value.

Gold and silver money has serious flaw - the supply is limited by the availability of metal.  However, this is alleviated by increasing the velocity of money and creating credit.   Velocity of money is a fancy name for reuse.   A buys from B, B buys from C etc...  the same money facilitated multiple transactions.


Credit is a legal note created by a creditor, and backed by his tangible assets.   It is an obligation to buy back the note after the prescribed time for the principal plus interest.  This obligation must be enforced by law.   Money is an equivalent of labor.   It works like a rechargeable battery.   It "stores" human labor in a convenient form for later consumption.   However, people rarely need a pure human labor like the "professional" services of a doctor or lawyer.   In most cases we need "goods" ie. things which have been made by labor. The labor itself is hidden from consumer  in the "value" of these goods.   The value of the "product" is a measure of a desire of people to consume it.   Thus, "money" is an equivalent of goods and labor and a store of value ie. desire to consume.  


Credit is equivalent of work to be done in the future by the debtor in exchange for money borrowed from the creditor.   To account for the risk to the creditor the borrower has to pay interest.


Currency is a credit note issued by the government as a legal means of exchange.   In theory, the government promises to buy it back at any time for money.  The government is a debtor, the saver is the creditor.  It is a cheap credit as the government does not pay interest [or very little of it].   Money can not be easily created.   It has to be saved and pooled to create capital.  

Money is an asset and will hold value for as long as people desire gold and other rare objects.


Currency is a piece of paper. It has value as long as the government says it does. This "value" can be wiped out with one stroke of a pen. Currency is someone's liability. It holds value only as long as the issuer is credit-worthy and can pay back its debt..


Gold Rubles and gold Krugerrands are money . The Reichsmarks were currency. It lost all real value on 9-May-1945.


In the mid 20 century something curious had happened - currency had become "money".   The liability has become an asset.  The piece of paper acquired value backed by the creditworthiness of entire nations.  It is not the first time it has been tried.  The kings of France tried this.  The kings of England tried this.  The results were rather sorry - the kings lost their heads.  The current massive experiment lasted 70 years for over 3 generations.  One could think it was successful, but the fraud was just so big it took a very long time for the results to first appear.  Now the cows are coming home.  The currency will go to zero again, but that is a subject for another essay.

This simple definition of  "money" and  "currency"  has a very far reaching consequences.  First, it provides a clear distinction between human producers and parasitic consumers.  Second, it provides a clear distinction between money and currency.  Third, it clearly defines the role of the "government".

There are many people who have no skills or no desire to produce anything. Yet they need the manufactured goods and services in order to survive.   I call them "Monkeys" because just like the monkeys they tend to congregate into troupes and many are actually destructive.  The critical statement is this: since Monkeys do not make anything they can not "earn" money.  They have to steal it or extort it.  They congregate in groups of alike individuals and use agression to hustle a living.
The Currency is NOT money. It is a piece of paper. It obfuscates the role and the very nature of money as a deferred labor.  It enables the incompetent, destructive "monkeys" to pretend they also create "value".


However, currency is designed and promoted as the equivalent of money thus the equivalent of labor but unlike labor,  it can be printed at will.   It makes "credit" cheap.   After all, all it takes is to print a piece of paper.   It makes savings an oxymoron.   The banks do not need savings to issue credit.   Sooner or later credit printing gets out of control and the whole fraud unwinds.  We are witnessing it now.

The only products government can manufacture and sell is law and security.   Personal security.  It is a legitimate role and a legitimate products.   In fact, it is priceless.  Laws permit economies to function.  It enables property ownership and civility.   Personal security is the first step to political freedom which has been proven to promote wealth creation.

This has become a book. The real point can be made starting here with the "Monkeys" taking over the government in the times of prosperity and the replacement of  money with currency.  The system starts rotting from the top and the disaster is unavoidable.


I have no desire to write this book.  I know you know the end.  We both know the resulting cycle is very long.  In fact, this may well be the explanation of the Kondratiev's super-wave.  There has to be a longer cycle - about 3-4 generations.  In short, the cycle starts with competent people and real money and it ends with "Monkeys" in charge and worthless paper currency.

See you tomorrow.
Stan P.

(Text in brackets [] and quotes added by Heretic)
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Update 24-April-2010.
More comments posted on this subject, see under the previous article.

External debt of Ireland falls to €1.61 trillion

According to todays' Irish Times article.  Population of the Republic of Ireland is 4.5M.

Quote:

Ireland’s external debt continued to fall, standing at €1.61 trillion at the end of December 2009, a decrease of €26 billion compared with the end of September. The figures from the Central Statistics Office (CSO) include general government, the monetary authority, financial and non-financial corporations and households.    ... Credit institutions and money market funds had debt of €661 billion at the end of last year, a fall of close to €30 billion compared to three months earlier, and a decline of €107 billion compared to a year earlier.  However, general Government foreign borrowing rose €2 billion to €75 billion between the end of September and December 31st 2009 as new long-term debt securities were issued, off-setting redemptions in short-term securities. Compared to a year earlier, it was €17 billion higher.  Intra-group borrowing and fluctuating exchange rates accounted for a rise in direct investment debt liabilities of €10 billion to €210 billion.

My comments:

It will take 31 years to pay back 1.6Teu at that rate providing that Irish institutions and households find enough assets to pay all that.   There are many questions,  I am curious as to who the creditors are?  British? Germans?    Why did they lent so much to a country with no assets other than property they were lending for?    If most of that was backed up by property, that is clearly under water now, since the 50% property price drop in 2007-2009.  How could an island nation of 4.5M people own 1.6Teu worth of properties to back that all up?   How long (maturity) are those liabilities?  Does Ireland really own that much in backup assets or is most of that 1.6Teu really unsupported by anything other than a promise to pay it back?  That would be roughly 1Meu per family/household!     Iceland's case springs to my mind.

Are Saudis evacuating their money? Is a new war imminent?

I will make exception and post this comment on the recent news:

Suitcase With $134 Billion Puts Dollar on Edge: William Pesek (Bloomberg)

I consider it to be too bizarre to be false. I totally do not buy the "mafia forgery" theory. I also doubt that it has anything to do with Japan but of course have absolutely no proof whatsoever.
I think its time to buy some more oil...

US TBonds crashing?

What makes me think of that possibility?

Fekete's article:

... U.S. debt [1T$ in TBonds] in Chinese hands has no definable value: any time the Chinese want to sell a sizeable amount, all bids are withdrawn. The Chinese are stuck with it. They have to wait for their money until maturity. But who knows what the purchasing power of the dollar will then be? The best the Chinese can do is to “grin and bear it.” They can’t even say “ouch”, because this would further hasten the deterioration of marketability of their paper. The periodic warnings from China that the U.S. government should display greater fiscal responsibility and it should follow a stricter monetary regimen sound like whistling in the dark. ...

And this:

Fed to buy up to $300B long-term Treasury bonds

WASHINGTON (AP) -- The Federal Reserve announced Wednesday it will spend up to $300 billion over the next six months to buy long-term government bonds, a new step aimed at lifting the country out of recession by lowering rates on mortgages and other consumer debt. ...

Let me review some of the relevant events of the last months, chronologically:

1) Chinese gov is declaring a 600B$ stimulus for Chinese infrastructure

2) Chinese central bank is (probably) trying to sell some of their US TBonds discovering (probably) that they either cannot sell or that they have to discount them.

3) Chinese government officials complain to the US government and criticize US in public on the subject of the integrity of the foreign held paper assets issued by the US Treasury.

4) For the first time since the financial crisis begun, Federal Reserve is printing very large amount of cash (300B$) to buy TBonds on the market.

Why do I have a nagging suspicion that the events 2 and 4 may be somehow related? Is the Federal Reserve buying up the US TBonds that the Chinese bank was trying to sell on the market but couldn't? Note that buying TBond by Fed is equivalent of printing cash! 300B$ is probably 20-30% of the existing money (M1) in circulation.

Conclusions:

- this is highly inflationary, and is likely to counteract the current bank-bailout engineered deflationary credit squeeze.

- the old rule that the pre-mature resale value of the long bonds (but not short term bills) is supposed to be inversely proportional to the yield, no longer seems to apply or requires a large correction factor in the zero yield limit.

I suspect that the long term fixed income assets become illiquid or may even lose value once the yield goes below about 3% or so (at present). It's a case of a theory stretched and extrapolated beyond it's proven domain. Everyone assumed that since lowering the yields from 12% to 6% increased the money velocity in the past and increased credit supply, then lowering it from 3% down to 1.5% or from 0.5% to 0.25% is going to have a similar effect. I think what the present events have demonstrated is that the system is non-linear and that the money supply versus yield curve reverses below a certain yield threshold such as 6% (not sure of the exact figure, read also this - scroll down to the entry on Wed 2 July 2003 titled "What exactly is the relation between interest rates and inflation?" ). The result seems to be the opposite to the expected: forcing the Treasury yields below 3% seemed to have REDUCED the credit supply on the market and led to deflation!

Since everybody loves predictions, I have to finish on this note:

- if China could not easely sell their TBonds so will the US gov not be able to do so either, in the nearest future, forcing the US gov to print even more money than today's 300B$, counteracting deflation and eventually (probably) causing inflation.

- falling TBond resale prices on the open market will increase inflationary expectations and will force all the other new bonds to carry higher yields - despite the government's central banks declarations.

- large players, such as sovereign funds are likely to question the role of the dollar as the universal currency, to renumerate their assets in. The death of the US TBonds (if that happens) means also a death of the dollar!

P.S. (21/03)

I wrote it in the morning, later it was announced that the total sum is 1.2T$: 300B$ of new cash to buy US TBonds on the market and the rest to buy some other dodgy paper assets. That move is effectively doubling the money supply. I have seen that kind of economics in the People's Republic of Poland in the 1970-ties. I have seen the "future" and it did not work! Ask any Pole who lived through this period what a "virtual coal" was. 8-)

A crash has just begun in Ireland!

Fasten your belts and brace for a crash landing!

Today's Irish Independent article :

The publication of the two reports coincide with the news that at least €10bn has been withdrawn from Ireland in the past week as the impact on Ireland's financial reputation emerges.

If the outflow of funds has begun as I wrote in my blog 3 months ago, if that is 10Beu/week then it is a matter of a few weeks before all Irish banks will run out of cash and the gov will have to either fork out that cash (if it has got any left), renege on the promise or let them all fail! In my back of the envelope estimate there is only 20-40Beu of cash reserves left with the Irish banks, perhaps even less!

Updated 19/04/2009

I was off by 2 weeks. The banks ran out of cash after 6 weeks instead of 4 as I thought. Irish government managed to save their bacon, for the time being by injecting 90B eu of fresh money into their system, in the first week of April. Irish banks ONE : Irish taxpayers ZERO, everybody happy, all love! This should last them about 3 more months assuming that the cash bleed rate stays the same. We should expect some more interesting news in the middle of the summer. So far so good, go to a pub, drink beer...

Can US Treasury Bonds default?

http://www.kitco.com/ind/willie/oct302008.html

Quotes:

A topic raging lately between us has been the failures to deliver USTreasurys. This extraordinary phenomenon highlights the extreme mountain of toxic bond (in)securities spewed worldwide by the corrupted US financial sector, but it also highlights the questionable legitimacy of USTreasury Bonds. The traded volume of USTBonds had been recorded a few years ago to be over $2 trillion above official issuance in USTBonds. So maybe we are seeing a redux of counterfeit issuance of USTBonds in order to satisfy unprecedented demand. By the way, USTreasury management is done, and accounting is done, handled by only one giant bank.

Could the failures to deliver USTreasurys, as shown in the alarming graphic below, be a precursor to actual default? We will see. Kirby maintains a period of tremendous hyper-inflation is coming. My forecast is for a possible USTreasury default, as conditions grow out of control, and economic disintegration catches the nation by surprise. The collapse of General Motors could trigger a profound change in perception concerning the effective implementation of USGovt and Wall Street bailouts and rescues. Either way, disruptions like never seen before are on the horizon. The settlement failures bring into question the integrity of the USTreasurys as a legitimate market. Their counterfeit from more supply than issuance is well documented, and rings like a loud echo to the naked stock shorting chapter of US financial markets.


P.S. (post-edited 6-Nov-2008)

I thought I had to add this: the reason I believe it's important is because it reminds me of the same pattern of discovery of the massive (though illegal) naked shorting of the small cap and recently the large cap companies, on the US stock market! (see the refs below.) The first sign of the "smoke" was the "failure to deliver" of the stock to Depository Trust & Clearing Corporation (DTCC) within 3 days following a transaction. Apparently, just before the current financial collapse begun earlier this year, the failure to deliver reached a few % of the total volume. If the same now seems to be affecting the bond market, it means massive shortfall of the T-Bonds, that is some institutions were trading "I owe yous" without having the said assets available to cover.

In other words, a fractional reserve banking principle applied to bonds rather than just to the monetary base!

This is a much bigger potential issue in the financial system than the naked shorting of some stocks. About ten times bigger!

References:

The Register article

Patrick Byrne (Deep Capture blog)

(Added 4-Dec-2008)

The Value of Money by J.E.Carrasco

Quote:

"US 30 YEAR BONDS
Having been an institutional bond trader, it is absolutely unbelievable to me that the 30-year US bond is trading at a yield of 3.19%. In light of the current liabilities facing the US government (discussed below) and the fact of the coming Baby Boomer cohort's retirement, I can't help but conclude that the final credit bubble to burst is the US long bond. Yields will greatly increase sooner than later as all these liabilities are assumed by the US tax payers."

(Updated 5-Dec-2008)

Jim Grant: Go Ahead, Fools, Keep Buying Treasuries

(Updated 31-Dec-2008)

Bond Dealers, Hedge Funds Will Face Penalty for Failed Trades

Quote:

With interest rates so low, bond market participants have less incentive to solve settlement problems because they’re forgoing less return than usual on a failed trade.

...

Fails climbed in the weeks following the Sept. 15 collapse of Lehman Brothers Holdings Inc. as demand for the relative safety of Treasuries increased.
Failures to deliver or receive securities rose to a record $5.311 trillion in the week ended Oct. 22. While the amount fell to $891 billion by Dec. 17, that’s still above the average of $165 billion before credit markets seized up in August of last year, according to Fed data dating to 1990.