China’s 9 dash lines and the demise of the $ (Part II)
Nov 2016 I wrote on the high possibility of the huge US debt crashing the economy. I went to great length explaining economics, money, the special strength of the $ as a world reserve currency, how the loans were affected through issue of Treasury Bills which have never ever been repaid as maturing issues are simply replaced by new issues, and how some countries are taking steps that will marginalize the use of the $. (See The Rube Goldberg machine). My conviction remains the same and in this article I’ll review it from other perspectives.
The $ is facing pressure from:
- Another asset bubble
- A colossal national debt
- Junking of the $ in international trade
THE NORMALCY BIAS :
Normalcy bias is a psychological state of mind of denial by people faced with the possibility of a disaster. Those with a normalcy bias have difficulties reacting to something they have not experienced before. The defense mechanism kicks in and they tend to underestimate the chances of the disaster occurring or downplay the impact that it may cause. Something that has never happened before is unlikely to happen. This is a big problem for those managing disaster preparedness when they face resistance to evacuation orders.
And so it is with the precarious position of the $. The public is still largely unaware and unwilling to believe the almighty $ can topple. They have seen markets crash and each time the Fed has managed to nurse the economy back to health, or so they thought. The few who look at the bigger picture differently are deemed as over-reacting or as doomsday preachers.
IS THERE AN ASSET BUBBLE :
The 2008 sub-prime crash was practically left unresolved. All the govt and the Fed did was to save Fanny Mae, Freddie Mac and the big wall street banks. The underlying problems were left unresolved. They simply kicked the can down the road, again.
What are financial bubbles all about? Basically, they come about from a wrong distribution of resources of production – too much money going into a particular asset. Prices build up to a point where there is nowhere to go but implode. Rightfully, they should have been allowed to collapse in 2008, along with all those institutions that didn’t do their job well. Out of the ashes, the system will rebuild and be stronger for that.
There was no reset, and the 2008 underlying problems were covered up like putting a lid on a volcano. The pressure was never released. Outside, everything seems well again, but inside, the active volcano pressure is building up again, and this time the energy will be many times more destructive.
Housing price levels are now back to pre-subprime crash status. The S&P Corelogic Case-Schiller US National Home Price NSA index shows the national average is now at 185 compared to 175 in 2008.
The Dow Jones Industrial Average was 14,000 in 2007 just before it popped. It is now in new territory at 20,1000.
The Industrial Production Index above shows the US has no interest in manufacturing. Money hasn’t been going into production of goods, but instead into building asset bubbles.
The Equity Buy-Back Funding chart is the most telling. All those QE (“Quantitative Easing”, by the Fed) and zero interest rates were meant to stimulate the economy. In times of high liquidity and cheap money, businessmen will borrow and expand their business, thus creating jobs, exports and help the GDP. That’s the theory. Instead, corporates capitalized on cheap money; they borrowed to buy-back their own shares. This has 2 effects — (1) It helps to push equity prices up creating an illusion of a boom. (2) Fewer shares in the market means their EPS (earnings per share) improves, creating another illusion of healthy growth. The reality is they have done nothing to improve cashflows. The crunch comes when interest rates start to rise. There is no cashflow to fund it. The Dotcom and subprime bubbles both exploded when the buy-back funding peaked and it is now peaking again.
From 2016 onwards, there is added pressure from pension fund problems. There will be more people cashing out than paying in. The demographics have shifted. The result is there will be much less cash holdings in the hands of mutual funds.
WHY IT IS MORE SERIOUS THIS TIME :
The asset markets capitalization is much higher than it ever was in 2008. The subprime 2008 crash was not allowed to go fullblown and thus it did not trigger problems in the derivatives markets other than the Credit Default Swaps and Collaterized Debt Obligations bundled with the housing mortgages. This time round, if the govt cannot contain it, the asset markets meltdown might be contagious and suck more derivatives into it. The derivatives market is mindboggling huge. The nominal value is estimated at $1.2 quadrillion in the US.
Easy money in the past several years has generated a huge build up of corporate debts. The corporate bond markets have seen a 275% increase since 2008 internationally. As $ interest rates rise, bond yields have slipped. There are about $10T bonds in the world trading at negative yields currently. Historically there has never been a bond market crash, yet there are many that fear a possibility of one in the works. A bond or an equities market crash this time round is likely to trigger a crash in the other.
All important international markets are concurrently having deficit problems one way or another. There are no other resource to call on this time. As big as the Fed is, during times of financial crisis, they too need international assistance. The 2008 crash required the Fed to utilize huge $ swap facilities offered by the World Bank, IMF, and various central banks around the world, particularly Bank of England, Bank of Japan, Monetary Authority of Singapore and the Deutsche Bundesbunk. These lines may no longer be there or sufficient to complete a rescue.
8 years of QE both in US and Europe have seen the central banks taking tremendous amounts of corporate bonds into their balance sheets. It may well be they have painted themselves into a tight corner leaving them with very little monetary ability left to contain the next market crash.
IS AMERICA BANKRUPT :
These are the staggering statistics :
- The national debt is now about $19.7 trillion.
- The US trade deficit is about $540 billion per year.
- The federal budget deficit is now about $1.3 trillion per year.
Every year the country needs another $1.84 T. Where are the savings needed to repay the debt?
In the Freddie Mac and Fanny Mae rescue package, the govt basically guaranteed all their bond issues. No one really knows what is the extent of the govt’s off-balance sheet liabilities. The cost of this is filtering into the Treasury’s books.
On top of this, many of the states are also bankrupt and there is no way the Federal Govt can fund the state deficits. In the 2011 budget, 46 states reported a total $160 B budget deficit. The Federal govt can print money to get out of jail, the states cannot do that. Some of the states have resorted to desperate moves like selling and leasing back state assets, reducing prison population by early releases, one state has instituted the takeout of dead person policies (if a person dies, the pension goes to the state), legalizing the sale of marijuana, etc.
To top it off, they need $60 B pension payout each year.
Is America bankrupt?
It is as bone dry as the sun-drenched skull of the longhorn in the desert sand.
WHERE IS THE INFLATION :
Since the sub-prime crash of 2008, the Fed has been pursuing a policy of QE and interest rate decreases to ramp up the economy. QE is simply a fanciful word for printing money, or monetizing the debt, or inflating the debt away. QE pumps liquidity into the market and low interest rates encourage people to borrow and expand businesses.
After 8 years of QE, coupled with China dumping $1 trillion of their $ reserves, doubters are prone to ask why is there no inflation in the US, and why indeed is the $ strengthening? The economy has not grown so where did all the liquidity go? The answers to this puzzling situation are :
- Most of the money went right back to the same asset markets that caused the financial problems in 2008 — real estate, equities and derivatives.
- The $ has always been the refuge currency when world economies are in trouble. Right now there are serious problems everywhere — Japan has been in deflation for 2 decades, China is facing asset bubbles about to burst, Europe is in a mess, Brazil is in crisis, Russia is as broke as all the others, and India is having riots on the streets from a demonetization exercise. It is not a case that the $ is strong, but that the other major currencies are in equally bad shape. The strength of the $ is artificial and is on borrowed time.
- The govt is bending the data. The various economic metrics have been massaged to display a more favorable situation.
Take the unemployment figures. Previously, it used to be straightforward — if a person is out of work, he gets into the unemployed figure. Today, unemployment is based on employment benefits. If a person is receiving the benefits, he gets into the data. The moment his benefits expire, he drops out of the data, although he still has not found a job.
Still don’t believe? Take the CPI (consumer price index), where certain heavy items have now been omitted, like rents. So from 2009 to 2016, the reported official inflation rate averaged 1.8%, with the highest being 3% in 2010.
The Chapwood index is a private enterprise effort that collects data across 50 cities using a CPI with 500 items more reflective of ordinary things that people spend on. Their index for 2011 to 2015 showed a 5 year average inflation rate of 11.2%.
Who said there was no inflation!
DEFAULT OR INFLATE :
A default will unleash a financial disaster that will have a domino effect throughout the world. $ interest rates will shoot North due to perceived increased risk and all currencies in the world will rise in tandem, bringing many economies to their knees.
All countries with monetary sovereignty (that is, countries that have the right to print their own currencies) will never do this. These countries have the advantage that EU countries like Spain, Portugal, Greece and now Italy, never have had, and for which their capability for monetary management is curtailed.
“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” Alan Greenspan.
Technically, Greenspan is correct, of course. With fiat money, this has been the preferred choice of action taken by many countries before. History has shown that countries that take the “print money and inflate the problem away” route have never turned out well. In the past 100 years, Russia , Ukraine, Poland, Chile, Brazil, Austria, Argentina, Japan, Germany, Mozambique, etc, took the printing approach and got devastated. The result is always inflation and skyrocketing interest rates; the value of currencies diminish, and economies plummet.
PLAYING THE RATE CARD :
If they feel the economy is too hot, the Fed will stop QE and raise interest rates to reel in inflation. Here lies the problem. Easy money from 8 years of QE and zero interest rates have created too much corporate debt. Increases to Fed rates will create a credit bubble because corporations do not have the needed cashflows. Furthermore, with a $19.7 T national debt, an increase of 100 basis points will add an additional interest burden of $200 B to the Treasury. The recent rate increase, the first after so many years, was a miniscule 25 basis points. Yellen has said there may be 3 more increases in 2017.
A hefty increase in rates in 2017 will pull the rug from under the feet of the equities market and precipitate a crash.
DEFENDING THE $ :
From President Reagan onward, the national debt began its spectacular climb. Obama alone chalked up almost $8 T in debts and on this basis alone, I see no way of ever judging him a great president. It became very apparent that protecting the value of the $ is critical to preserving the American way of life. With oil/gas being one of the biggest components in $ transactions, keeping the industry within US sphere of influence is key which in turn has heavily influenced American foreign policy. America will go to war to protect this interest. When looking at world events, the big picture always shows secret US objectives:
- US invasion of Afghanistan in 2001 was portrayed publicly as going after the Talibans for sheltering Osama bin Laden after 911, but it was actually to protect the Turkmenistan–Afghanistan–Pakistan–India gas pipeline project. This ensures gas supplies into Europe do not need to use the Russian pipelines.
- Gulf War II invasion of Iraq was supposed to be to destroy weapons of mass destruction that Saddam Hussein supposedly possessed. There were no WMDs. It was to topple Saddam because he was making arrangements to stop using $ to price Iraqi oil.
- The Syrian civil war isn’t about toppling Assad, but frustrating the Iranian gas pipeline construction.
- The Ukraine civil war is about delaying the Gazprom pipelines that will make Europe gas dependent on Russia.
- Economic sanctions against Russia indirectly frustrates Siberian oil/gas from gaining a more prominent role. For example, to reign in bank risks, Morgan Stanley had to divest its huge and lucrative energy divisions. The Russian energy company Rosnett was in the bidding but eventually backed out in 2014 because US sanctions made it difficult to take over the Morgan Stanley operations. That takeover would have allowed the Russians to play a very important role in oil trading activities, including price fixing.
The real question is, what will an America under Trump do to further defend the $? Will it resort to some conflict and roll out the military complex to drive the economy? Is there any wonder that the Chinese now fear a war with the US is inevitable? Do Chinese defensive moves in the 9 Dash Lines make any sense at all?
WHOEVER CONTROLS THE CURRENCY IS KING :
Most people do not realize that the US currency is not controlled by the govt, but by a small group of bankers who own the 12 Federal Reserve Banks. The shareholder banks earn a statutory 6% dividend on the capital invested, and all net earnings are transferred to the Treasury Dept. In 2015, the Fed transferred almost $100 B, clearly demonstrating no hanky panky as far as operations of the Fed are concerned. It is in policy decisions and rate fixing where one suspects conflict of interest will always see national well-being sacrificed, as has been the case over and over again, when big banks get bailed out in times of crisis.
The likes of Illuminati, Bilderberg Group, Commission of Foreign Relations, Trilateral Comission, Skulls and Bones are no longer in the realms of conspiracy theory. Proponents for a New World Order do exist. Some say it is as ancient as the Knights Templar and there is another suggestion that this had its roots from the days of the British Raj that once ruled India. Groups of people coming out of the experience of the powerful East India Company (that ruled India on behalf of the Queen) realized that whoever controls the currency is king. Remember, in those days, the British Sterling was the world’s reserve currency. This shadowy group of ultra wealthy makes Machiavellian moves that shape world events and wars. The family that seems to be deeply entrenched in this are the Rothschilds.
Apart from the NWO groups of old wealth, the modern world’s mega deals have created many new immensely rich people. These are people who today have such financial clout that they can take positions that impact the economy of a country. George Sorros’ $5B profit in one day in the foreign exchange market betting against Asian currencies in the 1997 financial markets crash is folklore. John Paulson made $20 B in the sub-prime crash 2008. Jacob Rothschild was rumored to have made $1 T betting against BREXIT. What I’m trying to highlight here is that there are people who have a keen interest on the status of the $, and there are some who game the $ at a very serious level.
Four US Presidents and a senator running for president were assassinated because they threatened the status quo of bankers.
- Abraham Lincoln : When the banking cartel agreed to finance the Civil War at 24% to 36%, he was aghast at the greed. Abe passed a law that allowed him to print $400 million in treasury notes called “greenbacks” and financed the war interest free. Bankers from London and many European capitals saw the danger of a govt printing it’s own money, so they advocated for the destruction of America. After Abe’s death, money printing rights went back to bankers and ‘greenbacks’ were paid off.
- James Garfield : He made a public statement “Whosoever controls the volume of money in any country is absolute master of all industry and commerce . . . And when you realise that the entire system is very easily controlled, one way or another, by a few powerful men at the top, you will not have to be told how periods of inflation and depression originate.” Within weeks, he was dead.
- William Mckinley : He advocated a gold-based currency. In 1900, he signed the Gold Standard Act, which formally placed U.S. money on the gold standard. With Mckinley out of the way, the Fed Reserve Act was passed in 1913.
- John F Kennedy : He passed Executive Order 11,110, which effectively shut down the Fed. He printed silver-backed notes to replace the fiat Fed Reserve notes. When Lyndon Johnson took over, the silver notes were withdrawn immediately.
- Robert Kennedy : The senator was in the presidential race when he was assassinated to prevent him re-instituting his brother’s action.
Donald Trump has mentioned during election that he will dismantle the Fed. He has billionaires and bankers in his cabinet so it’s not clear yet what he will do. If he advocates doing away with the Fed, he will be assassinated.
THE DEMISE OF THE $ :
The big picture of the $ is this. In international trade, most transactions have been priced and settled in $ simply because its stability was trusted. So it took on a defacto world reserve currency role. This means that, in addition to its own domestic requirements, America has to supply the currency to enable world trade. $ supply grew in tandem with the world economy in the past few decades. So America learned they have a franchise to print $ to finance deficit spending because international demand for $ is insatiable. Instead of manufacturing goods to sell to the world so they have the money to fund the budget, they ‘print’ $ by issuing Treasury Bonds which are snapped up by international buyers, in the process piling up the national debt because those bonds need to be repaid eventually. The wonderful thing is that all those $ that were created went into offshore markets, thus domestic inflation was not a big problem. (But enough of it entered the domestic market to cause asset bubbles and some inflation). Now the fairy tale is coming to an end. World trade is not expanding that much anymore, oil prices have tumbled, faith in the $ strength is diminishing (because of the national debt), govts and corporates are getting out of $ reserves or positions, countries are making all sorts of arrangements to avoid using $ in transactions — all this means the vast offshore $ will slowly find their way into domestic circulation. Crazy inflation is unavoidable and it’s just a question of when. Another problem is, if nobody is going to buy Treasury Bonds, where is the money to fund the budget deficits going to come from?
In the Rube Goldberg article, I detailed some of the steps various countries are taking to side-step the use of $ in international transactions. Here’s another — in 2009, China, Russia, Japan and Gulf Cooperative Council countries met secretly to agree on pricing oil in other currencies. They will use Euros, Yen, Rmb, gold, and a new common currency of the GCC countries they are planning, which they call ‘Bancor’. They will also create their own payment system similar to the SWIFT.
The Yuan is now in the IMF’s basket of currencies for the SDRs (special drawing rights).
The above chart clearly shows central banks are dumping their Treasury Bill holdings. China used to be the country with the highest holdings in $ reserves — about $3 T. They have since disposed more than a $1 T.
Many central banks are building up their gold reserves. The gold refineries in Switzerland simply cannot cope with deliveries. The Chinese now have substantial gold reserves.
All those families with great wealth know that the only constant in the financial advice they receive is to move all assets out of $ based paper. And why would they park their wealth in $ earning zero interest? The likes of Soros, Rothschild, Paulson, etc, have taken huge positions in gold. Having done so, these scavengers will work against the $, and they can do serious damage.
Anti-trade moves by Trump (he has scrapped the TPP) will lead to lower growth, add to inflationary pressure, and hurt the $.
ONE WORLD CURRENCY:
There are two wrong notions held by the public that the move to get rid of the $ as a world reserve currency is due to (1) a political move by China as it gains stature as world leading economy, (b) a conspiracy theory of a New World Order pushing for world dominance with one single currency that it alone controls. Both are nonsense.
In the 1960s, economist Robert Triffin pointed out that any country whose currency is used as a world reserve currency faces a conflict of economic interests that arises between their short-term domestic and long-term international objectives. This is because it must always maintain a huge trade deficit as it tries to supply vast sums of its currency to fund the rest of the world’s trade requirements. This is called the “Triffin dilemma”.
Actually, this problem was noted long ago by Maynard Keynes and he proposed a solution – the creation of a global reserve currency “Bancor”. The Bretten Woods council never took that up.
The Governor of Bank of China, Zhou Xiaochuan, in 2009 blamed the Triffin delimma and the non-adoption of Bancor for the 2008 crash. He proposed strengthening existing global currency controls through the IMF and the creation of a new world reserve currency.
In 2010, the IMF published a paper “Reserve Accumulation and Intl Monetary Stability” which called for the creation of a global central bank with a new international currency, Bancor.
DESPERATE GOVTS DO DESPERATE THINGS:
Demonetize the Federal Reserve notes —
Runaway inflation will cause the govt to withdraw the Federal Reserve notes and replace it with something new. Have you heard of the “Rainbow Notes”? The govt has already printed these; they are stored in 100 warehouses in the East Coast. They come with new security features and the official reason for the issuance is to flush out counterfeit notes. Really?
If not done properly, the country will explode. The Indian experience shows exactly what can go terribly wrong. There will be riots, people without access to cash will go hungry. In India, people died because they could not get hold of the new currency to buy food.
Capture the 401(K) and the IRA pension monies —
Monthly payouts will be restricted to a small sum, or the govt might issue special treasury bonds where maturing 401(K) or IRAs will be forced to buy these.
Ban sale of gold —
In the 1930s during the recession, the govt banned the purchase of gold bullion by individuals.This restriction was lifted in the 1970s. It may be re-imposed again.
Capital controls —
Opening of foreign bank accounts may be banned and it may become more difficult to move funds overseas.
Homeland Security —
They are already building capabilities to control people in times of anarchy.
Nationalize untapped natural resources —
The govt may nationalize all those resources still in the ground — gas, oil , gold, silver, copper etc., so they may sell them forward to build up international reserves to back a new currency.
Wealth tax —
Used as an excuse to strip cash from the wealthy to fund deficits.
National Deficit Bond —
Similar to war bonds, the govt might create a special fund to help out with the deficits. It may be compulsory for everyone to purchase such bonds.
This is an ominous topic but public discourse is necessary. We need to know if our public officials are on top of things and have taken precautionary steps to shield the country from what’s coming. The Bangko Sentral’s build up of Rmb reserves not too long ago was definitely one such concerned move. For those countries with huge sovereign wealth funds, we certainly want more transparency to understand their strategies to protect the national assets. In America, the preppers used to be some nuts preparing for the anarchy that will cover the land after a natural catastrophe. Over the past few years, their rank has been swelled by upper crust society types preparing for a coming financial meltdown that they know is coming.