Signposts Towards The Inevitable

by Lawrence Tout. February 13, 2009

What’s in a Depression?
Is the USA in a Depression yet? It’s a question that a lot of us are asking currently. Well it’s rather hard to tell because it seems that no one really knows how to define a depression. It appears there is no formal definition to be had with attempts ranging from the ‘not very helpful’ to the ‘how the heck did you arrive at those figures’ types. The vague to the more specific range of definitions basically run from “a prolonged and severe downturn in economic activity” to “a decline in real GDP exceeding 10% or a recession lasting 3 years or more”.

Does it really matter you may well ask? To which I would reply – I wish Mr. Bernanke had the foresight to manage our deflation expectations as well as he managed our inflation expectations. When you are dealing with rigged casinos rather than free markets; when whole economies teeter on a knife-edge, and when two thirds of GDP are derived from wanton consumption, consumer confidence and expectations are key.

In the absence of a sound formula therefore, it is more apt to rely on popular consensus. So can we confidently say we are in a Depression when enough Main Stream Media (MSM) economists use the ‘D’ word or maybe when it seems that ‘all-things-economic’ have gone to hell in a hand basket. Until then we will just have to read more saner commentary (try here and here), read the signposts along the way and try to make up our own minds. Interestingly enough it seems that the ‘D’ word is even sinking deep into the psyche of world leaders. Gordon Brown’s (Freudian?) slip of the tongue recently made UK headlines.

There is no end to the flood of negative economic news being issued on a daily basis around the world. We can view the USA as an originator and a proxy to some degree but the problem is worldwide and the problem is systemic. The financial world of today is in the process of a fundamental paradigm shift although this is a best kept secret. As with most predictable events, these only tend to be visible by the MSM in the rear view mirror whilst the likes of Schiff, Panzer et al have written copiously on the subject for some time now. If like them, we have the wherewithal to switch off the likes of Fox News et al, tune out and look at the fundamentals, it is not too hard to reach a reliably conclusive prognosis. The following are some of the signposts or pointers that are either already upon us or will be evident before not too long. Bear in mind that inflation, when it finally impacts, will modify any nominal figures below and will need to be taken into account in the future.

The Unemployment-Consumer-Debt Spiral
A second wave of mortgage resets (see below) will hit a US home market that is already trying to pick itself off the ground from the first wave of Sub-Prime losses. It will push more home owners further into debt and eat further into salaries; those still lucky enough to have jobs that is. Credit card debt is already stretched with card companies being more rigorous in the supply of credit (future debt). Rising payment defaults are forcing them to up interest rates to fill their own revenue shortfalls. Even those homeowners unaffected by resets will be forced to tighten their belts and commit to saving for rainy days. As Jim Willie rightly says:

“Consumer confidence is rock bottom, plumbing lower levels than ever. Job losses are the mushroom cloud, badly understated. Despite criticism of European high unemployment, the US has a very high jobless rate right now, when the novel approach is used, COUNTING PEOPLE WITHOUT JOBS. Even the broader U6 jobless rate published by the Bureau of Labor Statistics is at 13.5%, which counts the discouraged workers dropped from state insurance. The Shadow Govt Statistics folks go further, and ferret out other jobless who are typically ignored in a systematic fashion by the BLS. The SGS jobless rate is estimated at 17.4% alarmingly.” – (Deception in Quest of Remedy)

As the US consumer-economy implodes through lack of confidence translating to decreased spending, retail and manufacturing sectors bear the brunt, forcing job cuts. As unemployment rises, so do defaults on debt payments, whether home loans, car loans or credit card loans etc. Unfortunately the US consumer, like a kid in a candy shop, has overspent using vapourised home equity or freely available credit (debt). No wonder the US savings rate turned negative in 2005.

According to the Federal Reserve Board of San Francisco there may have been three possible causes:
1- The “wealth effect”: When people become richer (or perceive themselves to become richer), they spend more.
2- As Americans have become more productive and are, in general, earning higher wages. If they believe these increased incomes are likely to continue, they’re willing to spend more because they believe they’ll have money in the future.
3- Easy access to credit. Though the first major credit card was created in 1958, and use grew in the sixties and seventies, credit cards didn’t play a prominent role in American life until the 1980’s
To the above I would reply “all of the above” but most especially No.3. Now once again we see savings pulling back up to +3%. In 2005 Americans did not feel like saving, but in 2009 this time the mindset is different and tight belts are the latest fashion. The US manufacturing industry therefore gets a double whammy. Firstly the US public show a preference for cheaper foreign imported goods over local ones and now secondly, what little market share local manufacturers managed to hang onto, is being eroded as consumers are either choosing to pay down on their debt, or for the more fortunate ones who can… to squirrel away their meagre earnings so they can dip into them during the long Kondratieff winter that lies ahead. This cycle of…

Lower Consumer Spending, leading to
Lower Retail Demand, leading to
Lower Manufacturing Demand, leading to
Lower Manufacturing Output, leading to
Lower Employment, leading to
Lower State Tax Revenues, leading to
Higher Taxation, again full circle to
Lower Consumer Spending

…is a self perpetuating, self reinforcing downward spiral and is bad news for US GDP. This simplified cycle is the driving mechanism for recession and depression. Throw in some economic curve balls and the process accelerates further. The horrific job losses we have seen so far are just for starters. We can expect to see well known companies continue to announce layoffs through 2009. We can expect smaller companies to declare bankruptcy one after another. We can also expect shocking failures of household names.

The Next Wave of Foreclosures
While many people (thanks to the MSM) place the blame for the source of our current economic woes on the Sub-Prime mortgage problem, this was but one symptom that first manifested from the fundamental American Govt. disease of abusive largesse of its world reserve currency. However, with this flawed former line of reasoning, the same people come to the erroneous conclusion that solving the housing crisis will solve the whole problem. This is only partly true. Whilst underpinning the deteriorating housing situation would be a great first step forward in this mess, the FED seems more intent on bailing out the investment banks which were complicit in willfully slicing, dicing and packaging all the highly complex and highly suspect derived debt instruments in the first place.

Yet the Sub-Prime problem pales in comparison to the next wave of loan resets and associated defaults that is about to hit. With the bulk of the Sub-Prime ARM resets out of the way, we have another wave of Alt-A and Option ARM resets to undergo. This will be an additional blow on top of all the other financial fallout that is currently hitting the fan.

The graph below shows an extended Wave 2 due to hit an already stressed and systemically weakened financial shoreline in April/May09.

If we are to believe certain analysts, this second wave (affecting $2 trillion worth of mortgages) is twice as large as the first in terms of dollars lent although to me the areas under each wave look comparable. Larger or similar in size, it matters not. With an already cash-strapped US home owner and an already battered US economy, the ensuing fallout may be multiples of the Sub-Prime defaults. We are already seeing huge declines in home real estate prices especially in the hotter areas. Bob Chapman estimates average house price declines could reach 35% from their Jun05 highs while hotter areas could fall by 60%.

Growing consensus expects the commercial real estate market to be the next property class to go pear-shaped, as retail outlets and financial firms go bust. New York real estate was already down 61% in Nov08 by Gerald Celente’s reckoning. We can expect these figures to be periodically revised downwards as the full extent of the wash-out becomes apparent. My gut feeling is an average decline figure around 80% from the high as we will not simply be returning to sensible pre-binge norms but diving deeper below them. The following is from the Wall Street Journal:

“In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels.
Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.
Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession.” (What Other Financial Crises Tell Us)
My point being that this is not your typical severe financial crisis. So even if President Obama does suddenly find religion and decide to bailout real estate owners rather than giving TARP (tax payer’s) money to the investment banks, or into infrastructure spending, we can expect another wave of foreclosures coming to a shoreline near you to scuttle any hope of a quick recovery that many fairy-tale MSM analysts proffer. This second wave will not only hit consumers where it hurts but also put the final nail into the coffin of an already beleaguered US construction industry. With consumerism and home-related service industries having made up such a large proportion of past US GDP, it is not hard to read where this signpost leads.

Toxic Derivatives Lead to Banking & Hedge Fund Failures
Enough has been written about derivatives but they still get surprisingly little press coverage considering their size ($683 trillion worldwide), their fairytale notional values and the amount of leverage employed by the banks involved. Even Nouriel Roubini now admits that the US along with the entire banking industry is technically insolvent i.e. their debts outweigh their assets and cash. Derivatives are the real ‘Elephant in the Room’ as far as the financial world is concerned.

A brief glance at the Comptroller of the Currency’s 3Q08 report reveals the following salient points:

The notional value of derivatives held by U.S. commercial banks is $175.8 trillion (25% of the world’s total)
Derivative contracts remain concentrated in interest rate products (i.e. they are interest rate sensitive)
Derivative contracts comprise 78% of total derivative notional values.
Credit default swaps comprise 99% of credit derivatives

These interest sensitive, highly leveraged, globally connected incendiary devices are primed and ready to make their presence felt if interest rates start to assert themselves once again and notional value turns into real world value(less). The amount of wealth destruction and dollar-equivalent vaporisation that will occur should this chain reaction start, will create a black hole that would swallow world GDP twelve times over.

The top 25 US banks ranked by greatest holdings of derivatives are shown below:

JP Morgan (the FED’s bank) has $87 trillion’s worth of derivatives alone. That’s fifty times the total value of its assets. The tiniest of mark-to-market write down and JP Morgan is toast. Not to mention counter party risk and the knock-on effect throughout the system if such a bank collapses. Hence the term ‘too big to fail’ as we have seen with the likes of AIG and others. However Bill Murphy has coined the phrase ‘too big to bail’. With such a huge negative debt dumped on their balance sheet if the unthinkable happens, not even the US Govt. will be able to create enough money to bail them out and the derivatives genie will be well and truly out of the bottle.

Since late 2006 there have been 328 US lending companies that have imploded. The majority of these were primarily specialising in mortgage lending or were over exposed in this area and thus became victims of the initial Sub-Prime fiasco. The www.ml-implode.com site defines imploded lenders as follows:

The "imploded" status is somewhat subjective and does not necessarily mean operations are ceased permanently: it can mean bankruptcy filing, temporary but open-ended halting of major operations, or a "fire sale" acquisition. The Companies include all types (prime, subprime, or a mix of both; retail or wholesale; subsidiaries and entire companies). Note: Companies listed here may still be operating in some capacity; check with them before making assumptions.

This subjectivity notwithstanding, with the massive coming downturn in the economy still ahead of us, the mistrust of banks to lend, the more rigorous lending procedures and with the forthcoming regulatory clampdowns, it is hard to foresee credit conditions loosening in the near future or at least until the much anticipated FED-driven inflationary expansion occurs. Bankers are rapidly becoming the pariahs of the new millennium. This whole crisis including recent big bank failures, the nationalisation of major investment banks (in Europe also), governments’ preferences to bailing instead of failing incompetent banks, the spending of tax payer’s money to save corporate asses – this has all led to a deepening dislike and mistrust of the banking fraternity. As mentioned, confidence is key and when the public no longer trusts the banks they will try and pull their money out. We can then expect Obama to truly emulate FDR and give the American people a Bank holiday or two plus see the banks impose withdrawal limitations.

With further foreclosures, Credit Default Swap problems and slowing business activity plus low interest rates reducing bank profits, we can expect to see an acceleration of bank failures at local levels plus more consolidations working their way up the food chain as big fish swallows small fish until finally the biggest fish i.e. government, nationalises and swallows the entire damn banking sector. On the way, we may also expect to see bank runs. In the US, FDIC reserves will be depleted as public confidence expires. We can fully expect Congress being called upon to bail out the FDIC once its coffers are emptied.

Only 4% ($273bn) of the $6.84 trillion of US bank deposits exist as physical cash in vaults. The other 96% has been lent out or exists only as digital impulses on a computer screen. What happens then when there is a rush for cash? Whole banking systems are already in a highly fragile state. A British Lord Myners revealed recently just how close the UK banking system came to failing (The day the banks were just three hours from collapse). Between 1930-40 a total of 9000 US banks (37%) failed. Might we expect to see a similar percentage (over 3000 banks) close their doors this time around?

A record number of hedge funds (344) closed their doors in 3Q08 amid increased investor redemptions and chaos in the financial markets. In the first nine months of 2008, 693 hedge funds went bust, a 70% increase compared with the same period in 2007. As it stands, hedge funds do not have to publicly mark-to-market all their assets and disclose all their underwater positions, allowing them to hold positions that may currently have irrational prices. Additionally hedge funds can keep their investors from withdrawing money, unlike listed companies. If it were not for these privileges one could expect to have seen a far greater number fail.

The highly leveraged nature of their investments especially in credit derivatives make them far more vulnerable than more ordinary funds. With worsening economic conditions watch out for more hedge funds going under and some big-players to make prominent headlines for all the wrong reasons. It was not that long ago that LTCM went belly-up after Russia threw a curve ball by defaulting on its debt. The then $4 billion loss is now peanuts when compared to the amounts we have seen lost in this current crisis.

With their highly speculative and leveraged plays, hedge funds have helped turn the markets into the casino that they currently are and whilst no man in the street would shed a tear for the demise of any bank much less any hedge fund, the instability the latter create is not good for one’s heart rate. How many more curve balls are headed their way?

Currency Crises & Sovereign Debt Defaults
It is said that the value of the currency is the measure of a country’s economic health. A currency crisis is a sign that something is very wrong within its economy and we are not short of past historic examples. The most infamous ongoing modern day example exists in a country only 300 miles from where I sit writing this. As I have mentioned in a previous editorial (The future is here, we just don't know it yet) when you enter Zimbabwe, you enter an alternate reality. One where a bus fare to work is the equivalent of a month’s salary and where not even the government wants its own money. As near as anyone can figure out there are currently Z$40 trillion to US$1. By next week you can probably double that. I still see reports saying the Zimbabawe dollar is ‘virtually’ worthless. How more ‘virtual’ can you get? The government has scrapped exchange controls and now some LOCAL TAXES are payable in foreign currency only.

Is this the future for the US$?

Reports vary on the size of Zimbabwe’s new 2009 budget from US$2-3 billion. Nobody has asked where all that forex will come from and no amount of Z$ will be a substitute. There are substantial rumours that they are about to knock another 12 zeros off which, what with last years reductions, makes a total of 25 zeros stripped off the Z$ in a year. They have given up measuring inflation which when last calculated was running at 230,000,000%.

Zimbabwe is definitely undergoing its own Weimar experience but according to Jim Sinclair, this is the future fate in store for the USA also. Now while it is hard to believe that things could get as bad for the US as they are in Zimbabwe (current unemployment is at 94%) many other commentators argue for future hyper-inflation in the US.

Currency crises occur when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value. i.e. when investors lose faith in a currency. Although they are not necessarily a sign of impending Sovereign bankruptcy such a crisis points towards a much lower standard of living for its citizens. Traditionally a last ditch effort by governments to stave off a currency crisis, and thereby unwittingly sealing their fate, is to print more money in a futile attempt to stimulate their ailing economies. They never seem to learn that you can not solve the problem with more of the same action that caused the problem. Is all this starting to sound familiar?

Smaller economies are more susceptible but behemoths like Russia (1998) are not immune. Incidentally it looks like Russian history is repeating itself a decade later (The coming Russian Debt Crisis). Indeed entire economic zones can fall victim as in the 1980’s Latin American debt crisis. And this is indeed just what we are experiencing today but its not just one zone now, IT IS GLOBAL!

(Stephen Jen, Chief Currency Strategist at Morgan Stanley) - “Since the fall of Lehman, we’ve been seeing clear signs of currency crises throughout the world of emerging markets, including Eastern Europe. This time, it’s not an Asian crisis or a Latin American crisis, it’s a global crisis”

The Euro zone is under increasing pressure as Ambrose Evans-Pritchard relates:

Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992. “This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon. Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. (Europe on the brink of currency crisis meltdown)

It seems like the world is becoming more and more allergic to the stuff that makes it go around - paper fiat money. Why? Competitive currency devaluations. What/Who is to blame? The American Govt. disease of abusive largesse of its world reserve currency. Is there an echo in this room?

Once again we can ask ‘could the unthinkable happen?’ Could the US, the largest sovereign debtor nation, default on its debt? Unfortunately an increasing number of investors are putting their money where their mouths are and are betting on a US Treasury default:

(Reuters) – “Rising U.S. government borrowing has a growing number of investors betting on a potential default by the Treasury down the line, according to credit default swaps data on Wednesday (4Feb09).

According to CMA DataVision, five-year U.S. CDS spreads stood at 82 basis points on Wednesday, having closed on Tuesday at a record 85.9 basis points. As a result, it currently costs $82,000 a year to protect $10 million of U.S. debt. That is up tenfold from levels seen a year ago and even more from the negligible levels that were common before the credit crisis.

The CDS market is used to hedging against the possibility of sovereign and corporate defaults, and has played a controversial role in exacerbating the credit crisis.

Many believe a default by the U.S. Treasury is a physical impossibility, since all of the government's debts are denominated in its own currency and it could conceivably print more dollars to meet their obligations.” (U.S. Treasury default bets surge, hit new record)

(James West, Seeking Alpha) -“The prospect of the United States defaulting on its debt is not just likely. It's inevitable, and imminent.

The U.S. Federal Reserve suggested last week that it was going to step up its treasury-buying activity, and the mainstream media interprets this as a form of market support. What it actually is evidence of is growing anxiety and desperation on the part of the Fed as the realization dawns that demand for treasuries is progressively evaporating.” (US debt default dollar collapse altogether likely)

Currently rates of return on treasuries are some of the lowest on record and money is only being parked there as it is believed to be a safe haven when all equities are heading lower. As the credit worthiness of the US deteriorates investors may have to re-evaluate their strategies. We can expect to see an exit by investors out of bonds and when that exit comes it will be a rapid one as the Treasury bubble goes pop!

Insolvencies and Bankruptcies
It is no exaggeration to postulate that many major investment banks both in the US, Europe and elsewhere are currently insolvent and on life support. Recent nationalisations have shown that there is financial favouritism from governments. Insidious links between govts. and banks are becoming ever more obvious with each passing bailout.

With the ongoing degradation in the financial system and its associated ripple effects we can expect to see more nationalisations. Also a growing number of bankruptcies at town, state and national levels as govts. bow to public pressure and eventually realise that they can not bail-out the entire universe. With a morbid fear of setting off the derivatives neutron bomb, we can (as in the past) expect bailouts to be concentrated on those banks and corporations with the most lethal derivative exposures whilst the better disciplined ones are left on the roadside to die.

At a state level in the US we are already witnessing signs of impending trouble as 46 out of the 50 states are looking at budget shortfalls. This is nothing new I hear you say. Counties like Orange County have gone bust before and survived. True, but this time the problem is on a national scale with the likelihood of most states having to go cap-in-hand to an already insolvent, debt-laden government which means more abuse of the printing presses.

The bigger they are the ‘sooner’ they fall – it seems to be so in the case of California State insolvency. Governor Schwarzenegger is having a hard time getting the new budget passed as the state is US$40 billion (35%) short. In Dec08 he declared a ‘Fiscal Emergency’ saying that by Feb09 the state would run out of money. Well we are now there and waiting to see where state legislators will cut the budget. We can expect Californians to experience a sharp decline in their living standards, a fact which 130,000 resident tax payers have already realised leading them to relocate out of state and further exacerbate falling tax revenues. In the land of fruit and nuts you can expect to see increasingly more alarming effects of not having enough money and increasingly dire methods of generating much needed cash. (see California goes broke and California bankruptcy problems continue)

At a Sovereign level many pundits maintain the that the UK and US are already insolvent. To understate things, they are both in the throes of an extremely severe debt crisis. To have any hope of keeping their heads above water they either have to increase manufacturing (extremely difficult to achieve in the current contracting environment) or reduce spending (a difficult proposition for a population addicted to consumerism for the last two decades). Trying to print their way out of the problem is unfortunately seen as an easier option, but in reality is one which will only prolong the party and make the hangover more painful.

Once again, either which way, citizens are going to have to come to terms with a drastic reduction in their standards of living. It will be an easier adjustment if we willingly come to terms with this sooner, rather than having it forced upon us later. What could force this upon us sooner rather than later? The Icelandic economy was not brought to its knees by a loss of confidence in its currency or out of control deficit spending. Its demise was a lot quicker and simply due to the massive Euro/Dollar debts of its 3 largest banks. Admittedly it is a small country with a population of 300,000 but how many more Icelands are there out there waiting to happen. Even in the US/UK, the failure of the shaky over-leveraged financial sectors, as developed as they are, would be enough to deliver the coup de grace to their economies as we know them.

The Useless Deflation versus Inflation Debate
Keynes said ‘In the long run, we are all dead’ which was his way of criticizing obvious long term projections when what we really need are short term details. However with the ongoing D-I debate I have to leave those details to someone else. There are simply too many unknowns and too many sneaky manipulations going on these days to make any useful sense out of short term indicators.

Inflation? Deflation? Why does it matter anyway? If we have inflation there is too much money made available, things need ever increasing amounts of money to be bought and eventually nothing can be afforded. If we have deflation, there is not enough money to go around, you can not get hold of enough money to buy things and thus nothing can be afforded. So I would paraphrase Keynes and say “In the long run, we are all broke’.

This is hardly comforting though. The way the story is unfolding it seems a pretty certain bet that we will get a bit of both and end up with a hyper-inflationary depression i.e. (still broke). Barring radical rejection of the dollar by other nations, this seems the only logical conclusion with a FED that seems hell bent on using the printing presses as the only misguided solution to the current financial crisis.

So hyper-inflation is on its way and most serious numbers are in the trillions these days instead of billions. The FED has already committed $9 trillion thus far for starters. We can expect this amount to rise as stimulus after stimulus fails to spend our way out of the crisis.

Technically most countries are already inflating with abandon in their attempt to keep up with the king of inflators. The following graph tells us the whole story of the recent increases to the US money supply.

Never in the field of economic conflict has so much been printed by so few for so many. You will recall that in Mar06 the FED suspended reporting M3 based on the implausible excuse that it cost too much, regardless of the fact that it would not stop us calculating it ourselves. Now we see why.

Interestingly enough a recent UK banking Bill is trying to hide a clause with a similar objective. If passed, this Bill will mean:

“The Bank of England will be able to print extra money without having legally to declare it under new plans which will heighten fears that the Government will secretly pump extra cash into the economy… some have warned that it means there is nothing to stop an unreported and unmonitored flooding of the money market by the undisciplined use of the printing presses." (Reform plan raises fears of Bank secrecy)

So with the new buzz-word, Quantitative Easing (debt monetisation), a firm inflationary course is set. However, I still remain in the deflationist camp for what its worth. Not because I can not see the rampant inflation that the US and others have embarked upon with reckless abandon, but because it counts for nothing when all this newly created money goes towards patching the holes in bank’s balance sheets, neutralising toxic debt and paying fat corporate bonuses. Even if the money supply has been inflated, such inflation has not yet manifested itself where it matters; in the commodities markets or on Main Street.

With Quantitative Easing, will the dollar hyper-inflate?

The surprising strength of the dollar due to deleveraging can not last indefinitely. At some stage as the dollar gets progressively weaker as the US heads nearer towards its very own currency crisis, key dollar confidence will evaporate and inflation will hit the streets. Peter Schiff writes:

“The stronger dollar gives the Federal Government plenty of cover to a pursue a policy of rampant monetary inflation in order to re-inflate the collapsing bubble. Even though the Federal Reserve has thrown trillions of new dollars into circulation, those dollars have actually gained purchasing power - contrary to economic law. This, along with inventory liquidations and going-out-of-business sales, has kept a lid on consumer prices. The continued, although misguided, appeal of U.S. debt has also made it possible for the government to garner cheap financing for its equally misguided and massive bails-outs and stimulus packages.” (This is Just the Beginning)

One large grey area is the actual size of the deleveraging black-hole pit that all this new money is being pumped into. Given the immense amount of leveraged, notionally-valued derivatives out there, even with their digital printing presses, will govts. be able to pump in enough to fill that hole and thus manifest inflation? We do not yet know for sure they can, or if they can, how long it will take. Yes we are most probably headed for a hyper-inflationary depression but the precise sequence of events that will see us arrive there are still uncertain. There are so many wild cards that can be thrown into the game at any stage.

BEWARE! If we do see inflation finally start to emerge earlier rather than later, it will be heralded as the successful solution to our economic woes and greeted as a return to normality. Bernanke and Obama will be worshipped as gods for their economic prowess and leadership. However, the fact that this inflation will not be driven in the main by productivity but rather by the printing presses, means that any signs of economic growth will be largely illusory. Everything will seem fine for a while until fundamental market forces reassert themselves and people see this short reprieve for the bear market rally it really is. Then the carnage continues.

2008 Year of the RAT, 2009 Year of the RIOT!
I would like to wish our Chinese brothers and sisters around the globe a Happy New Year of the Ox (26th Jan). 2008 was the Year of the Rat in the Chinese zodiac. According to legends, the rat got on the back of the ox, the leader of the pack of animals. When the ox was near the finish line, the rat jumped off, ahead of the ox, to be the first, and I find it fitting that 2008 was indeed a year packed full of rats in full view.

Political rats campaigning for their big cheese positions, banking rats drowning in financial cheese meltdowns, FED rats stealing cheese from the poor mouse in the street, and corporate rats lobbying to get those last stinking, leftover cheese crumbs. I wish we could truly say goodbye to these rats but I fear they are here to stay a while longer for there is plenty of cheese transferring left to be done.

Nobody likes to see their standards of living go down. Its not fun. Less to spend on luxuries; having to make do with necessities. Watching the grass grow tall on the foreclosed property over the road. Watching your neighbors lose their jobs and watching the neighborhood crumble into disrepair. Seeing cutbacks in community spending and a lower upkeep of your social environment. Schools and hospitals stretched with fewer resources. Ever more inept governments reneging on promises, executing absurd policies, taxing us all more harshly and making the situation worse not better. Eventually people are going to be forced out of their armchairs as growing anger quickly dissipates the fog of apathy.

We can expect to see further increasing police-state control, the ongoing removal of more civil liberties and more indirect taxations. As unemployment grows we can expect to see the re-emergence of Trade Unions as a renewed force, increasing numbers of strikes and the rise of protectionism and trade wars. In the previous week we saw strikes mushroom in the UK over the use of migrant workers. Already the storm clouds are gathering and ‘people power’ is finding its voice once more. We have already seen food riots last year when commodities prices surged as they will again once inflation finally bites. We saw riots in Greece initially over the shooting of a young boy, but these quickly morphed into an expression of pent up rage against a government out of touch with the people.
(George Papandreou, Greek Socialist opposition leader) - "The country doesn't have a government to protect it. Citizens are experiencing a multiple crisis: a social crisis, a crisis of values. People have lost trust in the government." With many struggling to make ends meet, and one in five living below the poverty line, there is growing anger at the tough fiscal policies of a government determined to reach the prescriptive benchmarks set out by Brussels and rein in budget deficits. The disaffection has been exacerbated by allegations of corruption and a series of scandals. (Greece riots)
2009 will be the year of the riot. How so? As the levels of endemic corruption within government are uncovered layer by layer, this will give rise to a ground swell of anger which will be directed towards those whom are supposed to care and protect rather than steal and enslave. People are beginning to wake up to the reality that has been shrouded from view. The blatant Goldman Sachs – Government revolving door antics are but one example of the in-bed relationship currently existing between corporations and the US Govt. (here and here)

If you want to realise the level of corruption within today’s markets, listen to Jim Puplava’s interviews with Bud Burrell or with Patrick Byrne or to the Youtube Bloomberg special on naked shorting, to get an inkling of the massive fraud being perpetrated in the markets. Burrell tells it like it is and estimates that counterfeit shares equal or may even out number the outstanding market shares. To put that another way, for each legitimate share there is a corresponding illegitimate counterfeit share courtesy of the practice of naked shorting. That is an astonishing and downright scary claim and he is VERY convincing.

And all the while with these claims escalated to the SEC, nothing is done just like with the current Madoff scandal or the Comex Silver manipulation investigation. After hearing Markopolos testify before congress with his damning report of the failure of the SEC on all fronts, one can only conclude that at best the SEC are a bunch of inepts or, at worst, are in bed with the fraudster corporations. Either way they should be disbanded ASAP and the job of regulation given to the Department of Justice or FBI.

"Government has coddled, accepted, and ignored white collar crime for too long.
It is time the nation woke up and realized that it's not the armed robbers or drug dealers who cause the most economic harm, it's the white collar criminals living in the most expensive homes who have the most impressive resumes who harm us the most. They steal our pensions, bankrupt our companies, and destroy thousands of jobs, ruining countless lives." - Harry Markopolos in Congressional Testimony

Trying to trade these markets is no better than playing against a rigged casino. The system has to be ripped apart and rebuilt from scratch. The FED and other Central Banks must be dissolved and the Debt-based financial system replaced with a truly tax-free market with fair weights and measures. This will eventually happen and indeed we are coming to the end of the process but it is currently a painful and drawn-out process as those responsible are loathe to relinquish their dominance of the system. There is unfortunately no easy solution and the system must go through a necessary pain in order to rebuild itself. This is what we are all trying to avoid but inevitably the bitter medicine must be swallowed.

Revolution Becomes Reality
There is a new ‘R’ word in town and that word is no longer Recession, it is Revolution. History tells us that the masses will only put up with so much crap for so long. There will come a point when rioting turns into full blown rebellion. The only question is the speed at which events will transpire. Will rebellion come from a grass roots level or will the seeds be sown in a more formal manner via the legislative process. This ultimately depends on the levels of corruption within governments and how willingly and forcefully the honest politicos can effect change. Does this all sound surreal or preposterous? If it does then you might consider yourself out of touch for it is already happening in the US.

You are beginning to see a number of states starting to attempt to push through legislation to claim their own sovereignty under the Tenth Amendment; New Hampshire (here), Washington (here), Montana (here), Oklahoma (here).

What does this mean? It means that individual states are losing faith and confidence in the direction the Federal Govt. is taking and that they would rather invoke the Tenth Amendment and thus have control over their own destiny using the Constitution as their roadmap. Such Bills limit Congressional and Presidential powers over individual states. The following is extracted from the House Resolution No.6 Bill currently being discussed by the New Hampshire legislature.

“all powers previously delegated to the United States of America by the Constitution for the United States shall revert to the several States individually. Any future government of the United States of America shall require ratification of three quarters of the States seeking to form a government of the United States of America and shall not be binding upon any State not seeking to form such a government;”

We are witnessing a backlash against big-brother-big-government as exemplified by this comment from Oklahoma State legislator Charles Key - “We, the people in the states, created the federal government. They act like they created us and we’re under their authority, and that’s really not the case.”

What we can hope for is a groundswell of support so we see other states also distancing themselves from centralised control. If such legislative measures fail or are only implemented in a partial fashion, we could see rebellion at grass roots levels. As history has shown, when governments do not attend to the will of the people, they are eventually replaced, and forceably if necessary. If things get really crazy it is not impossible to contemplate the breakup of the Union whether it be the United States (national union) or Europe (economic union). Any such breakup will be driven by dire economic conditions leading to discontent and unrest.

Potential Tipping Points
There may be some catalyst that will speed this process to completion allowing a new financial system to rise like the proverbial phoenix from the ashes. Since the cause of the problem is the world reserve currency and those who manipulate its supply, either one of these will have to be overthrown before we can start to make things right. With the current state of affairs the dollar is looking like the weaker party and its demise is a tipping point. What events might cause the tipping point for the dollar?

They are many but summarised below are some possibles:

Collapse of the treasury bond market bubble
Derivatives blow-up
Gold and/or Silver demand explosion
Financial Dollar Sabotage by foreign sovereign entities
Emergence of a new gold-backed currency/basket of currencies
Sudden interest rate rises

All of the above are possibly linked with it taking just one to activate others. Which one will be first to go is a whole new discourse.

Protect Yourself Now
Although gold is most reviled by those who like to keep us shackled to this debt-based system, there is no doubting its status as a safe haven in exactly such times as these. This has been proved time and again over the course of history and although we are moving to a new financial paradigm, immutable gold will still remain the rock to cling to in turbulent times.

The sterling work done over the last 10 years by the GATA team has not only wrestled gold manipulation theories away from the clutches of the conspiracy theorists, but it has also proved clearly and systematically that manipulation of the gold markets is an important ongoing concern for central bankers. Gold is anti-dollar and anti-debt and this terrifies the central bankers because if enough people knew this and could suddenly conceive of a financial system that does not tax and beggar the masses, it has the potential to bring their debt-based system crashing down. The problem is that like a fish born into water, we are born in the debt system and know of nothing but death and taxes so they become as natural as the air we breathe.

In contrast from the depressing situations described in this article, gold offers a taste of freedom. It is therefore exciting to see a shift in the gold mindset occurring. Admittedly this is also a factor of things only starting to get better after they have got sufficiently worse but nevertheless investors are smelling a change on the wind.

Are we ramping up into a new gold bull market phase? There are the beginnings of a flight to gold. It’s a flight because times are sufficiently dire enough to warrant some degree of panic especially where the subject of money is concerned. A lot of our identity (and therefore our survival instinct) is invested in money so it is only natural that we should go to great lengths to protect it. When fiat money is exposed for the transient sham that it is, it is only fitting that we gravitate to other more tried and tested forms of wealth storage.

We are witnessing hedge funds starting to buy gold e.g. Greenlight Capital. We are seeing investment banks raise their gold price forecasts and giving buy signals on the gold producers. We are seeing gold shed its barbarous relic mantle and starting to come back into fashion. This is hugely exciting owing to the very small size of the gold market. At the last check the combined market cap of the gold mining industry was only equivalent to a couple of Microsofts. Gold was one of the few asset classes to gain last year. Up 5% in dollar terms and 35% in Sterling, compare this with the Dow down 40% and versus genral equities:

With its rarity and the lack lustre appeal of traditional equities when (not if) big money piles into gold equities it will send the price of gold into the stratosphere. Not only will this make early gold buyers vast profits, but more importantly it will set gold up centre stage as THE reliable asset and a store of value to which all lesser money can be pegged to. Whether this will be sufficient to dissolve the debt-system once and for all remains to be seen but even if not it will surely shine a more piercing light on the debt-system and maybe get one or two of us to start to conceive of living in a world where debt is a conscious choice rather than an enforced burden.

My advice for 2009 – We should get prepared, so panic early and avoid the crush. Buy physical Gold/Silver bullion and hang on tightly to your cheese!

Contact Information

Lawrence Tout, Investor | Botswana | Email