Monday, June 6, 2011

The Ticking Time Bomb

When I was young and in college we used to ask ourselves rhetorical questions just to show we could think. A favorite was, “What happens when an irresistible force meets an immovable object?” And the answer was, “Immeasurable energy.”
We are about to learn if that thesis is true or not. The irresistible force is the $600 trillion in derivatives. The immovable object is the $60 trillion world economy. Basically a $60 trillion economy cannot support a $600 trillion bucket of used lottery tickets that everyone wants to pretend still have some value. They don’t.
The only real question is just how much actual money is left and I suspect the answer is “near zero.” That’s the ticking time bomb.
I’ve always believed that the growth in derivatives from a low of about $60 trillion in 1997 to its high point of about $800 trillion in 2008 was the foundation stone for credit running totally out of control worldwide.
Brooksley Born famously attempted to regulate the Wild West environment of derivatives in 1997 only to be slapped down in a classic Washington DC turf war led by Alan Greenspan, Larry Summers and Robert Rubin. We are going to rue the day she lost that battle.
In pieces I’ve written since I first began warning 321gold readers about the dangers of derivatives in early 2002, I’ve made the comment a number of times I don’t think there are ten people in the world who really understand derivatives. I’m not kidding. I think next to nobody actually understands this most dangerous of markets.
What is going on in Greece, Spain, Iceland and Ireland is all part of the same ticking time bomb. Some of the events almost defy imagination.
Three relatively small banks in Iceland issued over 50 billion euros in debt that blew up in early October of 2008. The governments of the UK and Holland made local savers in those countries whole and then demanded the citizens of Iceland repay the losses. After two nationwide votes, the citizens of Iceland basically told the UK and Netherlands governments to pound sand. Why should the citizens of Iceland have to repay the losses of the banks? It’s a good question.
What is actually going on is all governments are trying to pretend the debts can be paid and all citizens are demanding the benefits continue. Irresistible force and immovable object. The citizens and all governments believe the good times will continue. They can’t. We can’t afford it.
Spain and Greece both used non-transparent derivatives to improve their financial books so they could enter the EU. The cooked books are now pretty obvious and Germans are objecting to having to work to the age of 67 so Greeks can retire at 50. Tick. Tick. Tick.
I was watching some of the violence taking place in Spain today and it caused me to realize I needed to write this piece. Greece is the proverbial canary in the coalmine. I think they are going to effectively default next week. When they do, the party stops at once as a series of cascading defaults consume the financial system far faster than governments can print money to dump on the problem.
I was working for EDS in New York when then President Nixon made his famous speech on August 15th, 1971 taking the US off the gold standard. You have to be pretty old to still remember it but his speech wasn’t actually about gold or the dollar, the speech was about putting the US on Wage and Price Controls. The speech pissed me off because I knew Ross Perot would use it as an excuse to stop pay raises already promised. He did. Cheap bastard.
In any case, after the dust settled, I began to think of the implications of the US being totally off the gold standard. For most of the last 40 years, I have firmly believed the US dollar would die as a result of hyperinflation. I was an early adopter in the hyperinflation theory and now it’s commonly accepted as how the dollar will end.
I may have been wrong, totally wrong. We know the $600 trillion in derivatives has to disappear. The chances of $600 trillion in derivatives being around for much longer are about the same as the future of a snowball in Hell. It’s actually pretty surprising that the system has lasted as long as it has.
Greece, Spain, Ireland, Iceland, they are just part of the burning fuse. We hear very little rational discussion about the issues. The issues are simple. The world has far more debt than it can support. Unions and workers have extracted promises from government that can never be paid. We simply cannot afford the lever of government we have but no one wants to address the issue. They keep kicking the can down the road. One day very soon the music will stop and everyone will try to find a chair to sit in only to find in this epic game of musical chairs, there are no chairs.
It’s heresy for me to suggest it but the very best investment for the next six months might well be cash. The kind of dirty filthy cash that you can shove under your mattress and use when the system comes to a grinding halt. Gold may well be the currency of choice to rebuild the system but to get through the chaos that is coming, I think you want the kind of cash you can hold and spend.
The revolution may have started in Egypt and Libya and Spain and Greece but I’ll bet money, cash money, that revolution heads our way soon.

1 comment:

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