Reading time: 3,389 words, 11 pages, 9 to 14 minutes.
Another milestone! The authorities’ utter failure to fix our collapsing global economies is now evident in the incredible incompetence of the U.S. Federal Reserve losing control of interest rates.
I have long said we are past the point of no return. Fed Chairman, Ben Bernanke has now confirmed it with his imbecilic remarks about a “tapering” of Quantitative Easing (QE). The subsequent market reaction proves it. So, hang on everybody; we’re in for another wild roller coaster ride.
In testimony to the US Congress in May, 2013, Bernanke hinted the Fed would begin reducing (“tapering”) the Fed’s QE program. Note that he did NOT say it would end, but merely begin to reduce its seemingly endless money printing. Then, during the June 19th FOMC press conference he outlined the Fed’s exit strategy from QE.
The markets, like any addict denied its “fix”, went wild with increased volatility in stocks, bonds and currencies. Worse, long dated Treasury bonds started collapsing as interest rates began to rise.
Remember, bond prices and interest rates are inverse to one another because the value of older, low interest bonds decrease as new, higher interest rate bonds are issued. Simply, existing bonds are going to get slaughtered because governments have finally lost control of the bond markets. 50 years of cheap credit and 30 years of low interest rates are coming to an end with devastating consequences.
The two graphs below illustrate the damage.
FIGURE 1: VOLATILITY INCREASING FIGURE 2: ASSET PRICES DECLINING
Why are Government Bonds So Critical?
a) Bonds are the biggest bubble in history. At $70 trillion they surpass the housing bubble and stock markets and every other asset class. Many other assets are based on bonds to one degree or another; hedge funds, mutual funds, pension funds, insurance, banks and other financial institutions, investors, etc.
Pensions are in jeopardy because most are based on bonds. Defined contribution pension plans will suffer again thus making it even more difficult for workers close to retirement to retire as many have already seen their plans devastated by the last downturn.
Businesses and governments that are required to ‘top up’ defined benefit pensions (what I call ‘divine’ benefit) will face increased costs and reduced (business) profits. Governments will begin reducing, clawing back and outright eliminating their bloated pensions.
This has already begun with municipalities, counties, towns and cities. Detroit, the largest U.S. city so far has recently reneged on bond payments. Next up are states and provinces with federal governments not far behind.
b) A large part of Western economies are tied up in housing. Mortgage rates are closely tied to long term treasury rates. As treasury rates increase, so do mortgage rates . Rising mortgage rates make home ownership more expensive and will slow down the fragile housing market and could push house prices off a cliff.
Tip: If you’re a homeowner, NOW is the time to lock into a long term mortgage. If you’re buying a home, do NOT get an adjustable (variable) rate mortgage, but lock in a long term mortgage. Better yet, keep renting, ride out the storm and buy a cheaper house later.
c) Making matters worse is the effect on lenders. Rapidly rising interest rates make financial institutions more reluctant to lend at current rates if future rates continue to increase. This is a blow to those seeking mortgages, further dampening the housing market.
d) It is also a blow to businesses unable to secure capital. We are already seeing that with miners delaying or cancelling new mine projects, and putting existing marginal mines on ‘care & maintenance’. All this will damage the economic growth that governments been working so hard to create thus requiring even more stimulus, the effectiveness of which decreases with each new injection.
e) Over-indebted governments will now pay ever higher interest on their excessive debt. The more tax revenue they divert to interest payments, the less money there is for real necessities. They try to calm us with talk of deficit reduction, but that all it is: talk.
Remember the difference between deficit and debt. Deficit is the annual shortfall. Debt is the accumulation of all the previous deficits. Lowering the deficit (even if it were possible) still increases debt albeit at a slower rate of increase. To reduce debt requires surpluses. When’s the last time you heard any government say the word ‘surplus’? Do you see how much trouble we’re in?
f) Derivatives will again raise their ugly heads. I’ve been sounding the alarm on derivatives for almost six years now. It is for good reason Warren Buffet called these structured financial instruments created out of thin air, ”Weapons of mass destruction”.
Many of these derivatives are ‘interest rate swaps’. These are hedges supposedly designed to protect companies and banks against changes in interest rates.
Unfortunately, we have learned that they work well in theory but not in practice. The problem is counter-party risk. In other words, they are worse than useless when the party on the other side of the bet has gone broke.
In the words of Eric Sprott, “When you have a notional (one) quadrillion dollars of derivatives and they change by 1% on one quadrillion, that’s 10 trillion dollars right there. It’s just incredible. It would wipe out the (entire) banking system.
“It’s a zero sum game, except the guy who’s losing can’t pay. Then of course they whole system comes crashing down ….”
Included in that quadrillion dollars of derivatives are $441 trillion in interest rate derivatives unable to withstand a large increase in interest rates. Compare that to the size of the global economy at about $60 trillion and you begin to see the gargantuan size of the coming collapse.
g) The incompetence of central banks, especially the U.S. Federal Reserve is now plain for the whole world to see. Incredibly, they believe their own propaganda; that economies have recovered enough that QE printing money out of thin air could actually come to an end.
The Telegraph’s Ambrose Evans-Pritchard says, “The US Federal Reserve has jumped the gun. It has mishandled its exit strategy from quantitative easing, triggering a global bond rout that it did not anticipate, and is struggling to control.
“That the Fed should tighten even as it cut its own growth and inflation forecasts for this year is a bizarre state of affairs.”
As I’ve said numerous times, they CANNOT stop QE. Jim Sinclair calls it “QE to Infinity”. If they stop, economies will collapse overnight. If they DON’T stop currencies will eventually collapse. As the old saying goes, “pay me now or pay me later”. They’re caught between a rock and a hard place. As I’ve also stated endlessly, we are beyond the point of no return.
One of Evans-Pritchard’s readers summed it up thus, “Here, let me do a Readers Digest version of this… You can’t print worthless money forever because sooner or later the suckers catch on.” The rumbling we hear in all the asset markets is the suckers catching on that the end is near and everyone is rushing for the exits for a second straight month.
h) Having previously announced that QE would continue into 2014, Bernanke chickened out, froze and hinted at tapering. The resulting market turmoil caught him completely off guard and he responded to a journalist’s question about the rise in interest rates by saying he was “a little puzzled by that”. In other words, he doesn’t know what the hell he’s doing. He is completely out of his depth.
i) The incompetence of U.S. Fed Chairman Ben Bernanke is becoming more evident every day. The idiot apparently believed his own government’s “recovery” propaganda! No sooner does he utter the word ‘taper’ then:
– the markets have a heart attack,
– gold gets manipulated even lower,
– the Fed raises the unemployment target from 6.5% to 7%
– and they quickly orchestrate the Bank of England plus Mario Draghi of the European Central Bank plus six Fed governors feebly trying to assure us that, ‘People have misread it.’
Want to bet you’ll never hear another official mention the word ‘taper’ ever again?
j) This is NOT just an Amerikan problem. It’s global. Graham Summers of Phoenix Capital Research in the article The Great Global Rig is Ending… reports that, “China is on the verge of a “Lehman” moment as its shadow banking system implodes. China had pumped roughly $1.6 trillion in new credit (that’s 21% of GDP) into its economy in the last two quarters… and China GDP growth is in fact slowing.
“This is what a credit bubble bursting looks like: the pumping becomes more and more frantic with less and less returns.”
Technical analysts will notice that China’s stock market has broken the trend line to the downside on the graph below. This is a very reliable bearish signal.
Another bearish downside break is Brazil, another “coming economic superpower” that is experiencing rampant riots (over two million people) with soaring inflation. The chart below is pointing toward 2008 recessionary levels
And, European stocks have already plunged to 7 month lows.
k) Rising interest rates will continue to hammer the stock market. According to Charles Hugh Smith, “once you can get 5+% yield on cash again, few people are willing to risk capital in the equities markets in the hopes that they can earn more than 5% yield before the next crash wipes out 40% of their equity.”
l) Most significant of all, the Bank of International Settlements (BIS), the central bank of central banks worldwide has GIVEN UP trying to prevent further collapse. You can read the full speech HERE.
The Coles Notes version is simple; the era of extraordinary central bank intervention is coming to an end. Lots of patting themselves on the back for preventing blah, blah, blah. But, the bottom line is they’ve tried everything they could; it hasn’t fixed the unfixable. We need more of the same that hasn’t worked before; more spending, more debt, more globalization blah, blah, blah. It’s an admission of abject failure and now they’re going to let it all collapse which they should have done long ago.
Had they done the Swedish model (1990) it would have been a painful couple of years that would now be long behind us. Sweden let their insolvent banks collapse and their pieces were picked up by stronger banks. Three years later, Sweden’s economy was humming again.
In the Japanese model (also 1990) they tried to prop up their banks and busted real estate companies. Japan has been in a depression ever since. Once upon a time, we said we’d all have to learn to speak Japanese in order to talk to our future bosses. We haven’t heard that joke for 23 years.
The only thing we learn from history is we never learn from history. So, we’re doing the Japanese model. How incredibly stupid can we be? Our so-called leaders are not only incredibly incompetent, they are clearly insane.
Gold and Silver Crash
There shouldn’t be any doubt to anyone who’s been following the gold and silver crash commentary that the crash has been manipulated by governments and their stooge banksters in order to:
– cover massive bankster short positions, and
– allow the insolvent banksters to go long to profit on future gold price increases
– enable government to start re-filling empty vaults. Remember, when Venezuela requested the repatriation of 200 tons of their gold, the U.S. complied immediately but when German asked for 321 tons of their gold only two months later, they were told it would take 7 YEARS.
– “trick the world into thinking that the world financial system is stable,” according to Sprott Asset Management CEO Eric Sprott tells King World News
– and divert the public’s attention from collapsing global economies discussed above.
As Cody Willard says in the MarketWatch article The gold and silver crash was artificial. “So both the U.S. government and the banks that they’ve bet our future on are now in a position where they need to get their hands on as much physical gold and silver as they can and the easiest way to do that is by plundering the wealth of the world’s people by artificially crashing gold and silver here to try to induce them to sell away their physical gold and silver coins and bullion at lower prices.”
Incidentally, Cody Willard is giving away his Amazon best-selling book, “Everything You Need to Know About Investing,” for free in either PDF or Kindle format. Email him HERE or support@TradingWithCody.com and request your free copy while it’s still available indicating which format you want.
The Idiocy of Central Planning
Neo-Keynesian imbeciles have created this global economic mess and are utterly incapable of fixing it. How can a problem fix itself? Moreover, the idiocy of central planning has been a major contributor to this disaster. Central planning i.e. government control of all aspects of life (especially economic) has been tried with disastrous consequences throughout history.
It didn’t work in the Soviet Union. They went bankrupt and collapsed. It’s not working in the Cuban ‘worker’s paradise’ where everyone shares a common level of poverty. It doesn’t work in starving North Korea or in impoverished Zimbabwe. It doesn’t even work in oil-rich Venezuela.
So why do our so-called leaders try to make it work here? Well, there are several reasons:
1 – The only thing we learn from history is we don’t learn from history.
2 – The only thing more evil than government is big government because the bigger it gets, the stupider it gets.
Telegraph reader tofollowrome sums it up very well:
“It’s bizarre that almost all economists agree that trying to centrally planning an entire economy Soviet Union style is foolish, but yet they believe centrally planning the financial part of the economy not only can, but should be done. They are all taught more or less the same failed theories at almost all major universities.
“The FED and other central banks around the world have painted themselves into a corner. They have propped up bond and stock markets with new money. They foolishly believed they could continue forever because there was no obvious inflation, or at least no serious inflation.
“Keeping bond and stock markets and housing markets inflated artificially through QE keeps the illusion of economic recovery, but with horrible unintended consequences of borrowing cheap money, and creating bigger and better bubbles further down the road. The practice prevents the correction of huge economic imbalances, drags out the recovery, and will result in an even worse catastrophic crash once the QE finally stops, which eventually it must. At some point, the massive amounts of money on bank balance sheets has to start leaking into the real economy. Take less pain now, or more pain later, red or the blue pill, it would however have been better not to start QE in the first place. Bernanke will take the red pill and double down on QE, thats all he knows, print, print , print money; which will be a ludicrous $178bn a month, pack his bags and get the hell out of there.”
With hindsight, we can clearly see the disastrous effect of central planning and the incredible incompetence of Fed Chairman Bernanke. By allowing the Fed to pay more interest to banks for parking the money on the Fed’s balance sheet that they borrowed at near zero interest, it created a ‘liquidity squeeze’ that discourages inter-bank lending and, most important, it discourages lending to Main Street thus preventing a real recovery. The graph below illustrates the excess reserves parked at the Fed.
Jeff Hummel, economics professor at San Jose State University, warns that paying interest on reserves “may eventually rank with the Fed’s doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.”
Zero Hedge calculates that a 3% increase in interest rates would cause U.S. Treasury bonds to “lose more than $1 trillion, or almost 8% of US GDP … The losses for holders of debt issued by France, Italy, Japan and the United Kingdom would range from about 15 to 35% of GDP of the respective countries.
“Yields are not likely to jump by 300 basis points overnight; but the experience from 1994, when long-term bond yields in a number of advanced economies rose by around 200 basis points in the course of a year, shows that a big upward move can happen relatively fast.”
Charles Hugh-Smith explains Why Centralization Leads to Collapse
– “In eliminating inefficiency and messy decision-making, centralization eliminates redundancy, decentralized pathways of response and dissent. Once you lose redundancy and all the feedback it represents, you lose resiliency and fault-tolerance. The centralized system is fault-intolerant and fragile.
– “As Nassim Taleb has observed, dissent is information. Eliminate or marginalize dissent and you’ve deprived the system of critical information.
– “A system that suppresses dissent is fault-intolerant, ignorant and fragile.
– “The event that triggers crisis and collapse isn’t important; the system, rendered unstable and fragile by centralization, is primed for crisis and collapse. The dry underbrush is piled high, and if the first lightning strike doesn’t start the fire, the second one will. With dissent and the inefficiencies of redundancy and decentralized pathways of response gone, there is nothing left to stop a conflagration that consumes the entire forest.”
This is how the Mises Institute explains the dilemma: “whenever the Fed raises the pace of monetary pumping in order to “revive” the economy it in fact creates a supportive platform for various non-productive bubble activities that divert real wealth from wealth generators. Whenever the US central bank curbs the monetary pumping this weakens the diversion of real wealth and undermines the existence of bubble activities—it generates an economic bust. We suggest that there is no way that the Fed can tighten its stance without setting in motion an economic bust. This would defy the law of cause and effect.”
There are now so few bond buyers left that central banks bought up almost the entire $2 trillion issuance of AAA bonds worldwide over the past year. So distorted have the bond markets become that central banks have become the market themselves.
The hubris that an army of brainless government bureaucrats can somehow control economies is beyond imagination. Of course, they will try to control the damage, but at this point it will be all talk and no action. Even the BIS has given up.
Consider the fact that the majority of bond buying is by central banks and they are STILL losing control of interest rates. This is without a doubt the beginning of the end.
Note to government bureaucrats: central planning does NOT work. You screwed up big time. Again!
In the words of Zero Hedge “Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now.”
By the way, Ben Bernanke dropped a few hints about leaving when his term expires in January. Obama obliged him by practically firing him in public. Benny knows it’s time to leave now so the house of cards collapses on someone else’s watch.
The Disaster of Central Planning
Friedrich von Hayek in “The Road to Serfdom” warned against government central planning. The solution is to go back to the unfettered capitalism of individual liberty and free choice unconstrained by the stupidity of government bureaucrats.
Below are three eye-opening 1-hour videos that demonstrate this road to serfdom has been a long time in the making.
Well this was supposed to have been a brief update and, as usual, it got out of hand because there’s so much to report. To think that this is only a small fraction of the scary stuff I’ve seen, read and researched!
Are you prepared yet? We’re running out of time. Martin Armstrong forecasts the shit hitting the fan about 2015. That’ll arrive before you know it.
I conclude with the words of Charles Hugh Smith, “asset classes that depend on cheap, abundant credit are doomed: once yields/rates rise, the valuations of those assets implode. And once valuations implode, there’s not enough collateral left to support the loans used buy all those cheap-credit-inflated assets. So the financial system also implodes.”
Remember the mantra:
We cannot borrow our way out of debt.
We cannot spend our way to prosperity.
We cannot pretend our way out of trouble.
June 30, 2013
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Check this out Gerold…
Thanks for the excellent link, Markus. Good information.
Keep in mind it’s actually worse than that because many of the statistics (inflation, unemployment, etc.) that Rick Mills uses are “official” numbers and the real numbers are far worse. The official numbers conceal the true extent of our shrinking economies and declining living standards.
Amazing post and very interesting stuff you got here! I denfiitely learned a lot from reading through some of your earlier posts as well and decided to drop a comment on this one!
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I have been following your blog for a couple of years now and as I have heard you say before, economics seems to be a lot simpler than most people realise (especially economists!!), particularly in relation to demographics and their spending habits.
I’ve followed work by numerous ‘doomsday’ pundits such as Harry Dent Jnr, Peter Schiff and to a lesser extent Satyajit Das, all of who I think put forward very valid points in relation to the future of Keynesian economics.
Previous to reading your web page I started to form an image in my mind about how a real capitalist economy should work, with limited interference from government and a proper free market system (without government subsidies!!)
When I stumbled across your blog I couldn’t believe I had found someone with such a similar view on what direction the world economy is heading, and how blind western (and Chinese) governments are to the detriment of their enormous deficits and debt loads.
I could go on forever, but I’d just like to say that I’m a 29 year old farmer from Australia, which is in a lot of ways similar to Canada, and I have been telling friends for the last four years that when Chinese growth starts to go backwards (it’s starting to), Australia’s economy will suffer dearly (it’s beginning to). They said I was mad. And a lot of that knowledge is from reading this blog. One of the highlights of my day is visiting your site to see if you have posted a new article.
Thank you for the kind words.
You’re right: it’s not easy separating the wheat from the chaff (or the “pepper from the fly shit” as a friend is wont to say). On the one extreme we have the deliriously blind ass media and on the other extreme the doom & gloom Chicken Littles perpetually telling us the sky is falling. Finding one’s way through the middle is a challenge.
Unfortunately, you’re right about China and its effect on Australia and to a slightly lesser degree on Canada and other resource nations. The Chinese so-called “miracle” will be soon be seen as a mirage. Their statistics have always been suspicious especially coming from a command economy. And, their slowdown will effectively remove the last commodity consumer nation from the global economy.
Stay tuned. It keeps getting more interesting. As much as Australia and Canada will suffer through the next leg of this continuing Stealth Depression, I can think of many worse places to live. At least our countries are civilized as exemplified by the cooperation and mutual assistance among the recent Alberta flood victims. Many other countries would have seen widespread looting or worse.
Gerold: so what’s your advice regarding pension investments in mutual funds? should we withdraw all money and keep it cash in banks to be secure?
I’m not an accredited financial advisor and I don’t know the details of your personal situation (how much, tax situation, dependents, etc.) so I cannot give you detailed financial advice. There is no more safety in cash in a bank than in funds. The only safety is assets the government can’t get their hands on i.e. farmland, gold, silver, stockpiled essentials and food. However even that is subject to theft and confiscation so a ‘balanced portfolio’ is recommended.
Personally, I keep a minimum of cash in a credit union to pay bills plus the above plus hope my defined benefit pension plan holds out. Our greatest asset will be ourselves, social network, attitude, knowledge and ability to adapt.
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Great piece Gerold … pretty much nails it !
Thanks, Fred. Wish there was better news to report …
On the other hand, I can’t think of a better country to live to weather the coming storm. Happy Canada Day!
Best country ever ! Happy Canada Day to you as well !!