Fiat and Credit - "The Coming Financial Holocaust"
Towards the Final Denouement - the 2007 - 2008 Crash
"Make Money your God and it will plague you like the Devil" --Henry Fielding (1707 to 1754)
Setting the Scene
This article builds on earlier essays by the writer based on a similar theme. However, as the reader will see, this gold boom cycle will be like none before it, and, as is often the case in human affairs, events of the past, whilst similar in outline, may differ significantly from presently unfolding events. To quote Winston Churchill, they are "variants on a familiar theme". That theme is determined by repetition of man's own inherent weaknesses: lust, greed and desire for control exercised through power and his preoccupation with the here and now. Technology merely a par, albeit a very important one, of the ever changing and evolving environment within which man reenacts his greater deeds or, more often, his follies.
It should now be apparent to all readers of these pages that we are in the midst of the largest FIAT money experiment ever witnessed by an entire order of magnitude, and the first FIAT money exercise to be put to the test on a truly global scale. Hitherto, the political, economic and technological environment was not conducive to enabling such an incredible scheme to be successfully put into effect. To enable this required the presence of one hyper-economic power that also controlled a global currency and the velocity of capital movements made possible through modern communications technology. Another critical factor essential to enabling FIAT to be expanded without control was the destruction of the gold standard on which the value of all issued paper money was formerly based, and the strict financial discipline this exerted throughout the global financial system. It was, therefore, vital to the promulgators of FIAT that gold was no longer seen as a monetary instrument by the general public or, indeed, governments. The reader may be wondering why elected democracies would wish to support this vast and virtually uncontrolled expansion of paper and digital money, and the attendant explosion in inflation and associated wealth destruction of saver's funds, and for what purpose this is all intended. The reasons, as this article proposes, are as awesome as the scheme itself.
The United States has, since World War 2, dominated the world economy. Essential to this dominance was the acceptance, by proxy, of the US dollar as a global currency in which all commodities are traded and intrabank transactions settled. In a post war world, where financial stability was essential to reconstruction of a shattered Europe and Far East, this situation worked to everyone's mutual advantage. However, it enabled successive US administrations incredible global, political and economic leverage hitherto not given to any one nation state. Furthermore, through this global financial dominance and influence, the US Federal Reserve was able to influence the entire world economy and, dare one say, manipulate it to its own advantage, by either the issuance of vast amounts of new capital or by putting on the brakes through interest rate increases. Hence, the former boom and bust cycles which became as much a lynchpin of US global economic strategy and their ubiquitous and ever expanding military presence. The US finally cut all ties between the dollar and gold under the Nixon administration in 1972. This ushered in an explosion of FIAT, inflation and a surge in the gold price to its highest ever price of US$ 850 per troy ounce. This single event convinced the central bankers that gold must, by some means, be controlled and, if necessary, suppressed, otherwise it posed a major threat to their plans to embark on their own version of interstellar space's creation in the "Big Bang" with colossal expansion of credit and digital money. But, what end was this scheme designed to achieve?
As Bill Murphy and the GATA organization has successfully demonstrated, the world gold market has been the subject of intense manipulation against all the precepts of free markets. The importance of manipulating the gold price centers on two key issues, namely: the importance of protecting the huge carry trade pyramiding profits upon the leasing of physical gold, at very low interest rates, at its foundation; secondly, the removal of the notion of gold as a monetary instrument was central to the creation of the digital money system under which we now live. This being the greatest confidence trick ever played upon a largely unwitting human race. The eventual social and political costs of this scheme are barely worth contemplating, so wide ranging are the implications.
As though to emphasize the first fact, the UK Government, amidst much hullabaloo and extreme obfuscation, purportedly centered on the proposed UN debt relief program, decided, in May 1999, to carry out a phased sell off of 50% of the UK's gold reserve, amounting to 415 tonnes, in the first sale of its type since the Napoleonic wars, with the astonishing timing of selling at the very bottom of the gold market. The sale lost the UK taxpayers in excess of 2 billion US dollars - a fact suitably glossed over by the Chancellor of the Exchequer, Gordon Brown and the Prime Minister, Tony Blair. The real reason for the gold sale was the saving of some very significant and highly influential figures at the top of the world banking system and their elaborate carry trade and gold based derivatives and tied hedging commitments. The nonsensical story about UN debt relief was nothing other than an elaborate smokescreen that simply serves to underscore the enormity of the lies told by the world's so called "leaders". It also clearly highlights who really call the shots behind the scenes. World leaders are little other than cosmetic marionettes dancing to tunes played behind the managed media curtain.
Another immense smokescreen, exposed by Bill Murphy and Frank Veneroso, centers on the supposed physical gold reserves held by the world's central banks. As Veneroso has so well documented, the Central Banks have an estimated 10 to 15,000 tonnes of physical gold and not the 31,000 tonnes they have reported. In an accounting "sleight of hand", Central Banks routinely report "gold and gold receivables" or "gold and gold deposits" as one item. This hides the fact that swapped gold is recorded as an asset when a legal change of ownership has occurred. This double counting has had the beneficial effect of inflating reserves held by Central banks. This fortuitous double accounting serves to mask the extent of the gold based carry trade and derivatives markets and the obvious conspiracy to cap the gold price.
This is only the tip of a veritable continent sized iceberg of problems manifesting in today's financial and capital markets. More than 90% of the complex interlinked and highly leveraged hedge funds and derivatives markets, which are so much arcane science to the uninitiated, carry enormous risks should interest rates increase much above current levels.
The second issue concerns FIAT currencies and the immense confidence trick attendant in their actual value and continued existence. Everyone is fully aware that all paper currency has devalued to a mere 1% of its value a century ago. Inflation has been underway and accelerating since 1913 and the creation of the US Federal Reserve Bank. However, this accelerated with the destruction of the world gold standard. Two key events caused the issuance of digital money to go through two major periods of expansion. The first, from 1982 to 1992, experienced a "modest" 8% year-on-year expansion in the money supply. However, from 1992 to 2002 expansion moved into overdrive with the deregulation of global markets with a year-on-year expansion of more than 12%. Since the 2002 post 9/11 crash, the expansion of the money supply has been running at greater than 15% with the lowest interest rates seen since in 45 years. As though to underscore the extreme rate of expansion the Fed has stopped publishing M3 money supply figures. This highly insidious move is little more than an attempt to mask the facts and raises serious questions about the honesty, integrity and objectives of the system we now live under.
The CPI figure has so little basis in factual reality that it serves only to underscore the age old adage "there are lies, damn lies and statistics". Indeed, this figure is little more than a piece of "voodoo economics" designed to fool the unwitting populace that inflation is only a third or quarter of what it really is. The objectives are merely to put intense downward pressure on labor market wage settlements. Furthermore, besides its political value, the impact of the CPI figure has complex ramifications throughout the financial markets and pension funds markets. Another bogus statistic is the unemployment figure. This is another highly tampered with set of figures designed to give a politically important "feel good factor" and disguise underlying unemployment and, more importantly, the actual structure of the labor market and mask major underlying problems by keeping them out of the political debate.
The following are a shortlist of some of the major problems facing a debt saturated world, in particular, the world's largest economy, the USA:
The US Government deficit now exceeds US$8 trillion. The ceiling for the deficit has recently been raised again by Congress;
The US needs to receive funding at the rate of US$65 bn./month or more;
The trade deficit is now running at an "eye popping" US$730 bn. per annum or 6.7% of GDP;
The derivatives and hedge fund markets top US$240 trillion;
The US has reached a level of debt saturation hitherto thought unimaginable and unsustainable, comprising, at its heart, mountainous mortgages and pyramiding credit card debt. More and more Americans have burdened themselves with maximum mortgages taken out with the perception of a real estate market set on an ever upwards trajectory. Most of these mortgages are at the limit that the mortgagee can support, and this sustained by ever more complex and financially dubious mortgage products increasingly designed to underwrite ARM (Adjustable Rate Mortgages) mortgages. This is little other than a horrifying scenario based on a "colossal leap of faith" in the persistence of low interest rates and economic naivety by the population at large;
The Feds policy of total accommodation, with interest rates falling to 1% in 2001 to 2002, to avert the inevitable major bond and stock market crash and all it implied for the world economy, was the signal for the surge in commodity prices many of which have more than doubled in price. Amongst the most prominent is the rise in the oil price from US$22 to US$65, but others, to name but a few, include: platinum, gold, silver, nickel, copper, lead, zinc, soy, sugar, coffee and cocoa. Most of these commodities are currently trading at increases of from 120% to 300% above 2002 prices. However, have all been reliably told that headline inflation rates are below 2.5%. Perhaps one needs to look at the salary and benefit increases of executives in the World's leading companies to see what they have been awarding themselves to determine what they know to be the real inflation rate. This, you will find, is running at between 12% to 15% per annum, and a lot more if other perks such as generous stock options and severance packages are factored into the equation. So much for the CPI;
Finally, but by no means least, we have "the forever war" on terrorism. Congress has approved the largest ever increase of some 40% in the Defense Budget to a mind boggling US$450 billion. This means that the US spends more than all the other countries in the world combined on its military. One may wonder what such expenditure might achieve if even a fraction of it were directed to such things as: US infrastructure including roads, railways, power stations, hospitals, and construction of better schools; or, medical research; development of new sources of energy; reducing the effects of pollution in the US; or if some was directed to alleviate world poverty and assist developing countries? The current Iraq war is little other than a debacle that has brought untold misery. Even worse, the ugly inheritance of Winston Churchill's policies has come back to haunt the citizens of Iraq with a fracticidal civil war now underway which is engulfing Sunni Muslims, Shi'ite Muslims and Kurds. In a nightmarish scenario, this war could well drag in Kuwait, Iran, Turkey, Jordan and Saudi Arabia. Neither the US nor the UK has a clear exit strategy for Iraq. In fact, they are linked together in a mess that neither can extricate themselves from. The full consequences of this immense policy failure will become apparent over the coming months and years. Long will the Allies live to rue the day the got involved in Iraq. History will not judge Messrs Bush and Blair kindly. Eventually, the truth will out.
The Great Crash of 2007 - 2010 and the destruction of World FIAT
Almost all analysts have suspected that a major correction or crash is coming, from Morgan Stanley's Chief Economist, Stephen Roach, to Prudent Bear's Doug Noland. However, people have given up calling the timing of the crash because so many have been wrong-footed or dumbfounded by the action of the Fed and the markets. However, this writer feels confident enough to call the timing of the crash and presents two long term charts of the DJIA (Dow Jones Industrial Average) which measures the top 30 US stocks and the technically more significant S&P 500 (Standard and Poor's 500 largest US traded stocks).
To gain a real perspective of the situation developing, the writer has looked at the past 35 years of trading activity. Superimposed on these charts are the 50, 250 and 500 day moving averages. Several important features are apparent on these charts, as follows:
On the long-term charts it is apparent that the current bull market in the DJIA is complex but the following features are obvious:
The current bull market is the largest by an entire order of magnitude from any preceding bull market;
The 2001 to 2006 double bull market is actually forming the largest technical 'double top formation' ever witnessed in the history of the equities markets. This market includes the Phase 1 run up from 1982 to 1992 but shows major acceleration following the deregulation of markets in 1995. The top, at 11,700 points, came in 2001 forming the immense head of what should have been the all-time classic "head and shoulders" formation. However, given such a clear technical picture and economic landscape the Fed aggressively dropped interest rates to the lowest level in 45 years to create a strong rally off the right shoulder of the head and shoulders formation thus producing the world's largest ever technical double top formation. Now, with inflation in commodities markets running an almost out of control bull market, and debt saturation close to total throughout the entire world, the scene is set for the economic and mathematical denouement;
With interest rates set to rise around the world and marginal FIAT currencies such as the Icelandic Krona and the New Zealand dollar in freefall against the US dollar, the dominoes have started their collapse. The next currency to fall will be the Australian dollar which is already in steady decline and then the Canadian dollar and Sterling and the Euro. This will stimulate competitive interest rate rises to halt the collapse of all currencies against the "world commodity currency", the US dollar. As the US is forced to carry on raising rates, the bond market will steadily fall, and then implode taking the US dollar, the equities markets and the dollar with it in the greatest stock and bond market crash of all time.
The timing of this crash can be derived by examining the 50, 250 and 500 day moving averages (MA) on the charts presented as Figures 1 and 2. It can be seen on Figure 1, of the DJIA, that the 250 day MA has now formed an unusual plateau at exactly 10,000 on the DJIA. This is diverging from the 50 day MA but closing with the still rising, due to lag, 500 day MA. This it has never done in the charts' 35 year history. On Figure 2, the 250 day has already crossed the 500 day MA in the S&P 500 index. However, the key inflexion point will be when the 50 day MA crosses the 500 day MA which should occur from 8 to 12 months from now. The 500 day MA will then complete the other side of a perfect poisson distribution curve; i.e., the downside. This will usher in the crash which should be underway from October - December 2006 and gather momentum into 2007 amidst a climate of rising interest rates, political and economic uncertainty, debt saturation, gross economic distortion and imbalances, and war.
Just how far the collapse will go is hard to predict. However, from the technical charts, a reduction in the DJIA and S&P 500 to somewhere around 10% of today's levels looks probable.
From the foregoing, those fortunate enough to own their own homes and other core assets, and possess a mix of quality gold mine stocks and physical gold will be amongst the few who survive this financial equivalent of a holocaust. The current boom in the gold price is not a boom in real terms. Gold has in fact underperformed most other commodities in relative terms and moreover in terms of general asset inflation. The gold price has barely kept pace with inflation, until very recently, over the entire period from 1999 (when it was already seriously depreciated), due to excessive manipulation by the Commercials. Indeed, according to Russia's Central Bank, gold should have been at US$750 in 2004, to have kept pace with inflation. This writer firmly believes even this is a substantial understatement. A recent report by Chevreaux's Paul Myrchreest has raised their mid-cycle gold price to US$ 900. This writer believes the venerable doyen of the markets, Richard Russell, is closer to the mark with his estimate of the gold price peaking at US$3,000. However, all this depends upon just how far the FIAT currencies collapse. There is definitely scope for a complete implosion of all the world's major currencies to levels reminiscent of the Weimar Republic's Mark where German banknotes were overprinted first in multiples of millions of marks and then billions. Gold lives on to see its final revenge on mankind's incapability to remain honest in his handling of money and other peoples hard-earned savings.
Finally, of one thing we can be sure, the coming rise of gold, silver and platinum and puncturing of the colossal credit - debt balloon, will usher in an entirely different world in which the economic and social - political landscape will have changed forever. We are witnessing one of history's great turning points. Let's hope the changes wrought will be positive!