'Happy' 2009?

Greetings good citizen,

So much for ‘hardy New Englanders’. A minor winter storm has quashed plans for our annual New Years Eve gathering.

So I sit here wondering if this is a function of ‘maturity’ (a little snow never stopped us in our younger days) or if we have reached an age where ‘wisdom’ has replaced recklessness?

I instead conclude that we are tiring of the ‘routine’. Sadly, the New Years celebration has become one more instance of SSDY. Add snow removal chores into the mix and tonight’s ‘skip it’ becomes more understandable.

Perhaps this time next year will find us longing for anything familiar or routine.

I wish you all peace, happiness and prosperity in the coming year…

Regretfully, I predict ‘none of the above’ are likely outcomes for a vast majority of us.

So we arrive at tonight’s offering [Hat tip: Jesse’s crossroads café .com via SAR.] Where Jesse provides some piercing insight to the ramblings of Brad ‘follow the money’ Setser.

Dancing on a Precipice: The Tenuous Balance in Global Finance

“If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem.” Jean Paul Getty

We imagine J. Paul Getty would probably like to update that quotation to billions if he were still alive. We knew some people who subscribed to this notion that you keep borrowing until you gain a measure of control over your banks, since your default would be so painful to them. It is a tool of financial engineering roughly related to a passive form of extortion, a long con.

Here is an extended quote from a 29 December 2008 essay by Brad Setser titled The collapse of financial globalization...

"Both private capital inflows to the US and private capital outflows from the US have fallen sharply. They have gone from a peak of around 15% of US GDP to around zero in a remarkably short period of time …

Direct investment flows have continued. Other financial flows though have largely gone in reverse, with investors selling what they previously bought. In the third quarter foreign investors sold about $90b of US securities (excluding Treasuries) and Americans sold about $85 billion of foreign securities. And the reversal in bank flows on both sides (as past loans have been called) has been absolutely brutal.

This sharp fall has bearing on the bigger debate over the role global capital, global savings and foreign central banks played in helping to create the conditions that allowed US households to sustain a large deficit for so long — and whether American and other policy makers should have paid more attention to the risks that came with the surge in foreign demand for US financial assets earlier this decade...

I think we now more or less know that the strong increase in gross capital inflows and outflows after 2004 (gross inflows and outflows basically doubled from late 2004 to mid 2007) was tied to the expansion of the shadow banking system. [Largely via the ‘securitization’ of debt instruments.]

It was a largely unregulated system. And it was largely offshore, at least legally. SIVs and the like were set up in London. They borrowed short-term from US banks and money market funds to buy longer-term assets, generating a lot of cross border flows but little net financing. European banks that had a large dollar book seem to have been doing much the same thing. The growth of the shadow banking system consequently resulted in a big increase in gross private capital outflows and gross private capital inflows... (Hence the subsequent spike in the value of the dollar from the eurodollar short squeeze we have recently seen - Jesse)

Why didn’t the total collapse in private flows lead financing for the US current account deficit to dry up? That, after all, is what happened in places like Iceland — and Ukraine.

My explanation is pretty straightforward.

Central banks were the main source of financing for the US deficit all along. Setting Japan aside, the big current account surplus countries were all building up their official reserves and sovereign funds — and they were the key vector providing financing to the deficit countries."

The implications of this are rather profound. The much touted notion that the US is the preferred destination for private wealth, thus sustaining an out of balance trade deficit through a financial services economy, is rubbish at best, and propaganda at worst. It is rooted in the Dick Cheney nostrum that "Reagan proved that deficits don't matter."

What we have today is a very lopsided vendor financing arrangement, wherein the US is largely supported by China and Japan whose industrial policy currently recommends their support of a US debt that is increasingly unpayable.

If and when China and Japan are no longer able to support the continued growth of US deficit financing, the dollar and the bonds will contract (decrease) in value, and perhaps precipitously, like a house of cards. It is much worse than we had imagined, and more concentrated on these two countries, along with Saudi Arabia, than we had thought.

For now the balance is maintained because of self-interest and fear. But we cannot stress enough the highly artificial nature of the arrangement, and its inherent instability, now that the charade of sustained private investment flow is shown for what it is. There is no economic theory to support this model other than a distorted form of neo-colonial parasitism. Substitute US paper dollars for opium and you get the idea.

Japan and Saudi Arabia are understandable as virtual client states under US military protection, but we struggle with how China was taken into this arrangement which is so potentially destabilizing of their internal political and economic stability. [Sadly, methinks we have yet another instance where personal greed trumped both common sense as well as the common good. Apparently Chinese politicians are no less greedy than their ‘developed nation’ counterparts. This is a mistake that many of them will pay for in blood.]

This is why the world has not developed a sound replacement for the dollar hegemony. It is because if they do, they must navigate around the probability, not possibility, of a collapse of their dollar reserves, and a dislocation of their own export driven economies, much worse than we might have imagined. It is not a matter of economic inventiveness; it has become a matter of will.

Who will be the first to flinch? History shows it is rarely a conscious decision, but rather some incident, an accident, some trigger event, even one so small, that it creates astonishment at the size of the avalanche it unleashes.

To make it clear and simple, this is the first evidence we have seen to suggest that hyperinflation is in fact possible in the US. As you know, we have been strongly adverse to the extremes in outcomes, both in terms of a sustained deflation and a significant hyperinflation. [Um, many (like Mr. Williams at SGS) have predicted hyper-inflation but most have been unable to prove it. It looks like Jesse, through Brad, has ascertained what many of us have only theorized.]

That has now changed. The dollar is a Ponzi scheme, the waters of debt are overflowing the dam of artificial support, and only a few countries, two of them somewhat unstable, are holding back the deluge.

My regular readers are aware of what ‘Dollar Hegemony’ is but I’d posit that the average citizen is clueless. They have no idea what those who have been ‘entrusted’ with managing our money supply have done to us.

Simply put good citizen, Dollar Hegemony really is the ‘crime of the century’.
Exporting nations have been shipping their products to the US for decades in exchange for ‘worthless paper’. The damning part is they had to cooperate or their own economies would fall apart.

What we’re witnessing today is the ‘end result’, the ‘dump’ is full.

Naturally, the perpetrators took a ‘gamble’, both their ‘deed’ and the gains they have reaped CAN be ‘erased’ with ‘the stroke of a pen’.

You can’t do a ‘swap’. You have to do a ‘reset’, like the one outlined in ‘A Simple Plan’.

I find it more interesting that the more you look at it, the only way out of this mess where the average citizen not only retains their former freedoms but adds new ones would be under ‘A Simple Plan’.

There is no way anyone will ever trust ‘representative currency’ again.

You may (grudgingly) trust it today…but that won’t be the case this time next year.

I’ve outlined the scenario many times. You walk into a store and nothing has a price on it. So you pick up what you need and head for the register…and the clerk picks up the phone and calls his supplier to find out what it’s going to cost him to ‘replace’ what you bought. (If he fails to charge you more than the replacement cost, he won’t make a profit nor will he have the funds to secure more inventory.)

That’s how ‘rapid’ the rate of inflation is rising in Zimbabwe…and it will happen here as well.

What you may have missed is the ‘why’ behind this. The 665 trillion ‘dollars’ worth of securitized debt out there…it’s denominated in dollars. This is the ‘Shadow Banking System’.

Now the weasels that created this stuff are trying to ‘incorporate’ it into the 53 Trillion dollar global economy. If you can do simple math, you see that this can’t work without massively ‘diluting’ the global money supply.

You and everyone else’s purchasing power will drop by a factor of twelve.

Everything will cost a dozen times more than it does today…and you aren’t going to see your pay increase by anywhere near that amount.

If it hits quick, most businesses won’t be able to afford the price of ‘inputs’, which will bankrupt them. The entire supply chain will collapse and then the ‘real fun’ will begin.

Since the activities that led to this massive build up in credit derivatives are, um, suspect to put it mildly…and incorporating them into the global economy would be ‘suicidal’, you’d think they’d be declared illegal.

Well, that shoe hasn’t dropped, yet.