Editorial
The Fiscal Cliff Is A Diversion: The Derivatives Tsunami and the Dollar Bubble
The "fiscal cliff" is another hoax designed to shift the attention of policymakers, the media, and the attentive public, if any, from huge problems to small ones.
The fiscal cliff is automatic spending cuts and tax increases in order to reduce the deficit by an insignificant amount over ten years if Congress takes no action itself to cut spending and to raise taxes. In other words, the "fiscal cliff" is going to happen either way.
The problem from the standpoint of conventional economics with the fiscal cliff is that it amounts to a double-barrel dose of austerity delivered to a faltering and recessionary economy. Ever since John Maynard Keynes, most economists have understood that austerity is not the answer to recession or depression.
Regardless, the fiscal cliff is about small numbers compared to the Derivatives Tsunami or to bond market and dollar market bubbles.
The fiscal cliff requires that the federal government cut spending by $1.3 trillion over ten years. The Guardian reports that means the federal deficit has to be reduced about $109 billion per year or 3 percent of the current budget. More simply, just divide $1.3 trillion by ten and it comes to $130 billion per year. This can be done by simply taking a three month vacation each year from Washington's wars.
The Derivatives Tsunami and the bond and dollar bubbles are of a different magnitude.
Last June 5 in "Collapse At Hand" pointed out that according to the Office of the Comptroller of the Currency's fourth quarter report for 2011, about 95% of the $230 trillion in US derivative exposure was held by four US financial institutions: JP Morgan Chase Bank, Bank of America, Citibank and Goldman Sachs.
Prior to financial deregulation, essentially the repeal of the Glass-Steagall Act and the non-regulation of derivatives − a joint achievement of the Clinton administration and the Republican Party − Chase, Bank of America, and Citibank were commercial banks that took depositors' deposits and made loans to businesses and consumers and purchased Treasury bonds with any extra reserves.
With the repeal of Glass-Steagall these honest commercial banks became gambling casinos, like the investment bank, Goldman Sachs, betting not only their own money but also depositors money on uncovered bets on interest rates, currency exchange rates, mortgages, and prices of commodities and equities.
These bets soon exceeded many times not only US GDP but world GDP. Indeed, the gambling bets of JP Morgan Chase Bank alone are equal to world Gross Domestic Product.
According to the first quarter 2012 report from the Comptroller of the Currency, total derivative exposure of US banks has fallen insignificantly from the previous quarter to $227 trillion. The exposure of the four US banks accounts for almost of all of the exposure and is many multiples of their assets or of their risk capital.
The Derivatives Tsunami is the result of the handful of fools and corrupt public officials who deregulated the US financial system. Today merely four US banks have derivative exposure equal to 3.3 times world Gross Domestic Product. When I was a US Treasury official, such a possibility would have been considered beyond science fiction.
Hopefully, much of the derivative exposure somehow nets out so that the net exposure, while still larger than many countries' GDPs, is not in the hundreds of trillions of dollars. Still, the situation is so worrying to the Federal Reserve that after announcing a third round of quantitative easing, that is, printing money to buy bonds − both US Treasuries and the banks' bad assets − the Fed has just announced that it is doubling its QE 3 purchases.
In other words, the entire economic policy of the United States is dedicated to saving four banks that are too large to fail. The banks are too large to fail only because deregulation permitted financial concentration, as if the Anti-Trust Act did not exist.
The purpose of QE is to keep the prices of debt, which supports the banks' bets, high. The Federal Reserve claims that the purpose of its massive monetization of debt is to help the economy with low interest rates and increased home sales. But the Fed's policy is hurting the economy by depriving savers, especially the retired, of interest income, forcing them to draw down their savings. Real interest rates paid on CDs, money market funds, and bonds are lower than the rate of inflation.
Moreover, the money that the Fed is creating in order to bail out the four banks is making holders of dollars, both at home and abroad, nervous. If investors desert the dollar and its exchange value falls, the price of the financial instruments that the Fed's purchases are supporting will also fall, and interest rates will rise. The only way the Fed could support the dollar would be to raise interest rates. In that event, bond holders would be wiped out, and the interest charges on the government's debt would explode.
With such a catastrophe following the previous stock and real estate collapses, the remains of people's wealth would be wiped out. Investors have been deserting equities for "safe" US Treasuries. This is why the Fed can keep bond prices so high that the real interest rate is negative.
The hyped threat of the fiscal cliff is immaterial compared to the threat of the derivatives overhang and the threat to the US dollar and bond market of the Federal Reserve's commitment to save four US banks.
Once again, the media and its master, the US government, hide the real issues behind a fake one. The fiscal cliff has become the way for the Republicans to save the country from bankruptcy by destroying the social safety net put in place during the 1930s, supplemented by Lyndon Johnson's "Great Society" in the mid-1960s.
Now that there are no jobs, now that real family incomes have been stagnant or declining for decades, and now that wealth and income have been concentrated in few hands is the time, Republicans say, to destroy the social safety net so that we don't fall over the fiscal cliff.
In human history, such a policy usually produces revolt and revolution, which is what the US so desperately needs.
Perhaps our stupid and corrupt policymakers are doing us a favor after all.
This column was originally published at paulcraigroberts.org and is reprinted here with the author's permission. Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal, columnist for Business Week, Scripps Howard News Service, and Creators Syndicate and has had many university appointments.
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Posted by 1776 on 02/13/13 03:01 PM
Schiff: 'We're Going To Have A Major Economic Crisis,' 'Going To Take' One To Address Debt February 13, 2013 By Dan Joseph
Click to view link
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Posted by voluntaryist on 01/21/13 08:03 PM
I understood little of what PCR wrote. I agreed with his conclusion that this country needs a revolution. I disagreed that "policymakers" (he should have said rulers) are stupid. They are thieves. And theft of this magnitude eventually (100 years and counting) destroys the victim. The victims are sanctioning their own destruction by superstitiously supporting the myth of government by cowardly refusing to identify its nature. They deserve their fate. However, there are a few of us, maybe less than 1%, who do not support being governed, And we will suffer also. Not as much because we have our assets in gold coins and foreign places, but our roots are here. And the revolution will fail to change the system, only the faces of the thieves, if it is not accompanied by economic/political enlightenment.
I hope the internet with Click to view link, DB, Click to view link and many more will provide that enlightenment.
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Posted by Bischoff on 12/19/12 12:50 AM
@ nailheadtom
TOM: "If the government got out of it, honesty in business would make a comeback."
BISCHOFF: Yes, if the government got out of the business of imposing an irredeemable currency, the alternative would have to be a redeemable currency based on monetizing discounted Real Bills.
A "managed" currency system is part of a managed economic system which requires the imposition of all kinds of laws and restrictions on business.
At the time when RBD currency circulated, any signer of a Real Bill who purposely defaulted on payment was immediately ostracized from the Real Bills market and the business community which meant the demise of his business. If you needed a letter of reference for business purposes, you'd contact your banker.
You are absolutely correct. Get the government out of creating currency and honesty in business will necessarily make a comeback. I have no doubt about it.
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Posted by Bischoff on 12/19/12 12:28 AM
@ laceja
LACEJA: "Thanks for the history lesson, Mr. Bischoff. But, you miss the point. We're not going to get any of those things you say we need without a revolution, period."
BISCHOFF: I don't think I missed the point at all. I clearly pointed out that what was needed is an understanding of history and monetary systems in order to make decisions which peacefully move ahead the agenda for the return to RBD currency.
Your point is that a revolution is needed to topple the elite which imposed a managed currency upon us, despite the protection afforded us against the imposition of such currency by the original Constitution.
How is your revolution going to accomplish this... ??? Are you not proposing to apply the "fiftytwo card pickup" method in advocating your revolution... ??? Throw the whole system up into the air to see how it lands... ??? This method certainly appeals to the "low information" populus.
If you want to start something revolutionary, stop paying billions of dollars ro support a totally coopted, and corrupted education establishment.
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Posted by nailheadtom on 12/18/12 10:27 PM
[i] To keep all this information hidden from depositors & investors is unfair.[/i]
Depositors and investors can't expect to simply hand their money to someone and expect a return, like Bernie Madoff's customers did. When government regulates the be-jesus out of the financial industry, innocents think that their money is being protected. Of course, it might not be and it shouldn't be. If the government got out of it, honesty in business would make a comeback.
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Posted by Danny B on 12/18/12 09:39 PM
Oh Great Bell, it seems that other developed countries have a problem with poverty.
"The report said half of the children at homes receiving welfare were obliged to work to help boost income, up from 19 percent last year, and 10 percent resorted to begging on the streets, compared with three percent a year earlier"
Read more: Click to view link.lb/News/Middle-East/2012/Dec-17/198842-israelis-fear-economic-collapse-more-than-iran-study.ashx#ixzz2FSfvKc5C
(The Daily Star :: Lebanon News :: Click to view link.lb)
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Posted by laceja on 12/18/12 09:06 PM
Thanks for the history lesson, Mr. Bischoff. But, you miss the point. We're not going to get any of those things you say we need without a revolution, period.
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Posted by Bischoff on 12/18/12 08:50 PM
ROBERTS: "In human history, such a policy usually produces revolt and revolution, which is what the US so desperately needs. Perhaps our stupid and corrupt policymakers are doing us a favor after all."
BISCHOFF: Revolution is not what we need. What we need is a little understanding of history, and an understanding of how a currency system works.
There are two types of currencies, a "managed" currency and a "free market" currency. Managed currencies are the only currencies which are left in the world today.
A managed currency is normally created by monetizing government debt. Its value is set by politically influenced central bank policy involving the establishment of the prime interest rate. Because managed currency depends on the sale of debt, it has negative value. The U.S. has had managed currency domestically since 1935, and a fully managed currency internationally as well since 1971.
In contrast, the creation of "free market" currency is based on the Real Bills Doctrine of Adam Smith which provides for private, commercial banks to acquire 90 day commercial instruments at a discount to create currency
against their value which is redeemable for gold. When the 90 day Real Bills mature, i.e. the full face value is collected by the banks, the currency created against the value of the Real Bills extinguishes. For a bank to stay in business, it must constantly seek out producers for whom it can discount Real Bills in order to keep RBD currency circulating. The amount of RBD currency which is redeemed for gold normally amount to 10%. It constitutes the savings of people. It is the willingness of savers to depart with their gold savings for investments which earn interest, i.e. gold bonds that determines the prime interest rate. In contrast to "managed" currency, RBD currency has positive value, because it is measured using the value of a specific amount of gold as the standard of value. In other words, without the possibility of redemption for gold, a currency cannot be a "free market" currency. RBD currency has existed as primary currency in the North American colonies and in the U.S. from 1750 until 1933. It created the industrial might of the U.S. Its demise lies at the foot of rogue bankers violating procedures required under the Real Bills Doctrine and Banking Law.
The shortfalls of "managed" currency were recognized by the U.S. Congress. On one hand, it passed the 1935 Social Security Act to compensate for the inability of people to save for their "old age" using managed currency. On the other hand, it passed the 1935 Glass-Stegall Act to create a wall between the "dependent" banks circulating "managed" currency, and investment trusts which invest managed currency "savings" of people.
It must be clear that "managed" currency inevitably leads to a "managed" economy, i.e. socialism. This means that government mandates the distribution of the wealth produced, rather than wealth being distributed through the "free market".
Without getting into the reason why interest rate swaps are down right insane, lets just say that managed currency depends on the sale of debt which carries with it the seed of doom. The exponential growth of interest on the debt destroys faith in the value of the managed currency. It requires the constant lowering of the prime interest rate by the central bank to chore up the asset value of the "dependent" banks. Interest Rate SWAP derivatives can only stave off the inevitable collapse of the "managed" currency for only so long. They cannot prevent it.
The solution to the dismal monetary situation is not a revolution. The solution is the return of RBD currency which circulates parallel with "managed" FRN currency. Thereafter, let the best currency win.
If policymakers want to do the country a favor, let them remove the "legal tender" protection from the FRN which it has enjoyed since the passage of the Coinage Act of 1982. The minute this is done, the Real Bills market will re-emerge enabling private, commercial banks to create RBD currency again. When RBD currency competes with the federal government's managed FRN currency, the FX markets will settle the difference between the value of the two currencies. This is a solution which does not require government intervention, other than to return to us the right to accept "legal tender" as we see fit.
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Posted by Frank on 12/18/12 04:26 PM
In April of 2010, former President Clinton admitted he got bad advice from his former Treasury Secretaries, Robert Rubin and Larry Summers, advising him against regulating derivatives. I know that he had at least one other top government official demanding they be regulated & warning him of the potential consequences. At the bare minimum, the companies involved in derivatives should have to list them annually on their financial statements, how big the the derivative bets are and the consequences if they go bad. This way, at least depositors in banks engaged in these things & people that invest in the stocks of companies involved in derivatives know the potential liabilities of these banks/companies. With hundreds of trillions of "bets" in derivatives floating unseen around the world, odds are this ticking time bomb will explode sooner or later. To keep all this information hidden from depositors & investors is unfair.
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Posted by ccuthbert on 12/18/12 03:01 PM
nailheadtom, derivatives are NOT insurance. They are bets. They lack at least two features of insurance: 1. capital retained to offset claims and 2. financial interest, ie those who buy insurance must have some financial interest in that which is insured. (Ex. one cannot buy fire insurance for someone elses house.) The equivalent situation to which you allude would be a car insurer that writes policies against a huge number of cars without any money to pay off the claims, and also buys insurance for thousands of cars they don't own. Do you see that as good biz, or economic in any way???
I am completely opposed to regulation, but since the gov't has backstopped these casinos with tax money, banks should be prohibited from being in this market.
Roberts is 100% wrong that there was deregulation in the financial industry and it pisses me off that he says it. The fact that Glass Steagall was repealed does not mean there was any general level of deregulation, only that one act was repealed. The financial industry is one of the most heavily regulated in the US.
He also doesn't mention the other main reason there is so much gambling going on in the financial industry, other than the gov't guarentees, and that is ZIRP.
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Posted by inibo on 12/18/12 02:24 PM
I like Paul Craig Roberts a lot, but he does not understand economics. Finance, sure, but finance and economics are not the same thing.
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Posted by dave jr on 12/18/12 11:39 AM
Nailheadtom,
Quite so, but the isurance industry operates within the fiat system, fiat in/risk/fiat out. Derivatives have the potential to cross the divide between fiat and real wealth.
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Posted by nailheadtom on 12/18/12 11:23 AM
Derivatives are insurance. Auto insurance companies have an exposure equal to the limits of their combined policies. What do you suppose that would total? If every driver in the country was simultaneously involved in a fatal accident that destroyed both cars what would the financial exposure be? The insurance companies are pretty sure that such an event isn't going to occur, however. So they continue to write "derivatives" for automobile owners that far exceed their resources.
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Posted by dave jr on 12/18/12 11:19 AM
zbrain,
Money is not the point, it is only fiat. Pledged assets and/or the obligation is the point. We have to put ourselves in the shoes of the central banker to understand him.
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Posted by Col on 12/18/12 11:15 AM
Peak Oil (& other scarcity memes), Global Warming-Climate Change, Government Budget/Spending Cuts -----
Itz all just one big Austerity Party & you're all invited!
Tonight's theme will be " Falling Living... erm Sustainable lifestyles "
Free Punch will be serverd with just a dash of
"a continuous slide into serious poverty"
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Posted by zbrain75 on 12/18/12 10:53 AM
Hmmm.. and who collects on all the bad bets? It sounds more like a way to transfer money when a person is so powerful to hire management of a company and tell them how to bet both the organization's money and their client's money.
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Posted by dave jr on 12/18/12 10:02 AM
"The only way the Fed could support the dollar would be to raise interest rates. In that event, bond holders would be wiped out, and the interest charges on the government's debt would explode."
But what if the Fed and its four cronies are the predominant bond holders? Bonds now including mortgages... The Fed has the power to make dollars disappear but the obligations don't. They could then foreclose on the world. Or at least use it as leverage toward accepting... God knows what.
Could derivatives just be a label for a huge curtain that conceals the true holder of obligations?
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Posted by rossbcan on 12/18/12 08:53 AM
PCR: "Perhaps our stupid and corrupt policymakers are doing us a favor after all."
Cannot implement "policies" (forced CHOICES, independent of facts, marching orders for the collective, smite dissenters) if the people are FREE:
Click to view link
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Posted by rossbcan on 12/18/12 08:40 AM
PCR: "The only way the Fed could support the dollar would be to raise interest rates."
... or, back it with fictional gold reserves and convertability:)
INDEPENDEPENT of what they CHOOSE, what they (and WE) DO determines outcome. If the result is a continued overt or covert assault on freedom and the productive, a shifting of resources from those who EARNED them, to those who COVET them, independent of whether people comprehend, or not, the result is the same: SOCIAL / ECONOMIC COLLAPSE OF CIVILIZATION:
Click to view link
... which, IMHO is the end game, desired goal of the alliance of Psychopaths, Luddites and population reductionists IN CONTROL (so long as WE "obey"), whom we should be collectively opposing, and enforcing, by blowback, peaceful, if possible: YOU FIRST.
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Posted by rossbcan on 12/18/12 08:24 AM
PCR: "deregulated the US financial system."
REGULATION IS FUTILE:
Click to view link
... but, decisively dealing with CRIMINAL ACTIONS (initiating aggression, fraud, breach of trust) collapsing of peace and civilization IS NOT:
Click to view link
Ignore what THEY say, watch what THEY DO. Anticipate and place defensive impediments.
