Lets look at the problem from the simple mans perspective, the one that most people in congress are using. According to the Investment Company Institute (www.ici.org) the total value of global stock markets was approximately $62 trillion in December 2007 and has since shrunk by almost half to around $30 trillion. That loss in value alone has been spread amongst shareholders, issuing banks and bank holding companies. Banks and those investment houses now scrambling to become banks shouldered approximately $2.5 trillion dollars of that burden.

Taken along, that single burden, while huge, is not enough to cripple the banks. The slowdown in the real estate market commenced along with the global slowdown however and its affects, when added to stock holding losses produced a sizeable chink in the banks armor. Housing became the visible scapegoat for the banking industry. People understood housing, even those who didn’t own stocks. They saw the value of their own houses decline and understood that the value of banks’ portfolios of houses also declined. Oh, those poor poor banks who loaned out trillions of dollars to customers who could no longer afford to pay. There losses on these house would be huge, right?

Well, maybe? First I would like to remind you that the banks began to cry uncle long before the houses came home to roost so to speak. Banks were beginning to fail before those poor people were being foreclosed upon. Banks were under huge stress before homeowner #1 failed to pay his mortgage. How is this possible?

Here is where the dirty little secret in the world of REAL money comes into play. According to figures released in the December 2007 quarterly review by the Bank of International Settlements (www.bis.org) the total notional amount of outstanding derivatives in all categories was a mind boggling $596 TRILLION.

Derivative? What the heck is a derivative? The short and simple answer is this…there has been so much freaking money created by banks over the past 50 years that there is no longer enough actual stuff for that money to buy. So, instead of buying actual stuff, like a stock certificate for General Electric, that money is spent to by a derivative against the movement of General Electric stock. Essentially, it is a bet between 2 people, one betting the stock will go up and the other betting it will go down.

Derivatives are also commonly highly leveraged. Lets say for example that a company uses a large quantity of Natural Gas in its equipment production, so much so that a big swing in the price of gas would hurt the company badly. They might fear that the price of NG would go up and wager $100,000 on a short term (3 month) contract that the price of Natural Gas would go up. If this was a straight bet, it would pay 1:1 up or down and would provide no real benefit versus just “taking their changes” on the gas price. So, instead they use this $100,000 as collateral on a $2million loan and use that loan to purchase the derivative contract.

In normal times when fluctuations are small, they may lose their initial investment, or double it. In the case that they doubled it, the proceeds are used to purchase the now pricier commodity for their daily production and operations continue. If they lose, the losses were a calculated risk and already assumed in the cost of production. But this past year was NOT NORMAL TIMES.

Price fluctuations over the past year were dramatic to say the least. Fluctuations in currencies, commodities, stock prices, real estate, corporate debt, everything that derivative junkies gamble on.

Due to the speed of the decline we could have more than a third of the total derivatives pool underwater. My best guess puts the number at about 35% upside down with the average bet losing more than 15%. That means that $208 Trillion dollars of derivatives are now being held off book by firms that are hoping and praying to be able to foist any or all of them on some government entity or otherwise stupid fool. The losses look to be somewhere in the $30-32 trillion dollar range. The problems that we are seeing and will continue to see with investments that have real assets attached to them may be able to be fixed. It will take upwards of $5-8 trillion dollars by the time its all over, and inflation will kills us when its done, but we could fix that. That $30 trillion dollar derivative monster? Now you go and figure out a way to fix THAT!

The more worrisome news is THIS. Recently I have been seeing article with titles like “AMD to Cut 1100 jobs, remainder asked to cut pay” and “Caterpillar execs take 50% paycuts, rest getting 15% reductions”. This is BAD, BAD news. What we are going to get in this country is a crapstorm like we have never seen before. Corporate executives all across the country are drinking the Kool-aid and jumping on the bandwagon. What bandwagon is that you might ask? The “Let’s keep unemployment under 20% at all costs” bandwagon.

How are they going to do that you might ask? Well, several people I know at JC Penny corporation were “repurposed” from full time, 40 hours per week with benefits to part-time, 32 hours per week and no benefits. Like it or leave it. The companies listed earlier are using the lousy job market to reduce their costs by 15-20% on the backs of their employees. Sure, this prevents 15-20% of the workforce being laid off and it all looks good on paper, helping your fellow man keep his job and all. What does it REALLY do?

First off, the government doesn’t see these people showing up on the unemployment lines and the numbers look better. Breath a collective sigh of relief, the economy is getting better, right? NOPE! Now we have 100% of these people employed at less than they were before. 15-20% less in fact. Anyone want to guess how much of these peoples discretionery spending gets cut? My guess is 60-70%. Consumption plummets, corporate profits fall due to reduce economies of scale and stock prices continue to plummet. Instead of 15-20% of the people looking for new jobs, starting businesses, etc. Now we are all GETTING USED TO DOING WITH LESS.

This is social engineering at its best. Social engineering with a smile.

When it is all over, who wins. Well, the Government got by without having to pay loads of benefits it couldn’t afford anyhow. Corporations get crushed short term, but will recover nicely as they now have cheaper labor at home and people, well. People get screwed. Oh, yeah. the corporations flush with cash will use this opportunity just like Banks are using TARP funds. Buy up competition, push more shares to executives and take a defensive stance until someone else blinks.

Here is what I look for in the future.
1. Lower wages helping corporation through this mess while burdening workers.
2. Continued deflation of assets making acquisition by the largest corporations easier.
3. Rising unemployment, but even larger increases in the under employed.
4. Continued inflation in priority goods and consumables, food and fuel. Just because we have no money doesn’t mean that we don’t still have to eat.

It StagCraptasticFlation time.

All one has to do is watch what happened to the first half of the TARP money to understand that we are already in a liquidity trap. Hundreds of Billions of dollars have been directly injected into the largest banks in the country with more than a Trillion more in guaranteees. What has happened so far? Banks reserves have gone up, way up, but lending has only inched forward by the tiniest fraction.

Why Isn’t This Liquidity Being Lent?
Well now, that is the $200 Trillion Dollar question, isn’t it! My quess is that the banks are totally insolvent. That’s right, the banks have huge loads of unfundable liabilities because of their leveraging against sub-prime and other bad debt. The debt snowball that has been created is sneaking up behind them to bite them in the behind. Notice I didn’t say the issue was because of sub-prime loans, the issue is because of LEVERAGING sub-prime loans. When times were good, banks could make BILLIONS of dollars in profit from hundreds of millions of dollars in loans. They simply packaged up fractional packages of these, added in a huge batch of unsecured off-book debt and viola! Instant profits.

Unfortunately for them, when the reverse happens, as what occurs when the value of those originating loans fails, you can then LOSE billions on millions. In this case though I think we are looking at losses of tens of TRILLIONS against hundreds of TRILLIONS in gamblers loans.

What will the FED do next?
Well, the Federal Reserve is out of “Traditional Tools” at this point. Lowering rates and injecting proportionally reasonable amounts of money into the banks are their primary tools. Their secondary tools? Well, they will use what they have, the ability to create money. I suspect the FED will inject LUDICROUS amounts of capital into the system. I also suspect that this money will not be made real by the external purchase of U.S. Treasuries. Nope, I susupect they will begin to monitize their own debt on behalf of the good people of the United States.

Hyper Inflation Alert
My best guess is that they will be forced into injecting so much money, so fast, that they overshoot their targets by a factor of 50 or so where inflation is concerned. They are trying to prop up a system that is, or should be, at the end of its useful life. Keep in mind that I am not one of those people who hopes for the end of this system. I know the two likely outcomes and they both stink. Outcome #1, we all end up in debt slavery to a private banking system. Outcome #2, we end up in anarchy. I’m too old to play Mad Max. I’ll take a crash that injures us all bad enough that we stand a chance against the evil banking system when its all over. If we end up with outcome #2, I’m afraid we won’t even get a chance to play.

Another Ghastly Alternative?
The Federal Reserve Bank may even request the creation of a NON-US DEBT Federal Reserve Note. Remember, the FEDERAL RESERVE IS A PRIVATE BANK. I don’t think that they can resist the temptation of issuing their own private currency at a time like this. This would allow them to create money as debt for the American Taxpayers as well as their own private currency. Whenever you can see (and control) both sides of the coin, you can work the factors in your favor and end up the only winner. America, the land of the Free could become America, Inc. A privately held company.

The opinions expressed here are the result of too many long drawn out days of staring into the future of a country whose Financial System has seperated from its Economic System. Coupled with large quantities of anti-depressants and alchohol, my appologies for the dark tone today.

The Carry Trade

One of the surest bets that a large financial institution could make during the past decade of prosperity was to use the Yen Carry Trade to finance the purchase of US Treasury Bonds. Here is how it would work. First, the institution would approach a bank in Japan requesting a large line of credit. In the case of large US financial institutions, investment firms and hedge funds, they would have no trouble getting this line. The line would usually carry an interest rate between 1/2 and 1 percent, essentially free money. Next the firm would use that money to purchase United States Treasure securitys for short periods of tim, usually 30 or 90 day notes. The Treasuries were paying out 3 1/2 to 4 percent, so the spread (difference between interest cost and earned intetrest) ran around 3 percent.

Currency exchange rates on these monsterous trades were very low, or even waived by the exchanges due to the volume of money they were bringing into the various markets. Billions of dollars of trade carried on this way for years, making Japanese Banks and those who used this carry trade extremely wealth. Two or three percent doesn’t sound like much on a passbook savings account, but how much is 3% of $10billion? You get the point. All of this was being paid for by the U.S. Government and the taxpayers because of the voracious appetite for money they had attained.

We all Fall Down

Everything goes along swimingly just so long as those things that we had come to expect continue to be true. The Japanese Government needs to continue to issue money at an interest rate near zero. The U.S. Government needs to continue to pay 3-4 percent on their Treasuries and the exchanges have to be incented to not charge a high exchange rate on thie trades. All of these factors are no longer true.

The technical definition of a Recession is quite simple, “Negative growth of the Gross Domestic Product of a country for a period of 2 quarters (6 months)”. While not everyone agrees with this definition (for very good reasons) it is a generally acceptable baseline. A Depression is simple an extended Recession that enters a second full year.

The most important thing about a recession, or a depression for that matter is how it feels to you, how you are personally affected. I have lived through 2 recent recessions, those of 1987 and 2000. During the recession of 1987 I was young and in the midst of a period of time in my life where my income was growing quite well. I was still at that point where I was nowhere near the peak of my earnings potential. The so-called recession of 1987 did not impact me much at all, truth be told I was quite oblivious to it at the time. I had just changed jobs and gotten quite a nice raise. I was in a position where my expenses were not out-stripping my income and the inflation during this period was pretty mild. While the country as whole was losing power, mine personally was growing.

The recession of 2000 was quite a different story for me personally. As a business owner involved in mechanical manufacturing, the year 2000 was just another nail in the coffin to a long slow decline in manufacturing in this country. The spedd of the decline simply kicked up another notch. The decline in manufacturing in the 2000 recession was disproportionately bad compared to most other industry segments. In orther words, 2000 hurt.

The average man however may have seen some of his artificially gained wealth from the dot-com boom disappear, but was otherwise unscathed. Both of these recessions came as short term corrections that did not have a lot of physically evident inflation tied to them.

The coming recession, or perhaps even depression will. Will what you ask? Will Hurt. Will come with TONS of inflation. Will impact the average person. Will last a long time. Will evolve into a depression (unless the clouds above open up and deliver wisdom unseen in a century).

You can learn more right here:

You can learn more right here:

You can learn more right here:

You can learn more right here:

You can learn more right here: