Central Bank Has Lost Control of Credit Crisis


Not one but three different banks are warning investors of major crisis ahead. Note to the banks: where have you been for the last year? A thousand martini lunch?

The slow-motion credit crisis is nearly twelve months old. The question today is whether the competing interest rate policies of the European Central Bank and the U.S. Federal Reserve will lead to more selling in global stock markets and higher commodity prices. Inflation is winning the war.

“A very nasty period is soon to be upon us – be prepared,” says Royal Bank of Scotland’s chief credit strategist Bob Junjuah. In Wednesday’s U.K. Telegraph Junjuah says, “The Fed is in panic mode… The massive credibility chasms down which the Fed and maybe even the European Central Bank will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets.”

Aussie stocks are caught in the thematic cross fire. Higher commodity prices are good for commodity producers. But global inflation sows the seeds of global recession, which is not bullish for resources.

Morgan Stanley’s European research team says an European Central Bank rate hike next month (the one Jean Claude Trichet has threatened to deliver) could lead to a “catastrophic event.” Morgan’s report concluded that, “We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe.”

Hang on. If the U.S. dollar stays weak and the euro falters, where does that leave us? Well, you might see more strength in higher-yielding “commodity currencies” like the Aussie and New Zealand dollars. Not Canada though, as the Canadian economy will suffer from a U.S. recession. But the real eye opener of simultaneous dollar and euro weakness is what it says about paper currencies.

Investor’s don’t believe that the central bank is really in control anymore. They are losing confidence in the main product of central banks, paper money. Precious metals and energy are the nearest, liquid investment alternative to paper currency weakness.

Even the Bank for International Settlements-sometimes referred to as the central banker’s central bank-says the danger from the bursting of the credit bubble is not over and could get much worse. The only people that think this is news are the people who thought you could have a bear market in credit and rising stock prices. That is utter balderdash.
Let’s take a quick look at BIS working paper number 137, “The Great Depression as a Credit Boom Gone Wrong“, published in 2003 by BIS author’s Barry Eichengreen and Kris Mitchener. In that delightful read (published right before the U.S. housing boom went parabolic) the Bank tells us how credit bubbles lead to real busts.

“A capsule account of the role of credit in macroeconomic cycles, as informed by the experience of the 1990s, would go something like this. There is first an upswing in economic activity. As the economy expands, banks and financial markets provide an expanding volume of credit to finance the growth of both consumption and investment, particularly where regulation is lax and competition among bank and nonbank financial intermediaries is intense.”

“Whether because the exchange rate is pegged or for other reasons such as a positive supply shock, upward pressure on wholesale and retail prices is subdued. Hence, the central bank has no obvious reason to tighten and stem the growth of money and credit, leading to a further expansion of output and further increase in credit.”

“Higher property and securities prices encourage investment activity, especially in interest-sensitive activities like construction. But, as lending expands, increasingly risky investments are underwritten. The demand for risky investments rises with the supply, since, in the prevailing environment of stable prices, nominal interest rates and therefore yields on safe assets are low.

“In search of yield, investors dabble increasingly in risky investments. Their appetite for risk is stronger still to the extent that these trends coincide with the development of new technologies, in particular network technologies of promising but uncertain commercial potential.”

“Eventually, all this construction and investment activity, together with the wealth effect on consumption, produces signs of inflationary pressure, causing the central bank to tighten. The financial bubble is pricked and, as asset prices decline, the economy is left with an overhang of ill-designed, non-viable investment projects, distressed banks, and heavily indebted households and firms, aggravating the subsequent downturn.”

Everything in that description of the credit cycle matches this latest boom/bust, except the last part. Inflationary pressures in the world economy have two sources: rising resource consumption from emerging markets and loose monetary policy in the major developed economies. Demand and money supply are both growing.

The obvious effect is rising prices. But the central bank has not reacted to higher rates of inflation by raising rates…because if they do that…at least in the States…it will absolute wreck household balance sheets already heavily leveraged.

And so here we are. Three crash warnings-all of them one year too late. Here’s a thought: The destruction of wealth will continue but the world will not end.

The biggest credit bubble in history takes years to deflate. It was naive to think the market could price it all in a few months. That would have been impossible, if only because we still don’t know the full economic effect of falling asset prices and the billions of securities still tied to the value of U.S. homes.

You can’t properly price what you don’t know. The best strategy in that case is to stay as far away from financial stocks as humanly possible.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. But dont all Australians unfortunatley have exposure to financial stocks whether we like it or not in the form of compulsory super annuation? What to do? put it in cash funds… self managed super? could there be a bigger catastrophe heading for Australia?

  2. Im betting the funds are also under the carefully trained hands of economists and accountants as well (cold sweats)……

  3. Hmm, I saw all this coming last year and changed my super into the cash management options of the super fund I’m with (Q Super), only to discover that it er, continued to slide downhill. Q Super finally published an apology and said “due to unprecedented market pressures” they had now moved the money into more “secure” cash options. Like WTF?

    June 21, 2008
  4. Yeah Im just a little more than very concerned I work in mining in a remote location so cant really look after an SMSF. Although I am wondering how much information is put out to support the industry like you need 200,000 minimum to make it viable, PAH! Im with ING I have a superb selection to choose from, fund managers like UBS, Credit Swiss, Hedge this hedge that, set and forget about your money!
    And the amount of red tape to leave one of these funds, my word, you might as well have given it to charity…
    Well anyway when I take my next holiday, somekind of review will have taken place on SMSF’s and hopefully shaken the tree of rotten fruit, and left a few good SMSF hosts standing. I was thinking I might just create a fund, open an account somewhere and stash it full of things that arent dollars…like gold and currencies that were once backed by gold but arent, currently.

  5. Be careful – cash options aren’t necessarily cash options. My (ex) super fund AGEST had a cash option that consisted of “cash securities” traded on the money market. The nominated manager of these securities is Macquarie. I moved this money to SMSF, which I now manage and administer myself. It’s more effort, but at least I now know exactly where my money is, and I certainly feel more secure now given recent concerns about Macquarie. This is not for everyone I know, and as Tm says watch out for exit fees and other costs.

  6. Whats also strange about the whole thing is that very people can be bothered even thinking about their super, let alone what to do with it. I notice that its only us three (so far) talking about this here I would have thought there might be more. Or perhaps the others are so well sorted it doesnt matter…but in general I find people I talk to often say “Yeah mine is all over the place, I need to consolidate, I dont even know who some of my super is with, let alone what the fund is doing…” Set and forget…
    Yeah as for these cash funds, Kage, like what cash is it? where have they put it? and then its probably lent out from there.
    I think maybe they acheived what they wanted by manufacturing our consent, so that we would forget. Not to sound like a conspriacy theorist, but how much of Australia’s peoples money was involved in the bubble of credit? “Cash Securities”…loan contracts?
    Mainly I just object to having my money forcibly contributed for me to something I know nothing about, and then having it go somewhere I know nothing about…it just becomes someones play thing…to test some model, some rule…

  7. Managing funds within large industry schemes is now at a similar risk level to trading options off a margin loan.

    I swithched to the psuedo “cash” options prior to the May 07 correction. For my sake, I hope that the equity markets will be approaching near bottom BEFORE the “Cash” based investments begin defaulting.

    Another (albeit small) risk in all of this is that the funds LEND title to YOUR shares to other parties, often the banks. Therefore if a bank were to (hypothetically collapse) it may take your super with it – Opes Prime style.

    I don’t have super choice. The Federal Government mandates what fund I contribute to. If the whole thing does belly up I guess I could join a class action against the Crown but at this stage the paper money balances may be worthless anyway.

    Today I would say there is about a 10% change of a complete meltdown (This is a high probability for this sort of event). A more likely scenario is a significant world recession.

    Now back to the world of the reasonable! ???

    Coffee Addict
    June 23, 2008
  8. I have never trusted super fully so have kept funds in residential property and cash, with the balance in growth super small caps and industrials. This has done well but the perfect storm of aging population selling stocks to fund retirement, inflation, subprime and peak oil, a government starved of cash will chase self funded retirees.
    I am thinking more and more of gold/silver in a country other than home in a safety deposit box.

  9. Yeah maybe we should stuff our self managed super funds full of beans and rice haha

  10. Robert, try this you have heard of them already http://www.goldmoney.com its basically a good gold and silver backed bank account. Im not in them myself but was looking at it just found that they only deal with British pounds, euro, canadian dollar and Us dollar. inconvenient for me. It all sits in an insured vault. Couldnt fault it just the currency thing…

  11. We could purchase some islamic dihnar…probably be chased and labelled a terrorist though ha

  12. Response to coffee addict. I gave my brother a stock tip on the ASX, he bought the shares (NO MARGIN) with his own money held by Opes Prime, bought @ 0.024 went to 0.077, guess what, OP shut down AND HE LOST THE LOT. ANZ BANK SOLD EVERTHING. The story is not finished, ANZ may be in big trouble with ASIC for dubious lending and foreclosing procedures, lots of unanswered questions and lots of pissed off ivestors………

    LouisThe Fly
    June 23, 2008
  13. LTF. I wish your brother well in his fight against ANZ. I’m not following the Opes Prime fallout that closely but the ANZ Bank’s Achilles Heel would be any form of confirmation that they were indeed a party to the Opes Prime “Scheme” of arrangement. If this can be demonstrated in court, (and it will come out if the staff involved are put on the stand), the plaintiffs could argue that the representations of the Opes Prime/ANZ partnership (rather than the small print) consitiuted the actual contractual agreement. In this case, ANZ willhave to pay the investors back. ANZ will of course try to argue that they were operating at arms length to Opes Prime.

    Coffee Addict
    June 23, 2008
  14. Coffeee Addict, ANZ have quietly paid some of the larger/noisier clients who threatened to take it to the media. The story is the boys/directors didnt call in the margins when should have on their buddies/big guys, didnt cover there butts, went to ANZ to fix problem, Anz gave them just enough to not be able to make it through the month and foreclosed… THAT’S WHAT IS HAPPENING TO THESE “SECURE” FUND MANAGERS @ INVESTMENT HOUSES. This is just the start

    LouisThe Fly
    June 23, 2008
  15. Well as they say markets and things only give you what you deserve, you should always take C.A.R.E (cover ar*e retain employment) and K.I.S.S (keep it simple stupid)…

  16. Hello BT has a cash (as in interest) super fund $5 a month

    I think it is super not DIY super not sure


    What do you think did I miss understand it or is it any good?

    Ps what an excellent web site the reckoning is

  17. Even ancient economies had supply demand inflation, we used the gold standard for thousands of years and then decided in the later part of the 20th century that such a standard did not value a countries assets properly and it suppressed growth.

    So began credit valuing of assets that were not that were taken for granted such as infrastructure falling apart. We decided that rationalism should pay for any discrepancies, so the mums and dads became part of the new western economies and of course with all this the new emerging economies hoped on board.

    Saving of course that the developing kingdoms of Asian and other third world economies are using the ancient economic practice of virtually enslaving the labour of their mums and dads and children – interesting that the real hedge to economic reform in the developing kingdoms is to adopt a working poor ethos that was also the mainstay of ancient economies.

    It also happens to be the hedge the western world used to rationalise closing our factories, reducing R&D, reducing technocratic learning, etc, etc, because it is just not the done thing (yet) to enslave our people like we did in ancient times up to and including the industrial revolution.

    We are all running out of food, water, arable land, clear air. But wait there is a new solution……..the carbon economy…….how about a new stock exchange just for carbon? Dumb! Even then the logic that there are too many ‘carbon units’ on the planet will evade us. Try and hedge that people.

    So where is the logic of human function, when are the technocrats going to rule? There is a golden age, but it will come at a great cost to the human race. I agree for a different reason that Carbon is chemically too valuable to burn up, it is also too valuable to lock up in the form of human biology.

    Imagine now a world where the cost of labour is irrelevant, and that our old rubbish dumps and other dumping around the planet are more valuable than raw ore, dumps becoming the new mines of the future, in essence we recycle at the molecular level.

    Query: In the interim could we not abolish all forms of taxes except GST, and except say 20% company tax which could be further deducted through rebates on investment in R&D, training, OH&S development. We could nationalise all super funds and create State owned enterprises that could be both Governmental and Private enterprise. We need to value add our economy through technocratic training of our own people, not disenfranchising and devaluing our people through the import of unskilled labour and export and obtuse valuing of third world kingdoms.

    We need a whole new economic value process.

    Conclusion: The word hedge should mean a “a close-set row of bushes, usually with their branches intermingled, forming a barrier or boundary in a garden, park, or field”.

    Charles Norville
    June 24, 2008
  18. To Charles Norville,
    Hear hear!

    Everybody should read the bok.
    The Grip of death
    A study of modern money, dept slavery and destructive economics.
    By Michael Rowbotham

    Is there any way of putting my superanuation into gold and silver??



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