–Yesterday was the day the world’s capital markets turned into a giant fiat money casino. Consider yourself warned. You can trade your way to profits this in this market on the tide of easy money being printed now by the Federal Reserve and the European Central Bank. But the financial markets are now setting up for the mother of all collapses.

–Up until yesterday, we’ve seen the end of the super cycle in fiat money as a process that could take years to unfold. The piecemeal nationalisation of certain industries…the assumption of private sector liabilities on the public sector balance sheet…the abrogation of contract in the form of defaulted mortgages that are not foreclosed on…and higher-and-higher public debt-to-GDP ratios were all signs that the government everywhere was sucking the life out of the economy to preserve the status quo, and turning dozens of firms and institutions into zombies with no real productive economic future.

–But yesterday is a day that sent a bit of a chill down your editor’s spine. And it’s not because the €750 billion bailout package by the ECB caused a frisson here in St. Kilda. Granted, it did wonders everywhere else. The S&P 500 was up 4.4% in New York. Local stocks rallied. And most impressively, the spread between 10-year Greek debt and equivalent German bunds shrunk by a massive 570 basis points.

–And if you’re a speculator – and especially a high-yield bond hunter – why not get on the gravy train? If the ECB is going to print money to buy public and private sector debts to “ensure depth and liquidity” in certain markets, it’s not a trend you want to fight. If the central banks are going to splurge on assets to support debt markets, bond yields will fall and asset prices will rise. For now.

–But we reckon it is not for long. This really is Act V of the fiscal welfare state, in which monetary policy becomes the shameless handmaiden of fiscal policy in order to sustain an unsustainable kind of riskless society with massive benefits for everyone paid for by a few. That is an unaffordable illusion, the shattering of which leads to lower standards of living – a fact many in Europe find politically unacceptable (even if the fiscal facts speak for themselves).

–To delay the day of reckoning, the ECB is offering European banks nearly unlimited amounts of cash for three and six month borrowing periods. You can imagine those banks – proud owners of heaps of sovereign debt from Greece, Spain, Italy, Ireland, and Portugal – are happy to sell that stuff to the ECB and borrow some short-term cash to lever up into an equity rebound. More privatised profits and socialised losses that favour the financial industry.

–And why wouldn’t you play that game if you were playing with other people’s money? We’ll get to WHOSE money in just a moment.

–The immediate question you might have is, “Will this work?” It depends on what you mean by “work”. By throwing wads of cash at stressed banks, the ECB alleviates the immediate threat in the market that bond yields spike and a liquidity crisis sets in. But enabling debt-laded countries to take on more debt hardly seems like a long term solution to the problem of living above your national means.

–“You cannot make any nation that is unable to service its accumulated debts more creditworthy by extending more credit!” said Jeremy Batstone-Carr, analyst at Charles Stanley in today’s Wall Street Journal. “If the EU lends Greece money, the loan will increase that country’s public sector debt. The interest on the additional loan, whatever it eventually proves to be, will increase the public sector deficit. Total debt-servicing costs will rise, raising the burden on public sector cash flows. At some point in the future, the loan will have to be paid back.”

–EU policy makers hope that by extending more credit now to sovereign governments, bond investors will just, you know, back off! It’s amazing to read how officials blame derivatives and a “wolf pack” of speculators for the crisis. As if it was the speculators who ran up huge debt-to-GDP ratios. As if the solution was to ban credit default swaps and remove the one market pricing mechanism which alerts investors to rising sovereign credit risk.

–Incidentally, this is a minor trading point…but worth thinking about…who is on the other side of all the credit default swaps underwritten on European debt? Remember it was AIG that collected premia by writing default insurance against sub-prime mortgage backed securities and collateraised debt obligations. Goldman, among others, bought that insurance.

–If you were a handy speculator right now, you’d find out who sold default insurance on Greek and Spanish debt. And then you might consider shorting the daylights out of them.

–Of course maybe the ECB really has solved the problem by throwing a wall of fake money at it. But we reckon yesterday’s action gives you fair warning about what’s ahead and a bit of time to do something about it. A massive monetisation of debt and an increase in public sector liabilities has now been set in motion. The euro itself will soon, again, become a target of speculators once the next major tranche of sovereign debt must be rolled over and there’s no one but the ECB there to buy it.

–How long can Europe pay its bills and creditors with money that doesn’t exist?

–But the buried item in yesterday’s news reveals that the U.S. dollar might be on the hook too. The Fed re-opened its swap lines with major banks around the world. This means the Fed will be expanding its balance sheet again…and sending a flood of dollars out into the world to shore up banks that need them. The Fed had closed the swap line with the ECB in February, when everything was just fine.

–To the barricades, dollar standard! But this really could be a kind of lass stand for the dollar as the world’s reserve currency. Unbeknownst to the American taxpayer, the Bernanke Fed has now thrown the dollar once more into the breach of a liquidity and solvency crisis. It may not survive.

–That’s what you should watch for, then: the expansion of the Fed’s balance sheet. It will be hard to keep your eyes on that target with so many green numbers on so many shares and indices. The ECB has invited the entire financial world to speculate on the house. The ECB’s monetisation – with the Fed’s cash – is going to lead to a quick reflation of some markets; that’s for sure.

–The biggest inflation, though, could come in precious metals. In fact, as a hedge against the central bank monetisation strategy, precious metals are about the only sensible speculation in a market which has essentially been reduced to total speculation by the distortion of values from the flood of money.

–Things that can’t be printed by a central bank and aren’t anybody else’s obligation to pay might be the best investments for the rest of this year. And beyond?

–The Welfare State has met its great funding crisis with a fraud. And the fraud is going to cost a lot of people a lot of money. If you’re in markets now, be aware that markets no longer bear any relation to underlying risk or reality. It’s never been more dangerous. And given the last few years, that’s saying something. More tomorrow on when the U.S. debt shock may hit.

Dan Denning
for 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. I know this topic has got a lot of attention from Dan but is it really inevitable that the markets will be held to account? Or will this perpetual need to rescue nations that are faltering see these grossly mismanagement economies go unaccounted for.

    To me this behavior sends a signal to all individuals and nations who can borrow, be that $100 or $100,000,000, to do so at their own discretion. There will be NO accountability for financial promiscuity, take the risk we will bail you out.

    I have spruiked heavily about the Australian housing market being at least 50% over valued in relation to wages and CPI. I was very naive to the intervention of governments and since 2005 housing has almost tripled in value and in some areas it has surpassed this. Negative gearing, capital gains tax concessions and first home buyers grants are the tip of the ice berg, they will spend billions more to keep it going as it is a linch pin.

    Housing falls in price and the chain reaction is unstoppable, although people are leveraged to their eyeballs in interest only 35 year terms, behavior most see now as normal but i consider speculative and risky, government will reward this behavior with financial assistance.

    I do not think there will be a day of reckoning and if there is it will be more a period of stagnation than runaway declines. I say that with slight tinge as i fell the global economy would benefit greatly from a mass cleansing. I myself have lived in very impoverished circumstances, it changes your mindset for the better and stems the appetite for such unsustainable economics.

  2. Ah Dan, the idea of fair and rational bets is an anachronism. USD leverage can take market prices and the cost of debt any which way toward crony profit. And overall their best opposing player is always going to be the taxpayer. So that means the EU bailout will fail and Goldman will profit.

    The banksters think that control of unchecked debt can create anything endlessly no matter the corner they fight from … as long as they can beat those on the other side. Getting the opponent to play on their home currency means game over …. so they think. And they get away with it too until they trip the b/s meter of the mug investor who controls their fractional dollar when they take that one step too many, that one step that a cretin bankster can never resist, like the parasite that can’t resist killing the host.

  3. “If you’re in markets now, be aware that markets no longer bear any relation to underlying risk or reality” – what ever if this means, don’t let it get in the way of a good-buying opportunity.

    “It’s never been more dangerous” – time to buy, or don’t give up on the stock market just yet?

    “Investors in oil shares are more bullish on the U.S. economy than any time in the last eight years, convinced the biggest decline in equities since the bull market began will prove a buying opportunity.

    “The 39 energy producers and equipment makers in the Standard & Poor’s 500 Index have traded at an average 19.1 times earnings in 2010, compared with 17.8 for the index. The last times they had higher valuations in 1994, 1999 and 2002, the benchmark gauge for U.S. stocks surged an average of 22 percent in the next year, according to data compiled by Bloomberg” (Whitney Kisling, Bull Market Signaled by Oil Stocks at 19 Times Profit,, May 10, 2010).

    “U.S. stocks could jump as much as 20 percent, led by technology companies, as the global economy rebounds from Europe’s debt crisis, said Barton Biggs.

    ““I’m betting the next move in the U.S. market is going to be up 15 to 20 percent,” Biggs, who runs New York-based hedge fund Traxis Partners LP and whose flagship fund returned three times the industry average last year, said in a Bloomberg Television interview today. “I would just point out that the world is having a strong economic recovery, and so is Europe.”

    “Biggs recommended buying U.S. stocks last year when benchmark indexes sank to the lowest levels since the 1990s. He did not give a timeframe or refer to any specific stock index in his comments today…

    “There are plenty of opportunities in the U.S.,” Biggs said, adding that shares in drug developers look cheap and that property companies are also attractive. “It’s by no means a foregone conclusion that we have a crisis every three years and, my God, that the world is coming to an end. I don’t believe that’s what’s happening at all”” (Shani Raja and Susan Li, Biggs Says US Stocks May Surge 20%, Led by Technology Shares,, May 11, 2010).

    History suggests that the 1930s and 1970s are the best templates to view the present and future.

    As I Have argued in “1930s, 1970s and Today – Contraction, Expansion, Contraction” we are in the middle phase of the crisis years.

    [In a post to this forum in 2009, prior to the Pittsburgh Steelers winning the superbowl, I said this: “History suggests that the Dow Jones Industrial Average is on the cusp of a 70%+ rally over the next couple of years”. The precedent for this call was the 76% stockmarket rally of December 1974-September 1976 – the Steelers won in 1975.

    [On my website I also had this quote: “Since the first Super Bowl was contested in 1967, the average annual return for the S&P 500 index has been 25 percent in the six years the Steelers competed, regardless of whether the team won or lost, according to Capital IQ, a division of Standard & Poor’s” (Ros Krasny, Steelers in Super Bowl may bring luck to investors,, January 30, 2009). The S&P 500 was up 23.5% for 2010.

    [The Dow rally from March 2009 to April 2010 was 71% (closing figures)].

    1932, 1974 and 2009 stockmarkets at 12 year-lows signalled bull market; Goldman Sachs in trouble post 1929, post 1970 (Penn Central) and post 2008; 1929, 1974 and 2010 ‘hung’ British parliaments:

    “The elections of 1929 brought the last hung parliament for a long time; in the meantime Labour had replaced the Liberals as one of the two dominating parties.

    “Since the elections of 1929, there have been two general elections that resulted in hung parliaments in the UK. The first was the result of the election in February 1974 and lasted until the October election that year. The second was the May 2010 election, the result of which was a hung parliament with the Conservative party as the largest single party” (Hung Parliament, Wikipedia)

    History suggests a market top between December 2010 and November 2011. The bearmarket to follow setting up a Republican presidential win and severe recession/depression in that administration.

    Bearmarket to be preceded by inflation, rising interest rates and problems arising in Eastern Europe – cp. Vienna in 1873 and 1931 – both dates associated with the beginning of the Great Depressions of the Nineteenth and Twentieth Centuries respectively.

    Steven Keen too optimistic – house prices to drop by at least 60 percent.

    This coming depression will be severe as it is part of a major hegemonic restructuring (from America to Europe). The last restructuring involved two world wars and a Great Depression – this was a transfer between friendly powers. A transfer from a friendly power to a hostile power emerging, out of the Great Depression, spell more serious trouble for Britain and America.

    “The United States’ economy has been in recession only nine times in the last 60 years, or roughly once every seven years. Before the last recession in 2001, the economy even expanded for a full ten years. And the average recession has only lasted for about four quarters” (Joachim Fels, Recession 2007,, November 18, 2005).

    “And you shall count…seven times seven years…forty-nine years. Then you shall cause the trumpet of the Jubilee to sound on the tenth day of the seventh month; on the day of Atonement [Yom Kippur] you shall make the trumpet to sound throughout all your land. For the fiftieth year shall be holy, a time to proclaim liberty throughout the land to all enslaved debtors, and a time for cancelling of all public and private debts. It shall be a year when all the family estates sold to others shall be returned to the original owners or their heirs” (Leviticus 25:8-10, NKJV/Living Bible).

    If Moses and Irving Fisher were alive today they would shake their heads.

  4. Gold Maintains Solid Gains, Close to All-Time High

    By Jim Wyckoff
    11 May 2010, 10:41 a.m.

    Comex gold futures came within a couple dollars an ounce of scoring a fresh all-time record high Tuesday morning. June Comex gold hit a high of $1,225.20 Tuesday, which is just shy of the record high of $1,227.50, basis nearby futures, hit in December of 2009. June gold last traded up $17.70 at $1,218.50. Gold continues to benefit from safe-haven buying interest amid the European Union’s sovereign debt crisis that just will not fade into the background.

    Looks like it is not being taken too well this Euro “rescue”

    May 12, 2010
  5. 12/05/2010 6am ……gold @1233.. parabolic mode. Crumbs this last rally went from 1184 to here in 36hours. Gettin scary…think I might start building a bunker :(

  6. The rescue packages get incrementally larger as the gold rallies get larger.

  7. “If Moses and Irving Fisher were alive today they would shake their heads.”

    If Mary and Joseph were alive today, they’d shake their heads and guffaw:
    “Jesus, what was _that_ all about?!~”

  8. When Nostradamus wrote his treatise ‘Cash in the Shrubbery’ on 10th July 1543, noting convergence of the heavens “…when the moon is in its seventh house and Jupiter aligns with Mars…” was he simply referring to hegemony?

    Biker Pete
    May 12, 2010
  9. Reading watcher7 is always a pleasure. Watcher hasn’t explained the Dow flat lining through the norties. I was onboard equities in May 08 and he only got on later in 09. I think his wave is out of synch and the market had hit his Dec10-Nov 11 already. He thinks liquidity has hit the streets, many others do too. In Australia I agree somewhat & in China I agree but in the US where consumers are post-maxed out and in an EU where each person is more fearfull of their liabilities I don’t see it. Upper income borrowers in Australia are also doing it tough and won’t stand anything going negative. Sorry but I’m still a deflationist, all this fuel and very little effect. It will deflate anyway in anything but fiat currency terms (the revenge of the CPI basket)

  10. Yes, the references to America football teams’ performances affecting global economies are as instructive as his prediction that Australian property will fall by 60%. Our local big girls’ netball team has had seven straight wins, which probably means an out-of-synch tsunami will wipe east coast cities off the map, bringing about mass migration to the West, where values will rise.

    As Lachlan suggests: “…think I might start building a bunker :( “

    Biker Pete
    May 12, 2010
  11. You’re not de-bunking the relationship of the Pittsburgh Steelers winning streak to the DOW Jones Industrial Average, I hope, BP? You really don’t understand the principles of alchemy, do you, you godless fool?!~

  12. “You really don’t understand the principles of alchemy, do you, you godless fool?!~ ”

    Well, it appears I can turn beach sand into gold, son. This morning’s ‘West Australian’ (p. 12) reports that the beach suburb in which we have most of our property appreciated 26.4% in the last twelve months. By contrast, the beach area we quit only appreciated 10%. Must be doing something right. :)

    OK, if it makes you happy I’ll concede Watcher7’s claim that an American football team’s success does, in fact, drive the DOW Jones Industrial Average. Will that help me pass through the Pearly Gates with you other True Believers? ;)

    Biker Pete
    May 12, 2010
  13. Ah, but Nostrildamus nose all, Biker Fool. Was it not written that he shall descend from the great Virgin (Richard Branson) to breathe upon your lands a hot fiery breath… and lo, the stargivers shall smite thee a great smote and shall turn their first finger to point lo? Look, granddad, anything I decree earns me the five-pointed blessing… and thyself the cheese.
    It is written.

  14. Ross wrote: “Watcher hasn’t explained the Dow flat lining through the norties”.

    A little background first – in viewing the future, I employ the Anglo-American Hegemonic Cycle (AAHC). This cycle takes as its starting-point the ‘Kondratiev Wave’:

    “In the early 1920s a Russian economist N.D. Kondratiev, later an early victim of Stalin, discerned a pattern of economic development since the late eighteenth century through a series of “long waves” of from fifty to sixty years, though neither he nor anyone else could give a satisfactory explanation of these movements, and indeed sceptical statisticians have even denied their existence. They have since been universally familiar in the specialist literature under his name. Kondratiev, by the way, concluded at the time that the long wave of the world economy was due for its downturn. He was right… That good predictions have proved possible on the basis of Kondratiev Long Waves – this is not very common in economics – has convinced many historian and even some economist that there is something in them, even if we don’t know what” (Eric Hobsbawn, Age of Extremes, (London: Abacus, 1995), p.87).

    The peaks and troughs of the wholesale price index helped defined the Kondratiev longwaves. The AAHC uses the same for the early years but for the later years the P/E ratio – both 12-month and 10-year earnings to establish common ground between cycles.

    The Peak to low, in the selected P/E ratio scheme, are 1929-1949; 1966-1982; 2000-2018(?).

    The Dow valuation peak was in 1966 followed by a nominal peak in 1973 – just under seven years later.

    The Dow valuation peak was in 2000 followed by a nominal peak in 2007 – just under 7¾ years later.

    The Dow rallied from 2002 to 2007, a period of five years. But the Dow rallied roughly two years from 1970 to 1973 but if the “go-go rally” of 1966(7) to 1968, the ‘Nasdaq’ rally of the 1960s, is added to the former, significant rallies occurred over four years – from a “mania” perspective the the “glamours” of the “go-go” boom of 196697)-1968 rhymes with the “dot-coms” of the “tech boom” of 1998-2000. Cp. Fairchild Camera P/E ratio of 443 in 1968 and Yahoo! P/E ratio of 632 in 2000.

    The 1973-75 recession rhymes with 2007-2009(?); the 1974-76 stockmarket rally rhymes with the present rally that started in 2009.

    Ross: “I was onboard equities in May 08” – The Dow closed at 13,010 on May 1, 2008 – it had another 6463 points to fall – just under a 50% fall from May 1.

    The Dow dropped 45% from January 1973 high to the December 1974 low.

    It was not to February 2009 that the Dow had a similar fall to 73-74.

    (I did not take this into consideration, which I should have, when I was looking for the bear-market low in the last quarter of 2008, particularly December – compare July 2002 and October 2002).

    The Dow dropped 54% from October 2007 to March 2009 low.

    In the seventies we had inflation, then Volcker raised interest rates and the result was disinflation. This time round I expect to see inflation, raised interest rates and then massive deflation.

  15. “This time round I expect to see inflation, raised interest rates and then massive deflation.”

    Me too.. Have said as much in previous posts on the topic of inflation/deflation..

    May 12, 2010
  16. “This time round I expect to see inflation, raised interest rates and then massive deflation.”

    Hindsight helps of course.

    Based on your AAHC instrument, the estimated timeframe for these three periods would be…. ?

    Inflation: 2010 –

    Raised Interest Rates: 2010 –

    Massive Deflation: –

  17. Watcher, I missed this post and shoes reply for some reason. I was going off memory of your earlier long wave posts, apologies if I misinterpreted your cycle. I was value picking mid 08 and you have exposed my dim market recall. Memory works but recall has issues. Am always looking forwards but I do pay regard to your thoughts. Shoes, I see velocity as a real rather than an imagined issue in inflation. There is enough stimulus out there for velocity but for mine it hasn’t escaped the bottomless holes of fed and bank balance sheets in the US. All talk is US turning but look today at tech reports. I still believe its dead. Commercial r/e isn’t being revalued and is being held at pre gfc prices. So I am opossite, deflation event first and inflation shortly thereafter in the panic. I respect your opinions which have it the other way around. Lets see in the next month which way, watcher would be able to quote the full line about the May and June truism.


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