Fighting Words


— “The focus of the market is still in Europe, but we must be aware that the US fiscal situation is much worse than in Europe,” said Chinese central banker Li Daokui.

–Thems fightin’ words!

–Or bond selling words. The Chinese central banker was merely reminding everyone that tax cuts in the U.S. might support consumer spending (and keep money out of the hands of profligate government). But they won’t do much to pay down the deficit.

–You won’t win many popularity contests by talking about bond yields. But they do tell an important part of the story for today’s markets. If global bond vigilantes think the American government is just as insolvent as the one Dublin and the one in Madrid and the one in Athens, then U.S. bond yields will rise. Investors will demand higher interest rates to loan to the U.S., which is just what the chart below shows.

U.S. Ten-year yields rise, bond vigilantes fire warning shot at Washington


–The chart is really a testament to the law of unintended consequences and/or a monument to Ben Bernanke’s incompetence. Ten-year yields began rising in early October. That was right around the time Bernanke was announcing QEII and hoping it would have the opposite effect.

–The lower-ten year yields go, the easier it is for the government to refinance its massive debts at low rates. But more importantly, the interest rate on a 30-year mortgage in the US tracks the ten-year yield. If rates spike on the 10-year notes, mortgage rates go up.

–And when mortgage rates rise, it threatens refinancing activity, which threatens the whole U.S. housing market, which has been threatening everyone for years with its corruption of the capital of the global banking system.

–Sadly, it doesn’t look like it’s going to get any better soon. U.S. house values could fall by another $1.7 trillion this year, according to That would bring total losses in U.S. household net worth to almost $9 trillion since the housing market peaked in 2006.

–That could never happen here.

–But moving on, the U.S. Treasury market is massive. If rising ten-year yields are a leading indicator that investors are looking for better options, where will they go? It’s a lot of money to move out of one market and into another. Will its movement cause bubbles in other asset classes like, say copper?

–On the subject of copper, Diggers and Drillers Editor Alex Cowie has chimed in on what he thinks is going on. Alex sent this note earlier today:

The copper market has been hurtling headlong into a prolonged shortage. Loads of copper projects shut down during the financial crisis. Now that demand is rising fast again there’s just not enough new mines producing copper to keep everyone happy. In this mad scramble for copper, the highest bidder wins.

Now the opportunists are turning up the heat. Those nice chaps at JP Morgan have apparently got their grubby little mitts on over HALF of the copper on the London Metal Exchange (LME). This represents 175,000 tonnes, or a THIRD of the worlds reported copper stash.

Imagine you went to the pub with a hard earned thirst. It’s been a hot day and you’re up for a good few beers with some mates. You then find some punter got in early, and bought up a third of the pub’s beer. Then he says ‘when you really want this beer, I’ll sell it to you at a profit’.

The people that actually need the copper; sparkies, plumbers, and manufacturers are all in the same predicament. In my pub analogy you’d most likely be having words with the publican. But the genuine users of copper don’t have this choice.

This is a game-changer for the copper market. The price is going to jump on this sudden market tightness.

JP Morgan are using the copper to build a copper backed ‘exchange traded fund’ (ETF). This makes it possible for anyone to buy ‘shares’ in actual copper metal, with the aim of sell it for a profit to the guys that actually need the stuff.

Copper proucers are laughing all the way to the bank. Their comfortable margins are looking even sweeter. I’ve been on the copper story for a year. The first tip is up 80%. The second is more recent, and hasn’t had a chance yet. It’s due to jump in the next few months, and when it does, this recent copper news will take its progress up a gear or three.

–If you’ve got an inquisitive mind, you might wonder if JP Morgan’s copper position is related to its massive naked short silver position. Our colleague Eric Fry wrote about this recently as well. Good luck the JP Morgue.

–How about some reader mail?

Sometimes you guys act like you forgot the basics about central banking and the fractional reserve banking (which you must know). One of the classical problems of banking is that even a sound bank (one if liquidated could meet all its obligations when its loans mature) cannot meet the demands of all its depositors to with draw simultaneously.

I am sure you know this, so why do you continually imply that banks that cannot meet all its depositors requests (i.e. every bank in a fractional reserve system) is unsound, or has done something wrong? If a banking panic starts EVERY bank is vulnerable, and a series of bank crashes leads to a vast reduction in the money supply, job losses etc, the old boom and bust cycle.

I suspect that Milton Friedman is too left-wing an economist for you fellows, but Friedman, in his history of the monetary system, claims that the Federal Reserve in the thirties allowed perfectly sound banks to crash, with disastrous effects. The purpose of the Federal Reserve System was to stop bank runs by supplying sound banks with loans to meet all the requests of their depositors, thus stopping the panic. It failed to do this in the Great Depression despite many of directors saying at the time “this is what we should be doing”.

Do you have any information about the Troubled Assets Relief program (TARP)? My understanding is that the US Treasury has resold all but a few million worth of those assets it bought.

If your position is that fractional reserve banking is the problem, you should say so, and explain the money system you want. And don’t say just say “gold” but explain your position on fractional reserves, because it would be perfectly normal for a bank in a gold system to have a balance sheet that looked like


Gold in vault $30m

Gold owed to bank from people we lent to: $70m


$100m of gold owed to depositors

If every depositor turned up and asked to withdraw their money (gold) the bank cannot do it, without calling in all its loans, which may not be due. The problem is fractional Reserve Banking, not gold versus paper. The bank above has a very conservative 30% Reserve.

If a panic starts, a run on this sound bank is possible and history shows exactly that has happened, doesn’t it?

Michael M.

–Our position, articulated before but not recently, is that fractional reserve banking is not only unsound but immoral. Credit in a financial system should not exceed available savings.

–Friedman’s critique of the Fed in the 1930s was correct to a point. The collapse of banks fed a genuine liquidity crisis in which the money supply contracted and the economy with it. Sounds banks probably went down with unsound ones.

–But the real problem was the credit boom that preceded the Depression. Artificially low interest rates created an asset price boom and credit boom. Capital was created and misallocated and led to all sorts of mal-investments in the real economy that were not reflective of underlying (sustainable) consumer demand (from savings). You got a stock market bubble.

–Today, the Fed thinks liquidity is the problem. But solvency is the real issue. Banks are still capitalised with bad debts. A write-down in those credits will wipe out bank equity. Secured creditors of the banks (mostly other banks) and unsecured creditors (investors in bank equity) would be wiped out if banks took losses on those bad debts. Depositors would be protected to the extent they have deposit insurance.

–So why not let the creditors and the equity investors get what they have coming? A big pile of losses on the risks they took? Oh…that’s right. The banks who would take the biggest losses are also the banks that control and own the Fed. No wonder the Fed keeps shovelling bad money after worse. And no wonder investors are starting to head for the exits.

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. “Immoral” Dan’s Thomas Aquinas alter ego is out to pay again.
    What they did holding labor rates and depreciating the dollar is what screwed them in the 30’s.

  2. Here is a report that reflects the US going back to Volcker’s 80’s supply side govt debt binge while depreciating the dollar.

    That’s the same one that smashed Bush Sr out of politics after combining that debt with mid east warring and hitting sovereign debt funding limits.

    The same one that led to Rubin-Clinton-Summers pulling the derivatives and merchant banker leverage rabbit out of the hat to turn debt from 1 part public to 50 parts private just like our Paul Keating acolytes did here in the 80’s and the NULAB mates did in the UK.

  3. Another from Denninger reporting Bernie Sanders and Sim Johnson

    Banks with 63% of GDP in alleged “assets”, he quoted Simon Johnson, and he gave you a prescription to end this crap – “BREAK THEM UP.”

    I wonder what the Australian banks assets to GDP ration is. We don’t have ZIRP derived carry trade unless you count Macquarie Bank who even had the hide to do it off the back of the govt guarantee funding, so we should be a long way down – but are we?


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