Gold, oil, stocks...you name it. Pretty much everything was down on Friday in the States and the Dow broke its eight-day winning streak (still on light volume). Do you wonder how the market will react if the U.S. House of Representatives passes the Senate health care bill? Hmmn.
Say what you'd like about the proper role of government in your life. But no matter which way your politics lean, it's clear that making expansive social promises is an expensive business. Someone has to pay for these things. Whether it's business, rich people, or the unborn children of the next three generations (debt), someone has to pay.
It does seem a little odd that America is expanding the Social Welfare State at just the moment the whole experiment seems to be collapsing in Europe. It's amazing no one is taking Greece more seriously. It's as if investors and pundits are convinced this is just a run of the mill deficit problem and not an indication that the finances of the Welfare State are hopelessly compromised and failing.
Perhaps fiscal collapse lies in the eye of the beholder. But we reckon it's a more tangible phenomenon. Either your finances are sound or they are not. Either your money is sound or it is not. Come to think of it, either your civilisation is sound, or it is not.
That might sound like hyperbole. But according to America's self-described "#1 political prisoner" Martin Armstrong, the Western world's fiscal malfeasance has left it trapped between two equally undesirable but unavoidable outcomes: default of civil unrest. We are at the pointy end of the crisis (Phase two as he describes it). Yet very few people seem to appreciate what's actually happening.
In his latest missive, Armstrong points out that the structure of the European Monetary Union - twelve economies, twelve difference fiscal policies, one interest rate - made this day inevitable. "The EC is in dire position and a debt crisis at [the] sovereign level and the CFTC move to limit currency trading by the public from 100:1 to 10:1 can cause a liquidity crisis that backfires, magnifying everything."
You have to unpack Armstrong's analysis a bit to see what he's getting at. This is just our interpretation. But we think he's suggesting that the sovereign debt crisis in Europe will lead to rising interest rates (borrowing costs) in the debtor countries. He says the interest rate rises will "cause only an outflow of national wealth."
That is, faced with a sovereign fiscal crisis, investors in Europe will head for the exits and take their money with them. This would explain (and predict) a short-term U.S. dollar strength. But this reaction is also just the sort of thing government's want to avoid. And they can begin to do so with capital controls and restrictions on cross-border currency transactions.
Hence the move by the Commodities Futures Trading Commission above, mooted in January, that would reduce retail leverage from 100:1 to 10:1. The target here is currency speculation, although one wonders why the retail investors are the target and not institutions. Besides, is excessive leverage in currency trading really the cause of the Greek crisis?
Armstrong fears capital controls and reduced leverage could create a liquidity crisis. "I have burned my brain raw trying to come up with a solution. But there is only one! A complete restructure that is a debt for equity swap. Debts will never be paid and interest expenditures are the greatest transfer of wealth in history. This is causing rising rising taxes in all areas from Europe to the US, suppressing economic activity, fuelling higher unemployment and civil unrest. Western society is falling apart."
It may not look or feel that way if you're dialled in to American Idol or getting your Dream Team ready for the footy season. But Armstrong has many points worth considering. For starters, he makes the deflationists point that in a world with too much debt, the only instruments that can cancel that debt are worth buying.
As we understand them, this is the main reason the deflationists are bullish on the U.S. dollar and near-cash U.S. Treasury notes. On the other hand, Professor Antal Fekete, whom we had the pleasure of meeting at last year's Gold Standard Institute annual conference in Canberra, reckons that "gold is the only ultimate extinguisher of debt." This is presumably why central banks have been net accumulators of gold recently.
Whether the dollar rallies or gold rallies, or the dollar crashes and gold rallies, or everything falls..it's clear that something has to be done with the debt. There are no more rugs large enough to sweep it under. Europe needs a bigger rug.
The rug that just might conceal the debt problem is the debt-for-equity swap Armstrong refers to. This is a bit like the "bad bank" we mentioned recently for the U.S. mortgage market. But building a new institution of the transmogrified debt of an institutions or a government is not exactly cutting edge financial alchemy. It's old school hokus pokus.
The South Sea Company was capitalised with nearly £10 million in British government debt which was then resold as interest-bearing units to investors. Voila! Debt becomes equity becomes capital. The government got its debt financing in exchange for trading concessions in South America granted to the company. This is what investors expected to produce huge returns, and what generated a premium (bubble) in the company's shares.
How would a scheme to convert sovereign debt or mortgage debt into equity work today? Who knows? Only the government would be stupid enough to buy shares in a company capitalised by bad debts. But we live in such times. So it's not a huge leap to predict it will happen.
The shareholders will be the "public." And the securities will be backed by the underlying assets (houses, or the government's promise to pay.) The interest will be paid in some new scrip, or in America, perhaps by a new GST or VAT. If the Fed or Europe can pull out a debt-equity swap that cleans up bank/national balance sheets without undermining currency confidence or leading to spiralling interest rates, it will be the greatest magic trick ever.
But if not?
"If we do not act, civil unrest will explode," Armstrong finishes. "The current choice is default or higher taxes and civil unrest...As Europe weakens, the dollar, Dow, and Gold would rise. When the debt concerns then turns to the US, the dollar will get hit only then."
So there is no dollar crisis yet. But if you care to acknowledge it, there IS a EURO crisis. And if you think we're just wearing our tin-foil hat today, keep in mind that IMF Deputy Managing Director John Lipsky has also warned that the finances of the fiscal welfare state are not exactly healthy.
In remarks delivered in Beijing and reported by the Wall Street Journal, Lipsky said the advanced economies need to begin reigning in deficits now, even if economic recovery remains in doubt. He said that, "Merely winding down the stimulus won't come close to bringing deficits and debt ratios back to prudent levels, considering the projected increases in health care and other entitlement spending."
What does this mean for Australia? Stay tuned to tomorrow's Daily Reckoning for the exciting details. Until then...
Dan Denning
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- Rock and Hard Place
- USA Has Fives Times As Much Sovereign Debt As All the PIIGS Put Together
- How the Fed Prints Money Under the Guise of Currency Swaps
- Why Europe’s Plan to End the Debt Crisis Can’t and Won’t Work
- Government Debt
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Justin on 22 March 2010:
Debt for equity? Sounds like a ponzi scheme. Gold just keeps on looking better, it being the 'ultimate extinguisher of debt'.
Comment by Sambo on 22 March 2010:
Alas, the lessons will STILL go unlearned by the financial sector. Every single time they are bailed out or 'too big to fail', they will fail at learning the fine art of risk management.
I liken it to my youngest sibling. He is always in some trouble. My mother bails him out every time. He never learns his lesson, all he learns is better ways to emotionally blackmail my mother into more bailouts. I tell her that the solution is 'cold turkey', let him learn. But she won't, at least not until he has well developed these bad, risky habits.
And I agree with you Justin, although I don't like Mr Fekete a whole lot, he seems to me like an extremist.
Comment by Ross on 22 March 2010:
Nobody that is incorporated globally wants to confront the liquidation. There isn't any sovereign or corporation to call in the receiver. Like this alludes to above oppressed Joe public will make the call in the end.
The Bilderberg gang got their dream, they turned the world economy into a single corporate conglomerate and imagined a seemingly endless supply of global reserve fiat currency credit. The conglomerate learnt how to do round robins, mezzanine, and financially engineer country subsidiaries with incredible leverage. They made a USD fee earning bitch out of every deficit country and the assets that backed them. Savings became troublesome rather than desirable because they just got in the way of income producing sentiment and in part resisted their hegemony.
And it blows up just like an overleveraged conglomerate too.
US households have dropped $10 trillion in wealth already and mark to market hasn't gone near half way down the path yet. Ben and Timmy have only put in $3 trillion that has mainly gone in carry and balance sheet props. The 3 tril itself already has US sovereign debt soaring without contemplating the un or underfunded off balance sheet liabilities. On just current expenditures vs current receipts they are collecting way less than 50% and lending into the real economy is at negative growth. They are circumventing reaching a market rate of interest that might be interesting to savers taking the risk by displacing current account surplus savings buyers and adding more sovereign debt to buy those same USTs to keep the rate suppressed. Deliberately inflating when famed exposes the fact that unfunded liability cost negatives will swamp the appropriation of foreign capital and savings; and it too could set off deleveraging and reverse carry that would appreciate the USD behind the military state that backs it.
And almost any significant liquidation event anywhere in the globe will set off deleveraging and a liquidity crunch and no matter what the currency it will all happen back in the land of the greenback and everyone will be short covering and buying USD's not for security but because they are getting calls due to deflating collateral in Greece or whereever. And the rump of the currency and interest swap's counterparties will all be exposed as bankster sponsored shop fronts with no wherewithalls.
Remember those USD currency swaps that brought a halt to the liquidity crisis? Those that flushed the world with USD liquidity and that were funded by undeclared US Fed borrowing. Well that was almost a one card trick and will have diminishing stabilisation returns in the next leg.
The US financial hegemony knows how resolute and resourcefull people left with less than nothing can be. So extend & pretend will last until it doesn't.
Comment by Justin on 22 March 2010:
Fekete an extremist!?
I think not, the extremists are those passing off debt as the 'ultimate extinguisher of debt'. How can debt extinguish debt? Impossible.
Beware, the central bank becomes more illiquid by the day, those caught holding its obligations on the 'evil day', the day gold 'takes no prisoners', will realise that debt cannot extinguish debt.
Comment by Sambo on 22 March 2010:
Hi Justin. I personally don't think anything will extinguish debt, other than perhaps war or currency inflation. The Euro can be printed...
Ultimately it is all pretty horrible.
Have you actually considered what it would be like on a gold standard? I met Mr Fekete and asked him some questions about that. He is slightly obsessed with a 'gold standard' (naturally) but I don't think he has thought it through, beyond the ideology. I am pro-gold, but a gold standard cannot appear without some serious serious problems.
For example, why would anyone work, if you could pan for enough gold to buy a car? What would that do to productive enterprise? There is not enough gold for everyone to happily own ten ounces each. That is not to say that gold isn't divisible, sure you can turn it electronic like Gold Money or Bullion Vault. But the point is, for gold to be divided to the extent that the entire world can use it (electronically), gold would need to increase in value substantially due to its rarity.
It is also worth mentioning that if gold was worth so much, there would be startup miners all over the world, pillaging the planet (more so than usual). It would be the most profitable industry ever, just so very terrible.
Fekete had no answers to any of this. Other than to be dismissive. He is quite caught up in his cause, disappointingly so for a person who is praised so highly (by some). The way I see it, anyone who is not willing to engage and debate counter-arguments, does not have a case.
However...Fekete and the people he associates with DO see the economy in generally the same way that Bill Bonner and Dan Denning do. So i'll give them that. It's not a good reason to start a gold religion though.
Comment by prozak on 22 March 2010:
Sambo,
I've not met or spoken to "gold bug" that CAN listen to and debate the other side of the argument.
My stance on anything is that unless I can represent a strong case for the opposite view to mine - then I don't know my stuff and it is all wishful thinking.
Comment by Richo (the Second) on 23 March 2010:
CTFC move to limit FX trading leverage to 10:1 ??!! Aaaggh - just choked on my sandwich. Leave FX traders alone!
Comment by o tool riely b on 21 April 2011:
arm .
strong. released. see "How + When"
West nations in hock to pay interest, avoid principal.
S .a. m. 's sum of borrowings $189t. twelve zero. Kot.
Lee
Cough says
Comment by o tool riely b on 21 April 2011:
see www "total u.s. debts, $189t, tril twelve zero'
Kot. Lee
Cough says. West nations now paying only interest, not principal.