I have been watching closely for the cracks in the "Goldilocks" economy that the media pundits seem to be spouting on the financial news channels.
The cracks are not only visible but growing. As I wrote last week
, more and more companies are issuing warnings about earnings for this quarter as well as lowering their 2015 forecasts. Many of the companies are attributing this to the strengthening U.S. dollar. While this may be true here and now, what the world is not seeing as they rush to the dollar is the inherent trap they are entering into.
One of the biggest reasons for the financial collapse of 2008 was that there was too much leverage and debt in the U.S. As a result of excess liquidity, asset prices were in a bubble — stocks, homes, oil and any globally traded financial asset. The complex mortgages and financial instruments were mere instruments generated to feed the greed of the money managers of Wall Street.
What was the solution to help the people survive the 2008 crisis? Issuance of more liquidity, a tidal wave of free cash; more debt, a massive dose of debt. As a result we have a much bigger crisis on our hands now.
Let's talk about the Federal Reserve. I have long wondered if it is bankrupt. Reading one of my favorite writers, Jim Rickards, I was stunned to hear him say that one of the Federal Reserve governors has conceded to him in private that this is true. If that is remotely true, the game is truly up!
Back just before the first quantitative easing began, the Fed was leveraged 22:1. This means that for every $1 of capital, the Fed had $22 in debt. While this is a very high and uncomfortable number to accept, that leverage ratio stands at 77:1 now. So what that means is that technically the Fed has only $1 to satisfy every $77 of debt it owes. If that is not bankruptcy, I don't know what is.
Usually the issuance of debt leads to leveraged growth. Back in the 1970s, every new dollar of debt used to bring in about $2.4 of economic growth. As we all know, the principle of diminishing returns kicks in at some point. Now each $1 of debt brings in $0.03 of economic growth. So we are in real negative territory and soon the actual economic growth will turn negative.
Did you know that globally we now have more than $700 trillion of derivatives? Yes, trillion not billion. That is more than 10 times the global GDP. Banks trade derivatives with each other daily. Imagine a world if one or two major banks fail and cannot fulfill their obligations on their derivatives. The domino effect would be very swift and drastic. No stress test on earth can compute the effect of that default. So the window-dressed stress tests that the European Central Bank and Fed perform are mere jokes at best.
The first signs of the flashpoints that can act as the catalyst to the start of the domino chain are already in effect now. Russia started dumping U.S. Treasurys back in October 2013 and each month since. That should have been a clear sign that they would start something big. China also started dumping U.S. Treasurys. And yet the demand for U.S. Treasurys never declined. A new mystery buyer appeared — Belgium.
Belgium started buying U.S. Treasurys worth more than its entire current account surplus every month. How can that be? Are they a front for someone else buying Treasurys?
In all of this meltdown, the one pillar of strength that will emerge will be gold. Physical gold will be worth its weight in gold, pun intended!
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