Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Silver Notches Best Month Since 1979 - 12th Aug 20
Silver Shorts Get Squeezed Hard… What’s Next? - 12th Aug 20
A Tale of Two Precious Metal Bulls - 12th Aug 20
Stock Market Melt-Up Continues While Precious Metals Warn of Risks - 12th Aug 20
How Does the Gold Fit the Corona World? - 12th Aug 20
3 (free) ways to ride next big wave in EURUSD, USDJPY, gold, silver and more - 12th Aug 20
A Simple Way to Preserve Your Wealth Amid Uncertainty - 11th Aug 20
Precious Metals Complex Impulse Move : Where Is next Resistance? - 11th Aug 20
Gold Miners Junior Stcks Buying Spree - 11th Aug 20
Has the Fed Let the Inflation Genie Out of the Bottle? - 10th Aug 20
The Strange Food Trend That’s Making Investors Rich - 10th Aug 20
Supply & Demand For Money – The End of Inflation? - 10th Aug 20
Revisiting Our Silver and Gold Predictions – Get Ready For Higher Prices - 10th Aug 20
Storm Clouds Are Gathering for a Major Stock and Commodity Markets Downturn - 10th Aug 20
A 90-Year-Old Stock Market Investment Insight That's Relevant in 2020 - 10th Aug 20
Debt and Dollar Collapse Leading to Potential Stock Market Melt-Up, - 10th Aug 20
Coronavirus: UK Parents Demand ALL Schools OPEN September, 7 Million Children Abandoned by Teachers - 9th Aug 20
Computer GPU Fans Not Spinning Quick FIX - Sticky Fans Solution - 9th Aug 20
Find the Best Speech Converter for You - 9th Aug 20
Silver Bull Market Update - 7th Aug 20
This Inflation-Adjusted Silver Chart Tells An Interesting Story - 7th Aug 20
The Great American Housing Boom Has Begun - 7th Aug 20
NATURAL GAS BEGINS UPSIDE BREAKOUT MOVE - 7th Aug 20
Know About Lotteries With The Best Odds Of Winning - 7th Aug 20
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

How to Prepare For China’s Coming Derivatives Default

Stock-Markets / Credit Crisis 2009 Sep 13, 2009 - 04:48 PM GMT

By: Graham_Summers

Stock-Markets

Best Financial Markets Analysis ArticleIn case you have not heard the news, China has announced that it will be instructing its state-owned enterprises to potentially default on their derivatives contracts. As I have written extensively in the past, the derivatives market is a massive time bomb just waiting to go off. China’s latest move may be the match that lights the fuse.


All told, US Commercial banks own $202 trillion in derivatives in notional value. To put that number into perspective, it’s roughly four times the global GDP. And 96% of this exposure sits on five banks’ balance sheets. I’ve shown the below chart before, but it’s worth re-visiting (chart is denominated in TRILLIONS).

Of course, not ALL of the $202 trillion these guys own is “at risk.” As their name implies, derivatives are “derived” from underlying assets (homes, debt, etc). The actual “at risk” money can be far FAR smaller than the “notional” value of derivatives outstanding.

However, when you’re talking about $200+ trillion, even a marginal amount of “at risk” money can mean ENORMOUS losses. Consider, if 1% of that $200 trillion were at risk, you’re talking about $2 trillion in capital. Now, if even 10% of those bets go bad, you’re talking about $200 billion in losses.

Now consider that, combined, the top five banks (JP Morgan, Goldman, BofA, Citi, and HSBC) have roughly $700 billion in equity.

And that’s it only 1% of the derivatives outstanding are actually “at risk.” Given the over-leveraged, stupid plays Wall Street made on mortgage-backed securities and credit default swaps (both investments that had SOME degree of oversight, even if it were paltry), as well as the fact that derivatives are COMPLETELY unregulated, I would argue it’s quite possible that as much as 5% or even 10% of the derivatives outstanding could be “at risk.”

In that case, we’re talking about $10-$20 trillion in “at risk” capital. If even 10% of these bets go wrong, you’ve wiped out ALL the equity at all five banks AND THEN SOME.

As I mentioned just now (and before many times), the primary problem with derivatives is that they are COMPLETELY TOTALLY unregulated. NO ONE has any idea what’s “at risk” or who owns what or who’s betting against who.

But we may be about to find out.

I’ve detailed the ongoing conflict between China and the US regarding monetary policies on these pages before. The brief overview is that China owns $800+ billion (by some accounts $1.3 trillion or more) of our Treasuries (debt) and is not too happy about Ben Bernanke and other US monetary figures throwing trillions around in bailouts and emergency measures to counteract the financial crisis.

China has fired a couple of “warning” shots already, mainly in the form of various Chinese diplomats expressing concern and frustration with the US’s monetary policies. They even flew China’s Vice Premiere to an unscheduled talk with US monetary officials back in July.

No one knows what was said during the talks, but given that Ben Bernanke is extended Quantitative Easing to October and has shown little signs of reversing his current “anti-dollar” policies, it’s pretty clear China didn’t get what they wanted.

I’ve often wondered what China would do if push came to shove. Their decision to have their state-owned enterprises default or renege on their derivatives contracts may be the answer.

Let me explain.

As I’ve stated on these pages before, I view the “bailouts” as nothing more than an attempt to funnel taxpayer money to the large US banks so they can raise capital to avoid insolvency. It was essentially a “re-capitalization” effort using public funds. And it came at the expense of the dollar and Treasuries.

China, who owns more Treasuries and dollar-denominated assets than anyone, was obviously not too pleased about this. They’ve asked time and time again for the US to stop what it is doing. However, Geithner, Bernanke, et al, simply plowed ahead ignoring their requests (Geithner actually told a group of students in China that the math behind the US’s policies were solid which resulted in the students laughing at him).

China’s decision to default on its commodity derivatives is a very clever means of slapping the US Federal Reserve in the face without “going nuclear” by selling Treasuries outright.

Commodities account for the smallest portion of derivatives on US commercial bank balance sheets ($938 billion out of $200 trillion). A default here would trigger a chain reaction that could essentially wipe out the Fed’s attempts are re-capitalization (the US banks would suddenly be on the hook for billions in losses that they didn’t expect). It’s a very serious indirect way of China saying, “if you want to continue screwing around, we’ll simply walk away from the table.” But they’re doing it in a select asset class that no one but Wall Street engages in (derivatives).

The primary issues now are:

  • Whether China WILL actually begin defaulting (remember, so far it’s just a threat).
  • Whether or not China’s decision would trigger a larger chain reaction in the derivatives markets.
  • How the US will respond to China’s threat.

I do not know the answer to these issues. No one does.

I DO know, however, that a derivative chain reaction throughout the financial system could cause a full-blown implosion like September-November 2008. We’re talking about massive volatility (2%+ swing days) and a stock market collapse of 20-30% within a matter of weeks.

Remember, computers account for 70% of the market’s volume. And they can simply walk away OR even worse, start driving the market lower as they adjust to trading in the new environment. These are not sensible, brain driven, investors who can make qualitative judgments. They are computers trading based on algorithms that track various metrics. If we get a black swan even (and China defaulting on derivatives would be one) these computers could go completely haywire and instigate a repeat of the ’87 Crash.

I am not saying that this WILL happen, but mention all of this to remind you of the investing environment we’re in. Pull the plug on the computers and you’ve got panicked selling galore and a repeat of October 2008 if not 1987.

I’m preparing our portfolio for this eventuality this week (more on this in a minute) with a number of trades that should prove extremely profitable if the Crash I’ve been predicting for months comes to fruition.

However, we also need to consider the socio-economic implications of what could happen should China start defaulting on its derivative contracts with the US. If China chooses that route, the US could choose to default on its debt to China. At that point we would be in a full-scale economic war and potentially on our way to military conflict.

The fact that Japan’s new leadership has also expressed displeasure with the US’s monetary policy adds to the mix. This creates additional issues that I do not know the outcome of (Japan and China are our largest creditor nations).

I am not saying any of this to be “scary” or “doom and gloom.” But things are coming to a head in a very REAL way on the global stage. And it is not looking good at all. This financial crisis is nowhere near over. If anything we’re at the end of the beginning. Many, many more banks will go under. We can and will see a lot more volatility in the bond and currency markets (a bear market in bonds would be a nightmare we haven’t seen in 30 odd years). And stocks (already overbought and propped up via manipulation and accounting gimmicks) are primed to take a full-scale nosedive (more on this in a minute).

My Personal Message: BE PREPARED

In light of this, and on a more personal note, I am suggesting you prepare for the WORST if you are in the US. This means stockpiling food, and having enough cash on hand to survive an economic shutdown if it happens. We came close to such an event last fall (the story was not widely spread but banks in US and UK considered shutting down ATMs and having a holiday).

I can tell you that I personally have stockpiled food (3 months’ worth) and am telling my family and friends to do the same. After all, what’s the worst that could come from doing this? If I’m totally wrong and everything gets better, you simply eat the food just like you would anyway.

But if I am right, and things do get MESSY, then stockpiling now means you’ve got food on the table later. Again, we have the making of several black swan events that could push an already weak economy into SERIOUS trouble. Among them are:

  • China defaulting on derivatives (triggering a chain reaction in the financial markets)
  • China selling Treasuries (flight from the dollar and all paper money)
  • Japan sell Treasuries (ditto)
  • The $7 trillion commercial real estate market (as bad if not worse that the US residential market)
  • Some other chain reaction event in the $1 QUADRILLION derivative market
  • The H1N1 virus (a major flu pandemic would stop all economic growth in its tracks)
  • A major bank failure (rumors of Wells Fargo or someone else are swirling)
  • Some other item no one sees coming (e.g. Gmail shut down for an hour a few weeks ago, imagine if the NYSE’s servers did the same thing).

All of these could portend another crisis for the US economy and stock market. I put the likelihood that we are out of the Crisis and the Great Depression II (it is a DEPRESSION, not a RECESSION), at less than 5%. Even if we go the route Japan did in the ‘80s instead of a full-blown black swan induced meltdown, then we’re talking about weak economic growth for a two decades with high unemployment, lower quality of life, and the stock market slowly losing 80% of its value.

I’ve put together a FREE Special Report detailing THREE investments that will explode when stocks start to collapse. I call it Financial Crisis “Round Two” Survival Kit. These investments will not only protect your portfolio from the coming carnage, they’ll also show you enormous profits: they returned 12%, 42%, and 153% last time stocks collapsed.

Swing by www.gainspainscapital.com/gold.html to pick up your FREE copy!!

Good Investing!

Graham Summers

http://gainspainscapital.com

Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets. 

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

    © 2009 Copyright Graham Summers - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

    Graham Summers Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Benjamin
13 Sep 09, 22:48
The Truth

It seems the only people telling the truth lately are all saying the same thing. All the TARP is about to blow away in the economic hurricane coming our way.


Jerry
14 Sep 09, 15:54
How to Prepare For China’s Coming Derivatives Default

If the derivatives are common to wall street but not main street, what can main street watch to see if this is occurring?


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules