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Central Bankers Warn of an Impending US Fiscal Crisis - Feds Bernanke, ECB's Trichet

Economics / Analysis & Strategy Jan 30, 2007 - 05:52 PM GMT

By: Dr_Martenson


This past week, Ben Bernanke warned the US Congress that our nation faces a ‘fiscal crisis' if the out of control spending habits of Washington aren't soon curbed.   I suspect he used the word ‘curbed' quite deliberately as the politicians starting back at him probably looked like a row of dogs listening to white noise.  Can't you just picture it?  A bunch of congressional heads all tilted to the side with studious expressions on their faces, but a stylized question mark floating in a little text balloon over each of their heads?

Central Bankers Warn of an Impending US Fiscal Crisis - Feds Bernanke, ECB's Trichet

As the author Upton Sinclair famously remarked; "It's difficult to get a man to understand something, when his salary depends on him not understanding it." Which is a fancy way of saying that roughly zero congressmen "understood" what Bernanke was saying, although at least a few probably possessed the requisite intellectual candlepower to ‘get it'.   

Bernanke began his testimony by restating what we already know:

"Dealing with the resulting fiscal strains will pose difficult choices for the Congress, the administration, and the American people," Bernanke said.

"However, if early and meaningful action is not taken, the U.S. economy could be seriously weakened, with future generations bearing much of the cost," he added.

Breaking out our handy-dandy central banker decoder ring we can decipher his statement as follows: 

  1. "You guys are gonna have to either break your past entitlement promises and face an angry electorate or you're going to have to raise taxes to hurtful levels and face an enraged electorate".
  2. "Unless you do one (or both) of these things, the future looks mighty bleak". 

Which is why all the congressmen resembled dogs listening to white noise.    But Bernanke was probably quite comfortable with their feigned puzzlement as long as he was able to deliver the real message, possibly of the CYA variety, a little later: 

He said the worrisome outcome taking no action would be what over indebted corporations call "the death spiral": 

"Thus, a vicious cycle may develop in which large deficits lead to rapid growth in debt and interest payments, which in turn adds to subsequent deficits," Bernanke said.

Ah!  Now we see.  Bernanke is actually worried about what will happen to our monetary system once the era of ‘ free money for everyone' that congress has grown so accustomed to over the years lurches to a halt.  The virtuous cycle of ‘more borrowing leading to more money chasing fewer economic opportunities leading to lower interest rates' will someday morph into it's evil twin the vicious cycle where (1) more borrowing leads to (2) higher interest rates which lead to (3) higher debt payments which the lead back to (1) more borrowing, which leads to (2), then (3), then (1,2,3 - real quick), then (123123123123123) so fast you find yourself running to store to spend your money only to find they ran out of wheelbarrows a long time ago. 

In short, he's worried about how his particular private industry, the Federal Reserve and its member banks, are going to fare under this scenario.  And he's not the only central banker out there hitting the pavement and making dire statements. 

First, Paul Volcker, the legendary (and deservedly so) former Federal Reserve Chairman stated in 2005 that there was a 75% chance of a dollar crisis in the next 5 years and that ‘we are skating on increasingly thin ice" . I know these quotes come from nearly two years ago but they set the stage and everyone should be aware of them.  When Volcker says such things, it is best to listen.  It's like the fire marshal telling you to exit a crowded movie theater...knock people over if you have to but get out of there! 

Next, Timothy Geithner, a Federal reserve Governor , had this to say about derivatives in September of 2006:  The same factors that may have reduced the probability of future systemic events, however, may amplify the damage caused by and complicate the management of very severe financial shocks. The changes that have reduced the vulnerability of the system to smaller shocks may have increased the severity of the large ones.

What Mr. Geithner is saying here is that derivatives have ushered in a period of relative calm, which is a good thing, but like a geological fault line storing up energy, this could instead translate into a larger financial earthquake in our future.   The longer the period between seismic tremors, the worse they tend to be.   Personally I'd rather have small and more frequent tremors than one gigantic one, but I'm not calling the shots here and it certainly wasn't my advice to lower interest rates to 1% and hold them there for more than a year.  Further, I have no say in setting investment margin requirements, managing hedge fund leverage, or setting back reserve or bank capital sufficiency ratios.  Those would be Mr. Geithner's job. 

Then, on January 26th 2007 it was reported that Alex Weber of the European Central Bank (ECB) sternly told the Davos participants that "If you misprice risk, don't come looking to us for liquidity assistance" meaning that he wanted everyone to know that the Central Bank would absolutely not bail them out if they got into trouble, and that the wealthiest market players in the world would have to accept their losses just as you or I would.  However, this must have been entirely too unthinkable an outcome for the Davos participants because Alex immediately softened that harsh rhetoric by saying that of course "systemic threats to financial stability" would be treated ‘differently' which, - let me access my banker decoder ring thesaurus function here - turns out to be an alternative spelling for ‘to a bailout'.  While Mr. Weber took many words to convey his true message, I managed to encapsulate it in a single short memo: 

"If you'd like to be eligible for the ECB bailout program, please endeavor to be sure that your bets are large enough to possibly ruin the system.  Thank you.  A. Weber"

And finally, reinforcing the comments above was the head of the ECB Jean-Claude Trichet who stated that conditions in world financial markets appeared "unstable" and that participants should brace themselves for a risk re-pricing event.  Again, this is bank-speak which, translated, means "things could get real ugly when (not if ) you all figure out that you overpaid for your junk grade assets and used too much leverage while doing so". 

And what are we to make of all this banker hand wringing?  Are there any steps we should take? 


All of this talk of systemic risk means that you need to consider your exposure to the banking industry.  Are 100% of your monetary assets tied up in a bank somewhere?  If the answer is ‘yes' you might want to consider buying physical gold and/or silver, which you can hold outside of the banking system.  As well, I am a proponent of holding several weeks worth of cash on hand, a lesson reinforced by the lessons of Katrina. 

The theory here is that you would be able to utilize those assets for your daily living expenses and would be able to carry on where others would struggle if the banking system suddenly had to shut down for a while to ‘figure things out'. 

On a smaller scale this happened in Argentina in 2001 (for 2 weeks), but I remain concerned by the lessons of Fannie Mae, a single company whose derivative books were so confusing that it took 1,500 accountants 2.5 years and $800 million dollars to answer the simple question "How much did Fannie Mae make/lose in 2004?" 

Should the "risk re-pricing" event that is currently worrying the ECB officials come to pass, how many accountants, years, and dollars would it take to untangle the resulting mess?  And while they were sorting things out, how would banks know which checks to honor?  In all likelihood the system of domestic and international money transfers would have to cease operations until we approximately knew who was bankrupt and who was not.

I would expect checks, debit cards and credit cards to be non-functional during this period. I would expect the period to be pretty lengthy because there simply aren't that many accountants in the world.  Under this scenario your cash would tide you over and your gold/silver would skyrocket in (paper dollar) price as the people who lost faith in the paper money system turned to the oldest and most trusted stores of value that remain among the very few monetary assets that are not somebody else's liability.

"Paper money eventually returns to its intrinsic value - zero." ~ Voltaire - 1729

As for me, I am going to bring a dog whistle to Bernanke's next congressional hearing to see how many representatives I can get to turn my way when I give it a toot. 

By Dr. Chris Martenson

Dr Martenson is the creator of The End of Money economic seminar series, has extensive experience analyzing and communicating financial information.  Dr. Martenson combines a scientist's attention to fact and analysis (PhD, Duke University, Pathology and Toxicology) with a solid understanding of finance and economics (MBA, Cornell, Finance) with strategic thinking (4 years as a management consultant) to produce an insightful and powerful lecture. He is currently devoted to researching, writing and presenting economic and financial analyses delivering his message via his website, lecture series and is currently working on a related book & movie.

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