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Monetary Inflation to be Joined by Price Inflation Crisis During 2008

Stock-Markets / Financial Crash Jan 10, 2008 - 01:55 PM GMT

By: Jim_Willie_CB

Stock-Markets Best Financial Markets Analysis ArticleUnproductive Assets, Wasted Productivity The US system has been the dog led by the financial sector tail, as the tail wags the dog, for over two decades. Systematically, the United States has abandoned manufacturing in favor of financial sector dominance with futile attempts to manage inflation, and money changers pushing to foreign lands the capacity that actually makes things and adds value. Such is the painful costly consequence of chronic monetary inflation. Unfortunately, the nation has invested heavily for decades in unproductive assets like military hardware and recently homes. The entire US Economy was made heavily dependent upon the housing boom and mortgage finance craze. Now that a housing crisis and mortgage debacle seems a nightmare without end, we are treated to utterly moronic opinions that the US Economy will glide through the storm. It will not.

A recession has begun even after the false 4% lift given to the Gross Domestic Product, as in the recession is soon to be worse than a 4% contraction, and soon. The nation has squandered its productivity, the most important achievement next to innovation. The major innovation in recent years has been in lunatic option-laden adjustable mortgages, not much to write home about to mother lately. The major productivity has been in the assistance of outsourcing of job overseas by replacing US workers with advanced equipment. The nation is witnessing the vicious backfire of decades of destructive investment in unproductive assets, wasted productivity, and innovation in devices which kill the banking system.

Gold has noticed, poised to reach $1000 before the daffodils and jonquils break ground in the spring flower beds. The gold price will respond on all continents from uniform policy by central banks to stimulate economies enough to avoid recession. Today, the Euro Central Bank talked about a rate cut, but choose no action. The major theme for gold will be rampant money supply growth on the front end, accompanied finally by rising price inflation on the back end.

With the US Economy reeling toward recession, the US Federal Reserve has no choice but to cut interest rates again and again. Even Goldman Sachs (aka Dept Treasury) and JP Morgan (aka US Fed itself) expect a 50 basis point rate cut at the next FOMC meeting at the end of January. An interim cut could occur. The prevailing guesses have become how far the US Fed will cut rates, currently way too high at 4.25% now. GSax thinks the official Fed Funds rate goes all the way down to 3.0% before the autumn ends. We have a strange situation where the real economy is contracting while the financial sector attempts a massive monetary inflation effort. The storm vortex is building, from competing high pressure and low pressure zones.

Meanwhile, gold will march upward. The US Dollar might not suffer a collapse just yet, as the Europeans will be forced into cutting interest rates soon. The competing currency wars continue to weaken all economies. The global stimulus to ward off recession will lift gold tremendously. Gold might zip past $900 soon, but might consolidate a little more above the $850 breakout level. It don't mattah! The next chapter for gold has been written.

If one peeks ahead to read two chapters forward, a glimpse can be snatched at a gold price past $1500. Fortunately for mining firms, energy prices will relax from the slower economies. What follows is an attempt to tell the story of how the United States painted itself into a corner. Its banking system is in the process of collapse. Its value added economy centers largely on services, including bankruptcy counseling and mortgage lawsuits. The US Dollar has become a ballot for global votes cast against the US stewardship of the world reserve currency, against the reckless design of the bond & risk management model, against blank checks written for Medicare, against the management of the US war machine. Truly dangerous times lie ahead.


When the Vietnam War was triggered in the 1960 decade, the US $-gold standard bound by the 1971 Bretton Woods Accord was doomed. The Great Society pushed by Lyndon Johnson in the same decade sealed the US Dollar's fate. However, it would take three more decades before the system would undergo its final gasps. That is now! The payment for the huge $1 trillion cost of the Vietnam War sent the US Govt federal budget into deficit for the first time. The seeds of socialism widened those deficits. The ‘Guns & Butter' theme was a boast, but also it was much more an obituary title . History repeated itself in the 1990 and 2000 decades, as the staggering costs of the Medicare program delivered a socialist death blow to a reeling system. Then in 2001, a bizarre mysterious attack occurred, which laid the cause for war against Iraq and Afghanistan . Certain groups might have wanted war, greater funding, and control. The costs associated are again staggering, enough to render the budget as permanently broken. The entire privatization initiative for some military functions is a final metastasizing cost cancer.

As a coincident effect of war and socialism, the US Economy suffered chronic price inflation, all deemed essential for prosperity by the incompetent compromised cast of economists. The resulting higher wage structure rendered the United States exposed to foreign competition. The 1980 decade saw the technology industry migrate to the Pacific Rim and Japan . The 1990 decade developed the PacRim Tigers and their economies into powerhouses. The 2000 decade, after the Most Favored Nation was granted to China , finished the process of industrial migration away from US shores.

The chronic inflation ravaged the US Economy on a structural level. With lost industry, the US Economy was forced to rely on an increasing basis upon asset inflation as a power generator. Greenspan blessed the process as legitimate. It bought him enough time to leave town. In the 1990 decade, it was the stock market. In the 2000 decade it has been the much larger twins of the housing market and bond market, whose combined size is at least 5 to 6 times larger than the stock market. Worse, the credit derivative market pyramid is closely attached to the bond market, rendering the housing/bond complex even more dangerous. Nobody knows who counter-parties are anymore, or how strong they are, or whether they are already dead. The ripple effects from mortgage bonds have already hit the derivatives in the form of Collateralized Debt Obligations. The CDO bonds typically have leverage of 3 or 6 or 10 times, depending upon level of desired client risk. The bank system has close ties to the bond market, asset backed bonds, dominated by mortgage bonds. Most interbank commercial paper is mortgage bonds.

The housing crisis and mortgage debacle have delivered a death blow to the US banking system. It is dead, only full accounting remains. The big banks are one by one going to suffer very public deaths, labeled at first as struggles with insufficient capital. Right now, many are vampires, as in walking dead. That is why they are lending much less. Their own executives are unclear of their own solvency, as illiquid markets conceal their own bankruptcy. Most of them are loaded to the gills with bad loan portfolios and severe losses on mortgage bonds. Where CDO bonds are involved, losses are amplified. The biggest players in CDO's will be the first banks to die. Losses have been huge, but it is very early. Ultimately, bank losses will be ten times larger than those disclosed to date.

The overdone housing construction boom has left hundreds of thousands of workers without jobs, since they embarked on a path out of control. The banking system initiated and urged on the structures to finance the housing boom, seen now as a suicidal course. The mortgage bonds have a $10.4 trillion size, steadily falling. The housing market has a $22 trillion size, steadily falling. In its motivated need to sustain the housing boom, the banking executives and Wall Street firms made conscious decisions to bend the lending rules for loans and securitized packages. Not only did subprime mortgages become popular, but on a much bigger scale innovative adjustable prime mortgages went out of control. Bankers pushed the limit until the process ran out of available sucker buyers of homes and willing buyers of acidic bonds across institutions worldwide.


The tragedy has a theme that is a consequence of the military & socialist emphases, in the form of investment in ‘Unproductive Capacity' of two types. In the 1980 decade, a tremendous surge occurred in military spending with Star Wars technology. The Arms Race with the Soviet Union killed the Soviets quickly, but contributed quietly to set the stage for the US demise also. The stronger US Economy permitted many more years of systemic dismantlement, as the world's biggest and most diverse economy was gradually gutted, one industry at a time, from technology to steel to machine tools to cars to household appliances to housewares. Investment in military weapon projects does little to create efficiency, to encourage a lengthy trickle down, so that the end of the sequence is either an idle wasting weapon or a destroyed target complete with backlash damage. In Iraq and Afghanistan , we are witnessing destroyed targets and entire fleets of vehicles destroyed by sand erosion, brutal wear & tear.

ON THE DOMESTIC SIDE, the US Economy was forced under Greenspan leadership and encouragement to invest in unproductive capacity in the form of residential housing structures. They do lead to jobs, with a certain supply chain, but they are not ongoing productive structures where value is added in an commercial sense like an office building. People eat, sleep, socialize, endure weather, and entertain in homes. They do not sustain the economy, except with continued outrageous consumption of things like oversized home electronics, Jacuzzis, cool gadgets, spiffy furniture, stylish kitchens, the latest in textured wallpaper designs, and unending room additions.

The tragedy of the USEconomy is outlined in unproductive capacity investment gone hogwild out of control, with truly mindboggling unprecedented economic planning stupidity. The United States has hosted the worst economic counselors, stewards, and banking managers in modern history. The failure of the banking system is their testament. The final throes of the bank system failure can be diagnosed with my three favorite themes: Ripples, Momentum, Feedback. These themes have been periodically brought up in my analysis. The ripples now extend from subprime mortgages to CDO bonds to interbank commercial paper to halted loan processing to strains on LIBOR. Ripples extend from fallen home values to lower magnitude home equity loans to reduced consumer spending. Ripples extend from unsold homes to job layoffs to harmed households. The ripples are working in complex powerful interconnected directions. The momentum factor is powerful, as bank losses mount. As mortgage bonds lose value, they build strong forces within the bond market for further losses, since sales are forced by both banks and institutions. Debt ratings agencies issue downgrades, like gasoline tossed onto the fires. When entire firms collapse, heavy liquidation volume sales occur, further pushing down prices.

The feedback loops are only recently being seen in action. They will be powerful in 2008 as the prime adjustable rate mortgages (ARM) begin to fail in volumes perhaps five times greater than the subprimes. The process has already begun, not well covered by the financial media networks. The Mortgage Bankers Assn reports an overall 5.6% mortgage default rate at end September, the highest since 1986! Of foreclosures in progress, 18.7% are prime ARM holders, and 17.6% are prime fixed rate mortgages. That means one third of foreclosures are from prime borrowers.

One key element of the feedback loop is the CDO bond derivative package itself, which places subprime and prime mortgages together in adjacent tranches. They are all sold together as the leveraged CDO bond fails from subprime lost value. Another feedback loop is the sale of homes from adjustable mortgages giving the option to underpay interest, now underwater and facing doubled monthly payment increases. We are witnessing the failure of the US financial engineering monster. We are witnessing the failure of the US risk pricing model and of the leveraged financial security products. Bank assets are collapsing under the weight of the housing bear market and rampant fraud. The reckless lending standards practiced have only added downward pressure. We are vividly witnessing the failure of the Greenspan Legacy, and the catastrophe led by his reckless leadership, but without the blame.

The relentless housing decline, lasting easily through 2008 and 2009, will break the entire US banking system as wave after wave of newer mortgages default and fail. Greenspan now advocates using USGovt cash to help defaulting homeowners. As banks show distress, they have lent less and will continue to lend less in more feedback loops. They will manage foreclosed properties, putting them onto the market for sale, forcing prices even lower via added supply. FORECLOSURE IS THE MOST WICKED OF FEEDBACK MECHANSIMS, BY BANKS ONTO THE HOUSING MARKET ITSELF.


The Basel 2 accounting rules are not discussed much in the financial press. This refers to Basel Switzerland , home of the Bank for Intl Settlements. My deep seated suspicion, more like incrementally reinforced conclusion, is that the powerful Swiss bankers have begun the process of receivership. They are forcing through the bankruptcy process in an international pull of the rug from under the corrupted US banking system. They have taken steps partly motivated by the global contamination of US mortgage bonds into the world's banking system, which must be addressed. The first step in the process is more proper full accounting of the horrendous damage done to US banks, principally Wall Street banks. Basel 2 requires banks to maintain an 8% minimum on capital ratios versus debt.

In England , the capital ratio has fallen to 2.5% (ex goodwill) compared to 5% in year 2000. York University professor Peter Spencer is chief economist of the ITEM Club. He asks, “How on earth did the Financial Services Authority [of England ] let this happen?... Brown hadn't a clue what he was doing.” The reference to Lord Brown pointed to changes pushed through in 1998 as Chancellor of the Exchequer, which caused the defacto cash and liquid assets to collapse from post-war levels above 30% to near zero.

The UK Current Account deficit is at 5.7% of their Gross Domestic Product, more than that of the US . The effect of the Basel 2 Rules on US banks in recent months are to force massive bond losses to come onto the balance sheets. Shrinking asset backed commercial paper coincides. One really must wonder if the objective the United States was to kill the banking systems, enabling Swiss control, with the British system collateral damage.

In the course of packaging mountains of securitized bonds, filled with mortgages and related derivatives like credit default swaps (insurance policies against loan portfolios) and interest rate swaps (contracts shifting risk from short-term to long-term), Wall Street firms were caught holding their own enormous inventory. Domestic institutional investors and finally foreign institutional investors halted their purchases. Additionally, private equity investors, akin to Blackstone, halted their purchases. Wall Street big banker brokers were left holding hundreds of billion$ in damaged asset backed bonds before they were fraudulently sold to investors.

Thus, the Wall Street firms choked on their own fecal securities held in inventory, unable to sell them. The old saying of “Do not defecate where you work” holds true. Wall Street firms were selling acidic lethal bonds, as the game stopped and investors wised up. Now Basel is forcing, along with US regulators, the process of taking the dreadfully damaged asset backed bonds and CDO bonds onto the Wall Street balance sheets, where they are absorbed and felt painfully. The initiators of the fraud might actually suffer the greatest financial losses of all, since they were doing a grandiose volume of packaging and sales. That is justice. They earned gigantic fees in the process. The entire drama of proved fraud will be interesting to observe. Some investors have begun the lawsuit process. See the Barclays lawsuit of Bear Stearns. The game is on, and will not relent. A Special Report is to be posted for the January Hat Trick Letter on lawsuits and fraud. Unfortunately, the rescue programs have been very slow to take root, partly because the USGovt and Congress do not wish for Wall Street firms to benefit from bailouts. They deserve criminal prosecution instead, complete with heavy fines and prison terms. The climate will be mixed with confusion, shock, anger, and desperation when the first Wall Street bank goes bankrupt.

My forecast is that the first Wall Street bankruptcy will not be Citigroup, but rather Bear Stearns. The lawsuits will overwhelm them. Their cash infusion in exchange for capital stakes will be inadequate to cover writedowns and set aside funds to litigation and lawsuit awards. The Citigroup bankruptcy will occur next year, with a possibility that a huge breakup of the conglomerate will coincide with bankruptcy restructuring of ailing subsidiary businesses so as to conceal their bankrupt condition. Other Wall Street firms will be the subject of great debate and controversy within rumor mills, since wider recognition will come that most are bankrupt. Other big lawsuits are also in progress. Class action lawsuits are only beginning. Their insolvency will lead to further problems on cash flow, enough to freeze them and force bankruptcy notices.


One of the true testaments to a national economy is its ability to pursue and delivery on innovation. Clever application of intelligence through innovation results in added productivity, improved efficiency, lower costs, more competitive products, and thus more savings to invest through plow back into the economy. In technology, that means faster computer processing, quantum leaps like with fiber optics in communications, bigger bandwidth and channels for cell phones, greater fuel efficiency with cars & trucks & jetplanes, reduction of viruses creeping into the computer networks, reduction of spam email into inboxes, more responsive supply chains to connect inventory with sales, cheaper production of photovoltaic cells to capture sunlight into electricity, and much more. In the United States , since the fatal loss of its manufacturing sector, its economy turned to financial innovation. The mfg sector was lost from active avoidance of higher cost structures inside the USEconomy.

As the financial sector dominated, the innovation even had an absurd name, financial engineering, often to scarf lazy bond yield differentials, attempting to manage the inherent risk. This innovation involved carry trades to capture differentials between foreign government bond yields and domestic USTBond yields (called carry trade), to capture differentials between mortgage bond yields and USTBond yields (called yield spreads), to capture differentials between mortgage bond yields and short-term corporate paper (called structured investments). To manage the risk, an array of other risky contracts was super-imposed, such as basic currency hedges, basic USTBond futures contracts, interest rate swaps and credit default swaps. In an effort to be thorough, one should regard USGovt fraud in the inventive doctored statistics as more misplaced innovation. Instead of creating growth and jobs without price inflation, they have used innovative techniques in grotesque deceptions.

What flowed in the last two decades is a series of bubbles puffed so as to attempt to create wealth, since legitimate wealth was no longer coming from value added enterprises such as manufacturing. Without much dispute, the USEconomy relied heavily upon its service sector, but also upon its financial sector to generate bubble after bubble on phony illicit wealth. The economic and banking leaders then engaged in systematic propaganda and false inculcation to deceive the public into accepting the doomed philosophy. Thus chapter after chapter of economic mythology followed, such as the Trickle Down during the Reagan years, the Macro Economy (aka Bretton Woods II) early in this decade, and the Asset Backed Economy in recent years (Greenspan's problem child). They were each devastating to the USEconomy. War played a key role to revive the moribund USEconomy during the early 1980 decade in the Cold War with the Soviet Union , and during the 2000 decade in the so-called War on Terrorism with the Islamics.

D-Day came on a quiet day in mid-August, when the initial shocks came to the mortgage arena. Since then, the nation and world is witnessing the backlash destruction of the phony financial innovation, the slow motion degradation of the risk offload model, and the failure of the US banking system itself. The process will continue through several stages without interruption. In the last few months, the subprime mortgages were the principal factor to break the system, by means of loan portfolios and related mortgage bonds. The next stage will be dominated by prime mortgage failures, and their usually pristine mortgage bonds. Here in year 2008, the banking system will be wrecked by the failure of innovative prime adjustable mortgages. Perhaps half of those originated since 2002 are under-water. Many newer mortgages have loan balances greater than their current home value.

Many newer mortgages will not reset upward only by 20% to 30% in monthly payment cost, but rather by 100% to 200%. They violated the negative amortization limit, and past unpaid mortgage interest is overdue! Leverage employed by the madcap financial engineers has amplified the damage. The bank system has responded with profound distrust of assets placed as collateral in commercial paper. The banking system is much more seized up in the United States than in Europe , although England is doomed to follow the US lead down the horrible path. The US bankers have turned increasingly to the London bankers, using the LIBOR rate. Notice the rise in the spread of the USTreasury over the EuroDollar recently. The TED Spread measures credit risk, defined nowadays at the difference in the 3-month bond yield of the EuroDollar (corporate risk) over the USTreasury Bill (no risk).

The Anglosphere, as it is sometimes called, led by English speaking nations, followed the US established model, instilling economic dependence upon asset inflation (houses), and lacing its banking system with toxic mortgage bonds. Given their commodity riches from natural resources, Canada and Australia will delay their appointed date with the wrecking ball. WE ARE WITNESSING THE FAILURE OF THE US FINANCIAL MODEL, ALL ITS HERETICAL PRINCIPLES, AND THE END OF THE ROAD WITH NO AVAILABLE BUBBLES. In reality, the final bubble is the commodity bubble, a revolt played against worthless fiat currencies. As the commodities rise in price, led by crude oil on the commercial side and by gold on the financial side, the USEconomy will crater from severe cost inflation much worse than seen a few years ago. Wages and product prices must be forced higher, or permitted to rise, if the USEconomy is to survive. Higher prices are prevented by the Asians, who continue to export to US shores. Higher prices are not desired by the USTreasury Bond complex, which will be killed quickly if price inflation doubles.



History has repeated itself, with the same players even in the first chapter of crisis. In the 1980 decade, the US Congress deregulated the banking industry, which permitted Savings & Loans to approve and grant mortgages. A grand debacle ensued. At one point, almost $1000 billion was committed to the 1991 Resolution Trust Corp, laden with loans gone bad. The ultimate cost to the USGovt in the bailout was $265 billion, after a few years of salvage in liquidation. At a low point, Citibank was called ‘Too Big To Fail' at a time when Saudi Prince Al-Waleed entered the picture with a giant cash rescue of Citibank, in exchange for a capital stake. THIS IS THE EXACT OPPOSITE OF CAPITAL INFUSION, BUT RATHER EXPORT OF CAPITAL, PAID BY CASH. The Prince is not a fool. He supplied fresh cash in return for bank equity (capital) only after being assured of massive USGovt guarantees. The deal is the US keeps the Saudi robber barons in power, their sheiks buy USTBonds en masse, and then they come to our rescue when our inflation games go amok. Well, history repeated itself, worth saying twice. Once again, another housing bust has occurred, and once again, Prince Al-Waleed stepped in with a giant cash rescue in return for an outsized capital stake.

THIS TIME AROUND, THE BANK SYSTEM WILL FAIL, AND THE EVENTUAL BAILOUT COST WILL BE ASTRONOMICAL, AS IN AT LEAST $2000 BILLION. The age of financial engineering struck the bank a lethal blow. Many losses are amplified. Mortgage bonds are leveraged in reckless derivatives, and in contrast moronically destructive predatory time bombs were created, posed as adjustable mortgages. The 2000 housing crisis is accompanied by a mortgage debacle, whereas in 1980 no insane mortgage condition was concocted. The current problem seems intractable, beyond solution, since so deeply engrained within the entire system, from banks to bonds to mortgages to the economy. The current problem is more than one order of magnitude dangerous and out of control, and at least ten times larger.


The private sector, led by the US Federal Reserve, seems entirely unable to fix the current mess with monetary policy, which means using interest rate changes and easier refunding measures, from lower bank ratios. The USGovt must enter the picture with some fiscal solutions and broad programs. Let it be said further. The problem appears to have grown to the entire banking system and the economic system, inviting the question if this cycle refers to the 60-year cycle and entire systemic restructure. The solution, if one exists, will require far more than what the USFed can do by adjusting spigot flow.

The USGovt must step in with truly massive aggressive action, and even their directives might be insufficient, first because they will act timidly, second because they will act to protect their cronies before they direct attention to the system itself. Their urgent moves will cut 10% to 15% off the value of the USDollar, maybe more, all in time. The private US banks cannot be revived without direct monumental infusions of cash (corporate welfare) to reinvigorate absent capital. ALL THE TALK OF CAPITAL INJECTIONS IS THE LATEST PROPAGANDA, WHEN CASH IS INJECTED IN EXCHANGE FOR CAPITAL , AS THE MAJOR US BANKS LOSE CONTROL OF THEIR OWN COMPANIES. The USEconomy grew overly dependent upon the housing bubble and the mortgage finance bubble. Lower interest rates will accomplish little, but they will be given. The universal central bank stimulus will greatly lift gold, as they combat economic slowdown and recession. Monetary inflation will be joined by realized price inflation this year. The rise of gold will be the main investment story of 2008. It is already.


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