Tuesday, January 1, 2013

Fiscal Cliff Nothing Compared To Derivatives

With all the concern America had about the fiscal cliff a much larger problem lurks out of sight and under the radar. The Derivatives Tsunami and the bond and dollar bubbles are of a much greater magnitude. To many avoiding the fiscal cliff requires that the federal government cut spending by as little as $1.2 trillion over ten years. That  means the federal deficit has to be reduced just over 100 billion dollars a  year or 3 percent of the current budget. This reduction in spending can be done by simply cleaning out government waste and putting Washington on a diet, but even with the cliff avoided expect the debate to continue  about the sustainability of entitlement programs

Now lets take a look at the far greater problem of derivatives. According to the Office of the Comptroller of the Currency’s fourth quarter report for 2011, about 95% of the $230 trillion in US derivative exposure is held by four US financial institutions: JP Morgan Chase Bank, Bank of America, Citibank, and Goldman Sachs. The Derivatives Tsunami is the result of the handful of fools and corrupt public officials who deregulated the US financial system. Today these four US banks have derivative exposure equal to 3.3 times world Gross Domestic Product.  This is something beyond science fiction or anything that can be comprehended.

Hopefully, much of the derivative exposure somehow nets out so that the real exposure is far less then the hundreds of trillions of dollars on the books. Still, the situation is so worrying to the Federal Reserve that after announcing a third round of quantitative easing which includes printing money to buy bonds (both US Treasuries and the banks’ bad assets) the Fed recently announced that it was doubling its QE 3 purchases. In other words, the entire economic policy of the United States is dedicated to saving four banks that are too large to fail. The banks are too large to fail only because deregulation permitted financial concentration, as if the Anti-Trust Act did not exist.

The purpose of QE is to keep the prices of debt, which supports the banks’ bets, high. The Federal Reserve claims that the purpose of its massive monetization of debt is to help the economy with low interest rates and increased home sales.  But the Fed’s policy is already hurting and distorting the economy by depriving savers, especially the retired, of interest income, forcing them to draw down their savings.  Real interest rates paid on CDs, money market funds, and bonds are lower than the rate of inflation. Moreover, the money that the Fed is creating in order to bail out the four banks is making holders of dollars, both at home and abroad, nervous.

If investors desert the dollar and its exchange value falls, the price of the financial instruments that the Fed is supporting will also fall. The only way the Fed could support the dollar would be to raise interest rates. In that event, bond holders would be wiped out, and the interest charges on the government’s debt would explode. With such a catastrophe following the previous stock and real estate collapses, the remains of people’s wealth would be wiped out. Investors have been deserting savings accounts for equities and “safe” US Treasuries. This is why the Fed can keep bond prices so high that the real interest rate is negative, but for how long can this continue?

The hyped threat of the fiscal cliff is immaterial compared to the threat of the derivatives overhang and the threat to the US dollar and bond market because of the Federal Reserve’s commitment to save four US banks. Once again, the media and its master, the US government, hide the real issues behind a fake one.  The fiscal cliff, is a false issue, while it represents to many  a way for the Republicans to save the country from bankruptcy by destroying the social safety net put in place during the 1930s then supplemented by Lyndon Johnson’s “Great Society,” it does not reach the crux of the problem.

We have seen expanded and ever growing government during the last several decades. Now that there are no jobs, now that real family incomes have been stagnant or declining for decades, and now that wealth and income have been concentrated in few hands, this is the time, Republicans say, to destroy the social safety net so that we don’t fall over the fiscal cliff. In human history, such a policy usually produces revolt and revolution, which many people claim is what the US so desperately needs, to them perhaps our stupid and corrupt policymakers are doing us a favor after all.

Footnote; Most people have no concept at how large the government deficit spending is here in America. In the post below I break down the math and try to make it easy to understand, the article is titled,"Ugly Math Made Simple"

1 comment:

  1. For a fresh more detailed post concerning derivatives see my March 2014 article,