Even the thieves are starting to get it

Since we are definitely small fry, below is a brief presentation by a bona fide big shot that backs up the more detailed analysis found in The financial system is based on twelve promises that are lies.

The presentation is from a former top thief hedge fund manager who retired in 2004 and now sells a newsletter for other thieves Big Money investment managers that is so expensive that we mere mortals don’t normally get to hear what he says. But yesterday the slides from one of his recent presentations were made public on Zero Hedge. One interesting note: this is from a very successful career trader with a very successful trading newsletter, that is, this is someone who knows enough about how the system functions to out-trade the rest of the thieves. He says that people have six months left to trade and then:

“That is the end of the fractional reserve banking system and of fiat money…

We have around 6 months left of trading in Western markets to protect ourselves or make enough money to offset future losses. Spend your time looking at the risks of custody, safekeeping, counterparty etc. Assume that no one and nothing is safe…

As defaults in governments and banks come to fruition, we risk a closure of the stock markets entirely and a closure of the banking system…

There would be no trade finance, no shipping finance, no finance for farmers, no leasing, no bond market, no nothing……

All that is left is the Dollar and Gold.”

That means the physical stuff you can hold in your hand, folks. Not numbers printed on an account statement.

And the Dollar is fiat money. While its physical form will likely be in use longer than its electronic versions, at some point few will want that physical form either.

Here is the presentation by Raoul Pal: The End Game.

The financial system is based on twelve promises that are lies, Part 2

In yesterday’s Part 1, we covered these lies:

Lie #1: Real estate always goes up.

Lie #2: It’s best to use Other People’s Money.

Lie #3: We can buy cheap goods from countries with cheap labor, and yet keep our much-higher salaries and benefits.

Lie #4: Government pension and medical programs will deliver on their promises.

Lie #5: Your money is in the bank

Lie #6: Your money is in your brokerage account.

Lie #7: It is OK for financial institutions to use huge leverage.

Lie #8: The government guarantees it.

Today, we’ll cover the final four:

Lie #9: Government bonds are safe.

Most people are told, and believe, that the big culprit in the Great Depression of the 1930s was the stock market crash. This is an intentional re-writing of history. At least 10 times more money was lost when governments defaulted on their bonds in the early 1930s. These defaults were the source of thousands of bank failures, which led to untold numbers of farm, business, and personal financial failures, so the actual losses were far larger than the “10 times” cited above.

Who re-wrote that history and why? Governments, and the academic henchmen they support through direct employment or research grants. Governments and these hired academics conveniently ignore these government bond defaults because they want you to have full trust in government bills and bonds. Again, why? Because these bonds underpin the entire financial regime. When a bank claims to have capital, much of that capital is in the form of government bills and bonds. Same for insurance companies, pension funds, brokerages, etc.

And why did governments default on their bonds in the 1930s? Because they borrowed more than they could pay back. Sound familiar? Let’s forget about the incomprehensible trillions for now. Let’s just treat the US government like a household.

Monthly Income:       $1,900.
Monthly Expenses:   $3,000.

Monthly Borrowing to meet current expenses: $1,100.

So if this household went to their bank and said, “Look, I know I’ve been borrowing 60% more than I make each month to meet my expenses, and that I’m adding $1,100 to what I owe you each and every month, but you know, I really need that money.” How long do you think the bank would keep lending them a new $1,100 each month? Money that gets spent as soon as it has been borrowed.

Convert those hundreds to trillions and you have a good picture of US fiscal finances. Japan is doing far worse. The UK is similar to the US. Despite the evidence of history, people treat governments as if they are eternal, as if they will never fall. That they’ll pay back what they owe someday. History looks askance at that idea as well, as we have seen from the 1930s.

And for those who think that the alleged economic recovery is going to make these numbers better for the US, that this “recovery” is real, think again: The borrowing that the US has been doing for the last three years is equal to almost 10% of GDP, that is, it’s almost 10% of all the spending on goods and services that happens in the US each year. And they are claiming that the economy is growing at about 2% per year, which is itself an over-estimate. So what would happen if they stopped this borrowing and spending of 10% of the economy? The math is easy, and it’s called a severe depression, with the economy shrinking big time every year and so the government would have lower income from taxes and higher expenses for unemployment, food stamps, etc., putting them even further in the hole.

So, aren’t the people who usually buy treasury bills and bonds getting antsy about all this? Some clearly are, including “small players” like China. So the US, Japanese, and UK governments are doing what they call quantitative easing. Since this is a system steeped in lies, they don’t just say “printing money,” they have to come up with a BS term for it. (And they aren’t entirely stupid about that. Ask a few people what quantitative easing is. Most don’t know.) So the central bank of each country prints up money to buy the bonds and bills issued by the treasury when the treasury needs to borrow more money. The US Federal Reserve bought about two-thirds of the bonds sold by the US Treasury in 2011, so they covered two-thirds of the borrowing with newly printed money. If our household above had done that, its inhabitants would soon be in jail for counterfeiting, but that’s a topic for another day.

And one might think that governments can simply raise taxes to pay for these gargantuan debts. That might be true if the people weren’t already up to their eyeballs in debt. Historically, when all the debt in a country gets near three times their Gross Domestic Product, the country groans under this unsustainable debt load and has events like the Great Depression of the 1930s. According to Lacy Hunt, former member of the Federal Reserve Board (and I only cite that credential so you don’t think these numbers come from some deranged blogger), that total debt ratio is now 3.6 times GDP in the US, after peaking at 3.8x in 2009. Think the Eurozone is any better? They are at 4.5x! The UK is at 4.7x. And Japan is at 5x! (From Strategic Investment Conference – Dr. Lacy Hunt)

According to Boston University Prof. Kotlikoff, a guy who is enough of an insider that his work is sometimes published by the US Federal Reserve, when you consider all the future spending commitments of the US Government: “US government liabilities (official debt plus the present value of projected future non-interest spending) exceed government assets (the present value of projected future taxes) by $211 trillion, roughly 14 times GDP.” (From Shattering the American dream: The US government’s Ponzi scheme) In other words, unpayable doesn’t even begin to describe the situation.

So, it is clear that government bonds are a fraud. At some point, the holders of these bonds will not get back their capital and their expected interest payments, as the buyers of Greek government bonds recently found out. The only way these bonds are being kept afloat is by newly printed money. It’s a scheme, a Ponzi scheme, where new money has to be brought in to satisfy earlier investors. Such schemes always fail. This one will as well. You can take that to the bank. But as I think you can tell, we don’t recommend that. Taking it to the bank, that is. Because the bank–at least if it’s a large one–is part of the scheme. And so are your insurance companies, pension plans, etc. Take action accordingly.

Lie #10: Derivatives reduce risk in the system

Derivatives, famously called “weapons of financial mass destruction,” are a big topic, but it’s an important topic to understand because, when the derivatives implode, the whole financial regime will implode. We will do our best to keep it simple and sort of brief. If the description of this lie makes your mind fog, move on to Lies #11 and #12. They are easier to understand, and not to be missed.

A derivative is a financial instrument, a contract, whose value is derived from the value of some underlying asset. Examples of derivatives that have functioned well for years are agricultural futures, where a farmer and a grain buyer agree in the Spring on the price of a railroad car of oats for delivery in December. Both enter the contract to make their pricing in December predictable, removing some of the risk of running their businesses.

But the banksters couldn’t leave it alone. They created derivatives to insure against just about every conceivable financial eventuality. But they sell this insurance without setting aside the reserves typically required for writing insurance policies. Such reserves are normally required to cover the flow of insurance claims that inevitably arise. They sell these instruments to entities who are trying to reduce some financial risk they face, like currency movements, interest rate changes, a default on some bonds they own, etc. Some of the modern derivatives are so complex that, when the parties to a derivative contract have ended up in court, the court ruled that the 600-page contract that defined the derivative didn’t sufficiently cover all the contingencies! These derivatives are sold by the big banks and insurance companies to all sorts of financial entities from corporations to school systems to hedge funds. The school systems are trying to reduce risk; the hedge funds use derivatives as a casino bet. Since the instruments are complex, the banks charge big fees for access to these contracts.

This is now so out of hand that there are over $700 trillion worth of derivative contracts out there in the world. Yes, that’s more than 10 times the size of the world economy. These are insurance policies that obviously cannot be paid if the claims come in. And when the claims come in, the big writers of these insurance policies, the big banks, will be understood, for yet another reason, to be entirely bankrupt. And that money everyone thought they had in the bank will be gone, vaporized. When all that money is vaporized, there will be no money coming from your ATM, no ability to withdraw some from the bank, no paychecks (the checks will bounce), no ability to pay bills, no tax payments going to governments, etc.

So instead of derivatives reducing risk, which is what their proponents claim that they do, derivatives have concentrated risk in the very large banks, which puts the entire system at risk for the sake of large bankster profits.

So why is it inevitable that the derivative market will implode? After all, while no one denies that there are over $700 trillion of derivatives, and no one claims to have anywhere near that amount of money available, the banksters claim they will never have to pay up on that insurance. Here’s their reasoning:

  1. The things they write insurance for won’t ever happen, at least not to any extent that will have a big impact on anyone. And how do they know this? Because they have based their insurance on mathematical models designed by very fancy mathematicians and physicists. But the problem is this: their models are based on data from a small sampling of history. The data rarely even includes data from the era of the Great Depression. So here’s what happened in 2007-2009: some derivatives were based on pools of mortgages. These models assumed, because that’s what they saw in the historical data, that real estate prices always go up. As soon as real estate prices started going down in mid-2006, the payments on these mortgage-backed derivatives came due. And the banksters didn’t have the money to pay up. We all know how it ended, some failed, and the governments bailed out the rest. So when just one very small slice of the derivative payments came due, payments the banks and our beloved central banks said would never come due, the entire system was threatened. The rest of the derivatives in the world are based on similarly inadequate models. They will prove especially inadequate as the world faces the accelerating change that is apparent to so many of us. It is impossible that these mathematical models can account for events that have never happened on the planet before, or that only happen once every several thousand years.
  2. The banksters claim that, even though they may have written contracts for $100 trillion, their book of contracts is balanced, that it is hedged. By this, they mean that, if Spain defaults on its debts, that they have contracts that say that it will and contracts that say that it won’t. They will lose money on one set of contracts and make an equal amount of money on the other contracts. While multiple cases have shown this claim of being hedged to be an outright lie, it has a deeper underlying problem. Let’s say JP Morgue has a bunch of customers who want to buy insurance against a default by Spain. That would be a very unbalanced position for the Morgue. So they go to Bankrupt of America and buy protection against Spain defaulting. Now they think they are hedged, balanced. But there are less than a dozen banks in the world handling the vast majority of this $700 trillion in insurance. Remember AIG in 2008? They were a big writer of mortgage-pool-related insurance in 2007. They were not hedged. They were unable to pay. That inability to pay would have taken down several other institutions who thought they were covered because of insurance they had purchased from AIG. AIG needed a government bailout of $185 billion or the other banks would have gone under. So all it takes is one of those banks to make an error, to not be hedged, to not be able to pay up, and suddenly each of the others is also going under. This is where the concept of the Too Big To Fail banks has come in. All of them are so interconnected that if one fails, they all fail.

So then you might say, well won’t there just be another bank bailout by the governments? Two problems with that. First, no one can come up with anywhere near $700 trillion to fix a cascading failure of the mega-banks. If they printed that much money, the money you currently have would be seen by all to be worthless. Think wheelbarrows of money, hyper-inflation. Second, as we have seen, people have less and less trust in government finances. A large part of the temporary system fixes done in 2008-2009 were not the actual printing of money, they were guarantees. But if everyone understands that a government providing a guarantee is broke, then what is that guarantee worth? Bupkas. Nada. Nothing.

But this is, in fact, what the TBTF banks are counting on: they have a gun to the head of the governments, saying “you have to cover our backs on this huge and very profitable game or we’ll take down your system.”

So when the derivatives implode, all the electronic money in the world will be known to be either gone (fully imploded system) or worthless (tens or hundreds of trillions gets printed up, making all currency worth a tiny fraction of their current purchasing power).

Lie #11: Central banks protect the interests of their country and its citizens

Let’s just get right to the truth about this lie: Central banks protect the interests of large commercial banks. And not all banks. Just the really large ones. The central banks we are speaking of are the international ones, namely the Bank for International Settlements and the European Central Bank; and the national central banks such as the US Federal Reserve, the Bank of England, the Bank of Japan, etc.

Whenever you find it difficult to understand an action by a central bank, apply the principle in the previous paragraph and that action almost invariably makes complete sense. Everything else that central banks say and do is window dressing, secondary at best to their prime directive. Central banks were founded to protect the interests of the large banks, to keep the game of those banks going, and that is what they do.

And what is that game? Being able to create money from thin air and charge for the privilege.

So are central bankers, people like Ben Bernanke, liars? Or have they drunk the Kool Aid so deeply that they believe their own nonsense? The evidence points to the idea that both are true.

This topic is covered in great detail by many on the web, so I won’t recap it here. Please e-mail if you would like more detailed information on this.

Lie #12: Your paper/electronic currency is a reliable store of value.

For most people in the industrialized world, money means two things: a little bit of physical cash on hand, and more money than that in one or more accounts with financial institutions. This reflects the reports on world money supply: maybe as much as 1% of money is actual physical bills and coins, the rest is stored electronically.

This has a big implication, one not readily recognized by most. Every electronic representation of money is a promise by someone to pay up if that money is requested for possession or use. In other words, that money is owed to you. While you may consider it to be cash in your account, it is actually a debt, owed by the bank or money market fund, to you.

Everyone knows that, in the 19th Century, for example, money was backed by gold or silver. You could go to a bank and convert national paper currency for gold or silver coins. Because this restricted the ability of countries to wage war, that right was persistently eroded starting with world War I until it was abolished entirely in 1971.

So what backs up the money now? It is the ability and willingness of those who owe you money to pay up on demand. And the confidence of all who use the currency that they can exchange that currency for goods and services of real value.

Ability and willingness to pay: If the party who owes you money goes belly up or is unwilling to pay you, you are out of luck. That money you thought you had? Well, you don’t have it. In the case of complete bankruptcy, the money no longer exists, it went to money heaven. In the case of a bank, there is a government guarantee that, up to a certain amount, even if the bank goes under, the government will make good up to that guaranteed amount. Such guarantees were put in place in the 1930s after million lost their money due to bank failures.

Confidence: Everyone has heard of situations where people lost confidence in a national currency. The poster child is the Weimer Republic in Germany, with it infamous photos of people carting around wheelbarrows full of currency. And there have been such losses of confidence in Brazil, Argentina, Turkey, Zimbabwe, Viet Nam, and many others. In these cases, governments printed so much currency that it became a “hot potato,” where people wanted to exchange currency for something real as soon as possible because the currency was known to be losing value by the hour.

People can also lose confidence in a currency when a government is known to be going under, perhaps because they are losing a war.

People say that such fiat money, that is, money by the command of a government, is a medium of exchange and a store of value. It certainly is a medium of exchange for goods and services. Until it isn’t. And it isn’t when people lose all confidence in that fiat money as a store of value. Then it becomes that “hot potato.”

And it is somewhat surprising that people still regard it as a store of value. Since the inception of the US Federal Reserve in 1913, the US Dollar has lost, by the US government’s own statistics, 95% to 99% of its value, depending on what method is used for that calculation. People think that a loss of value over that much time is meaningless to them, allowing them to think, for example, that they were real estate geniuses for owning a house in the USA from 1971 to 1997, during which time that real estate “went up so much” in value. Most of that apparent gain was from currency debasement. People hear stories of how their great grandparents paid five cents for a loaf of bread and think that price increases for bread over time are normal. They are not! When money was backed by metals, prices for goods often stayed stable over many decades, with price fluctuations reflecting real changes in supply and demand in the economy, not politician-supplied increases in the supply of fiat currency.

Why have people come to accept increases in the money supply as necessary, and price inflation of 2% to 3% per year as normal, even as “low inflation”? Because it is key to the functioning of a financial regime where money is debt. When all money is debt, the borrower typically has to pay interest to the lender. On most of the money out there, namely that 99% of it that is stored in electronic accounts, people want some payback, interest payments, on their deposits. So let’s just say that, on average, 3% interest is due on all of the money out there. So every borrower, think banks as an example, who are borrowing from you because you have deposited money with them, has to come up with at least 3% more money every year to keep paying interest owed. So what happens if the economy doesn’t grow by at least 3% and there isn’t an increase of the money supply by 3%? It means that some borrowers will not be able to pay the interest they owe. And some of them will go bankrupt. Meaning that the money deposited with them might go to money heaven, disappear, subtracting a lot of money from the system. And this is a system where the amount of money in circulation must grow by that 3% every year or the system starts to go in reverse: instead of the supply of money growing, it starts contracting because of bankruptcies.

So now, do you see why those who run the financial regime go into a complete panic when the economy doesn’t grow? Why they start printing more money every time the economy and, thus the supply of money, shrinks? This is a crucial concept. An economy based on money that is debt must grow. Always. Infinitely. This is why politicians and central bankers repeat the word growth like a mantra. But ultimately, economies are based, at least for now, on finite resources. So how can they grow to infinity? This is the fatal flaw in a system where money equals debt: it must always grow. Which means it must always, as our economies are currently configured, consume more physical resources, especially fossil fuel energy. A steady-state economy is not acceptable when money is debt. It must grow and gobble up more of the resources of the planet. Forever. Which of course is impossible, at least until alchemy is a common skill. But the politicians like to ignore this and just keep chanting growth, growth, growth.

And all things economic obey the Law of Cycles. Things are created, they flourish, and then they pass away, making room for the new. To retain their power, the entrenched elite are trying to subvert that law.

WHY ARE THINGS THIS WAY?

Simply, for the guaranteed profit of a few at the expense of the many. This too is a topic for another day, but that’s the accurate and brief description that fits the facts.

WHAT THEN MUST WE DO?

We could go on and on about other fatal flaws of this financial regime that threaten its existence. The coming disruption from the US Dollar’s loss of reserve currency status. The unfairness of bailing out and supporting the banksters who are engaged, by any human standard, in blatant criminal activity. The subversion of the rule of law as government and its agencies are purchased by the banksters. About the accounting lies that allow financial feces to be counted on corporate balance sheets as shining light.

And you may not agree that the chickens will come home to roost on all twelve lies above. But recall that the financial regime almost fell from the demise of just one of its minor lies, the lie that real estate always goes up in value. Other lies above are for more fundamental to the regime, much more foundational in nature.

And it is because of the foundational nature of the lies that reform of the current system is impossible. Tweaking the rules will not address fundamental flaws.

So what then must we do? We will address that topic in our next article.

Many thanks.
Thundering Heard

The financial system is based on twelve promises that are lies, Part 1

At base, the world has a true financial system consisting of people producing goods and services with real value and trading those among themselves. But grafted onto that reality is an intentionally complex and confusing mega-structure built from a series of promises that are lies. As these promises are increasingly understood as lies, this mega-structure is proceeding inevitably down a path to disintegration. The primary purposes of this article are:

1. To provide you with a checklist so you can understand where we are in this process of financial system disintegration. There is a caveat in terms of using this as a serial checklist proceeding over time: more than one of these lies may get generally recognized in a single event, with understanding rapidly communicated to the entire world.

2. To forearm those who wish to prepare with an understanding of what is unfolding. This is a predictable process, but it may feel quite chaotic to the unprepared. With understanding, and with echoes from the words of the immortal Rudyard Kipling, you will be able to keep your head (and your heart!) when all about you may be losing theirs.

3. To encourage people to take simple steps to sidestep the consequences of the widespread recognition of these lies. It is important to understand that general recognition of just one of these foundational lies–the lie that real estate prices always go up–came within hours, in October 2008, of vaporizing almost all of what are considered to be assets in this financial regime. Evasive action needs to be taken before these lies are generally understood. It is better to do your run on the bank before everyone else decides that’s a good idea. Those who prepare will be able to provide some assistance to those who have not.

4. To allow readers to proceed from understanding, not from the fear that leads to panic, and not from the fear that leads to denial or to throwing up one’s hands and pretending there is nothing to be done about all this. We hope this article provides such understanding.

In terms of tracking this process, we have already seen one prominent lie from this system bite the dust:

Lie #1: Real estate always goes up.

The perpetrators of this lie trotted out pithy sayings about population always increasing and “they aren’t making any more land” to somehow prove that real estate prices always go up. People can’t be blamed for this erroneous belief. Many saw real estate prices rising for their entire lifetime. But if one takes a larger historical look, it is obvious that real estate prices obey the Law of Cycles. They rise and fall just like most prices. This cyclical behavior of prices would not have been a problem for most people except so many of them fell for the idea that they should buy one or more properties with borrowed money, with a mortgage. So when prices fell, the amount owed on the mortgage has turned out to be greater than the current value of the house. Which is a nasty problem because, if a person wants to sell such a house, the current sale price is less than what they owe, so they have to pay money to sell their house, money which many don’t have. So they lose their house in a short sale or foreclosure.

For those who now have the urge to bet that real estate prices have fallen enough, the evidence says it’s a bad bet if you are thinking you will get price appreciation. If you are buying with cash to navigate through tough times, that is, you are buying a place where you can grow your own food, produce your own electricity, pump your own pure water, cut wood to heat your house? Good idea, depending, of course, on price and location. But buying or holding real estate thinking that the price will rise? Bad idea. There’s lots of evidence that any miniature “bottom” in prices will be short-lived and that prices will fall for a generation. The main reason? Real estate prices are still floating on a sea of debt. Most governments are still propping up otherwise-dead mortgage markets with government loans and guarantees that only a fool, excuse me, a government, would make. In other words, these are uneconomic loans that no sane person would make, and these insane loans are still propping up real estate prices in a big way. It won’t last.

************

The remaining lies are in various states of disarray, but all still play key roles in the mindset that keeps the system intact.

Lie #2: It’s best to use Other People’s Money.

The farther in time we progressed following the 1930’s—the last time there were worldwide losses of homes, farms, and business to foreclosure, the last time governments defaulted on their bonds en masse, the last time there were huge numbers of bank failures—the more people were convinced that saving up money in order to buy something was for morons, and that buying things now, on credit, was the smart thing to do. The big deal became just how much borrowing one could “qualify for.” (This disease still persists for some, which is why, despite all of the pain it has inflicted, Lie #2 has not been relegated to the past in this article.) Paying it back was simple: money was worth less and less over time, everyone knew that; salaries always rose; the price of houses, the main collateral for loans, those always went up.

The result of this mindset is that so many people and organizations and even countries have become debt slaves to the bankers. To quote an anti-debt crusader in
Ireland: “Bankers want you to use your energy and your work to make their dreams come true.” Too bad more people didn’t know that before getting themselves so far into debt that it dominates their life.

Lie #3: We can buy cheap goods from countries that have cheap labor, and yet keep our much-higher salaries and benefits.

We’ve all heard for decades about how manufacturing, and in more recent years services, are moving from the developed world to the emerging markets. People in developed countries love to buy cheap goods from lands with ultra-low labor costs. But they expect their own salaries and benefits to remain the same or even increase. How can that be when the sources of income–that is, the jobs and profits and the tax base–that support that salary and benefits structure have moved to another part of the planet? This divergence between expected lifestyles and the labor required to support those lifestyles is bringing exponentially increasing strain to the developed countries. People and governments have tried to maintain their lifestyle illusions by borrowing more money than they can ever repay. They have used this borrowed money to try to bridge the gap between falling real income levels and their habitual spending. Much of the borrowed funds are coming from the countries currently doing all the work to produce those cheap goods. The signs that this attempt is coming apart at the seams are everywhere for those who choose to look.

Lie #4: Government pension and medical programs will deliver on their promises.

Many currently depend on government pension, medical insurance, and disability programs. Many more consider them an essential ingredient in their upcoming retirement plans. But as discussed in Lie #3, the tax base that supports these programs is rapidly eroding, and their funding assumptions were based on far shorter lifespans, lower medical costs, and flawed demographics in terms of the shrinking number of people paying into the system versus the growing number receiving benefits. And governments forcing interest rates to near zero in lame attempts to boost their economies means that pension fund assets earn far less in interest payments than expected. (This is a serious problem for private pension plans as well, most of whom still claim they can earn 8% on their assets a year on average, something very few are able to consistently accomplish. Without that level of earnings, they will not be able to meet their commitments.) If the liabilities of governments were calculated the way they are for businesses, the governments would be promptly declared bankrupt and hauled into court, where evidence of fraud would be a dominant topic.

Governments have four options regarding this slow motion train wreck:

  1. cut promised benefits;
  2. radically increase tax revenue;
  3. borrow even more money;
  4. print new money. (In the typical fashion of these times, they came up with a new name for this counterfeiting process of printing new money, they call it “quantitative easing.”)

Because the last two options on that list are the most politically palatable and the least painful to current voters, these are the options strongly preferred by politicians. They believe that telling the truth about this situation and taking responsible measures to put these programs on a sound footing would get them promptly kicked out of office, which is likely correct. So they take the borrowing and printing route because the pain from these is hidden from most people, and most of the pain is dumped on people’s children and grandchildren. Oddly, for all the noise people make about wanting to leave great things to their children, most people don’t care a whit about passing this huge government borrowing burden onto the children and grandchildren about whom they claim to care so much.

The problem with the borrowing and printing regime is that markets and people are increasingly catching on that: the borrowings are too large to be repaid; and the printing debases the money people have saved and earn, driving up the prices of necessities. Countries such as Greece, to whom the markets will no longer lend money and which cannot independently print money because of membership in the Eurozone, have already cut retiree pensions by two-thirds, and there are more cuts to come.

And while federal government programs have so far garnered most of the attention in terms of their unsustainability, most state, province, and city pension and insurance programs are no better off, and many are worse off, and they generally don’t have the option to print money. In the US, the Pew Research Center and others have estimated that state and local pension programs are underfunded by more than a trillion dollars. Yes, a trillion dollars is one of those numbers that is too large to comprehend. But the takeaway for anyone depending on these programs is that you will not receive the benefits you expect. And yes, when the bankers need a bailout or the governments want to fight yet another war, then it’s deficits be damned, they can easily come up with a trillion dollars. But when it comes to helping regular people, then it’s: “Sorry, we’d love to help you, but we can’t afford it, we have these deficits, you know, so we can’t help you.”

Lie #5: Your money is in the bank

The banking cartel loves to make you feel like they are rock solid and that the money you deposit with them is “in the bank,” safe and sound. As most actually do know, it isn’t. Or rather, only a small portion of it is actually “in the bank.” The rest, generally 90% to 95% of it or more, gets loaned out. (Or is used by the bank for speculative trading.) The bank pays you, at best, a paltry amount of interest on your deposit, and utilizes your money for something that pays them at a higher rate, and thus makes money from your money. And in many countries, governments assure us that banks are a truly rock solid place for your money by saying that, if the bank really messes things up and loses your money, the government guarantees that you will get it back.

This works quite well—until it doesn’t. This model of banking, the “fractional reserve” system, where only a fraction of the deposits are kept on hand, depends on the idea that not all depositors will want their cash at the same time, so most of the deposits can be loaned out. This is fine until a group of depositors needs that money, or they get frightened that perhaps the bank won’t have their deposit available for them when they want it, and they start a “run on the bank.” We’ve all seen pictures of what that looks like. Some of them show a well-behaved line of people waiting to get their funds. Other pictures show an angry, unruly mob clustered at the front door, perhaps bashing some bank windows. And if the bank has loaned out 95% or more of their deposits, it doesn’t take a large group of depositors to drain all the cash from the bank.

When this happens at a single bank, no problem. The government steps in with its guarantees and depositors are made whole up to the level of what the government guarantees. But in the Fall of 2008, we saw the start of a run on the banking system. Seeing the collapse of some banks and hearing rumors of many more, some people and corporations worried that the entire banking system was going kaput (it was!), and they started withdrawing all they could from the system. So governments quickly stepped in with far larger guarantee programs than had ever existed before, covering types of deposits, such as those in money market funds, that had never been guaranteed before. It was made clear that money would be printed to cover deposits, and so depositors calmed down and stopped their run on the system.

So the problem was solved, for the time being, by governments guaranteeing that the failure of private, commercial, corporate banks would not hurt their depositors. But now, those who astutely foresaw that the 2007-2009 phase of the crisis was coming, and warned about it loudly and clearly before it happened, see that people are rightly suspicious of government guarantees because it is becoming obvious that governments are broke. And who wants to rely on a guarantee from a bankrupt entity! More on this topic below at Lie #8.

The real problem for the banks is that they own what are called toxic assets. When the banks were perceived to be failing, it was because people knew that what the banks were counting as “capital” was losing value hand over fist and that, in fact, many banks, especially the big ones, actually had no capital left at all. Because of the political power of the big banks, governments attempted to solve this problem in three ways:

1) They let financial institutions lie about the value of their assets. They came up with accounting tricks that enable a bank to say that a loan portfolio is worth 100% of what they paid for it even if the collateral backing the loans, for example houses or shopping malls, is now worth far less than 100%. People call this the “extend and pretend” model. It is not a real solution, but it temporarily covers up the problem.
2) They buy toxic assets from the banks at full value and transfer the toxicity to the government. For example, the US Federal Reserve purchased $1.2 trillion worth of mortgage backed securities to take the losses away from the banks and to put taxpayers on the hook for the loss. People call this the “privatization of profits and the socialization of losses” model.
3) They lend them scads of short term cash to keep them afloat. Most banks in Spain would now be closed without the accounting lies from point 1 above and from hundreds of billions of euros worth of short term loans of newly-printed money from the ECB, the European Central Bank.

And in Greece and Spain, for example, some depositors are wising up. Billions of euros of deposits are being drained from Greek and Spanish banks each month, making bank solvency an even more distant hope with each passing month.

Lie #6: Your money is in your brokerage account.

Most people used to think–many still do–that brokerage accounts were safe from the fractional reserve threat to bank accounts, that is, they believed that brokerages did not lend out their money the way banks do, that their deposits to brokerage accounts just sat there waiting for deployment or withdrawal. Ha! Now that we are all wising up, how could we have thought that Wall Streeters could keep their grubby hands off that large pool of money. What the brokerages do is called the hypothecation of these assets, that is, they loan them out for a profit. And the entity, and I use that word intentionally, to whom they loan these assets often re-hypothecates them, that is, they loan those assets to yet another entity. It turns out that the City of London, an entity that operates quite independently of UK law in several respects, is the world playground of re-hypothecation, where the same asset can be re-lent several times. Have you wondered why it’s been so difficult for regulators to determine where the client money is in the recent failure of Jon Corzine’s MF Global brokerage? Look no further than the world of re-hypothecation, in which it can be difficult for anyone to know “where the money is” at any point in time.

So this is another part of the system where everything works well until it doesn’t. If people, intelligently I might add, start withdrawing significant amounts of money from the brokerage industry, they will find that it is yet another fractional reserve environment. So, is your money in your brokerage account really there? Maybe. Remember all that fine print they sent you when you opened your account that you didn’t read? Maybe that part about your account being a “Sweep Account”? Are the Wall Streeters sweeping your money for their profit?

Lie #7: It is OK for financial institutions to use huge leverage.

The Powers That Be/Were who run the financial regime think it is OK for central banks, commercial and investment banks, brokerages, and hedge funds to operate using massive leverage, in other words, massive borrowed funding. The system allows the likes of the Goldman Sachs, Bank of America, and Deutsche Bank to borrow tremendous amounts of money. In normal times, these big banks are considered reliable borrowers; when times are difficult, they are presumed to be backstopped by their governments.

The huge banks routinely operate at 20 to1 to 50 to 1 leverage. 50:1 leverage means that, for every $2 of reliable capital they have, they can operate in the marketplace as if they have $100. So a 2.5% loss wipes them out, makes them insolvent. In world markets operating at ever-increasing speeds, how can any participant always avoid a 2% loss? They can’t. Thus the financial system goes from crisis to crisis. As long as such large-scale leverage persists, the next bubble, and therefore the next crisis, will never be far off. Big leverage was at the base of every major crisis of the modern financial era: the Crash of 1987, the LTCM debacle of 1998, the tech stock crash of 2000, and the real estate bubble.

So why is this allowed to persist? Because these influential institutions can make a lot of money using leverage when times are good. Money they can use to influence the political and regulatory process. And when times are bad? Their losses are taken over by the taxpayers. Heads they win; tails we lose.

And consider what happened, and continues to happen, in the real estate market, when a buyer only has to come up with a 2% down payment. That means they are operating at a leverage ratio of 50:1. This has worked out very poorly for buyers and lenders. Yet in the USA, the government agency known as the FHA still guarantees hundreds of billions of dollars worth of real estate loans each year where the buyer only needs to come up with 3.5% as a down payment.

Lie #8: The government guarantees it.

Governments love to guarantee things. It makes people feel good, thus helping to secure votes, and typically it costs nothing up front. It’s a politician’s dream. So governments guarantee all kinds of things: bank deposits, mortgages, private pensions, student loans, loans to build what no sane person would build such as nuclear power plants, the bonds for infrastructure projects, loans made by a zillion government agencies, zombie banks (ones that would be promptly out of business if they weren’t being propped up by the government), companies considered too important to be allowed to fail, export-import loans, mortgage-backed securities…the list is long. And we have seen it expand promptly when an emergency hits.

But now people are questioning these guarantees. Iceland actually allowed citizens to vote on some of their government guarantees when the payments actually came due…and the people promptly threw those guarantees out. Guarantees in Ireland are on very thin ice. Very few trust government guarantees in Greece. Portugal, Spain, and Italy are likely next on the docket. In the past, very few people calculated these guarantees as part of government debt because they assumed that a guarantee was sufficient, that because of the guarantee, no money would ever have to actually be paid out. Now some of these guarantees are taking a big bite from government budgets. In the US, billions are being paid quarterly from government coffers into mortgage monsters Fannie Mae and Freddie Mac to cover losses on guaranteed mortgages.

Note that the public questioning of guarantees is mostly now happening in Europe because the individual countries in question do not have the authority to print new Euros. But the fact is that finances in Japan, the US, and the UK are worse than those in some European countries, but because these countries can print money at will, which they are also doing in volume, people still “trust” their guarantees. It is worth considering whether such trust is well-placed when printing trillions is required to keep the guarantees intact. People and markets will ultimately decide that it is not. It is best to stay ahead of this curve and to understand whether your bank, your pension fund, or any institution on which you rely is on a sustainable path. If it is not, make other plans as well as you can. And take action soon.

Let’s take a break! In tomorrow’s Part 2, we will cover these lies:

Lie #9: Government bonds are safe.

Lie #10: Derivatives reduce risk in the system

Lie #11: Central banks protect the interests of their country and its citizens

Lie #12: Your paper/electronic currency is a reliable store of value.

Many thanks.
Thundering Heard