Is Draghi's Bond-Buying Dream Circling The Drain As ECB/Bundesbank Lawyer Up?


Following closely on the heels of our recent (now must read) discussion of the potential illegality of Draghi’s OMT, Reuters is reporting the somewhat stunning news that the ECB and Bundesbank are getting lawyers to check the legality of the new bond-buying program. Germany’s Bild newspaper – via the now ubiquitous unnamed sources – said in-house lawyers were checking both what proportions the program would have to take on and how long it would have to last for it to breach EU treaties (that specifically ban direct financing of state deficits).

While Draghi – full of bravado – likely said whatever he felt was necessary at the time to stop the inversion in the Spanish yield curve, it is becoming clearer that, as usual, the premature euphoria (in the complacent belief that central banks can solve every problem with a wave of the magic CTRL-P wand) was misplaced.

Bild goes on to note that this matter could be referred to the European Court of Justice – and the ECB/Buba were preparing for such an event. Of course, since every other rumor in recent months, most of which have originated in credible media, has proven to be a lie, it is likely this is also merely leaked disinformation to push the German case, i.e. anti-Europe.

 

Via Reuters:

 

BERLIN, Sept 25 (Reuters) – The European  Central Bank and Germany’s Bundesbank central bank are getting lawyers  to check the legality of the ECB’s new bond-buying programme, a German  newspaper said on Tuesday.

 

German tabloid Bild, which did not name  its sources, said ECB and Bundesbank in-house lawyers were checking  both what proportions the programme would have to take on and how long  it would have to last for it to breach EU treaties.

 

The newspaper  said this meant there was a possibility that the issue could soon be  referred to the European Court of Justice and added that the ECB and  Bundesbank wanted to legally “arm” themselves for this scenario.

 

Bild  said the background to this was controversy over the issue of whether  the ECB bond-buying programme violates the ban in EU treaties of direct  financing of state deficits. The ECB and the Bundesbank were not immediately available for comment.

 

ECB  President Mario Draghi announced earlier this month that the central  bank stood ready to buy unlimited amounts of bonds issued by euro zone  member states, provided they put in a formal request for aid and  fulfilled strict domestic policy conditions.

 

Jens Weidmann, head of the Bundesbank, was the sole dissenting voice in the ECB’s decision.The  plan is designed to lower the borrowing costs of euro zone states such  as Spain and Italy by buying their bonds, but it has stirred anxiety in  Germany where some people fear the ECB is venturing beyond its mandate  and potentially exposing taxpayers to billions of euros in risky debt.Draghi has said the plan is strictly within the ECB’s mandate.

Now Taiwan Is Also Claiming The Senkaku Islands: 70 Fishing Boats Set Sail To Stake Claim


If you thought it was complicated when “only” China and Japan were disputing the recent escalation in property rights over who owns those three particular rock in the East China Sea, to be henceforth called the Senkaku Islands for simplicity’s sake because things are about to get far more confusing, here comes Taiwan, aka the Republic of China, not to be confused with the People’s Republic of China for the simple reason that the latter officially asserts itself to be the sole legal representation of China and actively claims Taiwan to be under its sovereignty, denying the status and existence of ROC as a sovereign state (yet one which benefits from US backing), to also stake its claim over the disputed Senkaku Islands. It has done so in a very confusing manner: by replicating what it thinks China did some days ago when an “armada” of 1000 fishing boats set sail in an unknown direction and which the trigger happy media immediately assumed was in direction Senkaku. It subsequently turned out that this was not the case and as we reported, “China’s fishing season stops every year in June-September in the East China Sea, where the islands are located. This year, the ban was lifted on Sunday.” In short the (PR)China fishing boat amrada was not headed toward the Senkakus. Taiwan however did not get the memo, and as NKH reports, “several dozen Taiwanese fishing boats have set sail for the disputed Senkaku islands in the East China Sea, to claim access to their fishing grounds.

So to summarize: a country which (PR)China claims does not exist and is under its own sovereign control, has replicated what it thought was (PR)China’s strategic move to reclaim the Senkaku Islands (which was nothing of the sort), and is sending its own fishing boat armada to reclaim islands whose ownership has sent Japan and (PR)China on the verge of more than mere diplomatic warfare. The only thing that could make this any more confusing is if someone discovered title deeds ceding ownership of the Senkakus to Japan, the People’s Republic of China and the Republic of China at the same time, and signed by Linda Green.

From NHK:

More than 70 boats from a fishing cooperative in northeastern Taiwan set out Monday afternoon, hoisting banners claiming that the islands belong to Taiwan, and that Taiwan’s sovereignty and fishing rights must be protected.

 

The cooperative is protesting Japan’s purchase of 3 of the islands in the Senkaku chain from a private owner earlier this month. The cooperative says the waters surrounding the islands have long been a major Taiwanese fishing ground.

 

The cooperative says the boats will be joined by vessels from other cooperatives along the way to the islands.

 

The fleet plans to arrive at a point about 40 kilometers southwest of the islands by early Tuesday morning.

 

The boats are to circle near the islands after forming into groups of 5, with the aim of entering Japanese territorial waters.

 

More than 10 Taiwanese Coast Guard vessels will be on hand to monitor the fishing fleet’s activities.

So who’s next in order of territorial claims – Argentina?

In short- utter confusion which can only mean one thing – sit beck and enjoy. It’s popcorn time.

Get Your Fake Tungsten-Filled Gold Coins Here


In the aftermath of the recent stories about Tungsten-filled 10 ounce gold bars discovered in midtown Manhattan, there have been two broad sentiments expressed by the precious metals community: i) that this is as many have expected, and that of the physical inventory in circulation, much is fake (particularly that held in official hands, either via ETFs or in sovereign repositories which for various reasons still can not be publicly assayed) and ii) is the comfort that while it is relatively easy and cost-effective to use tungsten to falsify larger gold bars and bricks, those who own primarily gold coins are safe as for some reason, it is less economic, feasible or widespread to counterfeit smaller precious metal denominations. Sadly, while i) may be true, ii) is patently false. The proof comes courtesy of a firm called ChinaTungsten Online which proudly markets its broad “tungsten-alloy services” including, you guessed it, the gold plating of various tungsten formulations among them “gold” bricks, bars and, yes, coins. Oh did we mention a Chinese company openly advertizes its tungsten gold-plating and precious metals replication services, something which the tabloid media’s CTRL-C/V majors openly mock as improbable conspiracy theory. Well, as they say, it is only conspiracy theory until it becomes conspiracy fact.

From the website’s Tungsten Heavy Alloy Scan Gold Coin section:

Tungsten is the only lower value metal that has a specific density close enough to gold to fabricate passable counterfeit pieces of the same size and weight as genuine Pictures of tungsten fake gold coins and ingots. Over the years, there have been a few isolated reports of smaller tungsten fake gold coin found to have been drilled to remove some of the gold which was replaced with tungsten. However, tungsten fake gold coin is far more profitable to fabricate larger original bars of tungsten that are then scanning gold.

 

Because the existence of counterfeit tungsten fake gold coin could have such a huge impact on the financial markets, there is a huge potential for deception and misinformation to be passed around. Be very careful about automatically believing any story you may hear. For your own protection, tungsten fake gold coin would be better to take physical possession of the smaller sizes of tungsten fake gold coins and now, and know that what you own genuine solid tungsten fake gold coin. [ZH: reread that sentence: “genuine solid tungsten fake gold coin”]

 

Notice: Chinatungsten Online (Xiamen) Manu.& Sales Corp. is a very professional and serious company, specializing in manufacturing and selling tungsten fake gold coin and other tungsten related products for more than two decades. We are a professional tungsten fake gold coin manufacturer. Our tungsten gold fake coin is only for souvenir and decoration purpose. Here we declare: Please do not use our tungsten fake gold coin and other fake gold coin products for any illegal purpose. We can provide all kinds of tungsten fake gold coin as your requirements.Our tungsten fake gold coin products are qualified.

 

Pictures of Tungsten Fake Gold Coins:

Therefore, if you are interest in tungsten fake gold coin, please feel free to contact sales@chinatungsten.com, or telephone 86 592 512 9696.

Well at least the company that markets itself as proving “all kinds of tungsten fake gold coin” has extensive disclaimers. The point is that anyone wishing to, can procure tungsten-plated gold coins with one simple telephone call.

Of course, for those for whom gold coins are not enough, the Chinese firm is happy to provide every other imaginable formulation. Such as Tungsten fake gold bars:

Detecting a high-quality tungsten fake gold bar would be extremely difficult. It would likely require significant and material alterations to the bar being tested and this would negatively affect the marketability if its hallmark veracity were vindicated. Some applications require the tungsten to be fake gold. The main reasons for tungsten fake gold bar are to protect the wire from corrosion or to solder it to other metals.

 

Besides, tungsten alloy products could also made as tungsten fake gold bar which posses a better electric conductivity, and contribute greatly to the world industry development. Also tungsten fake gold saves the energy and poses no pollution threat to the environment and thus to achieve a sustainable development.

 

Notice: Chinatungsten Online (Xiamen) Manu.&Sales Corp. is a very professional and serious company, specializing in manufacturing and selling tungsten fake gold and other tungsten related products for more than two decades. Our tungsten fake gold product is only for souvenir and decoration purpose. Here we declare: Please do not use our gold-plated tungsten alloy products for any illegal purpose.

 

Pictures of Tungsten Fake Gold Products

There are many more options, for those who are so inclined, to reinforce their inventory of gold-plated tungsten products on the company’s website. And naturally, in addition to the bolded applications of tungsten gold bars, one can conceive of some more. Especially in verticals in which the actual end product does not exist, and all that does exist is a receipt claiming gold is at the end of a rehypotehcation chain. One wonder how many invoices CIF Liberty 33 or various other gold ETF secret “warehouses” one could find upon rummaging through the garbage behind the firm’s headquarters in Xiamen.

With all that said, perhaps the best use of the abovementioned services would be for a contingency case in which the government of country X, Y and/or Z were to decide to replicate a certain 1930’s executive order in a global coordinated attempt to devalue the fiat system not on a relative basis, something which fiat printers are more than capable of, but on an absolute basis by confiscating all the gold in circulation. It just might make such a confiscation more complicated if all the usual suspects were to hand over to said governments not gold but gold-plated Tungsten, which in turn would make the endgame, i.e. the terminal currency devaluation of fiat, that much more problematic.

It would be truly ironic if in the end the same Tungsten that is now the bane of precious metals dealers everywhere would be the reason why central bank X, Y and/or Z was unable to destroy its currency sufficient fast.

Note: Zero Hedge does not advise, encourage nor endorse its readers to hypothetically exchange their gold inventory for a comparable but worthless yet prominently positioned inventory of “rehypothecated” pseudo-equivalent products – note that only bankers have been known to rehypothecate valuable assets into worthless liabilities – in advance of an even more hypothetical physical gold confiscation order endorsed by the authorities.

h/t SilverDoctors

Japanese Ministry of Finance To Japanese Bondholders: You’re Screwed!


Wolf Richter  www.testosteronepit.com

This has got to be the icing on the Japanese cake. The otherwise bland website of the Japanese Ministry of Finance, more specifically the FAQ page on government bonds, has been catapulted to stardom on Facebook and Twitter. Not in a good way. As you flip through the MoF’s website, page after page, you will mostly see zero Facebook likes and zero tweets. Social media and the MoF ignore each other.

But go to the FAQ page, skip down past the categories of Budget, Taxation, and Tariffs to item 4, Government bonds. Under the second group, skip past Tax questions for individuals, Miscellaneous (Is it a crime if I make a copy?), Price and yield questions, and Coupons to the infamous question 5: “In case Japan becomes insolvent, what will happen to government bonds?

Tweeted 1,645 times, liked on Facebook 3,733 times!

The MoF website isn’t some blog to be ignored (at your own risk) but the official voice of the most important ministry of the most indebted country in the world, whose debt will reach 240% of GDP by the end of this fiscal year. The country borrows over 50% of every yen it spends, and it spends more every year. With no solution in sight. Other than more borrowing. Certainly not cutting the budget, which would be too painful. It wouldn’t be enough anyway. Even cutting the budget in half would leave a deficit. And the recently passed consumption tax increase? It will raise the tax from its current 5% to 8% in 2014 and to 10% in 2015, way too little to deal with the gigantic problem, and years too late. Yet it won’t kick in unless GDP grows at least 2% per year—which has practically no chance of happening.

No, there is no longer a good solution. And everyone knows it.

About 95% of Japan’s debt is held within Japan by government-owned institutions, the Bank of Japan, banks, companies, pension funds, and directly or indirectly by individuals. Hence the question—”In case Japan becomes insolvent, what will happen to government bonds?”—is of primordial importance to just about all Japanese adults.

The question and its answer weren’t decided by some underling. Each word was carefully weighed by experts in the highly hierarchical bureaucracy of the MoF. As these words were polished and examined for every nuance, they were passed up the ladder until they landed on the desk of an official at the very top who approved not only the wording, but also whether or not that question should even be on the website. And the official answer is:

 “Rest assured that the Japanese government will redeem the bonds responsibly.” 

Here is a screen shot of the question and answer:

“Rest assured!” How bondholders can possibly rest assured under these circumstances remains a mystery, in particular since the MoF then proceeds to tell them exactly how they will get kicked in the groin: bonds will be redeemed “responsibly.”

Not when they mature, but responsibly.

Thus, we have the MoF’s official action plan for the moment when the big S hits the fan, the moment when Japan with its declining wages and shrinking working-age population can no longer save enough to mop up all the government bonds necessary to keep the government afloat [read…. Japan’s Slow-Motion Tsunami].

A selective default. Bonds will retain their “value,” but the government won’t redeem them when they mature. It will redeem them in bits and pieces, stretched into all eternity, as it sees fit. You’ll die before you’ll see your money.

This is THE answer, the official answer we’ve been looking for all along, and now we find it on the MoF website where it would have remained hidden in plain sight had not some enraged Japanese spread the word via Twitter and Facebook.

And they filled the ether with caustic FB comments:

  • “LOL!”
  • “Isn’t it called ‘insolvent’ because you can’t pay?”
  • “This is absolutely nothing but mocking the general public. How dare they say such gibberish!?”
  • “Should be a joke.”
  • “Isn’t it supposed to go, ‘Rest assured that the Japanese people will redeem the bonds responsibly?’“
  • “Yeah, the only thing they could rely on is the people’s savings….”

When the legendary savings of the Japanese are drying up, as they’re in the process of doing, the word responsibly will take on a new meaning within the context of one of the greatest recent acts of governmental irresponsibility: creating that debt monster in the first place.

John Mauldin of Mauldin Economics sees similar issues in the EU and the US. The EU, he says, is only left with choices that are now between very bad and disastrous. In the US, he says, Republicans and Democrats will have to hold hands and walk off the cliff together. And he throws in an intriguing tax plan. Read the excellent interview…. John Mauldin's Prescription for Avoiding Economic Catastrophe.

And here is my first foray into Japan—a “funny as hell nonfiction book about wanderlust and traveling abroad,” a reader tweeted. Read the first few chapters for free…. BIG LIKE: CASCADE INTO AN ODYSSEY, at Amazon.

The Fed Has Another $3.9 Trillion In QE To Go (At Least)


Some wonder why we have been so convinced that no matter what happens, that the Fed will have no choice but to continue pushing the monetary easing pedal to the metal. It is actually no secret: we explained the logic for the first time back in March of this year with “Here Is Why The Fed Will Have To Do At Least Another $3.6 Trillion In Quantitative Easing.” The logic, in a nutshell, is simple: everyone who looks at modern monetary practice (as opposed to theory) through the prism of a 1980s textbook is woefully unprepared for the modern capital markets reality for one simple reason: shadow banking; and when accounting for the ongoing melt of shadow banking credit intermediates, which continues to accelerate, the Fed has a Herculean task ahead of it in restoring consolidated credit growth.

Shadow banking, as we have explained many times most recently here, is merely an unregulated, inflationary-buffer (as it has no matched deposits) which provides the conventional banking credit transformations such as maturity, credit and liquidity, in the process generating term liabilities. In yet other words, shadow banking creates credit money which can then flow into monetary conduits such as economic “growth” or capital markets, however without creating the threat of inflation – if anything shadow banks are the biggest systemic deflationary threat, as due to the relatively short-term nature of their duration exposure, they tend to lock up at the first sing of trouble (see Money Markets breaking the buck within hours of the Lehman failure) and lead to utter economic mayhem unless preempted. Well, preempting the collapse in the shadow banking system is precisely what the Fed’s primary role has so far been, even more so than pushing the S&P to new all time highs. The problem, however, as we will show today, is that even with the Fed’s balance sheet at $2.8 trillion and set to rise to $5 trillion in 2 years, it will not be enough.

Before we begin, we urge readers new to this topic to read some of the more pertinent posts we have written on the issue of shadow banking, as it is not a simple subject. Some of the more relevant ones:

For those who are somewhat familiar with the topic, but not quite, we believe a useful visualization of how traditional bank liabilities (defined simplistically and easily recreated using the Flow of Funds report using total liabilities at U.S.-Chartered Depository Institutions, L.110, plus total liabilities of Foreign Banking Offices in the US, L.111, plus Total Liabilities of Banks in US Affiliates Areas, L.112) which serve as the backbone of the entire US fractional reserve banking system, compare to US GDP is in order.

More than anything the chart above, which shows the amounts of traditional bank liabilities and GDP on the same Y axis, confirms one simple thing: economic “growth” is only and nothing more than an increase in systemic credit, aka money creation (just as Ray Dalio observed a few days ago). The problem with traditional bank liabilities is that for the most part they have corresponding money aggregates in the form of M2, which in turn is primarily fungible deposits, as an opportunity cost. And, as Germans living in the 1920s recall all too well, putting meaningless theory aside, deposits, when escaping the fractional reserve system and used to pursue hard assets, are the primary driver of such unpleasant monetary events as hyperinflation.

The nuisance that are “deposits” is also why the banking system is desperate to prevent bank runs, which are not so much a threat to systemic liquidity: any central bank can and will step in and guarantee all the banks’ viability overnight if it has to, as it did at the peak of the financial crisis, but an asset allocation decision to shift out of an asset equivalency system built upon faith, and into a mode of hard asset ownership, based on lack of faith in the system (it also explains why the Fed hates when you use your cash to buy “worthless” and cash-flow free hard assets as gold, silver, copper, crude, etc). Of course, what happens with asset prices should $9 trillion in deposits suddenly exit bank vaults and seek to purchase “stuff” would make even the Hungarian hyperinflationary episode, in which prices doubled every several hours, seem like a walk in the park.

So how to fix this? How to ensure economic growth without the threat of inflation at any corner should a central planner make a false move leading to an uncontrollable bank run and deposit outflow? Simple: create a representation of money without the actual money, i.e., M2 equivalents, whether currency in circulation, or even electronic deposits.

Enter the shadow banking system, which is simply the traditional banking system however without the deposits and without the threat of monetary redemptions from the banking system (and the threat of a collapse of fractional reserve banking): it is quite simply, the essence of bank transformation funded by “faith”, or a system in which credit money is created, but without an offsetting money equivalent unit. It is a system in which assets and liabilities are essentially the same concept, interwoven in a daisy chain of rehypothecated ownership claims, and in which every incremental layer of credit money creation serves to ultimately boost the nominal quantity of credit money in circulation.

What this does is it allows for near infinite credit-money expansion within a financial system, without a threat of inflation. It does, however, not prevent the threat of a deflationary collapse should faith in this same system be shaken, and counterparties demand to be made whole on their exposure, which incidentally peaked at  $21 trillion in 2008.

But by far the biggest threat with shadow banking, which perceptive readers have already grasped is nothing but the greatest ponzi scheme ever conceived, is that it works brilliantly in an environment of increasing leverage, but should deleveraging commence, is an asset price black hole, as the entire Schrodinger Asset/Liability Function collapses in on itself upon the realization that there are no real asset at the end of a rehypothecation chain. In other words, the moment a liability is accelerated, due to maturity, request for deliverable or any other inverse “faith” transformations, the jig is up.

As the second chart below shows, one of the primary reasons for the surge in US capital markets beginning in 1980 is not so much the “great moderation”, which was certainly a necessary but not sufficient condition for Dow 36,000, as much as that starting in roughly June of 1982, when shadow liabilities crossed the $1 trillion line for the first time and never looked back, the US shadow banking system became a more and more prevalent form of credit money creation, until it overtook traditional liabilities in 1995 in terms of total notional. While traditional liabilities have historically matched GDP dollar for dollar, when one throws shadow liabilities into the mix, one can see a distinctively different picture: the one below.

But where did all those extra trillions in credit money created via Shadow intermediation end up if not in the economic growth of the US? Why in its capital markets of course! This, ironically, makes sense from a symmetrical point of view. Recall that shadow liabilities, by their nature, are not inflationary as they do not have matched monetary aggregates: the US Stock market is also, at least according to the US government and the economic canon, is ot viewed as being part of any inflationary measurement, even though all it really is deferred purchasing power: for example, if everyone is long AAPL and if everyone manages to cash out at the very top, when the market cap of AAPL is $1 quadrillion (for illustrative purposes), all that cash would then exit the capital market and compete with other former AAPL shareholders for physical goods and services. It is in this sense that the S&P merely is a conduit to the latent inflationary build up that infinite credit money creation can lead to. Implicitly, and as a rational benchmark, this boils down to creating infinite purchasing power based on “faith” in a world of very finite goods and services. Not to get cute about it, but when an infinite purchasing power meets an immovable and very finite universe of goods and services, what one gets is hyperinflation. But that is irrelevant in the topic at hand: we will write more on that in a different post.

As noted above, it all worked great for nearly 30 years… and then Lehman brothers hit. What happened next can only be classified as an epic collapse in shadow banking as all the faith in the system had been extinguished and counterparties, unsure if anyone would be standing tomorrow, demanded an acceleration on their credit, liquidity and maturity transformed liabilities, irrespective of what state or what penalty such acceleration would entail. And this is where the Fed comes in.

The chart below shows the total amount of shadow liabilities broken up by constituent parts since the 1960s. What is obvious is the exponential surge in notional, hitting a peak of just shy of $21 trillion in Q1 of 2008, and then going straight down.

More important, however, is the sequential change in liabilities within this “shadow” system: having grown every quarter for decades until June 2008, things changed rapidly with the end of Lehman brothers, and much to the chagrin of the Fed, have not improved 4 years later. In fact, as the chart shows, the peak draw down in one quarter was a stunning $1.5 trillion in credit money deleveraging in one quarter! This is an amount that all else equal, would have caused an epic collapse in either US GDP or the stock market, as trillions in credit money were taken out of the system. Remember: credit money is fungible, and ‘fractionally reserved.‘ All said, there has been over $6 trillion in deleveraging within shadow banking since the Lehman collapse.

Which brings us to the point of this post.

In Q2, as per the just released Flow of Funds report, the deleveraging continued. In fact, between money market funds, GSEs, Agency Mortgage Pools, Asset Backed Security Issuers, Funding Corporations, Repos, and Open Market Paper, also collectively known as “shadow banking liabilities”, in the second quarter the US saw another $141 billion in deleveraging take place, following the $164 billion in Q1, or a total of over $300 billion year to date.

This took the total amount in shadow liabilities to $14.9 trillion for the first time since 2005. It also means that as of right now, the shadow banking system, which continues to deleverage, and the traditional banking system’s liabilities, which continue to grow primarily due to reserve creation by the Fed during periods of unsterilized QE (such as right now courtesy of QEternity), and which amounted to a record $14.9 trillion as well, have reached parity.

This is a historic inversion point for three main reasons:

  1. As the shadow banking system delevers, the Fed has no choice but to relever traditional bank liabilities, via reserve injection to keep the system at least at equilibrium, if not leveraging at the consolidated level. In both Q1 and Q2 the Fed failed to generate the all critical credit releveraging, as first $110 billion in Q1, and then $58 billion in Q2 credit money exited the closed system via maturities without being rolled over, redemptions, conversion into hard assets, etc.
  2. Paradoxically, it is precisely due to its action, with which the Fed continues to remove faith in the US financial system as a standalone entity and one that can function effectively without a central bank backstop at every corner, that the ongoing deleveraging within the all critical shadow banking system – the one monetary conduit which as noted above is the closest thing to a inflation-free lunch due to the lack of immediate inflationary threats – continues. As noted above, so far in 2012 there has been $300 billion in deleveraging here alone.
  3. Completing the Catch 22 loop, the Fed, which is cornered, will continue to do what it does, reflating traditional liabilities, creating reserves, deposits, and currency, all of which have an exponentially greater inflationary propensity that the circular liabilities continued within shadow banking, and which eventually will breach the dam door of inflationary expectations leading to an epic surge in priced in and/or concurrent inflation.

Visually, this can be presented as follows:

The chart above shows what the consolidated deleveraging – combining shadow and traditional banks – since the Lehman collapse. All told there is still a $3.9 trillion hole that need to be plugged for the ‘market’ to simply return back to its 2008 peak credit levels. But what is truly a slap in the face of the Fed, and what confirms that the more the Fed “acts” the more it shoots itself in the foot, is that the last time we did this analysis, the hole was “only” $3.6 trillion. In 6 short months, the Fed’s relentless intervention in markets, managed to force the deleveraging of over quarter of a trillion in additional credit money!

It also explains why the Fed knew long ago, that it would have to engage in a relereving program that offset at least the continuing deleveraring in shadow aggregates: first $40 and then $85 billion a month sounds about right, and is an amount that will at best keep the system at its current state as opposed to actually growing it.

And while one does not have to be a rocket scientist to have grasped by now that all the Fed does is self-defeating, what the above analysis does do is provide a primer to all those Economy PhD’s who still fail to grasp how the modern economy works, specifically why so far the inflationary surge has been deferred.

In short: the more the Fed actively relevers using conventional conduits that spur the threat of inflation, and the more that shadow conduits delever, the greater the risk that inflation will finally come to roost. Because that $3.9 trillion in incremental reserves (and recall that already both BofA and Goldman, following our example, determined that the Fed will need to do at least another $2 trillion in QE, which means much more in reality) that will be created to offset the ongoing shadow deleveraging will simply pump up various asset classes, until the hard asset spillover finally hits, and no matter how much SPR jawboning, no matter how many CME margin hikes, no matter how many Saudi rumors of increase crude production, prices of hard assets will finally explode.

We can at this point say that an inflationary surge is an absolute certainty if not for one thing: if somehow the deleveraging in the shadow banking system is finally offset (and with the GSEs now in runoff mode this is a virtual impossibility), and Bernanke can take his foot off the gas, then there may still be a chance. However, as noted, 4 years in, this has not happened, and it will not happen for one simple reason: at its core, the market, which despite all of Bernanke’s attempt to the contrary, realizes that a centrally planned system is ultimately unsustainable, and quietly, behind the scenes, those who have shadow credit relationships are promptly unwinding them while they still can, and using the proceeds to invest into hard asset for the inevitable T+1 moment.

The bottom line paradox here is that the more forcefully the Fed intervenes, the greater the implicit loss of confidence in the system, the greater the shadow deleveraging, and the more definitive is the ultimate destruction of the capital markets as we know them. Of course, there is still a chance that Bernanke will step back and realize what he is doing. However, since all Bernanke is, is a pawn of those whose wealth is conserved in the US equity tranche, it means that it is now, and has been for the past 4 years, impossible for him to stop.

And in not stopping, Bernanke has sowed the seeds of not only his, but everyone else’s destruction.

* * *

Finally, and confirming the above observations have some basis in actual reality, is the following chart from Citi’s Matt King, who implicitly summarizes everything said above as follows: “Much credit growth was based on collateralized lending.” Well, the collateral has now run out.

And the “wrong horse” is precisely what all those who come up with convenient, three letter goal-seeking theories to justify an ideological bent, are focusing on. If instead of reading 1980s textbooks, all those “modern market” thinkers were to grasp just what it is that drives the market, we might still have a chance. 

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