As I have chronicled the global financial meltdown, I have been amazed at the number of economists, traders, and politicians that seem to be in complete denial of the facts of the current crisis and at each step either they have reacted in exactly the opposite manner required to respond to the crisis, or they have failed to act at all for self-centered political reasons. Some examples include banks sitting on huge cash reserves instead of stimulating the economy, the US CONgress adding $1.3 trillion in new debt with tax cuts, central banks everywhere printing money willy-nilly without regard to the consequences. But most of all, we, as citizens and the main participants in the economy merrily skipping down the road without a care in the world. That is until you are homeless and hungry, then the feelings are anger and despair.
Then the other day, I had a conversation with an old friend who was a forensic psychologist for one of the US Government alphabet agencies. He is retired now, but his job was a “profiler”. He would investigate crimes and other “stuff” to help the agents understand the make-up of the criminal or spy and maybe predict “next” moves. When I lamented about those around me who I love and respect being in complete denial as to the grave nature of the current economic situation, he explained that this is a very natural response to extreme crisis and distress. It is called Normalcy Bias.
In short, when humans are faced with natural disasters or a man-made crisis that overwhelms them, they simply slip into complete denial. Logic and intelligence functions stop. He pointed out some startling examples. Consider this. In Germany in 1937 there were nearly 550,000 Jews. Long established the Jewish German community was rift with businessmen, intelligentsia, professional people who were just beginning to enjoy a good life again after recovering from World War One.
As Hitler rose to power with his hate mongering and obsession with the Jewish community, it became very apparent that the Jewish community was facing more and more injustices. Property seizures, business taxed at 100%, lose of civil rights, street beatings by the Brown Shirts, still they did not understand the danger they were in and believed being rational and calm would weather them through the storm. Only about 100,000 Jews fled in time. We know the tragic end to that story.
However, things are heating up on the currency warfront. This week saw many assaults on the US Dollar. Let me stop here and talk some basics. Currently the US policy and the FED policy simply has been to print more money. The US enjoys a unique position when it comes to currency because the US dollar is the world’s transactional currency. For example, if Germany wishes to buy oil, it must first convert Euros to Dollars to purchase the oil.
However, keeping the dollar as the global transactional currency only lasts as long in the faith of the value of the dollar remains in the rest of the world. The US actions of the last week, both at the FED and CONgress have gone a long way to weaken that faith. What is happening is both countries and companies are choosing to use other methods to transact business.
So we are beginning to see news items like this. In spite of its infancy, interest in the offshore renminbi market is growing quickly. Caterpillar, the US-based maker of earth-moving equipment, launched a Rmb1bn ($150m) bond issue last month, making it the second multinational to tap the market, following an August issue by McDonald’s, the fast-food chain.
What makes these bond issues important is that the offshore renminbi market is much more than just a new avenue for debt financing – it is one of the core components in a plan to internationalize the Chinese currency. The process will be a slow one, with more baby steps than giant leaps, and it is by no means assured that the renminbi – also known as the yuan – will forge a decisive international role. But it is one that could have a huge long-term impact on trade, the global financial system and even international politics.
If the plan works, the renminbi could become the main currency for doing business in Asia, the world’s most economically dynamic region, and in the long run it could become a significant part of the reserves of the world’s central banks. Indeed, some Chinese officials have already called for the renminbi to be included in the International Monetary Fund’s basket The timing is also full of portents. The renminbi is starting to go global just as the future of the euro and the dollar is looking increasingly uncertain. Eventually the shift could have an impact on the ability of the US to borrow overseas in its own currency. In China, some have taken to calling their currency the hongbi, or “redback”, to rival America’s greenback – a moniker that gives a flavour of the geopolitical undercurrents.
“We may be on the verge of a financial revolution of truly epic proportions,” says Qu Hongbin, China economist at HSBC, one of the banks pushing the renminbi to its corporate clients. “The world economy is, slowly but surely, moving from greenbacks to redbacks.”of main currencies.
So even though the Fed has flooded the credit markets with cash, spreads haven’t budged because banks don’t know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is “the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue.”
Today, the banks have a problem on the asset side of their ledgers — “all these exotic securities that the market does not know how to value.” “Why are they ‘toxic’?” Ms. Schwartz asks. “They’re toxic because you cannot sell them, you don’t know what they’re worth, your balance sheet is not credible and the whole market freezes up. We don’t know whom to lend to because we don’t know who is sound. So if you could get rid of them, that would be an improvement.”
And economics professor and former Secretary of Labor Robert Reich wrote in 2008:
The underlying problem isn’t a liquidity problem. As I’ve noted elsewhere, the problem is that lenders and investors don’t trust they’ll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years — the derivatives, credit default swaps, collateralized debt instruments, and so on — has undermined all notion of true value.
What everyone here is cryptically referring to is the credit derivatives and credit swap facilities which no one knows the value of when conducting a transaction. Indeed only nine major banks control this $1 quadrillion market. No I didn’t make a mistake, I said $1 quadrillion! We were just getting our heads around what a trillion really meant. Here is the fundamental problem with this situation. $1 quadrillion represents about 20 times the Global GDP! This is pure insanity. There is no other way to describe what is going on right now.
Economists focus on the whole notion of incentives. People have an incentive sometimes to behave badly, because they can make more money if they can cheat. If our economic system is going to work then we have to make sure that what they gain when they cheat is offset by a system of penalties.
Wall Street insider and New York Times columnist Andrew Ross Sorkin writes:
“They will pick on minor misdemeanors by individual market participants,” said David Einhorn, the hedge fund manager who was among the Cassandras before the financial crisis. To Mr. Einhorn, the government is “not willing to take on significant misbehavior by sizable” firms. “But since there have been almost no big prosecutions, there’s very little evidence that it has stopped bad actors from behaving badly.”
Indeed, polls show that people no longer trust our economic “leaders”. See this and this. A psychologist wrote an essay published by the Wharton School of Business arguing that restoring trust is the key to recovery, and that trust cannot be restored until wrongdoers are held accountable.
Government regulators know this – or at least pay lip service to it – as well. For example, as the Director of the Securities and Exchange Commission’s enforcement division told Congress:
Recovery from the fallout of the financial crisis requires important efforts on various fronts, and vigorous enforcement is an essential component, as aggressive and even-handed enforcement will meet the public’s fair expectation that those whose violations of the law caused severe loss and hardship will be held accountable. And vigorous law enforcement efforts will help vindicate the principles that are fundamental to the fair and proper functioning of our markets: that no one should have an unjust advantage in our markets; that investors have a right to disclosure that complies with the federal securities laws; and that there is a level playing field for all investors.
If people don’t trust their government to enforce the law, government will become more and more impotent in addressing our economic problems. If government leaders take action, the market will not necessarily respond as expected. When government leaders make optimistic statements about the economy, people will no longer believe them.
Then also on the warfront, China and Russia announced they will trade in their own currencies. In addition, the IMF recently released a report suggesting that given the weakness of the Euro and the Dollar, we should be moving toward a global central bank and a single global currency, which they are calling the Bancor. Several banks no longer are accepting deposits in dollars.
What does this really mean and why should you care about it. I have one word for you, hyperinflation. The world is currently pushing back on US policies and are demanding that either the US deal effectively with the deficit or devalue the dollar. When the pressure gets strong enough, and I believe that could be as soon as the next three months, the US will acquiesce and devalue the dollar by as much as 40%.
This will happen suddenly and overnight! You will wake up to $8 gas, $5 bread, a 4000 point dip in the Dow and events will rapidly cascade from there to riots in the streets of the US just as we have riots now in Ireland, Greece, Italy, France, and Britain. The war is reaching fever pitch. Pay close attention now because bunker time may not be far off.