“Black Tuesday”; Après le deluge
By Mike Whitney
“Ring around the rosy
A pocket full of posies
Ashes, ashes,
We all fall down” Children’s lyric
03/09/07 "ICH" -- -- Hank Paulson is sweating bullets right now.
In fact, a shrewd investor could probably make a fortune just
figuring out what type of high-blood pressure medication he’s on
and then betting the farm on the manufacturer.
Last week the stock market bull plopped down on an I.E.D. and
wound up in intensive-care sucking food from a straw and
drifting in and out of consciousness. That put Paulson on the
road to South Korea, Japan and China where he’ll meet up with
his foreign counterparts to strategize on the deteriorating
state of world markets. It’s a daunting task. The sudden rise in
the yen has set off a brushfire that’s swept through the global
system clearing out the dead-wood and sending panicky fund
managers out onto the streets.
Paulson downplayed worries that the roiling markets were reason
for concern. Before leaving for Japan he confidently proclaimed
that the global economy was “as strong as I’ve seen in a
lifetime. All the economies are growing, inflation is low, and
liquidity is high.”
That may be, but today’s market is built on an ocean of red ink
and any upward movement in the yen is likely to send listing
indexes to Davy Jones locker.
Glub, glub!
This is the most over-extended, over-leveraged, debt-plagued
stock market in the history of the world; a sudden gust from
Tokyo or Beijing and down-it-goes like a straw house in a
wind-tunnel. That’s what happened last week when the yen lurched
upward and Wall Street suddenly plummeted 416 points. That’s why
Paulson quickly tossed his toothbrush and an extra pair of
astronaut diapers in his duffle-bag and scampered off to the Far
East.
For years, savvy investors have borrowed trillions through the
Yen Carry Trade (YCT) at nearly zero percent scarfing up US
government debt (paying 4.25%) or maximizing their leverage in
other riskier funds or derivatives. It’s created a daisy-chain
of debt (similar to fractional banking) which will inevitably be
broken by disruptions in the money supply and a decrease in
liquidity. When interest rates go up; money gets tighter, and
equity bubbles come crashing to earth. That’s what’s happening
right now, although Paulson and his fellow-pranksters at the
Federal Reserve think they can keep the balls in the air a bit
longer.
Chris Laird of prudentsquirrel.com summarizes the state of the
current stock market like this:
“Up to now (even still), speculators could borrow and leverage
to the hilt – the Yen carry trade made that what appeared to be
a relatively riskless endeavor. The amount of leverage in
financial markets is at historic highs, and people did worry
about that. First one investor puts up some capital, then, funds
leverage that among themselves multiplying that leverage several
times. Then multiply in derivatives that have infected every
financial vehicle. I have stated you can consider markets at 50
to 1 leverage at the price margins” chris laird
I’ve been hearing the same shocking news from analysts who’ve
studied this issue for more than a decade, Steven Williams who
sent me this e mail just yesterday:
“Without regulation or oversight of any kind, traders will
always find ways to maximize profits... a path of least
resistance. The yen carry trade (YCT) for a very long time was a
zero risk opportunity. Buy cash at zero interest and use it to
purchase higher paying interest securities, also zero risk, such
as US Treasuries or other country treasuries & notes.
When the cost of money is zero, the leverage is virtually
unlimited. I am surprised if the YCT is only 50:1. When the YCT
was generating substantial profits, those gains were used to
leverage into even more YCT trades, and those gains into more
YCT, and so on, and so on”.
This is a classic pyramid scheme, the only difference being that
Wall Street’s survival depends on ever-increasing infusions of
debt which masquerades as investment.
Williams further reinforces the 50 to 1 ratio (of debt to real
investment) citing a report that he wrote on a major brokerage
(which will remain nameless) He says:
“Several years ago I wrote about the massive notional derivative
position held by (nameless brokerage). At the time they held $32
Trillion and the ratio was 50:1 to their assets. In other words,
if they were to suffer a mere 2% across the board notional loss
to their derivative book, the company as a functional
corporation would cease to exist. I did a follow up article for
Gold-Eagle called "Derivative Dangers". The latest from the US
Comptroller of the Currency report on Bank-held derivatives
shows (the same brokerage house) holding $58 trillion with $1.1
trillion in assets, so the ratio is still 50:1. Long-Term
Capital Management was apparently leveraged 50:1 before it
collapsed.”
This illustrates how brittle the present market really is and
how susceptible it is to the slightest interest rate
fluctuations half-way around the world.
When interest rates go up, (as they must to curtail inflation)
then the hairline fractures in Wall Street’s Crystal Palace
quickly turn into gaping cracks that threaten the whole fragile
edifice. That’s why we expect a global liquidity crisis, because
there’s not enough fiat-currency in the world to fill the black
hole of debt created by the maxed-out hedge funds and
derivatives markets.
(Shaky derivatives are equally hazardous. As Chris Laird notes:
“The Yen carry since has grown to incredible levels. And
leverage in every market has also grown to incredible levels,
and then add on top of that the explosion of the derivatives
business – formerly at only $20 trillion about 1990, that is
now, in my estimation over a $quadrillion in value (1000
trillion).”)
So what does Hank “Houdini” Paulson have up his sleeve? What can
he possibly do to forestall the inevitable collapse? He’s
already been undercut by his former colleagues at Goldman Sachs
who warned that “dead bodies” are likely to surface from last
weeks meltdown. Jim O'Neill, G-Sachs chief global economist
said:
“There has been an amazing amount of leverage on currency
markets that has nothing to do with real economic activity. I
think there are going to be dead bodies around when this is
over…Our concern is that the repricing of risk we are seeing
could spread to the credit markets. This is potentially more
difficult to deal with, and needs watching.”
By “dead bodies” O’Neill means that there may be over-exposed
hedge funds that have already given up the ghost and are being
gingerly tossed on the meat-wagon. Clearly, the market-shakedown
has triggered a massive liquidation that threatens to sweep
through other asset markets.
There’s nothing Paulson can really do. The (market)
pendulum-swings are bound to get broader and more destructive;
generating a series of crises which will put the market in a
downward spiral and bring out the bears. This is unavoidable. If
the Secretary of the Treasury is hoping for a “soft landing”
he’d better think again. After all, we’re talking about
trillions of dollars here, not billions. There’s not much the
Federal Reserve can do either, except pump more money through
the normal channels into the flagging market. (re: The Plunge
Protection Team)
But the Fed is currently trapped between the two millwheels of
dwindling foreign investment and a real estate market which is
slowly grinding into dust. The best they can do is dispatch
their doe-eyed professor, Gentle Ben Bernanke, to Capital Hill
to sooth frayed nerves while the printing presses keep pumping
out crisp 100 dollar bills. It’s a pretty grim performance.
It’s all up to G-Sachs’ wunderkind, Hank Paulson. He’s our man
at the tiller our last best hope. The future of the faltering
American economy now rests on his bony shoulders. He’ll need to
rebuild investor confidence in Wall Street while placating the
jittery public. He’ll have to sweet-talk China into loosening up
its currency while coordinating with foreign Central banks to
shore up the markets. And, he’ll have to anticipate the next
unforeseen disaster that could expose the over-leveraged stock
market and bring it down in a heap.
It’s a “tall order” and well-nigh impossible. If I was Paulson,
I’d keep the high-blood-pressure medication in one drawer and
Dr. Kevorkian’s phone number in the other.Click here
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