European banking system needs redesign to prevent another crisis

There is widespread anxiety about the true condition of German banking, writes Colm McCarthy

By Colm McCarthy

Sunday February 13 2011

The new government will take office on March 9 (Ash Wednesday, as it happens) and will face immediately the task of forging a response to the Franco-German plan to resolve the Eurozone crisis unveiled at the Brussels summit last Friday week.

It calls, as these documents invariably do, for greater integration of European economic policy. The main proposals are for closer harmonisation of tax and spending policies, including constitutional limits on borrowing, a common approach to corporation tax, higher retirement ages in state pension systems and an end to wage indexation. The theme is a more competitive Europe with better fiscal discipline.

The plan has already received a frosty welcome. Everyone is in favour of better fiscal discipline, preferably at some distant future date, but states which have wage indexation want to keep it, higher retirement ages are unpopular in countries where the current figure is low and member states with attractive rates of corporation tax (Ireland is not the only one) want to keep them. There is a far better reason to resist the proposals, however. Europe is facing a serious financial crisis and the Franco-German programme looks like another integrationist push rather than a serious attempt either to resolve the continuing crisis or to prevent the next one.

The crisis in Europe, with the possible exception of what has happened in Greece, does not have its origins in loose budgetary policy. Its origins lie in a crisis of overleveraged banks making foolish lending decisions. Banks differ enormously in life but are indistinguishable in death: they go bust because they make bad loans and bad investments. Prudent banks, with cautious balance sheets and borrowers able to repay, do not go bust. In Europe, the introduction of the new common currency in 1999 was followed by a period of excess, not in loose fiscal policy but in the careless expansion of bank balance sheets through the accumulation of large liabilities to bondholders and wholesale lenders, in addition to the normal reliance on retail deposits.

These growing resources were deployed in the acquisition of dud assets. An extreme example was Anglo Irish Bank, which appears to have written off about 45 percent (and counting) of the amount it lent. In Ireland the dud assets were property and mortgage loans in the main. Something similar but on a smaller scale happened in Spain and in the United Kingdom. The dud assets acquired in France, Germany and other continental countries included exotic derivatives of mortgage loans in the United States as well as bonds issued by dodgy banks in places like Ireland.

The result of the banking crash has been a descent into unsustainable budget deficit in many countries. Those which had big government debts to begin with (Greece), or which allowed a greater banking bust to emerge (Ireland), have ended up in the most trouble. But the problem is general and in Germany, for example, the budget rules of the Eurozone were broken earlier than in countries like Ireland and there is widespread nervousness about the true condition of large parts of the German banking system.

Any plan from the EU Commission, the European Central Bank or the traditional political engine in the shape of Franco-German initiatives needs to pass one or both of the following tests: does the plan clean up the crisis which has arisen, and does it help to avoid a recurrence?

The latest Franco-German plan does not pass the first test, since it studiously avoids addressing the nature of the crisis. The European economies have not been experiencing the worst recession since the Second World War because the retirement age is too low, or because there are national differences in corporation tax rates. Ireland is not in an IMF bailout because the budget deficit, in the years before the crisis, was outside the Eurozone parameters. There was exemplary compliance with the fiscal policy rules and all boxes were ticked, up until 2007, in Ireland and in most Eurozone countries. This is a banking crisis and it remains unresolved three years after the bubble began to burst.

Resolving the crisis which has arisen in the Eurozone requires three simple steps. These are: stress-test the banks properly, in a manner which has credibility in the markets; distribute the losses, and re-capitalise whatever banks are deemed necessary for the long haul. Preventing the next crisis requires a redesign of the Eurosystem, including credible bank supervision and the avoidance of moral hazard, that is, the compensation of imprudent risk-taking.

The stress tests attempted by the European Central Bank last July were not believed. One of the banks which passed was AIB, which has since, to all intents and purposes, gone under. For a central bank dealing with a crisis of confidence in the solvency of its banks to deliver a non-credible stress-test is worse than doing nothing. A new set of stress-tests, under ECB supervision, is currently being conducted and the results are expected in April. If they give a clean bill of health to, for example, every bank covered, or if the tests conveniently exclude banks which are dodgy, the exercise is another waste of time and will fail again. It is extraordinary that the European banking system is still being stress-tested three years after the failure of Bear Sterns signaled the onset of the international financial crisis.

Adequate stress-tests should identify the banks which need recapitalisation, once and for all. If private equity is not available, which will not be the case for the basket-cases, the gap must be made up by taxpayers or through hair-cutting bondholders foolish or unlucky enough to have invested in these banks. To expect taxpayers alone, and only those in the countries unlucky enough to have hosted the mis-supervised banks, risks sovereign default in these countries, of which Ireland is the prime example.

Barry Eichengreen of the University of California at Berkeley summarises the position thus: “But one item is prominently absent from the new agenda: financial regulation. Aside from Greece, whose problems reflect years of fiscal profligacy, the euro crisis is fundamentally a banking crisis. Although the European Union activated three new ‘financial regulators’ for banking, securities markets, and the insurance industry on January 1, these new entities have limited powers. They mainly act to coordinate the periodic meetings of national regulators.

“In a monetary union, the idea of leaving financial regulation in the hands of individual countries is madness. Given the interconnectedness of national banking markets in the European Union, the actions taken by any one national regulator — say, Ireland’s permitting its banks to borrow huge volumes of foreign money to engage in all manner of reckless property speculation — can have serious repercussions for the rest of the European Union. Why Friday’s summit wasn’t used to propose the creation of a single powerful EU or euro-area bank regulator is a mystery. If one didn’t know better, one might suggest that Germany, whose banks are exceptionally highly leveraged and poorly capitalised, was cowed by certain special interests.”

There is a practical objection to a Europe-wide bank resolution: it would finally address the burden-sharing issue which French and German politicians wish to avoid. The ECB, whose policy throughout the crisis to date has been driven by no-bank-must-fail mantra and the protection of bondholders, needs a thorough redesign if another crisis is to be avoided. The Franco-German plan is also silent on this crucial issue.

Aside from employees of the European Central Bank, prominent economists have been virtually unanimous these last few months in dissenting from the non-policy being pursued. Bloomberg quoted another well-respected practitioner of the dismal science during the week in the following terms: “Senior bondholders of European banks should take a haircut on their investments instead of struggling banks being supported by taxpayer bailouts,” Citigroup’s chief economist, Willem Buiter, said.

“As soon as the end of this year, all the European zombie banks could be restored to health or put out of business by making senior bondholders pay instead of the taxpayer,” Mr Buiter said, adding that state support for failing financial institutions should be removed as soon as possible.

The risk of another European banking crisis down the road can be minimised only through the redesign of the ECB and the Eurosystem. The redesign should involve the centralisation of bank supervision, which in an integrated banking market cannot safely be delegated to small countries with limited administrative resources. This logically raises the question of abolishing the national central banks altogether. In seeking a better deal for Ireland in the resolution of the European banking crisis, Irish politicians should not be shy about urging a better deal for Europe; a deal which at least addresses the unresolved current crisis and the prevention of the next one.

Colm McCarthy lectures in Economics at University College Dublin. He has headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua

– Colm McCarthy

Sunday Independent

Forecast 2011 – Gird Your Loins for Lower Living Standards

By James Howard Kunstler
on January 3, 2011 7:22 AM

 

Introduction

Sheesh. Was I ever wrong last year about those stock market indexes. I called for Dow 4000 and look where the darn thing ended up: 11,577.50.  Some of those fabled “green shoots” must have grown clean through my brain-pan while I slept off 2010’s New Year’s Eve festivities.The damage was so severe, apparently, that I missed the takeover of Wall Street by front-running high frequency computer programs battling for supremacy of the algo-space which, along with massive insider trading, daily tweaks stage-managed by the Federal Reserve via their trusted allies in large banks, and relentless propagandistic cheerleading on the theme of if-you-wish-it-so-it-will-be, kept the Dow Jones and Standard & Poors indexes in a frothy state of perma-levitation through the year.

The outstanding question from the get-go of 2011 is just this: can a political economy be kept floating along like a Winnie-the-Pooh balloon on gusts of sheer fakery? To me, the simple answer is no. The people running things in the USA have tried everything from pervasive accounting fraud to complete opacity in trading procedures to looting the republic’s future. The consensus trance of “recovery” makes itself manifest through every conduit of public utterance – cable TV news, The New York Times, the pronouncements of every last elected official – even though the Consumer Price Index omits items such as food, gasoline, and heating oil in its calibrations, while heaping on fictional “hedonic” adjustments.

What’s left of the American economy is a web of financial rackets divorced from the production of real wealth, dependent on an elaborate computerized three-card-monte edifice of swindling. Those groans and creakings you hear are the agonies of this ediface swaying under its burden of lies, while underneath it the ground of history shifts.

A secondary outstanding question – I get it all the time – is whether the people running things know how fake this picture is, and how horrifying the view behind-the-curtain is. Does President Obama understand the relation of our energy predicament to the workings of our economy? How could he not? Certainly he has had a conversation or two with Energy Secretary (and eminent physicist) Steven Chu over the past two years. Mr. Chu should have explained to the president that a decline in the primary energy resource used by an industrial society portends a decline in living standards, which can be expressed in an economy, for instance, by people having less money, or  by people having lots of money that is increasingly worthless. This concept may lie outside the strict purview of physics, but surely somebody like Paul Volker was at hand in the White House to connect the dots – and perhaps explain further that anything in the picture beyond that equation amounts to a looting operation by people positioned to systematically cream off the dwindling equity base of a roughly 200-year-old venture.

By the way, to aver to “people running things” is not evidence of a persecution complex. Lots of people are in positions to make decisions. The president may be a hero, a con man, a victim of history, a bungler, a hostage to events – but you can be sure that he makes real decisions that affect people’s lives every day. Where I depart from darker views is the idea that there is some shadow gang of hidden puppeteers behind the visible leadership – the Council on Foreign Relations, the Trilateral Commission, the Bilderbergers – bent on a quasi-religious crusade to impose “one-world government,” or some kind of totalistic domination scheme out of comic book politics. I denounce such views as childish, deranged distractions from a reality that is challenging enough without the intrusion of paranoid fantasies.

If there are “bad guys” or string-pullers on the scene, then they are figures in plain sight, like Jamie Dimon and Lloyd Blankfein at the big banks, or John Paulson in his hedge fund, or the many figures who have moved back and forth between Wall Street and government in recent years, and their machinations are pretty well understood, and explicated daily by diligent observers on the scene – from William Black to Yves Smith, to Simon Johnson, to Janet Tavakoli, and many many others. The legerdemain of  the Federal Reserve in shoveling money to dominant banks has fooled only those who exhaust their attention on The Real Housewives of Beverly Hills, Lady Gaga, and the National Basketball Association.

The larger riddle of life-in-our-time surrounds the absence of the rule of law in money matters. To say that people are actually running things out there doesn’t mean that are running them effectively or optimally. The US Department of Justice, for example, appears to be led by a zombie, Attorney-General Eric Holder, somebody of this world but no longer quite in it, who is pioneering a new method of Zen law enforcement based on a maximum of doing and saying of nothing. Of course, my ongoing theory since the national election of 2008 is that Barack Obama has been warned repeatedly by many credible figures that any move to disturb the operations of banking would bring down such a wrathful ruin on this nation that he had no choice but to keep his hands off the levers of enforcement. In fact, it’s the only theory that explains adequately the yawning gap between reality and the representation of it by those assumed to hold authority.

Whether we can overcome these obstacles to action and move this crippled society to a re-set of daily life consistent with what the planet provides is a whole other question. My guess is that we will eventually be dragged kicking and screaming to this re-set, which I have described in my book The Long Emergency and my novels World made By Hand and The Witch of Hebron. That outcome is rather severe, basically a “time-out” of unlimited duration from the orgy of techno-comforts that have defined existence in “developed” societies for many decades. It implies a massive loss of things that people will not let go of, and so the political games around money matters really all amount to one thing: a campaign to sustain the unsustainable at all costs. It obviously requires monumental levels of mass self-deception, of pretending, of fakery, of lying, of denial. The psychology of all this is another thing that is thoroughly understood, but such is the collective anxiety about our situation that knowing how-and-why we behave a particular way does not alter our behavior.

These have been my preoccupations in recent months, and they mostly revolve around what happens in the USA, but there is a wider world out there and I sense that the more clarifying actions will arise out there in the year ahead. Perhaps the most striking thing about the scene last year (and several preceding it) is the eerie absence of major disruptive events on the world stage. This suggests a dangerous build-up of tensions that are bound to release – and releases of this kind are often destructive, like the energy stored along tectonic fault lines. In fact, I’m describing many points of tension, which have the potential of setting each other off in chains of destruction. And in this fractal disposition of energy flows anything can happen.

The Forecast

The paradigm we’ve called Globalism is falling apart now. Followers of Tom Friedman (The Earth Is Flat) tried to put across the story that Globalism would become a permanent feature of the human condition, an idea I regarded all along as utter nonsense. Rather, Globalism was a set of transient economic relations characterized by particular conditions of a certain era (the post-WW2 cheap energy era), and that when history moved on, Globalism would dissolve. As is the case now, first in the unraveling of global financial arrangements – a terrifying matrix of irresolvable mutual obligations that are destined to be repudiated in an ugly way. Everybody owes too much money to everybody else. A worldwide game of financial musical chairs is currently eliminating various nation-players too weak to plant their asses in the diminishing chair-space. Iceland dropped out first, then Greece, then Ireland, and so it goes. Entering 2011, the trouble is that the world is out of runt countries to shove to the sidelines. There are Portugal and Belgium to go, and from these on all you’ve got are nations too big to fail and too broke to keep going, the most conspicuous being Spain.

The Euro took center stage in the global financial fiasco in 2010. I don’t really see how that medium-of-exchange endures when so many of the exchangees are economic basket-cases beating a path back to pre-1850 modes of existence (if they’re lucky). The serial bail-outs engineered by the European Central Bank have been shams based on an imaginary “fund” that really only amounts to more promises of back-stops by bankrupt countries to other bankrupt countries. In the grand gesture last fall, around the collapse of Ireland, promises were made by the ECB to give the appearance that the usual suspects (the PIIGS) would cover their quarterly debt service obligations to March of this year. No real money was involved, only assurances, which will soon be revealed as empty. Bottom-line: another graver round of debt crisis in Euro-land in the first quarter if 2011.

It can only be resolved two ways: by 1.) countries defaulting, dropping out of the Euro monetary system, returning to a currency of their own and activities that reality will admit; and 2.) Germany, France, and Holland taking the others in like poor relatives and paying their living expenses. I really don’t see Number 2 working out. The voters in the bigger three economies will revolt. Of course, the Number 1 route implies the destruction of a whole bunch of European banks, perhaps all of them, and their shareholders positions, and big trouble for the wealthier Euro member countries – ultimately leading to the same place: a lower standard of living, even in Germany, for all its frugality and efficiency.

The United Kingdom is in a strange class of its own. It uses the pound sterling, not the Euro, yet the City of London (their equivalent of Wall Street) is the banking capital of Europe (and the Middle East and Africa). For a while now, the City has been the UK’s sole economic generator, lately specializing in swindles and Ponzi schemes, just like America. There’s not much else left in “Old Blighty,” not much coal mining, or shipbuilding, or making those fabulous tin soldiers we got for Christmas in 1956. If the City goes up the spout, the UK has no economy left at all. On paper, the UK is epically insolvent and, unlike Spain with its Euros, the UK can’t even hold the rest of Europe hostage. It just sinks. Living standards crater, people freeze to death and go hungry, and the interesting politics commence in all their multicultural splendor. Prince Charles will not get out much in 2011, but he has a lot of nice estates to hole up in.

In any case, the Euro banking mess surely will infect American banks, which secretly paid to bail out European banks through TARP in the 2008 crash and has been shoveling money into them ever since. Global banking operations are hopelessly intertwined and hopelessly damaged now, and any problem on the Euro bank scene could easily be the tipping point for a global retreat by all countries to defend their own barricades of money, in whatever form money shakes out as, not to mention whatever’s left of real productive activity, meaning the end of free trade as we’ve known it. This might temporarily favor the US dollar as a refuge for the desperate, but the holistic equation of money factored into trade in vital resources like oil, metals, and grains suggests, once again, just a different route to reduced living standards anyway you slice it.

There’s been chatter all year about Russia surreptitiously laying in stores of gold in order to base the ruble on it and make that the go-to currency for soundness and safety. I don’t have any information that this is factually occurring. At this point in history, sound, gold-based money would be a wise thing for any nation that wanted to function above the barter level. Russia is a big place with, historically, pretty sturdy gold resources of its own, not to mention oil and gas reserves (which, for now, they seem content to piss away for other people’s paper). These fossil fuel reserves of theirs promise to leave them in an advantageous position vis-à-vis Germany and the rest of Europe for some time to come, but they could also become the object of a dangerous envy and for military mischief in a part of the world that likes to imagine that war is a barbaric relic.

I’m still not among those who view China as the onrushing new hegemonic world power. Their banks are more reckless than the western banks because they really don’t have to account to anyone for lending (or getting paid back). The government IS the banks. Some jaboney in Guangzhou wants to start a company that manufactures licorice dildos and borrows sixty million yuan through a guy he knows at the regional office of the PBOC (for a piece of the action). The business doesn’t work out, say, because the Australian wheat harvest failed and the first guy couldn’t get enough wheat paste to make the darn licorice. Oh, and that sixty million yuan on the books? The dog ate the books (then we had the dog for lunch). Meanwhile, that sixty million is circulating, driving up prices. It doesn’t sound all that different from the western banks, but they don’t even have casual watchdogs in their government-run news media, let alone an FDIC.

The result for the moment in China is pretty serious price inflation. Officials are jacking up some wages more than 25 percent at a crack. Their building bubble (whole new empty cities!) makes the state of Arizona look like the doll house section of Toys R Us. The massive lending failure it represents has not yet thundered through the Chinese banking system, such as it is, and may never in the western sense of a true clearing (though you could argue that the clearing process is a world-wide anachronism). But it will be expressed in other ways: possibly hyperinflation, crashing living standards (all roads lead there now), and ultimately political trouble in a nation with an unelected government that can really only change via popular uprising of some kind or another.

Among the consequences of all this mischief would be to the sort of interbank lending that makes letters-of-credit possible (promises to transfer large sums of money for large shipments of goods), and without letters of credit global trade withers. The last time this happened, in 2008, the Baltic Dry Index, which measures shipping tonnage, slipped down off the charts. When this occurs, the resource countries can’t move any of their stuff. Australia, for instance, which I visited recently, jokes to itself about being “China’s mining operation.” Without letters of credit they won’t move any of their coal and copper – or wheat (and ten years of drought plus one season of Biblical flooding has put the schnitz on their grain exports to principal clients, the Middle East and China) – all of which adds up to trouble Down Under. In the bigger picture nothing moves anywhere, not plastic salad shooters from China to the Altoona WalMart or buckwheat from Russia to Senegal or even oil from Abu Dhabi to Westville, New Jersey. People go hungry and get cold.

What lubricates free trade is the reasonable expectation of getting paid, and that’s heading out the window. Maybe nations will make “special” arrangements with each other for this or that commodity outside the banking system but that’s desperation-level trade, not something that will lead to more cell phone customers and burgeoning middle classes. In fact, I’d call 2011 as the turning point in the global growth of the middle class. We’ve maxed out, passed the high point. The entry gates are closing and the eviction squads are prepping for action. The cracks in the floor are widening and lots more people will fall through while the ladders for climbing up will be withdrawn over the parapets. There just isn’t enough stuff left in the world, even while the movement of remaining stuff gets stuck in political bottlenecks.

One place I’d look for trouble on this is India. They have no energy resources of their own. They face climate change associated grain harvest failures. They may have to shut down a lot of call centers. Tata motors might take it on the chin as the growth of mass motoring recedes to the elephant’s graveyard of dashed hopes. As India’s prospects dim in 2011, look for political animus to focus on their perennial adversary next door, Pakistan. In its fury at losing economic momentum, India might turn the next “insult” from Pakistan into a real smackdown. Pakistan is renowned for having the world’s most unstable nuclear arsenal – something around a hundred warheads or bombs – but who knows whether they can actually deliver one to a target? India, on the other hand, probably can. If Pakistan really does something to piss off India – another hotel massacre type stunt, say – look for India to turn Islamabad, Lahore, and Karachi into incense burners. Islam elsewhere around the world then goes absolutely apeshit, of course.

I don’t know what the hell Japan is going to do in 2011 (and I doubt anybody else does). It has no energy resources either, and if global banking seizes up, well…. It has stoically gone broke by slow degrees for twenty years. It may opt out of modernity altogether – it tried to before once and got suckered back in. Letting go is not the worst outcome. The rest of the world can slug it out in the boardrooms and bunkers. Let the bond vigilantes eat Norway and Illinois. Fuck the car-making industry – that ole sun sure ain’t rising anymore. Japan will quietly bury their old folks and turn back to Shogun where you can still get a nice hot bath and eat some raw clam sushi and hack around with interesting swords. Pray that the Chinese don’t roll in with an army of occupation. Raise silkworms. Make nice things out of clay and rice paper. What’s not to like?

I’ve heard people say that North Korea is China’s stalking horse in some kind of world domination scenario out of the James Bond script locker. That doesn’t really add up to me. North Korea is like a nineteen-year-old autistic nephew jacked up on vodka, LSD, and crystal meth, with seventeen pounds of Semtex taped to his chest and grenade in each paw. You wouldn’t give such a creature the run of the neighborhood, would you? Of course not. You’d whack it in the head with a shovel, drag it down the coal chute, and starve it to death. My forecast for 2011 includes such a schooling by China to that reckless rogue state. South Korea becomes a vassal of China’s eventually, but not in 2011. They just gaze at the world scene in wonder and nausea and try to puzzle out what happened to that global economy they depended on.

The Middle East

This sorry-ass corner of the world, a neighborhood of camel-herders turned lottery-winners, has the most potential for blowing up than any other region except Korea. One way or another, they’re all on the downside of oil production, even poor beat-up Iraq, with its El Dorado of presumed reserves. They’re all wildly overpopulated, given their unfortunate geography, scarce water resources, and blast furnace climates. They’re all chronically enraged over some sectarian hermeneutic or old tribal grudge, or swindle in the souk.

And then there’s Israel, settlement of my people since 1945 (traditionally, for millennia), but a very troubled polity in which a cult of religious fanatics every bit as extreme as their counterparts in surrounding nations are taking over by sheer population explosion. This suggests something less than a happy ending. The inversions of history can be very cruel. A people of great learning and philosophical liberalism comes to shelter there after an earthshaking genocide, and then commits suicide in a fugue of ideological nuttery. I don’t have a religious bone in my body and I pray for Israel’s survival under the circumstances. Or maybe the dwindling sane among them can come to Nebraska now. I’m not joking. I know it’s not the exact spot on the planet assigned by Yahweh, but it is reasonably buffered against Israel’s modern political enemies and increasingly available from a real estate point-of-view as the descendents of the original sodbusters pack up and leave to become film-makers in LA.

Which of what numerous booby traps and flashpoints might blow in the Middle East in 2011? An obvious one is Hezbollah in Lebanon, next door to Israel. They’ve been collecting Iranian rockets by the truck-load since their last active jihad against Israel in 2006. That’s a lot of rockets in a lot of years. Their fingers might be getting itchy. That leads to some questions about Iran itself but also some strange corollary politics of the region, namely the curious mood of Shia Islam where that sect is concentrated on the rim of the Arabian Peninsula along the Persian Gulf and down into Yemen, comprising nearly half the population of that country. Consider that King Abdullah of Saudi Arabia is going on 87 years old. Sure, he has access to pretty good medical care, but he’s been sick and immortality just isn’t in the cards. His official successor Crown Prince Sultan is pushing 83. What I’m driving at is the possibility of turmoil in Saudi Arabia aggravated by Shia provocations emanating from Yemen against the Wahhabist-inflected Al Saud dynasty. Anyway you look at it there is going to be a fight for control of the Arabian Peninsula and its oil riches, and the family that has been in charge since the oil first began to flow in the 20th century could easily get kicked out. It might not get replaced by anything nearly as stable, or as friendly to western interests. It might not get replaced at all. The region could remain fragmented indefinitely, and that would not bode well for the oil trade. If there is a breakdown in order in Arabia, a lot of hardware could get smashed up in the process, too. Oil terminals, pipelines, drilling rigs.

I’ve also heard the idea expressed – though it did not originate from me – that such a Shia instigation on the Arabian side of the Gulf could stimulate instability throughout the Persian Gulf region, even extending into the capital of Shi’ism, Iran. I mention it because I thought it was an interesting out-of-the-box idea and will leave it to you to chew over. Bottom line for the Middle East: all kinds of world-inflaming mischief possible there in 2011.

Over 2010, the anxiety over Iran’s nuclear ambitions was allayed somewhat by the appearance of the Stuxnet computer worm, a piece of “malware” allegedly of Israeli origin that went in and gummed up the computers at Iran’s Bushehr nuclear facility before it even officially opened for business. It’s not altogether great news because it suggests the opening round of world-wide computer hacking wars, which could shut down whole societies and economies in the years ahead – a subject that will no doubt preoccupy the blogosphere until the moment it is brought down by a computer worm. But, at least, Iran’s nuclear program might be neutralized – and kept gummed up through the foreseeable future.

Actually, while we’re on the subject of matters Islamic, lets just get straight to the issue of America’s wars. The Afghanistan project is hopeless and therefore stupid. There are two main objectives in Afghanistan: to control the terrain and to control the population. We can’t do either. We have no chance of ever accomplishing either. Apart from that there are some other undeclared strategic purposes. One is to make a baloney sandwich out of Iran, so to speak, with American troops garrisoned on both the east and west sides of that nation with its nuclear ambitions and its hostility to us and our friends. Another is to keep an eye on the train wreck called Pakistan. Actually, it’s way more up close and personal than that. We launch drone aircraft attacks on supposed “bad guys” there from our positions in Afghanistan. By the way, the targets may indeed be bad guys. The trouble is there is an inexhaustible supply of them, so whacking a couple of dozen a year is not exactly a victory.

There’s idle chatter about Afghanistan containing nice reserves of lithium and other vital resources that would allow the US to run WalMart on batteries, but the geography of the remote, landlocked country rules out any orderly exploitation of these materials. It’s said to cost over $400-a-gallon just to supply our troops there with gasoline to run their Humvees. We’re not going to get any ores out of there at those rates, so strategically the idea is absurd. Our official policy is to get our troops out of Afghanistan in 2011. I have no idea whether we actually will, or will find some way to fudge it. But it’s certain that we can’t finance these adventures indefinitely.

Iraq has all but faded from the American news-scape. They’ve quit fighting amongst themselves for a while, but the government is a thing constructed out of baling wire, spit, duct tape, and old Mars bars wrappers. US troops are not getting killed there lately, but it must cost a lot to keep them there. I imagine we will keep somebody there for quite a while into the future, even if we whittle down the numbers. After all, the original purpose of the venture – contrary to conventional thinking about democracy, or even Iraq’s oil – was to establish a police precinct in the Middle East right between the two baddest boyz in that hood Saudi Arabia and Iran. If monkey business does break out on the Arabian Peninsula, or along the shores of the Persian Gulf, then Iraq could easily turn back into a hot battleground again. For the USA, it’s just another sizable vein among many oozing our lifeblood. Situation uncertain for 2011.

Back on the Home Front

News flash: That extension of the Bush tax cuts? It’s already been gobbled up at the gas pumps, at least for those citizens of the USA who have to pay attention to stuff like the price of gasoline and groceries. Oil closed over $91-a-barrel on New Years Eve. That means it’s well into the price zone where it crushes economic activity of the type were used to: everything from the sales of Dunkin’ Donuts to the subscriber base of cable TV to hotel stays in Disney theme parks.The shaggy beast people call “recovery” is Bigfoot, a creature often reported and never actually captured. I began this long forecast by implying that we were quite out of our gourds collectively. Since one of my cardinal beliefs is the idea that delusional thinking rises in exact proportion to economic hardship, I can only conclude that the national state of mind will deteriorate further.

We’re already looking like a nation of ax murderers and cannibals with our tattoo fetish, strange costumes (baby clothes for young men; hooker get-ups for the ladies, which should tell you that adulthood is the new final frontier of the American Dream), and our retarded patois of like-like-like and go-go-go speech – all set in a porn-saturated total immersion huckster hologram (thanks Joe Bageant) of visually incoherent, civically-impoverished, and economically spavined suburbia. I’m sorry, but we just look like a nation of goners. Surely the levels of clinical depression are high out there, and a lot of our fellow citizens are suffering profoundly inside – but is acting like killer-clowns the only option?

In 2011 everything just gets harder for the masses of Americans not on the payrolls of banks or hedge funds. The middle class is a state-of-being that recedes deeper into the mists of history while resentment builds ominously. Something could convert it into anger in a flash – I still think the announcement of the annual banker bonuses could bring it out (but I thought that last year, too) – or maybe it will just keep simmering. We’ll get an idea by summertime.

In the absence of productive activity we have Federal Reserve money injected everywhere in the economy like botox in a Real Housewife of Beverly Hills, and to about as much effect. QE-1 didn’t do anything because existing notional wealth disappeared at a much greater rate than computer bits the Fed could hope to replace it with. (Money is loaned into existence and defaulted out of existence.) Officially sanctioned (by the FASB) accounting tricks that permit the concealment or suppression of real asset prices, along with a complete failure of regulation and law enforcement in lending procedures allowed the nation to just barely stay open for business through 2010. QE-2 is slated to run in monthly installments of US bond purchases (through “primary dealer” banks, at a premium) for the first half of the year. But housing prices continue to fall, meaning the collateral behind the “toxic” securities that the Fed stuffed its vaults with keeps losing value, meaning the Fed is functionally bankrupt, meaning actually that its member banks are toast – because the Fed is not an actual bank itself but a consortium. How long can an institution pretend it exists?

We can look forward to an entire year of trouble with foreclosures and everything they entail legally, from robo-signing lawsuits to title quarrels, even as defaults mount to a climax. The courts are losing legitimacy like everything else in America. In Florida, according to Matt Taibbi, there isn’t even anything resembling perfunctory legal protocol, as it is known in societies where people eat with forks and spoons. In 2011 we’ll see the introduction of new instruments in the foreclosure courts: firearms. It will be a bad sign.

Sooner or later all this dishonesty will terminate in collapsing living standards, loss of public services, growing civil disorder, and political crisis. You can get there via deflation (no money) or via inflation (plenty of worthless money) but the destination is the same. I don’t see how America fails to begin arriving at that destination before Halloween 2011. Europe may get there by springtime, anyway, dragging the rest of the developed world into a vortex.

The reality of Peak Oil glowers in the background all the time. These epic disturbances in money and banking are expressions of it, but they will also feed back into the oil industry imposing a generalized shortage of capital that will make the decline of oil production ever worse – since new fields will not go into production and exploration will stop – and will also impede the movement of inventory around the world. These dynamics will feed back into economies and hurt every kind of business, probably destroying demand for oil which will lead to further shortages of capital in the industry and lead to even lower oil supplies. Finally, economies may be so devastated that oil could sink to something like $25-a-barrel – the catch being that no one will have any money to pay for it. More likely through 2011, we’ll see rising prices joined by regional scarcities. The US is a prime candidate for scarcities since we import more than two thirds of our oil and a lot of that comes from countries that have an ax to grind with us. The aforementioned potential for disarray in the Middle East would only make matters much worse.

The fate of the stock market is actually trivial in the context of constricted energy supplies and chaotic behavior in currencies. Anyway, the stock market is the primary object of the Fed’s pumping because in the past its symbolic value has been crucial to the project of self-deception, of presenting to ourselves the appearance of an economy that is okay – because, in a therapeutic culture, feeling okay about something is the same as being okay. Just don’t lose sight of the fact that a pumped and gamed stock market has no relation to economic well-being. It may go up forever now, and if so then it will just be another thing that needs to be swept away in the re-set to a reality-based economic system.

As usual, though – annually for several years, in fact – my target number for the DJIA is 4000, which coincidentally may be exactly where gold is going, too. In a true correction process, historically, the stock market’s indexed value meets the equivalent value of an ounce of gold. Gold floats up on sheer uncertainty as much as fear of inflation. While it is certainly true that you can’t eat gold or heat your house with it, it’s not likely to lose its meaning as an ultimate repository of wealth. Humans will continue to regard it as an alternative kind of money, maybe more real than paper money. There isn’t much of it in the world to begin with and the newer deposits get lower in grade every year.

My personal belief is that things could get desperate enough in the USA that we begin to circulate silver coins again to pay for stuff. That’s the World Made By Hand outcome anyway, though it is admittedly a “made-up” story, a novel set in the not-distant future. Part of the reason silver (and some gold) circulates in that fictional world is because modern industry as we know it has ceased to function, so silver is not being gobbled up by the electronics-makers and a thousand other manufacturing activities. I don’t see that happening as soon as 2011, but owning silver in the form of pre-1965 coins is a good idea (if you can get them, which is increasingly difficult as the recognition of our predicament grows), or any other form of bullion you can get your mitts on.

A lot of people dread the political scene for 2011. Both major parties are blameworthy for the horrible condition of the nation, and both will be blamed, good and hard. Mr. Obama is thought to have made a grand finish of 2010 with his tax compromise and the Don’t-Ask-Don’t-Tell bill. But the tax issue had already lost meaning in sheer purchasing power terms, and even sympathetic voter blocs may grow impatient with the looming gay marriage pleading while practical issues of economic survival loom even larger. I think the glow of the lame duck congressional victories will wear off quickly in 2011. The only thing left to Mr. Obama now is to start telling the truth, to stop cheerleading for phony recovery to a consumer utopia that’s gone for good, and prepare the public for reality-based living. I don’t know whether he has it in him. We’ll find out. Sometimes I wish he’d just come out and declare he won’t run again to give himself some freedom of action. Four years is enough for a lot of things. Abraham Lincoln didn’t get a full four – and he didn’t try to pretend that the Union wasn’t coming apart, either.

The Republicans want to be seen as riding to the rescue, naturally, but they will have the misfortune of coming on just in time to preside over renewed financial fiasco. In the face of it, they’ll militate for deals and gimmicks every bit as raw as the TARP scam that Hank Paulson shoved through a quivering congress in 2008 – and the party’s remaining credibility will slide down the drain, Ron Paul, Rand Paul, and all. I’ll peg 2011 as the year that other political factions beyond the Tea Party start coalescing in the vacuum of legitimacy. Some new parties may actually be made up of non-morons with something besides holy retribution on their minds.

Everybody is worried now about the fate of states, counties, and municipalities. Just about all of them are broke one way or another. A state and muni bond bail-out would only send interest rates to the moon, meaning the absolute end to lending and servicing of existing debt and, well, really all business as usual. I don’t think it can happen. It will be interesting to see what does happen to states and localities if left to dangle slowly slowly in the wind. If they can be induced into some kind of real bankruptcies they’ll get rid of a lot of dead weight – which will, very unfortunately, also mean lost jobs, incomes, and homes, since so many people are on a government payroll of one kind or another – but how else do you get out from under unendurable promises to pay for people to play golf?

This would be a scenario not unlike the collapse of the Soviet system, in which virtually everybody got fired at once. We may not survive it as well as they did – after all, the collapse of the Soviet Union was historically extraordinary in the sense that it generated almost no bloodshed. Imagine that! (Read your Dmitry Orlov.) Americans are too undisciplined, too heavily armed, and too deeply programmed in melodramatic vengeance-seeking to pull something like that off.  We’ll be all over each other like cheap suits. That might be the point where you have to send the army in, and if a president won’t do it because the constitution frowns upon it, the army might send itself into the White House in the form of a coup d’état. It’s not something I’d like to see but let’s face it: shit happens. This republic has had a long run compared with all the others that have ever existed and nothing lasts forever, even if your flag lapel pin came from Tiffany and was blessed by the restless ghost of Abe Lincoln.

Good luck in 2011 everybody!  And keep your hats on!

12 Economic Collapse Scenarios That We Could Potentially See In 2011

What could cause an economic collapse in 2011? Well, unfortunately there are quite a few “nightmare scenarios” that could plunge the entire globe into another massive financial crisis.  The United States, Japan and most of the nations in Europe are absolutely drowning in debt.  The Federal Reserve continues to play reckless games with the U.S. dollar.  The price of oil is skyrocketing and the global price of food just hit a new record high.  Food riots are already breaking out all over the world.  Meanwhile, the rampant fraud and corruption going on in world financial markets is starting to be exposed and the whole house of cards could come crashing down at any time.  Most Americans have no idea that a horrific economic collapse could happen at literally any time.  There is no way that all of this debt and all of this financial corruption is sustainable.  At some point we are going to reach a moment of “total system failure”.

So will it be soon?  Let’s hope not.  Let’s certainly hope that it does not happen in 2011.  Many of us need more time to prepare.  Most of our families and friends need more time to prepare.  Once this thing implodes there isn’t going to be an opportunity to have a “do over”.  We simply will not be able to put the toothpaste back into the tube again.

So we had all better be getting prepared for hard times.  The following are 12 economic collapse scenarios that we could potentially see in 2011….

#1U.S. debt could become a massive crisis at any moment.  China is saying all of the right things at the moment, but many analysts are openly worried about what could happen if China suddenly decides to start dumping all of the U.S. debt that they have accumulated.  Right now about the only thing keeping U.S. government finances going is the ability to borrow gigantic amounts of money at extremely low interest rates.  If anything upsets that paradigm, it could potentially have enormous consequences for the entire world financial system.

#2Speaking of threats to the global financial system, it turns out that “quantitative easing 2” has had the exact opposite effect that Ben Bernanke planned for it to have.  Bernanke insisted that the main goal of QE2 was to lower interest rates, but instead all it has done is cause interest rates to go up substantially.  If Bernanke this incompetent or is he trying to mess everything up on purpose?

#3The debt bubble that the entire global economy is based on could burst at any time and throw the whole planet into chaos.  According to a new report from the World Economic Forum, the total amount of credit in the world increased from $57 trillion in 2000 to $109 trillion in 2009.  The WEF says that now the world is going to need another $100 trillion in credit to support projected “economic growth” over the next decade.  So is this how the new “global economy” works?  We just keep doubling the total amount of debt every decade?

#4As the U.S. government and the Federal Reserve continue to pump massive amounts of new dollars into the system, the floor could fall out from underneath the U.S. dollar at any time.  The truth is that we are already starting to see inflation really accelerate and everyone pretty much acknowledges that official U.S. governments figures for inflation are an absolute joke.  According to one new study, the cost of college tuition has risen 286% over the last 20 years, and the cost of “hospital, nursing-home and adult-day-care services” rose 269% during those same two decades.  All of this happened during a period of supposedly “low” inflation.  So what are price increases going to look like when we actually have “high” inflation?

#5One of the primary drivers of global inflation during 2011 could be the price of oil.  A large number of economists are now projecting that the price of oil could surge well past $100 dollars a barrel in 2011.  If that happens, it is going to put significant pressure on the price of almost everything else in the entire global economy.  In fact, as I have explained previously, the higher the price of oil goes, the faster the U.S. economy will decline.

#6Food inflation is already so bad in some areas of the globe that it is setting off massive food riots in nations such as Tunisia and Algeria.  In fact, there have been reports of people setting themselves on fire all over the Middle East as a way to draw attention to how desperate they are.  So what is going to happen if global food prices go up another 10 or 20 percent and food riots spread literally all over the globe during 2011?

#7There are persistent rumors that simply will not go away of massive physical gold and silver shortages.  Demand for precious metals has never been higher.  So what is going to happen when many investors begin to absolutely insist on physical delivery of their precious metals?  What is going to happen when the fact that far, far, far more “paper gold” and “paper silver” has been sold than has ever actually physically existed in the history of the planet starts to come out?  What would that do to the price of gold and silver?

#8The U.S. housing industry could plunge the U.S. economy into another recession at any time.  The real estate market is absolutely flooded with homes and virtually nobody is buying.  This massive oversupply of homes means that the construction of new homes has fallen off a cliff.  In 2010, only 703,000 single family, multi-family and manufactured homes were completed.  This was a new record low, and it was down 17% from the previous all-time record which had just been set in 2009.

#9A combination of extreme weather and disease could make this an absolutely brutal year for U.S. farmers.  This winter we have already seen thousands of new cold weather and snowfall records set across the United States.  Now there is some very disturbing news emerging out of Florida of an “incurable bacteria” that is ravaging citrus crops all over Florida.  Is there a reason why so many bad things are happening all of a sudden?

#10The municipal bond crisis could go “supernova” at any time.  Already, investors are bailing out of bonds at a frightening pace.  State and local government debt is now sitting at an all-time high of 22 percent of U.S. GDP.  According to Meredith Whitney, the municipal bond crisis that we are facing is a gigantic threat to our financial system….

“It has tentacles as wide as anything I’ve seen. I think next to housing this is the single most important issue in the United States and certainly the largest threat to the U.S. economy.”

Former Los Angeles mayor Richard Riordan is convinced that things are so bad that literally 90% of our states and cities could go bankrupt over the next five

 

#11Of course on top of everything else, the quadrillion dollar derivatives bubble could burst at any time.  Right now we are watching the greatest financial casino in the history of the globe spin around and around and around and everyone is hoping that at some point it doesn’t stop.  Today, most money on Wall Street is not made by investing in good business ideas.  Rather, most money on Wall Street is now made by making the best bets.  Unfortunately, at some point the casino is going to come crashing down and the game will be over.

#12The biggest wildcard of all is war.  The Korean peninsula came closer to war in 2010 than it had in decades.  The Middle East could literally explode at any time.  We live in a world where a single weapon can take out an entire city in an instant.  All it would take is a mid-size war or a couple of weapons of mass destruction to throw the entire global economy into absolute turmoil.

Once again, let us hope that none of these economic collapse scenarios happens in 2011.

However, we have got to realize that we can’t keep dodging these bullets forever.

As bad as 2010 was, the truth is that it went about as good as any of us could have hoped.  Things are still pretty stable and times are still pretty good right now.

But instead of using these times to “party”, we should be using them to prepare.

A really, really vicious economic storm is coming and it is going to be a complete and total nightmare.  Get ready, hold on tight, and say your prayers.

Jim Rogers Says $200 Oil Will Lead Massive Commodity Surge

When it comes to state visits the devil is in the detail. It’s the nuances of the arrangements that allow you to calibrate just how important a relationship is. That’s why the world has been watching the visit of the Chinese President Hu Jintao with such attention. The state dinner at the White House – described as an “intimate” event – apparently signifies that Washington rates China as pretty much the most important nation, economically, on earth. But the visit has also prompted much speculation in the press about how long the Chinese economic miracle can last and whether it is about to come to a juddering halt. Jim Rogers, the legendary investor who co-founded the Quantum Fund with George Soros, has moved his family to Singapore and is making sure his two young daughters can speak Mandarin. He spoke to the Business Daily’s Justin Rowlatt.

Transcript is below

Jim Rogers: The largest creditor nations in the world are in Asia now: China, Korea, Japan, Hong Kong. This is where the assets are. You know who the debtors are and where they are.

Justin Rowlatt: But listen, I mean the Chinese economy is still way behind the American economy is and it is about the third the size of the American economy.

Jim Rogers: Yes, of course. They had a disaster for 300 years, but about 30 years ago, they woke up, they changed their minds and they said we got to try something new. They unleashed entrepreneurship and capitalism again, and they have been astonishing for 30 years. It takes a while to go from a disaster to rival the Americans, but they are on their way.

Justin Rowlatt: Do you really believe the Chinese boom can continue, because lots of people are saying there are all sorts of asset price bubbles that are going to trip the Chinese up in the coming years?

Jim Rogers: Well, the only asset bubble I see potentially in China is in urban coastal real estate, but real estate is not nearly the entire Chinese economy as it was in America and the U.K. Sure, they will have setbacks.

Justin, in the 19th Century, America had a horrible civil war. We had 15 depressions with a ‘D.’ We had very few human rights. We had massacres in the streets regularly. We had very little rule of law. You could buy and sell – you can still buy and sell congressmen in America, but in those days they were cheap. America had horrible problems, but they came out of that and had a pretty good 20th Century.

Justin Rowlatt: So what does that imply about where people should put their money; where are the sensible investments in Asia?

Jim Rogers: Well, the best way to invest in Asia in my view is to buy commodities, because the Chinese have to buy cotton, they have to buy zinc, they have to buy oil, they have to buy natural resources because they don’t have enough.

If you want to invest in China and you own cotton, they are going to be very nice to you Justin. They are going to pay the bills, they are going to take you to dinner, they are going to pay you on time. If you want to invest in stocks, you have to do a lot of homework and know what you are doing. Another way is to invest in the currency. I own the renminbi. I expect the renminbi to go up a great deal over the next decade.

Justin Rowlatt: But commodities are already at relatively high prices, aren’t they? I mean hasn’t that horse bolted already?

Jim Rogers:No, no, the only commodity I know which is making an all time high is gold. Some commodities are up, yes. Sugar is up a lot, but Justin, sugar is still 50% below its all time high. How can you say that’s bolted? Silver is going up, but silver is 40% below its all time high. Yes, commodities have been going up recently, but they are still extremely depressed on a historic basis.

Justin Rowlatt: So what about oil? I mean oil prices are pretty high, aren’t they? Almost $100 a barrel. Are they really going to go higher do you think?

Jim Rogers:Well, the surprise is going to be how high the price of oil stays and how high it goes, because Justin we have had no major elephant oil discoveries in over 40 years. The International Energy Agency is going around the world pleading with people to listen. Known reserves of oil are declining. It is not good news. Unless somebody discovers a lot of oil very quickly, prices are going to go much higher over the next decade.

Justin Rowlatt: How high do you think the oil price could go then?

Jim Rogers:Justin, the price of oil is going to make new highs. It will go over $150 a barrel. It will probably go over $200 a barrel.

Justin Rowlatt: Over $200 a barrel? I mean that’s a world record high, isn’t it?

Jim Rogers: Of course it is, but Justin, the world is running out of known reserves of oil. Maybe there is a lot of oil in the world, but if there is, we don’t know where it is or how to get to it.

Justin Rowlatt: You got the pre-salt deposits off the coast of Brazil, there is Arctic oil, I mean there are big reserves of oil yet to be tapped, aren’t there?

Jim Rogers:Justin, those reserves off the coast of Brazil are wonderful if you own them, but even the wildest and most optimistic estimates would only add one year’s reserves to the world. The world is using 86 million barrels of oil everyday Justin. Even if it stays static or goes down a little bit, those finds off Brazil will make somebody rich, but they are not going to solve the world’s problems. And, if you know of a lot of oil in the Arctic, please tell us where it is, but it is going to be very difficult to get it out of there.

Justin Rowlatt: What other things should people be looking out for do you think Jim?

Jim Rogers:Well, there are many parts of the world economy which are going to do well no matter what happens. Chinese agriculture is going to boom because Mao Zedong ruined agriculture in China and now they are spending huge amounts of money trying to solve the problem.

Water is going to be a great growth industry, because India has a huge water problem, China does, America does. Many places have big water problems, so huge fortunes will be made in water in the future.

Chinese tourism is going to boom. They have not been able to travel for about 300 years. Now they can get passports easily. They can take money out of the country. And Justin, there are 1 billion 300 million of them. They want to see their own country and they want to see the world. It is going to be a great growth industry.

Justin Rowlatt: You said that obviously there are going to be issues for water for countries like China and India in the future. How would you make money out of the kind of water demand that there is in many developing countries?

Jim Rogers: Well Justin, countries can survive civil war, epidemics, all sorts of things, but one thing the countries cannot survive is that they run out of water. China has a terrible water problem in the north as does India, which has an even worse problem. So if you can figure out a way to transport it, pump it, clean it, whatever you got to do, you will make a lot of money in water.

I would not suggest you own water, because if you own water, when things get really bad, the politicians will sneer and say, “You filthy horrible capitalist, you are making money off people’s God given right to water.” And if you are lucky, they will hang you in the city square. But if you can solve the water problems, they will build a monument to you in the city square and you will be extremely rich.

Original source

Silver IS The New Gold

Submitted by Ryan Jordan on Sun, 23 Jan 2011

A Popular Delusion Called Cheap, Industrial Silver

From the beginning of the financial crisis in 2008, contrarian investors began murmuring about getting into gold and short term Treasuries. It was almost a mantra: gold and Treasuries… gold and Treasuries. Something missing? There certainly was from the perspective of the silver bugs. But the conventional wisdom, among goldbugs at least, was that silver was a mere “industrial metal” that would easily drop in a weak economy. And those who referred to silver as an “industrial metal” seemed to be backed up by the COMEX exchange in 2008, where the price of silver was basically cut in half, from twenty dollars to below ten. This takedown may have seemed justified at the time because the super rich were not loading up on bulky thousand ounce bars of silver, but smaller, more portable, easily stored amounts of gold. Silver was left out, ignored, shunned, and that seemed to be just the way the market worked.

I remember thinking in the fall of 2008 that part of this push into gold and Treasuries really was motivated by memories of what people did between 1929 and 1932. You see, the last time we had a Depression “gold and Treasuries” was the common sense move to protect assets. Silver in 1930? Silver was practically a base metal, it was in the coinage you used to buy a hot dog. Remember that at the depths of the Depression the mine supply of silver was nearly 5 TIMES the domestic US demand for both industry and coinage!! Things were so bad for silver that western Senators demanded that the U.S. prop up the silver price after it dropped to under 50 cents an ounce! Needless to say, few Americans in the last Depression thought of silver as the go-to monetary metal to protect wealth against a shattered banking system.

Fast forward 45 years and the view of silver as an abundant, cheap industrial metal would be further reinforced in the aftermath of Silver Thursday in 1980. This is because the price spike in the mid to late 1970s was not coming from industrial demand- that peaked about six years earlier, in 1974. Rather the price surge was coming from the Hunt Brothers’ Corner on the COMEX: in other words, investment demand. All that was needed was for the COMEX to change the rules on the Hunts- a kind of capital control against the longs- and the price collapsed. As the price collapsed over 60% in the 1980s (with the help of government dishoarding), and as mine supply increased, once again the perception continued that silver was some sort of easily extractable, base metal. Gold was the money of the bankers- “he who has the gold makes the rules” was the tried and true saying. Silver? A distant second as far as those trying to insure their assets were concerned.

Suffice to say, most people in the investment world have been conditioned to believe that a silver shortage is impossible, in addition to being fixated on gold as the only insurance you need for your portfolio. This is the power of recent history, of the language that is used to describe silver (its industrial), and a view that is still encouraged by some gold dealers. While I haven’t done a poll, I would bet many in the gold industry assume that a genuine silver shortage for industrial purposes is highly unlikely. This perception is largely reinforced by the major world market maker in the white metal, the COMEX division of the New York Mercantile Exchange.

COMEX and thin ice on the Hudson

In my mind, the COMEX is simply a warehouse and storage center for silver. A large warehouse, yes, but a warehouse that is, frankly, living off of its former glory: once the exchange legitimately had access to hundreds of millions silver ounces that could be sold, but now it likely has less than 50 million ounces for sale (this data is almost a year old), or about 1.5 billion dollars. And given the lack of government stockpiles, and how little new mine supply goes into bullion, this 50 million ounces is in many ways irreplaceable. (I will address jewelry and silverware stockpiles below). To further show how small this 50 million silver ounces number is, the COMEX has less silver for sale than is stored by a well-known gold and silver closed-end fund, the Central Fund of Canada (the COMEX also has much less silver than the SLV ETF, but I realize many question what this ETF actually has under its direct control.) So why does the COMEX have such sway in the silver market? Because the COMEX enables big players to buy on paper, with big leverage- I guess what they call “liquidity” in the world of finance. On any given day the COMEX trades millions and millions of these paper “ounces” of silver. The vast majority of these contracts are not settled in physical silver- it is impossible to do so! But the volume of money passing through and over this silver warehouse is what makes the COMEX the alpha dog, the leader of the pack in terms of setting the world price in silver.

But in this era of uncertainty regarding our financial system, the paper leveraged nature of the COMEX leads many to question its viability as the world market maker in silver. Because at the end of the day, the paper game played on the COMEX demonstrates how floating exchange rates allow for the irresponsible mispricing of important strategic and industrial assets like silver (but the list could be included to other commodities.) Worse, there is a motive for banks in league with the Federal Reserve to use as many of their Federal Reserve Notes to play the short side of the paper game, even though these banks know full well they could not deliver on what they are selling short. But banks likely play this game to maintain the image that the fiat dollar is doing just fine: large price moves higher in gold and silver are a warning light regarding the end of the fiat dollar. However, the lower the silver price is kept by large banks and their naked short positions, the more silver is consumed in spite of a tightening physical market. The silver paper market, in other words, is completely and totally disconnected from the realities of supply and demand on the ground.

The casino-like quality of this paper market is related to the fallacy that you can just print more and more money and not have incredible shortages erupt in goods that cannot be printed. We are already seeing shortages for real things in places like Tunisia- we all have to wonder how long before these kinds of shortages come to the western world. But the FED is convinced that it can solve the employment problem with cheap money, and will continue to pretend the looming inflation problem does not exist. And the FED is not only showing disregard for poor people whose budgets are easily consumed by food increases. The callous attitude of the Federal Reserve System also extends toward the holders of capital- epitomized with the zero percent interest rate policy. This attitude is an expression of the fallacy that the holders of capital will always be relied upon to invest capital into risk taking ventures such as mines or other productive enterprises. This is a very dangerous, stupid assumption. What if those holders of capital feel abused by the banking elite and government authorities and refuse to take the risks necessary to provide the resources needed for the American economic model of growth at all costs? And what if those holders of capital decide to put their money into something unprintable- like silver? So, in my mind, the COMEX is one more, very important symbol of an unsustainable economic and monetary model. The implications of the COMEX running out of silver, or trying to institute capital controls when it fears a run on silver, could not be more bullish for the holders of the white metal.

For now, though, the COMEX price is generally honored by dealers. Yes, there are premiums for small amounts of silver, but there are not yet significant premiums for larger bars of silver. There are hundreds of thousands of major bullion dealers who aren’t big enough to rock the boat of COMEX pricing- at least not yet. But what happens if the silver inventory at the COMEX keeps dropping- irreplaceable inventory as far as I’m concerned- and all the leveraged paper players try to convert their paper into silver. If there are eighty more paper contracts settled in paper for every one settled in bullion, you get the idea what will happen when the other 79 try to rush into a silver market where the silver does not exist. In other words, the COMEX is susceptible to a bank run.

This is an important point: the silver market does not need any new “investors” for the price to go higher- it simply requires people holding paper silver (which is plentiful) to try to convert it into physical (which is scarce).

Although the physical scramble could occur by the populace who do not deal with the COMEX, at this point it is much more likely to be initiated at an institution such as the COMEX. When capital controls are put into place at the exchange to end the delivery of silver bullion to investors, there will be hundreds of billions of dollars trying to land on a pile of silver outside the exchange in the single billions of dollars. At some point, some of the estimated 20 billion ounces of jewelry and silverware may come into the market, but likely only at much higher prices. Think about it- how much does women’s silver jewelry cost when compared to its scrap value? In other words, silver prices will have to launch significantly higher before this jewelry comes out of hiding. And then, I predict, the Silver Users Association will make sure that it gets first dibs on what is being scrapped, leaving investors in the cold. Quite possibly, silver in coin and bullion will never be as plentiful as gold coin and bullion, even though some people still claim that there is some large overhang of silver which could make the amount of silver bullion equal to that of gold.

The trend is your friend

As a final point of fact, the above ground stockpile of silver- around 22 to 25 billion ounces and mostly jewelry and silverware at this point- has not changed much over the last half century. (Mind you, at the moment less than 1 billion are silver coins or bullion.) However, the above ground stockpile of gold has grown substantially from under 1 billion to nearly 7 billion ounces over the same time frame. Beside the fact that the above ground ratio of all silver to gold is less than 4 to 1 (and not 50: 1 as currently expressed in the price), the trend in physical gold and silver is clearly toward parity, or at least something close to it. And yet here we are with silver having recently “corrected” in price to a mere $27.50 an ounce, while gold is $1350. Silver- which could one day get awfully close to the price of gold- remains very much a screaming buy.

Jim Rogers Calls for $200 Oil, Remains Bullish on the Yuan; Limiting Factors Rogers Misses

Jim Rogers says oil will hit $200. Please consider this audio interview with Justin Rowlatt at the Business Daily.

Justin Rowlatt: Do you really believe the Chinese boom can continue, because lots of people are saying there are all sorts of asset price bubbles that are going to trip the Chinese up in the coming years?

Jim Rogers: Well, the only asset bubble I see potentially in China is in urban coastal real estate, but real estate is not nearly the entire Chinese economy as it was in America and the U.K. Sure, they will have setbacks.

Justin, in the 19th Century, America had a horrible civil war. We had 15 depressions with a ‘D.’ We had very few human rights. We had massacres in the streets regularly. We had very little rule of law. You could buy and sell – you can still buy and sell congressmen in America, but in those days they were cheap. America had horrible problems, but they came out of that and had a pretty good 20th Century.

Justin Rowlatt: So what does that imply about where people should put their money; where are the sensible investments in Asia?

Jim Rogers: Well, the best way to invest in Asia in my view is to buy commodities, because the Chinese have to buy cotton, they have to buy zinc, they have to buy oil, they have to buy natural resources because they don’t have enough.

If you want to invest in China and you own cotton, they are going to be very nice to you Justin. They are going to pay the bills, they are going to take you to dinner, they are going to pay you on time. If you want to invest in stocks, you have to do a lot of homework and know what you are doing. Another way is to invest in the currency. I own the renminbi. I expect the renminbi to go up a great deal over the next decade.

Justin Rowlatt: But commodities are already at relatively high prices, aren’t they? I mean hasn’t that horse bolted already?

Jim Rogers: No, no, the only commodity I know which is making an all time high is gold. Some commodities are up, yes. Sugar is up a lot, but Justin, sugar is still 50% below its all time high. How can you say that’s bolted? Silver is going up, but silver is 40% below its all time high. Yes, commodities have been going up recently, but they are still extremely depressed on a historic basis.

Justin Rowlatt: So what about oil? I mean oil prices are pretty high, aren’t they? Almost $100 a barrel. Are they really going to go higher do you think?

Jim Rogers: Well, the surprise is going to be how high the price of oil stays and how high it goes, because Justin we have had no major elephant oil discoveries in over 40 years. The International Energy Agency is going around the world pleading with people to listen. Known reserves of oil are declining. It is not good news. Unless somebody discovers a lot of oil very quickly, prices are going to go much higher over the next decade.

Justin Rowlatt: How high do you think the oil price could go then?

Jim Rogers: Justin, the price of oil is going to make new highs. It will go over $150 a barrel. It will probably go over $200 a barrel.

 

A Picture Worth A Thousand Words

This chart depicts the current condition of the concentrated short position for every applicable physical world commodity, in terms of days world production, from data published by the CFTC. (Chart courtesy of sharelynx.net)

There is no legitimate economic reason why silver would have such a large concentrated short position, when compared to every other physical commodity. I conclude that the abberation in silver (and, to a lesser extent, gold) can only be explained by manipulation. This is the point that the CFTC and the NYMEX continue to evade.

So – the price of Silver and gold is being fixed. How long can it be before it breaks free?