Archive for March, 2012

The stage 4 CANCER of the currency system:

By Graham Summers of Seeking Alpha

Cancer of the currency

Cancer of the currency

Friday I noted that the “addict/dealer” metaphor for the Fed’s intervention in the markets was in fact not accurate and that the Fed’s actions would be more appropriately described as permitted cancerous beliefs to spread throughout the financial system, thereby killing Democratic Capitalism which is the basis of the capital markets.

Today I’m going to explain what the “final outcome” for this process will be. The short version is what happens to a cancer patient who allows the disease to spread unchecked (death).

In the case of the Fed’s actions we will see a similar “death” of Democratic Capitalism and the subsequent death of the capital markets. I am, of course, talking in metaphors here: the world will not end, and commerce and business will continue, but the form of capital markets and Capitalism we are experiencing today will cease to exist as the Fed’s policies result in the market and economy eventually collapsing in such a fashion that what follows will bear little resemblance to that which we are experiencing now.

The focus of this “death” will not be stocks, but bonds, particularly sovereign bonds: the asset class against which all monetary policy and investment theory has been based for the last 80+ years.

Indeed, basic financial theory has proposed that sovereign bonds are essentially the only true “risk-free” investment in the world. While history shows this theory to be false (sovereign defaults have occurred throughout the 20th century) this has been the basic tenant for all investment models and indeed the financial system at large going back for 80 some odd years.

The reason for this is that the Treasury (US sovereign bond) market is the basis of the entire monetary system in the US and the Global financial system in general. Indeed, US Treasuries are the senior most assets on the Primary Dealers’ (world’s largest banks) balance sheets. To understand why this is as well as why the Fed’s policies will ultimately destroy this system, you first need to understand the Primary Dealer system that is the basis for the US banking system at large.

If you’re unfamiliar with the Primary Dealers, these are the 18 banks at the top of the US private banking system. They’re in charge of handling US Treasury Debt auctions and as such they have unprecedented access to US debt both in terms of pricing and monetary control.

The Primary Dealers are:

Bank of America (BAC)
Barclays Capital Inc. (BCS)
BNP Paribas Securities Corp. (BNP)
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc. (C)
Credit Suisse Securities (USA) LLC (CS)
Daiwa Securities America Inc. (DSECF.PK)
Deutsche Bank Securities Inc. (DB)
Goldman, Sachs & Co. (GS)
HSBC Securities (USA) Inc. (HBC)
J. P. Morgan Securities Inc. (JPM)
Jefferies & Company Inc. (JEF)
Mizuho Securities USA Inc. (MFG)
Morgan Stanley & Co. Incorporated (MS)
Nomura Securities International Inc. (NMR)
RBC Capital Markets
RBS Securities Inc. (RBS)
UBS Securities LLC. (UBS)

I’m you’ll sure you’ll recognize these names by the mere fact that they are the exact banks that the Fed focused on “saving” thereby removing their “risk of failure” during the financial crisis.

These banks are also the largest beneficiaries of the Fed’s largest monetary policies: QE 1, QE lite, QE 2, etc. Indeed, we now know that QE 2 was in fact was meant to benefit those Primary Dealers in Europe, not the US housing market.

The Primary Dealers are the firms that buy US Treasuries during debt auctions. Once the Treasury debt is acquired by the Primary Dealer, it’s parked on their balance sheet as an asset. The Primary Dealer can then leverage up that asset and also fractionally lend on it, i.e. create more debt and issue more loans, mortgages, corporate bonds, or what have you.

Put another way, Treasuries are not only the primary asset on the large banks’ balance sheets, they are in fact the asset against which these banks lend/ extend additional debt into the monetary system, thereby controlling the amount of money in circulation in the economy.

When the Financial Crisis hit in 2007-2008, the Fed responded in several ways, but the most important for the point of today’s discussion is the Fed removing the “risk of failure” for the Primary Dealers by spreading these firms’ toxic debts onto the public’s balance sheet and funneling trillions of dollars into them via various lending windows.

In simple terms, the Fed took what was killing the Primary Dealers (toxic debts) and then spread it onto the US’s balance sheet (which was already sickly due to our excessive debt levels). This again ties in with my “cancer” metaphor, much as cancer spreads by infecting healthy cells.

When the Fed did this it did not save capitalism or the Capital Markets. What it did was allow the “cancer” of excessive leverage, toxic debts, and moral hazard to spread to the very basis of the US, indeed the entire world’s, financial system: the US balance sheet/ Sovereign Bond market.

These actions have already resulted in the US losing its AAA credit rating. But that is just the beginning. Indeed, few if any understand the real risk of what the Fed has done.

The reality is that the Fed has done the following:

1) Set itself up for a collapse: at $2.8 trillion, the Fed’s balance sheet is now larger that the economies of Brazil, the UK, or France. And with capital of only $54 billion, the Fed is leveraged at 51 to 1 (Lehman was at 30 to 1 when it failed).

2) Called the risk profile of US sovereign debt into question: foreign investors, now fully aware that the US’s balance sheet is suspect (the US has lost its AAA credit rating), are dumping Treasuries (see China and Russia). This has resulted in the Fed now being responsible for the purchase of up to 91% of all new long-term (20+ years) US debt issuance.

3) Put the entire financial system (not just the private banks) at risk.

The financial system requires trust to operate. Having changed the risk profile of US sovereign debt, the Fed has undermined the very basis of the US banking system (remember Treasuries are the senior most asset against which all banks lend).

Moreover, the Fed has undermined investor confidence in the capital markets as most now perceive the markets to be a “rigged game” in which certain participants, namely the large banks, are favored, while the rest of us (including even smaller banks) are still subject to the basic tenants of Democratic Capitalism: risk of failure.

This has resulted in retail investors fleeing the markets while institutional investors and those forced to participate in the markets for professional reasons now invest based on either the hope of more intervention from the Fed or simply front-running those Fed policies that have already been announced.

Put another way, the financial system and capital markets are no longer a healthy, thriving system of Democratic Capitalism in which a multitude of participants pursue different strategies. Instead they are an environment fraught with risk in which there is essentially “one trade,” and that trade is based on cancerous policies and beliefs that undermine the very basis of Democratic Capitalism, which in the end, is the foundation of the capital markets.

In simple terms, by damaging trust and permitting Wall Street to dump its toxic debts on the public’s balance sheet, the Fed has taken the financial system from a status of extremely unhealthy to terminal.

The end result will be a crisis that makes 2008 look like a joke. It will be a crisis in which the US Treasury market implodes, taking down much of the US banking system with it (remember, Treasuries are the senior most assets on US bank balance sheets).

I cannot say when this will happen. But it will happen. It might be next week, next month, or several years from now. But we’ve crossed the point of no return. The Treasury market is almost entirely dependent on the Fed to continue to function. That alone should make it clear that we are heading for a period of systemic risk that is far greater than anything we’ve seen in 80+ years (including 2008).

The Fed is not a “dealer” giving “hits” of monetary morphine to an “addict”… the Fed has permitted cancerous beliefs to spread throughout the financial system. And the end result is going to be the same as that of a patient who ignores cancer and simply acts as though everything is fine.

That patient is now past the point of no return. There can be no return to health. Instead the system will eventually collapse and then be replaced by a new one.

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Will the Koreas now come to terms?

Reuters) – North Korea agreed on Wednesday to stop nuclear tests, uranium enrichment and long-range missile launches, and to allow checks by nuclear inspectors, in an apparent policy shift that paves the way for resuming long-stalled disarmament talks.

The surprise breakthrough, announced simultaneously by the U.S. State Department and North Korea’s official news agency, makes possible the resumption of six-nation nuclear negotiations with Pyongyang. It followed talks between U.S. and North Korean diplomats in Beijing last week.

“These are concrete measures that we consider a positive first step toward complete and verifiable denuclearization of the Korean peninsula in a peaceful manner,” White House spokesman Jay Carney said.

While analysts cautioned that Pyongyang has backtracked repeatedly on past deals, the moves by North Korea mark a sharp change in course, at least outwardly, by North Korea’s reclusive leadership following the death in December of veteran leader Kim Jong-il.

One senior U.S. official said the move “unlocked” an impasse over the six-party talks, but that follow-through would require persistence and patience.

“We believe that it’s important to translate this initial sign of Pyongyang’s seriousness of purpose into substantive and meaningful negotiations on denuclearization that get at the entirety of the North’s nuclear program,” the official said.

The State Department said that in return, the United States was ready to go ahead with a proposed 240,000 metric-ton food aid package requested by North Korea and that more aid could be agreed to based on continued need.

Along with halting weapons activities, North Korea said it would permit nuclear inspectors from the U.N.’s International Atomic Energy Agency to visit its Yongbyon nuclear complex to verify the moratorium on uranium enrichment has been enforced.

“The DPRK, upon request by the U.S. and with a view to maintaining positive atmosphere for the DPRK-U.S. high-level talks, agreed to a moratorium on nuclear tests, long-range missile launches, and uranium enrichment activity at Yongbyon and allow the IAEA to monitor the moratorium on uranium enrichment while productive dialogues continue,” North Korea’s official KCNA news agency said.

North Korea is known formally as the Democratic People’s Republic of Korea (DPRK).

Secretary of State Hillary Clinton told a Congressional panel the North Koreans had made “a modest first step in the right direction,” but noted that Washington continued to have profound concerns over a range of North Korean activities.

The IAEA, which withdrew its inspectors from North Korea in 2009, said it was ready to return, calling the moratorium deal “an important step forward.”

South Korea and Japan both welcomed the announcement, with the Foreign Ministry in Seoul saying it could form the basis for a broader agreement on North Korea’s nuclear program.

IMPROVING TIES?

The U.S. decision to resume food aid was a gesture toward Pyongyang, which has sought international help to cope with chronic food shortages.

The United States halted food aid to North Korea in 2009 amid a dispute over transparency and monitoring, compounding problems that have followed a crippling famine in the 1990s that killed an estimated one million people.

Under the new aid proposal, the United States is ready to provide about 20 metric tons of emergency nutrition per month, including corn-soy blend, vegetable oil and therapeutic foods to help fight chronic malnutrition among young children, pregnant women and other vulnerable people, U.S. officials said.

The surprise announcement was a step forward for Washington’s campaign to rein in renegade nuclear programs around the world and comes as the Obama administration steps up pressure on Iran over its nuclear ambitions, which western governments fear are aimed at producing nuclear weapons.

It also comes several weeks before U.S. President Barack Obama visits Seoul for a nuclear security summit in March.

Analysts called the deal an important preliminary step and said the return of IAEA inspectors would give the international community an important window into North Korea’s nuclear work.

“This puts an element of control back on the North Koreans’ nuclear development program as well as their existing capabilities that we have not had for almost four years,” said Jack Pritchard, a former U.S. negotiator with North Korea who heads the Korea Economic Institute.

But Pritchard said he believed it was unlikely that Pyongyang’s young and untested new leader Kim Jong-un was ready to comply with demands that he scrap the entire nuclear program.

“How does a 28-year-old give up the only legitimate piece of leverage that he has in dealing with the superpowers to preserve the survivability of his regime? He’s not going to do that,” Pritchard said.

In Congress, the powerful Republican head of the House Foreign Affairs Committee said Pyongyang would likely continue its clandestine nuclear program “right under our noses.”

“We have bought this bridge several times before,” Rep. Ileana Ros-Lehtinen said in a statement.

NEW LEADER AT THE TOP

The announcement followed talks between the United States and with North Korea last week in Beijing, the first such meeting since Kim Jong-un succeeded his father as leader of the communist state two months ago.

Bruce Klingner, a Korea analyst at the Heritage Foundation, said the move did not necessarily represent any fundamental change by Pyongyang, noting that it tracked a draft deal U.S. diplomats were nearing at the time of Kim Jong-il’s death.

“This is the first step in a very long road,” he said, saying it may simply provide the framework for additional meetings between the United States and North Korea to haggle over an agenda for any broader nuclear talks.

U.S. officials said it was up to North Korea to contact the IAEA to discuss resumed inspections, and that they expected tough negotiations over the sequence of steps to be taken.

“I wouldn’t look for people to be in motion right away here,” one official said.

North Korea agreed to curtail its nuclear activities under a an aid-for-denuclearization agreement reached in September 2005 by six-party talks bringing together North and South Korea, China, Japan, Russia and the United States.

Under the agreement, the North agreed to abandon its nuclear programs in exchange for economic and diplomatic incentives to be provided by the other parties involved in the negotiations.

But the embryonic deal was never fully implemented.

Instead, the North held two nuclear test blasts — in 2006 and 2009 — and later disclosed a uranium enrichment program, giving it a second path to obtaining fissile material for bombs, in addition to its long-standing program of producing plutonium.

The United States, South Korea and their allies had been skeptical of North Korea’s assertions that it stands ready to return to the six-party talks, and U.S. officials said they would insist on demonstrable progress.

“The truth is we’ve been around the six-party block before. It has a history of ups and downs, sometimes more downs than ups … we can’t allow the same patterns of the past to repeat themselves.”

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