Thursday, August 04, 2011

Financial house of cards is tumbling…

I’ve reviewed a number of current articles concerning weakness of European banks, especially Italy’s, the struggling Eurozone economy, and the influence of US debt limit discussion on the world’s financial psyche.

There is growing consensus that the Eurozone’s structure is to blame and cannot be sustained.  It is a “one-size fits-all” institution.  It is not fully integrated enough for a “central bank” to move money around to where it’s needed.  Critics suggest that “national politics” is in the way.  For example, relatively well off Germany will never agree to sacrifice its own strong economy to save Italy or Spain.  Euro bailouts of Greece, Ireland, and Portugal have exhausted the political will and fiscal capacity of stronger European countries to continue their bleeding into weaker nations economies.

It is likely that Italy’s banks will fail and the economic systems of other Euro countries will follow suit.  This will create additional stresses on the US economy, most prominently in the form of pressure to raise borrowing costs.

There are a number of economic head-scratch provoking situations that have occurred today.

Why did commodities fall along with the stock market?  Commodity prices usually rise when stocks fall.  The popular answer is that the commodity markets are anticipating a decline in production which means a decline in energy usage, i.e. oil.  But that doesn’t explain why gold and silver prices fell significantly.  One explanation is that hedge fund managers had to liquidate anything they owned to come up with cash to cover their positions in the falling equities market.  So they sold gold.

Why did the interest rate in treasuries plummet?  This has brought down the interest rate on home mortgages even lower than recent record lows.  It also has the peculiar effect of creating negative interest rates for institutions that have large amounts of funds in treasuries – in effect these institutions have to pay the government to keep their money.  Weird.  One explanation for these ultra-low treasury rates is European investors believing that the dollar (believe it or not) is a safer investment than the Euro at this point in time.  So funds are pouring into US treasuries, which pushes interest rates lower. 

All this makes the dollar, and thus our economy appear stronger, right?  Relative to Europe, it is.  But “appear” is the operative word.  The fact is, the European and US economies are sinking together.  It just so happens that the European economy is sinking earlier and faster.  But make no mistake.  We are going down as well.

Many experts claim that the cause of all of this financial stress is that money is not circulating.  How can interest rates remain at record lows for so long without causing the hoards of dollars to circulate?  It is being hoarded out of an abundance of uncertainty.  But why is there uncertainty?  Governments have been mismanaged.  Political interest groups have demanded more and more costly government programs.  Governments have spent well beyond any sustainable revenue stream and have entitlement commitments that only sovereign defaults and bankruptcies can erase.  The trust of the people of the nations in their governments and in their government’s fiscal Ponzi schemes is eroding.  You will begin hearing popping sounds in one or two European countries, then in  four or five, and then the US.  There is no one to effectively bail out Italy.  And there is definitely no one to bail out the United States.

This is looking more and more like a world-wide perfect economic storm.

Once the institutions sell the commodities they need to prop up their remaining equity holdings, you will see gold and silver resume their upward trend.

The question of interest to me is to what extent will all this eventually result in civil unrest and societal breakdown in the US.  You’ve seen only the beginnings in several European countries.

There are dozens of insightful articles on these topics published today and available by Googling “Italy bank run” “Euro default” and looking for August 4 or 5 dates.  One article worthy of note is this one from The Blaze.

And a very good insight into what is driving the world’s economy and the likely near-term outcome is a book by Vox Day titled “Return of the Great Depression.”  Get it.  Read it.

Happy financial planning!



Ann Barnhardt wrote the following a couple hours after I wrote the piece above last night.  And she knows more about the economy than I do…


Notes on the Global Market Crash

Posted by Ann Barnhardt - August 4, AD 2011 11:16 PM MST

1. I think metals and all commodities were down hard Thursday (counterintuitively) for two reasons. 1.) Major metals and commodities holders - possibly in Europe - were liquidating long positions in order to get an influx of needed cash and 2.) people are scared of another massive margin requirement increase exactly like what happened on May 2nd when the CME doubled margins in one day. People were scrambling to get out or at least boost their cash position ahead of that.

2. The Hang Seng in Tokyo has opened and is crashing - down 4.75% as of this writing.

3. The worst news though is out of Europe. Italy MAY be facing a full-blown bank run situation.

I'll let KD explain it, quoting Larry Kudlow.

4. Also worth your time is this post at Copy and paste this URL into your address bar:  

Mutual funds are carrying hardly any cash - the lowest cash levels ever. What this means is that they have no excess buffer or slack to absorb this selloff. My futures clients understand this. If they have no buffer, they will be forced to liquidate positions (aka liquidating to meet the margin call), which will feed the selloff even more. Very, very bad.

This could be it, guys. We knew a collapse was inevitable, but this may be it. I agree with KD above that we could easily be looking at taking 30% off the market in fairly short order. That would retrace the Dow to 8000. The 2009 low was 6500ish, and beyond that there is a very firm support plane at zero. Interest rates are already at zero. The Fed has absolutely nothing left to do . . . except print money, which we know they will. And then we will be Zimbabwe.

Pray for strength and courage.

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