The Death of the Dollar is Nigh

The Gold Report

If dollar-dumping turns from a trickle into a flood, look out. Exploding prices (aka exorbitant inflation) resulting from the devaluation of the dollar will compound the problems we saw in 2007–2009. Catastrophe will come when everybody realizes that the dollar is an "IOU nothing." That's the downside in the decade(s) ahead, according to Casey Research Chairman Doug Casey. But an optimist at heart, in this exclusive interview with The Gold Report, Doug also identifies some reasons to be hopeful.

The Gold Report: You've been talking about two ticking time bombs. One is the trillions of dollars owned outside the U.S. that investors could dump if they lose confidence. And the other is the trillions of dollars within the U.S. that were created to paper over the crisis that started in 2007. Are these really explosive circumstances that will bring catastrophic results? Or will it just result in a huge, but manageable, hangover?

Doug Casey: Both, but in sequence. One thing that's for sure is that although the epicenter of this crisis will be the U.S., it's going to have truly worldwide effects. The U.S. dollar is the de jure national currency of at least three other countries, and the de facto national currency of about 50 others. The main U.S. export for many years has been paper dollars; in exchange, the nice foreigners send us Mercedes cars, Sony electronics, cocaine, coffee—and about everything you see on Walmart shelves. It has been a one-way street for several decades, a free ride—but the party's over.

Nobody knows the numbers for sure, but foreign central banks, and individuals outside the U.S., own U.S. dollars to the tune of something like $6 or $7 trillion. Especially during the recent crisis, the Fed created trillions more dollars to bail out the big financial institutions. At some point, foreign dollar holders will start dumping them; they are starting to realize this is like a game of Old Maid, with the dollar being the Old Maid card. I don't know what will set it off, but the markets are already very nervous about it. This nervousness is demonstrated in gold having hit $1,900 an ounce, copper at all-time highs, oil at $100 a barrel—the boom in commodity prices.

Some countries are already trying to get out of dollars, but it could become a panic if the selling goes from a trickle to a flood. So, yes, it's a time bomb waiting to go off, or maybe a landmine waiting to be stepped on. If a theatre catches fire and one person runs out, soon everybody rushes toward the door and they all get trampled. It's a very serious situation.

TGR: If panic erupts on the U.S. dollar, would products manufactured in the U.S. become super-cheap or super-expensive?

DC: They would become super-cheap. Everybody says that devaluing the dollar will stimulate U.S. industry because the products will become cheaper and foreigners will buy them. This is a huge canard everybody repeats and nobody thinks about. Yes, it is true for a while, but if devaluation were the key to prosperity, Zimbabwe should be the most prosperous country in the world as it has already collapsed its currency.

A strong currency is essential for a strong economy. Sure, a strong currency can hurt exporters for a while. But, a strong currency encourages manufacturers to invest in technology, and become more efficient. It rewards savings and results in the growth of capital that's critical for prosperity. A strong currency allows businessmen to buy foreign companies and technologies at bargain prices. It results in a high standard of living for the country, and yields social stability as a bonus. The idea that decreasing the value of currency to stimulate exports is a short-lived, stupid and counterproductive solution to the problem. People seem to forget that while the German currency was rising about sixfold from its level of 1971, and the Japanese yen about fourfold, those countries became the world's greatest export economies. It didn't happen despite a strong currency, but in large measure because of it.

TGR: Given that the U.S. is the world's biggest consuming nation, wouldn't fleeing the dollar create a big consumer vacuum in the international community? Doesn't the rest of the world want to keep up the high level of exports to these U.S. consumers?

DC: That's exactly why the U.S. is in such trouble; it's idiotically focused on consumption, while only production can create prosperity. The world doesn't need to stimulate consumption. This is another canard, because everybody has an infinite desire for goods and services. I know for myself, I'd like not just a car, but 10 Ferraris, a couple of Gulfstreams and 10 houses around the world. So, by myself, I have an infinite desire for goods and services. Multiply that by 7 billion other people. The only way to gratify those desires is by producing enough to trade with other people to give you what you want. When so-called "economists" think the problem is that we don't have enough consumption, that shows that the profession itself is bankrupt. It's actually quite embarrassing.

TGR: But other countries currently produce enough of what the U.S. wants. With U.S. dollars, that trade won't look good on their side eventually.

DC: The problem is the U.S. doesn't produce enough in return. The U.S. has been lucky to have a currency that has, so far, been accepted by everybody. But when everybody realizes that the dollar is an "IOU nothing" on the part of a bankrupt government and a society that doesn't really produce anything anymore, it's going to create a worldwide catastrophe. Those $7 trillion held by foreigners are going to become instant hot potatoes.

TGR: Considering what you said a moment ago, that the world doesn't need to stimulate consumption, you must find some irony in the Obama administration's plan to stimulate consumption again in the U.S. as a way to spur some economic growth.

DC: I'm afraid that after being counseled by the fools that surround him, Obama talking about economics is like the blind leading the doubly dismembered. They want to spend $450 billion trying to create new jobs—but these are government jobs, where you have people digging holes during the day and filling them up at night to create the appearance of employment. No government has any idea what the market really wants and needs. There should be zero government involvement in this. The government cannot and should not even try to create jobs. If Obama wants to stimulate the economy, he can decrease the size of the government. I would say a 90% reduction would be a good starting figure.

TGR: But that will create even more unemployment. That's one of the big concerns. States laying off employees could increase unemployment even more.

DC: It is wonderful that states are starting to lay off employees. Once they lose their state jobs, which suck wealth from taxpayers, maybe those people can find real, productive jobs providing goods and services that people actually want and will pay for voluntarily. So I'd argue that getting rid of state employees is essential to a sound recovery plan.

TGR: You warned early on in the 2008–2009 economic crisis that it would really be more of a hurricane. In the last year or so, we've been in the eye of the hurricane and there's more turmoil to come. Will the other side of the storm be worse than the first? And given the recent economic news, do you think we have moved out of that eye?

DC: Yes, I think we are moving out of the eye and going into the other side of the storm. This storm will be much more severe because we haven't solved any of the problems that caused the hurricane in the first place. The fact that governments all over the world have created trillions of currency units has only aggravated those problems. Now, I expect exploding prices to compound the problems that we saw back in 2007, 2008 and 2009. That will devastate the prudent people in society who saved money. They saved it in the form of currency, and wiping out their savings will be catastrophic.

TGR: Will this affect only North America and Europe?

DC: Mostly North America and Europe, but it's going to be very serious in Japan, too. It could be even more disastrous in China. The Chinese real estate market bubble is very inflated, driven by the lending of Chinese banks that won't be able to recover their loans. They will all go bankrupt, taking out the Chinese populace's savings with them. At the same time, those who own real estate will find it worth vastly less than what they paid for it. Those problems will create social disruptions in China, leading to riots, perhaps even revolution, and who-knows-what. The fallout is going to be terrible.

TGR: Many pundits and economists still project growth in China, albeit at a lower rate, and anticipate further expansion of the middle class.

DC: The 21st century will be the Chinese century, but the distortions and misallocations of capital that have occurred over the last 30 years—notwithstanding the truly phenomenal progress the country has made—are serious and have to be washed out. I am a huge bull on China for lots of reasons, but I am bullish for the long run. I think it is going to go through the meat grinder over the next 10 years. I don't know how it will come out; maybe China will break up into five or six different countries. Actually, that would be a good thing. Most of the world's nation-states are artificially constructed and too big to be manageable as political entities.

TGR: Your outlook on China fits right in with something you've been saying for years—about this being the "Greater Depression," which is also the topic of your upcoming presentation at the sold-out Casey Research/Sprott Inc. "When Money Dies" summit next month in Phoenix. Your opening general session talk is entitled, "The Greater Depression Is Now." We are now four years into it, based on your 2007 start date.

DC: Actually, depending on how long a historical scale you look at, you could say that, for the working class in the U.S. anyway, the depression started in the early 1970s. After inflation, after taxes, their take-home pay hasn't risen in real terms for 40 years. But the definition of a depression that I use is "a period of time during which most people's standard of living drops significantly."

Net savings shows that you're living within your means and putting aside capital for the future. In the U.S., people have been living above their means for many years—that is what debt is all about. Debt means that you are borrowing against future production, which is exactly what the U.S. has been doing.

TGR: So, how long will this Greater Depression last?

DC: It doesn't have to last long at all. It could be quite brief if the U.S. government, which is basically the root cause, retrenches vastly in size and defaults on the national debt, which is essentially an enormous mortgage, an albatross around the neck of the next several generations of Americans. The debt will be defaulted on one way or another, almost certainly through inflation. I simply advocate an honest, overt default; that would serve to punish those who, by lending to the government, have financed its depredations. Distortions and misallocations of capital that have been cranked into the economy for many years need to be liquidated. It could be unpleasant but brief. The government is likely to do just the opposite, however. It will try to prop it up further and make it worse—compounding the problem by expanding the wars. So, it could last a very long time. In that sense, I'm not optimistic at all. I think there is little cause for optimism.

On the other hand, I'm generally optimistic for the future. There are only two causes for optimism. First, smart individuals all over the world continue, as individuals, to produce more than they consume and try to save the difference. That will build capital, which is of critical importance. They should just save by holding paper currency. Second, expanding and compounding technology will increase the standard of living. Remember that there are more scientists and engineers alive today than have lived in all previous history combined. Those two factors countervail the government stupidity around us. Whether they will be overwhelmed and washed away by a tsunami of statism and collectivism, I don't know.

TGR: You say that the U.S. government is the root cause of this problem. Isn't that putting too much blame for a worldwide problem on one nation?

DC: The institution of government itself is the problem, and the problem is metastasizing like a cancer all over the world. But, sad to say, the U.S. is the most serious offender because it is currently both the most powerful and the most aggressive nation-state. It has been greatly abetted by the fact that the U.S. currency has been accepted globally. The U.S. dollar is, in effect, the reserve that backs all the other currencies in the world. That is why the U.S. government has been the most destructive from an economic point of view. Furthermore, military spending—which in the U.S. equals that of all the other militaries in the world combined—is purely destructive. It serves no useful economic purpose at all. The military is no longer "defending" anything—least of all liberty. It's actively creating enemies and provoking conflict. So, yes, I think the U.S. government is actually the most dangerous force roaming the world today.

TGR: Do you see that changing after the next election?

DC: No. I think the chances of Obama being reelected are high, simply because more than half of Americans are big net recipients of state largesse. The U.S. has turned into a larger version of Argentina politically, where the electorate is effectively bribed to vote for the biggest thief. It is likely to turn out much worse than Argentina, however. Unlike the Argentines, the U.S. government is fairly efficient. And, unlike Argentina, the U.S. is rapidly turning into a police state.

Electing a Republican might be even worse, though. With the exception of Ron Paul and Gary Johnson, the potential Republican candidates absolutely make my skin crawl. So, no, there is no help on the horizon. The U.S. government is spending about $1.5 trillion more this year than it takes in, and it is not going to cut that. In fact, foolish spending to bail things out will increase. And, worse than that, the Fed has artificially suppressed interest rates for three years. Interest accounts for roughly 2% of $15 trillion official national debt, or $300 billion per year. As interest rates inevitably rise, that interest amount will grow. At 12%—and I'm afraid they'll have to go even higher than that—it would add another $1.5 trillion just in interest payments.

I absolutely see no way out without a collapse of the U.S. currency and a total reordering of the U.S. economy.

TGR: When Money Dies, the title of your summit, implies some return to a gold standard. How do you see that playing out?

DC: Nothing is certain, but when the dollar disappears—and it's going to reach its intrinsic value soon—what are people going to use as money? Will we gin up another fiat currency like the euro? The euro is likely to fail before the dollar. My suspicion is that people will want to go back to gold. It's not because gold is anything magical, but simply the one of the 92 naturally occurring elements that—for the same reasons that make aluminum good for planes and iron good for steel girders—is most useful as money. In fact, the reason that gold has risen as high as it has is that the central banks of third-world countries—places that don't have large gold reserves, such as China, India, Korea, Russia, even Mexico—have been buying the stuff in size.

TGR: The concept of going to a gold standard seems impossible in the sense that there is only so much gold above ground—6 billion ounces? Maybe $11 trillion worth? But it's only a fraction of the U.S. GDP. Even with gold at $2,000 an ounce, that leaves an immense gap. In that scenario, how do you convert to a gold standard?

DC: In terms of today's dollars, gold should probably be a lot higher than it is. I don't know what the number will be, because a lot of those dollars will disappear in bankruptcies; they will dry up and blow away. It's like a real estate development that was worth $1 billion on somebody's books; when it fails, that's $1 billion destroyed. It's a question of the battle of inflation (with the government creating dollars to prop things up) against deflation (where businesses fail and wipe out dollars). But put it this way: the U.S. Government reports it owns about 265 million ounces. Its liabilities to foreigners alone are at least $6 trillion. If they were to be redeemed for a fixed amount, that would require roughly $22,000/oz. gold. And that doesn't count dollars in the U.S. itself.

I'm a bargain hunter and a bottom fisher, and bought most of my gold at vastly lower prices. But I think gold is going much higher because most people still barely even know that the stuff exists. As inflation picks up, they are going to want to get rid of these dollars—but what other monetary commodity can they turn to? So, gold is going higher. I'm still accumulating gold.

TGR: You said that the storm as we emerge from the eye of the hurricane will be worse than it was on the other side. If they don't own gold, how do investors protect themselves?

DC: It's very hard to be an investor in today's world because an investor is someone who allocates capital in a way to create new wealth. That is not easy in today's highly taxed and regulated economy. It's late in the day, but not too late, to buy gold, silver and other commodities. Productive assets are good to own. Of course, the easiest way to buy most productive assets is through the shares of publicly traded companies, but the stock market is quite overvalued in my opinion, so that's not the best option right now.

In addition to trying to build personal holdings of gold and, to a lesser degree, silver, I think people should learn to be speculators. This is not to be confused with gamblers, who rely on random chances. Speculators position themselves to take advantage of politically caused distortions in the marketplace. In a true free market society, you would see very few speculators because there would be few such distortions. But regulations, taxes and currency inflations are likely to keep markets very volatile. Good speculators will position themselves to take advantage of bubbles, and identify bubbles that have been blown to their maximum and are about to deflate.

Government actions are going to force people to become speculators, whether they like it or not. Most won't like it, and very few will be good at it.

TGR: What bubbles might speculators look to exploit?

DC: I'd say the world's biggest bubble is real estate in China, but real estate bubbles are just starting to deflate elsewhere, too—in Australia and Canada, for example. It's relatively hard to short real estate, of course. Shorting bank stocks is an indirect way to play it. I'd say bonds are the short sale of the century. They're going to be destroyed. Bonds pose a triple threat to capital because:

Interest rates are artificially low, and as interest rates rise—which they must—bonds will fall.
Bonds are denominated in currencies, and most currencies, let's say dollars, are going to lose a lot of value.
The credit risk of most bonds, certainly those issued by governments, is high.

On the long side, mining stocks are very cheap relative to the price of gold right now. I'd say there's an excellent chance of a bubble being ignited in gold mining stocks, especially the small ones; in fact, I'd put my finger on that as likely being the easiest way to make a killing.

TGR: Technology was one of the two areas of optimism you mentioned earlier. Do you see a bubble forming there?

DC: You have a point, but I'm not sure you can talk about technology stocks as a whole; technology is too variegated, too vast a field. Although, I've long been a huge believer in nanotech, which is likely to change the world as we know it. With gold stocks, however, you can jump into a discrete universe, that's likely to become a mania.

TGR: Thank you for the tips, Doug, and as always, for your thoughtful insights.

Doug Casey, chairman of Casey Research LLC, is the international investor personified. He's spent substantial time in over 175 different countries so far in his lifetime, residing in 12 of them. And Doug's the one who literally wrote the book on crisis investing. In fact, he's done it twice. After The International Man: The Complete Guidebook to the World's Last Frontiers in 1976, he came out with Crisis Investing: Opportunities and Profits in the Coming Great Depression in 1979. His sequel to this groundbreaking book, which anticipated the collapse of the savings-and-loan industry and rewarded readers who followed his recommendations with spectacular returns, came in 1993, with Crisis Investing for the Rest of the Nineties. In between, his Strategic Investing: How to Profit from the Coming Inflationary Depression broke records for the largest advance ever paid for a financial book. Doug has appeared on NBC News, CNN and National Public Radio. He's been a guest of David Letterman, Larry King, Merv Griffin, Charlie Rose, Phil Donahue, Regis Philbin and Maury Povich. He's been featured in periodicals such as Time, Forbes, People, US, Barron's and the Washington Post—not to mention countless articles he's written for his own various websites, publications and subscribers.

At the sold-out Casey/Sprott Summit "When Money Dies," more than 20 seasoned investment pros, economists and freethinkers will provide their insights and advice on the coming currency collapse and what you can do to protect your assets. Listen to the timely investment advice and specific stock recommendations of North America's top financial experts from the comfort of your home—in 20+ hours of power-packed audio recordings on CD (or MP3). Pre-order now and save $100 off the regular price.

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ETF's Dangerous Gearing Instruments (WMFD)

Weapons of Mass [Financial] Destruction WMFD  - the 'de-commissioning' of which is affecting the whole banking system.

London, UK - 18th September 2011, 17:35 GMT

The World as Risk?

We have mounted an investigation into the role of Exchange Traded Funds (ETFs) linked to the $2 billion black hole at UBS. We have uncovered a complex entangled world wide web of $1.4 trillion including derivative exposures and counterparty risks.

ETFs: Rising Proliferation, Rising Risk

Extreme Perils of Exchange Traded Funds (ETFs), Derivatives and Unlimited Black Swans (UBS)

Exchange-traded funds are back under the spotlight because of their connection with the alleged $2bn "rogue trader" scandal at UBS's Delta One ETF operation. No one who truly understands the technical makeup of these financial instruments is surprised to see the words ETF and rogue trader in the same sentence! However, purveyors who believe that ETFs are good enough financial "assets" for "widows and orphans" act clueless and some feign total surprise.

Financial Stability Threatened

Regulators around the world have expressed concern that ETFs might be a new source of market instability for nearly a year now.

1. America's Securities and Exchange Commission (SEC) has launched a probe this week into whether ETFs are contributing to market volatility by offering investors a way to quickly lift and reduce their exposure to the financial markets. This, in turn, forces large entries and exits from the underlying securities, or derivatives, that mirror the assets or asset class that the ETFs seek to track.

2. The Bank of England warned in June 2011 that ETFs are potentially dangerous for unsophisticated investors. The rogue trading event that hit Societe Generale in 2008 also originated on a desk that was buying on the market to compile portfolios that underpinned ETFs. The UK's new Financial Policy Committee (FPC) has warned that ETFs are shrouded in "opacity and complexity". It said it was concerned that ETFs "could become a source of risk to the system as the market evolves".

3. The Financial Stability Board (FSB), an international super-regulator based at the Bank for International Settlements in Basel, Switzerland, wrote a prescient paper "Potential financial stability issues arising from recent trends in Exchange Traded Funds (ETFs)" in April 2011. Its central warning was that ETFs are neither cheap nor transparent.

What are ETFs?

ETFs are listed securities that mirror various assets or asset classes, including shares, market sectors, indices, commodities, fixed-interest securities and their sectors.

How big are ETFs?

The ETF market is growing rapidly. It was relatively minor on the financial landscape when the new century began, with investments of just $74.3 billion, all of it in equities. ETFs grew to $797 billion in 2007 when the global financial crisis erupted, and passed $1 trillion in 2010. BlackRock, the US-based asset manager that owns the biggest ETF provider, iShares, estimates that ETF assets totalled $1.4 trillion on 49 global exchanges by June 30, 2011, and forecasts that their total will pass $2 trillion in 2012.

Popularity

The last decade saw an explosion in the popularity of ETFs because of their well known benefits:

1. Relatively low costs;
2. Buying and selling flexibility including the capacity to trade them throughout the day;
3. Tax efficiency including favoured status by tax regimes;
4. Market exposure and diversification; and
5. Implied transparency.

Majority of ETFs are traded by institutional investors and hedge funds. Acceleration in growth of ETFs is linked to their presence on superannuation and other retail investment platforms in the secondary market. It is often incorrectly claimed that ETFs are simple products. Once upon a time, this was true. Now, this argument no longer holds water. Many ETFs are extremely complex and simply beyond the comprehension of individual investors and professionals alike.

Derivatives

Some ETFs do not hold physical assets of the sort they seek to track. They are "synthetic" and hold derivatives. For example, around half of the ETFs in Europe today do not match the index they are designed to track by holding all of its constituent shares. Unlike the plain vanilla "full replication" old ETFs which used to do so, nearly half of the new market is in the form of so-called "swap-based" ETFs which instead use derivative agreements, often with investment banks, to simulate the performance of the underlying assets. When an ETF security is bought, the investment bank or funds management group that is selling the ETF buys corresponding exposure, to pair the ETF's performance with the assets it is tracking. This is sometimes done by purchasing the physical asset -- shares or a share index -- but as the industry has grown it has become increasingly common for ETF vendors to take the exposure by buying derivatives, and to also use derivatives to insure against unwanted extraneous market movements.

Leveraged ETFs

Leveraged ETFs are a special type of ETF that attempt to achieve returns that are more sensitive to market movements than non-leveraged ETFs. They require the use of financial engineering techniques, including the use of equity swaps, derivatives and rebalancing to achieve the desired return. The most common way to construct leveraged ETFs is by trading futures contracts. The rebalancing of leveraged ETFs may have considerable costs when markets are volatile and can lead to substantial losses.

Counterparty Risks

The derivative-based make-up of ETFs gives rise to counterparty risks. As we saw with the UBS incident, some interesting risks arise within the counterparties supplying the basket of derivatives. What happens if such ETF trades cause such a mammoth loss in a counterparty that it does not have sufficient capital to bear the loss and pay out under the derivative contract? Answer: The ETF fails, leading to massive counterparty losses! ETFs based on derivative trades add a second layer of uncertainty to the unavoidable sudden ups and downs of the market and include the counterparty risks that may cause the organisation on the other side of the contract to go bust. This toxic aspect of ETFs is unclear to most investors in ETFs, who treat these complex financial instruments as if they were as safe as equities and bonds.

Conflict of Interest

Unbeknownst to the investor, the provider of the ETF might sometimes be a part of the same organisation as the derivatives desk carrying out the swap. When a financial institution acts in this dual capacity -- given the inadequate disclosure rules -- there is a significant potential for a conflict of interest in which the end investor comes off second best. There is currently no obligation for the basket of assets used as collateral to actually match the assets the ETF purports to be tracking. Hence a bank may choose to hold less liquid assets to back the fund which it could struggle to sell if too many investors want to exit at the same time. Think of all the gold ETFs and then ask yourself: How much physical gold actually underpins the gold ETFs? Answer: Not a lot! As much as half of the trades in gold are now driven by ETFs, while some blame them for speculatively driving up food prices.

Volatility, De-Coupling and High Risk

Extreme volatility makes ETFs behave unpredictably. ETFs do NOT always match the underlying asset or asset class in the way investors expect. Given the daily rebalancing and compounding, an investor can own a leveraged long ETF and end up losing money over a period when the market goes up but during which there are some sharp falls. Equally, an investor can own an inverse ETF -- which provides a short exposure -- during a period when the market goes down but if there are some sharp rallies, the investor ends up losing money. This actually occurred with some inverse ETFs in 2008, for example. ETF investors would not normally expect to be leveraged long and lose money if the market goes up or be leveraged short and lose money when it goes down. Yet, this is entirely possible with ETFs and is not known as an outcome to most investors.

Massive Short and Long Positions: High Frequency Trading (HFTs)

A big unrecognised risk with ETFs is related to the ease with which traders -- hedge funds and High Frequency Traders (HFTs) in particular -- are able to use such funds to short markets or go long. It is technically possible for the number of shares sold short or long in an ETF to exceed the actual number of shares available massively! It has been suggested that the "Flash Crash" of May 2010, in which US shares fell 1,000 points before bouncing back in a matter of minutes, was a consequence of this: around 70 percent of cancelled trades at the time were reported to be for ETFs by High Frequency Traders (HFTs). Given that hedge funds and financial institutions can apparently rely upon creating the units to deliver on their short, some market participants are short 1,000% or 10 times the amount of the ETF available. The danger of allowing short sales which are a multiple of the value of a fund in an area where it may not be possible to close the trades by buying back the stocks are clear. Yet, purveyors of ETFs claim that there is no such risk in shorting ETFs. Do they not understand the product they are offering, and if they can't, what chance has the retail investor got?

Camouflage and Subterfuge: Insider Trading

ETF stripping allows virtually untraceable insider trading. The way this works is that rather than take a position in a security where someone has inside information, The trader buys or sells the ETF and does the opposite on all the stocks that make-up the ETF, except the one for which they have insider knowledge.

Liquidity Out Of Thin Air

The problem of liquidity is an increasing issue with ETFs because of the way in which the funds have branched out into other asset classes such as fixed income and commodities including gold and oil. In these markets, liquidity is typically thinner than in big equity markets such as those measured by global indices like the S&P 500 or the Dow Jones. Liquidity is only ever a problem at times of market stress. Unfortunately, that is precisely the time when it matters, as Mortgage-Backed-Asset (MBA) investors discovered a few years back when the property market turned down and their managers were unable to sell enough properties to pay back redeeming unit holders. Investors were locked in. If the ETF is in an illiquid sector, can one really rely upon creating the units as one may not be able to buy (or sell) the underlying assets in a sector with limited liquidity?

Undisclosed Profitability

Although ETFs are billed as low cost they are also the most profitable asset management product for a number of providers. How can this apparent contradiction exist? The answer is that the charge for managing the ETF is only one part of the cost. There are also hidden cost benefits in the synthetic and derivative trades which the provider undertakes for the ETF.

Mis-selling

There is a rising possibility that ETFs are being mis-sold to the retail market and risks are being incurred in running, constructing, trading and holding them, that are not sufficiently understood. After the UBS incident, this mis-selling of ETFs might become indisputable.

Conclusion

1. Exchange Traded Funds (ETFs) have in a remarkably brief space of time become a trillion-dollar plus trading instrument with critics of ETFs arguing that they represent short-term speculation, that their trading expenses decrease returns to investors, and that most ETFs provide insufficient diversification.

2. The latest UBS black hole is likely to have repercussions, because it has occurred in the ETF sector, a part of the market that is rapidly becoming system-critical. The sudden loss of $2bn at UBS ought to remind investors of the pitfalls of these derivative-based instruments. It is likely that there will be moves to increase oversight of the ETF market in the wake of the UBS scandal. Are regulators going to slam the ETF barn door after the horse has long bolted?

3. Like many financial innovations -- such as the mortgage-related debt obligations that triggered the global financial crisis in August 2007 -- ETFs started out as a good idea. For some investors, in their most transparent form, they remain so. Now, a tangled web of complexity has rapidly developed. What was once a straight-forward means of gaining access to a market has turned into a minefield for investors and one which, as UBS discovered, has the potential to become the next toxic scandal!

4. Some critics claim that ETFs can be, and have been, used to manipulate market prices, including having been used for short selling that has been asserted by some observers to have contributed to the market collapse of 2008 and other severe market corrections.

5. Investors in Exchange Traded Funds (ETFs) ought to review each of the ETFs in which they are invested to reassess the true content and degree of risk embodied in them.

Busted Banks and Financial Scandals

 Are all 'Western Banks' Bust? What is the actual and realistic levels of 'security' that they hold to cover their mortgage books? Are there risk factors that are being hidden, and does the UBS debarcle simply indicate that nothing has really changed?

Metals and Currency Exchanges

Should we simply have let the banks go to the wall for all the toxic debt that the general population is now expected to cover? Can we as voters/businesses consider defaulting to send these 'failing banks [the majority it seems] on their way to allow more efficient financial "institutions" to replace them. And where will Gold and commodities fit in with the World's needs to trade.

Consider this article from George Mangion from today's Malta Times. It raises some serious questions that are simply not being addressed. In practice Banks themselves are the problem. They have evolved into instutions of greed. In practice the basis of banking in both boring and highly marginal.

But the creation of credit and derviatives have turned the Banks into 'monsters', like 'black-holes' who are devouring the middle classes, and their impotent Governments. We need much more than Basel 111. We need radical break-ups, new trading platforms and transparancy. But do not hold your breath! JB

The fabled Higgs-Bouson Particle has more realism than the creation of bank credit

"Banks under fire"
by George M. Mangion from the Malta Times

Article published on 18 September 2011

It does not rain but it pours when financial scandals erupt. Little did we expect that with the introduction of strict banking regulation, including the implementation of new stress tests and Basel 111 rules, another bank would bite the dust? Reference is made here to the shock news that police in London had arrested a “rogue trader” in connection with allegations of unauthorised trading in UBS. At a time when the markets and shares show unprecedented losses, one could hardly believe that this trader at UBS bank caused an estimated $2 million loss. It was immediately reflected in an 8.00 per cent drop in UBS’ share value. Luckily, no client positions have been affected so far, yet the news came as a bolt out of the blue for FINMA, Switzerland’s financial regulator.

Ironically, at a time of such austerity, global banks are under stricter supervision and hence they will struggle to recoup the fat returns they had grown used to, prior to the credit crunch, by trading anything from complex bond derivatives to gold and currencies they made millions. It is obvious that after the balmy pre 2007 days when bank profits flowed so copiously in their Balance Sheets they now face an escalating debt crisis and heightened uncertainty both in Europe and more so in the US where we are seeing banks’ share value dip in market trading.

ZKB trading analyst Claude Zehnder said of the UBS scandal, “They obviously have a problem with risk management.” The Swiss taxpayer had bailed out this top Swiss bank in the 2007/8 banking crisis, following huge losses on toxic assets held by its investment bank. Recently, UBS made 3,500 workers redundant leaving 65,000 staff worldwide. It hoped to save $2.3 billion in wages and salaries and now, paradoxically, it lost them in this last scandal that rocked the UK branch. Furthermore, it was associated with a serious tax evasion dispute with US authorities and was forced to disclose over 300 client names and pay a $780 million fine. In another instant it agreed with the US authorities to reveal data on 4,450 American clients. All this echoes the risks that Swiss banks in post sub-prime crisis are facing. British economist Professor Chris Roebuck said UBS has tightened its compliance and rules, but this latest breach “is a staggering demonstration that all the clever systems that the banks now have still cannot stop a determined individual getting round them if they want to”.

Sadly, this reflects poor corporate governance and lower audit oversight in sensitive sectors such as currency trading where millions are made or lost in a trade. This “casino” style trading is a lucrative edge of each international bank but while it lays the golden egg when things go wrong it conjures visions of ugly days. Just remember when we saw other rogue traders, including the one at Société Générale, rogue trader Jerome Kerviel, who was arrested in 2008 over unauthorised trades that cost the bank €4.9 billion. Following his arrest, a court sentenced him to three years in prison in October 2010. Records show it was one of the largest investor losses in France’s history.

So what is the solution that can plug a bank’s defences against such expensive fraud? Can effective risk management process result in zero risk occurrences? Hardly, as these systems are not watertight and still cost a lot of money to operate. Banks are sometimes unable or unwilling to implement this high level of control. It’s still unclear if management of Société Générale knew about Kerviel’s scam, though he has claimed that it’s impossible his managers didn’t know what was happening, given the level of risk and the amount of cash involved in his trades was perpetrated inside the four walls of the financial institution. Critics argue that it requires inside knowledge of the bank’s security policies and means how to override those policies. Or else the risk mitigation and compliance processes in place were fundamentally flawed. Critics also question how trades of this nature could go unidentified amid the network of risk management in place at a large bank like Société Générale. The bank stated it had no indication that the trader had taken massive fraudulent directional positions in 2007 and 2008 far beyond his limited authority. It is no consolation that France’s regulator fined the bank €4 million in 2008 and issued a formal warning to the bank for “grave deficiencies” in its internal controls that “made possible the development of the fraud and its serious financial consequences”. It looks more like shutting the stable door after the horse has bolted. The Kerviel scandal was a record heist, superseding losses involved in 1995 when Nick Leeson (now a free man) burnt a €900 million hole in Barings Bank plc.

Barings was one of the oldest and most respected British investment banks. After the fraud was discovered in Singapore, it was subsequently sold to Dutch bank ING for £1. Another bank under fire is Ireland’s largest bank, Allied Irish. In 2002 it discovered a rogue US trader John Rusnak who had defrauded its US subsidiary of up to $750 million. His labours netted him a generous salary while his clever manoeuvres landed him with a scheme worth $850,000 in salary plus juicy bonuses from for five years. So have we learnt any lessons from these banking fiascos? Perhaps we did not heed Leeson’s own words when he was interviewed after the Barings fraud was discovered. He was critical of the way banking supervision is entrusted to certain authorities. Perhaps one may say the kettle calling the pot black but when more frauds are discovered it makes you wonder if the gatekeepers are asleep on their watch. The former trader said: “The core, or the key to this fraud problem is that you then have a central bank and a government that don’t really understand the financial markets.” He meekly asserts that in 1995 the government in Singapore did not detect the fraud and he continued to blame the central banks, which omitted to unravel it, saying it was too complex for them.

Banking investment scandals of such magnitude are unheard of in Malta. This is thanks to a closely supervised network operated by trained banking and investment inspectors at the financial watchdog MFSA. Still, one can recall the downfall of the BICAL private bank in the early seventies, which saw the loss of many subsidiaries owned by the family-controlled bank face bankruptcy. Recently, the demise of La Valette multi-manager property fund managed by a subsidiary of Bank of Valletta saw thousands of small investors protesting in court that overzealous banking staff had urged them to invest in risky projects when they alleged that they were ignorant of the potential risks. Luckily for them, sanity prevailed and Bank of Valletta as the custodian agreed without admitting guilt to compensate such investors up to 75 per cent of their investment (provided they renege on their rights at court). This brought a happy ending to a long drawn saga that was hitting local media and was not doing any good to the solid banking reputation enjoyed by the island. Bad news followed with another claim by Finco Treasury Management, a stockbroker firm, in the name of some 40 claimants who were allegedly encouraged by BOV to invest in Lehman Bros perpetuals. It appears that such investors were not informed of the risks involved and they lacked any financial background, and most of them were not experienced investors. The claimants say BOV failed to explain the risks of the perpetual securities; in fact they were described in purchase contracts as “straight bonds”. They were not informed that these perpetuals could be converted to ordinary shares without investors being able to halt the conversion. In their judicial protest, the claimants say they were advised by the bank to place their savings in ‘junior subordinated bonds’ and perpetuals in the Lehman. Unfortunately, this triple A bank went into bankruptcy in 2008 when housing prices crashed in the United States. The worrying news for BOV is that Finco alleges the bank is at fault for not having warned investors of the worsening credit risk of the Lehman Group when the bank itself had suffered massive losses after investing in Lehman securities. On its part, Bank of Valletta has rebutted all claims but stated its intention to meet the claimants to better explain its position.

To conclude, it appears that in times of financial turmoil, the incidence of banking troubles increases exponentially. One hopes that an honourable solution is found for the hapless investors once MFSA as the regulator takes its time to investigate the claims and issues its verdict on the underlying facts that led to their losses. Banks are under fire and they certainly welcome all the protection they can muster from their patron saint in the sky.

The New Dollar?

$$$ THE USGOVT IS SECRETLY ATTEMPTING TO FLOAT AN IDEA TO RETIRE THE USDOLLAR, PAY OFF CREDITORS WITH TOILET PAPER, RETIRE THE ENTIRE DEBT, DEVALUE OLD ASSETS, START ANEW, AND ISSUE A NEW USDOLLAR. THIS NEW USDOLLAR CONCEPT SEEMS GROTESQUELY FLAWED SINCE IT LETS THE UNITED STATES OFF THE HOOK AS DEFAULTED DEBTOR, AND IT ASSUMES NO CONSEQUENCE FROM THE USTREASURY BOND LIQUIDATION. THE USGOVT AND USECONOMY WOULD DESTROY THE URGENTLY NEEDED CREDIT TO MAINTAIN ITS ONGOING MASSIVE DEFICITS. $$$


In early February, over 150 US State Dept emissaries were called home to WashingtonDC for secret meetings. The news came and went quickly on internet journals. Many thought meetings were convened to discuss the growing Arab world upheaval. Instead, my sources report that the USGovt wanted to canvass opinions and coordinate feedback, if not to simply float a trial balloon on an historically unprecedented idea. The USGovt is trying to end the USDollar, to retire it, and to replace it in a fresh start after forcing a stern devaluation on all US$-based assets in conversion. The Boyz are printing $100 billion per month. So why not print $5 to $6 trillion and pay off all creditors with fresh colored toilet paper? The plan would call for all foreign creditors to be paid off, and all US-based depositors converted, both parties suffering devaluations. They would all be betrayed under the conceived plan, handed a hefty 30% instant devaluation that would accompany the birth to the new Republic Dollar by name, backed 80% by gold and 20% by silver. My guess is that Gold & Silver would be revalued at $7000 and $250, or $5000 and $175, something like that.

The old US$-based USTreasury Bond debt would be paid off with Printing Pre$$ toxic effluent output. The new US Republic Dollar would be backed by precious metals finally, in a return to the Gold Standard. The entire concept does not receive solid confirmation, but rather numerous repetitions from the same secondary source, and reports on support mechanisms working feverishly to enable its enactment. The story does receive an echo from Bob Chapman. The plan is very unclear about the status of old US$-based stock and bond and property assets, but my belief is they would be devaluated in hidden manner, to minimize public objection and to enable acceptance. It is also unclear the status of old US$-based debt obligations like home loans and car loans and business loans, but my belief is they would be converted in like kind. Recall that the world rejected the Amero concept for a omnibus North American currency before, largely because the United States could not dictate terms of contracts across the world, like between Chile and Europe on copper or between China and Brazil on sugar cane or between Canada and China on industrial metals.

My thinking has many parts, best summarized with a caption heading NO WAY IN HELL but summarized in three reasons.

1) The USGovt does not own enough Gold & Silver to back a new currency, even at higher precious metal prices.

2) The USGovt is the debtor nation, and debtors never dictate the terms of liquidation and restructure. The creditors do.

3) The USGovt has huge deficits, and the USEconomy has huge deficits, each not to be funded since creditor nations would halt all new credit to the US after they are handed forced devaluations on the instant payoff and devaluation.

The USGovt and USBankers cannot possibly dictate the terms of a new USDollar since they are bankrupt, since they are guilty of multi-$trillion bond fraud, and since the USGovt and USEconomy are both deeply insolvent with ongoing massive deficits. The defaulting debtor does not dictate terms to the creditors, even if the debtor is dominated by global banker elite. The wild card in such a deal would be nuclear weapons and an eager CIA to deliver terrorist attacks surreptitiously to any creditor nation seeming uncooperative. Instead, somehow, unsure how, the global elite bankers eat some crow, mixed with toxic bread & butter, and are demoted on the global stage of power, secret pacts with China notwithstanding.

With a new US Republic Dollar, the deficits would cripple the United States immediately. The USGovt deficit would force the United States to find and hand over many tons of Gold & Silver every quarter and year, without fail or exception or forgiveness, since no more scheister paper repayment in settlement. The US lacks the base monetary metal from which to continue the outsized and worsening deficits. The USEconomic deficit would force the US into insolvency immediately. The result would be that right away, the US would forfeit massive amounts of Gold & Silver that it does not own to settle trade gaps. Perhaps massive hidden Syndicate Gold supply would come to the table, taken as counter-party from Wall Street shorts that destroyed those shell corporate entities. My position has been stated before, that a new hard currency behind the US financial system would result in rapid insolvency and ruin, since the old systemic insolvency would instantly cripple any new launched monetary initiative. Thus the US never proposes one like the new Republic Dollar. Other foreign nations that would use the new Republic Dollar would generate large surpluses, and therefore make possible grand demands for US forfeited Gold & Silver. A new gold-backed US$ currency would force an immediate Black Hole inside the US system. The new system would promote in fast return exactly the same grotesque imbalances in a grand degradation. The United States could not expect to be given renewed credit after betraying the world's major creditors with the USTreasury Bond devaluations and liquidations, not in this real world.

Lastly, the new Nordic Euro currency would have to be subjugated under the new Republic Dollar. Such a development could only happen under some very scummy power sharing agreement with Russia and China and Germany. Then again, they might make a decision under nuclear threat. Any new Chinese Yuan currency with a hard asset backing would also have to be subordinated under the new Republic Dollar also. Those agreeing to subjugation under continued Anglo banker rule must accept $trillions in losses from USTreasury Bonds, USAgency Mortgage Bonds, even US Corporate Bonds during the devaluation process. The surplus nations, those blessed by huge surpluses, huge reserve savings, robust industry, and absent debts are planning the new Nordic Euro currency, a gold-backed currency. My belief is that as the Nordic Euro comes closer to its anticipated June 2011 launch, enormously important negotiations, hidden battles, important posturing, and desperate ploys will be put forth. The new Republic Dollar seems fanciful and totally impractical, surely such a desperate ploy to be shot down, unless a nuclear threat is delivered.

My best banker source, with solid international experience over 30 years, dismissed the idea as a wet dream by Anglo criminals to gain forgiveness, or rather to dictate forgiveness. This sage generous veteran claims the next phase will unfold very differently, with the foreign group called the Eastern Alliance pulling the rug from under the criminal Americans and British bankers, who operate a syndicate and display an evil streak. They are plainly nazis with nice wrappers. Neocon meant fascist nazi, for those naive in the crowd. The coming arrival of the gold-backed New Nordic Euro is causing a rush to duplicate it. The United States and Great Britain will either maintain a control position within a huge global slavery fascist brutal regime (featuring genocide), or else the US will descend into the Third World with a dead currency which must bid for the good useful currency in order to secure supplies. My belief is that the US$ in current form will be rejected within 18 months, globally, for crude oil and global trade settlement. My belief is that the USEconomy will suffer profound price inflation in the coming two years. My belief is that a new Republic Dollar would fall on its face before launch, but after presentation. A payoff of USTreasury Bonds with soon retired toxic paper with promise of deep devaluation would have immediate consequences of grave proportion, like the US being totally isolated from global commerce. The other name for that place is the Third World, marred by huge price inflation and credit cut off.

◄$$$ UNFOLDING EVENTS REGARDING THE USDOLLAR AND USTREASURY BOND DISPOSITION WILL NOT OCCUR ACCORDING TO ANY USGOVT AND USBANKER PLAN, OR PREFERRED DIRECTION. ANGLO BANKERS ARE NO LONGER IN CONTROL. NO NEW USDOLLAR CAN BE BORN FROM THE CRIMINAL SYNDICATE CRUCIBLE THAT HAS EXPLOITED AND BETRAYED THE AMERICAN CITIZENRY AND GLOBAL INVESTORS. BEHOLD WHAT COMES, A NEW EQUITABLE BARTER SYSTEM THAT REQUIRES ACCOUNTABILITY. $$$

In continuation of the new Republic Dollar theme, and the urgently needed transition to some currency vehicle in a viable fashion, my solid reliable banker source sent this note. He wrote, "It is not going to happen the way any US bankers would choose or direct. It is is unfortunate and regrettable that the USA has begun and is about to commit financial and political suicide. Today's USA power establishment is incompetent, delusional, and outright evil. It is less the criminal foreign policy and all the wars the US prosecutes. It is the treason the US power elites commit in regards to exploiting and betraying its own citizens. They can try whatever they like. They are done, finished. The engrained problem is too big for anyone or any group or any institution to fix. It is not about the price of Gold or Silver. Price is irrelevant. It is about purchasing power of Gold & Silver that has not really changed over the last 60 to 80 years. Take a look at Libya, a similar scenario that you will see unfolding on a larger scale. By comparison, the USA has its own Gadhaffis. We shall have a commodity based money regime and a non-monetary trade system called barter. Back to basics. It is as simple as that. That is what comes in the future. An entire new system has been in the works for almost two years, much planning, much development, an equitable system that has no place for freeloader or deadbeat nations. It will be a very accountable system, a fair system. Nations that do not participate will not have a supply chain. It is that simple."

Willie

Buy Gold, Buy Gold, Buy Gold

Very, very good advice, apparently, reckons the Mighty Mogambo...

SO CHRIS MAYER was quoted in the 5 Minute Forecast newsletter noting that "If history is any guide, inflation will likely get much worse," writes the Mogambo Guru from Tampa, Florida, in The Daily Reckoning.

Being the kind of guy who goes absolutely insane about inflation in prices, you can imagine the effect this had on me, although with a modest touch of understatement, he does not take things to the logical conclusion, namely that "We're Freaking Doomed (WFD), you morons! And now everyone is going to see what happens after an excessive creation of money has distorted the economy, little by little over the decades, into a grotesque, corrupt, cancerous, incestuous economy feeding on government spending that, in the local, state and federal aggregate, now comprises an outrageous 50% of all spending in The Whole Freaking County (TWFC), and yet the Federal Reserve keeps creating more and more so that the federal government can borrow more and more and thus spend more and more!"

I would suggest, of course, that he would finish up with, "And now I, Chris Mayer, speaking both for myself and the 5-minute Forecast, and everyone on the planet who has not lost his or her freaking mind, the only logical thing to do is to follow the sage advice of The Mighty Mogambo (TMM) to Buy Gold and silver, gold and silver, gold and silver, more and more and more until they are stashed in huge piles all over the house and you are stubbing your toes on them all the damned time, costing you as much in doctor bills as the silver goes up in price, which means (with certain simplifying assumptions yet yielding 3-decimal place precision) you have reached maximum utility!"

This is Very, Very Good (VVG) advice, and provides a good place to finally stop Buying Gold and silver, as taking the next step is the path to insanity, which starts when you find yourself getting peevish about your inability to get a permit to construct a lousy combination precious-metals vault and oil storage facility in your backyard, using land acquired all around my house by buying out the neighbors who thought they were so smart not to buy gold and silver when I told them, "Buy Gold and silver, you morons, when the evil Federal Reserve is creating So Freaking Much Money (SFMM), or one day you will regret it, and I one day I will buy your stupid houses for pennies on the dollar and kick you out, just before bulldozing your homes to rubble and having it hauled away so that every trace of you and your 'no gold or silver for me' stupidity is gone forever! Wiped out! Hahahaha! Morons!"

Well, apparently everyone has heard of my Strident Mogambo Advice (SMA) to Buy Gold, silver and oil equities, and it doesn't even rate a raised eyebrow anymore, as proved when Mr. Mayer went blithely on "Everyone seems to know the US inflationary story of the 1970s. The official inflation rate hit nearly 14% by 1980."

I am stopped from going ballistic about such horrors of inflation only because the rate of inflation is worse in other countries, where, Mr. Mayer goes on, "it was worse. In the UK, inflation topped out at 27%; in Japan, 30%." Yikes!

I used the word "Yikes!" in the sense of "ancient history" since, as far as most people are concerned, 1980 was 31 years ago, which was before most people were born, and which is all a sorry result of the aftermath of 1971, which is 9 years earlier, when the dollar's last tenuous tether to gold was severed by Nixon, allowing dollars to be created "at will" by a whore Federal Reserve, which they were, which is why debt soared and there has been constant inflation in prices and now we are all ruined.

Here is where I forsake the use of, "Yikes!" to use the words, "We're Freaking Doomed!" in the sense of "current events," because if inflation in 1980 was 14%, what is the inflation rate when a reader of Chris Mayer's commented, "He may have cited the Wells Fargo forecast of 4% increase in food prices, but between packaging size reductions and slight price increases, we're currently running between a 10-15% increase on core grocery items."

And it gets worse than that, as the reader goes on, "Add that with the upward trend in energy prices, you're slowly barking up a tree that's 15-20% higher than what we started with a year ago"!!

Perhaps the link between the creation of money and inflation does not impress you, the casual reader who has wandered across the MoGu newsletter by accident, and who wonders if there is something of any significance or interest beneath the dull veneer of my poor writing and weirdly recurring thinly-disguised threats against the Federal Reserve as revenge for creating their so much excess money that it creates inflation in prices which makes life Very, Very Tough (VVT) for the poor.

If so, let me bring you up to speed: 15-20% inflation is enough to destroy you and everything, and everybody, you love, and your best bets are to get a lot of gold and a lot of silver, which is automatically proved, in a metaphysical, mystical way, in that "best bets" are anagrams, and "silver and livers" are anagrams, and if there is one thing you can't live without, it's a liver!

Okay, I admit that I am stretching it with this "silver and livers" thing, but after all the other thousands of reasons to Buy Gold and silver that I have used over the years to convince people to get up off of their fat, stupid butts to go out and buy gold and silver, I am simply out of ideas.

I am desperate for some new reason to buy gold and silver beyond the first 3,000 reasons, although, fortunately, as far as buying them is concerned, easy is easy is easy, and no more need be said of its ease, expect for, perhaps, "Whee! This investing stuff is easy!"