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Iraq, Oil & The Coming Wealth Transfer

Chris' recent interview on USAWatchdog
Tuesday, July 1, 2014, 4:28 PM

Yesterday, Chris was interviewed by Greg Hunter of USAWatchdog. Greg was a former investigative correspondent at ABC and CNN who now operates his own digital "news station". He invited Chris on to discuss the latest implications of ISIS' inroads deeper into Iraq, as well as the larger consequences the world faces if plunged into another -- potentially worse -- Great Recession:

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10 Comments

shawns333's picture
shawns333
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Posts: 42
Really well done, Chris

Especially the last 5+ minutes of it was really great in terms of wrapping up the big picture of what does it all mean, what should be done and put into just plain realistic and approachable terms.  Bravo, that's excellent communication and clarity in thought.  I'm going to watch that again at least once more to let some of it sink in more.

Also, really appreciate your overall perspective that is not political party or ideology biased, but just cuts through it with lessons of history, impartiality and the focus on real critical thinking and not "buying the package" of what those that want to control your mind & wallets want you to think.

Excellent and thanks! yes

davefairtex's picture
davefairtex
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does money go to money heaven?

Short answer: yes, but...

Whenever a bank loan is defaulted upon, money (in the due course of time) is sent off to money heaven.  Likewise, when a bank loan is paid back, the bank credit money created by that loan also goes to money heaven.

Now then, what happens when the bond market crashes?  Is that a transfer, or does the "money" vanish?  In terms of bank credit, its simply a transfer.

However, many people think of very short term bonds as money - say you have a money market account with a balance that shows "$100,000" on it.  Most of us have been trained to think of money market funds as being "money".  So if the bonds behind that fund default, then most definitely your bond "money" goes to money heaven.

But no actual "bank credit" (M1) vanishes when a bond (even a short term bond in a MM fund) is defaulted upon, or when a stock goes from $100 down to $10.

Thought experiment: let's say you buy $100k in IBM stock from your friend Joe, and then IBM crashes and goes to $10k.  Where did the $90k go?  Simple - it went to Joe.  You transferred $100k to him for the stock.  Joe now has $100k, and you have the stock, and $0k.  After the crash, you can use that stock to have someone else transfer $10k to you - perhaps Joe again.  He then would have both the stock, and the $90k you lost.  Stocks (and bonds) are just money transfer vehicles.  No (bank credit) money is created or destroyed by the movement of stocks & bonds - only transferred.

However that account balance of yours sure does go down.  Your trading account balance reflects: "the amount of bank credit you could instantly transfer from other participants to yourself if you were to sell all your assets at the current instant."

Last wrinkle.  When banks take depositor money and "invest" in the stock and bond market, the losses they suffer do actually result in money going to money heaven.  My proof?  Cyprus.  When Greek sovereign debt was defaulted on, that blew a massive hole in the balance sheets of Cyprus banks.  Eventually, that was "resolved" through bail-ins, which ended up destroying actual bank credit.  That's an example transmission mechanism for stock & bond losses to end up affecting real M1/bank credit: when banks move outside of lending and into stock & bond investments.  [Gee, maybe they shouldn't be doing that sort of thing.]

Spanish banks own 30% of the outstanding Spanish sovereign debt.  If Spain the sovereign defaults on its debts, it will blow a massive Cyprus-like hole in the Spanish banking system, which will only be resolvable through bail-ins (or bank bankruptcies) and the resulting destruction of bank credit money, which will end up sending a whole lot of depositor money straight to money heaven.

cmartenson's picture
cmartenson
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If Spain Defaults
davefairtex wrote:

(...)

Spanish banks own 30% of the outstanding Spanish sovereign debt.  If Spain the sovereign defaults on its debts, it will blow a massive Cyprus-like hole in the Spanish banking system, which will only be resolvable through bail-ins (or bank bankruptcies) and the resulting destruction of bank credit money, which will end up sending a whole lot of depositor money straight to money heaven.

First, great explanation above the part I quoted...to which I would only add that when a bank gets in trouble and goes under, any amounts that are not in some way insured also go 'poof' are never to be seen again by its putative and former owners.

This happened a lot in the Great Depression, and recently in Cyprus, where people who thought they had money in the bank discovered (again) that they were really unsecured creditors of leveraged financial companies that produce nothing and took risks. 

Now, as to the Spanish example, I'd like to add that Spanish banks are almost assuredly insolvent as indicated by their 13% bad loan ratio.  Assuming a normal fractional reserve ratio and bank capital, anything approaching 10% is 'lights out.'  So I think the Spanish banks are already cooked.

The only things that could save them would be (1) the economy and real estate sectors recover enough that those bad loans are returned to 'good' status by people resuming payments on them and/or (2) the Spanish economy recovering enough that new loans of sufficient quantities can be made that will allow the banks to safely bury (retire) the bad loans.  

#2 is the exact mechanism that was pursued during the US subprime episode where new loans were being made at a faster rate than old loans were defaulting allowing the whole thing to appear roughly "OK" while this was happening.  The death blow came when no more entrants (suckers) could be lured into the real estate scam as every mirror-fogging patsy had already been drawn to the table and the bad loans came roaring up from behind and crashed the party.

shawns333's picture
shawns333
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davefairtex wrote: However,
davefairtex wrote:

However, many people think of very short term bonds as money - say you have a money market account with a balance that shows "$100,000" on it.  Most of us have been trained to think of money market funds as being "money".  So if the bonds behind that fund default, then most definitely your bond "money" goes to money heaven.

But no actual "bank credit" (M1) vanishes when a bond (even a short term bond in a MM fund) is defaulted upon, or when a stock goes from $100 down to $10.

Thought experiment: let's say you buy $100k in IBM stock from your friend Joe, and then IBM crashes and goes to $10k.  Where did the $90k go?  Simple - it went to Joe.  You transferred $100k to him for the stock.  Joe now has $100k, and you have the stock, and $0k.  After the crash, you can use that stock to have someone else transfer $10k to you - perhaps Joe again.  He then would have both the stock, and the $90k you lost.  Stocks (and bonds) are just money transfer vehicles.  No (bank credit) money is created or destroyed by the movement of stocks & bonds - only transferred.

So, are we exploring this and answering it in "theoretical" terms or in real terms, meaning what normal people know or care about?

If the latter, then it didn't work.  Money market funds are definitely real money and people expect it to purchase things and is not play money.  Similarly, when your asset drops 90% in price, you lost 90% of your asset.  That's a real change and impact.  I also don't see a transfer there, in that the receiver of your asset (the purchaser at $10/share) now does NOT own $100K in value.  That value was obliterated during that price crash.

Now, when it comes to Chris' point about if that $10/share is still a claim on some theoretical claim of $100/share of value (or assets).  I guess that could be true in some sense.  But, again, the reality is that for all intents & purposes for both Joe and I we are dealing with $10K of value today and I lost $90K of value.  So, in that way, it seems that the $90K really has been destroyed.

Maybe in theoretical or macro- terms that is not the case, but the interview, this website and the focus is on real terms of normal people, so I don't see how the theoretical is terribly relevant outside of academic and high-level policy conversations.  Or, help shed some additional light to help me understand?

davefairtex's picture
davefairtex
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at least two discussions here at PP

shawns-

Maybe in theoretical or macro- terms that is not the case, but the interview, this website and the focus is on real terms of normal people, so I don't see how the theoretical is terribly relevant outside of academic and high-level policy conversations.  Or, help shed some additional light to help me understand?

Ok, so I heard something in the interview that you might have missed.  Greg at one point said, "money doesn't just go to money heaven."  I was responding to that comment, not to the rest of the stuff that was said.

As for your assertion that "this website and the focus is on real terms of normal people" - I think you are viewing the world strictly through your own lens.  From my observation, this site has (at least) two sets of discussions going on in parallel, all the time.

First, there are the practical, pragmatic issues addressed in raising chickens, gardens, fruit trees, bee-keeping, and the overall personal resiliency issues that are critical to sustaining life regardless of what happens in the paper world of high finance.  If this is your focus (and from what you say, it seems to be the case), then you are 100% right that your stock that goes down has the same effect on your personal balance sheet that your bank account being bailed-in would have.  From your perspective, assets and cash are treated identically with the net result being: "I lost money."

At the other end of PP some people engage in more theoretical discussions about economics, money supply, currencies, national debt issues, gold backing of currency, sovereign defaults - things that are very far removed from our own individual experiences - all that "academic policy stuff" you mentioned.  What does M1, a gold standard, or a better understanding of the mechanics of bank credit have to do with the issues of losses on your own personal balance sheet?  Pretty much nothing.  They are two poles apart.  However in this other world, a stock that went down in price is quite distinct from a bank balance that was bailed-in by the government, and each type of loss would result in distinctly different macro economic outcomes.

In this world, declining bank credit via a bail-in means "money goes to money heaven", while a loss on an asset leaves total bank credit unchanged.  And the impact of each event is (most likely) quite different on the macro economy.

Hope that helps.  If you want to know more about my viewpoint and how it might possibly affect things (and why some people might care about the distinction between credit money vanishing vs. an asset price dropping) I'd be happy to go further.

 

davefairtex's picture
davefairtex
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spanish banking

Chris-

Totally agree about depositors being unsecured creditors.  Its basically only good fortune that Cyprus honored its deposit guarantee.  That seemed up in the air for entirely too long for me to feel sanguine about it happening again if things get worse.

Now then, about Spanish banks.  They've been cooked for quite some time - but I think, much worse than the "13%" number would indicate.

I think the number of non-performing loans were probably far in excess of 13% back in 2009, especially in the corporate loan area.  Here's a chart of Spain's domestic loans to two major sectors: corporate, and household.  Note the drop from 2008-present: corp loans declined 350 billion euros, or almost 37%.  My guess: extend and pretend allowed the banks to slowly earn their way out, gradually "recognizing" losses on their loan portfolios over a six year period, along with the Spanish "bad bank" that had the taxpayer foot the bill for some of the worst loans in the system.  Spanish taxpayers paid "40% of face value" for those bad loans, which (in the Irish experience) will end up being sold for about 10%.  Or less.

But as long as the regulators turn a blind eye, and as long as the population can stomach the deflation (employment loss, asset declines, etc) that comes along with a steady decline of bank credit, it "all works out" especially for the bankers that lent foolishly during the boom time, and who get to keep their jobs during the tough time.

Financial repression and "enough households paying" (no bankrupcy or walkaways allowed for homeowners in Spain, sadly - notice the difference in the loan decline rates on "households" and "corporate" in the chart above) keeps those banks alive.

But boy, the number of years of misery until the system eventually resets - is it worth it, just so the bankers keep their jobs?  That same chart is visible in Japan's private debt too, but over a 20 year period rather than just 6.

However, the issue with the soverign vs private debt really is crucial.  With private debt, since there are so many debtors each with their individual story, a bank can perhaps get away with extend and pretend as long as the regulators cooperate.  However if a sovereign defaults and your bank has 10% of its balance sheet in defaulted sovereign bonds, those losses hit your balance sheet immediately.  The hole is there, and you cannot pretend it away.  One caveat to that - Cyprus banks *did* get to pretend, for an entire year, after the Greek restructuring happened, that nothing had gone on.  "No losses here."

Until the ECB stepped in one day and said enough was enough.  One wonders why it waited an entire year to pull the trigger on that one, rather than one day after the Greek sovereign default as it should have done.

Perhaps one doesn't wonder after all.

davefairtex's picture
davefairtex
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spanish banks - rough balance sheet

According to SDW:

http://sdw.ecb.europa.eu/reports.do?node=1000003346

Assets:

  • 3.1 trillion euro in total assets.  (Spanish GDP: 926 billion euro)
  • 1761 billion (56%) in loans (3% govt, 45% corp + homeowner, 8% other banks)
  • 613 billion (20%) in "securities other than shares" (10% govt, 8% corporate, 2% banks)
  • 218 billion (7%) in shares
  • 192 billion (6%) in external assets
  • 53 billion (2%) in fixed assets (buildings, etc)
  • 288 billion (9%) in "remaining/other"

Liabilities (partial list):

  • 1.47 trillion euro in corp & homeowner deposits.
  • 510 billion in deposits from other banks.
  • 434 billion in reserves and capital.
  • 277 billion in bank bonds (i.e. junior & senior bank debt: bail-in fodder)
  • 130 billion in external liabilities
  • 244 billion in "remaining" liabilities

 

shawns333's picture
shawns333
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davefairtex wrote: Ok, so I
davefairtex wrote:

Ok, so I heard something in the interview that you might have missed.  Greg at one point said, "money doesn't just go to money heaven."  I was responding to that comment, not to the rest of the stuff that was said.

Understood and that is the basis of my comments, as well.  Yes, there is a theoretical/macro-/or whatever side we want to talk about to money (M1/M2/M3/etc.).  That said, I heard the conversation around "is there wealth destruction?" "does wealth just transfer?", etc.  This is an Internet interview being viewed by a variety of people and given the lack of understanding that the population (both US & World) have around all matters of economy, credit, money and the like, I am assuming we're trying to have a "real" conversation about "real" matters of everday people and not an academic conversation about a field that 99% of are not in (public economic policy, private banking, central banking, private economic think-tank, etc.).

 

davefairtex wrote:

As for your assertion that "this website and the focus is on real terms of normal people" - I think you are viewing the world strictly through your own lens.  From my observation, this site has (at least) two sets of discussions going on in parallel, all the time.

Fair point, touche.  I didn't mean to pain PP.com into my own views of what it is or should be.  Again, we have about 100 years in this country of extreme ignorance about all things related to economics and finance, that I feel strongly the more we can educate and help along the "average/normal" person the better with things on real terms.  I have an MBA and 20+ years working in the corporate world and consulting for the biggest household name companies every day.  So, if I struggle with some of these concepts and desire to "bring it down to earth", I'm assuming a huge swath of people out there have the same challenge.  So, to bring positive change, it starts with education and even lofty concepts have to become real somehow so people can appreciate them and know why they should care.

 

davefairtex wrote:

At the other end of PP some people engage in more theoretical discussions about economics, money supply, currencies, national debt issues, gold backing of currency, sovereign defaults - things that are very far removed from our own individual experiences - all that "academic policy stuff" you mentioned.  What does M1, a gold standard, or a better understanding of the mechanics of bank credit have to do with the issues of losses on your own personal balance sheet?  Pretty much nothing.  They are two poles apart.  However in this other world, a stock that went down in price is quite distinct from a bank balance that was bailed-in by the government, and each type of loss would result in distinctly different macro economic outcomes.

We'll agree to disagree perhaps.  I know exactly where you're coming from and what you're stating.  But, to say they are completely different and somehow build an artificial barrier between them (that's what I'm hearing) doesn't serve any useful purpose.  It's all linked together at the end of the day and no matter how complicated or fancy it gets, there's no denying the bottom-line of the cause and effect between all of this.  To treat it as "opposite poles" I find unenlightening and keeps us where we've been/are --- ignorant, removed, abstract, no bearing on "normal" reality, etc.  Which I don't believe has to be the case.

That was my main point and I personally am not terribly interested in the more lofty macro conversations about the various machinations of accounting and finance principles that are utilized.  Yes, they're very significant and rule various aspects of our lives and we need to be educated about them.  I also believe we need to bridge the gap so the abstract macro becomes real/understandable from a micro perspective to effect real change or actions from people.  That's all.  Feel free to drop it, as I'm not trying to get in the way of folks talking purely on the macro side.

davefairtex's picture
davefairtex
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not terribly interested

shawns-

If you hadn't just stated you were "not terribly interested" in the subject matter I'd happily discuss this with you further...I do have one suggestion though: the next time you feel a subject is uninteresting, you might consider not engaging in the discussion.

Just saying.

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darleneortiz
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Posts: 17
The Middle East is under oil

The Middle East is under oil and gold. And Europe and America seem to hate this thing. Some people are constantly trying to get the resources.

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