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    Financial Distress – Bank Stocks Reveal Urgent Weakness

    by Chris Martenson

    Wednesday, June 18, 2008, 1:11 PM

    Wednesday, June 18, 2008

    Executive Summary

    • Relatively benign stock market index performance is masking severe financial weakness
    • Judging by their stock charts, several good-sized banks might file for bankruptcy soon
    • Financial market liquidity supplied by the Fed is at odds with their words that "credit market conditions are improving"
    • The assets of the banks under duress are many, many multiples of total FDIC assets

    "Pay no attention to the man behind the curtain!" barks the booming voice.

    Unfortunately for the dumpy, balding ‘wizard,’ the curtain has already been removed and he’s been spotted.

    The first two weeks of June (2008) have been all about knowing where to look. Let’s peel back the curtain.

    Let me begin with a personal story. One of my main trading accounts was with a company called Lind-Waldock, a very reputable, stable, old company that got bought out by fast-flying Refco. All seemed well for the first few months, I had the same broker at the other end of the phone and I noticed no difference in my trading experience. But I was wary of Refco, so I kept a live stock chart up on my computer monitor, which I kept a close eye on. One day, the stock price of Refco took a stomach-wrenching dive, losing nearly 20% in a single hour. I immediately called my broker and shifted my funds out of that company that very day. I even got a call from the head of the division asking me to remain, insisting that all was well, and explaining that the stock was falling on the basis of unsubstantiated and certainly untrue rumors. It turns out that the rumors were true; Refco was involved in some shenanigans and had clumsily tried to hide billions in losses by stuffing them in an off-shore subsidiary. Refco was actually insolvent and ultimately went bankrupt. And it was also true that my money would have been safe even had I not moved it, but my position on these matters is to bring the money home and ask the detailed questions later.

    Below you will see many examples of stock price performance that would cause me personally to remove my money to a safer location and save the questions for later.

    After the dangerous downdraft in the dollar and the stock market seen on Friday the 6th of June, the Federal Reserve and their brethren in Europe, the ECB, were all over the airwaves beginning Sunday the 8th in an attempt to prevent the markets from selling off any further. Judging by the headline stock index performance, they did pretty well, as the indexes closed more or less unchanged for the week. However, if we peek behind the curtains, we see something very different.

    I want to focus on the issue of banks and bank solvency. Actually, I want to broaden this definition to include what are termed "financial institutions," which include mortgage brokers and commercial lending institutions. Why? Because we are now a financial economy. Measured in dollars, our economy has much more activity in the business of moving money around than it does in the manufacturing real goods.

    It used to be said that "as goes GM, so goes the US," meaning that the economic health of the country could be measured by the activity of its (formerly) largest manufacturer. Now it might be said that "as goes JP Morgan, so goes the country."

    Here are the warning signs that major and probably systemic financial distress remains threaded throughout our economy like termite tunnels in a load-bearing beam.

    The Fed’s words and actions are not aligned

    Bernanke recently said that the risk the economy has entered a substantial downturn "appears to have diminished over the past month or so," while Alan Greenspan said that financial markets have shown a "pronounced turnaround" since March. Which leads us to the recent inflation-fighting words of Bernanke, who said that the Fed would "strongly resist" expectations that inflation will accelerate, hinting at the possibility that interest rates will be raised. Of course, all of these are simply words. What are the actions?

    Since you and I know that inflation is caused by too much money lent too cheaply, we’ll spend less time listening to words and more time looking at the monetary data. In other words, let’s pay attention to what they are doing, not what they are saying.

    Through a combination of Federal Reserve and Treasury actions, the total amount of liquidity that has been injected into the banking system has advanced over $40 billion in the last 10 days, smashing to a new all-time record of more than $307 billion dollars. If the worst was behind us and inflation was a real concern, this would not have happened. The actions here tell us that the fear of whatever is ailing the banking system vastly outweighs any concerns about inflation.

    Further, short-term interest rates are set at 2.0%, which is a full two percent below the rate of inflation. What do you get when you combine negative real interest rates with extremely loose monetary policy? Inflation.

    And finally, here’s a chart of the money supply of this nation. If this was a roller coaster ride, you’d be pressed back in your seat staring at the sky – not unlike oil, grains, and other basic commodities.

    So there you have it: On the one side, record amounts of liquidity, deeply negative real interest rates, and a near-vertical rise in monetary aggregates. And on the other side, words.

    Bank and financial stocks under attack

    When I want to know how a company is doing, I turn to a chart of its stock price. Long before the headlines are written of a company’s undoing, the stock price has already told the tale. The story currently being told by the stock price of several mid-sized banks, mortgage companies, and bond insurers is nothing short of a disaster in the making.

    You need to be paying attention to these next few charts. Remember, Bernanke and Greenspan want you to think that the worst is behind us and that things turned around in March.

    First up is Bank of America (BAC): $130 billion in market capitalization, a giant bank, and the highest bidder for Countrywide Financial Corp (CFC). BAC has lost 42% of its value over the past 8 months and is 10% lower than it was even at its lowest in March. This is an ugly chart and says that BAC is in some pretty serious trouble. Based on this one chart alone, we can say "no, it’s not over yet."

    Now, maybe the market is frowning upon the fact that BAC seems intent, for some reason, on going ahead with their purchase of Countrywide (CFC), which, to this observer, ranks as one of the least fiscally-sound moves of all time. I mean, CFC is saddled with an enormous portfolio of non-performing subprime, no-doc, and option ARM mortgages, not to mention more than 15,000 repossessed properties.

    If this is true, then the market should be rewarding the CFC share price while punishing the BAC share price. Let’s see if that’s true…

    Nope, it’s not true. That, my friends, is as ugly as it gets, and is the chart of a soon-to-be-bankrupt company. So we can pretty much conclude that BAC and CFC are being hammered on the basis of their business models and not as a result of their unholy alliance.

    So, what sort of issues could the stock price be telegraphing about BAC? Let’s consider that BAC has a grand total of ~$150 billion in equity, but over $700 billion in level 2 assets (i.e. "modeled value") and an astounding $32,000 billion in derivatives on the books.

    In fact, let me print the list of banks with significant derivative exposure, because I’ll be referring to several of these banks here:

    There’s BAC, sitting at #3 on the list with an enormous derivative exposure, and their stock price is sinking like a stone. If Bernanke, et al., are not connecting these dots, then I am extremely worried, because it means they do not know trouble when they see it. But these are really smart folks, so we can fully assume that they are even more aware of this than anybody, leaving us to scratch our heads and wonder why their words do not even remotely match the situation. "Behind us?" Please, not a chance. This thing is just getting underway.

    Tip: If you bank with a company whose share price is sinking like a stone, you should think carefully about the joys and sorrows of becoming part of a massive FDIC receivership process.

    Speaking of bank stocks giving off some bad odors, consider these:

    Citigroup: $107B market cap, 62% loss within the past year, #2 on the derivative list.

    Description: Citigroup Inc. (Citigroup)is a diversified global financial services holding company whose businesses provide a range of financial services to consumer and corporate customers. The Company is a bank holding company. As of March 31, 2008, Citigroup was organized into four major segments: Consumer Banking, Global Cards, Institutional Clients Group (ICG) and Global Wealth Management (GWM). The Company has more than 200 million customer accounts and does business in more than 100 countries.

    Wachovia: $36B market cap, 65% loss over the past 8 months, #4 on the derivative list.

    Description: Wachovia Corporation (Wachovia) is a financial holding company and a bank holding company. It provides commercial and retail banking, and trust services through full-service banking offices in 23 states.

    Fifth Third Bank Corp: $6.8B market cap, 70% loss within the past year, #21 on the derivative list.

    Description: Fifth Third Bancorp (the Bancorp) is a diversified financial services company. As of December 31, 2007, the Bancorp operated 18 affiliates with 1,227 full-service banking centers, including 102 Bank Mart locations open seven days a week inside select grocery stores and 2,211 Jeanie automated teller machines (ATMs) in Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania and Missouri

    Suntrust Bank: $14b market cap, 55% loss within the past year, #9 on the derivative list.

    Description: SunTrust Bank (the Bank), the Company provides deposit, credit, and trust and investment services. Through its subsidiaries, SunTrust also provides mortgage banking, credit-related insurance, asset management, securities brokerage and capital market services. The Company operates in five business segments: Retail, Commercial, Corporate and Investment Banking (CIB), Wealth and Investment Management, and Mortgage. The Bank operates primarily in Florida, Georgia, Maryland, North Carolina, South Carolina, Tennessee, Virginia and the District of Columbia.

    Fannie Mae: $24B market cap, 65% loss within the past year. Derivative exposure unknown.

    Description: Federal National Mortgage Association (Fannie Mae) is engaged in providing funds to mortgage lenders through its purchases of mortgage assets, and issuing and guaranteeing mortgage-related securities that facilitate the flow of additional funds into the mortgage market. The Company also makes other investments that increase the supply of affordable housing. It is a government-sponsored enterprise (GSE) chartered by the United States Congress and is aligned with national policies to support expanded access to housing and increased opportunities for homeownership. The Company is organized in three business segments: Single-Family Credit Guaranty, Housing and Community Development, and Capital Markets.

    General Electric: $287B market cap, 31% loss within the past year, derivative exposure unknown. Note: GE is hugely exposed to finance through its GE Capital division – some wags say that GE is a finance company that also makes stuff.

    Description: General Electric Company (GE) is a diversified technology, media and financial services company. With products and services ranging from aircraft engines, power generation, water processing and security technology to medical imaging, business and consumer financing, media content and industrial products, it serves customers in more than 100 countries. GE operates in six segments: Infrastructure, Commercial Finance, GE Money, Healthcare, NBC Universal and Industrial.

    MBIA: $1.6B market cap, 91% loss within the past year, exposed to $137 billion in Credit Default Swaps.

    Description: MBIA Inc. (MBIA) is engaged in providing financial guarantee insurance and other forms of credit protection, as well as investment management services to public finance and structured finance issuers, investors and capital market participants on a global basis.

    Each one of the above examples is signaling a severe financial crisis. These examples, of which I could pull many more, represent the largest financial company in the world (Fannie Mae), one of the largest banks in the world (BAC), two regional banks (Suntrust and Fifth Third), a national bank (Wachovia), the third largest company in the world (GE), a bond insurance company (MBIA), and a pure-play mortgage company (CFC). In short, we are seeing severe financial weakness across a diverse set of sectors, regions, and products, and I am at a complete loss as to how anyone could view these charts and make the claim that we are out of the woods.

    Tip: If your bank is publicly traded, follow the stock closely. At any sign of weakness, get out and get safe.


    Okay, why did I drag you through this tour of stock charts? Because I desperately want you to understand that this party is just getting started. The comforting words of the Federal Reserve are grossly mismatched to the price signals that these very large and very leveraged financial companies are giving off. The charts above are screaming that "something is broken." I don’t know exactly what it is, but my suspicion is that the derivative mess is at the heart of it.

    My analysis suggests that the FDIC lacks sufficient funds to adequately insure all of the potential losses. Read my report on the FDIC if you need a refresher on the matter.

    As go the financial companies, so goes America.

    That’s what this fight is all about, and that is why the Fed is pouring liquidity on the markets even as inflation is screaming higher and ruining lives. The alternative, collapse of our banking system, is viewed as the far greater threat.

    And rightly so.

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    Commodities Crushed and How This Can Help You

    by Chris Martenson

    Wednesday, August 6, 2008, 1:40 AM

    Tuesday, August 5, 2008

    World commodity markets have entered a sudden free-fall. This information is important enough that I want both subscribers and registered members of the site to be aware of it. Please feel free to distribute this report.

    My strong advice is to hold off on pre-purchasing your winter heating oil and not lock in any contracts for natural gas. Ditto for pre-purchases of food, all metals, and gasoline/diesel.

    If you were thinking of buying into gold or silver, better prices would seem to lie in the future, although the charts are a little less clear here.

    This is all consistent with my advice from the last Martenson Report for subscribers (sent 8/2/08), where I said:

    “I have my concerns about commodity prices over the remaining portion of 2008, and even more so for 2009. The reason is that extra supply from mines and newly planted acreage should be coming online right as the recession (depression?) is hitting full force in 2009.”

    Here are the charts of the commodity damage:

    Below is a chart of heating oil, the price of which is falling rapidly. After the price (the blue line) broke through the 50-day moving average (red line), the price declines have been relentless. Because of this, I am personally waiting to lock in my winter oil. I will keep a close eye on the price of heating oil and alert you if or when I think it is ready to climb back up.


    Natural gas. Wow. Just wow. This price decline is staggering enough that I suspect there was some heavily leveraged hedge fund on the wrong side of this trade that has now blown up. Somebody is losing a lot of money and somebody is gaining a lot of money. If it turns out that Goldman Sachs was, again, on the right side of a destroyed hedge fund, I will be ready to call “foul.” At any rate, based on this chart you should not lock into any long-term natural gas prices right now, because what you will be sold is natural gas that was bought by your provider a few months ago.


    And here’s crude oil. This chart also speaks of severe weakness that could see oil return to $100/barrel in pretty short order. At that point I’ll want to re-evaluate where it might head next. For now, expect cheaper energy prices in the near future.

    And here’s the chart for gold. It’s much less clear what’s going on here, although there is certainly price weakness. Should that weakness continue, my next downside target is $850, where I see strong support. If it gets there, I would be a modest buyer of gold while I evaluated its next probable moves.

    The next two charts of corn and wheat speak to enormous cash-flow difficulties for farmers. Since farm debt and land prices are in all-time record territory, lots of farms are going to go broke on these declines. But the outfits most affected by such wild price gyrations will be the grain elevators, who have to use grain futures to hedge their operations. These price declines will translate into huge swings in the margin positions of their futures accounts, and quite a few are going to find their profits entirely eaten up by interest payments on bank loans to cover their margin calls. Many will go bankrupt as a result. Given that the bankrupt grain elevators will get bought out by well-positioned financial and private equity firms, we are witnessing one of the largest transfers ever seen of physical wealth due to a paper crisis.



    I am still not quite sure what has happened to commodities, though I suspect that a major hedge fund or two has “blown up.” But it’s going to take awhile for this dust to settle. I speculate that world governments started pushing on these markets to help bring commodity prices down in order to allow them more political room to re-liquefy a stricken world banking system. I worry that the governments have actually triggered a destabilizing price crash that will bring its own issues of insolvency to farmers, grain elevators, energy companies, and pension and hedge funds. I fear that the law of unintended consequences will strike, and that ham-fisted government attempts to create the appearance of stability in the larger markets (by interfering with the commodity markets) will actually create the very thing they fear – a series of cascading cross-defaults within the financial system. We shall see.

    What do I mean when I say “governments interfere with the markets?” One form of interference is words. Recently the European Central Bank, in concert with the G7 ministers, has made public statements about the dollar being too weak. Bingo! Next thing you know, the dollar turns around and starts going the other way. Since commodities are priced in dollars, the effect of this is to put downward pressure on the commodities. In the US, Congress held meetings and proposed new rules to reign in the impact of speculators on oil prices. There is nothing quite like the threat of government-enforced rule revisions to change the way people think about and act within targeted markets. I have no specific evidence that the government has been directly selling into the commodity markets, but this would not surprise me in the least, especially if done via a proxy, such as a well-connected Wall Street firm or two.

    Which is why, if it turns out that Goldman Sachs is, once again, on the right side of this commodity rout (and we’ll know this by their trading profits), I will be more than suspicious – I will be pretty certain that they had implicit or even explicit Federal backing.

    I am not against cheaper heating oil. But I am dead set against official interventions in markets because I don’t trust central planning, especially if done by the current crop of “leaders” in DC, who seem to have neither a sense of the risks and challenges we face nor any plan for the future. Worse, such “band-aid” approaches only serve to mask the underlying issues and can even exacerbate them by creating the illusion that everything is returning to ‘normal,’ thereby nurturing a prompt return to the same imbalances that are the source of our current ills. What we need is to wring out the excess borrowing, lending, and spending that marks the past 25 years and eliminate government-dictated pricing designed to hide the impacts of additional monetary and fiscal excess.

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    The Credit Crisis Is Not Over – It Is Just Beginning

    by Chris Martenson

    Monday, August 18, 2008, 1:52 AM

    Sunday, August 17, 2008

    In our debt-based economy, new credit is the source of new money. Without ever more money (meaning credit) to fuel ever more spending, our economy will contract. Which is why I keep a close eye on credit. The stories below tell a very different tale from the recent stock market action.

    In this type of economy, nothing is more important than the continuation of ever more borrowing in ever larger amounts. If this falters for any reason, extreme financial instability would be the expected outcome, especially given the extreme degree of leverage in the financial system, which we would experience as collapsing financial institutions and rising levels of default. The three main sources of demand for new borrowing are consumers, businesses, and the government. I will examine each below, along with some other evidence to make the case that our financial crisis is not over; in fact, it has hardly begun. This means that the recent perplexing actions in the dollar and the stock market very likely represent one of the largest head-fakes of all time.

    We are all familiar with the fact that US residential real estate activity is basically down 33% from its all-time peak. This represents roughly 2 million homes that will not be sold this year, compared to 2005. Among other things, this includes 2 million fewer mortgages, sales commissions, inspections, title searches, and municipal transfer fees paid. The ripple effect extends to everything from granite countertop sales, to lumber prices, to furniture. Assuming that the average house sale resulted in a net increase of borrowing of $100,000 (= the size of a new loan on a newly purchased house when compared to the old one), that results in a direct borrowing hit of 2,000,000 times $100,000, or $200 billion. Add in the ripple effects, and we are talking another few hundred billion in lost activity.

    Further, Mortgage Equity Withdrawal, the practice of “extracting wealth” from a house, peaked at $682 billion in 2006, and will be lucky to break $200 billion this year, which will represent a loss of nearly $500 billion/yr from the peak and some $275 billion from last year. Taken together, residential real estate is already off some $500 billion in consumer borrowing from last year. The question lurks: What will fill in that gap? Business borrowing? Even higher levels of government borrowing?

    And here’s the mystery: For “money” to show up in the banking system, borrowing has to happen somewhere. Our indirect evidence that something is amiss rests in this chart of MZM, or Money of Zero Maturity, which is the next best descriptor of total money that we have left since the Fed stopped publishing M3 over a year ago. As you can see in the first chart below, MZM has been growing quite smartly throughout 2008, and you really have to squint at the very end of the chart to detect a slight abatement in the growth. There’s a little wiggle right at the end of the line.

    If this is not clear enough, then we can switch to the second chart, which shows the change in the money supply from a year ago. That is, if the chart reads “$1,000 billion” (which = $1 trillion), it means that over the past 12 months, $1 trillion of new money was somehow created in the banking system.

    This second chart of MZM shows a couple of interesting points. Note that in 1989, MZM went briefly negative, and we then entered a pretty nasty “double dip” recessionary period. Alan Greenspan got chewed out by Bush-the-First for “costing him the election,” because Greenspan failed to act quickly enough to remedy that situation. When money supply declines, it means credit is not expanding, and this quickly leads to economic pain and dislocation in our must-always-be-expanding system.

    The second time that Alan was faced with MZM heading into negative territory was in 1995 (marked on the graph), and this time he was ready. Unfortunately, he did something really exceptional to “goose” the creation of new money/credit – he effectively eliminated bank reserves.

    In theory a bank is limited in the amount of credit it can create by the so-called “fractional reserve” ratio, which is usually related to be 10%. But since MZM stands at 8,700 billion dollars and bank reserves currently stand at only $43 billion dollars we can easily determine that bank reserves are, in reality, only 0.5% of liabilities, not 10.0%. This means that instead of creating $900,000 out of every $100,000 held in reserve, banks have created something closer to $20,000,000.

    While this is all very interesting, the really important questions are, “How exactly has money grown by more than a trillion dollars over the past year?” and “Who exactly has been borrowing all that new money into existence?”

    Here’s where the story gets difficult, because we cannot easily identify these sources of borrowing in the news. For instance, one factor normally required for money/credit to continue expanding at a fast pace is that bank lending must remain easy and loose. As this next article makes clear, over this past year, banks have been making it harder, not easier, for borrowers.

    Credit squeeze getting worse, banks say (emphasis mine)

    Aug 11 – MarketWatch

    Despite all the aggressive moves by the Fed in the past year to ease the flow of credit to the economy, a record percentage of banks were making it more difficult for borrowers in the three months ending in July, the Fed said in its quarterly senior loan officer survey of 52 major banks.

    A majority of banks tightened their rules for granting loans to businesses and consumers. The survey shows little appetite at banks to lend for home mortgages, credit cards, home equity loans, commercial real estate loans, or commercial and industrial loans.

    No bank in the survey eased credit terms for any type of loan in the past three months, and only one bank said it anticipated easing standards for consumers in the next 12 months.

    C&I loans: 58% of banks tightened standards for commercial and industrial loans to large and medium firms, while 65% tightened for small firms.

    Commercial real estate: 81% tightened standards, while 50% said demand was weakening.

    Residential mortgages: A record 74% of banks said they tightened standards for prime mortgages, while 53% said they saw reduced demand. For subprime mortgages, 86% tightened standards, with the number of banks who offer such loans declining to 14% of banks from about 30% two years ago. For nontraditional mortgages, 84% tightened standards while 63% reported reduced demand.

    Consumer credit: A record 36% of banks reported less willingness to extend consumer installment loans; only 2% were more willing. Eighty percent tightened standards on home-equity lines of credit. For credit cards, 67% tightened standards, mostly by refusing new loans to consumers without good credit.

    Read this sentence again because it is truly unprecedented: “No bank in the survey eased credit terms for any type of loan in the past three months.”

    NO BANK. As in ‘none.’ Zero. For any type of loan. This survey makes it clear that banks have tightened right across the board, in every segment of lending, often by RECORD AMOUNTS.

    Now, it gets really tricky to understand how the money supply is reported to be close to a trillion dollars just this year while bank lending has dropped off by record amounts.

    Here’s another example of a former source of lending that has experience a quite dramatic drop-off in volume over the first half of the year:

    Office Building Deals Drop Off

    Aug 11 – Washington Post

    In the District [of Columbia], $1.4 billion worth of office space traded hands in the first six months of the year, a 61 percent drop from the $3.6 billion sold by mid-2007, according to Real Capital Analytics of New York. The drop-off was even more pronounced in Northern Virginia, where building sales plummeted 87 percent, to $914 million from $6.8 billion a year ago.

    “The commercial real estate game doesn’t work without debt, and it is very hard to come by these days on attractive terms,” said Dan Fasulo, research director for Real Capital.

    Other cities have faired similarly. Manhattan, the nation’s biggest office market, saw a 59 percent drop, to $6.4 billion from $15.5 billion. Deal volume fell 60 percent in Los Angeles, to $1.84 billion from $4.65 billion. Chicago had a 23 percent drop, to $1.7 billion from $2.2 billion.

    In major cities on both coasts and in the Midwest, office space deals fell anywhere from 23% to 87%. The deals fell through because debt could not be arranged and the game doesn’t work without debt. No debt = no money. No money = bad economy.

    So where is all the money coming from?

    Is it coming from overseas borrowing? Nope, not if this next article is accurate.

    The Credit Crisis Spreads to Europe

    Aug 11 – Time

    For banks across Europe, as for their U.S. counterparts, 2008 is proving painfully difficult. Globally, banks could write down as much as $450 billion more over the next three to four years, according to research from Deutsche Bank. Lenders, it says, are short of funds equivalent to 4% of their balance sheets, with those in Ireland, Spain and Britain finding fund-raising particularly tricky.

    Even the banks are having a hard time raising money for their own balance sheets, which means they are certainly not lending it out to businesses and consumers.

    Here’s one possible explanation for the continued increase in corporate borrowing: This link goes to a radio interview between a Bloomberg host and Mr. Goldman, who is a lively and clear orator. I really like the way Mr. Goldman makes clear that the so-called “credit crisis” is no such thing…yet. The credit crisis has not yet arrived, because major banks are contractually obligated to provide lines of credit to companies that are busy drawing those lines down. The credit crisis erupts when those loans are due to be renewed. He claims that banks do not have the balance sheets they need to extend that credit, and, therefore, the worst effects remain in front of us.  

    The bottom line:   I do not have a great explanation for the mechanism that is creating the large reported increases in the money stock. At this point, my strong inclination is to go with the media reports of the actual situations out in the real world. They may be anecdotal, but they seem more accurate than the opaque reporting of the Federal Reserve or government.

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    Follow the Money

    by Chris Martenson

    Monday, August 25, 2008, 1:22 AM

    Saturday, August 24, 2008

    Nobody can borrow and consume their way to wealth; no city can do it, no state, and no country either. For the past 25 years the US has been progressively producing less and less, consuming more and more, and borrowing to cover the difference.

    Today I stacked wood for the winter, which is always satisfying, and thought about where we really are in this credit crisis. That was decidedly less satisfying.

    It is important to remember that we did not get here all at once, and that this crisis was not caused by subprime mortgage defaults. Rather, those were effects, while the cause was the cumulation of 25 years of progressively larger borrowing…

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    Disappearing Money & The Great ‘Flation Debate

    by Chris Martenson

    Saturday, August 30, 2008, 8:40 PM

    Saturday, August 30, 2008

    Here are two recent reader emails and my responses to them. The first asks the question, “Why does money have to disappear when debts get paid down?” and the second asks why I favor an inflationary outcome over a deflationary outcome. Since I think each of these reflects a possible source of broad interest, I decided to give them full responses and turned them into this weekend’s report.

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    Exponential Money in a Finite World

    by Chris Martenson

    Friday, September 5, 2008, 11:48 AM

    Friday, September 5, 2008

    This is an article I was asked to write for the VT Commons, where it appeared on the front page in August 2008. It is largely a significant re-write of my The End of Money article. This article lays out the very foundation of my entire line of thinking, and I think it should be widely circulated and debated.

    Full permission to reprint, post, and/or distribute is granted.

    The greatest shortcoming of the human race is our inability to understand the exponential function.

    ~ Dr. Albert Bartlett

    Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.

    In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.

    It is this: Our monetary system must continually expand, forever.

    The US/world monetary system was designed and implemented at a time when the earth’s resources seemed limitless, so few gave much critical thought to the implications that every single dollar in circulation was to be loaned into existence by a bank with interest. In fact, most thought it a terribly “modern” concept, and most probably still do.

    But anything that is continually expanding by some percentage amount, no matter how minuscule, is said to be growing geometrically, or exponentially.

    Geometric growth can be seen in this sequence of numbers (1, 2, 4, 8, 16, 32, 64), while an arithmetic growth sequence is (1, 2, 3, 4, 5, 6, 7). In 1798, Thomas Malthus postulated that the human population’s geometric growth would, at some point, exceed the arithmetic returns of the earth, principally in the arena of food. To paraphrase, he recognized that the exponential growth of human numbers would meet with the constraints imposed by a finite world. As seen in the chart below, human population is growing exponentially, and is on track to reach 9.5 billion by 2050. To put this in perspective, it was only in 1960 that the world first passed 3 billion in total population, the same amount that is projected to be added over the next 42 years. Each new person places additional demands on food, water, energy, and other finite resources.


    In parallel with exponential population growth, our monetary system is also exhibiting exponential behavior. Consider this evidence:

    1) Money supply growth (see chart above). It took us from 1620 until 1973 to create the first $1trillion of US money stock (measured by adding up every bank account, CD, money market fund, etc). Every road, factory, bridge, school, and house built, together with every war fought and every other economic transaction that ever took place over those first 350 years, resulted in the creation of $1 trillion in money stock [1]. The most recent $1 trillion? That has been created in only 4.5 months. The dotted line in the chart is an idealized exponential curve, while the solid line is actual monetary data. The fit is nearly perfect (with a correlation of 0.98, for those interested). Data from the Federal Reserve.


    2) Household debt has doubled in only 7 years, growing from seven to fourteen trillion dollars. Think about that for a minute. It is a stunning turn of events. Have household incomes also doubled in 7 years? No, not even close; they have grown less than half as much, calling into question how these loans will be repaid, let alone doubled again. Data from the Federal Reserve.

    3) Total credit market debt (that’s all debt) had finally exceeded $5 trillion by 1975, but has recently increased by $5 trillion in just the past 2 years (from 2006 – 2008), and now stands at nearly $50 trillion. In order for the next twenty years to resemble the last twenty years, debt would have to expand by another 3 to 4 times, to somewhere between $150 trillion and $200 trillion. How likely do you think this is? Data from the Federal Reserve.

    How do we make sense of money numbers this large and growing this fast? Why is this happening? Could it be that the US economy is so robust that it requires monetary and credit growth to double every 6-7 years? Are US households expecting a huge surge in wages, to be able to pay off all that debt? If not, then what’s going on? The key to understanding all three of the above money and debt charts was snuck in a few paragraphs ago; every single dollar in circulation is loaned into existence by a bank, with interest.

    That little statement contains the entire mystery. As improbable as it may sound to you that all money is backed by debt, it is precisely correct, and while many of you are going to struggle with the concept, you’ll be in good company. John Kenneth Galbraith, the world-famous Harvard economist, said, “The process by which banks create money is so simple that the mind is repelled.” [2]

    Here’s how money (and debt) creation works: Suppose we wipe the entire system clean and start over, so that we can more easily understand the process. Say you enter the first (and only) bank and receive the very first loan for $1000. At this point the bank has an asset (your loan) on the books, and you have $1000 in cash and a $1000 liability owed to the bank. After a month passes, and the first interest accrues, we peek into the system and observe that the $1000 in money still exists, but that your debt has grown by the size of the interest (let’s call that $10). Now your total debt to the bank is $1000 plus the $10 interest or $1010 in total.

    Since there’s only $1000 floating around, and that’s all there is, clearly there’s not enough money to settle the whole debt. So where will the required $10 come from? In our system it must be loaned into existence, taking the form of $10 of new money plus $10 of new debt that must also be paid back with interest.

    But if our system requires new and larger loans to enable the repayment of old loans, aren’t we actually just compounding the total amount of debt (and resulting money) with every passing year? Yes, that is precisely what is happening, and the three money/debt charts supplied above all provide confirmation of that dynamic.

    In other words, our monetary system, and by extension our entire economy, are textbook examples of exponential systems. Yeast in a vat of sugar water, predator-free lemming populations, and algal blooms are natural examples of exponential growth. Plotted on graph paper, the lines tracking these populations start out slowly, begin to rise more quickly, and then, suddenly, shoot almost straight up, yielding a shape that resembles a hockey stick.

    The key feature of exponential functions that our species desperately needs to understand is illustrated in this next example: [3]

    Suppose I had a magic eyedropper that could dispense a drop of water with a most unusual trait – it will double in size every minute – and I place a drop of water in your hand. At first you’d just have a lonely drop of water sitting in your hand, but after one minute it would double in size, and after six minutes you’d have a blob of water that could fill a thimble. Do you have a sense of that growth? Now, follow me to Fenway Park, where I am going to place a drop from my magic eye dropper on the pitcher’s mound at 12:00 pm on January 1st of 2008. To make this interesting, let’s assume that the park is water-tight, and that I’ve handcuffed you to the highest row of bleacher seats. Way down there, on the mound, I bend over and plop a magic drop of water, so small you could not possibly see it from where you are sitting, and it begins to double. My question to you is, at what date and at what time would the park be completely filled? That is, how long do you have to escape from your handcuffs? Days? Weeks? Months? Years?

    The answer is this: You have until 12:49 pm, on that same day, before the park is completely filled. You have only 49 minutes to escape your handcuffs. And at what time do you suppose that the park is still 97% empty space (and how many of you will appreciate the seriousness of your predicament)? The answer is that at 12:45 pm the park is still 97% unfilled. The first 44 minutes filled just 3% of the park, while the last 5 minutes filled the remaining 97%. From all of history until 1960 to reach a population of 3 billion humans; only 42 years from now to add another 3 billion.

    And that’s why we need to appreciate exponential functions. For quite a while, everything seems just fine, and a few minutes later your park is overflowing. Time runs out in a hurry towards the end of any exponential growth system, forcing hurried decisions and limited options.

    So how does this pertain to our economic problems, and why should you care? The truth is, there’s nothing inherently wrong with exponential growth, as long as you have unlimited room and resources. However, there are clear signs that several key resources on our planet are in their final minutes, to use our Fenway Park example.

    And none of these are more important than crude oil. “Peak oil” is the global extension of the observation that individual oil fields, without exception, produce slightly more oil each year up to a point (“the peak”), after which they produce incrementally less and less oil each year, until their economics force abandonment. It is a fact that the US hit its peak of oil production in 1970 at approximately 10 million barrels a day and now produces barely more than 5 million barrels a day. It is now widely recognized that oil is a finite resource, and another cold, hard fact is that global oil discoveries peaked some 45 years ago. Because discoveries precede production (you’ve got to find it before you can pump it), we can be certain that production will peak too. We might disagree over the timing, but not the process.

    I’m focusing on oil because energy drives an economy, not the other way around. The engine of any economy is energy, while money is merely the lubricating oil. Without energy, no amount of additional money would make the slightest difference in our lives. Economists love to say that higher oil prices will stimulate new oil production, as if demand could magically create supply. (Joke: If you lock three economists in a basement they won’t worry about starving, because they know their grumbling bellies will soon cause sandwiches to appear.) But just as there is no amount of additional price hikes that will cause more cod to come from the depleted oceans, oil fields will yield their treasures in accordance to geological limits, not human desire.

    And here’s where the enormous monetary design flaw comes into the story. As Meadows, et al., in The Limits to Growth (1972) brilliantly predicted, we humans are now encountering physical, resource-constrained limits to our economic and population growth. So, on the one hand we have a monetary system that, by its very design, must expand exponentially in order to merely operate, while on the other hand we live on a spherical planet with finite resource limits.

    When we started our exponential monetary system, initiated by the Bank of England around 1700 but kicked into high gear in 1971 with the international abandonment of gold settlement, nobody ever thought that the day would come when we’d find our ball park filled nearly to the brim. Who ever thought that oil production would hit a limit? Who knew that every acre of arable land, and then some, would someday be put into production? How could we possibly fish the seas empty? Yet all of these things have come to pass, and our monetary system demands that even more follow.

    This is clearly an unsustainable arrangement. Someday soon, it will cease to be.

    Repeating an opening sentence, our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today. I wish this collision between a finite planet and an exponential money system was far off in the future. Alas, it is certainly within the lifetime of people alive today, and likely already upon us.

    We are leaving a legacy of debt to our children, born and unborn. Just as the direct printing of money favored by Wiemar Germany in the 1920s destroyed German’s purchasing power, so, too, does America’s debt accumulation promise to ruin our economy. Thus the moral argument beneath exponential growth in a finite context is: Should one generation consume beyond its means and either expect or hope that the next generations will somehow pick up the tab?

    In summary, because our economic model and our entire system of money enforce a doctrine of limitless growth, they have become anachronisms incompatible with the well-being of the planet on which we live and depend. Our global money system might be complicated, and it might be sophisticated, but it is soon to be a vestige of the past.

    Your job, your savings, your investments, and your future prospects and standard of living depend on the continuation of an unsustainable system now drawing to a close. You owe it to yourself to get ahead of the immense changes that are coming like water roiling up the steps towards the bleacher seat to which you are chained.

    Next time: We’ll use this understanding of our monetary system to examine where we are, and solutions that you and your community should consider before the system collapses. Remember, the end of one thing is always the beginning of another.


    [1] Having trouble picturing a trillion? Think of it this way: If you had a single thousand-dollar bill, you could have a pretty good night on the town with your friends. If you had a stack of thousand dollar bills that was 4 inches high, you’d be a millionaire. If you had a stack just 40 inches high, you would be worth ten million dollars. How high would your stack have to be in order for you to be a trillionaire? The answer is, a solid stack of thousand dollar bills 68.9 miles high.

    [2] If you need more help on this concept, please visit chapters 7 & 8 of my free, on-line Crash Course at

    [3] I gained a much deeper appreciation for the power of exponential functions from transcripts of speeches given by the mathematician Dr. Albert Bartlett. This link goes to an exceptional example of his ability to make this complex subject startlingly clear.

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    Fannie And Freddie Bailed Out – What Does It Mean?

    by Chris Martenson

    Sunday, September 7, 2008, 3:25 PM

    Sunday, September 7, 2009

    Like it or not, the "interesting times" have arrived. With this weekend’s nationalization of Fannie and Freddie, and other such bailouts of a financial industry beset with self-inflicted wounds (actions I predicted some 4 years ago), we have now crossed a line.

    Given that our entire banking system is insolvent, there are no financial solutions to this crisis, only political ones. The question before us now is both simple and stark: “Who is going to be left holding the bag?” This weekend, we found out with the nationalization of Fannie (FNM) and Freddie (FRE) that there is strong political, bipartisan support for making current and future taxpayers the ultimate recipients of the bag.

    At times like this, I feel the need to back way up and take in the big picture, because the details are too slippery and too numerous to grasp.

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    “The worst is yet to come”

    by Chris Martenson

    Sunday, September 14, 2008, 5:40 PM

    Sunday, September 14, 2008

    The title is actually the assessment of banking analyst Meredith Whitney, regarding where we are in the banking crisis. In this report, I run through a scenario of what a banking crisis might look and feel like, and examine the reasons why I consider myself in full agreement with this quote.

    Executive Summary

    • The damage so far: Bear Stearns, Lehman Bros.
    • The damage still to come: Washington Mutual, AIG, Merrill Lynch, Citibank, and many others
    • The risk of a major systemic banking crisis is very high at this time
    • While we wait to see what develops, cash out of the bank is a good idea.

    Before I get into the gory details below, I want to begin with the conclusion.  What I mean by a “major, systemic banking crisis” is the complete shutdown of the banking system.  All banks closed, none operating, no way for you to access your funds.  Because of this possibility, you need to get out at least one month’s worth of cash to have on hand (three months is better).  Keep it in a safe place.

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    So Long, Mr. Dollar

    by Chris Martenson

    Thursday, September 18, 2008, 5:49 PM

    Thursday, September 18, 2008

    Executive Summary

    • The chance of a major dollar crisis is one step closer to being a reality.
    • The US has thrown all fiscal caution to the wind in an effort to prop up our old way of doing things. 
    • We are exchanging future US liabilities for bad current debts.
    • All of this represents the bursting of the largest credit bubble in history.
    • The rules have changed.  Be prudent.

    This report explains the recent move by the Treasury in offering $100 billion in new debt to "help bolster the Federal Reserve balance sheet."

    I focus on this because I believe it marks the beginning of the end of the US dollar.

    Want to know why gold popped so hard, and the reason why I am ready to call for a major dollar wipe-out?

    It is all contained in yesterday’s news that the Treasury Department is going to “help bolster the Federal Reserve balance sheet” by selling Treasury bonds and giving that cash to the Fed.  Oops.  Today (9/18/08) the announcement is that the amount of new government debt is going to be $100 billion.

    Sept. 18 (Bloomberg) — The U.S. Treasury said it will sell an additional $100 billion in short-term debt to aid the Federal Reserve’s balance sheet, amid the biggest extension of central-bank credit to financial companies since the Great Depression.

    Yesterday the Treasury started a special program to help finance the Fed’s portfolio with an initial $100 billion in bill auctions. The proceeds will give the central bank cash to boost liquidity in credit markets struggling from $519 billion in writedowns and losses since the start of last year.

    I’m sure most of you are scratching your heads right now.  What does all this mean?  Whose balance sheet is doing what, and which money is going where?

    Let me demystify this process for you.

    Here’s the actual mechanism. The black arrows connote the movement of US government debt (the yellow boxes), and the green arrow shows the movement of cash. 


    1. Starting in the upper left corner, the Treasury auctions off (sells) bonds into the open market to financial institutions.
    2. The Treasury receives cash for those bonds.
    3. The Treasury then hands this cash over to the Fed (top green arrow).
    4. Separately, the Fed steps into the open market and buys bonds/bills and Mortgage Backed Securities (a.k.a. junk) from banks.
    5. The Fed pays cash to the banks/institutions for these bonds.

    Hang on here.  Isn’t this overly complicated?  It sure is, and that is the intent.

    As in a simple math problem, we can cancel some like terms and make this all a bit easier to understand.

    Here’s the simplified view with all the complexity stripped out.

    Ah!  That’s better.  It means that the Treasury just shipped $100 billion of newly created US Government debt over to the Fed, to use however it likes in battling this crisis.

    What does this mean?  It means that the Treasury Department is now sharing the burden of ruining its balance sheet alongside the Fed, which, truth be told, has pretty much already ruined its own balance sheet.  A year ago, the Fed had $880 billion of Treasury debt on its books, whereas now it has less than half that amount, the rest having been swapped for Mortgage Backed Securities in what I call the "Treasuries for Trash(tm)" program.  So this means that the US Taxpayer is now funding the ability of the Fed to do what it does, which is mainly to accept bad mortgage debt (and now equities too!) in exchange for safer, better Treasuries.

    What else does this mean?  It means that the chance of a major dollar crisis is one step closer to being a reality, because the US has thrown all fiscal caution to the wind in an effort to prop up our old way of doing things.  It means that we are exchanging future US liabilities for bad current debts.

    It means that if anybody asks you about this puzzling bit of maneuvering, you can simply say, "It’s just the Treasury Department going deeper into debt, so that the Federal Reserve doesn’t have to."

    While it is possible that this will work and everything will return to normal, I am not able to give it much of a chance of actually working, due to the numbers involved and the basic facts of the case.

    At bottom, all of this represents the bursting of the largest credit bubble in history.  For this all to return to normal, it will require houses to get back to their frothy levels of 2005, for credit to be as freely available as at the peak, for people to be “tapping their home equity” at the same rate as before, and for more autos to be sold than at the peak.

    Unless all of that happens, and more, the credit bubble will not expand beyond its old boundaries, and we will not be able to support all of the past debts.  Therefore, we can be pretty sure that some capital destruction, and possibly quite a lot of it, is on the way.  There’s really very little that can be done about that.

    My advice to you is the same as it has been for months:

    • Trim your expenses as far as humanly possible.
    • Don’t take on any more debt for any circumstances, unless you are speculating and can manage the risks.
    • Hold gold and silver, physical only.  How much?  That depends on how many of your US-dollar-denominated holdings you’d like to be absolutely sure do not go to zero.
    • Keep cash out of the bank.  Three months’ living expenses, if you can.
    • Develop a sense of community and get to know the people you can count on and who will count on you.
    • When you can, keep things topped off around the home.

    Please, be prudent.  The rules have changed, and this is no time for status quo reactions.  Not only are tough times coming, but they literally have no historical precedent, as we’ve never had a credit bubble this large burst so suddenly. 

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