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Setting up the trip-wire
Gamblers shorting the dollar and
bonds beware. Rumors about the imminent demise of
the dollar and the bond market are grossly exaggerated. Bear in mind not only
that the casino owner rigs your odds. He is also rigging the value of chips
in which payoffs are made, thereby confusing the issue further.
The teetering of the dollar at the 80 mark,
according to some the most important chart point ever in the history of charting, smells like a bear-trap. A lot of analyst predict that if the dollar violates that support, then
it is bound to go into a free-fall. Nobody is seriously considering the
possibility that this chart point, like everything else about the dollar, is
rigged. It is the trip-wire set to trip up the bears.
The demise of the US long-bond
market has been talked about for years. Analysts are so busy in writing the post mortem
that they have no time to look at the charts. Yet the charts clearly show
that the price of the 30-year US Treasurys is in an
upward
channel, where it has been for past 25 years. This in spite of the dollar
index being in a downward channel, where it has been for the past 35 years.
How is it that nobody sees a contradiction here that
cries out for explanation? That nobody sees the hand of the master-rigger
setting up the trip-wire?
Ticket to riskless profits
Here is a question for the
discriminating observer. How is it that interest-rate derivatives
do not obey the Law of Supply and Demand? The more there are of them, the
more they are in demand. Half-a-quadrillion (500 trillion) dollars’
worth are out there at last count (in comparison the US GNP is a paltry 13
trillion), and it is increasing at the rate of 40 percent per annum. At that
rate volume doubles about every other year.
Everything in human experience will tell you that
such a thing is not possible. The more of anything exists, the less it will
be appreciated. If the quantity of a security increases
exponentially, then its value is bound to decrease exponentially for the stronger
reason. Yet here we are, derivatives doubling in quantity every other year
and, far from losing value, they are ever more in demand. Why?
Because derivatives are tickets to
risk-free profits. As such they are the straw on which the
world’s banking system swims or sinks. Swims, as long as interest rates
are falling; sinks, as soon as they start rising in earnest.
Have the Chinese been tricked?
Enormous fortunes have been made on
the long side of the bond market by the bulls during the past 25 years, among
them by the Chinese, of all people. Make no mistake about it: their $1
trillion kitty is not all trade surplus. So much of
it is the wages of adroit gambling on the long side of the bond market for
the past 25 years. In 1982 the Chinese were astute enough to realize that US
30-year treasurys yielding 16 percent
per annum were a fantastic bargain. Not only did they lock in an income at
16% for 30 years, but they held out a promise for capital gains by doubling
in value at least twice as interest rates fell from 16% to 8%, and then again
from 8% to 4%.
The Chinese are not naive as suggested by the
analyst. They wrote the book on irredeemable paper currency when the paleface
treasurers in the Occident were still experimenting with the alchemy of
diluting silver and gold coins in circulation for the benefit of Old Coppernose. The Chinese invented paper without which
Helicopter Ben could not do his air-drops of Federal Reserve notes.
Noises from China about their
efforts ’to diversify’ the dollar portfolio is meant for the
gullible. Whenever they are ready to diversify in earnest, the Chinese will
not tell you about it in advance. Moreover, the fate of the dollar is already
pretty well in their hands. The Chinese have the power, through their
continued buying of US long bonds, to drive interest rates further down, all
the way to the Japanese, chalking up fabulous capital gains on their bond
portfolio in the process. Most importantly, they can do it even in the face
of continuing erosion in the purchasing power of the dollar.
Fast breeder of bonds not fast
enough
The bond market today is immensely
different from that of the 1980’s. Not only have T-bonds been created
through fast-breeders, bond gambling has been further escalated through the
creation of interest-rate derivatives. A new generation of derivatives is
„invented” every few months. The first generation was to hedge
the value of bonds. The second was to hedge the value of the first hedges.
The third is to hedge the value of the second. And so on and so forth, ad libitum.
There is
never enough of those derivatives because new risks crop up with the rise of
every new generation of hedges. Academic economists see in them an admirable
sophisticated instrument. Pity our poor forefathers. They had to do without
them.
Financial journalists want to stay
blissfully ignorant of the fact that derivatives have put the Law of Supply
and Demand into abeyance. „See no evil, hear no evil.” Cockaigne is here. Perpetual motion has been invented.
Enjoy it. Don’t ask questions. Sit down, sit down: you are rocking the
boat!
The con-conundrum
As I have said, the more of those
derivatives have been created the more are demanded, because they are
considered a ticket to riskless profits. So they are in Japan, and so they
are in the United States. When the casino-owner sells tickets to riskless
gains, the law of suppy and demand is suspended.
Both supply and demand tends to become infinite. Ask Charles Ponzi.
He’s been there. Interest-rate derivatives are proxy for bonds. They
are new chips that you can use at the casino. They augment a supply the size
of which already boggles the mind. On that count alone bond prices should be
approaching zero and, interest rates, infinity. Instead, what do we see? Bond
prices are still marching upwards. A conundrum indeed, if there ever was one.
A
con-conundrum.
Who says higher interest rates are
necessary?
Those who still believe in the
dictum of 19th century textbooks on bonds, that it takes higher interest
rates and lower bond prices to perk up excitement in a lethargic bond market,
are victims of the most brilliant confidence trick of all times. The gambling
spirit in the twenty-first century is being upheld, not by higher interest
rates, but by issuing ever more tickets to risk-free profits, that is, ever
more derivatives on interest rates. Those who still think that it is
necessary to bribe foreign suckers to buy more US bonds by the stratagem of
printing ever higher coupon rates on the new bonds are hopelessly
antediluvian. They have never heard of the miracle of creating capital gains
through pushing interest rates ever lower.
Analysts still fail to see the real
purpose of the derivatives monster. It has been sprung on the world in order
to keep bond values buoyant, so that the game of musical chairs could go on.
The dollar has fallen through 80. So what?
But what about the US dollar index,
allegedly showing that foreigners are getting tired of the infinite supplies
of US dollars of diminishing value that keep coming at them? It is nibbling
at the all-time low of 80 which, if taken out, you may never hear the dollar
to hit bottom. Analysts tell you that you cannot fool Mother Nature. The
dollar’s value is closing in on its intrinsic value: zero.
Don’t buy that. The dollar
index, just like the CPI number, is manipulated in order to fool the
uninitiated. Should the dollar fall through 80 and approach 70, foreign
central banks will see to it that their paper follow suit. They are all
too eager to match every point of the fall of the dollar. That will reverse
the trend. The Chinese, in particular, have a vested interest to keep the
fall of the dollar controlled and orderly. What is more, they have the power
to do so. They don’t mind taking a loss on the dollar here and there,
as long as it does not eat significantly into their mountain of paper profits
on the bond portfolio.
Central bank bag of tricks
There is no way to predict the
future scientifically. I would be a fool if I tried. I am simply saying that
a dollar collapse is extremely unlikely at this juncture. I am inclined to
lay far greater a store by the chart showing the US long bond in a 25-year
uptrend, than by the chart showing the dollar in a 35-year downtrend. Of
course, I know that the dollar, the yen, the euro are all being manipulated
lower, each by its own issuer. Why, the name of the game is „all fall
down”, isn’t it? But fall they must at a controlled pace.
Central banks have a bag of tricks with which they can slow down the
depreciation of currency values. The bag is infinitely deep. Furthermore,
central banks also have all the marbles. They make most of it. So you want to
win by placing a wager against the dollar? Good luck to you, but your odds
are infinitesimally small.
I stand by my earlier statement
that US interest rates are likely to fall more, replicating that of the
Japanese, violation of support at 80 notwithstanding. The world is not now
at a crucial turning point in 2007, like it was 25 years ago, in 1982, when
the Kondratyeff long-wave cycle switched from
rising to falling mode. I expect more of the same: falling interest rates,
firms losing market-share and pricing-power, stockpiles of commodities ever
more onerous to carry, which add up to a falling price level in disguise. The
dollar index? Forget it. It’s for the birds.
The Volcker-bluff
Why am I so stubborn in sticking to
the deflationary scenario? Here is my reasoning.
Hyperinflation almost engulfed the
world in 1980. When in a spectacular coup interest rates were allowed to
go to heights unheard-of at 20+ percent by the maverick Chairman of the Fed,
Paul A. Volcker, virtually all the banks of the world became insolvent (as
the value of their dollar assets was wiped out by the high-interest-rate
regime). The banks were bailed out unexpectedly by the new regime of falling
interest rates.
It is ridiculous to suggest that Volcker gave us a
strong dollar in 1980 - a repeatable feat. In actual fact Volcker gambled: he
staked the world’s banking system on saving the dollar from sudden
death. Luckily for him, the gamble worked. Before the bluff could be called,
the cascading of interest rates started fuelling bullish speculation in the
bond market.
Please note that the Volcker-bluff
is non-repeatable. In 1982 the world was riding high on the Kondratyeff long wave; 25 years later, in 2007, it is
languishing in the depths of the trough. Helicopter Ben could not take his
foot off the throttle. If he did, all deflationary hell would break loose,
and he knows it. The debt-pyramid would collapse in a fashion more
spectacular than that of the World Trade Center.
Keep our eyes peeled for the basis
How could central banks work the
miracle of making interest rates fall in the face of running the printing
presses overtime, and keep them from rising again? That’s just the best
part of it. They have let the genie of the derivatives monster out of the
bottle. The genie is mushrooming over the world economy, growing at a clip of
40 percent per annum. Right now it is half-a-quadrillion dollar strong,
doubling in about every second year. It is the derivative monster that keeps interest
rates low, and makes them fall further. Remember, derivatives are
just tickets to riskless profits in bond speculation on the long
side. It is as simple as that.
Does this mean that the
Ponzi-scheme of derivatives creation will go on forever? Of course not. We
have it on the authority of the Bible. Read the biblical story of the Tower
of Babel. But how do we know when the Derivatives Tower of Babel will start
to unravel? Forget the chart point 80, it is not your clue; nor is any other.
Keep
your eyes peeled for the silver and gold basis. This is the
subject of a blue ribbon panel discussion at the next session of the Gold
Standard University in August, 2007 (see below).
Do central banks
have all the marbles?
It may appear that central banks
have all the marbles. Indeed they do - except for one. They have foolishly
let the most important marble slip through their fingers. That marble is the gold marble.
The only wager against the dollar that has a chance of winning in the long
run is the one staked out by the gold marble. Ironically, it is also the
simplest, and anyone can play it, even people of modest means. That wager
consists in scale-down purchases of physical gold. Buy on every dip of the
gold price. Upon bigger dips, buy more. In doing so you may ignore all the
indicators with the exception of the basis: the CPI, the dollar
index, bond prices, foreign exchange rates, COT reports. You keep buying, and
never
sell. Your gold is fully paid for. It should be a source of infinite joy to
give up worthless (well, make that ultimately worthless) paper against
acquiring gold marbles.
The music stops when the basis
turns permanently negative, heralding the curtain on the last
contango in Washington. It tells the world that all
offers to sell physical silver and gold have been withdrawn in the markets.
The monetary metals are not for sale at any price. The game of musical
chairs is up. Fear not: your gold marble has reserved a chair for you.
If personal misfortune overtakes
before that happens, you still won’t sell. In an utmost emergency you borrow,
but not sell. Remember, interest rates are kept at an artificially low level
by the managers of the con-conundrum, offering you a gift.
Theirs is a gift that you may
accept.
Gold Standard University Live
Session Two of Gold Standard
University will take place between August 17 and 29, 2007, at Martineum Academy in Szombathely, Hungary. It will
feature a one-week course (13 lectures) entitled Gold and Interest,
as well as a blue-ribbon panel discussion entitled The Last Contango - Basis As an Early Warning Sign of
the Collapse of the International Monetary System. Tom Szabo will be present. He is one of the world’s
foremost expert on the gold and silver basis who on his website www.silveraxis.com has been tracking them for half a year. He is a
member of the research team of GSUL.
The second week is reserved for
sight-seeing and recreation, including the famous Savaria Roman
Festival featuring Roman togas and other habits, Roman cuisine,
Roman games, etc. Enrolment is limited; first come first served. For more
information please contact: GSUL@t-online.hu
Antal E. Fekete
Professor,
Intermountain Institute of Science and Applied Mathematics, Missoula, MT
59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
Correction. It was incorrectly stated in my article The
Golden Thorn in the Flesh, Part Two, that a translation of Melchior
Palyi’s 1968 paper Gold Standard
and Economic Order from German to English was made by Dr. T. Megalli. In
fact, the article appeared in English in the original edition of the
Festschrift Geld, Kapital, und Kredit
(Stuttgart, 1968) honoring Heinrich Rittershausen on the occasion of his
70-th birthday.
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