Precious metals guru David Morgan returns to address the great threat to the global financial/monetary system from derivative risk. He sees the world at an unprecedented moment in history where the interconnected nature of the global economy makes all players vulnerable to the mind-boggling volume of outstanding derivatives, which makes the sum of all world equity + debt look tiny in comparison (if you haven't seen it yet, look at this visual from The Money Project):
I want to give a very clear example that comes from gaming theory and I think this is a very concise and easy way for most people to understand our derivative risk exposure .
There are all kinds of gambling programs out there but one of the simplest ones before any computers was: you are at the roulette table (or you could be wherever, but roulette serves as the best analogy), and you bet a dollar on black and you lose. Then the next bet, you bet $2.00 and you lose. And then the next bet, you bet $4 and you lose. And the next bet, you bet $8 and you lose. The idea is that you keep betting on black, and eventually that's going to come up and you're going to win on the roulette table. The problem with that is this. You start to bet 2 4 8 16 32 64 128 256 and on and on, and what you are doing is you are betting $256. For what? To win a dollar. That is what you are doing. And that, Chris, I think is the best example I can give to the listeners about what we are doing in these derivatives.
This is based on simplified "delta hedging" which is fairly easy to understand. But now you've got these mathematicians out there writing these derivatives that make the example I just gave you look like child’s play. That's literally a fact. And these things are so interdependent and there is so much counter-party risk -- that is, of course the biggest, issue -- If you win the bet in the derivatives market, what happens if the counter party can’t pay you? That's what happened in 2008. People still don’t realize how close we were to the edge at that point because banks were not trusting each other or each other’s paper. So they weren’t trusting their counter-party. What happened was the Fed came in and said: Well, Bank A you don’t trust Bank Bs paper; Bank B you don’t trust Bank As paper -- here's what we are going to do: I’ll take your paper. The Fed is taking these worthless mortgages and saying: We'll settle in T-bills. You like those things, don’t you? The answer is: Of course. What is better than a T-bill?
So then they settled out and, of course, this is where this whole expansion of the Fed’s balance sheet has taken place over the past several years. Everybody is happy because you have paper you can trust. But what happens when you don’t trust government paper? And Chris, that is really what is happening now. If you look at the foreign markets ,what has been going on is they basically have been dumping the dollar. The exchange stabilization fund has come in and sopped it up so it's not transparent to the markets unless you really know how to dig deep.
We are, in my view, in a place where the world has never been. We are on the precipice of a situation that is global in scope and -- for all practical purposes -- is going to effect almost everybody on the planet.
I was wanting to jump right in there and say that our decisions aren't digital*. They are not this or that. But David covered that aspect, which was very relaxing.
There is a confidence bead on a length of wire. A healthy mind moves that bead around this way or that as it thinks about things. It is rarely parked in one spot for any length of time. In a healthy mind. In an unhealthy mind the bead is rusted onto the wire.
But a wire is a one dimensional surface. (Forget about the circumference, spinning the bead does nothing)
So then the metaphor becomes a plane and the bead has two degrees of freedom, and because this is a mathematical model we can add as many dimensions as we like. And there are a lot of variables, each with it's own dimension. So that should be a very busy bead.
Dogmatism is when the bead falls off the wire. You lose. The penalty is a healthy ego bashing. Trouble starts when the Ego is too embarrassed to pick bead back up from the floor.
Evidence that intelligence is a Quantum phenomenon. It's all about statistics.
"These people are not leaders anymore, they are rulers. They are ruling over us. That is a very unfortunate state of affairs and that is part of the problem as well as many others. It is something we need to have the ability to stand up and talk about, and we do." Such a simple statement and yet prophetic! I would add that we, middle America, are no longer the country's backbone but rather its enemy, or at least it seems that way.
The global financial system has become dangerously unstable and faces an avalanche of bankruptcies that will test social and political stability, said William White, ... former chief economist of the Bank for International Settlements (BIS).
"The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up."
"Debts have continued to build up over the last eight years and they have reached such levels in every part of the world..."
"It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something," he told The Telegraph on the eve of the World Economic Forum in Davos.
The next task awaiting the global authorities is how to manage debt write-offs - and therefore a massive reordering of winners and losers in society - without setting off a political storm.
Mr White said Europe's creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans: they are heavily exposed to emerging markets and are almost certainly rolling over further bad debts that have never been disclosed.
The European banking system may have to be recapitalized on a scale yet unimagined, and new "bail-in" rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.
…QE and easy money policies by the US Federal Reserve and its peers have had the effect of bringing spending forward from the future … In the end, the future catches up with you. "By definition, this means you cannot spend the money tomorrow," he said.
OK. If I thought this was true, I would get cash out of the bank now and buy gold. What will the billionaires at Davos think?
Chris and David,
Do you guys have any plans to videotape this solutions conference? I actually live in Salt Lake City, but I absolutely cannot make this conference - I'm in graduate school and Mondays (Feb 22 is a Monday) are our test days. I love the idea of a solutions conference and I know I would have a great time, but some people (including me) may be willing to purchase the rights to view videos of this conference. I'm not sure how much it would cost to hire a videographer, but I think it's worth considering, especially if you guys are trying to reach as many people as possible.
The major cause for the equities market to increase in the past 7 years has been the Federal Reserve's massive infusion of base money into the banking system, who then pumped that money into the stock market. In simply looking at the graphs, you can see how high of correlation it is between the base money chart and the Wilshire index. Mike Maloney covered this in his videos recently, actually. So, in comparison to the 2008 crash, which was really a popping of a giant private credit bubble, this stock market surge is due to base money… which doesn't behave like private money. Sure, there can still be fluctuations like we are currently seeing (market up today, anyone?), as the banks buy and sell, but the chance of a monumental collapse is unlikely since it's not mountains of leverage built upon private credit.
Interesting perspective. It would seem to me though that since cyclically adjusted price to earning ratios are in the nose bleed section a la 1929, 2000, 2008 that would be prima facie evidence of a bubble. the signature behavior of a bubble is binary ie. grows until it pops and then reverts to the mean possibly over correcting for a time.
My take is that at it's core, a bubble is reflecting herd behavior both on the way up and the way down. Whether the bubble is in tulips, Mc Mansions with granite counter tops or stocks, the gross overvaluations will revert regardless of the underlying origin of the funds.
I'm not saying the crash has to be a linear step function straight down (market up today anyone?) 2008 wasn't, but if stocks are in a bubble, and the bubble has popped than the overall direction of the 'fluctuations' will be downward until the prices reflect valuation reality.
If I understand your argument, you are saying that base money behaves differently which I think implies that un levered free money that the fed injected is essentially acting like an inflationary coefficient which is reflected in a permanently higher level of stock prices.
What I don't understand is how you can reconcile that with company earnings ie. the PE ratio. Especially as earnings come under pressure from deflationary and currency forces.
To summarize you are saying base money behaves differently but I would argue that the behavior that counts is of the people allocating the base money.
But this is not my forte, so I would be interested in learning more from you about how this base money difference manifests.
If we look at the behavior of gold, it would appear that it was in a bubble for 2008. Further, bubbles do not get reblown: they tend to shift. If that's the case, then the current downward trend of gold could be a couple of things:
Part of the deflation of the bubble
Post-bubble-pop, but part of the general state of deflation.
Of course, it could just be massively slammed on futures as a way of keepin the good folk down. But I'm just thinking that there are a number of scenarios which should be looked at, including that gold may have been in bubble, and still be popping its bubble.
And, of course, my favorite, Pd, having lost fifty percent or more of its value… is also in a more violent version of that mode.
Valuation of all things is of course relative to what it is measured in. The bubble argument for gold is complicated by the special case that gold historically functions as money. ie medium of exchange and store of value. It also pretty clearly carries a component of 'insurance' with premiums over relative purchasing power correlated with perceived future geo political and currency risks.
For example gold priced at 7000 Venezuelan Bolivars/OZ big number, but not because Gold is in a bubble down there.
Which isn't to say that there won't be a speculative blow off of animal spirits in gold some day, Gold at $1900 though adjusted for inflation doesn't qualify historically as the type of 'relative over valuation ' that I perceive is reflected in the PE ratios of stocks
at $1900 It appears more like within the range of it's historical purchasing power value with a risk premium.
But the single biggest factor arguing against gold having been in a bubble that peaked is…
Great to hear Chris and Adam will be at this conference…a fitting opportunity to start developing the new narrative. I am looking forward to making the conference and thanks for the heads up as I have been looking for some other diversified conferences like this to go to (and Vegas is easier to get to than some of the others). See you there.