Economic Showdown Part II

by | Jan 5, 2004 | Archives

In the past five decades there has always been too much money and too much of it has been spent unwisely.   This can bring economic disaster.   See one of seven ways to survive this here at.

See another plush, deeply carpeted room.   The curtains are drawn.   Traffic sounds are muffled, distant and everything is calm behind thick, solid walls.   Turmoil is far away and the atmosphere is of commanding authority and privileged wealth.  

We saw a similar office in our message at Let's return our imagination to important offices, this time the US Treasury.   Picture executives gathered at one end of a long wooden table constructed from a single enormous piece of polished cherry.   See them speaking in hushed tones.   Word has come down through the Secretary,   directly from the Presidency that the government needs money:   “Sell long term investment bonds”.   The value of the dollar is plummeting.   The government wants to pay interest and principal in cheaper currency over thirty years.

  But what would happen if the thirty-year bonds offered by the US government don't sell?   What if they were offered to the public, just as bonds had been for decades, but no one bought?   What if one of the country's largest insurance companies, which normally snatched a large percentage of the bonds for its accounts, was the first to sound the alarm.   “We're not buying any more long term US government bonds.   The government is doing nothing to strengthen the dollar.   We're not about to risk being paid back in a much weaker currency 30 years from now.”   That insurance company would have been sending a wake-up call: stop the printing presses, strengthen the dollar or we're not buying.

  And so the Treasury officials would huddle, speaking in hushed tones, as though unconsciously not wanting anyone outside the room (the public in particular) to know their thinking.   After much discussion, they might agree to reduce the term (or length) of the bonds to twenty years.   

   “Would twenty-year bonds be attractive?”   They would ask the bellwethers of the investing public (such as the officials at the insurance company).  

What then if the answer came back within hours.   “Twenty years is too long!”   The Treasury officials would have another meeting, make another plan.   “How about ten years?” they would ask.   But what if they again received another quick reply.   “Ten years is still too long.”

  Within days, those Treasury officials would lower their terms for the bonds to three years.  

  Does this sound like fiction?   It certainly reads like a futuristic novel.   But such a scenario has already been played out, almost exactly as described.   The only difference is that it did not happen with the US government, but in Canada.   It began in October 1983, Ontario Hydro, one of Canada's major utilities, issued 30-year bonds.   One of Canada's largest insurance companies flatly declared that they would not buy more worthless bonds.   Ontario got rid of the bonds by reducing the term from thirty to three years, something they clearly did not want to do.   They wanted to be able, as the Canadian dollar fell, to pay back the bonds in a weakened, cheaper currency years later.

  One of the most frightening aspects of this is that Ontario

  Hydro's bonds were rated AA- by Standard and Poor's rating service!   This is among the highest ratings a bond can have which shows how little you can trust any rating system today.  

  An important point to remember is that during times of turmoil even the most trusted institutions can no longer be trusted. All things living-plants, animals, nations institutions, even worlds all move through three cycles:   growth, inertia and decay.    

  Large financial institutions are built in the growth period of a nation or economic cycle, based upon services they can provide during steady social and economic conditions.  

  These large companies become fat, rigid and fixed in their ways.   They become the least capable of surviving the decay period of a nation, currency, etc.   Institutions in decay can create immense economic damage.

For example, look at Japan as a trusted institution in the global community.   A decade ago the Japanese government had the highest credit rating a country can attain.   Today their borrowings are so high that their investment rating is of the lowest investment grade equal to some countries in Africa.  

Still the Japanese government has the largest deficit of any industrial nation. Their deficit, as a percentage of GDP, is even 50% higher that the outrageous U.S. federal deficit.

This is quite a change in just ten years.  

We have seen so many huge institutions simply disappear on the last several years that no one can doubt this reality.    Think Enron,   AOL, and the numerous dot coms that have been devastated or no longer exist.

We can understand this last wave of devastation by looking back to mid October 1998   when there was a crisis when Long Term Capital Management of   Greenwich, Connecticut collapsed and Alan Greenspan was forced for a second time into an October collapse corner.

Not much was made of this as the Presidential impeachment was capturing the news at that time but an excellent article entitled Averting a Disaster by Martin Mayer in Worth magazine ( described the near meltdown in hair raising detail.

A close look at what transpired in that October can give us an idea of what to watch out for now.     Panic had reached the financial system with the debt payment collapse of Russia, Latin America and Asia.   This brought about the destruction of LTCM which had borrowed billions from banks all over the world.   All these bad debts created a huge liquidity crisis.   In the first weeks of October bankers, finance ministers and   financiers from all over the world came to Washington, by the thousands where the World Bank and IMF explained the global dire straits.

As the head of Merrill Lynch explained it, “On Saturday morning, October 3 rd I was   optimistic.   By that night I just wanted to crawl under the bed to hide.”

The Fed, major banks and Wall Street bailed out LTCM, but financial conditions remained far weaker in the US than anyone realized.

Bond markets went haywire.   And IPOs dried up.   There was a great withdrawing of   money in the market place.   By Friday, October 9 th at 11:45 the price of US Treasury   Bonds dropped $3,000 and had a maximum move lock limit down.   This blocked the pathway of the financial world to liquidity in what was supposed to be the world's safest investment.  

On Monday, October 12 in Geneva at the UN conference for Trade and Development most finance ministers of emerging markets stated that they probably would be in default soon.   The bankers concluded that there was no money available internationally and that a financial meltdown was about to begin.

This dire situation was only saved when on Thursday, October 15 Greenspan told the Federal Reserve System to put enough money into the system to push the stock market up.   Through skillful timing and good luck this worked.   From Thursday at 3 pm to 4 pm on Friday, the US stock indices rose more than six percent and added more than a trillion dollars of wealth into the world's system.   This began a stock market run up that became the greets bull market of all time.

The problem was temporarily fixed.  

Yet the but fundamentals grew worse.   Small investors jumped into the market and created the stock market bubble of 1999.   On paper, the world became rich.   Yet politicians did not use this breathing period to stop spending and reduce debt. They spent more instead!

The move by the Federal Reserve Bank in 1988   gave the global financial structure time to revive itself but no corrections were really made.   In fact in many ways this created a greater long term risk because all this extra money allowed the stock market to once again revive when it should have cleansed itself.   Our message last week about the upcoming sucker punch at shows that the market is way overvalued and that overall U.S. and global economics are terribly at risk because of the layers and layers of debt.

This means we once again face this crisis.   Only US consumer confidence has kept the global economy ticking along and this has now dramatically slowed.

There is economic strain everywhere-Asia, where Japan's market is at a decade low, Europe, Latin America, where Argentina is on the ropes and this threatens Mexico and Brazil.

We have the psychological impact of a continuing war in Iraq and the risk of a meltdown being kicked off by another terrorist attack.

Plus we have to burden the reality of the added costs of increased defense that is placing a huge disruption in social services, transportation and communications.

The sucker punch article also points out the dangers that lay in October, because the U..S. government is doing all it to increase employment now before the November 2004 election.  

Their added machinations and interference in the economy are likely to run the stock market into a bubble so when it finally corrects the cleansing will even more painful.

So why October?

Read tomorrow's message to see.