As the Obama administration continues to alienate almost everyone else around the entire planet, an increasing number of prominent international voices are starting to question why the U.S. dollar should be so overwhelmingly dominant in global trade. In previous articles, I have discussed Russia’s “de-dollarization strategy” and the fact that Gazprom is now asking their large customers to start paying in currencies other than the dollar. But this is not just a story about Russia any longer. As you will read about below, China and South Korea have just signed a major agreement to facilitate trade with one another using their own national currencies, and even prominent French officials are now talking about the need to use the dollar less and the euro more. John Williams of shadowstats.com recently said that things have never “been more negative” for the U.S. dollar, and he was right on the mark. The power of the almighty dollar has allowed all of us living in the United States to enjoy an extremely high standard of living for decades, but as that power now fades it is going to have profound implications for the U.S. economy. In future years the value of the dollar will go down substantially, all of the imported goods filling our stores will become much more expensive, and it is going to cost the federal government a lot more to borrow money. Unfortunately, with the stock market hitting all-time record highs and with the mainstream media endlessly touting an “economic recovery”, most Americans are not paying any attention to these things.
French oil giant Total is one of the largest energy companies in the entire world. On Saturday, Total’s CEO made an absolutely stunning statement. According to Reuters, he told reporters that there “is no reason to pay for oil in dollars”…
“Doing without the (U.S.) dollar, that wouldn’t be realistic, but it would be good if the euro was used more,” he told reporters.
“There is no reason to pay for oil in dollars,” he said. He said the fact that oil prices are quoted in dollars per barrel did not mean that payments actually had to be made in that currency.
If Gazprom’s CEO had made such a statement, it would not have really surprised anyone. But this came from a high profile French CEO. A decade ago, it would have been unthinkable for him to say such a thing. Wars have been started over less. Virtually all oil and natural gas around the planet has been bought and sold for U.S. dollars since the 1970s, and this is an arrangement that the U.S. government has traditionally guarded very zealously. But now that Russia has broken the petrodollar monopoly, the fear of questioning the almighty dollar appears to be dissipating.
And at this point even French government officials are not afraid to publicly discuss moving away from the U.S. dollar. Just check out what French finance minister Michel Sapin said to the press this weekend…
French finance minister Michel Sapin says “now is the right time to bolster the use of the euro” adding, more ominously for the dollar, “we sell ourselves aircraft in dollars. Is that really necessary? I don’t think so.” Careful to avoid upsetting his ‘allies’ across the pond, Sapin followed up with the slam-dunk diplomacy, “This is not a fight against dollar imperialism,” except, of course – that’s exactly what it is… just as it was over 40 years ago when the French challenged Nixon.
So why are the French suddenly so upset?
Could it be the fact that we just slapped the largest bank in France with a nearly 9 billion dollar fine?…
The remarks come a week after Paris-based bank BNP Paribas (BNP) SA was slapped with a $8.97 billion fine by U.S. authorities for transactions carried out in dollars in countries facing American sanctions. The fine spurred debate in France about the right of the U.S. in extending its regulatory reach beyond its borders.
This is yet another example of how the Obama administration is alienating friends all over the globe.
In fact, there doesn’t seem to be anyone that the Obama administration is afraid of crossing. Just a couple of days ago, the German press exploded in outrage when Germany arrested a U.S. spy. Why we feel the need to spy on our friends is something that I will never figure out.
And of course our relations with Russia are probably the worst that they have been since the end of the Cold War at this point. And as the Russians now rapidly move away from the U.S. dollar, they seem intent on bringing the rest of “the BRICS” with them. The following is a short excerpt from a recent Voice of Russia article entitled “BRICS morphing into anti-dollar alliance“…
However, in her discussion with Vladimir Putin, the head of the Russian central bank unveiled an elegant technical solution for this problem and left a clear hint regarding the members of the anti-dollar alliance that is being created by the efforts of Moscow and Beijing:
“We’ve done a lot of work on the ruble-yuan swap deal in order to facilitate trade financing. I have a meeting next week in Beijing,” she said casually and then dropped the bomb: “We are discussing with China and our BRICS parters the establishment of a system of multilateral swaps that will allow to transfer resources to one or another country, if needed. A part of the currency reserves can be directed to [the new system].” (source of the quote: Prime news agency)
It seems that the Kremlin chose the all-in-one approach for establishing its anti-dollar alliance. Currency swaps between the BRICS central banks will facilitate trade financing while completely bypassing the dollar. At the same time, the new system will also act as a de facto replacement of the IMF, because it will allow the members of the alliance to direct resources to finance the weaker countries. As an important bonus, derived from this “quasi-IMF” system, the BRICS will use a part (most likely the “dollar part”) of their currency reserves to support it, thus drastically reducing the amount of dollar-based instruments bought by some of the biggest foreign creditors of the US.
Of course the key economic player in the BRICS alliance is China.
So will China actually go along with a “de-dollarization” strategy?
Well, the truth is that China has been making moves to become more independent of the dollar for a long time, and it has just been announced that China and South Korea have signed an agreement which will mean more direct trade between the two nations using their own national currencies…
China’s central bank has authorized the Bank of Communications, the country’s fifth largest lender, to undertake yuan clearing business in the South Korean capital, the People’s Bank of China (PBoC) said in a statement.
The announcement came as Chinese President Xi Jinping wrapped up a state visit to South Korea on Friday. China is seeking to make the yuan – also known as the renminbi – used more internationally in keeping with the country’s status as the world’s second biggest economy behind the United States.
Unfortunately, most Americans don’t care about any of this at all.
They don’t understand that more U.S. dollars are actually used outside the United States than are used inside the United States. Because most of the rest of the world uses U.S. dollars to trade with one another, this has created a tremendous amount of artificial demand for our currency. In other words, the value of the U.S. dollar is much higher than it otherwise would be, and this has enabled us to import trillions of dollars of products at ridiculously low prices. The standard of living that we enjoy today is highly dependent on this arrangement continuing.
And our ability to fund the federal government and our state and local governments is heavily dependent on the rest of the planet loaning our dollars back to us for next to nothing. If we actually had to pay realistic market rates to borrow money, the finances of the federal government would have already collapsed long ago.
So it is absolutely imperative for our own economic well-being that this “de-dollarization” trend not accelerate any further. The rest of the world could actually severely hurt us by deciding to stop using the almighty dollar, and the more that the Obama administration antagonizes both our friends and our foes around the globe the more likely that is to happen.
We live in very perilous times, and the almighty dollar is more vulnerable now than it has been in decades.
If it starts collapsing, it will take down the entire U.S. financial system with it.
Let us hope that we still have a bit more time before that happens, because once the U.S. dollar collapses it will be exceedingly painful for all of us.
If you want to track how close we are to the next financial collapse, there is one number that you need to be watching above all others. The number that I am talking about is the yield on 10 year U.S. Treasuries, because it affects thousands of other interest rates in our financial system. When the yield on 10 year U.S. Treasuries goes up, that is bad for the U.S. economy because it pushes long-term interest rates up. When interest rates rise, it constricts the flow of credit, and a healthy flow of credit is absolutely essential to the debt-based system that we live in. Just imagine someone squeezing a tube that has water flowing through it. The higher interest rates go, the more economic activity will be squeezed. If interest rates continue to rise rapidly, it will be more expensive for the U.S. government to borrow money, it will be more expensive for state and local governments to borrow money, the housing market may crash again, consumer debt will become more expensive, junk bond investors will be in for a world of hurt, the stock market will experience a tremendous amount of pain and there is a good chance that we could see the 441 trillion dollar interest rate derivatives bubble implode. And that is just for starters.
So yes, we all need to be carefully watching the yield on 10 year U.S. Treasuries. On Friday, it opened at 2.76% and hit a high of 2.86% before closing at 2.83%. The yield on 10 year U.S. Treasuries is up nearly 120 basis points since the beginning of May, and almost everyone on Wall Street seems convinced that it is going to go much higher.
We are truly moving into unprecedented territory, because we have been in a bull market for U.S. Treasuries for the last 30 years. Many investors don’t even know that it is possible to lose money on U.S. Treasuries. They have been described as “risk-free” investments, but that is far from the truth.
In fact, we could see bond investors of all types end up losing trillions of dollars before it is all said and done.
And those in the stock market will lose lots of money too. Low interest rates are good for economic activity which is good for the stock market. The chart posted below shows that stock prices have generally risen as the yield on 10 year U.S. Treasuries has steadily declined over the past 30 years…
When interest rates rise, that is bad for economic activity and bad for stocks. That is why so many stock analysts are alarmed that interest rates are going up so rapidly right now.
And as I wrote about the other day, we have just witnessed the largest cluster of Hindenburg Omens that we have seen since before the last financial crisis. The stock market already seems ripe for a huge “adjustment”, and rising interest rates could give it a huge extra push in a negative direction.
By the time it is all said and done, stock market investors could end up losing trillions of dollars in the next stock market crash.
In addition, rising interest rates could easily precipitate another housing crash. As the Wall Street Journal discussed on Friday, as the yield on 10 year U.S. Treasuries goes up it will also cause mortgage rates to rise…
Higher yields will push up long-term borrowing cost for U.S. consumers and businesses. Mortgage rates will rise, and investors are keeping a close eye on whether this may derail the recovery of the housing market, which has shown signs of turning a corner this year.
In one of my previous articles, I included an example that shows just how powerful rising mortgage rates can be…
A year ago, the 30 year rate was sitting at 3.66 percent. The monthly payment on a 30 year, $300,000 mortgage at that rate would be $1374.07.
If the 30 year rate rises to 8 percent, the monthly payment on a 30 year, $300,000 mortgage at that rate would be $2201.29.
Does 8 percent sound crazy to you?
It shouldn’t. 8 percent was considered to be normal back in the year 2000.
If you own a $300,000 house today, do you think it will be easier to sell it or harder to sell it if mortgage rates skyrocket?
Yes, of course it will be much harder. In fact, there is a good chance that you will have to reduce your selling price significantly so that prospective buyers can afford the payments.
Let us hope that the yield on 10 year U.S. Treasuries levels off for a while. If it says at this current level, the damage will probably not be too bad.
But if it crosses the 3 percent mark and keeps soaring, things could get messy pretty quickly. In fact, according to a Bank of America Merrill Lynch investor survey, the 3.5 percent mark is when the collapse of the bond market is likely to become “disorderly”…
Our latest Credit Investor Survey, conducted July 8-11, showed that 3.5% on the 10-year is most commonly thought of as the trigger of a disorderly rotation – i.e. higher interest rates leading to outflows and wider credit spreads – among high grade investors.
Put differently, 3.0% on the 10-year will not lead to overall wider credit spreads if there is enough buying interest from institutional investors (though note that the 10s/30s spread curve would flatten further, as mutual fund/ETF holdings are concentrated in the belly of the curve, whereas institutional demand is disproportional in the long end of the curve). However, if the probability of a further move higher in interest rates to 3.5% is high – which will be the perception if interest rate volatility is high – certain institutional investors will choose to remain on the sidelines.
Thus there may not be enough institutional buying interest to mitigate retail fund outflows and contain overall high grade spread levels.
So what is causing this?
Well, there are a number of factors of course, but one very disturbing sign is that foreigners are selling off U.S. Treasuries at a pace that we have not seen since 2007…
One of the biggest fears in the financial markets is that foreign investors will stop buying U.S. Treasury securities, causing borrowing rates to surge.
Not that this is the beginning of a frightening trend, but new data from the Treasury Department shows that foreigners were net sellers in June. In fact, this is the largest net sale of U.S. securities since August 2007.
Do you remember all of the warnings that we have received over the years about what would take place when foreign countries started dumping U.S. debt?
Well, it looks like it may be starting to happen.
Unfortunately, there is no way that the party that the U.S. government has been throwing can continue without foreigners buying our debt. We have added more than 11 trillion dollars to the national debt since the year 2000, and according to Boston University economist Laurence Kotlikoff we are facing unfunded liabilities in future years that are in excess of 200 trillion dollars.
Even with foreigners continuing to loan us gigantic mountains of super cheap money, it would still take a doubling of our taxes to put us on a fiscally sustainable course…
Writing in the September issue of Finance and Development, a journal of the International Monetary Fund, Prof. Kotlikoff says the IMF itself has quietly confirmed that the U.S. is in terrible fiscal trouble – far worse than the Washington-based lender of last resort has previously acknowledged. “The U.S. fiscal gap is huge,” the IMF asserted in a June report. “Closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 per cent of U.S. GDP.”
This sum is equal to all current U.S. federal taxes combined. The consequences of the IMF’s fiscal fix, a doubling of federal taxes in perpetuity, would be appalling – and possibly worse than appalling.
Prof. Kotlikoff says: “The IMF is saying that, to close this fiscal gap [by taxation] would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.
“America’s fiscal gap is enormous – so massive that closing it appears impossible without immediate and radical reforms to its health care, tax and Social Security systems – as well as military and other discretionary spending cuts.”
Can you afford to pay twice as much in taxes to the federal government?
Very few Americans could.
But that is how serious the financial problems of the federal government are.
And all of the above assumes that interest payments on U.S. government debt will remain at current levels. If the average rate of interest on U.S. government debt rises to just 6 percent, the U.S. government will be paying out a trillion dollars a year just in interest on the national debt.
Also, all of the above assumes that we will have a healthy financial system that does not need to be bailed out again.
But if rapidly rising interest rates cause the 441 trillion dollar interest rate derivatives bubble to implode, the bailout that the “too big to fail” banks will need will likely be far, far larger than last time.
In fact, once that bubble bursts there probably will not be enough money in the entire world to fix it.
If the picture that I have painted above sounds bleak, that is because it is bleak.
Sometimes I get frustrated with myself because I don’t feel I am communicating the tremendous danger that we are facing accurately enough.
We are heading for the worst financial crisis in modern human history, and the debt-fueled prosperity that we are enjoying today is going to go away and it is never going to come back.
You can dismiss that as “doom and gloom” and stick your head in the sand if you want, but that isn’t going to help anything. Instead of ignoring reality you should be working hard to prepare your family for what is coming and warning others that they should be getting prepared too.
When a hurricane is approaching landfall, you don’t take your family out for a picnic at the beach. That would be foolish. Unfortunately, way too many Americans are acting as if nothing like the financial crisis of 2008 could ever possibly happen again.
If you deceive yourself into thinking that all of this is going to have a happy ending somehow, you are going to get blindsided by the coming storm.
But if you make preparations now, you might just be okay.
There is hope in understanding what is happening and there is hope in getting prepared.
So watch the yield on 10 year U.S. Treasuries. The higher it goes, the later in the game we are.
There is one vitally important number that everyone needs to be watching right now, and it doesn’t have anything to do with unemployment, inflation or housing. If this number gets too high, it will collapse the entire U.S. financial system. The number that I am talking about is the yield on 10 year U.S. Treasuries. When that number goes up, long-term interest rates all across the financial system start increasing. When long-term interest rates rise, it becomes more expensive for the federal government to borrow money, it becomes more expensive for state and local governments to borrow money, existing bonds lose value and bond investors lose a lot of money, mortgage rates go up and monthly payments on new mortgages rise, and interest rates throughout the entire economy go up and this causes economic activity to slow down. On top of everything else, there are more than 440 trillion dollars worth of interest rate derivatives sitting out there, and rapidly rising interest rates could cause that gigantic time bomb to go off and implode our entire financial system. We are living in the midst of the greatest debt bubble in the history of the world, and the only way that the game can continue is for interest rates to stay super low. Unfortunately, the yield on 10 year U.S. Treasuries has started to rise, and many experts are projecting that it is going to continue to rise.
On August 2nd of last year, the yield on 10 year U.S. Treasuries was just 1.48%, and our entire debt-based economy was basking in the glow of ultra-low interest rates. But now things are rapidly changing. On Wednesday, the yield on 10 year U.S. Treasuries hit 2.70% before falling back to 2.58% on “good news” from the Federal Reserve.
Historically speaking, rates are still super low, but what is alarming is that it looks like we hit a “bottom” last year and that interest rates are only going to go up from here. In fact, according to CNBC many experts believe that we will soon be pushing up toward the 3 percent mark…
Round numbers like 1,700 on the S&P 500 are well and good, but savvy traders have their minds on another integer: 2.75 percent
That was the high for the 10-year yield this year, and traders say yields are bound to go back to that level. The one overhanging question is how stocks will react when they see that number.
“If we start to push up to new highs on the 10-year yield so that’s the 2.75 level—I think you’d probably see a bit of anxiety creep back into the marketplace,” Bank of America Merrill Lynch’s head of global technical strategy, MacNeil Curry, told “Futures Now” on Tuesday.
And Curry sees yields getting back to that level in the short term, and then some. “In the next couple of weeks to two months or so I think we’ve got a push coming up to the 2.85, 2.95 zone,” he said.
This rise in interest rates has been expected for a very long time – it is just that nobody knew exactly when it would happen. Now that it has begun, nobody is quite sure how high interest rates will eventually go. For some very interesting technical analysis, I encourage everyone to check out an article by Peter Brandt that you can find right here.
And all of this is very bad news for stocks. The chart below was created by Chartist Friend from Pittsburgh, and it shows that stock prices have generally risen as the yield on 10 year U.S. Treasuries has steadily declined over the past 30 years…
When interest rates go down, that spurs economic activity, and that is good for stock prices.
So when interest rates start going up rapidly, that is not a good thing for the stock market at all.
The Federal Reserve has tried to keep long-term interest rates down by wildly printing money and buying bonds, and even the suggestion that the Fed may eventually “taper” quantitative easing caused the yield on 10 year U.S. Treasuries to absolutely soar a few weeks ago.
So the Fed has backed off on the “taper” talk for now, but what happens if the yield on 10 year U.S. Treasuries continues to rise even with the wild money printing that the Fed has been doing?
At that point, the Fed would begin to totally lose control over the situation. And if that happens, Bill Fleckenstein told King World News the other day that he believes that we could see the stock market suddenly plunge by 25 percent…
Let’s say Ben (Bernanke) comes out tomorrow and says, ‘We are not going to taper.’ But let’s just say the bond market trades down anyway, and the next thing you know we go through the recent highs and a month from now the 10-Year is at 3%. And people start to realize they are not even tapering and the bond market is backed up….
They will say, ‘Why is this happening?’ Then they may realize the bond market is discounting the inflation we already have.
At some point the bond markets are going to say, ‘We are not comfortable with these policies.’ Obviously you can’t print money forever or no emerging country would ever have gone broke. So the bond market starts to back up and the economy gets worse than it is now because rates are rising. So the Fed says, ‘We can’t have this,’ and they decide to print more (money) and the bond market backs up (even more).
All of the sudden it becomes clear that money printing not only isn’t the solution, but it’s the problem. Well, with rates going from where they are to 3%+ on the 10-Year, one of these days the S&P futures are going to get destroyed. And if the computers ever get loose on the downside the market could break 25% in three days.
And as I have written about previously, we have seen a huge spike in margin debt in recent months, and this could make it even easier for a stock market collapse to happen. A recent note from Deutsche Bank explained precisely why margin debt is so dangerous…
Margin debt can be described as a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. These loans are collateralized by stock holdings, so when the market goes south, investors are either required to inject more cash/assets or become forced to sell immediately to pay off their loans – sometimes leading to mass pullouts or crashes.
But of much greater concern than a stock market crash is the 441 trillion dollar interest rate derivatives bubble that could implode if interest rates continue to rise rapidly.
Deutsche Bank is the largest bank in Europe, and at this point they have 55.6 trillion euros of total exposure to derivatives.
But the GDP of the entire nation of Germany is only about 2.7 trillion euros for a whole year.
We are facing a similar situation in the United States. Our GDP for 2013 will be somewhere between 15 and 16 trillion dollars, but many of our big banks have exposure to derivatives that absolutely dwarfs our GDP. The following numbers come from one of my previous articles entitled “The Coming Derivatives Panic That Will Destroy Global Financial Markets“…
Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)
Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)
Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)
Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)
Bank Of America
Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)
Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)
Total Assets: $114,693,000,000 (a bit more than 114 billion dollars – yes, you read that correctly)
Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)
That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets.
And remember, the biggest chunk of those derivatives contracts is made up of interest rate derivatives.
Just imagine what would happen if a life insurance company wrote millions upon millions of life insurance contracts and then everyone suddenly died.
What would happen to that life insurance company?
It would go completely broke of course.
Well, that is what our major banks are facing today.
They have written trillions upon trillions of dollars worth of interest rate derivatives contracts, and they are betting that interest rates will not go up rapidly.
But what if they do?
And the truth is that interest rates have a whole lot of room to go up. The chart below shows how the yield on 10 year U.S. Treasuries has moved over the past couple of decades…
As you can see, the yield on 10 year U.S. Treasuries was hovering around the 6 percent mark back in the year 2000.
Back in 1990, the yield on 10 year U.S. Treasuries hovered between 8 and 9 percent.
If we return to “normal” levels, our financial system will implode. There is no way that our debt-addicted system would be able to handle it.
So watch the yield on 10 year U.S. Treasuries very carefully. It is the most important number in the entire U.S. economy.
If that number gets too high, the game is over.
Federal Reserve Chairman Ben Bernanke is on the way out the door, but the consequences of the bond bubble that he has helped to create will stay with us for a very, very long time. During Bernanke’s tenure, interest rates on U.S. Treasuries have fallen to record lows. This has enabled the U.S. government to pile up an extraordinary amount of debt. During his tenure we have also seen mortgage rates fall to record lows. All of this has helped to spur economic activity in the short-term, but what happens when interest rates start going back to normal? If the average rate of interest on U.S. government debt rises to just 6 percent, the U.S. government will suddenly be paying out a trillion dollars a year just in interest on the national debt. And remember, there have been times in the past when the average rate of interest on U.S. government debt has been much higher than that. In addition, when the U.S. government starts having to pay more to borrow money so will everyone else. What will that do to home sales and car sales? And of course we all remember what happened to adjustable rate mortgages when interest rates started to rise just prior to the last recession. We have gotten ourselves into a position where the U.S. economy simply cannot afford for interest rates to go up. We have become addicted to the cheap money made available by a grossly distorted financial system, and we have Ben Bernanke to thank for that. The Federal Reserve is at the very heart of the economic problems that we are facing in America, and this time is certainly no exception.
This week Barack Obama publicly praised Ben Bernanke and stated that Bernanke has “already stayed a lot longer than he wanted” as Chairman of the Federal Reserve. Bernanke’s term ends on January 31st, but many observers believe that he could leave even sooner than that. Bernanke appears to be tired of the job and eager to move on.
So who would replace him? Well, the mainstream media is making it sound like the appointment of Janet Yellen is already a forgone conclusion. She would be the first woman ever to chair the Federal Reserve, and her philosophy is that a little bit of inflation is good for an economy. It seems likely that she would continue to take us down the path that Bernanke has taken us.
But is it a fundamentally sound path? Keeping interest rates pressed to the floor and wildly printing money may be producing some positive results in the short-term, but the crazy bubble that this is creating will burst at some point. In fact, the director of financial stability for the Bank of England, Andy Haldane, recently admitted that the central bankers have “intentionally blown the biggest government bond bubble in history” and he warned about what might happen once it ends…
“If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally.” he said. There had been “shades of that” in recent weeks as government bond yields have edged higher amid talk that central banks, particularly the US Federal Reserve, will start to reduce its stimulus.
“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history,” Haldane said. “We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”
Posted below is a chart that demonstrates how interest rates on 10-year U.S. Treasury bonds have fallen over the last several decades. This has helped to fuel the false prosperity that we have been enjoying, but there is no way that the U.S. government should have been able to borrow money so cheaply. This bubble that we are living in now is setting the stage for a very, very painful adjustment…
So what will that “adjustment” look like?
The following analysis is from a recent article by Wolf Richter…
Ten-year Treasury notes have been kicked down from their historic pedestal last July when some poor souls, blinded by the Fed’s halo of omnipotence and benevolence, bought them at a minuscule yield of 1.3%. For them, it’s been an ice-cold shower ever since. As Treasuries dropped, yields meandered upward in fits and starts. After a five-week jump from 1.88% in early May, they hit 2.29% on Tuesday last week – they’ve retreated to 2.19% since then. Now investors are wondering out loud what would happen if ten-year Treasury yields were to return to more normal levels of 4% or even 5%, dragging other long-term interest rates with them. They know what would happen: carnage!
And according to Richter, there are already signs that the bond bubble is beginning to burst…
Wholesale dumping of Treasuries by exasperated foreigners has already commenced. Private foreigners dumped $30.8 billion in Treasuries in April, an all-time record. Official holders got rid of $23.7 billion in long-term Treasury debt, the highest since November 2008, and $30.1 billion in short-term debt. Sell, sell, sell!
Bond fund redemptions spoke of fear and loathing: in the week ended June 12, investors yanked $14.5 billion out of Treasury bond funds, the second highest ever, beating the prior second-highest-ever outflow of $12.5 billion of the week before. They were inferior only to the October 2008 massacre as chaos descended upon financial markets. $27 billion in two weeks!
In lockstep, average 30-year fixed-rate mortgage rates jumped from 3.59% in early May to 4.15% last week. The mortgage refinancing bubble, by which banks have creamed off billions in fees, is imploding – the index has plunged 36% since early May.
If interest rates start to climb significantly, that will have a dramatic affect on economic activity in the United States.
And we have seen this pattern before.
As Robert Wenzel noted in a recent article on the Economic Policy Journal, we saw interest rates rise suddenly just prior to the October 1987 stock market crash, and we also saw them rise substantially prior to the financial crisis of 2008…
As Federal Reserve chairman Paul Volcker left the Fed chairmanship in August 1987, the interest rate on the 10 year note climbed from 8.2% to 9.2% between June 1987 and September 1987. This was followed, of course by the October 1987 stock market crash.
As Federal Reserve chairman Alan Greenspan left the Fed chairmanship at the end of January 2006, the interest rate on the 10 year note climbed from 4.35% to 4.65%. It then climbed above 5%.
So keep a close eye on interest rates in the months ahead. If they start to rise significantly, that will be a red flag.
And it makes perfect sense why Bernanke is looking to hand over the reins of the Fed at this point. He can probably sense the carnage that is coming and he wants to get out of Dodge while he still can.
How is money created? If you ask average people on the street this question, most of them have absolutely no idea. This is rather odd, because we all use money constantly. You would think that it would only be natural for all of us to know where it comes from. So where does money come from? A lot of people assume that the federal government creates our money, but that is not the case. If the federal government could just print and spend more money whenever it wanted to, our national debt would be zero. But instead, our national debt is now nearly 16 trillion dollars. So why does our government (or any sovereign government for that matter) have to borrow money from anybody? That is a very good question. The truth is that in theory the U.S. government does not have to borrow a single penny from anyone. But under the Federal Reserve system, the U.S. government has purposely allowed itself to be subjugated to a financial system in which it will be constantly borrowing larger and larger amounts of money. In fact, this is how it works in the vast majority of the countries on the planet at this point. As you will see, this kind of system is not sustainable and the structural problems caused by such a system are at the very heart of our debt problems today.
So where does money come from? In the United States, it comes from the Federal Reserve.
When the U.S. government decides that it wants to spend another billion dollars that it does not have, it does not print up a billion dollars.
Rather, the U.S. government creates a bunch of U.S. Treasury bonds (debt) and takes them over to the Federal Reserve.
The Federal Reserve creates a billion dollars out of thin air and exchanges them for the U.S. Treasury bonds.
So why does the U.S. government go to all this trouble? Why doesn’t the U.S. government create the money itself?
Those are very good questions.
One of the primary reasons why our system is structured this way is so that wealthy people can get even wealthier by lending money to the U.S. government and other national governments.
For example, last year the U.S. government spent more than 454 billion dollars just on interest on the national debt.
Over the centuries, the ultra-wealthy have found lending to national governments to be a very, very profitable enterprise.
The U.S. Treasury bonds that the Federal Reserve receives in exchange for the money it has created out of nothing are auctioned off through the Federal Reserve system.
There is a problem.
Because the U.S. government must pay interest on the Treasury bonds, the amount of debt that has been created by this transaction is greater than the amount of money that has been created.
So where will the U.S. government get the money to pay that debt?
Well, the theory is that we can get money to circulate through the economy really, really fast and tax it at a high enough rate that the government will be able to collect enough taxes to pay the debt.
But that never actually happens, does it?
And the creators of the Federal Reserve understood this as well. They understood that the U.S. government would not have enough money to both run the government and service the national debt. They knew that the U.S. government would have to keep borrowing even more money in an attempt to keep up with the game.
That is why I call the Federal Reserve a perpetual debt machine. The Federal Reserve was created to trap the U.S. government in an endlessly expanding debt spiral from which there is no escape.
And the Federal Reserve is doing a great job at what it was designed to do. Today, the U.S. national debt is more than 5000 times larger than it was when the Federal Reserve was first created.
Another way that money comes into existence in our economy is through the process of fractional reserve banking.
I originally pulled the following simplified explanation of fractional reserve banking off of the website of the Federal Reserve Bank of New York, but it has been pulled down since then. But I still think it is helpful in understanding the basics of how fractional reserve banking works….
“If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+…=$1,000).”
When you put your money into the bank, it does not say there. The bank only keeps a relatively small amount of money sitting around to satisfy the withdrawal demands of account holders. If all of us went down to the banks right now and demanded our money, that would create a major problem.
If I put 100 dollars into the bank and the bank lends out 90 of those dollars to you, now it looks like there are 190 dollars floating around. I have “100 dollars” in my bank account and you have “90 dollars” that you just borrowed.
The new debt that you have taken on (90 dollars) has “created” more money. But of course you are going to end up paying back more than 90 dollars to the bank, so more debt has been created than the amount of money that has been created.
And that is one of the big problems with our financial system. It is designed so that the amount of debt and the amount of money are supposed to be perpetually expanding, and the amount of debt created is always greater than the amount of money that is created.
So is it any wonder that our society is swamped with nearly 55 trillion dollars of total debt at this point?
A debt-based financial system is unsustainable by nature because it will always create debt bubbles that will inevitably burst.
Are you starting to see why so many Americans are saying that we need to abolish the Federal Reserve system?
Our founding fathers never intended for our financial system to work this way.
According to Article I, Section 8 of the U.S. Constitution, the U.S. Congress is supposed to have the authority to “coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”.
So why has this authority been given to a private institution that is dominated by the big Wall Street banks and that has actually argued in court that it is “not an agency” of the federal government?
Thomas Jefferson once said that if he could add just one more amendment to the U.S. Constitution it would be a ban on all government borrowing….
I wish it were possible to obtain a single amendment to our Constitution. I would be willing to depend on that alone for the reduction of the administration of our government to the genuine principles of its Constitution; I mean an additional article, taking from the federal government the power of borrowing.
But instead, we have become enslaved to a system where government borrowing actually creates our money.
The borrower is the servant of the lender, and we have allowed our government to enslave us to the tune of nearly 16 trillion dollars.
There are alternatives to this system. Things do not have to work this way.
Unfortunately, the vast majority of our politicians consider the Federal Reserve to be good for America and steadfastly refuse to do anything to change the status quo.
So if you are waiting for “solutions” to these problems on the national level you are going to be waiting for a very long time.
The debt problems that the United States and Europe are experiencing did not come into existence by accident. They are the result of fundamental structural problems with the financial system.
A debt-based financial system is always going to fail in the long run. Unfortunately, most Americans still do not understand this and so we will all get to suffer the consequences.
Most Americans have no idea that the U.S. government once issued debt-free money directly into circulation. America once thrived under a debt-free monetary system, and we can do it again. The truth is that the United States is a sovereign nation and it does not need to borrow money from anyone. Back in the days of JFK, Federal Reserve Notes were not the only currency in circulation. Under JFK (at at various other times), a limited number of debt-free United States Notes were issued by the U.S. Treasury and spent by the U.S. government without any new debt being created. In fact, each bill said “United States Note” right at the top. Unfortunately, United States Notes are not being issued today. If you stop right now and pull a dollar out of your wallet, what does it say right at the top? It says “Federal Reserve Note”. Normally, the way our current system works is that whenever more Federal Reserve Notes are created more debt is also created. This debt-based monetary system is systematically destroying the wealth of this nation. But it does not have to be this way. The truth is that the U.S. government still has the power under the U.S. Constitution to issue debt-free money, and we need to educate the American people about this.
Posted below are pictures of the front and the back of a United States Note printed in 1963 while JFK was president….
Notice that there is a red seal instead of a green seal on the front, and it says “United States Note” rather than “Federal Reserve Note”.
According to Wikipedia, United States Notes were issued directly into circulation by the U.S. Treasury and they were first used during the Civil War….
They were originally issued directly into circulation by the U.S. Treasury to pay expenses incurred by the Union during the American Civil War. Over the next century, the legislation governing these notes was modified many times and numerous versions have been issued by the Treasury.
So why are we using debt-based Federal Reserve Notes today instead of debt-free United States Notes?
It seems rather stupid, doesn’t it?
Well, that is what Thomas Edison thought too.
Thomas Edison was once quoted in the New York Times as saying the following….
That is to say, under the old way any time we wish to add to the national wealth we are compelled to add to the national debt.
Now, that is what Henry Ford wants to prevent. He thinks it is stupid, and so do I, that for the loan of $30,000,000 of their own money the people of the United States should be compelled to pay $66,000,000 — that is what it amounts to, with interest. People who will not turn a shovelful of dirt nor contribute a pound of material will collect more money from the United States than will the people who supply the material and do the work. That is the terrible thing about interest. In all our great bond issues the interest is always greater than the principal. All of the great public works cost more than twice the actual cost, on that account. Under the present system of doing business we simply add 120 to 150 per cent, to the stated cost.
But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good.
Our current debt-based monetary system was devised by greedy bankers that wanted to make huge profits by creating money out of thin air and lending it to the U.S. government at interest.
Sadly, the vast majority of the American people have no idea how money is actually created in this nation.
In a previous article about money and debt, I explained how more government debt is created whenever the U.S. government puts more money into circulation….
When the government wants more money, the U.S. government swaps U.S. Treasury bonds for “Federal Reserve notes”, thus creating more government debt. Usually the money isn’t even printed up – most of the time it is just electronically credited to the government. The Federal Reserve creates these “Federal Reserve notes” out of thin air. These Federal Reserve notes are backed by nothing and have no intrinsic value of their own.
When each new Federal Reserve Note is created, the interest owed by the federal government on that new Federal Reserve Note is not also created at the same time.
So the amount of government debt that is created actually exceeds the amount of money that is created.
Isn’t that a stupid system?
The U.S. Constitution says that the federal government is the one that should actually be issuing our money.
In particular, according to Article I, Section 8 of the U.S. Constitution, it is the U.S. Congress that has been given the responsibility to “coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”.
So why is a private central banking cartel issuing our money?
As is the case with so many other issues, we desperately need to get back to the way the U.S. Constitution says that we should be doing things.
The debt-based Federal Reserve system is literally stealing the future from our children and our grandchildren.
Back in 1910, a couple years prior to the passage of the Federal Reserve Act, the national debt was only about $2.6 billion.
A little over 100 years later, our national debt is now more than 5000 times larger.
So why don’t we just admit that this system simply does not work?
Our current debt-based monetary system also requires very high personal income taxes to pay for it.
In fact, it is no accident that the personal income tax was introduced at about the same time that the Federal Reserve system originally came into existence.
Our children, our grandchildren and many generations after that are facing a lifetime of debt slavery because of us.
As I have written about previously, if the federal government began right at this moment to repay the U.S. national debt at a rate of one dollar per second, it would take over 440,000 years to pay off the national debt.
Neither the Republicans or the Democrats are proposing any solutions to this problem. Rather, both parties are only trying to slow down the rate at which we are going into even more debt.
But the truth is that the federal government does not have to go into a single penny of additional debt.
How could this be?
It is not too complicated.
If Congress took back the power over our currency and started issuing debt-free money a lot of our problems could be fixed.
A basic plan would look something like this….
#1) The U.S. Congress votes to take back all of the functions that it has delegated to the Federal Reserve and begins to issue debt-free United States Notes. These United States Notes would have the exact same value as existing Federal Reserve Notes, and over time all existing Federal Reserve Notes would be taken out of circulation.
#2) The U.S. Congress nationalizes all debt held by the Federal Reserve. That would instantly reduce the national debt by 1.6 trillion dollars. In fact, there are a few members of Congress that have already proposed this.
#3) A Constitutional amendment is passed limiting future U.S. government deficits to a reasonable percentage of GDP. Any future deficits would not be funded by borrowing. Rather, future deficits would be funded by newly created United States Notes. Therefore, the federal government would never again accumulate another penny of debt.
And it would be important to inject new money into the economy from time to time. When existing money is destroyed or when the population grows it is important to inject a certain amount of new money into the system in order to avoid deflation.
#4) The existing national debt would be very slowly paid off with newly created United States Notes. The U.S. government spent over 454 billion dollars on interest on the national debt during fiscal year 2011, and over time this expense would go to zero.
If the national debt is paid off slowly enough, it would not create too much inflation. I believe that it could be paid off gradually over 50 years without shocking the economy too much.
There are some that would object to any measure that would ever cause a small amount of inflation, but my contention is that we have created a $15 trillion dollar debt mess for future generations, and it would be absolutely criminal to pass that legacy on to them.
We created this mess, and it is our responsibility to clean it up.
While there is certainly a danger that we would have a limited amount of inflation under a debt-free monetary system such as the one described above, the reality is that we are absolutely guaranteed inflation under the Federal Reserve system.
Most Americans believe that inflation is a fact of life, but the sad truth is that the United States has only had a major, ongoing problem with inflation since the Federal Reserve was created back in 1913.
If you do not believe this, just check out this chart.
Sadly, the U.S. dollar has lost well over 95 percent of its value since the Federal Reserve was created.
So, yes, there would be a need for strict monetary discipline under a debt-free monetary system, but it would be hard to do worse than the Federal Reserve has already been doing.
And Congress could always slow down inflation using other methods. For example, raising the reserve requirements for banks (which should be done anyway) would help keep inflation in check.
If the above proposals were adopted, the end result would be something that we could all live with. The Federal Reserve system would be abolished, the national debt burden on future generations would be wiped out, the economy would not have to go through a devastating economic collapse that could last a decade or longer, and we could eventually make a fairly smooth transition to “hard money” if we wanted to after the national debt is gone.
Is there any other proposal out there that does all of those things?
There are many out there that would dispute some of the points above, and debate is good. By engaging in debate, we can hopefully help educate the American people about the nature of money.
The key is to get rid of our current debt-based Federal Reserve Notes and replace them with debt-free United States Notes.
The American people need to understand that it is a lie that the U.S. government “must” borrow money from somebody else.
When the U.S. government borrows money, it slowly transfers wealth from the American people to those that lent it.
At this point, we have created a financial nightmare for future generations that is unlike anything the world has ever seen before. We owe it to future generations to eliminate the debt problem without destroying the United States economy. Adopting debt-free money would allow us to do that.
But sadly, neither political party is even talking about debt-free money. In fact, most of the politicians in both political parties probably do not even know what debt-free money is.
So we need to get the American people educated about these things. Because if we stay on the course that we are currently on, an economic collapse is inevitable.
Is the U.S. government on the verge of a massive debt problem? For years, the U.S. government has been able to borrow all the money that it has wanted to at extremely low interest rates. But now many of the lending sources that the U.S. government has been depending on are drying up. Even before this recent crisis in Japan, a number of big players were moving away from U.S. Treasuries and the U.S. Federal Reserve was having to step in to pick up the slack. But now this debt crunch is about to get a whole lot worse. For years, many had feared that it would be China that would start dumping U.S. government debt, but now it turns out that Japan is going to be the real problem. Right now, Japan is the second largest foreign holder of U.S. government debt. Japan currently holds about $882 billion in U.S. Treasury bonds and they are likely going to have to liquidate much of that in order to fund the rebuilding of their nation. So needless to say they won’t be accumulating any more U.S. government debt. But the U.S. government still needs to borrow a trillion and a half dollars from someone every single year. So where in the world are they going to get it?
This is called a debt problem. Have you ever gotten to the point where you are in debt up to your eyeballs and nobody wants to lend you any more money?
Well, the U.S. government is rapidly reaching that point.
Even before the crisis in Japan, several of the big boys had starting moving away from U.S. government debt.
PIMCO, the biggest bond fund on the entire globe, recently acknowledged that they are dumping all of their U.S. Treasuries.
So if foreign nations like Japan are not gobbling up U.S. government debt and big bond funds like PIMCO are not buying any of it, then who in the world is going to be purchasing the massive amounts of debt that the U.S. government is constantly pumping out?
Well, many of you already know that answer.
The Federal Reserve is going to step in of course. The Federal Reserve knows that if the U.S. government cannot borrow gigantic quantities of money at super low interest rates it will go broke. So the Federal Reserve is just going to keep buying up most new U.S. government debt. It is just that simple.
But isn’t that a Ponzi scheme?
Of course it is. Let’s not mince words here. It is a total scam.
And it is a scam that cannot go on indefinitely.
The truth is that the Ponzi Scheme of the U.S. Treasury issuing bonds and the Federal Reserve buying them up cannot last forever as PIMCO’s Bill Gross noted in his March newsletter….
“Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t.”
Gross also noted in his recent newsletter that the Federal Reserve is currently buying up about 70 percent of all new U.S. government debt.
So now that Japan is out of the picture, how high will that figure go now?
Over the past several weeks there has been all kinds of speculation about whether “quantitative easing” will be extended past June or not.
Well, whether they call it “quantitative easing” or not, the truth is that the Federal Reserve is going to have to continue to “buy” most new U.S. government debt or the system will crash.
We have gotten to the point where the U.S. federal government cannot continue to function without Federal Reserve monetization of the debt.
This is a sign that we are rapidly approaching the financial endgame.
So why doesn’t the U.S. government just stop spending so much stinking money and stop getting us all into so much debt?
Well, because there isn’t enough political will in Washington D.C. to do any real budget cuts, and if our politicians did balance the budget at this point it would crash the economy.
Just the other day, the U.S. House of Representatives passed a continuing resolution to fund the federal government that would cut 6 billion dollars from U.S. government spending.
On that exact same day, the official U.S. national debt figure rose by 72 billion dollars.
Now the debt normally does not go up that much on a typical day. But what this example does show is the losing battle that our politicians are fighting.
On Wednesday, U.S. Treasury Secretary Timothy Geithner warned a House of Representatives appropriations subcommittee that they should not even think about not raising the debt ceiling….
“Congress has to do it. There’s no alternative.”
The truth is that the U.S. government has to keep going into more debt. Under the current system the alternative would be to collapse the economy.
But the debt that we have already piled on to the backs of future generations is absolutely criminal.
How mad do you think future generations are going to be with us for heaping 14 trillion dollars of debt on to their shoulders?
Talk about a debt problem!
But this is what we get for allowing a private central bank to run our financial system. This debt-based system was designed to fail from its very inception.
The man supposedly “in charge” over at the Federal Reserve, Ben Bernanke, has a track of record of incompetence that is absolutely staggering. It is a mystery why our representatives in Washington D.C. are not howling for his resignation.
Instead, most of our politicians continue to express blind faith in our current financial system and they continue to insist that everything is going to be okay.
Well, everything is not going to be okay. The Obama administration is projecting that the federal budget deficit for this fiscal year will be an all-time record 1.65 trillion dollars.
Of course they are also trying to convince us that budget deficits will go down in future years, but by now we should all know not to trust the rosy future projections of government officials.
After all, it was only a few short years ago that Bush administration officials were promising that we would be swimming in huge budget surpluses by now.
The truth is that the government has been lying about all of this for a long time. For now, the Federal Reserve is just going to keep monetizing U.S. government debt for as long as it can.
This Ponzi scheme will keep on working and working and working until someday it simply doesn’t anymore.
When that day arrives, the U.S. government debt problem is going to unleash hell on world financial markets.