Interesting Readings for August 18, 2010

Tom Wright and Siobhan Gorman in the Wall Street Journal on new thinking by Pakistan’s ISI about who is enemy #1.

Tamal Bandyopadhyay in the Mint on the campaign against C. B. Bhave. Also see Ashok Desai and Mahesh Vyas on these issues.

A. K. Bhattacharya in the Business Standard on the crisis of project management in government. This is what animates Nandan Nilekani’s TAGUP group and I hope this induces fundamental change in Indian public administration. Also see.

Fascinating new research by Devesh Kapur, Chandra Bhan Prasad, Lant Pritchett and Shyam Babu, written by Ila Patnaik in the Financial Express.

Jayanth Varma is dismayed at RBI’s lack of modern finance knowledge in thinking about CDS.

India on the FATF high table by K. P. Krishnan, in the Economic Times.

Neelasri Barman and Parnika Sokhi in DNA about the most important question in RBI reforms: that of HR practices. Roughly 30
years ago, RBI used to do direct recruitment at middle management levels. When the union became powerful and recruitment became restricted to the entry level, it had greatly damaging consequences on the organisation’s capability. If the HR falls
into place with really top quality people, then all the needed RBI reforms will rapidly get done.

William Dalrymple in the New York Times on Sufis.

Jeffrey Goldberg in the Atlantic magazine about the task of stopping Iran’s nuclear capability.

Jeff Frankel says that we have a lot to learn from small countries.

Damon Darlin in the New York Times tells the story about how Netflix worked on video over the net even though this directly
competed with its profitable DVD-by-post business.

Javier Blas and Greg Farrell in the Financial Times on the interesting role of agricultural commodity futures in the recent
flareup of prices.

Euro Evaporation Leading To Credit Default Swaps And IMF Gold

The IMF gold has serious geo-political ramifications in the background because of the nature of foreign exchange reserves, credit default swaps and gold.  Wikipedia:

South Korea and Japan are both home to large numbers of United States troops and neither are going to invite a nuclear attack.  The Kuomintang, which the US backed, retreated to Taiwan when they lost power and China still asserts their ownership over the tiny island and the US continues to honor their agreement to defend Taiwan.  Russia has been discharging dollars and acquiring gold while Brazil is bucking the buck.  Neither China nor India have significant reported physical gold holdings; they need a hedge to the major currency illusions.  In my book The Great Credit Contraction the liquidity pyramid represents the FRN$ will be the last major currency to evaporate.

liquidity pyramid

The Euro’s evaporation has increased and ultimately has only one outcome.  Sure, Germany wants to retain its voice on the world stage and is faced with a Hobson’s choice of bailing out Greece and eventually the other unproductive free-riding members of the Euro or let the Euro evaporate and lose their relevance on the world stage because Germany only matters if Europe as a whole matters.


But the Damocles sword of credit default swaps, which is falling toward’s Greece, can, ultimately, be measured only against gold because gold is no-one’s liability.  Just like the Chinese have feigned their interest in acquiring gold; many sophisticated investors have feigned ignorance of gold’s monetary role.  Many sophisticated investors, like George Soros who broke the Bank of England doubled his gold position in Q1 2010, Paul Tudor of Tudor Investments, John Paulson, David Einhorn, Eric Sprott, Jim Rogers, Peter Schiff, John Embry and many others are likewise allocating their capital based on the premise that gold is a major world currency.

Even Janet Tavakoli, a former adjunct associate professor of derivatives at the University of Chicago’s Graduate School of Business, and author of six books on derivatives recently wrote:

U.S. credit default swaps currently trade in euros. After all, if the U.S. defaults, who will want payment in devalued U.S. dollars? The euro recently weakened relative to the dollar, and market participants are calling for contracts that require payment in gold. If they get their way, speculators on the winning side of a price move will demand collateral paid in gold.

The market can create an unlimited number of these contracts very rapidly. The U.S. wouldn’t have to ever default to trigger a major disruption in the gold market.

The fiat currency and fractional reserve banking system is merely a confidence game built on an illusion and fraud.  Fiat currency is to be valued like the common stock of a government and in gold.  As such the current system will end and holder’s of capital will demand to be shown the money.  Just ask Harry Reid about karma.

The price of gold in evaporating currencies would not so much create a disruption in the gold market as cause a serious loss of confidence in the current system which would result in a tremendous increase in gold’s liquidity, hopefully through use by individuals in ordinary daily activities like what happened in Zimbabwe last year.  After all, who really needs to use fiat currency illusions and why?  In this case, we are seeing both China and India demanding to see the IMF’s gold, the Damocles sword jitters and there is only one protection.  Assets with intrinsic value.

Calm in the Face of Fiscal Insanity

Eric Fry here at The Daily Reckoning is “reporting from the Golden State with the tarnished finances”, which was a riddle that I instantly knew was, of course, California. But, for some reason, I never get asked a question when I know the answer. I usually get asked, instead, something like, “For 40% of your final grade, what is the principal export of California and total tonnage exported, expressed in kilograms per fortnight?”

Well, as much as I have enjoyed this jaunt down memory lane, the fact is, as Mr. Fry points out, that California “is facing a budget deficit this year of about $40 billion, which is roughly equivalent to 2% of the state’s $2 trillion economy (GSP). That’s”, he says, “dismal.”

At that display of stoic calmness, I held aloft a shot of tequila and toasted his amazing serenity in labeling California’s $40 billion budget deficit to be merely “dismal”, mostly because there are less than 100 million workers in the entire private sector of the US, and this $40 billion represents $400 for each and every one of us private-sector workers in the Whole Freaking Country (WFC)!

My voice a sudden peal of thunder, I shout, “In the Whole Freaking Country (WFC)!”

Immediately, I thought Mr. Fry’s eyes would glaze over in one of those, “Oh, hell! The Mogambo is yammering about something and he never shuts up!” expressions of disrespect and outright loathing, but instead he decided to just change the subject, and with that, he left this global hemisphere, and went to Greece, completely on the other side of the globe!

As my brain skidded to a shuddering stop at the sudden change of vector, he went on, “But over on the Mediterranean, Greece’s budget deficit is on track to hit $50 billion, which is a very big number for an economy that is one fifth the size of California’s. In fact, that’s a horrific number.”

At this point, I think that vomit, tinged with blood, coming out of my mouth and crapping all over myself in pure terror about such financial calamity speaks more eloquently than mere words allow, and Mr. Fry filled the sudden void with, “What’s more, Greece’s accumulated debt totals $443 billion – a whopping 113% of GDP.” Gaaaahhhh!

So, to distract both you and me from any acts of hysteria caused by such fiscal insanity, I ask you the following question, that will constitute 40% of your final grade: “If you were the prancing, preening, know-nothing, government-leech blowhard who wanted a shot at fame and glory by fixing what cannot be fixed, with lots and lots of other people’s money, while paying yourself and your friends handsomely, what would you do?”

Well, since this constitutes 40% of your final grade, I decided to get a little help to make sure I knew the answer, and I emailed Mr. Fry this very question. Either he did not know, or he just rudely decided not to answer either my original email or the follow-up phone call where his stupid answering machine said that he was “not available” and that I could leave a message “at the beep” and that he would call me back, which I did, and where I said, quite plainly, so there would be no mistake, “Call me back, and if I am not here, keep calling me and leaving messages proving that you called, or I’ll kick your butt, Fry! I’m not kidding!”

Well, whether or not this means anything, he does seemingly answer the question when he writes, “Well, the correct answer is the pricing of credit default swaps (CDS) on 5-year bonds from California and Greece. (Simply stated, a CDS is an insurance policy against default. The higher the CDS price, the higher the cost of the insurance).”

Of course, I understand none of this because I am tragically stupid, pathetically ignorant, am too lazy to do anything about it, and thus totally disinterested in the whole concept, which means that it all sounds like gibberish to me, especially since the bottom line is always the same; losses are on the books, somebody is going to have to take the hit.

Fortunately, mastery of such complexity is unnecessary for me, as I just buy gold, silver and oil, which will benefit mightily as the government and the Fed ruin everything with their deficit-spending of more and more fiat money. Whee! This investing stuff is easy!

Calm in the Face of Fiscal Insanity originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Bankrupting For Profit

At a Cambridge House Investment Conference I received a question about Bear Stearns.  In my answer I alluded to the possible financial benefit of some from its implosion.  When pressed I had to explain how credit default swaps worked and then we were out of time.  Because the owners of the majority of the financial press have too much money to make from bankruptcies this topic is sparingly covered.  But the Financial Times editor let an article wiggle through.

On 6 February 2009 the Kazakhstan Tenge went poof and was devalued by 18% in a single day.  The currency has continued falling from 110 to the current 150.60241:FRN$1.  The free-flowing credit to Eastern Europe ha stopped gushing months ago.  Although BTA, Kazakhstan’s largest bank, was taken over by the government it still serviced its loans.  BTA currently has total liabilities to credit institutions of 863,688,000,000 Kazakhstani tenge or about $5.7B.    As the Financial Times reports:

“But last week Morgan Stanley and another bank suddenly demanded repayment.  BTA was unable to comply, and thus tipped into partial default.  That sparked fury among some other creditors and shocked some Kazakhs, who wondered why Morgan Stanley would have taken an action that seemed likely to create losses.  One clue to the US bank’s motives, though, can be seen on the official website of the International Swaps and Derivatives Association.  One page reveals that just after calling in the loan Morgan Stanley also asked ISDA to start formal proceedings to settle credit default swaps contracts written on BTA.”


A credit default swap (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults.  In effect, the owner of a credit default swap is short the underlying going concern.

Many of the largest Wall Street banks are heavily involved in the derivative markets with reported notional amounts outstanding as of 31 December 2008 for JP Morgan at $87.4T, Goldman Sachs at $30.2T and the single digit midgets of Bank of America and Citigroup at $38.3T and $31.9T, respectively.

The Financial Times reports, “As a result speculation is rife that Morgan might have deliberately provoked the default of BTA to profit on its CDS, since a default makes the US bank a net winner, not a loser as logic might suggest.  Morgan Stanley, for its part, refuses to comment on this speculation (although its officials note that the bank does not generally take active “short” positions in its clients). And I personally have no way of knowing whether Morgan is short or long, since Morgan refuses to disclose details of its CDS holding.  Right now more than $700 million BTA CDS contracts are registered with the Depositary Trust & Clearing Corp. in New York.”

This represents about 12.3% of the total liabilities to credit institutions.  But later in the article the key point is hit upon:  ”But the rub for regulators and investors is that BTA credit risk has not entirely disappeared: Somebody right now is holding the other side of Morgan Stanley’s contracts, and unfortunately there is little way for outsiders to know exactly who.  Worse, the presence of those CDS contracts makes it fiendishly hard to work out what the true incentives of any creditors are. In theory, lenders should have an interest in avoiding default. In practice, CDS players do not. The credit world has become a hall of mirrors, where nothing is necessarily as it seems.  At best, this makes it very difficult to tell how corporate defaults will affect banks; at worst, it creates the risk of needless value destruction as creditors tip companies into default.


Financial companies have used their agents, U.S. lawmakers, to pressure the FASB to relax fair-value accounting rules.  The result has been the official endorsement of fair-value lying.  Then with the other hand tax evader and Treasury Secretary Timothy Geithner has constructed a framework whereby politically privileged banks with worse than worthless toxic assets sell them for cash at an inflated fair value lying price to a self-funded Special Investment Vehicle (SIV), a similar entity as Enron used, that receives a non-collateralized loan from their government puppets.


For the sake of argument and simplicity assume that Bank G loans Company M $1M in either a leveraged buyout or some other type of deal that was common over the past few years when credit flowed freely.  Then Bank G purchases a CDS on Company M’s loan for $30,000 from Bank B and the CDS is reinsured by Insurance Company A.

Company M deteriorates because its free cash flow and a little more all goes to service debt and Bank G sells 90% of its loan to Bank J.  Because credit risk has increased Company M’s bond now trades in the market for $25,000 and Bank J purchases a CDS from Bank L for the current market price of $60,000 and reinsured by Insurance Company A.  Banks B and L go bankrupt, the trader at Bank L who sold Bank J the CDS now either goes to work at Bank J or receives consulting fees and the privileged creditors of Banks B and L, such as subsidiaries of Bank J and G, receive government bailout payments through Insurance Company A.

Company B, while still able to service its debt, does violate some provision of its debt covenant.

First, being friendly competitors Bank G and J decide to both press for default proceedings and then initiate settlement of the CDS they own.

Second, they fund a SIV with $25,000 of cash which borrows another $825,000 from the Bank’s government puppets.

Third, the SIV pays Banks G and J $850,000 of cash for the Company M loan which, while trading for $25,000 in the market is being carried on their balance sheet for $600,000 and consequently results in a $250,000 gain on the income statement for the quarter after having written down a couple quarters ago.

Fourth, Banks G and J receive $2M in bailout funds for the failed CDS contracts.

Fifth, Company M is completely evaporated and thousands of workers lose their jobs.

Total profit for Banks G and J: $2.85M-$1M-$30k-60k=$1.76M. Nice pay for a days work slaughtering and cremating a slight hobbling but otherwise generally healthy going concern.


As the great credit expansion continued it culminated in hundreds of trillions of dollars worth of derivative instruments.  Some of these are registered while many, if not most, are not.  These instruments are at the evaporating top of the liquidity pyramid while gold and silver are at the bottom tip.

Just imagine what the GLD ETF Authorized Participants, including Bear Stearns & Co. Inc., Lehman Brothers Inc., Citigroup Global Markets Inc., Merrill Lynch, Goldman Sachs, J.P. Morgan Securities, and Morgan Stanley & Co., will use the language in the prospectus to do.

These derivatives, with their fiendish counter-party risk, infest the balance sheets of almost every publicly traded corporation along with many local, state and national governments.  Financial terrorists are greatly incentivized to detonate these financial weapons of mass destruction.  Because Wall Street is full of a bunch of sociopaths and because you cannot grow a conscience if you do not have one therefore these sociopaths are very trigger happy.


When confronted with these type of financial terrorists society has often had to take powerful measures.  For example, when John Law co-opted the French economy and tried to prevent its credit contraction by outlawing the use of gold and silver with the death penalty the French Revolution was sparked.

In the United States of America Section 19 of the Coinage Act of 1792 provided, “That if any of the gold or silver coins which shall be struck or coined at the said mint shall be debased or made worse as to the proportion of fine gold or fine silver therein contained, or shall be of less weight or value than the same ought to be pursuant to the directions of this act, through the default or with the connivance of any of the officers or persons who shall be employed at the said mint, for the purpose of profit or gain, or otherwise with a fraudulent intent, and if any of the said officers or persons shall embezzle any of the metals which shall at any time be committed to their charge for the purpose of being coined, or any of the coins which shall be struck or coined at the said mint, every such officer or person who shall commit any or either of the said offences, shall be deemed guilty of felony, and shall suffer death.”

Under Section 9 of that Act a Dollar is “to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy one grains and four sixteenth parts of a grain of pure, or four hundred and sixteen grains of standard silver.”

While the USA has 303M people about 2.3M are incarcerated or more than 1 in 100 American adults and it officially executed 59.  On the other hand, the police state China has about 1.5M incarcerated adults and officially executed 3,400.

While China has had its problems it has not appeared to have had any serious problems with their domestic banks and derivative instruments.  Perhaps a reason is because of how they deal with financial crimes.  For example, the New York Times reported that Zheng Xiaoyu, former head of the State Food and Drug Administration in China, admitted to taking bribes to approve untested medicine and he was swiftly executed.

The suiciding of some financial executives, like David Kellermann of Freddie Mac, may help delay bond sales and toll time periods in CDS or other derivative contracts which could benefit certain privileged parties.  But perhaps an official return of the death penalty for serious financial crimes would help curb some of the atrocious behavior by these financial terrorists who with premeditation and deliberation design, craft and trigger these financial weapons of mass destruction with absolute reckless disregard for both the individuals, companies, communities and nations which are affected.


Because the great credit contraction has begun, capital has started burrowing down the liquidity pyramid to safety and liquidity.  Individuals, companies and governments have more leverage than they can sustain.

With the Federal Reserve refusing to comply with Bloomberg’s FOIA request for where trillions of dollars have gone and with JP Morgan, Goldman Sachs, Bank of America and Citigroup all acting like Morgan Stanely and ‘refuse to disclose’ it does beg the questions: What are the next companies to be slaughtered and cremated?  How many hundreds of thousands of jobs will be lost as a result?  What will the American people do about it?

Disclosures:  Long physical gold and silver with no position in GLD, SLV, GS, C, BAC, JPM and MS.  No credit default swaps or other similar position in Bear Stearns or Lehman Brothers and neither a job with nor consulting income from JP Morgan or Goldman Sachs.