By The Acamar Journal / June 15, 2008 / www.acamarjournal.com /
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I started writing the Acamar Journal in April 2004 on the premise that the levels of debt (government, corporate and personal) in the US were rising to unsustainable levels, and that there would be a day of reckoning. I had predicted that the U$ would fall to record lows and gold rise to record highs.
All this has happened but we are only partially through the adjustment process.
Now comes a further warning from Bob Janjuah, chief credit strategist at the Royal Bank of Scotland. Mr. Janjuah is famous in London's financial circles for predicting the credit crunch that began in July 2007.
In a research note, Mr. Janjuah says that "a very nasty period is soon to be upon us - be prepared," warning that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets.
"The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets," he says.
Meanwhile, the Bank of International Settlements (BIS) has continued to warn of a possible second Great Depression. The Bank for International Settlements, the organisation that fosters cooperation between central banks, has warned that the credit crisis could lead world economies into a crash on a scale not seen since the 1930s. In its latest quarterly report, the body points out that the Great Depression of the 1930s was not foreseen and that commentators on the financial turmoil, instigated by the U.S. sub-prime mortgage crisis, may not have grasped the level of exposure that lies at its heart.
According to the BIS, complex credit instruments, a strong appetite for risk, rising levels of household debt and long-term imbalances in the world currency system, all form part of the loose monetarist policy that could result in another Great Depression.
A separate report from Goldman Sachs last month backs him up. Predicting total global credit losses of $ 1.2 trillion, Goldman Sachs warns that Wall Street will have to write off about $ 480 billion, of which they have only taken $ 120 billion in losses so far.
If this were to happen, it will badly damage the major US banks which are thinly capitalised due to recent write-downs and which are desperately seeking to raise capital and sell assets to shore up their balance sheets (Lehman and Citigroup being prime examples)
Despite new SEC regulations designed to help investment banks delay the recognition of portfolio losses, new accounting rules may force this issue by requiring banks to mark illiquid assets to market and bring off-balance sheets items parked in Structured Investment Vehicles (SIVs) onto the banks' balance sheets.
In fact, the entire shadow banking system, which is virtually unregulated, is now estimated by the Federal Reserve to be about $ 10 trillion in assets. It is the same size as the traditional banking system, which is heavily regulated (which does not seem to have helped prevent this credit crisis!). The Federal Reserve now plans to investigate this system and subject it to the similar rules on capital, liquidity and risk management as commercial banks. The reasons the banks put these assets outside the regular system was to free up their balance sheet from reserve requirements in order to expand their ability to provide credit.
This would not only cause major write-downs but will also raise reserve requirements, preventing banks from continuing to lend at current levels. Reduced credit would further exacerbate the economic downturn.
All banks balances in FDIC-Insured institutions in the US (up to $ 100,000) are guaranteed by the Federal Deposit Insurance Corporation (FDIC), which helps to provide liquidity and confidence in the system.
The FDIC now classifies 76 banks that are deemed to be 'troubled' (up 52% from last year) yet it only has $ 58 billion in assets. Total deposits within the FDIC-Insured Institutions were $ 6.7 trillion at June 30, 2007, providing less than 1% coverage.
The Savings and Loan Crisis (1986-1995) cost US taxpayers $ 158 billion, when the total deposit base in 1995 was less than half of what it is now.
During the Great Depression, 40% all of US banks failed, leading to prolonged economic and social agony as credit completely dried up. It is this kind of aggravated credit crisis that RBS is warning about. The bank run on Northern Rock, the first run on a British bank in 140 years, may be the sign of the times to come.
The U$, the Euro and Gold
Ben Bernanke was on the horns of a dilemma and he took a calculated risk. As inflation has begun to rampage ahead on a global basis and since the Fed's mandated role is to provide price stability, he would normally have had to raise interest rates to curb inflation.
(The irony is that it is the Fed itself that causes inflation. By definition, inflation is the rate of increase in money supply. It is the rapid increase in the supply of money {in excess of GDP growth} that leads to increases in consumer prices as more money chases the same amount of goods and services).
The problem arose when the ECB suggested that it was ready to raise interest rates rather than cut them, as had been widely anticipated. This would widen the yield differentials between Europe and the US, leading to more downward pressure on the U$.
To stop the negative impact on the dollar and manage inflation expectations without raising interest rates, which would severely hurt the economy, Bernanke bluffed. He talked about the fact that the US was prepared to take measures to support the U$ without making any firm commitments to do so.
Now, the Fed is not responsible for the U$, the US Treasury Department is, and it was unprecedented that the Federal Reserve Chairman directly addressed the issue.
He wanted reassure investors that the dollar was finding a floor at this stage since the Fed stood ready to act to support it but was hoping that just talking about it would be sufficient to support the dollar by convincing investors not to sell.
The dollar rallied but absent any signs of intervention and with no mention of any coordinated support for the U$ in the recent G8 meeting, the U$ promptly began to sink again.
The credibility of the Fed is on the line, but in a US presidential year and with a sharply weakening economy, it cannot afford to raise rates and so the dollar is likely to be attacked as the market realises that the Fed has issued a challenge but cannot act to defend the dollar.
In the meantime, Europe has major issues as well. With recessions now likely in England, Ireland, France, Spain and Greece and a slowing German economy, a rise in interest rates would be traumatic. But these countries no longer have control over their own monetary policy, the ECB does.
This is likely to create major strains on the desirability of a European Monetary Union (EMU) as things get worse.
And the Germans sense it. Ordinary Germans are now exchanging Euros issued in Italy, Spain, Greece and Portugal for those issued in Germany. The notes are identical in form and value but there is a perception that this may not last as the EMU might disband, creating disparate values in the Notes.
In a recent IPOS poll, 59% of Germans polled said they did not trust the Euro!!
Wholesale inflation in Germany has now risen to 8.1%. Germans have lived through two hyperinflationary periods in 1923 and 1948, so there is more concern about raging inflation rather than economic weakness.
As inflation rages and people lose faith in paper (fiat) money whose value declines with growing rapidity, more and more people will turn to gold as a safe haven. I believe gold will rise to values in excess of $ 3,000 per ounce within the next 3-4 years.
Signs of a Depression
The damage caused by the excesses arising from easy credit (for which Greenspan bears a lot of responsibility) will be substantial and lead to a major erosion in living standards in the US.
As US homes foreclosures have risen by 48% and housing prices have fallen 14.4% since last year, the effect has been rising unemployment and falling consumer confidence. Rapidly rising food and energy prices have come as the US has sunk into a recession that may be a very painful one.
Some of the things that occurred during the Great Depression are happening today:
FOOD BANKS: A record 26 million people in the US now receive food stamps (a government program to assist indigent people with buying basic groceries). A growing number of people get free meals from food banks (charities that provide free meals). Demand has increased by 15-20% and these charities are facing shortages in food supplies and some are running out of funds.
LIVING WITH THE ENEMY: Nice suburban neighbourhoods are turning into ghettos as developers have walked away from half built houses due to lack of credit and home buyers. With record levels of foreclosures and falling prices, banks are unable to sell foreclosed homes, which lie abandoned, in disrepair and unmonitored. Drug dealers and homeless people have moved in.
This has turned a dream of suburban ownership for some families into living nightmares. Crime rates are rising around them but they are unable to sell as there are few buyers. For some homeowners who bought bigger houses than they could afford due to low teaser rates, they now owe more on their mortgage than the house is worth, so they cannot sell and move.
TENT CITIES: As people lose their homes, and their credit and savings are destroyed in the process, some cannot afford to buy or even rent replacement housing. Tent cities are now springing up in major urban centers in California.
PAYDAY LOANS: As poorer Americans find themselves unable to make their paychecks last till the end of the month, more and more of them are turning to loan agencies for short-term loans.
These loan sharks charge exorbitant interest rates, as much as 2,000 per cent per annum!!The California legislature tried to pass a bill to cap total interest charges at 429% per annum but was unable to get enough votes due to lobbying pressure from these agencies.RISING UNEMPLOYMENT AND CRIME: Many US states, such as California, and municipalities are facing record deficits as property taxes are falling, which will lead to a decline in services including policing as they are forced to cut costs.
Add the fact that in 17 of the top 50 cities in the US the high school drop-out rate is over 50%, and that these teenagers and young adults may turn to crime and violence as the economy worsens and you get a potent sense of how bad things could really get.
These things, which are very reminiscent of the Great Depression and conditions at the start of the 20th century when living standards were abysmal, are taking place even though the recession has not even officially begun (though in reality it has been here since the start of 2008) and job losses are not yet severe.