Imagine a situation where the owner of a long-established building supply company sees his profits turning into losses with no way to turn things around. The owner has two options. The honest option is to acknowledge the situation and shut down and sell his inventory of goods, his buildings and his equipment. With some luck the sale will earn enough to fund a modest retirement.
The dishonest option is to continue to operate on the good name of the business in order to acquire lumber and hardware from suppliers on credit, and then sell the goods privately and deposit the proceeds in an offshore bank account. Finally, when his suppliers lose patience and threaten legal action the owner will arrange for the business to suffer a fire.
The fire serves two purposes. First, it directs attention away from the owner’s poor management as the cause of the firm’s difficulties. Clearly the fire destroyed the business, not the owner. Second, it obscures the owner’s fraudulent sale of inventory in the months leading up to the fire and so protects his ill-gotten wealth. The ashes in the lumber shed could just as easily be from the firm’s declared or actual inventory. With a full fire insurance payout based upon his declared inventory of lumber (and equipment and buildings) the owner will be able to settle with his suppliers and, with the remainder of the insurance settlement and the money squirreled away in his offshore account, enjoy a very comfortable retirement.
Applying the analogy to current events, in the aftermath of the 2008 global financial crisis it wasn’t immediately clear whether the situation was a temporary liquidity (or cash-flow) crisis or a deeper solvency (or bankruptcy) crisis. Assuming the former, governments around the world opened up the monetary taps to provide liquidity to the banking system. In the U.S., the Federal Reserve System embarked on two rounds of quantitative easing between 2009 and 2011 which tripled the U.S. money supply.
However, by late 2011 it had become clear that the global financial system faced a solvency crisis that money printing alone could not resolve.
Honest leaders would have declared a bank holiday and looked at the banks’ accounts in order to determine their state of health. Almost certainly, the banks would have been in much worse shape than the fictional building supply company described above. Many banks would have been found unable to pay their debts, and as one person’s debts are another person’s assets, many previously valuable stocks, bonds and other financial instruments would have been rendered worthless.
Sadly, our leaders chose the dishonest course, as explained in an article written last month by Deutsche Bank analyst Aleksandar Kocic. According to Kocic, the financial markets broke in 2012. As evidence, he looks at two measures of risk, the volatility index (VIX) which measures the market’s anticipated 30 day volatility taken from the trading of options, and the economic policy uncertainty index (EPU) taken from the frequency certain words (such as ‘deficit’ or ‘uncertainty’) appear in ten top American newspapers.
Until 2012, the two measures moved in tandem with one another. Financial market volatility reflected real world uncertainty. However, starting in 2012, the two measures diverged. While the EPU index has moved higher, the VIX is at record lows.
The VIX is not the only warning signal to convey a false sense of stability and calm. Last month the chairman and CEO of the Chicago Mercantile Exchange, Terry Duffy, said in a Fox Business interview that given the level of geopolitical and financial risk in the world, gold (the traditional safe-haven asset in times of trouble) should be trading for more than $5000 per ounce, 4 times its current level.
The most plausible explanation for these divergences is that the VIX and the gold price have been manipulated downward by the world’s banks and central banks in order to maintain confidence in the financial system. While in our story the building supply store owner is only able to buy goods on credit so long as his suppliers trust his good reputation, so banks and central banks are only able to issue their loans and currencies so long as there is confidence in the current financial and monetary system.
However, market manipulation can only get you so far. While certain measures of risk have been massaged to convey confidence, people like Kocic realize that the risks remain even if our ability to see them has been compromised.
As this realization spreads and threats to the current system become acute, it becomes time to arrange a fire. It is easy to see today’s geopolitical flashpoints as attempts to ignite a war which would allow the governments, central banks and banks which have systematically burdened our global economy with unpayable debts to both escape responsibility and protect their own wealth and power.
Looking at North Korea in particular, how is their acquisition of nuclear weapons even an issue? Two facts are worth keeping in mind: North Korea is a desperately poor country with only a limited ability to construct and maintain nuclear weapons, and the overriding concern of the North Korean government is survival.
What would happen if the North did launch a missile at South Korea, Japan or Guam? The response from the United States and its allies would be immediate and would result in both hundreds of thousands of deaths and the end of Communist Party rule. Fully aware of this, the North Koreans will not launch missiles against their neighbours unless they feel that their very existence is at stake and they have nothing to lose.
North Korean rhetoric, meanwhile, is absolutely not credible. Threats to turn the U.S. into a “sea of fire” are made to burnish the government’s image in the minds of the North Korean people. Without an external enemy to galvanize support for the Communist regime (and blame for the North’s poverty and backwardness), the Kim dynasty would have ended a generation ago. It is worth remembering that Saddam Hussein’s claims of possessing weapons of mass destruction (which did not in fact exist) in the early 2000s were similarly intended to reinforce Saddam’s image as a strongman in the minds of the Iraqi people.
Considering that the dollar-based global financial system has been obviously bankrupt for almost ten years (and began its slide towards insolvency as far back as the early 1960s) it is quite an achievement for those in charge to have kept it going for this long. However, with over 9 trillion dollars of government bonds now earning negative interest rates, our debt-based monetary system is clearly almost at an end. What better way to end it than with a spectacular fire that can be pinned on a couple of made-to-order patsies like Donald Trump and Kim Jong Un.