20 December 2009
Jim Willie CB,  “the Golden Jackass”

* Debt Default Vicious Cycle
* The US & UK Will Not be Spared
* Pathogenesis of Debt Default
* Resumption of Global Credit Crisis
* Discredit of Central Bank Franchise
* Debt Rating Agencies in the Spotlight



Special Report #2
Issue #69

BLUEPRINT TO SOVEREIGN DEBT CRISIS

DEBT DEFAULT VICIOUS CYCLE

◄$$$ MY FORECAST IS FOR A GRAND SEQUENCE OF DEBT DOWNGRADES AND DEFAULTS, THE NEXT MORE RAPID THAN THE LAST. THE SOVEREIGN DEBT SYSTEMS HAVE BEGUN TO TOPPLE. AN INSOLVENT BANKING SYSTEM THREATENS ITS NATIONAL DEBT. EVEN SOVEREIGN DEBT IS NO LONGER SACRED. THE SMALLER NATIONS WILL SUFFER DEFAULT FIRST. THEN MOMENTUM GROWS POWERFULLY. $$$

The process has seen the first two elements take place. The US financial system broke down from insolvency, with massive USFed expansion of its balance sheet, but almost nothing accomplished. Financial firm failures occurred, nationalizations were done, Black Holes were adopted for Fannie Mae and AIG, colossal bank rescues were completed, and USGovt took investment stakes in major firms (both financial and industrial). Yet no remedy took place or was even attempted, no restructuring to the banking system, no liquidation of impaired assets, no attempt to encourage a return of industry, no adherence to valid accounting rules. The lack of remedy and reform assures the US will suffer future major repeated calamity. The process will come full circle with total assuredness and hit the US financial system. All dispute is without basis, and usually ignores the lack of remedy and reform. Those in dispute point to the flood of liquidity, with pitifully little realization that excess funds caused the asset bubbles, and even less awareness that phony money causes capital destruction. See broken US industries, vanished US industries, and gimmicks to aid US industries like the Clunker Car Program and now the Home Repair Program centered on Home Depot.

The next step took several months to occur, as Dubai eventually did cave in to its prolific debt, lunatic ambition, and blind arrogance. Despite hidden motives like to ruin Iranian assets in Dubai and to interrupt Iranian imports through Dubai, the construction boom in Dubai will go down as the biggest property folly ever in history. The cycle of events now moves toward 6pm on the clock dial of the Vicious Cycle, as the important European fringe nations are ready to succumb to the reality of their own banking system failures, property price cave-ins, and the downward spiral of debt burdens. The momentum will grow in magnificent manner after the impact is felt more fully on the European fringe. A critically important factor has changed. The psychology regarding debt tolerance is suddenly completely different. The globe has accelerated into a new reality.

THE US & UK WILL NOT BE SPARED

◄$$$ LACK OF REMEDY OR REFORM GUARANTEES THE CREDIT CRISIS TO COME FULL CIRCLE TO THE UNITED STATES AND UNITED KINGDOM. EACH NATION HAS BECOME A POSTER BOY FOR RUINOUS DEBT MONETIZATION. MORAL HAZARD, ARROGANCE, MARKET INTERVENTIONS, AND FINANCIAL CORRUPTION LEAD TO A CLIMAX. $$$

The analysts will proclaim a new era of cleansing the system properly, little realizing that their own home turf is subject to the same cleansing, namely US, UK, and Central Europe. The contrast will be stark though. The US & UK have gone down a path marred by forfeited industry, commodity dependence, credit dependence, and damaged prestige. The Central Europe path will be paved by retained industry, certain commodity requirements, credit provision, and newfound prestige. Europe is busily forging a new alliance with Russia, to form a commodity lifeline of extreme importance, but with little publicity. The US & UK will turn to tragedy, as the latest chapters of Weimar Monetary Ruin, separated in an eerie isolation. The two nations have ramped up to high gear their money printing and blatant monetization practices, their investment stakes in destroyed businesses, and their dependence upon fiat money to cover new debt and rolled over debt for short-term obligations. This is the essence of monetary inflation, which when amplified is Weimar-like. USFed Chairman Bernanke said in the past deflation will not happen here. Obviously not, but instead hyper-inflation will take root and explode onto the scene. The USFed errors are like a predictable pendulum that swings from bubble to bust, from inflation to deflation, only the amplitude of the cycles has increased markedly. Think bigger asset busts and bigger episodes of inflation.

The US & UK are masters of moral hazard, the euphemism for doing the wrong thing to address a problem in a big way. They do consistently. The US & UK continue to display arrogance in their words, in stark contrast to the disrespect they receive from bankers at global summits. The US & UK are champions of market interventions, the disastrous practices that distort important price structures that lead to the imbalances. Most imbalances from one year ago are either still in place or growing worse. The US & UK are the centers for financial corruption, whose governments integrate and protect the syndicates that have usurped control and shown defiance to the people. Climax events come, but not to conform to any dictated timetable. Think event schedule.

◄$$$ A USDOLLAR CRISIS COMES, WHICH PREWARNS OF A USTREASURY DEFAULT EVENT, ALL IN TIME. AWARDS PROMOTE ARROGANCE, ISOLATION, BUT ALSO FOREWARN OF SETBACKS. $$$

While the United States boasts of managing the problem, and awarding USFed Chairman Bernanke the Time Magazine 'Person of the Year Award' in self-adulation, it ignores the risk. Worse, it celebrates the Moral Hazard risk in full view, as the best policy, the prudent policy, the necessary policy. The end of the road is a grand USDollar Crisis and a USTreasury Default. Both events are written in stone, but Wall Street and its vassal the USDept Treasury both refuse to openly admit the end game process in which they are stuck. They are locked on a path without good options to use. They argue and debate about the threat of inflation without knowledge of their own follies. They still cannot define inflation, cannot recognize inflation, and certainly cannot diagnose inflation as the cause for the current national insolvency in the US banks, US homes, USGovt, and US industry. They preside over the USTreasury bubble, which continues to expand, identified by its 0% yield. Expect the US$-based monetary crisis to occur first, timed after a sequence of unexpected events. It will tip off the globe, and its credit markets, for the ensuing USTreasury restructuring shoved down the creditor throats. The USGovt will be so brazen as to deny that a restructure writedown or forgiveness of debt constitutes a USTreasury Default.

Just a quick reminder. Back in January 1999, Jeffrey Bezos won the Time Magazine 'Man of the Year Award.' The honor was bestowed during the tech bubble frenzy, with little recognition of the imminent demise. The prestige of Bezos took a major hit in the bust, as did his personal fortune. One might conclude that the award to Bernanke signals a USTreasury Bond bubble soon to burst, or at least dissipate. Little if any recognition of the biggest global financial asset bubble is evident. The rotational cycle of sovereign debt challenges meshes well with the award given ominously.

PATHOGENESIS OF DEBT DEFAULT

◄$$$ INVESTMENT WATCH HAS LISTED NINE STAGES FOR THE EXPLOSIVE SETTING OF HYPER-INFLATION. WE ARE CURRENTLY AT A POINT THAT NEXT SHOULD SEE BOND BUSTS LIKE WITH SOVEREIGN DEBT AND SOARING MONETARY INFLATION FROM STAGGERING MONETIZATION. $$$

View the financial path to hyper-inflation as a pathogenesis, one not remotely recognized by the economists and bankers who push the progress from one step to the next. They are in the business of attempting to manage asset bubbles, and to avoid the asset price influence in price inflation calculations. The Boom Phase#1 occurred many times, but in 2007 when no more potential asset bubbles were available, the system crashed. Not a business cycle or a credit cycle, but a system cycle that happens every two or three generations. The Bust Phase#2 began in 2007 with the subprime mortgages, but was more clearly recognized in 2008 as a universal bond problem, marked by climax events in September. The Bond Boom Phase#3 is characterized by the USTreasury Bond bubble fully inflated today. It is maintained by bond monetization during auctions, tied at the hip to USGovt debt issuance. This bubble will probably be maintained by force soon, like with coerced diversions of bank deposits and pension money into USTreasury Bonds. Many competent analysts with a keen eye have identified the present stage as the 'Eye of the Hurricane' whose relative calm is misjudged amidst very strange times. This is the current Stabilization Phase#4 of today. It is not a recovery with remedy, but rather a recovery from the original wreckage of the powerful bust that strives to install some stability, even if false. Liquidations are not an option!

My argument centers upon nothing being fixed, no structural reform, no true remedy, only piles of phony money thrown into big banks, into the public domain, into wasteful projects, and into government sponsored Black Holes. My full expectation is for a resumption of the profound bust and broad damage, with grand extensions. We are heading toward emergency usage of phony money to enable what are believed to be rescues and repairs. The next stages are well described, and in my view certainties. They are worsening the embedded problems due to ignorance and desperation. The crisis will come full circle to the United States and United Kingdom. See the Investment Watch reference (CLICK HERE).

1)      BOOM. Markets rise. Creation of asset bubbles.

2)      BUST: Market Crash. Inflation goes negative. Central Banks overreact and cut interest rates. Money injections.

3)      BOND BOOM: Government debt balloons. Debt issuance soars.

4)      STABILIZATION: Stocks and commodities recover. Bonds stabilize. Volatility declines. >>>>>>> WE ARE HERE

5)      BOND BUST: Inflation goes positive. Bond buyers pull out. Central Banks step in and buy bonds (Quantitative Easing). This gradually crowds out and scares off real buyers.

6)      CURRENCY CRISIS: Money flees inflated currency, at first a trickle then a flood.

7)      INFLATION SOARS: Quantitative Easing. Currency weakness pushes prices. Inflation accelerates. Commodities rise. Inflation reaches pre-bust highs.

8)      POINT of NO RETURN: Central Banks are slow to contract money supply. Government continues to spend more. Deficits continue to grow. Real economy is still slow. Prices spiral.

9)      CURRENCY DESTRUCTION: Double digit inflation. Currency devaluation. Bond market crash. Inflation goes logarithmic. Confidence in money is destroyed. Eventually even monetary contraction will not help as demand for cash evaporates.

RESUMPTION OF GLOBAL CREDIT CRISIS

◄$$$ DUBAI DEBT DEFAULT MARKS A RESUMPTION OF THE CREDIT CRISIS THAT BEGAN IN SEPTEMBER 2008 IN NEW YORK. THE DUBAI EVENTS CONTINUED THE BANK DOMINOES 14 MONTHS LATER. SHOCK WAVES HAVE BEGUN TO REVERBERATE POWERFULLY IN EUROPE, ON ITS FRINGE. THE WRECKAGE WILL GAIN MOMENTUM, AS ATTITUDES TOWARD DEBT HAVE CHANGED. TOLERANCE IS GONE. $$$

The practices of holding bad debt forever could not last. A major change has occurred. The key is global attitudes toward debt have grown intolerant, impatient, and parochial. Plenty of initial rumblings occurred in both the United States and Great Britain. These events were well covered. Given all the USGovt bank rescues, financial firm nationalizations, and economic stimulus initiatives, combined with those of the UKGovt, many misguided analysts expected the worst was over. Not even close. Dubai debts are widely held in the London and European banking centers. A shock coming from the Persian Gulf was forecasted three months ago by the Hat Trick Letter. Default means certain large additional bank losses and writedowns, probably even bank failures.

Two very important lessons must be stressed as part of the Persian Gulf resumption in credit crisis. 1) The central bank franchise system has been discredited. Their efforts toward solution are proving extremely ineffective in either financial sector remedy or economic recovery, mainly because they delivery cures come with more tainted money without basis and more debt when excessive debt caused the original problems. This entire point has been analyzed on numerous occasions. 2) Once a banking system turns insolvent, it cannot be rebuilt. It instead rots in place like a hollowed out building, a process accelerated by rotten ethical values, euphemistically called moral hazard. The ample money flows through the dead rotten parts mainly resuscitate balance sheets. However, those balance sheets only look better due to accounting rules changes that deviate from mark to market (reality), and from USGovt equity grants. See the outsized mortgage bonds with no value at all. See the foreclosed homes withheld from the market for sale in bloated bank inventory. See the big bank balance sheets with large entries of idle money sitting in the US Federal Reserve. These gross distortions point out the lack of remedy and recovery, a continuation of gross imbalances that led to the September 2008 initial shock.

If truth be told, the dirtiest American secret in the banking world concerning the sustained US banking system is not monetization of bonds. It is that US banks would have suffered a worse fate in the last year if not for extortion from TARP funds as well as rescue funds coming from syndicate contraband accounts. Vast flows entered the big money center banks to shore up their balance sheets, from narcotics funds. One can only wonder about actual assets placed by money laundering. No wonder the USFed objects to an independent audit. See the Raw Story article and reference to the United Nations Office on Drugs & Crime (CLICK HERE).

The harsh reality from the weight of gravity and the passage of time resulted in a second bang. The biggest victims to Dubai debt default are the London and European banks heavily exposed. So why would sovereign debt for Greece, Spain, and Portugal be downgraded? They are not related. The answer in my view is the psychology has changed, toward appropriate action on debt recognition, toward demanded declaration of ruined conditions, and toward expectation of realistic default. The attitude has changed, since major horrific debt problems are global, and no remedy can come unless some important liquidations occur. Gone is tolerance toward debt locked in a downward spiral. The main point of Dubai is that they WILL NOT extend and pretend like the US and UK. The kings of fraud can extend and pretend but the rest of the world chooses to move on, or else the Anglo debt can be extended via pretense but non-Anglo debt will not be extended any further. The harsh irony is that much non-Anglo debt is underwritten by Anglo banks. Therefore the climax will come to Anglo credit systems last.

The Persian Gulf will not cover it up and carry it on, like a grand charade with waxy exteriors that display good health. The psychology has changed radically toward realism, as meaningful action is demanded like with garbage collection. My pure conjecture is that the Bank For Intl Settlements has ordered the next round of debt downgrades and defaults, giving full approval of the process, with a finger directly pointed at the Southern Europe fringe nations. The BIS was critical in setting the September 15th deadline in autumn 2008 for Wall Street to begin the death process. That timing coincided with a failed attempt for Barclays to acquire Lehman Brothers, under a BIS time deadline.

DISCREDIT OF CENTRAL BANK FRANCHISE

◄$$$ THE CENTRAL BANK FRANCHISE SYSTEM HAS A SHOCK IN STORE. THE DEBT DOWNGRADES WILL GROW MUCH WORSE, MORE PREVALENT, TO INCLUDE MORE NATIONS. THE DOMINOES HAVE BEGUN TO FALL, EACH EVENT MAKING THE NEXT EASIER TO OCCUR. THE PARLIAMENTARY MOVEMENT FOR THE EUROPEAN UNION WILL BE DEAD ON ARRIVAL. $$$

The central bank system has its next shock in store. The downgrades to government debt for Greece, Spain, and Portugal given last week by ratings agencies signal upcoming debt related earthquakes. In the United States, the game is known innocuously as Extend & Pretend, as terms of loans are extended under the pretended notion that the loans will eventually turn viable later. This is a concept in line with kicking the can down the road, avoiding the responsibility toward proper action. The Europeans are gifted in the same chicanery to a lesser degree. The entire banking system in Spain has kept housing inventory, whether from foreclosures or ruined projects, at still elevated prices, stubbornly refusing to mark them down the necessary 30% or 50%. As a result, Spain has a wide gap between bid and offer, and a huge inventory sitting idle, a stalemate that leads to sinkholes and shock waves. The space of time between upcoming major disruptive events will shorten considerably. The next nations to suffer the shame and insult of debt downgrades and defaults will be the smaller ones, where political risk and self-defense is much reduced. They are not deemed too big to fail. The process will still require much time, but events will accelerate in noticeable ways. Each downgrade makes the next downgrade easier to deliver. The first default will make the next easier to occur, with less financial or political resistance.

Notice the lack of US press coverage on the downgrades across Europe on sovereign debt. The story is mentioned with zero follow-up. US press actually boasts that the financial markets are handling the Dubai situation very well, and might be past it already. What incredible denial, but much expected. Maybe just powerful ignorance and utter arrogance. The second bang signals the beginning of sovereign debt defaults, several of them, and the reshaping of Europe, both with the European Union and the Euro currency. Many more event details and explanations of the dynamics appear in the Gold & Currency Report for December.

The movement toward a Parliamentary European Union might soon be dead on arrival, pushed by the Lisbon Treaty. Factions inside Germany are working hard to kill the treaty, which received some hasty and ill-footed support by Merkel after re-election as German Chancellor. The split of the Euro currency is soon to become a reality, a forecast made months before the Persian Gulf debt default forecast. The prudent action would be to put the Lisbon Treaty on hold while member nations default on sovereign debt. Instead, the more deeply rooted Parliament-based organization will be dissolved from member nation debt default. The unsustainable debt burdens for certain member nations are sure to produce unspeakable instability. Govt default in both Spain and Greece will soon default, with Greece first. The spillover of emotions will lead to much bigger events. The momentum of Spanish and Greek defaults will kill the European Monetary Union, and thus the EU itself. With such an unstable and uncertain overhang, not only will the Parliament be scrapped, but the European Monetary Union will fracture. The Euro currency must be quickly reshaped. Plans in place will be put into quick action after a year of preparation.

DEBT RATING AGENCIES IN THE SPOTLIGHT

◄$$$ DEBT RATINGS AGENCIES ARE CAUGHT BETWEEN COMPETENT DOWNGRADE OF DEBT VERSUS STARTING AN AVALANCHE OF DEFAULTS. SOME CALL EUROPE MOVING TOWARD ITS OWN A.I.G. DEBACLE, BUT WITHOUT A POTENTIAL TO SLIDE IT UNDER A US$-TYPE PRINTING PRESS RUG. $$$

Moodys, Fitch, and Standard & Poors are caught in a vise, just like in 2008 with US banks and mortgage debt. If they do the right thing and express objective professional opinions, they will precipitate the next crisis. Difficult decisions must be made. Clearly the next crisis is to occur in Europe, in fact already begun. If it remains silent, amidst full recognition of debt ruin, under the pressure of the Euro Central Bank and member nation politicians, it will lose yet more credibility. The factors to push the debt agencies into action are the obvious debt ruin, the momentum behind federal debt spirals, and the capital flight that makes it all real time, as in immediate. The fiscal situations in Greece and Spain might not deteriorate sufficiently to alone merit a credit crisis. However, the bond market and capital flight might indeed be sufficient to force the issue. My expectation is that this time around, the Big Three agencies will downgrade concurrently with disastrous developments and ruinous conditions, so as to avoid a total destruction of whatever is left of their reputations. By acting in unison, they will attempt to preserve their integrity. They are actually facing lawsuits within the 50 states who suffered deep losses on mortgage bond investments. State run pension funds are seeking a recovery from losses due to alleged fraud.

A perverse collusion was engrained throughout the current decade, marked by improper cooperation between the debt ratings agencies and their clients, the corporations that issued bonds for rating. The collusion was worst with Wall Street firms. Just as the Federal Deposit Insurance Corp engaged in counseling, brokering, and expedient games with the largest US banks and the USDept Treasury, the pattern might be in an early parallel stage with the same agencies. They have approached the Euro Central Banks and European nations in negotiations for retained bond ratings. It smells.