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Preparing for Disaster - Global Market Threats

The End for Lehman BrothersJuly 20, 2014 | by Steve McCurdy


Today’s Domestic Market Landscape

Broadly speaking, financial markets consist of three types of financial instruments; equities (the Stock Markets), bonds (the Bond Markets), and Financial Derivatives. In terms of the approximate relative sizes of US markets, total stock market value is $22 trillion, bond market value is $37 trillion, and the value of all derivatives is $735 trillion. In other words, aggregate derivatives are more than 10 X larger than the stock market and the bond market combined. World-wide, it is estimated that derivatives exceed $1 quadrillion.


The US National Debt today stands at $17.591 trillion, which is approximately 2.4 X larger than 2004 number of $7.379 trillion. The country’s deficit for 2014 (fiscal year ending 9/30) is expected be about $732 billion, up more than 5% from 2013. In four of the last six years, annual deficits have exceeded $1 trillion. (Deficits for 2013 and 2014 were down somewhat as the result of the legally mandated budget sequestration.) As of July 15, the actual US unemployment rate as measured by U-6 was 16.2%. 

The Derivative Market Explained

The Derivatives market is both complex and unregulated. According to Wikipedia, a derivative is “a special type of contract which derives its value from the performance of an underlying entity.” US Debt Clock defines derivative this way; “A derivative is a contract between two parties by which the Buyer receives a payoff if the underlying financial instrument defaults.” The “underlying instrument’ in a derivative can be any number of things, including but not limited to an asset, an index, an interest rate, or a mortgage loan.
Perhaps the best way to understand derivatives is to look at recent example, taken from an article by economist Michael Pento in King World News entitled “Wall Street’s Fantasy is Dark Market DerivativesAbout to Morph Into a Nightmare.” PIMCO TOTAL RETURN is the world’s largest mutual bond fund, with assets exceeding $230 billion. Bond values correlate inversely to interest rates. As interest rates rise, bond values decline, and vice versa. According to Pento, PIMCO is putting all its chips on the table and betting that interest rates will remain low for from 3 to 5 more years. PIMCO is selling insurance policies to its investors guaranteeing that rates will not rise beyond prescribed levels. If they do, then PIMCO will be forced to pay off on the insurance policies. Meanwhile, the TOTAL RETURN fund’s profitability will be improved by the premiums from the insurance sales. This insurance program is an example of an “interest rate derivative.” If PIMCO loses the bet and higher interest rates trigger payoff requirements, that means double trouble for PIMCO. If rates have increased sufficiently to trigger the insurance payoffs, then the value of its bond portfolio will also have dropped dramatically, causing fund investors to head for the exits, and forcing PIMCO to pay out huge amounts for bond redemptions. This scenario is one that by itself could be disastrous not only for PIMCO but also for the fragile financial markets as a whole.
“Credit Default Swaps,” another popular form of derivatives, were largely responsible for recently bringing down Bear Stearns, AIG, Lehman Brothers, WAMU (Washington Mutual), and other mammoth corporations. These credit default swaps were in essence failed bets that sub-prime mortgages would not default.
Legendary investor Warren Buffet refers to derivatives as “Weapons of Financial Mass Destruction.”
Unexpected rises in interest rates definitely represent one of the many  “Minsky Moments” that could trigger an econmic collapse. 

Bank Run - It's a Wonderful LifeProbable Government Responses to Market  Disaster

There have been countless sovereign economic and financial disasters throughout history, and governmental reactions are highly predictable. Preservation of power remaining and in office guide all government thinking and decision-making. History teaches us to expect the imposition of some or all of the following “Capital Controls,” to deal with a “National Emergency.”

International Travel and Customs Restrictions to Prevent Capital Flight – The flight of capital out of the country will be one of Government’s biggest fears, and strict restrictions will be imposed on the amounts of cash and the types of assets that international travelers can legally carry. Acquiring and renewing passports will become much more difficult and time consuming, and it will become extremely risky to dodge the restrictions by moving assets or investing offshore.
• Bank Holidays, Confiscation of Deposits, and Withdrawal Restrictions to Protect BanksIndymac Bank ClosureIn 1934 FDR declared a “Bank Holiday,” to give Government time to develop a plan to save the banks. From 1929 through 1933, more than 9,000 US banks failed, taking more than $140 billion of deposits from bank customers. From a strictly legal standpoint, the money you deposit in the bank belongs to the bank and not to you, and as we learned in Cyprus during the “Bail-In,” desperate banks can simply confiscate your money if they so choose. If the banks are allowed to remain open, they will place onerous limits on withdrawals.
Nationalization of 401K and Other Retirement Accounts  - It is estimated that the total value of  all IRAs, 401-Ks and other retirement accounts approaches $20 trillion. By comparison, total IRS tax collections are under $3 trillion annually. There has been significant speculation that the Government, to save itself from monetary meltdown, would nationalize these accounts, meaning that it would the redirect the values of all portfolios in these accounts into US Treasury Bonds or other Government securities that it might designate.
Confiscation of Privately Owned Gold and Silver – President Roosevelt took this step in 1933, when he issued Executive Order 6102. Those who surrendered their precious metals were compensated, but at far less than the then-prevailing market values. Ft. Knox was built just to house the metals confiscated from private citizens.
Temporary or Permanent Suspension of Entitlement Transfer Payments – Under the protective blanket of a “National Emergency” the Government could voluntarily or involuntarily suspend funding for Food Stamps, Medicare, Social Security and other entitlement payments. It would use this prerogative only as a last ditch measure because of the potential political damage but it is nonetheless possible depending upon the severity of the collapse.
Imposition of Martial Law and Curfews – Americans would be naïve to believe that the Government does not already have detailed plans drawn up to respond to all kinds of geopolitical or financial disasters, and those plans will almost certainly include  imposing martial law and curfews on the public.


The game is about over. The threat to global financial markets is a death threat. A global economic collapse has been delayed thus far only by the printing of massive amounts of new money. The mountain of global sovereign debt is not being reduced, and it cannot possibly ever be repaid. The complexity of the global financial system increases exponentially with every round of money printing and every sovereign bond auction. Last week rumors of margin calls against Portugal’s Banco Espirito Santo left Central Bankers holding their breath for several hours. We believe that lurking somewhere within the huge overhang of derivative contracts is the match that will light the fuse. The question is no longer if, but only when the apocalypse will arrive. The federal government has a disaster plan in place and we hope that you do too.

If so, we would like to have you share it with us below, and if you don’t, it’s time to put one together. These images will give you some ideas.

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