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The Swiss Franc Will Collapse

Monetary Metals's picture




 

By Keith Weiner

 

I have worked to keep this piece readable, and as brief as possible. My grave diagnosis demands the evidence and reasoning to support it. One cannot explain the collapse of this currency with the conventional view. “They will print money to infinity,” may be popular but it’s not accurate. The coming destruction has nothing to do with the quantity of money. It is a story of what happens when interest rates fall into a black hole.

 

Yields Have Fallen Beyond Zero

The Swiss yield curve looks like nothing so much as a sinking ship. All but the 20- and 30-year bonds are now below the water line.

Swiss Yield Curves

Look at how much it’s submerged in just one week. The top line (yellow) is January 16, and the one below it was taken just a week later on January 23. It’s terrifying how fast the whole interest rate structure sank. Here is a graph of the 10-year bond since September. For comparison, the 10-year Treasury bond would not fit on this chart. The US bond currently pays 1.8%.

 Swiss 10-year History

The Swiss 10-year yield was as high as 37 basis points on Friday January 2. By the next Monday, it had plunged to 28, or -25%. By January 15—the day the Swiss National Bank (SNB) announced it was removing the peg to the euro—the yield had plunged to just 7 basis points. It has been nonstop freefall since then, currently to -26 basis points.

What can explain this epic collapse? Why is the entire Swiss bond market drowning?

Drowning is a fitting metaphor. In my dissertation, I describe several harbingers of financial and monetary collapse. The first is when the interest interest rate on the long bond goes to zero. I discuss the fact that a falling rate destroys capital, and that lower rates mean a higher burden of debt. If the long bond rate is zero then the net present value of all debt (which is effectively perpetual) is infinite. Debtors cannot carry an infinite burden. As we’ll see, any monetary system that depends on debtors servicing their debt must collapse when the rate goes to zero.

I think the franc has reached the end. With negative rates out to 15 years, and a scant 33 basis points on the 30-year, it is all over but the shouting.

Not Printing, Borrowing

Let’s take a step back for a moment, and look at how the recent chapter unfolded. It began with the SNB borrowing mass quantities of francs. Most people say printed, but it’s impossible to understand this unprecedented disaster with such an approximate understanding. It’s not printing, but borrowing.

Think of a homebuyer borrowing $100,000 to buy a house. He never gets the cash in his bank account. He signs a bunch of paperwork, and then at the end of the day he has a debt obligation to repay, plus the title to the house. The former owner has the cash.

It works the same with any central bank that wants to buy an asset. At the end of the day, the bank owns the asset, and the former owner of the asset now holds the cash. This cash is the debt of the central bank. It is on the bank’s balance sheet as a liability. The bank owes it.

This is vitally important to understand, and it can be quite counterintuitive. If one thinks of the franc (or dollar, euro, etc.) as money, and if one thinks that the central banks print money, then one will come to precisely the wrong conclusion: that there is nothing owed, and indeed there is no debtor. In this view, the holder of francs has cash, which is a current asset. End of story.

This conclusion could not be more wrong.

Certainly, the idea of the central bank repaying its debt is absurd. By law, payment is deemed made when the debtor pays in currency—i.e. francs in Switzerland. However, the franc is the very liability of the SNB that we’re discussing. How can the SNB pay off its franc liabilities using its own franc liabilities as means of payment?

It can’t. This is a contradiction in terms. Thus it’s critical to understand that there is no extinguisher of debt in the regime of irredeemable paper currency. You may get yourself out of the debt loop by paying in currency, but that merely shifts the debt. The debt does not go out of existence, because paying a debt with an IOU cannot extinguish it. Unlike you, the central bank cannot get itself out of debt.

However, it can service its debt. For example, the Federal Reserve in the U.S. pays interest on reserves. Indeed, the bank must service its debts. It would be a calamity if a payment is missed, if the central bank ever defaulted.

The central bank must also maintain its liabilities, which is what it uses to fund its assets. If the commercial banks withdraw their deposits—and they do generally have a choice—the central bank would be forced to sell its assets. That would be contrary to its policy intent, not to mention quite a shock to brittle economies.

Make no mistake, a central bank can go bankrupt. This may seem tricky to understand, as the law makes its liability legal tender for all debts public and private. A central bank is also allowed to commit acts of accounting (and leverage) that would not be tolerated in a private company. Regardless, it can present misleading financial statements, but even if the law lets it get away with that, reality will have its revenge in the end. The emperor may claim to be wearing magnificent royal robes, but he’s still naked.

If liabilities exceed assets, then a bank—even a central bank—is insolvent and the consequences will come soon enough. The cash flow from the assets will sooner or later become insufficient to pay the interest on the liabilities. No central bank wants to be in a position where it is obliged to borrow, not to purchase asset but to service a negative cash flow. That is a rapid death spiral. It must somehow push down the interest rate on its liabilities (which are typically short term) to keep the cost of financing its portfolio below the revenue generated on the assets.

This becomes increasingly tricky when two things happen. One, the yield on the asset goes negative. Thus, the even-more-negative (and even more absurd) one-day rate of -400 basis points in Switzerland. Two, the issuance of more currency drives down yields even further (described in detail, below).

Events force the hand of the central bank. It goes down a path where it has fewer and fewer choices. That brings us back to negative interest rates out to the 15-year bond so far.

The Visible Hand of the Swiss National Bank

So the SNB issued francs to fund its purchase of euros. Next, it spent the euros on whatever Eurozone assets it wished to buy, such as German bunds.

It’s well known that the SNB put on a lot of this trade to keep the franc down to €0.83 (the inverse of keeping the euro down to CHF1.2) l. It also helped push down interest rates in Europe. The SNB was a relentless buyer of European bonds.

That leads to the question of what it did in Switzerland. The SNB was trading new francs for euros. That means the former owner of those euros then owned francs. These francs have to stay in the franc-denominated domain. What asset will this new franc owner buy?

I frame the question this way deliberately. If you have a 100-franc note, you can put it in your pocket. If you have CHF100,000, you can deposit it in a bank. If you have CHF100,000,000 (or billions) then you are going to buy a bond or other asset (depositing cash in a bank just pushes it to the bank, who buys the asset).

The seller of the asset is selling on an uptick. He gives up the bond, because at its higher price (and hence lower yield) he now finds another asset more attractive on a risk-adjusted basis. Risk includes his own liquidity risk (which of course rises as his leverage increases).

As the SNB (and many others) relentlessly push up the bond price, and hence push down the yield, the sellers of the ever-lower yielding bonds have fresh new franc cash balances.

The Quantity Theory of Money holds that the demand for money falls as the quantity rises. If demand for money falls, then by this definition the prices of all other things—including consumer goods—rises. It is commonly held that people tradeoff between saving money vs. spending money (i.e. consumption). The prediction is rising consumer prices.

I emphatically disagree. A wealthy investor does unload his assets to go on an extra vacation if he doesn’t like the bond yield. A bank with a trillion dollar balance sheet does not dole out bigger salaries if its margins are compressed.

So what does trade off with government bonds? If an investor doesn’t want to own a government bond, what else might he want to own? He buys corporate bonds, stocks, or rental real estate, thus pushing up their prices and yields down.

And then, in a dysfunctional monetary system, you can add antique cars, paintings, a second and third home, etc. These things serve as surrogates for investment. When investing cannot produce an adequate yield, people turn to non-yielding non-investment assets.

The addition of a new franc at the margin perturbs the previous equilibrium of risk-adjusted yields across all asset classes. Every time the bond price goes up, every owner of every franc-denominated asset must recalculate his preferences.

The problem is that the SNB does not create any more productive investment opportunities when it spills more francs into the Swiss financial system. Those new francs have to chase after the existing assets.

Yields are falling. They necessarily had to fall.

An Increasing Money Supply and Decreasing Interest Rate

The above discussion describes the picture in every developed economy. Interest rates have been falling for 34 years in the U.S., for example.

In a free market, the expansion of credit would be driven by a market spread: available yield – cost of borrowing. If that spread is too small (or negative) there will be no more borrowing to buy assets. If it gets wider, then banks can spring into action.

However, central banks distort this. Instead of the cost of borrowing being a market-determined price, it is fixed by the central bank. This perverts the business model of a bank into what is euphemistically known as maturity transformation—borrowing short to lend long. It’s not possible for a bank to borrow money from depositors with 5-year time deposit accounts in order to buy 5-year bonds. The bank has to borrow a shorter duration and buy a longer, in order to make a reasonable profit margin.

If the central bank sets the borrowing cost lower and lower, then the banks can bid up the price of government bonds higher and higher (which causes a lower and lower yield on the long bond). This is not capitalism at all, but a centrally planned kabuki theater. All of the rules are set by a non-market actor, who can change them for political expediency.

The net result is issuance of credit far beyond what could ever happen in a free market. This problem is compounded by the fact that the central bank cannot control what assets get bought when it buys bonds. It hands the cash over to the former bond holders. It’s trying to accomplish something—such as keeping the franc down in the case of the SNB, or preventing bankruptcies, in the case of the Fed—and it has no choice but to keep flooding the market until it achieves its goal. In the US, the rising tide eventually lifted all ships, even the leaky old tubs. The result is a steeper credit gradient, and the bank can eventually force liquidity out to its target debtors.

The situation in Switzerland makes the Fed’s problems look small by comparison. Unlike the Fed, which had a relatively well-defined goal, the SNB put itself at the mercy of the currency market. It had no particular goal, and therefore no particular budget or cost. The SNB was fighting to hold a line against the world. While it kept the franc peg, the SNB put pressure on both Swiss and European interest rates.

Something changed with the start of the year. We can understand it in light of the arbitrage between the Swiss bond, and other Swiss assets. The risk-adjusted rate of return on other assets always has to be greater than that of the Swiss government bond (except perhaps at the peak of a bubble). Otherwise why would anyone own the higher-risk and lower-yield asset?

Therefore, there are three possible causes for the utter collapse in interest rates in Switzerland beginning 10 days prior to the abandonment of the peg:

  1) the rate of return of other assets has been leading the drop in yields

  2) buying pressure on the franc obliged the SNB to borrow more francs into existence, fueling more bond buying

  3) the risk of other assets has been rising (including liquidity risk to their leveraged owners)

#1 is doubtful. It’s surely the other way around. It’s not falling yields on real estate driving falling yields on bonds. Bond holders are induced to part with their bonds on a SNB-subsidized uptick. Then they use the proceeds to buy something else, and drive its yield down.

One fact supports conclusion #2. Something forced the SNB to remove the peg. Buying pressure is the only thing that makes any sense. The SNB hit its stop-loss.

The rate of interest continued to fall even after the SNB abandoned its peg. Why? Reason #3, rising risks. Think of a bank which borrowed in Swiss francs to buy Eurozone assets. This trade seemed safe with the franc pegged to the euro. When the peg was lifted, suddenly the firm was faced with a staggering loss incurred in a very short time.

The overreaction of the franc in the minutes following the SNB’s policy change had to be the urgent closing of Eurozone positions by many of these players. The franc went from €0.83 to €1.15 in 10 minutes, before settling down near €0.96. For those balance sheets denominated in francs, this looked like the euro moved from CHF1.20 to CHF0.87, a loss of 28%. What would you do, if your positions instantly lost so much? Most people would try to close their positions.

Closing means selling Eurozone assets to get francs. Then you need to buy a franc-denominated asset, such as the Swiss government bond. That clearly happened big-time, as we see in the incredible drop in the interest rate in Switzerland. Francs which had formerly been used to fund Eurozone assets must now be used to fund assets exclusively in the much-smaller Swiss realm.

In other words, a great deal of franc credit was used to finance Eurozone assets. This is a big world, and hence the franc carry trade didn’t dominate it. When those francs had to go home and finance Swiss assets only, it capsized the market.

And the entire yield curve is now sinking into a sea of negative rates.

The Consequences of Falling Interest

Meanwhile, unnaturally low interest is offering perverse incentives to corporations who can issue franc-denominated liabilities. They are being forced-fed with credit, like ducks being fatted for foie gras. This surely must be fueling all manner of malinvestment, including overbuilding of unnecessary capacity. The hurdle to build a business case has never been lower, because the cost of borrowing has never been lower. The consequence is to push down the rate of profit, as competitors expand production to chase smaller returns. All thanks to ever-cheaper credit.

Artificially low interest in Switzerland is causing rising risk and, at the same time, falling returns.

The Swiss situation is truly amazing. One has to go out to 20 years to see a positive number for yield—if one can call 21 basis points much of a yield.

It’s not only pathological, but terminal. This is the end.

In Switzerland, there is hardly any incentive remaining to do the right things, such as save and invest for the long term. However, there’s no lack of perverse incentives to borrow more and speculate on asset prices detaching even further from reality.

Speculation is in its own class of perversity. Speculation is a process that converts one man’s capital into another man’s income. The owner of capital, as I noted earlier, does not want to squander it. The recipient of income, on the other hand, is happy to spend some of it.

We should think of a falling interest rate (i.e. rising bond market and hence rising asset markets) as sucking the juice (capital) out of the system. While the juice is flowing, asset owners can spend, and lots of people are employed (especially in the service sector).

For example, picture a homeowner in a housing bubble. Every year, the market price of his house is up 20%. Many homeowners might consider borrowing money against their houses. They spend this money freely. Suppose a house goes up in price from $100,000 to $1,000,000 in a little over a decade. Unfortunately, the debt owed on the house goes up proportionally.

With financial assets, they typically change hands many times on the way up. In each case, the sellers may spend some of their gains. Certainly, the brokers, advisors, custodians, and other professionals all get a cut—and the tax man too. At the end of the day, you have higher prices but not higher equity. In other words, the capital ratio in the market collapses.

To understand the devastating significance of this, consider two business owners. Both have small print shops. Both have $1,000,000 worth of presses, cutters, binding machines, etc. One owns everything outright; he paid cash when he bought it. The other used every penny of financing he could get, and has a monthly payment of about $18,000. Both shops have the same cost of doing business, say $6,000. If sales revenues are $27,000 then both owners may feel they are doing well. What happens if revenues drop by $3,500? The all-equity owner is fine. He can reduce the dividend a bit. The leveraged owner is forced to default. The more your leverage, the more vulnerable you are to a drop in revenues or asset values.

Falling interest, and its attendant rising asset prices, juices up the economy. People feel richer (especially if their estimation of their wealth is portfolio value divided by consumer prices) and spend freely. Unfortunately, it becomes harder and harder to extract smaller and smaller drops of juice. The
marginal productivity of debt falls
.

Think about it from the other side, the borrower. The very capacity to pay interest has been falling for decades. A declining rate of profit goes hand-in-hand with a falling rate of interest. Lower profit is both caused by lower interest, and also the cause of it. A business with less profit is less able to pay interest expense. Who could afford to pay rates that were considered to be normal just a few decades ago? It is capital that makes profit, and hence capacity to pay interest, possible. And it is capital that’s eroded by falling rates.

The stream of endless bubbles is just the flip side of the endless consumption of capital. Except, there is an end. There is no way of avoiding it now, for Switzerland.

How About Just Shrinking the Money Supply?

Monetarists often tell us that the central bank can shrink the money supply as well as grow it, and the reason why it’s never happened is, well… the wrong people were in charge.

I disagree.

To see why, let’s look at the mechanism for how a central bank expands the money supply. It issues cash to an asset owner, and the asset changes hands. Now the bank owns the asset and the seller owns the cash (which he will promptly use to buy the next best asset). A relentlessly rising bond price is lots of fun. It’s called a bull market, and everyone is making profits as they reckon them (actually consuming capital, as we said above).

How would a contraction of the money supply work? It seems simple, at first. The central bank just sells an asset and gets back the cash. The cash is actually its own liability, so it can just retire it. And voila. The money supply shrinks.

Not so fast.

There is an old saying among traders. Markets take the escalator up, but the elevator down. Central bank buying slowly but relentlessly bid up the price of bonds. Tick by tick, the bank forced it up. What would central bank selling do? What would even a rumor of massive central bank selling do?

Bond prices would fall sharply.

The problem is that few can tolerate falling bond prices, because everyone is leveraged. Think about what it means for everyone to borrow and buy assets, for sellers to consume some profits and reinvest the proceeds into other assets. There is increasingly scant capital base supporting an increasingly inflated—as in puffed-up with air, without much substance—asset market. A small decline in prices across all asset classes would wipe out the financial system.

Market participants have to be leveraged. Dirt cheap credit not only makes leverage possible, but also necessary. How else to keep the doors open, without using leverage? Spreads are too thin to support anyone, unlevered.

Banks are also maturity mismatched, borrowing short to lend long. The consequences of a rate hike will be devastating, crushing banks on both sides of the balance sheet. On the liabilities side, the cost of funding rises with each uptick in the interest rate. On the asset side, long bonds fall in value at the same time. If short-term rates rise enough, banks will have a negative cash flow.

For example, imagine owning a 10-year bond that pays 250 basis points. To finance it, you borrow at 25 basis points. Well, now imagine your financing cost rises to 400 basis points. For every dollar worth of bonds you own, you lose 1.5 cents per year. This problem can also afflict the central bank itself.

You have a cash flow problem. You are also bust.

The Bottom Line

The problem of falling rates is crushing everyone, but raising the rate cannot fix the problem. It should not be surprising that, after decades of capital destruction—caused by falling rates—the ruins of a once-great accumulation of wealth cannot be repaired by raising the interest rate.

I do not see any way out for the Swiss National Bank and the franc, within the system of irredeemable paper money. However, unless the SNB can get out of this jam, the franc is doomed. I can’t predict the timing, but I believe the fuse is lit and the powder keg could go off at any time.

One day, a bankruptcy will happen. Soothing voices will assure us it was unexpected. Then another will happen, perhaps triggered by the first or perhaps not. Then the cascading begins. One party’s liabilities are another’s assets. ABC’s bankruptcy wipes out DEF’s asset. Since DEF is leveraged, it cannot absorb much loss until it, too, is dragged under.

Somewhere in the midst of this, people will turn against the franc. Today, it’s arguably the most loved paper currency. However, I don’t think it will take too many capital losses in Switzerland, before there is a selling stampede. The currency will fall to zero, in a repeat of a pattern that the world has seen many times before.

People will call it hyperinflation (I don’t prefer that term). Call it what you will, it will be the death of the franc. It will have nothing to do with the quantity of money.

Two factors can delay the inevitable. One, the SNB may unwind its euro position. As this will involve selling euros to buy francs, the result will be to put a firm bid under the franc. Two, speculators will of course know this is happening and eagerly front-run the SNB. After all, the SNB is not an arbitrager buying when it can make a spread. It is a buyer by mandate (in this scenario) and must pay the ask price. Even if the SNB does not unwind, speculators may buy the franc and wait for it to happen. And of course, they could also buy based on a poor understanding of what’s happening, or due to other perverse incentives in their own countries.

Bankruptcies aside, the franc is already set on a hair-trigger. Something else could trip it and begin the process of collapse. There is little reason for holding Swiss francs in preference to dollars. The interest rate differential is huge. The 10-year US Treasury pays 1.8%. Compare that to the Swiss bond which charges you 26 basis points, and the difference is over 208 points in favor of the US Treasury. Once the risk of a rising franc is taken out of the market (by time or price action) this trade will commence. A falling franc against the dollar will add further kick to this trade. A trickle could become a torrent very quickly.

I would not be surprised if the process of collapse of the franc began next week, nor if it lingered all year. This kind of event is not susceptible to a precise prediction of when.

What is clear is that, once the process begins in earnest, it will be explosive, highly non-linear, and over quickly (I would guess a matter weeks).

 

I plan to publish a separate paper revisiting my Gold Bonds to Avert Financial Armageddon thesis in light of the Swiss crisis. I will save for that paper my assessment of whether or how gold bonds can provide a way out for the Swiss people trapped in the terminal phase of irredeemable paper money.

 

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Wed, 01/28/2015 - 08:30 | 5715133 goldenbuddha454
goldenbuddha454's picture

Attempting to understand the convoluted thinking here.  Basically, how I see it is the Swiss and other raging currencies that are actually having to repay bond money at less than they "borrowed" it are making money on the front and the backside and in the middle, especially if in the interim of the debt owed back to the lender (ie 2 yr, 10 yr, 30 yr etc...) there is raging inflation over the term of the bond.  What am I not seeing here?

Wed, 01/28/2015 - 09:01 | 5715227 Ghordius
Ghordius's picture

agree with both, particularly with limecat, who notes that the SNB has now the firepower to do with it's "product" whatever it wants, for a longer while, in both directions

Wed, 01/28/2015 - 09:44 | 5715349 Mayer Amschel R...
Mayer Amschel Rothschild's picture

This writer doesn't understand simple suppply & demand.  This is a craptastic article.

Wed, 01/28/2015 - 15:36 | 5716962 1033eruth
1033eruth's picture

There isn't any more "simple" supply and demand.  It has been extremely distorted by leverage, HFT and other factors.  One quick example is where a stock is heavily shorted for good reason as its going to fail and yet some behemoth comes along and squeezes all the shorts simply because they have access to more funds.  That is NOT "simple" supply and demand.  The entire system has become corrupt on behalf of the privileged few.  Soros was heavily short the franc as well but mysteriously he got a tip and yanked his bet just in time.  The article was here on zerohedge.

Wed, 01/28/2015 - 13:15 | 5716294 a common man
a common man's picture

Supply and demand is correct. If logic were to prevail, where would the US dollar be? Right, much lower. Logic does not explain markets.

Wed, 01/28/2015 - 16:08 | 5717065 Radical Marijuana
Radical Marijuana's picture

a common man:

The "logic" of organized crime explains "markets" ... However, since there there is nothing which is publicly significant other than controlled opposition to that organized crime, there does not appear to be much "logic."

What happens to "supply and demand" in a system based on enforced frauds?

How long can that continue?

I rather liked that article above:

"This is vitally important to understand, and it can be quite counterintuitive."

It is "counterintuitive" to most people that the established systems are based on governments being the biggest form of organized crime, controlled by the best organized gangs of criminals. The history of that was the War Kings creating sovereign states, whose powers were captured by the Fraud Kings, the new royality of Central Banks, which are effectively above the law, because they effectively control the processes that make and enforce the laws.

A common man lives INSIDE of those established systems where privately controlled banks can create the public "money" supply out of nothing as debts. Banks are allowed to legally counterfeit, while, for a common man, that is a crime. The vast majority of people are not able to understand the political economy, because they do not want to suffer through the extreme cognitive dissonance it takes to understand that money is measurement backed by murder, which actually operates through the maximum possible frauds and deceits.

Warfare is the oldest and best developed form of social science and social engineering, whose successes were based on deceits and treacheries. Economics is actually a subset of warfare, whose successes are based on frauds and bullshit. Since the vast majority of people were born, live and die, INSIDE of fundamentally fraudulent financial accounting systems, it seems to them, from their perspective WITHIN those systems, that basic notions such and "supply and demand" or other apparent forms of "logic" should make sense ... although various anomalies are becoming bigger and more blatant.

The realities which surround us are actually based on being able to back up legalized lies with legalized violence, where the only functional limits are the limits of the ability of violence to back up lies, WITHIN human society.

Sublime logic would be based on there being some conservation principles, in order that the world could possibly be intelligible. Ironically, most of what we call "economics" operates INSIDE of a world where fundamentally there is a MAD Money As Debt system, where there is NO conservation of money principle. (Although most people uncritically presume that there is, because that "logically" appears to be so, within their own little lives.)

That produces very counterintuitive results, since the ONLY connection between human laws and natural laws is the ability to enforce frauds. People INSIDE that society are proportionately successful to the degree that they can operate as professional liars and immaculate hypocrites, where those doing that the best are the most deluded to believe in their own bullshit. Thus, the whole of civilization is becoming more criminally insane, faster, as the contradictions due to ways that backing up lies with violence never makes those financial frauds stop being false, but nevertheless, continues to maintain those systems of enforced frauds as the dominate social systems. (Furthmore, the controlled opposition continue to promote bogus "soltuions" based on impossible ideals, that continue to actually cause the opposite to happen in the real world.)

It is POSSIBLE to understand human systems as entropic pumps of energy, which follow the basic energy laws. However, doing that requires perceiving the ways that governments are the biggest forms of organized crime, controlled by the best organized gangs of criminals, (currently the banksters). A common man does NOT want to do that, but rather, wants to continue to muddle through the apparently illogical situations, which can only be made to become logical by profoundly changing the perceptual paradigms.

All of the ways that our civilization appears to have become a Bizarro Mirror World, or a Wonderland Matrix, where everything appears to be proportionately backwards and absurd can be understood as the result of ORGANIZED CRIME & CONTROLLED OPPOSITION.

Thousands of years of the history of Neolithic Civilizations were always based on the applications of the principles and methods of organized crime, in which context nothing else survived as socially significant than the opposition which was controlled by that organized crime. Both warfare and economics FIT inside of the general energy laws, but those are socially discussed, and generally understood by a common man, in the most backward ways possible.

Wed, 01/28/2015 - 16:47 | 5717286 anonnn
anonnn's picture

Excellent analysis, tho I read thru it rather quickly. I offer this much shorter statement:

In the present time, what is the bedrock of the money system? There is none.

Any and all systems depend on bedrock, real or imagined, to support and maintain its continuation, or persistence.

The current money system has no bedrock. It is not gold or silver, nor law, nor IOUs, nor land titles, nor threats of death.

An electric motor, such as the AC or DC ones that everyone uses, is wonderfully successful because it has its bedrock. Namely, it is anchored by bolts to the stable platform of Earth. Planet Earth is its bedrock.

Without those bolts to the Earth, thus without its bedrock, that motor can exert no useable force. It would only spin and bounce around wildly into chaos. It is useless, ununcontrollable, destructive and has only scrap value. 

When thinking about money/finance/ buying and selling, wages, income, etc, look for the bedrock.

If you cannot find the bedrock, beware that continuing on that path invites chaos and the spin-bin.

Wed, 01/28/2015 - 21:07 | 5718331 Radical Marijuana
Radical Marijuana's picture

Indeed, anonn, there is

NO sane "bedrock" ...

When one can NOT find any sane "bedrock, beware that continuing on that path invites chaos and the spin-bin."

Wed, 01/28/2015 - 16:15 | 5717153 a common man
a common man's picture

Thank you the kind well articulated response. I am not knowledgable enough about the the balance of world trade enough to be confident that true supply and demand exists, ( I need to now read the next comment below yours). I make my comment about a weaker dollar as an accountant who sees the nation that the  world reserve curency is based upon as being insolvent. When other countries are insolvent, has not their currency declined in value. It may just be a matter of time until the day of reckoning comes.

Wed, 01/28/2015 - 16:30 | 5717204 Radical Marijuana
Radical Marijuana's picture

"It may just be a matter of time until the day of reckoning comes."

WHEN is the 64 to the nth power question!

There has never before been globalized systems of electronic monkey money frauds, backed by the threat of force from apes with atomic bombs. Being able to credibly back up that much fraud with that much force has driven the development of a sort of virtual financial world which has become orders of magnitude BIGGER than the flesh and blood people, and their physical lives, inside of the physical economy.

Most of the "trading" now gets done by computers, happening way faster than human beings can imagine. I believe that the people who originally made and maintained the established systems are no longer able to fully comprehend what those systems have become, and therefore, there is nobody in control anymore ...

Somewhere, buried deep, deep, deep, under all the layers of enforced frauds, there is some relatively more objective realities. However, since social realities are almost totally based on being able to back up lies with violence, which have been pumped up and UP by progress in science and technology, the MAGNITUDE of that has gone beyond human comprehension!

I do not believe anybody could precisely predict the future ... although I still believe that there will continue to be one precise future ...

P.S.

As a metaphor for that, I liked this little video:

http://www.youtube.com/watch?v=wvcGM6maGGk

Exploding iceberg in Antarctica!

Wed, 01/28/2015 - 10:27 | 5715503 Tall Tom
Tall Tom's picture

Certainly, the idea of the central bank repaying its debt is absurd. By law, payment is deemed made when the debtor pays in currency—i.e. francs in Switzerland. However, the franc is the very liability of the SNB that we’re discussing. How can the SNB pay off its franc liabilities using its own franc liabilities as means of payment?

 

On other terms, perhaps more understandable for you, is how can the SNB pay off its franc liabilities (promises to pay) using its own franc liabilities (promises to pay) as means of payment?

 

You just cannot continue to promise to pay. What are you promising to pay with? Another promise?

 

The genie is out of the bottle as the Banking System begins to implode. Anyone whom is not blind can see how ludicrous this is. It is actually laughable.

 

Try that with any of your creditors, like the Bank that owns your Home Mortgage, and see how quickly you will end up on the street.

 

I cannot pay you today but I promise...next week...I promise...I really do promise...I swear I promise...What? You don't believe my promises anymore?

 

LMFAO.

 

Well neither do the Bondholders of the SNB when they are taking it up the ass with negative interest.

 

Is that clear to you now?

 

Wait until it happens in the USA, the Last Domino. Mistakenly believe that it will not and you will be one of the bozos whom will end up homeless on the streets. That will be a promise that you can take to the bank....most likely with a Pitchfork in hand.

Mon, 02/02/2015 - 20:32 | 5737044 TheRedScourge
TheRedScourge's picture

These central banks are all in bed with the treasury departments of their respective governments. They make money on the spread between real inflation and interest rates, robbing everyone's purchasing power, and when rates are negative, they are paid to borrow, which is even better for them.

They can evaporate any sort of QE they do by merely holding their own bonds until maturity and optionally roll them over until infinity, which prevents them from caring about the fact that bond coupons decrease as rates drop, they will pocket the premium, and then return all the profit to their respective government treasury departments. The fact that money can't come from nowhere will simply be resolved through rising inflation. So long as they do not rack up debt too fast, people will stop caring about the debt after they predict its rise leading to a collapse and that collapse never coming, so they will discover that they can rack up infinite debt, and this will only be moderately inflationary. It is a ponzi scheme, sure, but the thing about ponzi schemes is they only collapse when the rate they promise is far higher than they're actually able to yield, and these are the most sophisticated ponzi schemes in world history, with infinity billion dollar loan guarantees from their citizens.

The only way things will come crashing down is on a derivatives unwind, where they suddenly find that they have made too many promises to bail out private industry, whereupon they will realize that the citizens do not have enough money to soak up the derivative losses. This is what almost happened in 2008, but it was small enough for them to delay that time. There will not likely be widespread currency collapse, they will simply destroy everyone else's wealth first, via various defaults, including various pension funds. The governments have the most to gain from such a collapse, because as the biggest debtors in the world, their debts will be wiped out when everyone goes back to zero. Fortunately, gold, silver, real assets, and resource stocks are a good investment anyway, hyperinflation or not, because all this chaos will bid up their prices when the collapse comes. The only downside risk to owning these things is that if the collapse does not come quickly, governments will come knocking to find a way to confiscate these assets to bail themselves out with, and if collapse comes quick, people will come knocking to see what they can loot off others as they become desperate. So don't forget to invest in some weapons and ammo too.

Wed, 01/28/2015 - 11:02 | 5715647 SWRichmond
SWRichmond's picture

You just cannot continue to promise to pay. What are you promising to pay with? Another promise?

You cannot hedge debt risk by owning more debt

- Antal Fekete

Wed, 01/28/2015 - 16:56 | 5717327 Ghordius
Ghordius's picture

OK, for Tall Tom and all the others

first, a CB can always count on it's FX reserves. If it has issues with it's balance sheet, it can devalue it's currency versus the others, making it's FX reserves higher... which are an asset

but le't say it goes badly even there

fine. there comes the very last anchor a modern central bank - assuming it does not ask for a re-capitalization, something the SNB could do easily, either over the federal government or the semi-sovereigns or their state banks, or on the market (the SNB's shares are traded) - is... gold

take your balance sheet. look it hard. how much liabilities are there? = X how much gold is there? = Y

ok, send out the sms to the press: my currency is now worth Y / X. this central bank will buy unlimited amounts of gold for that price-1% and will buy unlimited amounts of currency for gold at that price+1%

what do you have now? a fully gold backed currency. now factor in that even 30%-35% would be enough... here is the reason why central banks can't go broke, only become impotent because without ammo, i.e. FX and gold

Thu, 01/29/2015 - 09:02 | 5719255 Tall Tom
Tall Tom's picture

So in other words the banks will act to save themselves and Gold is the answer?

 

I cannot agree more. Buy Gold.

Thu, 01/29/2015 - 11:23 | 5719848 Theosebes Goodfellow
Theosebes Goodfellow's picture

~"So in other words the banks will act to save themselves and Gold is the answer?"~

Not just any banks, but central government banks. That's what ZIRP was all about. Buying gold is a great part of personal wealth protection, but gold bonds, (or should I say conversion of existing debt to physical gold-backed bonds, (along with not allowing any more debt-currency to be created), is the solution Kieth proposes.

The other question relevant to this is: "Will gold-bonds save the economies of the world?" My best answer is "I don't know." But its the only answer I've seen being put forth that is actually based in reality. I'm guessing that the Chinese have figured this out and are buying as much phyz as they can get their hands on for the day all nations will have to "put up or shut up" by backing all of their existing debt (currency) in gold. I reckon that is the day we get to find out exactly what's in Fort Knox, because that's the day its contents will have to represent over $18 Trillion. As the man above says, (er..., Kieth, not God), there will be a day of reckoning, and from his, (and many others'), point of view, that day ain't that far off.

Thu, 01/29/2015 - 02:47 | 5719004 Theosebes Goodfellow
Theosebes Goodfellow's picture

~"A small decline in prices across all asset classes would wipe out the financial system."~

Kieth Wiener is the smartest man in any room. Here's what he's not telling you that you should deduce on your own. This Swiss Franc Collapse is coming to a currency near you. When the CHF goes, so goes the Euro, the Yen and the Dollars, (Oz, Loonie and US). The Pound, the Yuan, the Ruble, (it's rubble already, isn't it?), all toast. The margin needed to make this happen is frightenly thin.

Wiener thinks that we can avoid the worst of what is coming by converting the debt to gold bonds. That will still cause a beating but it would avoid the worse one we would get from not implementing them. It's still "screwed if we do and screwed if we don't", except the one where we move to gold bonds eventually returns us to a) debt retirement and b) sound currencies.

Wed, 01/28/2015 - 11:15 | 5715696 Ghordius
Ghordius's picture

I have the impression that both Tall Tom and you don't understand the dynamics of central banks and FX reserves

Wed, 01/28/2015 - 13:29 | 5716370 Tall Tom
Tall Tom's picture

All Fx Reserves are backed by promises to pay, Ghordius.

 

But what is it a promise to pay, Ghordius?

 

Some other Nation's debt if the reserves are held in Foreign Fiat? 

 

The problem which we face is that this charade becomes all too apparent when policies of NIRP are adopted.

 

Are you in the market for liabilities, Ghordius? Or are you in the market for productive assets? If you are in the market for liabilities and negative cash flow then your own financial destruction is assured.

 

Sooner or later even the Bankers will have to ask themselves this same question. And they will act to save themselves.

 

You can put lipstick on this pig, Ghordius, but in the end it is still a pig.

 

You can deny the sordid reality all that you desire but the reality, the truth, will be revealed to its bitter end.

 

But the bankers will not.

 

And when that happens, Ghordius, the entire Ponzi Scheme of Debts collapse as a House of Cards, the result of a Currency War that is just a race to the bottom.

 

So please tell me what I do not understand about Foreign Capital Reserves. Adding another layer of stench to the onion just makes it a more odiferous onion..

Wed, 01/28/2015 - 16:17 | 5717159 Ghordius
Ghordius's picture

SNB has gold

Wed, 01/28/2015 - 14:24 | 5716583 jeff montanye
jeff montanye's picture

seems to me the historical problems of central banks were when gold, which they couldn't create at will, was involved.  of course countries owing debt denominated in another currency have a similar problem.  

but those owing their national currency, imo, don't have a problem until interest rates rise.  how can negative interest rates be a problem as far as raising more funds by issuing more debt?  i truly don't get this thrust of the article.  there are ancillary problems: asset price bubbles, wealth disparities, etc. which can be very pernicious, but the refunding problem doesn't surface, imo, until rates rise.

imo one cannot "adopt" a negative interest rate policy.  the rate must clear the market unless all sovereign debt is purchased by the central bank, which seems unsustainable.

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