Guest Post: The Global Economy - It's All About Increasing Leverage

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Global Economy - It's All About Increasing Leverage

If the global State/finance Empire can't increase systemic leverage, it will implode.

If we look at the global economy with unclouded eyes, we reach this conclusion: "This whole thing is about leverage." If leverage doesn't increase, the system implodes. But since collateral is disappearing from the global economy like sand castles in a rising tide, and disposable income has stagnated, there is no foundation for more leverage.

As a result, the State/finance cartel has only one choice: increase leverage by whatever means are left. There are only two:

1. Allow banks to claim phantom assets as capital/reserves

2. Lower interest rates so stagnant income can leverage ever greater quantities of debt

The State/finance Empire and its army of academic toadies (economists) must cloak this reliance on leverage from the citizenry, lest they grasp the precariousness of the entire financial system. As the economic Establishment is discredited by reality (that their sputtering reflation policies have come at an unbearable cost is now undeniable), their attempts to discredit their critics become increasingly comic: only PhD economists in the employ of the Empire are qualified to comment on the Empire's policies, etc.

Most discussions of leverage focus on the role of capital or reserves as the basis for leverage. This is the basis of the fractional reserve banking system: $1 in capital (cash, reserves) can be leveraged into $15 of debt.

The easiest way to "grow" is to increase leverage so more money/debt can be created. If a bank was constrained to only loaning the cash it held in deposits, that would severely limit the amount of money available in the system for purchasing villas in Spain, BMW autos manufactured in Germany, etc.

If we magically enable 25-to-1 leverage, then every euro supports 25 euros in debt (mortgages, auto loans, etc.)

The danger is obvious: if 1 of the 25 euros of debt goes bad, the lender has zero reserve. If 2 euros of debt go bad, the lender is insolvent.

The only way to "save" an over-leveraged system is to increase leverage and lower interest rates. If we claim phantom assets as real and increase leverage from 25-to-1 to 50-to-1, we have enabled a doubling of loans. All that wondferful new money will flow into the economy as spending, fueling "growth."

This explains why the State/finance Empire in Europe keeps lowering reserve requirements for its insolvent banks. If the reserve requirement is 10%, then you need 100 million euros on deposit in cash to support 1 billion euros in loans. If you lower the reserve requirement to 1 euro, then the contents of a child's piggy bank supports 1 billion euros in debt.

The other game is to claim phantom assets have market values that justify their substitution of cash. Let's say a bank owns a villa in Spain since the mortgage went bust. The market value of the villa is 100,000 euros and the bank's mortgage was 300,000 euros. If the bank sold the villa, it would have to absorb a 200,000 euro loss.

Yikes. Absorbing losses that exceed the net increase in reserves from profits would lead to the lender's insolvency being recognized. The "work-around" is to keep the villa on the books at 500,000 euros. Not only does the 200,000 euro loss go away, the bank now has 200,000 in capital to leverage into more debt. (500,000 in assets minus 300,000 in mortgage leaves 200,000 in phantom assets/capital.)

Any loan is fundamentally a claim on future income. Interest and principal will be paid out of future income.

They key to keeping the leverage-based system afloat is to lower interest rates. Let's say a household has $10,000 in disposable income to spend on housing. If mortgage interest rates are 15% (as they were in 1981), the household can only leverage that income into a $50,000 mortgage. that's all the debt that can be prudently leveraged from the $10,000 in income.

That inhibits "growth," so let's drop the rate to 1%. Presto-magico, the household now "qualifies" for a $500,000 mortgage. Wasn't that easy?

You see the problem here: once rates fall to near-zero, the leverage-income-into-more-debt machine runs off the cliff. Just in case you missed this chart from yesterday's entry Election Year 2012: two Landslides in the Making?, notice that the incomes of 90% of American households has gone nowhere for the past 40 years.

Unsurprisingly, the bottom 90% leveraged their stagnant incomes into mountains of debt to compensate for their declining purchasing power. The Federal Reserve (a key player in the global State/finance Empire) has been publicly fretting over the dreaded "debt divide," which is Orwellian econo-speak for the bottom 90% running out of leverage. Like Wiley E. Coyote, the bottom 90% has run off the cliff and is now in looking down at the air beneath them. (This chart shows the bottom 95% is in trouble.)

The same reliance on leverage has occurred in China, Japan, Europe and the U.S. The entire global economy's "growth" was based on increasing leverage. That machine has soared off the cliff, and now the Empire's global army of toadies is desperately attempting to mask this reality by substituting phantom assets for actual capital.

They can't do anything about lowering interest rates, though; that mechanism has already been maxed out as rates approach zero.

Longtime correspondent Harun I. recently described the leverage endgame in this deeply insightful commentary:

Much has been made over the Fed's efforts to "stimulate", however, IMHO the Fed's efforts are more concerned with preventing the sudden death of the monetary and banking systems. With private sector balance sheets hobbled, some entity must step in and create enough debt so that debts can be paid and, therefore, maintain the illusion that there is money (debt) in the system. At first this must seem contradictory. Remember there is no collateral, there is no asset. Therefore, the debt, which people will claim as an asset (at par (to what?)), is in reality an illusion.


It must be understood that leverage is such that even if there were no defaults, just normal everyday retirement of debt occurring at a rate faster than debt creation would cause the complete monetary base to disappear in short order. With $600 trillion or more in derivatives alone, that must be settled in the reserve currency with a monetary base of $2 trillion, there is 300,000 to 1 leverage. The fact is, leverage must continue to increase exponentially to avoid sudden death. Phase and jitter cannot be tolerated.


The idea of stimulating the economy at this point poses certain problems. One of my neighbors, a family of six, noted that their food bill had increased 50%. This presents the choices of consume less or save less. Cutting back on food is usually not the first thing people will resort to. So, as costs rise, they are consuming less, which is the opposite of stimulative.


Further, this creates trends that will likely be insurmountable in the future. The amount saved by this generation and the returns they must achieve to reach the goal of an independent retirement become more negatively skewed with each passing month of currency/labor debasement (notice I did not use the term "stagflation"). If there was no price inflation there would be no problem but prices are rising relative to wages, meaning dollars/labor is losing value, which, regardless of definitions, has the same effect as inflation.


Since time can not be manipulated, people must save more (which the Fed is fighting) or they must receive higher returns, which usually means assuming greater risk. Frankly, the situation works out that this generation would need the performance of the top money managers today to achieve a non-subsidized retirement.


Having allowed themselves to be misled about the true nature of housing as an investment, and with most throwing their money in some vehicle resembling a 401K while hoping for something good to happen, Boomers will have their challenges but the next generation, saddled with significant student loan debt and the debts of the previous generation, also facing, "The End of Work" will be even more challenged to retire with any semblance of simple dignity.


Of course, I don't think it gets this far. As I have stated, the system is now terminal. It is only a matter of time before, even without any defaults, the two factors of amplitude and frequency overwhelm system capacity in terms of money printing. I differentiate because productive capacity, which is the only reason for an exchange medium (the existence of money), has already been overwhelmed by the exponential phenomenon. Money now exists for the sake of itself, which is to say that it is worthless. As Einstein pointed out, "reality is merely an illusion, albeit a very persistent one."

Thank you, Harun. After four long years of protecting vested interests at the expense of everyone else and playing "stimulus and backstop" games, the State/finance Empire's Wily E. Coyote moment is finally approaching. Maybe they manage a few more extend-and-pretend mind-tricks (because we all want to believe the magic trick is real) and push the reckoning into 2013; we'll just have to see how long Wiley E. Coyote can run in mid-air.


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BaBaBouy's picture

PURE Gambling and taking down the middle class ...

sosoome's picture

All our debt are belong to you.

Precious's picture

This is way over the head of anyone in the current US administration.  Leverage?  Collateral? 

Snakeeyes's picture

Austrian economists warned about debt bubbles and how you can't recover from them easily. Thank Clinton for putting the debt bubble in place.

kridkrid's picture

Yes... this all started with Clinton... Come on, man!

sgt_doom's picture

This blog poster guy really has a gift for occasionally stating the obvious:  next he'll be explaining how the Federal Reserve is all about the creation of national bubbles?

Thomas's picture

It's not just Clinton. Society at large bought a scam and sailed off the cliff all holding hands. 

Here's a stat for you: a five percentile net worther ($1.2 million) has enough saved to spin off less than the median family income ($47K) from that savings. It tells me the top 5 percentile is totally hosed. I infer that others are hosed as well.

sgt_doom's picture

You're absolutely right:  it's always society's fault.

After all, I was the one responsible for taking David Rockefeller's call to appoint Paul Volcker at the Fed.

Yes, I signed that Telecommunications Act of 1996, the Gramm-Leach-Bliley Act of 1999, and the Commodity Futures Modernization Act of 2000.

Lordy yes, I was the guy behind the Private Securities Litigation Reform Act of 1995.

Truly, it was me, not JPMorgan Chase's Blyth Masters who devised that dastardly Credit Default Swap.

And yes, it was really and truly me who signed that Executive Order #12615 to authorize the creation of the Office of Privatization, not President Reagan as some may have been led to believe.

I, and I alone am responsible for the World Domination Society's coming into existence!

I hope that's enough faux culpability for you, Lackey Thomas?

gorillaonyourback's picture

Hey dumbass your ignorance is showing, those puppets you vote for have the same master

sgt_doom's picture

Thanx, my brother gorillaonyourback.

Sheer Insanity

You can’t support the Fascisti and not expect Fascism!

We have to categorically state that there is no qualitative difference between FoxFiction, CNN, NPR and Amy Goodman’s Democracy Now! --- none will ever address the real issues --- it’s always political theater!

We still have to battle on voting rights because those who fought for it once, allowed themselves to either be overshadowed by the Fascisti, or to now support them.

Please don’t mention to us the name of Andrew Young, who once took bribes from the BCCI, and worked for them as a consultant, and is now a member of the lobbyist group for the international super-rich, the Bretton Woods Committee (

Please don’t mention to us the names of Rep. Conyers or Charlie Rangel; we recall meeting with them many, many years ago, when the Black Congressional Caucus was bribed (received heavy donations) to create and successfully lobby for the passage of the legislation which removed defense-related jobs from the prohibition list --- thereby allowing them to be offshored with the affiliated tax breaks for shipping those jobs out of the country, along with a chunk of the GDP.

In the present, the disingenuous Joe Biden, just prior to a national tour for campaign contributions, goes public with a positive pronouncement for Gay marriage, thus “causing” President Obama to do likewise --- and their contributions rose considerably as a result.

Simpleton Gaytards are ecstatic --- ignoring the fascist record of the Obama administration on due process, habeas corpus, and their Gestapo raids for preemptive arrests of activists.

Ignoring the Obama administration’s financial support in the overthrow of the democratically-elected Honduran government; ignoring their tacit support for the Saudi military incursion into Bahrain to shoot the protesters there; ignoring the abomination of the Obama administration’s war on whistleblowers and obscene use of the Espionage Act in the subversion of democracy.

Support the Fascisti, and you have fascism!

Today Wall Street presents the electorate with the usual fascisti choices:  Barack Obama and Mitt Romney, assuring the continuation of the fascistic march to neoserfdom oblivion.

Only the most ignorant, the most simpleton, the most morally lazy, would embrace either of those depraved characters!

Highly paid propaganda specialists proclaim that America has made much progress as the latest Wall Street stooge in the presidency is only half-white instead of all-white, much like one retail brand claims to smell better than its competitor.

Negative!  It stinks to those of us who refuse to support the Fascisti!

All politics have been reduced to one part branding giveaways to Wall Street (cap-and-trade for the oil companies and banks) as a positive for the public welfare or the environment, with the other side attacking it for nonsensical reasons (not the obvious and truthful ones).

Wall Street will now enjoy their second-tier bailout in the guise of a health insurance bill which ensures a one-half trillion dollar money flow --- but does nothing to increase access nor decrease costs, with the staged legal battle to ensure the Supreme Court’s decision to set the legal precedent for the privatization of taxation.

Vile cretins, claiming to be democrats and progressives, seek donations for ever more giveaways to Wall Street!

Democracy has long been lost --- the Fascisti have long since won.

The treason of the people is moot.


LowProfile's picture

I noticed that several months ago a bunch of accounts which had lain dormant for about a year became active.  This could be one...

Goobermint bot-troll or not, it warms my cockles to see ZHr's routinely slapping down their partisan twaddle!

midgetrannyporn's picture

wile e coyote has balloons filled with vaporized dreams of the former middle class.

Cognitive Dissonance's picture

"If the global State/finance Empire can't increase systemic leverage, it will implode."

The statement above is the perfect explanation for chemical addiction as well. Either you increase (leverage) the amount of drug intake to maintain equilibrium or you implode and withdraw.........or die depending upon how far along the addiction curve you are.

And those who are not the actual addict, such as family, friends, co-workers etc are also directly affected by the addict's behavior and in so many ways seen and unseen have become co-dependent.

There are no innocent bystanders when it comes to addiction, only co-dependent survivors. The same can be said for fiat currencies and the impulse to inflate and debase.

holdbuysell's picture

On the subject of leverage, Michael Pento was recently on KWN where he described what he thought was coming:

1) BASEL eliminates capital reserve requirements for holding sovereign debt

2) Bernanke cuts the interest rate on excess reserves (~$1.5T) from 25bp to 0

3) Banks, now incentivized to do something with excess reserves, through fractional reserve lending, make loans to sovereigns (~$15T)


valkyrie99's picture

This seems like a fairly likely possibility based on historical reactions to the running out of available assets to leverage problem.  However it's worth pointing out that every time an asset is added to what can be considered reserves, there is a diminishing return as far as the length of time ‘stable’ growth can be expected as the need for new assets to maintain the ponzi increases exponentially. So what do they do next year?

falak pema's picture

emperor has no clothes but lots of bath bubbles all over his naked skin; blown by the Fed and other PHDs in economics of debt serfdom. Just wait for the wind to write its own tale on exposing that imperial tail, when it starts to blow those bubbles away. Tornado country on the horizon! 

Carl LaFong's picture

Basel III will do both #1 and #2 by elimination of reserve requirements for holding sovereign paper and thereby increasing excess reserves from 1.4 trillion "magically" (fractionally) to $15 trillion. Get ready for unlimited government spending around the globe.  The inflationary results will be staggering. 

LawsofPhysics's picture

Why not simply tell the truth  which is, the capital and resource mis-allocation and mal-investment continues.  Nothing changes until the bad debt is cleared, and real consequences for bad behavior returns AT ALL LEVELS.

Until then, hold/watch your physical assets closely, especially those that generate revenue.

ZIRP and NIRP have killled the free market as there is always a very real cost for capital creation (no matter what some fucknut nobel prize winner tells you).

Raymond K Hessel's picture

Most of us are not rich enough to follow Casey to South America.

What are WE going to do about all this?

JohnG's picture

Either buy land or retire your mortgage (if you have one) and learn to grow your own food.

TruthInSunshine's picture

Damn it feels to be one who gets to feed off the Ponzi Scheme that is the world's debt-based monetary system, where debt can be created/issued in infinite amounts at zero cost by the fractional reserve central banks (at behest of their owners), and people and businesses must use this monetary system (taking on debt to conduct commerce and basic transactions) by force of law, and the debt that was created and issued at zero cost to they who make "the loan" can be used to seize real assets having inherent value.

Why doesn't everyone see that the global economic system based on fractional reserve banking and zero cost basis "money"/debt creation using full fiat notes, is the fundamental essence of a Ponzi?

LEVERAGE simply allows the harvesting to happen on an accelerated basis and at more frequent intervals (i.e. ramps up the boom-bust cycles).


The 7 easy steps to controlling the world without doing any honest physical or mental labor (let's call it- oh, I don't know -The Red Shield Method):


  1. Buy off/bribe/blackmail/extort/destroy any lawmaker/politician/military officer who poses a risk of thwarting your plans. For those who doubt the feasability of this, or its relevance to current times, please refer to your course materials and the historical record regarding the events surrounding the meetings held by dominant global banking interests on Jekyll Island, off the Georgia Coast, in 1910.   *Very important first step.
  2. Create fiat from thin air at zero cost basis, using nothing more than a literal stroke of a key, that's backed by nothing of inherent value, that has nation-state enforced legal recognition (due to that which is stated in #1 above), and in fact, is a monopoly currency with no legally recognized alternative in the payment of debt, both public and private.
  3. Circulate such fiat via "loaning it out" (which is an oxymoron amongst oxymorons), charging interest upon it, and dramatically increase the volume of fiat/debt created in step 2 by many, many multiples, via the use of leverage (whether by allowing the mule banks to have articicially low capital requirements, or purposefully not regulating credit derivatives, or via a plethora of other mechanisms).
  4. Successfully get nations (war is a fantastic motivator to borrow), business entities and individuals (the need for food, energy, health care, security, etc. are great motivators) to borrow said worthless fiat that was conjured from thin air, and pay interest, pledging their real, inherently valuable assets in exchange for said worthless fiat (i.e. meaning that their real, inherently valuable assets can be taken if the conditions that make it impossible for them to repay the worthless fiat are [intentionally] induced).
  5. Set the rate of interest payable on the loans of fiat that was conjured from thin air, solely at their discretion (don't be Krugman-level disingenuous and proclaim anything remotely close to 'free market mechanisms' set these rates, especially at a time when the Bernank has just purchased [using fiat-debt conjured from thin air, so no skin of the Fed's nose] a massive chunk, roughly equaly to 60%+ of U.S. deficit spending- i.e. monetization- of U.S. Treasury Notes for about a 28 month period).
  6. Supply more of such fiat, or withdraw fiat, to/from the system, at their discretion, bringing about inflation or deflation.
  7. During times of large scale loan defaults, on the repayment of the fiat that they conjured from thin air, backed by nothing of inherent value, seize the most valuable assets that exist on the planet, many of which mankind depends on for its very survival.


Here is this week's homework assignment for any college student (or anyone else, for that matter) who was victimized as a result of the Bernank's recent public propoganda tour, which was done for the alleged purpose of casting light on the operations of the Non-Federal Reserve-less Bank, wherein Bernank played the role of a contortionist, but really merely attempted to create an illusion, where he tried to convince as many in the audience that he squeezed through the eye of a needle:

Write an essay answering these 3 questions:

  1. What is money?
  2. How is money created?
  3. Can money be destroyed, and if so, how?


You may use any references, materials or sources of information you wish, including, but not limited to, MODERN MONEY MECHANICS (I don't want to be accused of being biased against or in any manner unfair to the esteemed Federal Reserve 'Bank').

Coke and Hookers's picture

You forgot one step - the first one actually: "Encourage the gutting of manufacturing through outsourcing with the help of (unilateral) free trade treaties to push wealth creation below current level of consumption. That will create incentive for politicians to falsify the economy with fiat. Instead of having to bribe politicians you will be doing them a favor with your ponzi scheme because it keeps them in power."

valkyrie99's picture

To be fair, I would call your point something that happened much later in  the equation - we see the first emergences of the steps listed above in the 1300's and this becoming the major pattern of finance by the 1600's.  During those times the financial elite extracted raw resources from poor nations but manufactured finished good in there developed home countries generally - due to a combination of higher costs associated with transport of value added goods, lower relative labor costs at home then today, and a national loyalty among the elite of the day that has mostly diminished - at the time an English businessman would prefer to do most of his business with other elite Englishmen at home, or at least with elites from other Anglo-Saxon nations, whereas today the elite from around the globe have more in common and alliance to each other then their countrymen of lesser means. The exporting of manufacturing has only emerged in force in the last several decades, instead of the last several centuries - before this time we saw a transfer of wealth from poor nations to rich expecially the elite, now it's from all other classes at home and everywhere to the elite.

Bicycle Repairman's picture

When the markets no longer serve the state, the markets will be ended.  Prepare accordingly.

_ConanTheLibertarian_'s picture

Hey MDB, it's all the libertarians's fault is it?


crawldaddy's picture

time for some new schoolhouse rock


deflation flation whats your function? fucking up lives annnd entire nations..

Youri Carma's picture

As I said many years ago:


We just past the inflation fase and are in the deflation fase now. For people who have doubts about the first inflation fase scroll trough this post

‘Inflation=Money Printing’ – No it’s not! Cause it can be off-sett by toxic derivative black holes and there is the other factor of ‘Money Velocity’. But not everywhere around the globe you have these black hole pitts and there it is inflation is (and has) pop(ped) up like in China and India.

Altough I have to admit that ‘Money devaluation’ is felt like inflation in many countries. But that doesn’t matter cause for the people this results in Inflation also on the mainstream way of signalling inflation trough higher prices in a country.

ddtuttle's picture

It's worth noting that Steve Keen has identified the acceleration of debt as the driver of growth.  Increasing debt seems to be necessary to keep us from imploding, accelerarting debt is needed to create "growth".  This is all so totally perverse!  The tumor is now bigger than the patient.