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Listen to the Prophet: The Next Financial Crisis will be Hellish…and it’s on its Way

Occupy Wall Street - Oakland, CA
Occupy Wall Street – Oakland, CA

“There is definitely going to be another financial crisis around the corner,” says hedge fund legend Mark Mobius, “because we haven’t solved any of the things that caused the previous crisis.”

We’re raising our alert status for the next financial crisis. We already raised it last week after spreads on U.S. credit default swaps started blowing out. We raised it again after seeing the remarks of Mr. Mobius, chief of the $50 billion emerging markets desk at Templeton Asset Management.

Speaking in Tokyo, he pointed to derivatives, the financial hairball of futures, options, and swaps in which nearly all the world’s major banks are tangled up.

Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius’ guess of 10 times the world’s annual GDP. “Are the derivatives regulated?” asks Mobius. “No. Are you still getting growth in derivatives? Yes.”

In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.

What could it be? We’ll offer up a good guess, one the market is discounting.

Seldom does a stock index rise so much, for so little reason, as the Dow did on the open Tuesday morning: 115 Dow points on a rumor that Greece is going to get a second bailout.

Let’s step back for a moment: The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn’t pay back 100 centimes on the euro?

That’s a rhetorical question, since the balance sheets of European banks are even more opaque than American ones. Whatever the actual answer, it’s scary enough that the European Central Bank has refused to entertain any talk about the holders of Greek sovereign debt taking a haircut, even in the form of Greece stretching out its payments.

That was the preferred solution among German leaders. But it seems the ECB is about to get its way. Greece will likely get another bailout — 30 billion euros on top of the 110 billion euro bailout it got a year ago.

It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.

And what of the derivatives sitting on the balance sheet of the Federal Reserve? Here’s another factor behind our heightened state of alert.

“Through quantitative easing efforts alone,” says Euro Pacific Capital’s Michael Pento, “Ben Bernanke has added $1.8 trillion of longer-term GSE debt and mortgage-backed securities (MBS).”

Think about that for a moment. The Fed’s entire balance sheet totaled around $800 billion before the 2008 crash, nearly all of it Treasuries. Now the Fed holds more than double that amount in mortgage derivatives alone, junk that the banks needed to clear off their own balance sheets.

“As the size of the Fed’s balance sheet ballooned,” continues Mr. Pento, “the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.

“Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out.”

Mr. Pento’s and Mr. Mobius’ views line up with our own, which we laid out during interviews on our trip to China this month.

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U.S. Dollar Is The Next Financial Shoe To Drop

Obverse of the Series 2006 $20 bill
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There are a lot of headlines lately about the debt issues in the United States (not to mention Europe and Japan). But what does this issue mean for the investor? It appears that the whole system of fiat currencies is being challenged. In other words, the real issue here is how long will the Dollar (and Euro and Yen) remain viable currencies?

A little historical background is useful. By definition, fiat currency only has value because of government regulation or law; it is not convertible into anything, like silver or gold, and is declared as legal tender by the issuing country. When citizens and foreigners lose faith in a fiat currency, the value can turn to the price of confetti. In the case of the United States, the term “not worth a continental dollar” originated during the Revolutionary War when the U.S. Continental (a fiat currency) fell badly in value and, by 1780 was worth 1/40th of face value, and by May 1781 was so worthless it ceased to circulate as money. Their fall was blamed on too many bills being printed and counterfeits circulated by the British waging economic warfare. The founding fathers of the United States were very aware of the problems with fiat currency. To prevent runaway inflation from happening again, they included in Section 10 of the United States Constitution the statement that states could not “emit Bills of Credit” and “make any Thing but gold and silver Coin a Tender in Payment of Debts.” At first they included language allowing the federal government to print money, but this was later stricken from the final version. Yes, the founding fathers did not give the federal government of the United States the explicit constitutional right to print fiat currency. Jumping forward to the modern era, rising deficits during the Johnson and Nixon administrations led to a run on the dollar in the late 1960s when foreign holders sought to convert their paper dollars to gold before the U.S. vaults became empty. Facing complete loss of the nation’s gold, Nixon took the U.S. dollar off the gold standard in 1971, defaulting on the U.S promise for countries to redeem their dollars for gold. This event made the U.S. dollar a fiat currency.

Since then, the U.S. money supply has exploded in size. By 2005, it had expanded 13 fold (for perspective, over the prior 34 year time period from 1937 to 1971 it only doubled). Such a rapid monetary expansion can lead to hyperinflation, but the U.S managed to avoid this problem because the dollar is the world’s reserve currency. This has forced the world to buy and hold dollars. But reserve status is a privilege, not a right, and while substitution would be difficult, there are increasing calls around the world to remove the dollar’s reserve status. Recent commentary by the official Xinhua news agency of China questioned whether the U.S. dollar should continue to be the global reserve currency. “International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country,” the commentary said.

Loss of reserve status would be catastrophic for the value of the dollar. Foreigners would rush to get out of dollars, either by outright currency conversion or by bidding up the value of U.S. goods as they rushed to unload their dollar holdings. The exact impact is hard to calculate, but according to Peter Schiff of Euro Pacific Capital, the dollar could devalue by more than 70%. And this devaluation may be anticipated in the financial markets judging by the price action in gold and Swiss Francs.

The United States is in a bad financial situation where spending as a percent of GDP is above 25% and U.S. federal receipts as a percent of GDP is below 15% (Robert V. Green derived these figures from NBER, CBO, and White House data and published them at Briefing.com); never since World War II has the difference between these numbers been so large. The sad reality is the United States, in political gridlock, has lost control of its financial well being and the government’s cash flow now depends largely on the willingness of the Chinese government to buy its new Treasury debt.

The Chinese buy our debt because U.S. Treasuries have a deep liquidity pool unequaled by other places the Chinese can invest there excess cash. When the Chinese buy our debt, they also deflate the value of their currency with the view that a weaker Chinese currency helps their country by reducing the cost of their exported goods. While it is easy to argue that such a policy helps Chinese exports, the policy stunts domestic Chinese consumption by reducing domestic spending power with the overall effect of lowering China’s standard of living. By buying the U.S debt, China is essentially funding the U.S. consumer at the expense of the Chinese consumer. But the Chinese, as they lose confidence in the U.S. dollar, will find other places to invest their money.

In the end, the history of highly indebted nations that rely on overseas creditors is not good. My advice is it is far better to be early getting out of U.S dollars than late.

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Where to Go During an Earthquake

Remember that stuff about hiding under a table or standing in a doorway? Well, forget it! This is a real eye opener. It could save your life someday.

EXTRACT FROM DOUG COPP’S ARTICLE ON ‘THE TRIANGLE OF LIFE’

My name is Doug Copp. I am the Rescue Chief and Disaster Manager of the American Rescue Team International (ARTI ), the world’s most experienced rescue team. The information in this article will save lives in an earthquake.

I have crawled inside 875 collapsed buildings, worked with rescue teams from 60 countries, founded rescue teams in several countries, and I am a member of many rescue teams from many countries. I was the United Nations expert in Disaster Mitigation for two years, and have worked at every major disaster in the world since 1985, except for simultaneous disasters.

The first building I ever crawled inside of was a school in Mexico City during the 1985 earthquake. Every child was under its desk. Every child was crushed to the thickness of their bones. They could have survived by lying down next to their desks in the aisles. It was obscene — unnecessary.

Simply stated, when buildings collapse, the weight of the ceilings falling upon the objects or furniture inside crushes these objects, leaving a space or void next to them – NOT under them. This space is what I call the ‘triangle of life’. The larger the object, the stronger, the less it will compact. The less the object compacts, the larger the void, the greater the probability that the person who is using this void for safety will not be injured. The next time you watch collapsed buildings, on television, count the ‘triangles’ you see formed. They are everywhere. It is the most common shape, you will see, in a collapsed building.

TIPS FOR EARTHQUAKE SAFETY

1) Most everyone who simply ‘ducks and covers’ when building collapse are crushed to death. People who get under objects, like desks or cars, are crushed.

2) Cats, dogs and babies often naturally curl up in the fetal position. You should too in an earthquake. It is a natural safety/survival instinct. You can survive in a smaller void. Get next to an object, next to a sofa, next to a bed, next to a large bulky object that will compress slightly but leave a void next to it.

3) Wooden buildings are the safest type of construction to be in during an earthquake. Wood is flexible and moves with the force of the earthquake. If the wooden building does collapse, large survival voids are created. Also, the wooden building has less concentrated, crushing weight. Brick buildings will break into individual bricks. Bricks will cause many injuries but less squashed bodies than concrete slabs.

4) If you are in bed during the night and an earthquake occurs, simply roll off the bed. A safe void will exist around the bed. Hotels can achieve a much greater survival rate in earthquakes, simply by posting a sign on the back of the door of every room telling occupants to lie down on the floor, next to the bottom of the bed during an earthquake.

5) If an earthquake happens and you cannot easily escape by getting out the door or window, then lie down and curl up in the fetal position next to a sofa, or large chair.

6) Most everyone who gets under a doorway when buildings collapse is killed. How? If you stand under a doorway and the doorjamb falls forward or backward you will be crushed by the ceiling above. If the door jam falls sideways you will be cut in half by the doorway. In either case, you will be killed!

7) Never go to the stairs. The stairs have a different ‘moment of frequency’ (they swing separately from the main part of the building). The stairs and remainder of the building continuously bump into each other until structural failure of the stairs takes place. The people who get on stairs before they fail are chopped up by the stair treads – horribly mutilated. Even if the building doesn’t collapse, stay away from the stairs. The stairs are a likely part of the building to be damaged. Even if the stairs are not collapsed by the earthquake, they may collapse later when overloaded by fleeing people. They should always be checked for safety, even when the rest of the building is not damaged.

8) Get near the outer walls of buildings or outside of them if possible – It is much better to be near the outside of the building rather than the interior. The farther inside you are from the outside perimeter of the building the greater the probability that your escape route will be blocked.

9) People inside of their vehicles are crushed when the road above falls in an earthquake and crushes their vehicles; which is exactly what happened with the slabs between the decks of the Nimitz Freeway. The victims of the San Francisco earthquake all stayed inside of their vehicles. They were all killed. They could have easily survived by getting out and sitting or lying next to their vehicles. Everyone killed would have survived if they had been able to get out of their cars and sit or lie next to them. All the crushed cars had voids 3 feet high next to them, except for the cars that had columns fall directly across them.

10) I discovered, while crawling inside of collapsed newspaper offices and other offices with a lot of paper, that paper does not compact. Large voids are found surrounding stacks of paper.

Spread the word and save someone’s life…

The entire world is experiencing natural calamities so be prepared!

‘We are but angels with one wing, it takes two to fly’

In 1996 we made a film, which proved my survival methodology to be correct. The Turkish Federal Government, City of Istanbul, University of Istanbul Case Productions and ARTI cooperated to film this practical, scientific test. We collapsed a school and a home with 20 mannequins inside. Ten mannequins did ‘duck and cover,’ and ten mannequins I used in my ‘triangle of life’ survival method. After the simulated earthquake collapse we crawled through the rubble and entered the building to film and document the results. The film, in which I practiced my survival techniques under directly observable, scientific conditions , relevant to building collapse, showed there would have been zero percent survival for those doing duck and cover.

There would likely have been 100 percent survivability for people using my method of the ‘triangle of life.’ This film has been seen by millions of viewers on television in Turkey and the rest of Europe, and it was seen in the USA , Canada and Latin America on the TV program Real TV.

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