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Friday, May 27, 2011

Deflationary collapses, how quickly we forget!

WAY back in 2008, we had a market collapse followed by an economic collapse. In August of 2008, oil was spiking to 145 a barrel. All systems where go for a global economy on fire.

Then just 4 months later, oil was hitting 40 bucks a barrel. Amazing.

But what caused the collapse? The mass media did an utterly piss poor job explaining it.
Was it the fall of Lehman Brothers? Bear Sterns? Banks?

And how could a few companies failing be responsible for what turned into a global economic collapse? If they where to blame, holly hell, what where government regulators doing since 2001?

I'll ignore the corruption, the outright lies, and other main contributors for getting America to that fragile state.

The issue was simply LEVERAGE! If the US Financial system had no fractional reserve lending policy, it would in effect have no systematic leverage. What would happen is for every dollar a bank lent....a dollar must exist! Then if a dollar was lost, the existing dollar would pay for the bad loan.

In such a world, its hard to get into trouble, since, there is deposits that could pay off bad loans. Further, even when loans go bad, a percent does, not all loans do. So a 10% haircut may be painful, but a company would easily be able to survive based on it's remaining assets.

But thats not the world we live in. The world we live in is 100 deposited dollars can be leveraged to create a total of 457 of deposits, with 357 in loans, and a bank requirement to keep 89 dollars in reserve. (click for Wikipedia details)

So as you can see, if a loan goes bad, the "reserve" can be used quite quickly, leaving no reserve for remaining outstanding loans.

This my friend, is at the heart of a deflationary collapse. Once started, it can snowball into a cascade collapse. Banks and other institutions must dump assets to gain cash to maintain reserves. The system makes for some GREAT bull market runs and makes it easy for private institutions to fund growth. So when things are going good, the marketplace and business world is flush with liquidity (money) to finance business.

But if a tipping point of selling occurs, usually because of bad loans, a cascade failure can happen.
In 2008, the Federal Reserve, to its credit (its rare I complement them), acted quickly to stop the chain reaction to prevent a full all out collapse.

Unfortunately, the lesson learned was, lets do it again, but this time, lets press harder and involve the federal government directly. With governments involved, what could POSSIBLY go wrong?

For an example, lets take a look at Greece. That countries debts and financial situation is at a point of implosion. Greece will likely be the first country to be asked to leave the euro, and it won't be the last. (Spain, Portugal, Ireland) Once any country is asked to leave, it will make it easier to ask for others.

The question is, why is the European Union fighting so hard to prevent this from happening? Do the Germans, French, and other European nations love Greece for its art, food, and vacation spots? Is it they are really nice and like to lend money to others in a time of need?

I am of the belief that the European banking system is about to experience what America already endured, a deflationary collapse due to bad loans, fractional reserve lending.
Don't believe me? Lets see what a former European Central Bank Economist has to say about Greece.

“I’m skeptical about Greece,” said Former ECB Chief Economist Otmar Issing, who joined the ECB a year before the euro’s inception in 1999 and stayed there until 2006. “Greece is not just illiquid, it’s insolvent.”

This statement comes after many of the blogs I read have painfully detailed out that Greece is insolvent, while the European Banking system says otherwise. Mish has a great post of the quote above, and full detail of the pending Greece implosion.

In 2008, America took the hit as directly causing the financial collapse. 2011 will mark the rest of the world causing the next leg down. The European Union, and very likely, China. America's financial markets will get hit, and you can be sure that companies like Goldman Sachs will get caught in the "credit default swap" market losses it was a party to in Europe.

For since 2008, Credit Default Swaps which dwarf global output, ranging in the 55 trillion dollar liability range, with near zero regulation still!

So those looking for hyperinflation, think again, a little country like Greece may be the start of the great unraveling, and that is a deflationary event.

The currency debasement I fear will come AFTER this event. I still think currency debasement with hyperinflation is possible, that years off at earliest 2015-2017.

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