„The big one“ is the term used for the gigantic California earthquake that seismologists have been expecting for several decades. „The big one“ could also be an appropriate description of the coming and unavoidable collapse of the global financial system.
Both events have one thing in common: We know that they will occur, but we cannot exactly predict when. Other than these parallels there is one decisive difference: Whereas only seismologists can understand tectonic movements, you do not have to be a trained economist to grasp the basic workings of the financial system. So let’s take a look at its historical development in order to try to determine where we currently stand.
The Basic Foundations of our Financial System
Our present financial system dates back to the conference of Bretton Woods. The agreement reached in the hills of New Hampshire in 1944 tied the US dollar to gold, pegged all other currencies to it and thus opened up the world’s markets for US exports. In 1971 the continually increasing amount of dollars forced the US government to end the gold-dollar peg.
This would actually have ended the dominance of its currency, but in the mid 1970s the Nixon Administration closed a deal with Saudi Arabia, which ensured that from then on all the world’s oil would only be traded in US dollars. The deal established the so-called petro dollar and guaranteed the United States continuing dominance of the world’s currency system.
Most of the profits made in the oil trade (oil being the world’s most widely traded commodity) went straight to the accounts of Western banks and thus strengthened the position of Wall Street and the City of London.
At the beginning of the 1980s both financial centers supported the election of Ronald Reagan and Margaret Thatcher. In return the two politicians used their terms to massively boost neoliberalism – a policy based primarily on the interests of international finance capital.
Labor disputes like the air traffic controllers’ strike in the US and the miners’ strike in Great Britain were crushed, the influence of trade unions was severely restricted. Millions of jobs were slashed or moved to low wage countries, mostly in Asia.
While the living standard of workers began to deteriorate, the wealthy and their corporations were granted various kinds of tax relief. The continuous deregulation of the banking system led to the establishment of hedge funds (asset managements for the ultra rich that are not subject to the restrictions of the banking system) and helped the financial sector play an ever-bigger role within the economy.
In 1994 derivatives (financial products which are decoupled from the real economy, mostly bets on rising or falling prices) were supplemented by credit default swaps, invented by JPMorgan banker Blythe Masters. The volume of these “financial weapons of mass destruction” (US investor Warren Buffett) immediately exploded and led to the first near-collapse of the world financial system only four years later.
The First Shock
In 1998 the hedge fund Long Term Capital Management (LTCM) collapsed following the currency crisis in Russia. Its fall elucidated the consequences of deregulation and the unbridled use of derivatives: With less than $ 10 billion in equity LTCM had invested a total of $ 1.25 trillion.
Since its bankruptcy (which was mainly due to the maturity of credit default swaps) would have taken numerous financial institutions down with it and thus triggered a global chain reaction, LTCM was bailed out under the leadership of the Federal Reserve of New York. (Unlike in subsequent bail-outs the $ 3.6 billion needed for its rescue did not come from the state, i.e. the taxpayers, but from other financial institutions.)
Although politicians immediately vowed to take action not to let such a situation develop again, the following years saw almost no restrictions imposed on the financial industry.
On the contrary: In 1999, just one year after the near-crash, the Clinton Administration repealed the Glass Steagall Act which had banned commercial banks from high risk speculation with depositors funds for almost seventy years. If anything this was a clear indication that the financial sector had finally become more powerful than government and that Wall Street was dictating Washington’s policies.
Due to the loosening of legal restrictions, speculation in international financial markets not only continued but took on momentum. International corporations increasingly used profits made in commodity production for speculative purposes and thus misused the real economy as a source of money for their activities in the financial sector.
‘Liberalized’ accounting rules. i.e. the lowering of safety standards in the banking business, enabled the banks to engage in reckless ‘leveraging’ (which is nothing more than incurring more debts) and to continuously expand their lending business.
The Second Shock
The latter trend found its most pronounced expression in the US housing market, where constantly rising prices prompted the banks to grant loans asking for almost no collateral.
When prices began to fall the market collapsed almost overnight. Triggered by this so-called sub-prime mortgage crisis and followed by the collapse of banking giant Lehman Brothers in 2008, a whole series of international financial institutions were threatened with bankruptcy. Once again, a crash of the global financial system was imminent.
This time the sums involved were so large that the governments themselves had to step in. Declaring the endangered financial institutions “too big to fail”, they saved private institutions using public funds. Under its Troubled Asset Relief Program (TARP), the US Government handed $ 245 billion to the financial industry, 68 times the sum that LTCM had been saved with.
But it was not only the sums involved that were much higher than a decade earlier. The fall-out of this barely avoided crash went considerably further than in 1998 and confronted politicians and the financial industry with three major problems: the real economy showed no signs of regaining growth, governments were sitting on vast amounts of toxic (worthless) papers (which they had bought from the banks in order to rescue them) and the banks, due to their high losses, urgently needed fresh money.
Under immense pressure, the US Government decided to resort to two methods: Cutting interest rates and introducing “quantitative easing” (nothing but a euphemism for printing money).
On the pretext of handing out cheap money to the banks for them to pass it on to the real economy and thus bring the nation’s productive capacities back on track, the US Federal Reserve printed nearly 4.5 trillion US dollars in the following years, handing them out to the financial industry at close-to-zero interest rates.
However, the financial industry showed no intention to pass the money on to the real economy in the form of loans. Instead, it once again turned to the financial markets and engaged in even more speculation than before.
The current situation
The results of this third round of speculation can currently be seen all over the world. Huge bubbles have formed in the real estate market, the stock market and the bond market. The Bank for International Settlements estimates the present volume of shadow banking at 9 times global GDP (the sum total of all goods produced and all services provided).
Blackrock, the world’s biggest hedge fund, leveraged its holdings to more than $14 billion, almost 4 times German GDP, in 2014. Global debt has risen to $ 199 billion, $ 57 billion more than at the outbreak of the financial crisis in 2007 and $ 112 billion more than in the year of 2000.
This highly explosive mixture is overshadowed by an international currency war (the targeted devaluation of national currencies by money printing) which the European Central Bank (ECB) has joined in March 2015. By handing out 2 billion euros a day to the financial industry until at least September 2016 at near-zero interest rates, the ECB is deliberately weakening the euro and at the same time helping to boost even wider speculation in the euro zone.
This year has also seen a considerable deepening of the euro crisis, which has been smoldering since 2010. Greece is only the tip of the iceberg. The country’s public debt of 320 billion euros is not even its biggest problem. The real time bomb is an estimated $ 3 trillion to $ 5 trillion in credit default swaps, most of them probably held by large US banks and Deutsche Bank.
If Greece actually defaulted, these sums would definitely trigger a chain reaction and take down the whole global financial system. That is why a Greek default must be prevented at all costs – an impossible task in the long run for politicians facing a phenomenon that physicists would probably describe as a black hole.
The greatest risk to the global financial system, however, lies in the world’s most inflated market, which is the bond market. While the volume of the sub-prime mortgage market, which triggered the near-crash of 2007/2008, amounted to around $ 1.5 trillion, US bonds alone are currently valued at about $ 12 trillion.
As bonds are considered safe investments and most market participants expect their value to rise, buyers often accept extremely low returns in exchange, hoping to resell at a profit at a later date. (So far bonds worth 3 trillion have been acquired at negative interest rates.)
But what happens if the value of these bonds, contrary to all forecasts, decreases? A glimpse of this scenario could be seen in the bunds (German bonds) market in mid May where massive sales (probably by US speculators) provoked considerable turmoil and forced the ECB to intervene.
Although the rescue operation succeeded, the development clearly showed how far the process of degeneration of the world financial system has already progressed: The only way to prevent the bursting of the bubble was by blowing it up even further!
The current financial situation is mainly characterized by the fact that one of two remedies, the lowering of interest rates in order to jumpstart the economy, is no longer available, and that the other option, the printing of money, which has already been excessively applied, will only postpone the catastrophe and make it even worse in the long run.
In other words: we have reached the end of a historical phase. A reversal is excluded as politicians are not willing to write off huge amounts of debt and the financial aristocracy is not willing to give up its gigantic assets – both options being the indispensable prerequisite for a peaceful reset of the system.
How the financial industry and governments are preparing for a crash
But what will be the trigger for the final collapse of the financial system and when exactly will it happen? There are two reasons why this question is so difficult to answer: On the one hand there is an immense number of possible triggers of which a lot are interdependent. On the other hand we lack many important pieces of information, because the most crucial area of global finances, namely derivatives, is deliberately concealed from the eye of the public.
Still, there is a simple way to at least draw some conclusions as to the time-line of coming events. All you have to do is look at the pace at which the financial industry and politicians have been preparing themselves for what they see coming.
During the past two years they have legally replaced the principle of bail-outs (rescuing banks using taxpayers’ money) by that of bail-ins (rescuing banks by using savers’ and small investors’ deposits) in all Western countries and therewith legalized the future expropriation of ordinary citizens (especially the middle class) for the benefit of the financial elite.
Also the IMF has proposed a one-off tax on all households in one of its papers that not a single banker or politician has spoken out against. One can therefore assume that this option will definitely be considered in the case of a crash. Even more telling is the media campaign launched by a united front of journalists, politicians and the financial industry to convince the public that the abolition of cash would be to its benefit.
The campaign is solely prompted by the fact that depositors faced with negative interest rates are emptying their accounts. The abolition of cash has nothing to do with the prevention of money laundering, but is aimed at giving the financial institutions unlimited access to their depositors’ money in case of emergency.
Possible triggers of the crash: A black swan or the bursting of a bubble
All these measures go to show how hurriedly politicians and executives in the financial industry are presently preparing for the coming collapse. Although, as in the case of the „big one“, no one can predict its exact date, it is plain to see that the current situation is characterized by such enormous instability that a “black swan” (i.e.: an unforeseen event) could trigger a chain reaction at any given moment and that of all the financial means to prevent it, only one single measure remains: the printing of money.
As the size of the markets’ bubbles has already reached historical proportions and every further cash injection only brings them closer to the point of bursting, one does not exaggerate by stating that we are now in the final stages of a development that will change the face of the world.
By Ernst Wolff