Kill your saviour: currencies' crisis is looming

In February this year [2010] the author of this blog wrote a report which was commissioned by an organisation of sovereign wealth funds, "Money Multiplier effect on currency risk" ^*. The conclusion was inescapable at that time, which was well before the Greek crisis. The currencies of countries which are heavily in debt are facing realistic to high risk of collapse. This was true especially with respect to eurozone which was (and still is) facing a break-up or major realignment. The US dollar is not much on the radar but does not look much better. Since then German Chancellor, Angela Merkel, confirmed "The euro is in danger".

The global pyramid scheme which was engineered by bankers and financiers (with help and blessing of regulators and some politicians: how are you Mr Gordon Brown?) resulted in a very high Money Multiplier. I.e. $1 (£1, €1) real cash has to service to many dollars (pounds, euros) of liabilities on banks balance sheets. This resulted in ongoing liquidity crisis. Governments "rescued" the banks by pumping cash (and cash guarantees) into them thereby putting economies heavily in debt to a tune, globally, of trillions of dollars. However this has been only a temporary reprieve since it covered only a very tiny portion of banks liabilities (especially toxic papers on their books). Although Money Multiplier was reduced (i.e. improved) as described in "The largest heist in history" the improvement was insignificant and, very likely, it has grown since then. This put the economies into a deep financial trouble. Now chickens are coming home to roost: as predicted at the time (end of 2008) rather than curing the problem in the private financial sector, governments decided to buy their time by spreading it and making it much worse dragging taxpayers (and future generations of taxpayers) into it.

To repeat the advice from the end of 2008: "If governments do not liquidate the global pyramid scheme [as explained in this article what it was but primarily write offs of many financial instruments and liabilities of so-called "casino" banking], the money they injected will be, in time, converted into toxic instruments (e.g. securities) and cashed in by organisers and privileged customers of these schemes (or in the case of Albania, gangsters and their customer friends). As the amount injected is around 200 times less than the notional value of toxic instruments, the economy will not even see a difference. It will be a step back to September 2008, only now with trillions of dollars of taxpayers' money spent to sustain the pyramid scheme. It will be merely throwing good money after bad. But can governments afford to come up again with the same amount money and do it 200 times over or more? This is based on a very optimistic assumption that the notional value of toxic instruments is not increasing. If governments take the route of continuing to inject money, they will make taxpayers dependant on the financial system in the same way that criminal loan sharks control their customers — their debt is ever increasing and customers keep on paying forever as much as it is possible to extract from them."

The ongoing liquidity (banking) crisis and the sovereign debt crisis, that just blew up, are two sides of the same coin: much too high Money Multiplier, or in simpler terms the global financial pyramid is simply too huge and keeps collapsing.

There is a perverse, sinister side of this process: the very same bankers and financiers whose institutions (i.e. the vehicles of their actions and source of rather exuberant income; this must not be confused with proper ownership, shareholding) were saved from spectacular collapse with "stimulus packages" are now using their institutions, saved by taxpayers' money, and taxpayers' money to attack the budgets of governments (i.e. taxpayers). Kill your saviour if you have an opportunity to do so and it brings you benefits: it is a free market version of an old rule "dog-eat-dog". In fact a prediction made on this blog over a year ago that the financial system – society relationship would turn into a relationship akin to loan sharks and their victims has materialised. As it is taxpayers, and their children, have to keep on paying ever more, as much as they possibly can, with no hope of any recovery. This is called "austerity packages". Loan sharks developed such ideas for their victims in the past and now the mainstream financial industry has learnt such methods and is scaling it up to encompass entire economies. This was a predicted result of "stimulus packages" exposing governments as weak, incompetent and corrupt.

The next step on this path is very likely to be a currency crisis. We already see its beginning with euro. The US dollar will also not escape a reality check. But as pointed out in April 2009 in an article "A US way out?" this make take some time and end up in a somewhat unorthodox solution.

There is only one way out: a combination to a greater or lesser degree of the two processes:

- Zimbabwe way: inflating this crisis out (printing money will reduce Money Multiplier by increasing the volume of cash available to satisfy liabilities on banks balance sheets);

- Chapter 11 way: write offs of liabilities on banks and countries balance sheets (removing liabilities on banks and countries balance sheets will reduce Money Multiplier by reducing the size of liabilities that cash available has to satisfy): an extreme form of such scenario, which is quite likely, was presented over a year ago in a short article mentioned above "A US way out?".

(And of course banks must be banned from recreating the same problem again, for example by lending with loan to deposit ratio above 100%. This is all on this blog: a bit complicated for a paragraph of explanations here.)

From banks liquidity crisis and banking collapse to sovereign debt crisis to currency crisis. These are the stops on the same path: a collapse of the global financial pyramid scheme engineered by the financial world (or technically a result of much too high Money Multiplier). The Great Depression that started in October 1929 reached its grand finale in 1939 with the World War Two. Whether the end of the current crisis will be as dramatic and "spectacular" time will tell. But there is very little to feel optimistic since politicians live in a state of denial and do not tackle the root cause of the current situation. Well, they are unlikely to have a clue about it.

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^* If you would like to obtain a complete copy of this report published by Arab Financial Forum titled ”Sovereign Wealth Funds – Where Are They Going?”, please send a request to Arab Financial Forum Secretariat: info@meconsult.co.uk