There’s no avoiding a historic bust

Tuesday, 26 July 2022 — Paris, France

[9 min read]

Dear Reader,

It was the ‘90s, speculation in new technology was rife. One prospectus offered investors a return of 100%.

Edward Chancellor (an economic historian) wrote an excellent book on the history of financial bubbles, Devil Take the Hindmost: A History of Financial Speculation. Let’s see an excerpt from that book…

‘Then it ended. A crisis in public finance, a flight of foreign investors and a loss of investor confidence sank the prices of the leading companies.’

I know what you’re thinking, ‘so what’s new, we know that story from the 1990s.’

But the ‘90s I’m referring to was not the 1990s — it was the 1690s.

As told by Chancellor:

‘…the British public drove up the prices of shares in diving companies, which bragged of new technologies for searching the sea floor for sunken treasures. One prospectus assured investors of a 100 percent return. The public's thirst for quick riches spilled over into shares of companies ranging from those with new patents for burglar alarms or fire-extinguishing engines to banks and the bellwether East India Company.’

Speculation in something new and exciting.

Bubbles forming.

Justification found in that old chestnut…‘this time is different’.

Busts following.

Regrets aplenty.

Same pattern. Different eras.

People never learn…especially those charged with the responsible stewardship of the financial system.

Edward Chancellor’s latest book, The Price of Time: The Real Story of Interest, is highly critical of the modern-day central banker.

Chancellor’s forensic account of history’s bubbles and busts finds there is one common denominator…they always happen when interest rates have been kept too low for too long.

In a recent interview, Chancellor had this to say on the current ‘everything bubble’.

‘After years of ultra-low interest rates, central banks created a bubble in pretty much every asset class, they facilitated a misallocation of capital of epic proportions, they allowed an over-financialization of the economy and a rise in indebtedness.’

Bottom line, the bust has only just started. This is going to end really badly.

But how did the…

Fox take charge of the Hen House

More than 116 years ago, a devastating natural disaster put into motion the events that’ll cause the most devastating financial disaster in history.

In April 1906, San Francisco was struck by an earthquake that killed upwards of 3,000 people and destroyed more than 80% of the city.

Insurance companies in Britain were hit by massive claims.

Settlement of these claims required large amounts of gold to be moved from London to the US.

In an effort to stem the outflow, the Bank of England raised its discount rate to make it more attractive to keep gold in Mother England.

It worked. Gold flowed back from the US to England.

The tighter monetary conditions in the US resulted in one of the worst bear markets in US history.

In 1906–07, Wall Street fell 48%.

We’ll let Wikipedia tell the rest of the story…

‘Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered bankruptcy. Primary causes of the run included a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops.’

Without a central bank to restore calm, it was up to the most powerful banker of the day, John Pierpont Morgan (yes, the original JPMorgan) to save the day, and stabilise the system.

An angry mob is the ideal pretence for powerbrokers to implement their agenda.

The 1907 Panic was the crisis needed by the bankers to force US Congress to establish the US Federal Reserve Bank.

As noted in the US Federal Reserve’s history archives:

‘The Panic of 1907 was the first worldwide financial crisis of the twentieth century. It transformed a recession into a contraction surpassed in severity only by the Great Depression. The panic’s impact is still felt today because it spurred the monetary reform movement that led to the establishment of the Federal Reserve System.’

Under the guise of ‘we need a stable financial system to protect the people’, the bankers and politicians went to work on drafting up a central bank model.

More than five years after the Panic, the US Federal Reserve Bank was legislated into existence in December 1913.

During this five-year period, there was another panic in 1910–11 (emphasis added):

‘The Panic of 1910-1911 was a slight economic depression that followed the enforcement of the Sherman Anti-Trust Act. It mostly affected the stock market and business traders who were smarting from the activities of trust busters…’

Wikipedia

The 1910–11 panic did not create a bank run.

So, without another threat to the banking system after the Panic of 1907, why did the bankers and politicians persist with plan? Why not let the system work itself out?

The real story is in the fine print

That’s where the Motherhood statements tell the story.

The big picture plan, according to the Fed’s own site, was (and still is):

‘The Federal Reserve works to promote a strong U.S. economy. Specifically, the Congress has assigned the Fed to conduct the nation’s monetary policy to support the goals of maximum employment, stable prices, and moderate long-term interest rates.’

Who doesn’t want maximum employment, stable prices, and moderate interest-rates?

Sign me up.

As always, the real objective can be found in the fine print.

The US Federal Reserve Bank is made up of 12 regional banks…St. Louis Federal Reserve, New York Federal Reserve, San Francisco Federal Reserve, etc.

To quote from the Fed’s own site (emphasis added):

‘…each of the 12 Reserve Banks operates within its own particular geographic area, or District, of the United States, and each is separately incorporated and has its own board of directors. Commercial banks that are members of the Federal Reserve System hold stock in their District's Reserve Bank. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. In fact, the Reserve Banks are required by law to transfer net earnings to the U.S. Treasury, after providing for all necessary expenses of the Reserve Banks, legally required dividend payments, and maintaining a limited balance in a surplus fund.’

What this all means in layperson terms is that every commercial bank, by law, is required to keep 6% of its capital in its regional reserve bank.

In exchange for these reserves, the commercial bank is issued with an equivalent number of shares. Naturally, the bigger banks — like JPMorgan, Citibank, et al. — are allocated a greater number of shares.

The price of these shares is fixed at US$100.

The shares carry voting rights to about two-thirds of the board of directors for that regional reserve bank.

But here’s the good bit:

‘…the Reserve Banks are required by law to transfer net earnings to the U.S. Treasury, after providing for all necessary expenses of the Reserve Banks, legally required dividend payments…’

One of the expenses of the regional banks is…legally required dividend payments.

The shares held by the commercial banks are entitled to a dividend of 6%.

The Panic of 1907 was the Trojan Horse for the bankers to establish a system that’s been very beneficial to the banking sector…voting rights on the regional Fed banks, and a guaranteed 6% dividend.

Has the Fed delivered on its Charter?

Stable prices…read the highlighted section…

History indicates the period prior to the Fed’s creation (when market forces corrected any excesses) was far more stable over the longer term.

Moderate long term interest rates…I won’t even bother with that chart.

Zero bound for over a decade…that’s NOT moderate, it’s punitive.

The Federal Reserve system, designed by bankers, to be run by bankers, for the benefit of bankers, has, under the pretence of offering greater stability, created an immeasurable level of instability.

Rampant speculation. Derivative contracts priced in the hundreds of trillions of dollars. Record debt. Historically low rates. Unfunded welfare and pension promises. Unfettered money creation.

Our economic growth is a fraud built upon one giant (central bank cultivated) lie — that we can have our cake and eat it too.

We have generations who now believe…

Share markets will rise forever. House prices can never fall. Generous retirement income promises will be kept. Why save for tomorrow, when you can borrow today?

The Fed’s charade of prudent stewardship was briefly revealed to all in 2008.

The cracks in the central bank’s veneer of responsible management were quickly papered over with QE and ultra-low rates.

Curing a debt crisis with more debt, must surely rank as one of the stupidest policy settings in modern history. Yet, as a society, we bought it.

Why? Because the so-called pillars of our society, the banks, sold it to us.

These are the very same banks that are in on the Fed’s scam.

Applying even greater stress to a system that was already showing signs of strain, has only served to further weaken the foundations upon which our financial structures are built.

Yes, there has been one hell of an asset price party. Which, when you think about it, is only fitting. All great dramas have a final, spine-tingling crescendo before the tragic ending.

A seismic shock awaits

The widespread instability now embedded within the system, guarantees a man-made seismic shock in financial markets — far worse than 2008 — is in our future.

When that, ‘who-could have-predicted-that-crisis’ next occurs, watch for the bankers to once again lobby to implement a system (under the guise of needing to restore stability) that favours their interests, not ours.

We know they’ll try to sell it to an unsuspecting and gullible public as being in our best interests. Different era, same game plan.

Will the public be so naïve this time around?

Maybe.

But don’t discount the possibility of angry people taking to the streets to protest the graft, corruption, and inside trading that’s become endemic within the banker’s bank — the Fed.

The bust that’s coming is going to be history making…providing Edward Chancellor with a treasure trove of material for his next page turner.

Sadly, for far too many people, the lessons will be learnt too late.

Which means regrets aplenty.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

Dear Reader,

‘My advice is to dabble in cryptos for now. But don’t take it too seriously. Most of the coins out there now are going to go to zero. Cryptos are intellectually fascinating. But they’re not anything you want to put a lot of your money into in my view. At least not yet.’

Bill Bonner, 31 December 2018

The crypto world was wild, untamed, and almost lawless.

It was all great fun, as long as prices were rising. But when they came down, suddenly, everyone was looking for the sheriff. MarketWatch reports:

‘“Fraud is fraud”: Former Coinbase manager charged in first-ever cryptocurrency insider-trading case

‘Ishan Wahi is accused of tipping his brother and pal of upcoming crypto asset listings, from which they illegally netted $1.5 million in trades.

‘A former Coinbase product manager has been charged in the first-ever cryptocurrency insider-trading case, for allegedly tipping his brother and a friend to upcoming asset listings that weren’t yet publicly known.

‘Ishan Wahi, 32, of Seattle, worked as a product manager for Coinbase Global , the largest crypto exchange in the U.S., and was one of a small group of employees who received advance knowledge of assets that were soon to be listed on the exchange.

‘Federal prosecutors said that between August 2021 and May 2022, Wahi told his brother, Nikhil Wahi, 26, of Seattle, and their friend, Sameer Ramani, 33, of Houston, Texas, of the upcoming listings and that they used that information to place favorable trades ahead of time.

‘Prosecutors said that over the course of 14 separate trades Nikhil Wahi and Ramani illegally netted $1.5 million in illicit profits. All three men are charged with wire fraud and wire fraud conspiracy, and face up to 20 years in prison if convicted.’

‘When the wind blows strong enough’, say the old timers, ‘even turkeys will fly’.

Flying turkey

And in the gales of crypto madness, the skies filled with as many as 10,000 different crypto coins. These coins had no apparent ‘raison d’etre’. They were neither fish nor fowl — neither making products nor providing services. They claimed to be a new form of ‘money’. But what kind of money is it that you can create at will?

[Editor’s note: Our crypto expertise Ryan Dinse agrees by the way. In fact, there are around 19,000 different crypto coins. And most have no real-world value and are sure to go to zero. However, he says, there will be a few Phoenixes that will rise from these ashes. The smart money is already locking up supply. To find out which kinds of project these are, go here]

Nobody wanted to ask that question. It didn’t seem to matter. And nobody cared whether they were ‘ponzi schemes’ — not if they still got their money. But the trouble with Mr Ponzi’s scheme was that it was always doomed. And when the new depositors stop coming in, the old depositors feel they have been deceived. They thought cryptos were ‘money’…and their coins were ‘investments.’

‘A former employee at bankrupt crypto-lender Celsius has sued the company, calling it a “Ponzi scheme”: Jason Stone, the CEO and co-founder of the Defi firm KeyFi, later Celsius acquired in 2020, filed the complaint in New York on Thursday. His team was tasked with receiving “hundreds of millions of dollars of customer deposits” from Celsius to invest…Stone accuses Celsius of lacking basic security and risk management systems in place, and says the firm now owes money to his company and hundreds of thousands of customers.’

Bloomberg

When something seems too good to be true, it is usually neither good nor true. And when we first heard of crypto accounts that would pay as much as 18% interest, we guessed that the important part of the story was yet to be told.

‘Whatever they are paying’, we told colleagues, ‘it ain’t interest’.

Now, the story is coming out. Celsius Network advertised 18% interest. You got the money by putting your cryptos on deposit, where the company supposedly used them to ‘lend’ to other crypto projects. The whole story has yet to be told, but it appeared to us that the company was a ponzi scheme. It took in money…and used the money to gamble on other cryptos. As long as more money was coming in than going out, it could pay customers 18% ‘interest’.

The widening gyre

Like a flying turkey, Celsius stayed aloft — until the wind turned. But when customers wanted their money back, the company went into a tailspin. That is, the market went down. Its bets went bad. And it suffered ‘severe exchange rate losses.’

That is what we thought. But it was more complicated than that and much more interesting. And it shows what a clever bunch of desperadoes could do in the crypto business. For if we understand it correctly, the Celsius crew were betting on cryptos to go down, not up. They thought they had found a new angle to make Mr Ponzi’s scheme work even better.

It was fairly obvious that (as we guessed back in 2018) most cryptos would go to zero. And Celsius seems to have come up with a way to profit (for its managers, not its investors) by anticipating the final chapter. It was very simple. The company kept its liabilities in crypto form (it needed to be able to give depositors back their coins). But it converted the cryptos to dollars and used them to make more dollars.

What an elegant scam. In effect, you borrow a million dollars in cryptos (by promising an 18% return). You count on the cryptos to go to zero…so you never have to pay back the borrowed money. Then, you take the money and invest it to earn real money.

It might have worked. But the timing had to be just right. Instead, the crypto assets went in the wrong direction — up (during the relevant period). And the more the value of the cryptos increased, the worse Celsius’ balance sheet looked. When the problem became obvious to investors, they wanted their coins back (then worth more money)… and pronto.

Alas, Mr Ponzi didn’t have the money.

Regards,

Bill Bonner,
For The Daily Reckoning Australia