The shock that hit the market in August when major institutions all over the globe began to finally realize they were holding fraudulently rated securities and other “leveraged” debt was just the initial tremor that will shake the foundations of the US economy. Countrywide, a major lender and mortgage issuer, experienced a genuine “run on the bank” as frightened customers lined up to withdraw their money. Bank of America, perhaps the strongest bank in the US, came to the rescue with a $2 billion  investment.

Meanwhile, in the UK, the Bank of the Rock was rapidly eroding, and was also experiencing unprecedented bank runs—long lines of people waiting for their money, a sight that has not been seen in Western economies since the Great Depression. The government fretted over what to do while the world central banks opened their floodgates and poured money into the financial system. The torrent of bad debt backing up behind the financial dam was threatening to spill over into the “real economy,” and investors were decidedly nervous. Over $300 billion was infused into the system to keep it solvent, much of it simply printed. The money did not exist until the printing presses at the Fed went into overdrive. As the crisis deepened, affecting stock values, the markets looked to Fed Chairman Bernanke to salvage the situation. To soothe tempers, like that of TV entertainer and stock analyst Cramer, Bernanke cut the discount rate that banks use in emergency situations to borrow money from the Fed, and then knocked a full 50 basis points off the prime interest rate.

The markets loved the move, and rallied to regain much of the ground lost in August. By Oct 1st the Dow industrials hit an all time intraday high of 14,115. The bulls were back, led by Cramer, who urged on millions of TV viewers with his soundscaped buy buttons. But news soon emerged from some of the major banking institutions that all was still not well.

Citigroup and other banks announced massive losses, to be simply “written off” to the tune of billions.  (About $2.6 billion for Citigroup...which soon grew to $8 billion, then $11 billion). Not to be upstaged, UBS, Europe’s biggest bank, announced a $3.6 billion dollar loss this quarter, and 1500 job layoffs. Deutchbank followed with another multi-billion dollar charge off. The bad loans were going up in smoke all through the system. In the US, on-line bank “NetBank” was shut down by the FDIC—the biggest US bank failure in decades. This former darling of the NASDAQ saw the value of its shares skyrocket from $14. to $247 in just five years. On August 3 they were worth just $0.68 cents. Mid to late October threatens more bad news, as major banks report in the period Oct 15-20. Expect lots of red ink and huge losses.

But “huge” is a relative term. The sum of securitized mortgage debt (loans backed by some asset collateral, like a home mortgage,) is now $6.5 Trillion dollars. That’s 6500 billion. The losses reported by the banks thus far, a billion here, two billion there, represent only a tiny fraction of the loans presumed at risk now. Many have simply been rolled over as a way to postpone their finding a place as red ink on a balance sheet, but now that option is frozen, because no one will buy the debt. It’s a kind of financial denial that would make the typical alcoholic blush as they say “just one more...I feel fine.” Now the nation’s largest banks are reportedly hatching some kind of emergency plan, creating a $100 billion dollar fund from their combined dollar assets, to try and keep all that red ink at bay. Even if they could create this fund, it would still only stand watch over 10% of the bad commercial paper out there, hidden away by the clever keystrokes of the banking accountants.

Apparently shaken by news that has yet to reach the general public, both the US Treasury Department, and the UK Government have been running “scenarios” depicting a major crisis accompanied by a run on the banks. Hummm….  The FDIC may have intervened in NetBank, but they would be powerless to stem the tide of greater bank failures. Their reserves could only cover a small percentage of deposits in US banks, so don’t think the US is immune from Depression style banks runs, like the 1933 run pictured below.

Needless to say, the infusion of manufactured money and the weak-kneed policy of the Fed to rescue the market, has caused yet another crisis. The dollar fell against currencies worldwide, threatening the very thing that chills the Fed’s bones, inflation. The dollar index, which measures the greenback against other world currencies, reached a low of  77.9 In September. As it moved through the vital support level of 80, there was nary a whisper in the mainstream media, which also ignored oil breaking through the same level, in the other direction to exceed $80 a barrel. This 80-80 threshold failure showed that the crisis was far from over. A weakening dollar and soaring energy prices remain as severe threats to global economic stability.

“The dominoes are toppling. What began as a credit crunch has turned into a dollar crunch. We are witnessing a run on the world's paramount reserve currency, an event that occurs twice a century or so, and never with a benign outcome.” - Ambrose Evans- Pritchard for the UK Telegraph.

The US, now the world’s greatest debtor nation, has relied on the rest of the world to underwrite our massive spending spree for years. China, Korea, Japan and other economies buy up US Treasury notes, and hold dollars in vast amounts overseas. The number was so high that the Fed quietly stopped reporting it, (M3). Facing up to reality is apparently not their game. Now, with the dollar weakening, these same foreign investors are seeing their holdings erode dramatically. Many have already lost 40% on their dollar based investments, and other currencies, all strengthening relative to the dollar, look much more inviting now. The Euro, which was worth about .83 cents compared to the US dollar seven years ago, is now worth $1.41. If you had simply bought Euros with your hard earned greenbacks five years ago, you would have outperformed the Dow and avoided all the Bull, Bears and Bollinger bands.  And the  14,000 + market is resting on dollars that have lost 40% in value during the runup. In short, the all time highs recorded on Oct 1st were really only modest gains when you adjust for this weakened dollar. The value of stocks is therefore overrated, just like those CDOs people are whispering about these days. The gains if you held Euros, however, were real and substantial.  You can take your Euros held since 2000, buy dollars and have a gain of over 40%. (But I’d hold on to those Euros instead, or better yet, gold, which approached $750. an ounce as the dollar weakened this week.)

And this is exactly what many wealthy investors are now doing. They are “diversifying” out of dollar based investments and moving their money off shore, out of the United States. They see the storm clouds on the horizon, and are taking “precautions,” for once the true dimension of the crisis ahead becomes apparent, stocks will also plummet, making the modest, (yet illusory), gains of today into massive real losses. In a survey conducted on Marketwatch.com 22% of respondents said they had great fear of an impending market collapse. Another 31%, were concerned enough to take “precautions.” Only 15% took up Cramer’s “Buy” mantra. The smart money is already heading for the lifeboats.

Here’s a look at where dollars are being stockpiled, comparing the currency dollar reserves of major nations . As you will see, the US is in no way “the richest country in the world.”

The dollar is likely to erode further. Key nations are realizing they must ditch dollars to avoid further losses as the dollar weakens. Saudi Arabia, our friendly gas station in the Middle East, untethered its currency from the dollar, along with Kuwait. Iran has also shunned the dollar, largely in response to Neocon bluster about sending in the bombers, and will accept only 15% of oil transactions in greenbacks. These are the nations with the largest energy reserves on earth, and they are looking for other currency options.

Ambrose Evans- Pritchard of The UK Telegraph characterized the crisis this way: “The dominoes are toppling. What began as a credit crunch has turned into a dollar crunch. We are witnessing a run on the world's paramount reserve currency, an event that occurs twice a century or so, and never with a benign outcome. The US dollar has fallen through parity against the Canadian dollar and plummeted to all-time lows against a basket of currencies. This is dangerous. None of the mature economic blocs seems able to take the strain, let alone step in to restore order.”

A weakening dollar is bad for American consumers, the last unbroken pillar of our economy. As most goods sold here are manufactured in whole or part overseas, these things will begin to cost more as the dollar loses value.  These dollar blues are also likely to cast a pall over holiday shopping, and Wal-Mart is already boarding up the windows and battening things down for a potential negative holiday quarter by cutting toy prices 50% in early October! A Wal-Mart spokesperson characterized it on MSNBC by telling us that Wal-Mart was simply getting “back to its roots as a low price leader.” (It was cleverly phrased BS, and one had to wonder why the retail giant had strayed from that policy in the first place! Tisk, Tisk.) The truth was that the company feared sluggish consumer confidence by December, and so they simply decided to kick start the holiday season early...well before Halloween.

As Irwin Kellner wrote for Marketwatch .com this week:  “This year's holiday shopping season figures to provide all the merriment of a funeral. And don't think for one moment that merchants aren't aware that this could be one of the worst holiday seasons in years....the fact is that more households are in a bind today than in years - if not decades. For one thing, most families are spending more than they are earning. The national savings rate has virtually disappeared. People are unable to pull equity out of their homes to make up the difference between income and outgo because interest rates have gone up while home values have gone down. And when home prices fall, it makes people feel poorer, thus impacting their confidence - not to mention their ability to spend. Meanwhile, the cost of living keeps rising - especially for such essentials as food, gasoline and health care. Renters are watching their rents rise, while homeowners' property taxes are heading north as well.”

This year food is up over 20%, and energy up 12.7%. The price of oil doubled! This is just the beginning. These two vital necessities will continue to increase in price in the months ahead.  Have you begun to feel the pinch yet? Do you find yourself reaching for the plastic more often than not? Considering that Americans spend about 20-25% more than they earn each year, the truth is that credit purchases are soaring. Mish Shedlock sees this as ominous: “I think the market will soon begin to realize that the credit card lenders have, in essence, become the consumer lenders of last resort. As consumers have been shut out of the mortgage and home equity world, the last available credit is plastic. One statistic that I have found very troubling is the degree to which credit card balance growth is running ahead of retail sales growth - a key sign that the consumer is stretched.”

All this adds up to one big word…Depression. It’s October again, the 20 year anniversary of the biggest collapse in financial history, the Black October of 1987.  With housing prices in a freefall, one has to wonder just how much more bad news the markets can take this year before they react…. But don’t mind me. Go watch Cramer on CNN.

While you’re watching, the Government will be running yet another “scenario” in October. It’s called “Operation TOPOFF” and it will pretend that three dirty bombs go off simultaneously in the US, in Portland, OR, Phoenix and Guam. Why they selected that bustling metropolis of Guam is anybody’s guess. One theory is that the “bomb” will be on a ship coming into port. Perhaps they wanted to simulate an attack on a major US military installation, one that has been receiving war supplies and fighter squadrons in recent weeks. I suppose one way to take your mind off a real crisis is to simply make another one up. The crisis in the financial markets, and our eroding dollar, were all made up as well--by wealthy and powerful men who just thought they all knew better than the rest of us. They’ll have their assets well protected in off-shore accounts, and hunker down in gated estates guarded by security mercenaries, while the rest of us hit the bank and bread lines. Ah, the miracle of capitalism!

John Schettler – October 2007
 

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