Deflation In The Casino: Central Banks Play Their Last Chips To No Avail

by: David Lee Goldman

Originally published March 2016; Revised December 5, 2016

  1. This is not your grandfather´s capitalism
  2. A global $US short squeeze
  3. Negative Interest Rate Policy (NIRP): a perverse incentive to hold non-productive yield free cash
  4. Central banks approach end-game while fighting the last monetary war

Deflation today is a consequence of debt piled on more debt accompanied by failure to generate sufficient wealth, growth and employment resulting in an inability to service the debt. The dollar has risen against other currencies, not because it is strong, but because the lack of global economic growth has exposed the weakness of a petrodollar money-as-debt monetary system. The gaming of the monetary system by all the controlling players is the essence of 21st century capitalism. The failure of this capitalism will mark the end of the American century.

This is not your grandfather´s capitalism

The zero interest rate policies of the US Fed no longer encourage savings as a significant source of funds for private capital expenditure on productive assets. With unlimited money printing costumed as ¨qualitative easing,¨ QE, and ¨qualitative and quantitative easing,¨ QQE, the US Fed and other central banks have purchased trillions in debt issued by major banks and corporations in recent bubbles at face value rather than market value, supplying the financial sector, some of the largest constituents of which actually failed in 2007-8, with funds to lend to corporations at historically extremely low rates.

Many corporations are collectively spending hundreds of billions buying back their stock and issuing dividends rather than expanding their operations. This is a direct consequence of and a rational response to Fed policy. Former Fed governor Richard Fisher confirmed that the Fed injected ¨cocaine and heroin" into the system to boost the stock markets in furtherance of, among other things, the ¨wealth effect¨: the belief that rising stock markets generate confidence that translates into more consumer spending. The US SEC acknowledged the buybacks and asserted that buybacks under Rule 10b-18 are "voluntary safe harbor[s]" that preclude market manipulation charges. In another context this was called ¨dumbing deviancy down.¨ The result is a churning of liquidity to create the appearance of an economy producing wealth rather than the actual creation of wealth. And the creation of mountains of debt.

Further consequences of these policies unroll as global liquidity falls:

Source: Bloomberg

and a certain amount of quarter-ending corporate book cooking is required to make this new capitalism presentable. Large end-of quarter Fed reverse repo data suggest that the need for cash on the books on important accounting dates correlates with monetary base changes and stock index movements. US Treasury fails-to-deliver, at an average of $50 billion per day figure in this scenario as a way to address a shortage of money-good collateral.

Worse than that, entities - some of whom are central bank primary dealers - such as HSBC (drug money laundering), Standard Chartered (falsifying records of transactions with sanctioned countries, RBS (Libor rate fixing), BNP (transactions with sanctioned countries), Barclays (Libor rate fixing), Bank of America (mortgages), Citibank (forex rigging),Wachovia (drug money laundering) and JP Morgan Chase (take your pick) pay fines for criminal activity and recover the ¨losses¨ with more, uh, business. And by the way, the fines are tax deductible as a cost of doing business.

In 2009, according to the UN Office on Drugs and Crime, there was plenty of drug cartel liquidity supplied to banks in need, and the City of London now seems to be a major center of drug-cartel money laundering.

The Fed´s preservation of failed banks and corporations negates Joseph Schumpeter´s ¨creative destruction¨ that made the capitalism-that-was the dynamic engine that could. Richard Duncan calls a monetary system that continually issues more debt until the debt can no longer be serviced "creditism.¨ Unregulated derivative markets permit the gaming of all the debt in a manner that furthers the ability of the financial sector of the economy to operate as a profit center instead of a cost of doing business.

The FIRE components of the financial sector: finance, insurance and real estate, grew from 10.5% of GDP in 1947 to 21.5% in 2009. They do so at the expense of what most understand as the benefits of yesterday´s capitalism to have been: the generation of wealth, growth, employment and the capacity to sustain a consumer middle class. There was a time when the dominant oligarchs understood the need to reel in the worst excesses of capitalism. F. William Engdahl provides an excellent history in his ¨Gods of Money¨ detailing how the Rockefeller combination successfully lobbied in 1933 for the prohibition of commercial banking and securities transactions in the same bank, via the Glass-Steagall Act, against the wishes of Morgan & Co. Glass-Steagall was repealed in 1999 during the Clinton administration.

The fiat currency created by the money-as-debt monetary system is not generating inflation, with monetary velocity in the dog house and the global struggle to service increasing debt. Deflation today is a consequence of debt piled on more debt accompanied by failure to generate sufficient wealth, growth and employment resulting in an inability to service the debt. The major central banks are working in the service of what are essentially banks operating as hedge-funds when the Bank of Japan engages in infinite QE or the ECB increases its failed QE program from 60 billion euros per month to 80 billion per month. The financing utilities - the banks - have become the tail wagging what used to be the capitalist dog engine of growth.

A global $US short squeeze

As a result of the low price of oil, diminished petrodollar flow results in a decrease in global $US liquidity and a reduction in sovereign wealth funds which then must liquidate assets to meet domestic needs:

Sovereign Wealth Funds, Oil, and Markets


The total assets of sovereign wealth funds, as of last March, were estimated at $7.3 trillion by the International Monetary Fund. That figure has doubled just since 2007. The IMF adds that at least $4.2 trillion of this wealth was energy-related.

A nice chunk of this accumulated oil wealth was placed into global financial markets by countries like Saudi Arabia.

But now plunging oil and gas prices have pushed these countries into budget deficits.

For example, Bank of America estimates that $30 per barrel oil will balloon the Saudis' 2016 budget deficit to $180 billion. Add to that more than $100 billion in reserves spent in trying to defend its currency (riyal) peg to the U.S. dollar.

So it's no surprise that the Saudi Arabian Monetary Authority (SAMA) says their foreign assets fell by a record $108 billion in 2015. SAMA owned $423 billion in overseas securities as of November.

. . .

In the Gulf region alone, the IMF estimates the fiscal surplus of $200 billion in the 2015-20 period will now turn into a $145 billion deficit over the same period.

Draining Liquidity

The deficits are pushing the oil-producing countries to liquidate some of their holdings and free up monies. Even Norway was forced to tap into its massive $820 billion sovereign wealth fund - the Government Pension Fund Global - for the very first time last October.

. . .

The Royal Bank of Scotland's Head of Credit Macro Research, Alberto Gallo, estimated that the gross flow of petrodollars into the global economy fell to a mere $200 billion last year from $800 billion in 2012. [emphasis added]

Source: Tim Maverick, Wall st daily

In the US, Alaska is literally a failing petrodollar state:

With oil prices down along with oil production, the state is facing an Alaska-size shortfall: Two-thirds of the revenue needed to cover this year's $5.2 billion state budget cannot be collected.

Source: The New York Times

A second aspect of the squeeze may seem counterintuitive at first glance. The oil-based $US is in an inverse relationship to oil prices. The lower the price of oil the higher the $US:

This relationship suggests that when the petrodollar tide went out the $US is seen to have been swimming naked.

Another factor squeezing the $US is dollar credit issued to borrowers outside the US which now totals $9.8 trillion, of which $3.3 trillion is owed by borrowers resident in emerging markets. Debt financed with commodities/trade denominated in non-$US currencies makes for a continued demand for $US liquidity as the $US rises and the debt-servicing costs rise for entities using other currencies.

Yet another squeeze on liquidity for investment in the US especially has been the requirement that counterparties to US energy producers´ hedges cover their obligations as the price of oil has fallen. In April 2015 the estimate was that this liability was $26 billion as of December 2014. The price of oil has dropped further since that figure was published. Then there´s the increasing damage to energy loan portfolios of possibly $1 trillion. Or more. Moral hazard anyone?

The dollar has risen against other currencies, not because it is strong, but because the lack of global economic growth has exposed the weakness of a petrodollar debt-fueled monetary system. An otherwise small difference between world supply and demand for oil, about 1-2% more supply during 2014-2015, facilitated a major price decline -exacerbated no doubt by derivative trading in the casino - and revealed the critical shortage of dollar liquidity to service global debt.

Negative Interest Rate Policy: a perverse incentive to hold non-productive yield free cash

Negative interest rates in Europe and Japan represent the final frontier - to boldly go where no monetary policy has gone before - and the amounts involved are beginning to add up: ¨By February, more than $7 trillion of government bonds worldwide offered yields below zero.¨ The long-term consequences are unknown. In the short run, what could be better calculated actually to result in a run on safes in Japan, ¨lockers¨ in Germany and to stimulate banks in Germany to stack cash?

It doesn´t take much imagination to see NIRP might mean to the 20 Organisation for Economic Co-operation and Development country pension funds that have an ¨unstated $78 trillion in retirement-related debt.¨ In the long run how will pension funds finance payouts going forward? Throw in insurance companies and the situation becomes even harder to understand and to manage:

Munich Re, the world's second-biggest reinsurer, expects profit to decline this year as falling prices for its products and low interest rates weigh on investment earnings.

Source: Insurance Journal

Speaking of insurance, in a negative interest rate environment, gold shines more brightly: as the prospect of a monetary reset a la Bretton Woods (BW) that reintroduces gold into the mix as a brake on unlimited fiat money creation increases in thinkability, gold looks more and more like insurance and less risky than stacking cash. Germany´s Munich Re seems to agree as it proceeds to stack both cash and gold.

Central banks approach end-game while fighting the last monetary war

Central bank machinations amount to fighting the last monetary war. In 1944 the Bretton Woods agreement formalized the geopolitical reality of the 20th century: US world domination. The tools appropriate to that monetary world will not address today´s deflation. The central banks refuse to purge debt from the systems they ¨manage¨ and that dooms their policies to failure. None of the current dominant stakeholders will lead this purge because all their assets and control positions depend on continuing the money-as-debt based system. Upton Sinclair said: ¨It is difficult to get a man to understand something when his salary depends upon his not understanding it.¨

Central banks use QE, QQE and NIRP and never eliminate any of the overhanging debt that plagues the global monetary system. These policies eliminate the possibility of real-price discovery in all markets and therefore render the gaming of the system by all the major players the essence of 21st century capitalism. Drug cartels provide liquidity, corporations buy-back their own shares with borrowed low-interest loans, major banks commit fraud and pay fines as a normal course of business, the ECB faces an Italian bank crisis that dwarfs the Greek crisis and the European Commission (the executive branch of the European Union) is working its way to requiring Germany to insure a new eurozone-wide bank deposit insurance system - an idea anathema to the Germans, one of the few wealth-producing nations in the EU.

The 1973 petrodollar replacement for the BW agreement-oil became the basis for the $US- has run its course now that the diminished oil-export nation surplus liquidity is insufficient to provide liquidity to service the massive global debt. The loss of this increment of $US liquidity flow is crucial. The abandonment of the BW gold standard in 1971 marked the beginning of the end of the American century. The adoption of the petrodollar system and the emergence of industrial China after 150 years of western imperialist domination delayed the finale of the American century as China accumulated several trillion in $US denominated paper. The US dollar enjoyed a ¨dirty float¨: no nation could afford to operate without otherwise unredeemable $US reserves (Bernanke´s global savings glut?) that would allow them to transact international trade in that one reserve currency. In this casino the US was the house and no one could turn in their chips for anything but more of the same debauched chips.

On October 1, 2016 the Chinese yuan became an International Monetary Fund Special Drawing Rights currency. The Chinese yuan will become an International Monetary Fund Special Drawing Rights currency. In spite of China´s economic and banking excesses, note that China has

This could be China´s century. A monetary reset will upset all international geopolitical relations.


The world monetary system needs a governor on the creation of money-as-debt because excessive money-as debt creation has debauched currencies. Gold, the traditional governor on the global monetary system, has been deemed to be an anachronism largely because it has been more than a generation since any currency was redeemable in gold. The major decision makers have been schooled in a fiat system and have no experience with any other system and no incentives to curb monetary excesses. It´s the only system they know. In hindsight, those countries that increase their physical gold reserves will be deemed to have made obvious choices in an environment ripe for a reset, but now look anachronistic.

When will the reset occur and when will gold be reintegrated into the global monetary system? Not before nations begin steadily reducing the US dollar component of their national monetary reserves - now approximately 60% - well below 60% and not before the proportion of world trade conducted in the US dollar - now approximately 43% - falls significantly below 40% of the total amount of currencies used in trade. When these trends are understood to be irreversible, economic confidence in the current fiat system will erode because capital flows to where its owners deem it is safest. Loss of that confidence will trigger the reset.

Until then, it´s rational to stack cash and gold in secure places and to hedge holdings in sufficiently varied asset classes such that some will rise as others fall. For instance, one might invest in real estate and art as well as the war industries. It looks like the US dollar and US Treasury bond prices will continue to rise with the continued short squeeze on the dollar until the balloon bursts somewhere in high atmosphere black swan flight line.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.