Saturday, September 12, 2009

All we need now is a big hit to theoretical money - derivatives anyone?

Apparently, not for the chinese. 
Now, think about this for a second. China has engaged in hedging and speculation that has not resulted in benefits to its economy. Quite the contrary actually. Their perception is that we have played games and manipulated financial markets. [surprise, surprise since they thought they were free markets ;-) ] In any event, China owns tons of treasuries. Say we were to get an implosion of theoretical dollars within the financial system via some sort of large defaults...that would trigger real dollars to rise in value immeadiately, likely over the longer-term interest rates would also go up, and bonds down. In the big picture, that would further stress the chinese overall, stress their derivatives exposure and their most popular investment - treasuries plus the derivatives on those treasuries. The implications are not a funny thought. 

Now there is an interesting possible scenario here for the shorter term, one I am quite partial to...the chinese know that we need to keep interest rates low to even attempt to keep deflation at bay and that there is a shortage of real money dollars. If they were to force the collapse of large financial institutions, the buying power of their US treasuries paper could increase dramatically. If this were to happen their influence over the US Government would likely also increase dramatically. Also, their ability to influence our economy would also increase dramatically - at least temporarily. This condition would only be possible if interest rates were to remain low for some time after china's defaults forced major banks into receivership. So, if indeed this scenario were to play out, there could be a lot in it for china, since its reasonable to assume they could generate potentially dramatic positive returns by owning cash dollars while collapsing our debt money based financial system and then hijacking it. (see: Derivatives...what the heck were they for?)

Keep in mind that though the article posted below does not specifically discuss oil...oil is one of the markets that china has been playing in the biggest way...and the impacts of their gamesmanship would likely effect oil even more than soybeans, gold and cotton. This is why oil likely was down so substantially on Friday even though the dollar was weaker than the prior day.

In any case, back to the theoretical world of the fed and out financial system, derivatives are only agreements and agreements are susceptible to be broken and altered. Remember, that JP Morgan has 89 trillion of  purportedly "perfectly hedged derivatives".

"Perfectly Hedged"? We know this to be a lie. Why? It is impossible in the first place and secondly the very nature of a derivative agreement makes it highly improbable. So let's keep it simple and examine just the spread risk on those derivatives, despite what they or the fed may try to say, its in the trillions of dollars. 

Imagine if you will, owning one trillion dollars of some index leaps. Just look at the spread in the market now, do the math and then try to get filled at that spread. That risk alone will be 5 to 10% of capital easily - so, you place your order and immediately lose 100 million when you turn around and try to sell it. Now take the instrument make it 100 times more obscure and transacted in a private market that has limited liquidity...and the spread risk on the equity leaps look tame. Now for each component of a derivative position and its hedges there is spread risk. Unlike a simple directional leap position, which itself has 10% risk in taking into account both buy and sell sides...creating a complex position with hedges adds significantly more spread risk relative to capital required to maintain the position. To see this in real life simply model up a butterfly or any limited risk option strategy and then try to execute it. You will see large losses immediately relative to capital employed and the size of the trade. JP Morgan's spread risk (which is much more substantial than a simple options combination trade) alone makes the bank insolvent. Funky accounting and supportive manipulations of accounting rules, off balance sheet entities and SIV's make it possible to hide these inefficiencies by reflecting theoretical or derived values on the balance sheet - where everything can look - well, "perfectly hedged". 

All of these techniques are tacitly endorsed, lobbied or promoted by the Fed...and follow the pattern of regulation created to legalize criminal or inappropriate activity. In fact, the Fed itself uses these conventions themselves in a lot of cases. The fed's reported balance sheet is supposedly up to around 2 trillion dollars...up some 500% or so...their off balance sheet "balance sheet" makes that sum look like peanuts. So, not only does the spread risk alone accomplish that task of bankrupting JPM but that spread risk likely will add trillions  to our national debt when the JP Morgan's obligations are transferred to the tax payer (to be nice, lets assume 5% of 89 trillion is 4.5 trillion). Notice however, that I did not even mention the china situation yet - that's called counter party risk and that risk is much bigger than china alone. Add that to the equation, and the banking system in the US takes a 20 trillion or greater hit from JPM alone (and quite likely much more)....and guess who gets the bill? 

That's a lot of liquidity to take out of a theoretical and fiat system... the shortage of dollars will be tremendous. (see: Derivatives...what the heck were they for?, More dollar what-if discussion, crash warning and recommendationsThe Future of the Dollar - the biggest short squeeze ever,  The EURO - starting a trip to oblivion and Warren Buffett - the ultimate bull-market manifestation) 

Now you know why the fed has tried like hell to bail out JP Morgan at every turn (starting with Bear Stearns) and especially tried to protect their reputation and image of solvency. But JP Morgan is broke and when they are proven to be broke the whole system will be broke since most banks will be impacted directly and some indirectly.

Observe the chart below. Each large move in the SP500 was preceded by  period of correlated behavior between treasuries and stocks. We are presently in a significantly correlated pattern.
see the original reuters article here or read it below:
US commodities rattled by China derivatives stance

* China lets state firms default on derivative contracts- report
* US soy, gold and cotton pressured by report
* Lawyers doubt legal standing of the move
* Market suspects more potential losses prompt the move
* Foreign banks dismayed (Updates with US gold, soy and cotton markets weighed down by reported move; adds analyst quotes, adds CHICAGO to dateline)
By Eadie Chen and Chen Aizhu
BEIJING/CHICAGO, Aug 31 (Reuters) - U.S. gold and soybean markets fell on Monday following a weekend report that China's state companies may default on commodity derivative contracts with banks providing over-the-counter hedging services.
Traders in other commodities markets in the United States were cautious, underscoring China's predominance as a buyer in global markets from metals to grain to oil after it played a key role in rallying prices to record highs last year.
In a measure of the country's influence over the global economy, U.S. stocks fell after the Shanghai Composite index .SSEC fell nearly 7 percent to a three-month low on fears Beijing is trying to moderate growth and choke off speculation in its stock market by tightening bank lending.
Commodities markets were chilled by a report in Caijing magazine quoting an unnamed industry source as saying Chinese state-owned companies will be allowed to default on commodity derivative contracts. The report provoked anger and dismay among investment banks that feared a damaging precedent.
China's regulator of state owned enterprises, the Assets Supervision and Administration Commission (SASAC), has told six foreign banks that SOEs reserved the right to default on contracts, the magazine said in an article published on Saturday.
A government official said that the Bureau of Financial Supervision and Evaluation under SASAC was handling the issue. The official declined to be named and did not elaborate.
"A Chinese agency said they reserve the right to walk away from bad derivatives contracts and that stirred up a lot of worry not only about the stock market but soybeans as well," said Paul Haugens, vice president at Newedge USA.
China, the world's top importer of soybeans, has been an aggressive buyer of U.S. supplies, helping drive prices higher as stockpiles fell to the lowest level in over three decades.
Chicago Board of Trade soybean futures for November delivery SX9 fell 31-1/2 cents, or 3 percent, to $9.79-1/2.
December gold GCZ9 fell $5.30 to $953.50 an ounce at the New York Mercantile Exchange's COMEX division. U.S. cotton futures fell in early trading due to the news, but closed higher on month-end position squaring.

"Historically, it is not so unusual for China to either renegotiate or abandon some deals that have been made. Some traders who have been around for a while are certainly aware of that possibility," said Bill O'Neill, managing partner at New Jersey-based LOGIC Advisors.
Spokespersons at Goldman Sachs (GS.N), UBS (UBSN.VX), JPMorgan (JPM.N) and Morgan Stanley declined to comment, along with the Securities Industry and Financial Markets Association and International Swaps and Derivatives Association Inc.
The reported letter to the six banks follows an order from SASAC in July that required all state companies trading in derivatives to make quarterly reports about their investments, including details of holdings and performance.
"I won't be surprised if more state firms emerged with big derivatives trading losses. Or else SASAC won't come out with such a radical move," a Hong Kong-based derivatives analyst said.
"As far as I know, there are another number of state firms bogged down in such losses besides those surfaced ones," said the analyst, who declined to be named due to the sensitivity of the issue.
A SASAC media official said he was waiting for the "relevant department's" official comment before clarifying the situation with the media.
The report deals another blow to investment banks hoping to sell more derivatives hedges in China, the world's fastest-expanding major economy and top commodities consumer.
"It's a handful of companies who are being encouraged by regulators to renegotiate. It's outrageous, but it's China so everyone is treading very carefully," said a banking source.
Beijing-based derivatives lawyers said the so-called "legal letter" has no legal standing -- SASAC as a shareholder of SOEs has no business relationship with international banks.
"This can also lead to market chaos. For example, a foreign bank can tell its Chinese clients that it can reserve the right to default on contracts that will bring losses to the bank," said a lawyer from the derivatives risks committee of the Beijing Lawyers Association.
No bank names were reported in the Caijing report. The SASAC media officer also declined to specify any.

Chinese state firms, especially those that have suffered big losses in derivatives trading, have been complaining that their foreign banks sometimes did not disclose full information of potential risks when selling them complicated products. 

Market Observations - Oil and Gold

I would like to point out a few things...though I was unsure that it would occur  and though I thought that it would be optimal...the inflation/fear trade has occurred - setting up a very nice trap. I hope Peter Schiff appreciates the short voctory...(see: So, its all getting very interesting...The best part of the trade has been that Gold advanced strongly while the dollar sold off strongly. However, gold has not reflected price movements commensurate to the dollars price movement. Additionally, the commercial net short for gold is 287,000 the highest of any recent the same time as 90% of peopl eare now bullish inflation assets such as stocks - this is not the kind of condition that supports a strong continued rally in gold or the stock market. Also the 72 day cycle occurred this week for, its definitely setup for reversal. If that happens, we need to watch the dollar and for a potentially strong sell of in the markets. 

A pullback and another rise would and should not be an unexpected occurrence...the pullback we get next week out of our ABC move I presented earlier could be quite interesting and get the bears all excited only to setup one more move to new highs...The problem is that the patterns for BKX, XLF, UTY, OIL etc are not saying that that's what is in store for us. (see: Interesting charts - non confirmations...)

Below is the chart of Oil, the dollar did not move much today intraday though it was down fairly substantially overnight - but Oil was up max 36 cents and tanked the rest of the day. Rather than potentially confirming an ascending triangle...a head and shoulders pattern looks much more probable.

Daneric has some very good charts of the 2-4 channels from the depression to now...guess what we have retested? See: Grand Supercycle Backtest Update

All in all, this makes it very likely that we do not get the luxury of a predictable ending pattern...a perfect ending diagonal may not be in the cards. 

Friday, September 11, 2009

SP500 Symmetry

Most common ABC patterns are where C = A. Well, that's clearly what we have here. Additionally, the timing window for Sept 11 market high I pointed out earlier. Things are looking rather complete to me. Breadth continued to  contract even though we hit new highs. Banks, Financials, Utilities, Agriculture and other metrics are not anywhere making new highs. Sentiment towards the dollar dropped to 4% bulls. Oil collapsed with no commensurate rise in the dollar...and is setting up a head and shoulders pattern.

This market is an exercise in frustration...but there we have it things coming together nicely.

Interesting charts - non confirmations...

Problem charts...very interesting non confirmations

Thursday, September 10, 2009

SP500 Gap Zone

Market Observations

Below is a chart with all the critical trend lines for the SP500. Additionally, the projection of the optimal turn date for Primary wave 2 or B (depending on nomenclature)...

The irony is that the bottom was at 666 and the turn date starts 9/11/09...this is indicated by the magenta line on the chart. If that were to be the relationship that were to occur which does not seem unlikely then its truly an astounding coincidence. I referred to these two data points in some previous posts.

Also, keep in mind that earnings estimates for the third quarter at $14 for the SP500. That works out to a P/E of 75. This is an astounding number especially when earnings have significant risk of coming in much lower than that. Earnings expectations for this past quarter were cut by nearly 50% already. Companies can beat those lowered expections...but that does not fix the fact that earnings are low and going lower.

Below is a chart of the NDX.  We are in a serious resistance zone here...Two rising wedges at once. Perhaps we get a throw over and then fall through the bottom of the wedge.

Below is XLF, head and shoulders pattern continues to be valid. Financials have not been participating in the rally. Maybe, it more of a short squeeze in general since most of the financial shorts have been decimated well before now...Seems like we have to progress through the whole market squeezing every sector until its rung dry.

The RUT has a confluence of resistance above...seems like the next few days may get interesting. RUT has has had an especially strong rally. I wonder what the crash will be like?

Market update

Nasdaq unable to take out highs so far, SP and YM not confirming highs for Russell and EMD.

Breadth 1.85.

SP500 Backtest Playing out NOW

Either we break out or either case the parameters and stops are very close...
Low risk decision point IMO.

Wednesday, September 9, 2009

SP500 levels

This is an interesting chart of the SP500...along with the retest of the up trend line which we got today (not shown...stockcharts is down)...this trend line at 1041 is a big deal.

We'll see what happens.


Tuesday, September 8, 2009


I would like to take this opportunity to congratulate dan eric on two prescient calls that he made.
  1. The dollar ending diagonal (several weeks ago)
  2. The gold triangle (also several weeks ago)
Both of these calls and counts have played out as Dan had illustrated. I wish the P3 would have happened today as we were looking for...but I it looks like were are very nearly complete here.

In any case, I would also like to add that Dan is of course a much better elliotician than I am.  I like to write analytics and code for trading and trading systems, so please defer to his labeling when in doubt...Dan is consistent, timely, accurate and quite an asset for us all. My question to you Dan is: have you ever considered working for EWI? I spoke at length with some of the people there...seems like you could be a tremendous value to them too?

I any event congratulations on your tremendous work...and thanks.

Speaking of EWI...everyone should hear this hour long interview with Bob Prechter...its very interesting. Click here for the mp3 audio

p.s. please forgive my crude labeling sometimes and thanks for your feedback

Market Observations

VIX was up today...the whole day including from the gap up. Utilities Continued their lackluster hold of support at their channel. XLF head and shoulders are progressing nicely. Breadth was not great today...2.9 to 1.

The story of the day was the dollar which fulfilled the Ending Diagonal potential that I have previously discussed. There could be a small throw over...but overall the Dollar's down move looks finished and counts pretty close to complete. Therefore, this up move in the market is on VERY thin ice. I had been worried that the move down in the dollar could be time consuming...but am pleasantly surprised that it essentially hit my targets in 1.5 days. That shortens this rebound in the stock markets considerably.

DBA was down today regardless of the dollar and Oil traded weakly even though it was up. I was trading oil and made most of the money shorting it.

ES and Breadth

Here is a chart of today's breadth...

UUP Chart

This is a chart that Mathew Fraily has made and been watching with me for over a month...

Nice work Matt. check out matt's other work at

DBA - Deflation Is Clear and Present

Even with the dollar making its ending diagonal lows, DBA can not get out of its own way...

Dollar - Fullfills Ending Diagonal...

Market rally is a trap...Euro topped. Perhaps we can get a little throw over...but essentially the EURO is done and the Dollar has bottomed. Stock market prices should be a lot higher given the dollar weakness and DX should be confirming DXY prices.

Also, DXU09 is not confirming DXY price. usually the spread is 9 its over 25 cents.
[update: 9:23 am DX 77.5 DXY 77.19 = 31 cents spread - lower 2 - 4 line target for DXY is 76.7] we start to hear it. "UN Says New Currency Is Needed to Fix Broken ‘Confidence Game’"

 The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the “confidence game” of financial speculation, the United Nations said.
UN countries should agree on the creation of a global reserve bank to issue the currency and to monitor the national exchange rates of its members, the Geneva-based UN Conference on Trade and Development said today in a report.
China, India, Brazil and Russia this year called for a replacement to the dollar as the main reserve currency after the financial crisis sparked by the collapse of the U.S. mortgage market led to the worst global recession since World War II. China, the world’s largest holder of dollar reserves, said a supranational currency such as the International Monetary Fund’s special drawing rights, or SDRs, may add stability.
“There’s a much better chance of achieving a stable pattern of exchange rates in a multilaterally-agreed framework for exchange-rate management,” Heiner Flassbeck, co-author of the report and a UNCTAD director, said in an interview from Geneva. “An initiative equivalent to Bretton Woods or the European Monetary System is needed.”
The 1944 Bretton Woods agreement created the modern global economic system and institutions including the IMF and World Bank.
Enhanced SDRs
While it would be desirable to strengthen SDRs, a unit of account based on a basket of currencies, it wouldn’t be enough to aid emerging markets most in need of liquidity, said Flassbeck, a former German deputy finance minister who worked in 1997-1998 with then U.S. Deputy Treasury Secretary Lawrence Summers to contain the Asian financial crisis.
Emerging-market countries are underrepresented at the IMF, hindering the effectiveness of enhanced SDR allocations, the UN said. An organization should be created to manage real exchange rates between countries measured by purchasing power and adjusted to inflation differentials and development levels, it said.
“The most important lesson of the global crisis is that financial markets don’t get prices right,” Flassbeck said. “Governments are being tempted by the resulting confidence game catering to financial-market participants who have shown they’re inept at assessing risk.”
The 45-year-old UN group, run by former World Trade Organization chief Supachai Panitchpakdi, “promotes integration of developing countries in the world economy,” according to its Web site. Emerging-market nations should consider restricting capital mobility until a new system is in place, the group said.
The world body began issuing warnings in 2006 about financial imbalances leading to a global recession.
The UN Trade and Development report is being held for release via print media until 6 p.m. London time.
see full article at:

If there ever was a sign for a coming bottom in the dollar this is it. If there was ever a sign that Bernake is a liar this is it. Ron Paul called it...

If derivatives could not solve the problem for these manipulators, the best choice is to create a global currency...but you need a really good excuse for that. Derivatives were a good first try. Please see my posts on the dollar. (Derivatives...what the heck were they for?More dollar what-if discussion, crash warning and recommendationsThe Future of the Dollar - the biggest short squeeze ever and The EURO - starting a trip to oblivion

This is much further along than I expected. 

These guys will stop at nothing.

Monday, September 7, 2009

Sunday, September 6, 2009

Fed's Hoenig is worried about inflation...

"As we become more confident that we are at the bottom of the recession and are moving into recovery, we must become more resolute in systematically reducing our balance sheet and raising interest rates."
"If the government, the banks and consumers address the difficult issues of debt and the Federal Reserve begins to remove the significant stimulus in an orderly fashion, then we will come out of this recession without an inflationary hangover. Noninflationary growth will follow, new wealth will be generated, and we will continue to be the strongest, most successful economy in the world. But in the short run, these actions will involve painful choices, and it is the responsibility of citizens like you, and policymakers like me, to consider the impact of today’s choices on tomorrow. We must choose well."  
"If the monetary stimulus does not come out, the price level trend shown earlier in Chart 9 will only worsen. As a reminder of what that might imply, you need only study the early ’80s when high inflation undermined our economic system. "
"In considering these charts and the matters of policy, we should be aware of two pieces of legislation that I suggest influenced their contours: the 1946 Employment Act and the 1977 Amendment to the Federal Reserve Act. The 1946 Employment Act established as a national priority a goal of low unemployment.  Low unemployment is a worthy goal and one that I share, but it cannot be achieved by systematically keeping interest rates low.  In 1977, Congress passed the Amendment to the Federal Reserve Act—also called the Humphrey-Hawkins Act—which called upon the Federal Reserve, as the central bank of the United States, to pursue a dual mandate of promoting long-run stable economic growth and stable prices.
"Assume for a moment that the 20 largest institutions were required either to raise new equity, or to reduce their total assets to meet the 6 percent equity capital ratio.  This would require that they raise more than $300 billion in new capital or, as Chart 2 shows, they would need to shrink in size by $5 trillion, or some combination of the two options. The numbers in Chart 2 make clear how much of an advantage the larger institutions have over smaller banks, and show the excess leverage the largest banks have accumulated."
full text available here: Thomas M Hoenig Text

The above are quotes from Thomas M Hoenig, President Federal Reserve Bank of Kansas City. Clearly, Hoenig makes some very good points regarding our financial institutions over leveraged condition and debt situation overall. I would say its too little too late however. Isn't this something they were supposed to be watching for the last 25 years?

But worst of all, as professed students of the Great Depression and keepers of the money...he apparently thinks that the Fed has been successful in its mandate of promoting stable growth and stable prices. If you look at the dollar chart...a 96% decline IS NOT STABLE PRICES. It may be stable growth, but it is definitely NOT STABLE PRICES.

Additionally, Hoenig is worried about inflation. Can you see inflation in that DBA chart? I can't. And what does this depression have in common with the 1974 recession? Not much - I will tell you. All the Fed does is worry about inflation, because they need inflation in order to continue their policies regarding fiat currency and fractional reserve lending.

Clearly, he may be a smart man and certainly seems much more sensible than Bernake...but he should not have his job if I can understand the financial system better than he does. This is astonishing.

End the FED.

DBA - Ready for wave 5 down?

After a very long wave 4...DBA, despite Jim Rogers prognostications, looks rather negative here...again Tuesday is make or break. Given that the weakness in the dollar did not help DBA and the condition of oil - this does look like 4th time could be a charm. If indeed this is occurring this is a picture of deflation in progress...and likely herald the same for the stock markets.

Just a simple chart...

Utilities also made a very unconvincing bounce after their pullback...its at a support area could try to bounce a bit more...but looks weak.
Junk Bonds ratio to treasuries sport a completed impulse wave. This is something to keep an eye on.

Derivatives...what the heck were they for?

Let's discuss a few things regarding money. The creation of money as I have indicated in my previous posts is the creation of debt. (See: More dollar what-if discussion, crash warning and recommendations and The Future of the Dollar - the biggest short squeeze ever and The EURO - starting a trip to oblivion). We know from my earlier posts on the subject, that it is a banker's fantasy to dilute a currency while selling it for a positive return at 30 to 300 times leverage.
I am a factory owner. I make widgets. I am the only one who makes these particular widgets and they are terrific and everyone wants them. Now, I have a new and improved widget which I have not sold to anyone yet. An intelligent entrepreneur comes to me with an idea after he sees them. He thinks they are the best thing since sliced bread, so, he wants me to lend him 100 improved widgets and he promises to return my original 100 improved widgets in five years plus 8 of my improved widgets per year over a term of 5 years. 
Its an unconventional deal - but I think about it. "Good deal" I say "ok...lets do it". Now I like this deal be cause he is effectively short 40 improved widgets of which I control the supply. So, if he wants to get those 40 and they are not available I will control the transaction terms. 
He signs on the dotted line and we are all done. He now has an obligation to repay me 100+40 improved widgets. His first year in business goes very well with my improved widgets. And at the end of the year he attempts to locate 8 of them to give to me according to our deal. He looks in the market and is unable to locate any of my improved widgets anywhere. So, he says what the heck, business is good - I'll just deliver 8 of my 100 widgets and then I'll figure out how to get more later. So, our hapless entrepreneur is continuing on in his pursuits - business is going well - until next year when he is on the prowl for those widgets to deliver as per our transaction terms. He is astounded to find out that, I only created 100 of these things and I loaned them all to him. Clearly this is an unworkable situation and he should try to renegotiate the terms. But that's not the point of the story. 
When the entrepreneur borrowed 100 of my improved widgets...I created 100. He promised to repay 140. But I never created the additional 40. Ordinarily, you would think that me being a clever business man, I would want to sell as many of these new things as possible - thereby giving him a market to locate these 40 widgets he is short. However, that would only mask the conflict in the transaction. 
In order for me to create widgets based on the agreed terms, I need to create the stock and I need to create the 40 widgets that the entrepreneur is obligated to deliver. This is technically, a monopoly game. And the important point is that if I never create the additional 40 widgets, for what ever reason...the agreement falls apart but the entrepreneur is still obligated to deliver. If i create a lot of widgets, ultimately there is still an imbalance of 40 widgets that should be returned to me that theoretically do not exist - even though the market place would have plenty of stock available and would likely allow that imbalance to go unnoticed...until it mattered. 
The book report
Well, what I have described above? Its the mechanism by which money is created. Firstly, a bank is a factory for the creation of new money - a bank's job and earnings generation is predicated on the manufacture of new money in the financial system. Therefore, money is created when the bank (factory in the above example) loans you principle. An imbalance is created when you promise to repay money that does not exist - in the form of interest.

I know this is difficult to rationalize. But its the way things work. As long as ponzi scheme bankers can keep giving out loans and increasing the money supply the imbalance is not apparent. Until it is of course.

Now, if I was a smart ponzi scheme banker (and they are). What I would do is, try to create theoretical money. Imaginary money that everyone believed actually existed and could be used to settle future obligations - such as Warren Buffett's potential $50 billion+ obligation on his european style puts. (see: Warren Buffett - the ultimate bull-market manifestation)

This is like creating imaginary widgets in the story above. If the guy could simply turn over an imaginary widget to me and I would be satisfied with it - then he's fine and business goes on smoothly.

The vast pools of money
You have probably heard of the vast global pool of money - its supposed to be around $70 trillion. This pool of money simply trades the debt money created by fractional reserve lending activity - paper. $70 trillion does not even begin to touch the amount of debt + interest obligations there are in the world. One of the key elements of fractional reserve lending is that once a credit is created...a note or paper is created that represents the value of the borrowers promise to repay and assets he posts as collateral. That is what trades in the vast global pools of money. And as long as the music is playing - everyone is dancing. Credit (Money), however, is not for the most part created by these pools of money (theoretically that could represent value and that would not be good for growth). In the majority, it is created by regulation via fiat when fractional reserve lending takes place. And this is why the dollar chart looks the way that it does. The banks have shorted the dollar into oblivion and sold it to suckers who think buying a depreciating asset and paying interest for it is great if they can invest that money in inflating assets that theoretically outperform the depreciation of their dollars. Obviously, this is a hair brained plan and can not work when the music stops. It also blows up when your inflation assets depreciate.
Just to announce it formally - the MUSIC HAS OFFICIALLY STOPPED...but the fed is still dancing.

So this brings is to derivatives. 
Ok, we have all heard of naked shorting. This essentially means that people are selling shares that don't even exist. I have seen instances where the float of a company was tripled due to naked shorting. This operation creates theoretical shares. This is what the banks do with our financial system every day - only with currency.

Now what are derivatives? Who came up with them? Why did they come up with them? 
There are a lot of reasons that people will give as to why a derivative is useful or required.
  1. Hedging
  2. Risk Management
  3. Speculation
But do we need them and why were they created?
Let me answer that question in two parts. Firstly, people who work at banks do not ask themselves what money is. The question seems almost too ridiculous. So, most bank employees can not give you the correct answer as to what money is and how it is created. So, we have a lot of smart people furthering a scheme that they don't even know they are participating in. As long as its not illegal they go along with it.
With derivatives we have a similar situation. A lot of brain surgeon types never asked essential questions about what the real impacts of their work was. But lets look at what that is.

Theoretical money
  1. Asset appreciation
  2. Credit
  3. Interest on credit
  4. Modeled Obligations
When stocks or real estate go up, money is created that never existed before. When they go down the opposite happens.

When a loan is given, new money is created.

Interest on credit theoretically exists...but the credits (Money) for that interest money need to be created somehow. This is why we need derivatives or vehicles like them, to create the money for the interest due on debt money that is created by banks.

If I loan $100,000 to someone on a 30 mortgage at 7.5%. I create $100,000 of new money...but the person promises to repay me  $251,717.22. So, I need to create $151,717.22 somehow. If on the basis of that issue of credit I create more credit, I will have to create a lot more than $151,717.22. In any case, the only way to create the interest money is to create credit - which creates interest obligations (and that debt money does not exist) and ultimately blows up the system.

Modeled Obligations - to the rescue - they can create money at a whim similarly to how the stock market does...theoretically with no standard interest requirements and very few participants which is rather advantageous when compared to the stock market or other publically owned and priced assets. Essentially, if the most simplistic assessment of a derivative's function were to be accepted, the function is to defray risk and therefore insure against defaults. If defaults are insured, or accepted as such, then the money to cover a default exists and thusly debts can theoretically be satisfied. This, as in 1987 is a completely false interpretation or reality and a symptom of ponzinomics.
If I have a fraudulent money system. I need mechanisms that can create money (Debt) without requiring interest. That's what derivatives are for. And that's why we had 790 trillion dollars of them at one point and why JP Morgan currently has 89 trillion of them on their books (all perfectly hedged mind you).

But what are derivatives?
Derivatives are Modeled Obligations.
  1. Options
  2. Futures
  3. Exotic Agreements 
  4. CDS's
  5. CMO's
  6. CDO's
  7. Structured Products
Options are fairly simple - though spreads and volatility make them complicated. All derivatives have option characteristics. Options themselves do not usually create very much new money.

Futures are also quite simple. However, highly leveraged. With 1 future you can control 40, 50, 60, 80, 100 times the money requirement to trade the future. Guess what? That creates money...theoretically of course. Since you have agreed to take on all the risks of that position - the 100,000 of theoretical money can be written into the books - again theoretically of course. If you look at what it costs you to control that amount of money there is a problem. Clearly this credit is being supplied at such a high discount that there is barely a cost in the standard form of credit issuance. Therefore the money system is creating new money that can be theoretically used to pay the interest on existing credit with debt money that creates very little interest. Remember, how our money system operates - theoretically - of course.

Most of the other structured products and other derivatives operate on the same basis except even more leveraged and primarily based on ratios of one agreement to another...bundled up as a unit they can considered a single derivative - i.e. a derivative is usually built out of multiple subordinate derivatives.

What's our total debt?
The total dollar debt in the world is roughly in the 350 trillion area...with interest requirements that over the term of those notes requires 500 to 600 trillion of theoretical money to be created...this can be done as I indicated earlier through inflation or through theoretical mechanisms. Derivatives are the Fed authorized/endorsed/promoted mechanisms capable of theoretical money creation that does not implicitly create large interest obligations and can be used to support expanding asset inflation and as a result create enough money to theoretically repay all the interest on the total outstanding obligations.

When Tim Geithner discusses the need for Derivatives regulation, keep in mind that the development of derivatives was explicitly developed under his watch and Greenspan's auspices. These guys knew we needed derivatives. It was their only way out. And they implemented the scheme deliberately, promoting SIV's and off balance sheet transactions combined with flakey accounting along the way for spice, so that Bank balance sheets could be manipulated and theoretical money could be created without standard interest obligations.

The Fed is the driver of the Fraud. JP Morgan, among a very select few other we all know by name, is one of the primary vehicles for it and the most dangerous bank in the world.

This is big subject I will follow up with a lot more details as I get time... theoretically of course.
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