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For the duration of the first quarter 2020, I have been astonished that nobody in the financial media has discussed the biggest risk that exists in the global financial system, so I finally felt compelled to write the longest financial article I have written in the last decade to address this issue. I graduated from an Ivy League university, earned two master degrees, one in business administration with a concentration in finance and another in public policy, and have worked for two of the largest financial institutions in America as a Private Wealth Manager/Private Banker. Yet, by far, my greatest understanding of how global financial markets work and of how asset prices are set came nearly entirely from relentless years of self-educational activities pursued completely outside of the academic and corporate world. I often witnessed financial events while working at the two of the largest global financial institutions in America that directly contradicted the mechanisms of what I had been taught in school, like what makes one foreign currency stronger than another and what makes the price of stocks go up and down. And I also witnessed rampant systemic unethical behavior in the corporate world of profits over social good, much like Amazon CEO Jeff Bezos has exposed thousands of his Amazon warehouse workers to coronavirus infection recently because of his personal emphasis of profits over human life. However, I already had an inkling of such practices before I was imbedded in the industry, so though some of the details and systemic nature of such practices were novel to me due to my naiveté at the time, it certainly did not come as a complete shock.
Though I graduated from a top-15 MBA program in America, I graduated without ever learning about how Central Bankers act as gatekeepers for academic economists in America. I graduated without learning why dissent from Central Banking narratives, even in light of strong supporting evidence, is apt to kill the upward mobility of career academic economists. I graduated without ever learning about the true function of gold swaps, overnight repurchase agreements, and the Exchange Stabilisation Fund (ESF) division of the US Treasury Department. I graduated without ever learning about dark pools, high frequency trading (HFT) computer algorithms that sometimes were utilized by unethical bankers to “hunt” stop-losses in stock markets and artificially trigger losses for clients (i.e. Daniel Plunkett of Barclays Bank), and without learning about how quote stuffing and spoofing could artificially move stock and asset prices. I graduated without learning how increases in initial and maintenance margins in paper derivative futures markets could move commodity prices in exact opposition to swelling demand and shrinking supplies of these underlying commodities in the physical markets. In other words, my entire education about the real mechanisms that control the purchasing power of currencies and the movement of capital asset prices happened completely outside of the academic classroom and environment, despite my shiny academic pedigree that confused executive recruiters had confused for intellect during my entire corporate career. These recruiters never understood that I developed my levels of intellect despite, and not because of, my academic pedigree.
And ever since then, since my understanding of how global currency and stock markets work and how global asset prices are set increased tenfold, my record of predicting major global financial events has been completely stellar. For example, because of my expanded understanding of how global financial systems work, I was able to predict the first 2008 global financial crisis just eighteen trading days before it happened. In more recent times, within the last year, I’ve made a series of predictions that all have come true within relatively quick timeframes, including predictions last year of an imminent US stock market crash in 2020, the US Central Bank being handcuffed with no choice but to cut interest rates back to zero while Central Bankers were still predicting Fed Funds rates of greater than 3.0%, dozens of calls for specific stocks to crash, after which all of them but one did, and many more, all of which can be confirmed here. And back in August of last year, I posted the below chart of the US corporate junk bond yield chart with the question, “Does the Corporate Junk Bond Market Predict a US Stock Market Crash?”, warning that if the yield curve broke out of a massive multi-year cup and handle formation, that this would be predicting a stock market crash. And we can see the exact same chart, updated for 26 March, in which the yield spiked violently higher, breaking out of the cup and handle formation, on 20 February 2020. In fact, I would put my record of financial market predictions last year for events that were to manifest this year against anyone else in the world for level of accuracy.
But with my above predictions having already manifested, I am now turning my attention to a monster in the closet that has lingered since 2008 and has never been conquered, a monster about which everyone seems to have forgotten – and it is not the infamously Rolling Stone journalist Matt Taibbi’s described “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”. That monster comprised of Goldman Sachs bankers, is still very well and alive, and likely to be bailed out by taxpayer money again at some point moving forward. The monster that has been forgotten, still lurking in the shadows of which I speak, is the massive, risk-filled OTC (over the counter) global financial derivatives market. Shortly after the 2008 global financial crisis began, in September of 2008, the cumulative nominal value of global financial derivatives was estimated at $1.4 quadrillion, with the Bank for International Settlements (BIS) reporting that the global OTC derivative market accounted for $863 trillion of this number. Of the $863 trillion global OTC market, the largest amount by far, according to data compiled by the BIS, consisted of interest rate derivative products (with a notional value of $458 trillion), followed by unallocated derivatives ($81 trillion), ForEx derivatives ($62 trillion) and Credit Default Swaps ($57 trillion). Though the risk of CDS products garnered the lion’s share of mass media attention during the 2008 global financial crisis, they did not present the greatest threat to the global financial system, as that title went to the category of interest rate derivatives.
For the past two years, mass media outlets like the Wall Street Journal have consistently discussed reasons why US Central Bankers would continue to raise interest rates (see here and here). These discussions always confounded me, because a simple understanding of the massive inherent risk of the global interest rate derivative market should have painted a crystal clear picture to any financial analyst worth his or her weight in salt of the impossibility of significant Central Banker interest rate hikes to materialize, despite any propaganda to the contrary. For example, to start 2019, banker Karen Gillmore of the Federal Reserve Bank of Atlanta stated that she anticipated two interest rate hikes that would raise the Fed Funds interest rate to 3.25% at some point in 2019. However, understanding that such a behavior would crash the global financial markets, I stated in an article I published on my news site on 10 August 2019 that it would be near impossible for US Central Bankers to raise interest rates much above 2.25% to 2.50%. I stated that the debates on television of what US Central Bankers were going to do in regard to interest rate policy decisions for the remainder of 2019 were quite ridiculous as they had no choice, despite the fact that Central Bankers were still promoting the illusion that they had a choice. And sure enough the Fed Funds interest rate peaked at 2.25% the very month of my prediction, and then proceeded to steadily decline, until they finally declined all the way back to zero, just as I had predicted, in an emergency US Central Banker announcement in early March.
Later, during that same month of August 2019, I discussed why US bond market behavior back then was spelling out massive troubles ahead for US stock markets, and I repeated my warning again on 19 December at the end of last year, when I ridiculed the US Central Banker narrative that the economy was “robust”. In stark contrast, I bluntly stated that their provision of trillions of dollars of liquidity in the overnight repo market to US banks was a direct contradiction of their claim of economic “robustness”. By naming this article “Don’t Be Distracted by the Overinflated US Stock Market”, I could not have been more explicit in my warning that the US stock market was a massive bubble on the edge of popping, which of course, happened just a few months later, though the pop was falsely and conveniently blamed on the coronavirus pandemic by Central Bankers and top Wall Street bankers. The coronavirus pandemic, which I also labelled as a pandemic many weeks before the World Health Organization, was only the trigger for the US stock market rout, but certainly was not a primary, or even a secondary or tertiary reason responsible for the actual bursting of the Bubble of Everything. In fact, in this short video here, I even speculated that in coming months, the coronavirus pandemic would be blamed as the scapegoat for crashing global stock markets, even though I predicted in August of last year that the US stock markets would crash heavily months before any appearance of the coronavirus in China. Foolish Central Banker monetary policies and excessive years of near zero to negative interest rates that created distorted stock market prices were the true culprits of the US stock market rout that we have been experiencing (which, by the way, I believe is still only getting started).
Furthermore, in early 2020, I also opined that US Central Bankers were going to take the Fed Funds rate back to zero, or perhaps even into negative territory like some of their peers around the world. And well before the US Central Bankers’ emergency interest rate cut of 50 basis points on 3 March 2020, I stated that “Central Bankers’ Belief that Cutting Interest Rates is the Panacea for All Crises Will Eventually Fail, Sparking Higher Gold and Silver Prices”. As you recall, the financial media, after the 2008 global financial crisis materialized, fixated on Credit Default Swaps (CDS) as the type of derivative product most likely to blow up, and indeed, it was US insurance company AIG’s exposure to Credit Default Swaps that caused it to collapse. You may recall that back then, though the enormous risk of the $1.4 quadrillion global derivatives market was raised by more than a handful of people, that many in the financial media dismissed this risk, and stated that the fractionally smaller market value, not the $1.4 quadrillion notional value, was the real risk posed by the global derivatives market. Thus, the financial global derivatives market was nothing to worry about, the mainstream financial media concluded. And because the global financial derivatives market did not blow up and cause a domino effect of failing global banks back then, many falsely assumed that their analysis of the global derivatives market was the correct one, and consequently also the reason why everyone has completely ignored this risk at the current time.
However, such a conclusion was completely off-base and wrong back then, and the global banking system did not collapse due to the risk of the global derivatives market only because US Central Bankers bailed out the largest US banks, as well as some of the largest global financial banks, by giving them tens of trillions of dollars to prevent their bankruptcies. Without the oligarchical support of US Central Bankers, the entire world would have witnessed the destructive power of the global derivative markets back then. Just because the risk did not materialize in the years that followed 2008 did not mean the risk was not very serious and very real. And today, such a fault riddled conclusion would still be wrong, especially since additional risks now exist that did not back in 2008. Such a conclusion reflected a complete lack of understanding of how financial derivative contracts operate. As long as everything goes to plan, the risk of the global derivatives market remains at its market value. But as a heart surgeon once told me, surgery is simple “as long as everything goes to plan.” It’s when things don’t go according to plan, he said, that surgery becomes complex and technical. The global financial market is exactly the same. If platforms of global financial markets experience operational glitches and everything does not go “according to plan”, then the risk that global financial derivative markets can wreak havoc at amounts much greater than their market values, and this havoc can escalate at an exponential rate, much like a high R0 rate of an infectious disease. Obviously, since global financial markets have experienced operational glitches for several weeks already, the risk of global derivatives markets is firmly back on the table and in play, though there has been complete silence around the world about this risk thus far.
For example, consider a scenario in which Company A underwrites a CDS contract in which they will receive $100,000 of payments from Company B in return for guaranteeing a $1,000,000 bond issued by Company Z. If all goes according to plan and the bond performs, then company A receives $100,000 in profit for successfully guaranteeing the bond once Company Z successfully repays the bond. However, if Company Z fails, now Company A, as guarantors of a $1M bond, may now have to pay Company B $1M, thus inflating their risk to 10 times the amount of their potential reward for underwriting the deal. In this scenario, the losses from financial derivative products can be very real for Company A. Furthermore, the $1M loss suffered by Company Z may cause them to default on another deal that they had already underwritten, thus triggering a domino effect of losses across multiple financial institutions. The OTC (over-the-counter) global derivative market is even more opaque than the non-OTC global derivative market because OTC derivatives are not traded on any exchange, and OTC deals are consummated with no central counterparty. OTC derivative contracts are subject to much higher counterparty risk than the indicated market value of these contracts because each counterparty relies on the other to perform in order for the nominal values of these contracts not to come into play in the real world. For this reason, I have elected to concentrate this article on the risk posed by the global OTC derivatives market to global financial markets. Market values of derivative contracts are recorded on corporate balance sheets but the notional values of these contracts are recorded OFF balance sheet, even though the real risk, in a less-than-optimally performing global financial market may actually be closer to the notional value.
Recall above that the media fixated, back in 2008, on Credit Default Swaps simply because they were the type of derivative contracts that were most likely to blow up even though they constituted a very small part of the overall OTC global derivatives market. The sector of the global financial derivatives market that constituted the largest piece of the pie back then, interest rate derivatives, still constitutes the largest piece of the pie today (according to the latest data from the Bank for International Settlement (BIS) tabulated during the second half of 2019). However, in 2008, the interest rate derivative market was only considered “stable” and non-risky because of a few factors that no longer apply as we head further down the road into the abyss from March 2020 onward. Though we may assume that bankers learned their lesson in 2008, when they triggered a global crisis of epic proportions, this would be a false assumption. US Congress’s willingness to socialize the losses not only of Wall Street banks but also of foreign global banks, and charge them to the American taxpayer further emboldened the executives at the world’s largest banks to take bigger risks, instead of to decrease them, in the years that followed the debacle of the 2008 global financial crisis. In fact, the size of the global OTC interest rate derivatives market has grown an additional 14.4% from $458 trillion in 2008 to its current size of $524 trillion, and likewise, the global OTC ForEx derivative market has exploded higher by nearly 60% from $62 trillion in 2008 to $99 trillion by H1 2019.
Why the Massive Growth in Global OTC Interest Rate and ForEx Derivatives Market is So Dangerous
So why is no one in the world speaking of these combined sectors of the global OTC derivatives market that account for a notional amount of $586 trillion? The answer is simple. OTC contracts are conducted in private, out of the discernment of the public eye, and no one has access to the exact terms and stipulations of these contracts to accurately assess the true risk of these contracts sans the top global banking and financial executives consummating these deals. Since these two markets have not gone belly up as of the start of April 2020, I belief it is a safe assumption that the majority of these interest rate and ForEx derivative contracts were betting on sustained low US dollar and Euro interest rates.
Of the $523.96 trillion notional amount of OTC interest rate derivatives, 38% and 25.8% respectfully were denominated in US dollars and Euros, comprising the lion’s share of nearly two-thirds of all global OTC interest rate derivative contracts. Of the latest figures of $99 trillion of OTC ForEx derivative contracts that exist, an overwhelming 88% were underwritten for the US dollar. In addition, Central Banker interest rate decisions in 2020 that contradicted the narratives they publicly presented in 2019, and the reason I postulated in August 2019 that it was near impossible for US Central Bankers to commit to any interest rate policy other than to cut interest rates, was based upon my research of the OTC interest rate and ForEx derivative markets. I believe it is reasonable to conclude that US Central Bankers’ interest rate decisions since then have confirmed my assumptions about the global OTC interest rate derivative market. For the same reason that US Central Bankers could not raise overnight interbank lending rates in America much above 2.5% as the maximum rate, European Central Bankers also could not raise their marginal facility interest rate from its paltry 2019 0.25% level to even rates in the low single digits.
Why Global Bankers Religiously Suppress Gold Prices
Thus, we may be wrongly inclined to assume that the $614.7 trillion notional amount of the OTC global derivative market would stay safely out of play as long as US and European Central Bankers continued to maintain monetary policies that kept interest rates close to zero.
At first glance, such a conclusion seems reasonable, until we consider one scenario.
The very reason Central Bankers have so intently monitored gold prices and have perpetually manipulated gold prices lower since August of 2011 when it reached nominal prices of $2,000 per ounce is because of the threat that rising gold prices pose to the massive, nearly inconceivably large, global OTC interest rate and ForEx derivative markets. As has been well documented throughout the history of gold, there is an inverse relationship between gold’s price and the purchasing power of global fiat currencies like the USD, Euro, Yen and British Pound Sterling. Though this inverse relationship is not that well understood by the part of the world that lives in developed nations, it is most definitely better understood by the majority of the world that lives in the part of the world considered as “underdeveloped” or “developing”. In addition to many underdeveloped and developing nations possessing a history if fiat currency collapse that raises the level of gold as superior money in the consciousness of these citizens, the purchasing power of developing nations’ fiat currencies in recent years has sunk faster than a large stone in a bottomless trench. As people lose faith in the power of global fiat currencies to retain purchasing power over time when Central Bankers unnaturally keep interest rates at or near zero, or even cut them into negative territory, their faith in the power of gold to retain purchasing power grows. And while the regular Joe and Jane have not yet caught on to the purchasing power retention properties of gold, certainly many of the 0.1% to 1% of the world’s wealthiest have been buying physical gold like maniacs very quietly and out of the public eye since 2008.
The Massive Divergences Between Paper Derivative and Physical Gold, Silver, Platinum and Palladium Was Only a Sign of More Future Failures in the Global Financial System to Come
In March of 2020, the one item that gold and silver experts consistently got wrong was their discussions about plunging gold and silver prices alongside with plunging global stock markets. If we look at paper derivative prices for gold and silver, it is a simple fact to state that paper gold prices plunged in March of 2020 from above the $1,700 per ounce mark to a low mark of about $1,450 and silver from a high of $18.90 per ounce to a low mark of about $11.64 in March (as of 19 March 2020), marking significant 14.7% and 38.4% declines in paper prices respectively for gold and silver. However, every single gold and silver expert that I heard speak about plunging gold and silver prices on financial news shows failed to clarify that gold and silver prices had only plunged by the aforementioned percentages in paper markets. As I asked in this video, if no one can buy real physical gold and silver anywhere close to their plunging paper prices, is the price plunge even real? For example, on 19 March, 2020, silver futures prices traded at $12.00 an ounce and gold futures prices traded at $1,480 per ounce. Yet, on two well-known physical gold and silver bullion dealer websites, Apmex and JM Bullion, I never witnessed any lot of less than twenty 1-oz Silver American Eagle coins fall lower than a price of $24.19 per silver ounce, with the price of real Silver American Eagle coins falling only a fraction of the 38.4% price plunge for paper silver prices. Thus, for anyone holding real physical silver and Silver American Eagles, the only price drop that was relevant to holders of physical silver, and not paper silver, on 19 March 2020 was not the $12.00 paper price, but the price at which they would have been able to sell real silver coins to a willing buyer, or a likely price of more than $22.00 per ounce.
Likewise, when gold paper prices fell to $1,480, on 19 March 2020, the only relevant price to any holder of 2020 Gold American Eagle coins was not the paper price, but the price he or she would have been able to sell his American Eagle coin to another, or a price of about $1,600 per coin (for lots of less than twenty coins) as listed on various US bullion dealer websites. Furthermore, when considering earlier dated 1-oz gold and silver coins, the prices for physical gold and silver soared at even greater rates. On a date in March when I observed spot prices of silver at $12.70 per ounce, I observed 2002 dated Silver American Eagle coins selling at more than $32 per ounce. Thus the simple fact that physical gold and physical silver were selling at massive premiums above paper gold and paper silver prices was an inconvenient fact to bankers that was conveniently ignored by nearly every mass media talking head on financial TV shows.
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What Conditions Would Cause Nominal Amounts of the OTC Global Derivatives Market to Come into Play?
Connecting the Dots
How Rising Gold Prices Can Cause a Collapse of the OTC Interest Rate and Currency Derivative Markets, thus Ushering a Complete Collapse of the Global Banking System
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