by Paul Craig Roberts
June 5, 2012
Paul Craig Roberts was
Assistant Secretary of the Treasury for Economic Policy and
associate editor of the Wall Street Journal. He was columnist for
Business Week, Scripps Howard News Service, and Creators Syndicate.
He has had many university appointments. His internet columns have
attracted a worldwide following.
Ever since the beginning of the financial crisis and quantitative easing,
the question has been before us:
the Federal Reserve maintain zero
interest rates for banks and negative real interest rates for savers and
bond holders when the US government is adding $1.5 trillion to the
national debt every year via its budget deficits?
Not long ago the Fed announced that it was going
to continue this policy for another 2 or 3 years.
Indeed, the Fed is locked into the policy.
Without the artificially low interest rates, the debt service on the
national debt would be so large that it would raise questions about the US
Treasury’s credit rating and the viability of the dollar, and the trillions
of dollars in Interest Rate Swaps and other derivatives would come unglued.
In other words, financial deregulation leading to Wall Street’s gambles, the
US government’s decision to bail out the banks and to keep them afloat, and
the Federal Reserve’s zero interest rate policy have put the economic future
of the US and its currency in an untenable and dangerous position.
It will not be possible to continue to flood the
bond markets with $1.5 trillion in new issues each year when the interest
rate on the bonds is less than the rate of inflation.
Everyone who purchases a Treasury bond is
purchasing a depreciating asset. Moreover, the capital risk of investing in
Treasuries is very high. The low interest rate means that the price paid for
the bond is very high. A rise in interest rates, which must come sooner or
later, will collapse the price of the bonds and inflict capital losses on
bond holders, both domestic and foreign.
The question is: when is sooner or later? The purpose of this article is to
examine that question.
Let us begin by answering the question: how has such an untenable policy
managed to last this long? A number of factors are contributing to the
stability of the dollar and the bond market.
A very important factor is the situation in
There are real problems there as well, and the
financial press keeps our focus on Greece, Europe, and the euro.
Will Greece exit the European Union or
be kicked out?
Will the sovereign debt problem spread
to Spain, Italy, and essentially everywhere except for Germany and
Will it be the end of the EU and the
These are all very dramatic questions that keep
focus off the American situation, which is probably even worse.
The Treasury bond market is also helped by the fear individual investors
have of the equity market, which has been turned into a gambling casino by
High-frequency trading is electronic trading based on mathematical models
that make the decisions. Investment firms compete on the basis of speed,
capturing gains on a fraction of a penny, and perhaps holding positions for
only a few seconds.
These are not long-term investors. Content with
their daily earnings, they close out all positions at the end of each day.
High-frequency trades now account for 70-80% of all equity trades. The
result is major heartburn for traditional investors, who are leaving the
equity market. They end up in Treasuries, because they are unsure of the
solvency of banks who pay next to nothing for deposits, whereas 10-year
Treasuries will pay about 2% nominal, which means, using the official
Consumer Price Index, that they are losing 1% of their capital each year.
Using John Williams’ (shadowstats.com)
correct measure of inflation, they are losing far more. Still, the loss is
about 2 percentage points less than being in a bank, and unlike banks, the
Treasury can have the Federal Reserve print the money to pay off its bonds.
Therefore, bond investment at least returns the
nominal amount of the investment, even if its real value is much lower.
financial media tells us that flight from European sovereign
debt, from the doomed euro, and from the continuing real estate disaster
into US Treasuries provides funding for Washington’s $1.5 trillion annual
deficits. Investors influenced by the financial press might be responding in
Another explanation for the stability of the
Fed’s untenable policy is collusion between Washington, the Fed, and Wall
Street. We will be looking at this as we progress.
Unlike Japan, whose national debt is the largest of all, Americans do not
own their own public debt. Much of US debt is owned abroad, especially by
China, Japan, and OPEC, the oil exporting countries. This places the US
economy in foreign hands. If China, for example, were to find itself unduly
provoked by Washington, China could dump up to $2 trillion in US
dollar-dominated assets on world markets.
All sorts of prices would collapse, and
Fed would have to rapidly create the money to buy up the Chinese
dumping of dollar-denominated financial instruments.
The dollars printed to purchase the dumped Chinese holdings of US dollar
assets would expand the supply of dollars in currency markets and drive down
the dollar exchange rate.
The Fed, lacking foreign currencies with which
to buy up the dollars would have to appeal for currency swaps to sovereign
debt-troubled Europe for Euros, to Russia, surrounded by the US missile
system, for rubles, to Japan, a country over its head in American
commitment, for yen, in order to buy up the dollars with Euros, rubles, and
These currency swaps would be on the books, unredeemable and making
additional use of such swaps problematical. In other words, even if the US
government can pressure its allies and puppets to swap their harder
currencies for a depreciating US currency, it would not be a repeatable
The components of
the American Empire don’t want to be in
dollars any more than do
However, for China, for example, to dump its dollar holdings all at once
would be costly as the value of the dollar-denominated assets would decline
as they dumped them. Unless China is faced with US military attack and needs
to defang the aggressor, China as a rational economic actor would prefer to
slowly exit the US dollar. Neither do Japan, Europe, nor OPEC wish to
destroy their own accumulated wealth from America’s trade deficits by
dumping dollars, but the indications are that they all wish to exit their
Unlike the US financial press, the foreigners who hold dollar assets look at
the annual US budget and trade deficits, look at the sinking US economy,
look at Wall Street’s uncovered gambling bets, look at the war plans of the
delusional hegemony and conclude:
“I’ve got to carefully get out of this.”
US banks also have a strong interest in
preserving the status quo.
They are holders of US Treasuries and
potentially even larger holders. They can borrow from the Federal Reserve at
zero interest rates and purchase 10-year Treasuries at 2%, thus earning a
nominal profit of 2% to offset derivative losses. The banks can borrow
dollars from the Fed for free and leverage them in derivative transactions.
As Nomi Prins puts it, the US banks don’t
want to trade against themselves and their free source of funding by selling
their bond holdings.
Moreover, in the event of foreign flight from
dollars, the Fed could boost the foreign demand for dollars by requiring
foreign banks that want to operate in the US to increase their reserve
amounts, which are dollar based.
I could go on, but I believe this is enough to show that even actors in the
process who could terminate it have themselves a big stake in not rocking
the boat and prefer to quietly and slowly sneak out of dollars before the
crisis hits. This is not possible indefinitely as the process of gradual
withdrawal from the dollar would result in continuous small declines in
dollar values that would end in a rush to exit, but Americans are not the
only delusional people.
The very process of slowly getting out can bring the American house down.
Brazil, the largest economy in South
Russia, the nuclear armed and energy
independent economy on which Western Europe (Washington’s NATO
puppets) are dependent for energy
India, nuclear armed and one of Asia’s
two rising giants
China, nuclear armed, Washington’s
largest creditor (except for the Fed), supplier of America’s
manufactured and advanced technology products, and the new bogyman
for the military-security complex’s next profitable cold war
South Africa, the largest economy in
...are in the process of
forming a new bank.
The new bank will permit the five large
economies to conduct their trade without use of the US dollar.
In addition, Japan, an American puppet state since WWII, is on the verge of
entering into an agreement with China in which the Japanese yen and the
Chinese Yuan will be directly exchanged. The trade between the two Asian
countries would be conducted in their own currencies without the use of the
This reduces the cost of foreign trade between
the two countries, because it eliminates payments for foreign exchange
commissions to convert from yen and Yuan into dollars and back into yen and
Moreover, this official explanation for the new direct relationship avoiding
the US dollar is simply diplomacy speaking.
The Japanese are hoping, like the Chinese, to
get out of the practice of accumulating ever more dollars by having to park
their trade surpluses in US Treasuries. The Japanese US puppet government
hopes that the Washington hegemony does not require the Japanese government
to nix the deal with China.
Now we have arrived at the nitty and gritty.
The small percentage of Americans who are aware
and informed are puzzled why
the banksters have escaped with their financial crimes without
prosecution. The answer might be that the banks “too big to fail” are
adjuncts of Washington and the Federal Reserve in maintaining the stability
of the dollar and Treasury bond markets in the face of an untenable Fed
Let us first look at how the big banks can keep the interest rates on
Treasuries low, below the rate of inflation, despite the constant increase
in US debt as a percent of GDP - thus preserving the Treasury’s ability to
service the debt.
The imperiled banks too big to fail have a huge stake in low interest rates
and the success of the Fed’s policy. The big banks are positioned to make
the Fed’s policy a success.
JPMorgan Chase and other giant-sized banks can
drive down Treasury interest rates and, thereby, drive up the prices of
bonds, producing a rally, by selling Interest Rate Swaps (IRSwaps).
A financial company that sells IRSwaps is selling an agreement to pay
floating interest rates for fixed interest rates. The buyer is purchasing an
agreement that requires him to pay a fixed rate of interest in exchange for
receiving a floating rate.
The reason for a seller to take the short side of the IRSwap, that is, to
pay a floating rate for a fixed rate, is his belief that rates are going to
fall. Short-selling can make the rates fall, and thus drive up the prices of
When this happens, as
these charts illustrate, there is a rally
in the Treasury bond market that the 'presstitute' financial media
“flight to the safe haven of the US dollar
and Treasury bonds.”
In fact, the circumstantial evidence (see the
charts in the link above) is that the swaps are sold by Wall Street whenever
the Federal Reserve needs to prevent a rise in interest rates in order to
protect its otherwise untenable policy.
The swap sales create the impression of a flight
to the dollar, but no actual flight occurs. As the IRSwaps require no
exchange of any principal or real asset, and are only a bet on interest rate
movements, there is no limit to the volume of IRSwaps.
This apparent collusion suggests to some observers that the reason the Wall
Street banksters have not been prosecuted for their crimes is that they are
an essential part of the Federal Reserve’s policy to preserve the US dollar
as world currency. Possibly the collusion between the Federal Reserve and
the banks is organized, but it doesn’t have to be.
The banks are beneficiaries of the Fed’s zero
interest rate policy. It is in the banks’ interest to support it. Organized
collusion is not required.
Let us now turn to gold and silver bullion.
Based on sound analysis,
Gerald Celente and other gifted seers predicted that the price of gold
would be $2000 per ounce by the end of last year. Gold and silver bullion
continued during 2011 their ten-year rise, but in 2012 the price of gold and
silver have been knocked down, with gold being $350 per ounce off its $1900
In view of the analysis that I have presented,
what is the explanation for the reversal in bullion prices? The answer again
Some knowledgeable people within the financial
sector believe that the Federal Reserve (and perhaps also the European
Central Bank) places short sales of bullion through the investment banks,
guaranteeing any losses by pushing a key on the computer keyboard, as
central banks can create money out of thin air.
Insiders inform me that as a tiny percent of those on the buy side of short
sells actually want to take delivery on the gold or silver bullion, and are
content with the financial money settlement, there is no limit to short
selling of gold and silver. Short selling can actually exceed the known
quantity of gold and silver.
Some who have been watching the process for years believe that
government-directed short-selling has been going on for a long time. Even
without government participation, banks can control the volume of paper
trading in gold and profit on the swings that they create.
Recently short selling is so aggressive that it
not merely slows the rise in bullion prices but drives the price down. Is
this aggressiveness a sign that the rigged system is on the verge of
In other words, “our government,” which allegedly represents us, rather than
the powerful private interests who elect “our government” with their
multi-million dollar campaign contributions, now legitimized by the
Republican Supreme Court, is doing its best to deprive us mere citizens,
slaves, indentured servants, and “domestic extremists” from protecting
ourselves and our remaining wealth from the currency debauchery policy of
the Federal Reserve. Naked short selling prevents the rising demand for
physical bullion from raising bullion’s price.
Jeff Nielson explains another way that banks can sell bullion shorts
when they own no bullion.
Nielson says that JP Morgan is the custodian for
the largest long silver fund while being the largest short-seller of silver.
Whenever the silver fund adds to its bullion holdings, JP Morgan shorts an
The short selling offsets the rise in price that
would result from the increase in demand for physical silver. Nielson also
reports that bullion prices can be suppressed by raising margin requirements
on those who purchase bullion with leverage.
The conclusion is that bullion markets can be
manipulated just as can the Treasury bond market and interest rates.
If we knew precisely the date, we would be the
Here are some of the catalysts waiting to ignite the conflagration that
burns up the Treasury bond market and the US dollar:
A war, demanded by the Israeli government,
with Iran, beginning with Syria, that disrupts the oil flow and thereby
the stability of the Western economies or brings the US and its weak
NATO puppets into armed conflict with Russia and China.
The oil spikes would degrade further the US
and EU economies, but Wall Street would make money on the trades.
An unfavorable economic statistic that wakes up
investors as to the true state of the US economy, a statistic that the
presstitute media cannot deflect.
An affront to China, whose government decides that knocking the US down a
few pegs into third world status is worth a trillion dollars. More derivate
mistakes, such as JPMorgan Chase’s recent one, that send the US financial
system again reeling and reminds us that nothing has changed.
The list is long. There is a limit to how many stupid mistakes and corrupt
financial policies the rest of the world is willing to accept from the US.
When that limit is reached, it is all over for “the world’s sole superpower”
and for holders of dollar-denominated instruments.
Financial deregulation converted the financial system, which formerly served
businesses and consumers, into a gambling casino where bets are not covered.
These uncovered bets, together with the Fed’s
zero interest rate policy, have exposed Americans’ living standard and
wealth to large declines. Retired people living on their savings and
investments, IRAs and 401(k)s can earn nothing on their money and are forced
to consume their capital, thereby depriving heirs of inheritance.
Accumulated wealth is consumed.
As a result of jobs offshoring, the US has become an import-dependent
country, dependent on foreign made manufactured goods, clothing, and shoes.
When the dollar exchange rate falls, domestic US prices will rise, and US
real consumption will take a big hit. Americans will consume less, and their
standard of living will fall dramatically.
The serious consequences of the enormous mistakes made in Washington, on
Wall Street, and in corporate offices are being held at bay by an untenable
policy of low interest rates and a corrupt financial press, while debt
rapidly builds. The Fed has been through this experience once before. During
WW II the Federal Reserve kept interest rates low in order to aid the
Treasury’s war finance by minimizing the interest burden of the war debt.
The Fed kept the interest rates low by buying
the debt issues. The postwar inflation that resulted led to the Federal
Reserve-Treasury Accord in 1951, in which agreement was reached that the
Federal Reserve would cease monetizing the debt and permit interest rates to
Fed chairman Bernanke has spoken of an “exit strategy” and said that when
inflation threatens, he can prevent the inflation by taking the money back
out of the banking system.
However, he can do that only by selling Treasury
bonds, which means interest rates would rise. A rise in interest rates would
threaten the derivative structure, cause bond losses, and raise the cost of
both private and public debt service. In other words, to prevent inflation
from debt monetization would bring on more immediate problems than
Rather than collapse the system, wouldn’t the
Fed be more likely to inflate away the massive debts?
Eventually, inflation would erode the dollar’s purchasing power and use as
the reserve currency, and the US government’s credit worthiness would waste
away. However, the Fed, the politicians, and the financial gangsters would
prefer a crisis later rather than sooner. Passing the sinking ship on to the
next watch is preferable to going down with the ship oneself.
As long as interest rate swaps can be used to
boost Treasury bond prices, and as long as naked shorts of bullion can be
used to keep silver and gold from rising in price, the false image of the US
as a safe haven for investors can be perpetuated.
However, the $230,000,000,000,000 in
derivative bets by US banks might bring its own
JPMorgan Chase has had to admit that its
recently announced derivative loss of $2 billion is more than that. How much
more remains to be seen. According to
the Comptroller of the Currency the five
largest banks hold 95.7% of all derivatives.
The five banks holding $226 trillion in
derivative bets are highly leveraged gamblers.
For example, JPMorgan Chase has total assets of
$1.8 trillion but holds $70 trillion in derivative bets, a ratio of $39 in
derivative bets for every dollar of assets. Such a bank doesn’t have to lose
very many bets before it is busted.
Assets, of course, are not risk-based capital. According to the Comptroller
of the Currency report, as of December 31, 2011, JPMorgan Chase held $70.2
trillion in derivatives and only $136 billion in risk-based capital. In
other words, the bank’s derivative bets are 516 times larger than the
capital that covers the bets.
It is difficult to imagine a more reckless and unstable position for a bank
to place itself in, but Goldman Sachs takes the cake. That bank’s $44
trillion in derivative bets is covered by only $19 billion in risk-based
capital, resulting in bets 2,295 times larger than the capital that covers
Bets on interest rates comprise 81% of all derivatives. These are the
derivatives that support high US Treasury bond prices despite massive
increases in US debt and its monetization.
US banks’ derivative bets of $230 trillion, concentrated in five banks, are
15.3 times larger than the US GDP.
A failed political system that allows
unregulated banks to place uncovered bets 15 times larger than the US
economy is a system that is headed for catastrophic failure. As the word
spreads of the fantastic lack of judgment in the American political and
financial systems, the catastrophe in waiting will become a reality.
Everyone wants a solution, so I will provide one. The US government should
simply cancel the $230 trillion in derivative bets, declaring them null and
As no real assets are involved, merely gambling
on notional values, the only major effect of closing out or netting all the
swaps (mostly over-the-counter contracts between counter-parties) would be
to take $230 trillion of leveraged risk out of the financial system. The
financial gangsters who want to continue enjoying betting gains while the
public underwrites their losses would scream and yell about the sanctity of
However, a government that can murder its own
citizens or throw them into dungeons without due process can abolish all the
contracts it wants in the name of national security.
And most certainly, unlike the war on terror,
purging the financial system of the gambling derivatives would vastly
improve national security.