Credit Bubble  

Since the very essence of the long wave theory centers around the purging of excessive systemic debt within an economy, the onset of any Kondratieff Winter in the US or global economies would be marked by a severe contraction in credit to re-balance assets and liabilities.      Credit Bubble - recession, kondratieff wave, kondratieff cycle, nikolai kondratieff, super cycles, long wave, long wave theory, Elliot Wave, economic cycles, bear market, Great Depression, Ben Bernanke, stock market crash, dollar hegemony

Such a revision may be underway already as risk is now being re-priced all along the credit spectrum following the near meltdown recently witnessed in the mortgage CDO and commercial paper markets in the summer of 2007. Clearly at best we can assume much slower US GDP growth for the foreseeable future, and at worst something much more perilous as we edge closer to a recession with each release of economic data revealing an ever wider swath of carnage from the housing bubble. Assuming a downturn is coming, should we expect it to be a garden variety recession of the modern era marked by modest downturns for brief durations as in the late eighties or 2001 when Fed rate cuts or fiscal stimulus limited their scope and duration?


It’s quite possible that this time even extensive Fed easing will not be sufficient to improve conditions because of the magnitude of the excesses that have built up for so long, further compounded by the leverage applied through the derivative contracts interwoven between the all the financial capital markets now exceeding some $400 TRILLION dollars.  This factor is unprecedented in its size as well as its cause-effect impact potential on the global capital markets that even seasoned bankers cannot entirely fathom. Could this be the perfect storm of variables to ignite a terrific maelstrom, one unimaginable to most alive today as they unable to recall the misfortune of the Great Depression because they weren’t around to see it for themselves. Perhaps more scrutiny of the long wave cycles will help us to remember what conditions are most likely to cause such a calamity. The articles herein relate to the dynamics and creation of today’s credit bubble to consider how likely the damage can be contained.   

1.   Crisis Exposes Flaws in US Economy, Tarnishes Image - Bloomberg reports that the credit score of the US Treasury paper has risen from 2 basis points since July 2007 to over 30 today, according to BNP Paribas SA. This is a direct reflection of the exploding federal deficits and monetary debasement done by the Treasury and Fed in the bailouts of FNM, FRE. AIG, etc. That 30 score was reported BEFORE the multi- trillion bailout for the toxic mortgage paper soon to be announced, so expect that score to soar ever higher, causing yields on all US Treasury bonds to rise along with the cost to finance the deficits. Just as a homeowner with a beacon score of 600 must pay higher rates for his mortgage, so must the US taxpayer when our collective beacon score plunges. 

This article also highlights the shady accounting practices of the US Treasury, which parks hundreds of billions in liabilities off balance sheet with the Fed. That’s the same sort of practice that got Citibank and other banks in trouble earlier this year. It also points out what I have been frightened about for so long- that we cannot expect foreigners to keep lining up for our debt. Says David Walker of the Pet Petersen foundation, “That’s an imprudent assumption”.  (Posted September 20, 2008)

2.   The $55 Trillion Question - Fortune magazine here provides a current and insightful peek into the current state of the derivatives markets and how they have morphed from simple hedging instruments into the biggest casino the world has ever seen. This is precisely why the single greatest challenge before us now is assessing who is exposed and by how much. Until this is known, counterparty risk and uncertainty will continue to hinder our financial markets. (Posted October 2, 2008)

3.   The Financial Tsunami: The Financial Foundations of the American Century - This three part series from William Engdahl of Global Research is a brilliant historical narrative of the evolution of the credit markets in the 20th century culminating in the machinations of the Fed under Alan Greenspan. It traces the path from industrialization to asset securitization in fostering a series of asset bubbles through the root causes that are the cornerstone of our site-fiat currency and dollar hegemony- and reveals an agenda quite unknown to most of the public. Engdahl weaves a tapestry blending government, corporate and social policy directives over the past century that have molded the environment in which we are now engaged.

Part I - Part II - Part III

4.   The Financial Tsunami has not yet reached its climax - Perhaps nothing could usher in a Kondratieff Winter sooner than the implosion of the unregulated, multi-trillion dollar casino of Credit Default Swaps, the subject of the latest installment in William Engdahl's Financial Tsunami series. Most of the segments of the series have been archived on this site because they represent among the most articulate narratives yet published on the true scope and causality of the credit contagion now engulfing the capital markets. Here, Mr. Engdahl establishes the peril inherent in what Warren Buffet calls “weapons of financial mass destruction”. He maintains that they will, on top of causing financial markets to tumble in a self-fulfilling cycle of capitulation, they will also serve to cloud the very nature of credit risk and accountability as it becomes more and more obvious that the labyrinth of counter-party identities and obligations become more and more unclear to regulators and the markets. This may become just as unnerving as the losses themselves, for their implications to individual institutions can never be truly known or accounted for properly. How could anyone really expect any other outcome when the largest single derivative market, worth hundreds of trillions, is unregulated and mandates no margin deposit or accounting of the principals?   

5.   Peter Schiff- Expansion Continues - Wall St. contrarian Peter Schiff offers his dire assessment of the future of the US economy, dollar, and capital markets in clear and refreshingly blunt terms. He correctly predicted mortgage meltdown, the dot-com crash as well as $70 oil long before each happened. He can be seen regularly on CNBC making his case in the face of near-unanimous opposition by their pundits. For that and his track record he gets our top spot. Please visit www.europac.net for his updates. 

6.   The Credit Crisis Could Just be Beginning – TheStreet.com article exposes the layers of leverage that result in one real dollar supporting $20-30 of loans through the spiral of triple-borrowing that enables borrowed money to be used as collateral for other loans. Understanding this matrix of liabilities is crucial to appreciate the effects that such leverage could have on the downside. 

7.   When Crumbling Credit Meets Deadly Leverage - This examines the layers of derivatives in the credit markets- Structured Investment Vehicles (SIV’s), Credit Default Swaps (CDS’s) and the like to expose the increasing risk to largest banks on these off-balance sheet activities. 

8.   The Mother Of All Bubbles - I have long agreed with the notion put forth below by EuroPacific’s Peter Schiff that the 30 year Treasury market is the bubble of all bubbles. Articles in our Dollar Hegenomy section introduced the notion that for many years the US has enjoyed an artificially low cost of capital on its long term paper because so many foreigners were forced to repatriate their petrodollars into US government securities. As Mr. Schiff explains, the party may soon be coming to an end. In recent days the yield on the long bond has risen dramatically as the markets begin to digest that our fiscal deficits will remain sky high for quite some time. A spike over 5% would reflect a sea change in market psychology and put further pressure on US equities. What’s more troubling is that our tax receipts are sure to slow as our economy slides further into recession and capital gains are pared in a falling stock market. The fantasy world of sub 5% yield on the long bond may finally soon end with record fiscal deficits this year and beyond combined with protracted wars on two fronts and entitlement deficits in the trillions in the coming years. Us taxpayers, as usual will pay the price through ever higher deficits resulting from the higher interest paid on the trillions in debt we will need to maintain our government deficits going forward.

9.   Let the Housing Chips Fall - Peter Schiff at Europac always calls it like he sees it. And here, Peter makes the case for allowing housing prices to decline to their true level of affordability. He cites anecdotal evidence that the government’s attempts to put a floor in the housing market just won’t work this time. Remember that line “Don’t fight the tape”?