CRASH 2: Why we are approaching The Tulip moment.

A world in which nearly everything is overvalued cannot be sustained

At Zero Hedge this morning, Rick Ackerman (a bloke whose observations I find pretty sharp on the whole) posted a typically outspoken piece that included this extract:

‘…hundreds of billions of dollars – trillions of dollars, if you keep a running total – are floating in the financial ether, unable to find their way into the world of real goods and services. Only a liar or a dolt could assert that this all-too-transparent, economically valueless shell game will continue to provide “breathing space” to the banking system for much longer….’

He was referring to the various packaged investment derivatives sold to idiots by private banking firms, and the QEs or other financial system liquidity schemes mounted by central banks in general, and most recently by Mario Draghi at the ECB. But in a broader sense, the point Rick raises is one that’s been pestering me for five years: when is money ‘real’ money, when is it notional money, and is it safe to have traffic moving from one to the other?

To answer the last part first, the simple response  is ‘don’t be silly, how could it be?’. Banker denial of this reality has been easily the most absurd form of Elmer Gantry con anywhere on the roller-coaster of fantasy that began after Greenspan ignored all the obvious signals of growing insanity during 2004. Money created by the buying and selling of paper derivatives has nothing at all to do with real wealth, because after a certain point – not very far into the mission – the whole thing is based on the value of paper. Which is near to zero.

So really, this answers the first part too: wealth is only real when it is directly related to a known-value item or currency.

A thing is produced. It is manufactured or grown. It is sold into market. It gains a tangible value. This can last for centuries – until it becomes an antique. Instead of barter – and then precious metal purchase – people buy it with currency of a valued guaranteed by the Sovereign State. If I want some money upfront from my crop or factory production, I can sell a certain derivative value of it to a third party.

All the above is real. But seventeen purchases later – and later still, after it and a hundred other things have been salami-chopped into a meaninglessly packaged cacophony – that derivative is worth what somebody might pay for it on a good day. On a bad day, it is worthless. It is, simply, a piece of paper.

The trouble starts when, somewhere along the chain, somebody needs some real money: to buy a house, or a company, or 450 pcs following a competitor’s bankruptcy. That somebody – probably thought of as a nobody by the MoUs – sells his or her counterfeit derivative note….and in exchange gets the real thing: real money guaranteed by a Federal something or other, or a Crown Treasury, or a European Central Bank. Now that person has received money in return for something that represents nothing of a final, produced, grown or indeed physical nature at all. In doing so, the seller of paper must, by definition, reduce the value of the currency received in return…for the currency has been used to buy something that doesn’t exist.

In theory of course, what can happen is that – via a notional value bestowed upon it by users of the real currency – the counterfeit version gains a value in its own right. Except that what this produces is two currencies side by side. By doubling the amount of ‘money’ in circulation – when one of them has no intrinsic value guaranteed by a reliable government – the result is inevitable in the long-term: erosion of the real currency’s value – ie, inflation.

In good times, all this will go unnoticed. The tricky bit comes when economies stall, stock markets wobble, and lots of investors want to realise proper cash all at once – in order to buy the ultimately reliable things: gold, silver, platinum and so forth. Because this leaves a whole lot of folks suddenly holding paper with all the tradeable value of a Post-it Note.

Over the years, this is what I have come to call The Tulip Moment. In the 1630s in the Low Countries, a fashion for tulips turned into an insane obsession. A single Viceroy tulip bulb might sell for a value roughly equivalent to $1,250 in current US dollars, while a rarer Semper Augustus bulb might cost twice that. By the winter of 1636, Tulip traders were making over $60,000 a month at today’s prices. Then one day in Haarlem, just the one buyer failed to show up and pay for his Tulip bulb. Within ten days, Tulip values fell by a staggering 99%.

OK, that’s what we call a panic. Our current crop of leaders would have us believe that their control over every lever from buying toxic loans and worthless bonds to pumping liquid cash into the system ensures that any future ‘event’ can be controlled. This is bollocks: pure human hubris. There is no such thing as a gradual panic – and this is especially true of a system so complex, it takes even a high IQ person at least a week’s focused effort to even begin to understand it. As Woody Guthrie correctly observed, “Seems ter me, if a thang kint be ‘splained in two minutes, then t’ain’t worth a hill o’ beans”.

I believe we are very close now to our Tulip Moment. The Tulip this time is the entire credit default swap/derivate tickertape shadow currency that has been created for entirely venal reasons by the investment banking community. Only this time, it isn’t even circulating at a 1:1 valuation: the so-called derivatives sector is ‘worth’ ten times the entire real gdp of the planet.

None of this is new information. The problem is, this notional – almost astral – plane of ‘money’ is worth nothing at all: for it is no more and no less than a Xerox copy of what already exists in the physical world. Like an exact photocopy of the Mona Lisa, its value is 0.0004% of the real thing. However, thousands of naive souls out there have been convinced by snake-oil salesmen that 400,000 copies of the Mona Lisa are worth ten times the value of Da Vinci’s original masterpiece.

So when there is a run on Xerox copies, very quickly the owners will cotton on to what they bought. And once more, the 99% loss in ten days flat principle will apply.

I met a chap while on safari in Africa last Spring, and he explained to me at great length why, so long as derivatives aren’t traded at retail level, there will not be a problem. This is like saying that if we all keep Xerox copies of the Mona Lisa in Swiss bank vaults, they will keep their value. When macro-economic things go wrong, investors look for just two things: an insurer who will pay out on value, and other things not yet owned that cannot lose their value. They don’t give a good God Damn via what channel these things are available -  they just want them.

When nobody puts a value on derivatives any more – and almost every government has diluted its currency to protect the banks who perverted their original purpose – there is no telling what will happen. This isn’t a Damoclesian warning – it’s a fact: this has never happened before. But as Rick Ackerman notes, there will be no place in the real world of value for this bathroom tissue.

My parallel is simple: what inflated currency is to precious metals, so derivatives and flakey insurance are to real asset valuations. When everyone at once wants to get cash for valueless derivatives – and/or to call on their insurance – the whole system fails. The one thing likely to create exactly that unhappy coincidence of desire is horrendous bad debt – not just on a global scale, but also on every dimension of credit from plastic cards to Sovereign bonds. This is exactly what we face in 2012: a banking system whose value rests upon bits of paper – ranging from sovereign bonds to default swaps and insurance – that, in the final analysis, lack that important fiat message: “We promise to pay”.

Add to this the crazy, almost unbelievable fact that a huge amount of lending has been backed by collateral consisting partly or entirely of such worthless paper……no: don’t go there, you’ll only want to sleep with the light on forever and ever.

The financial system as it stands today is flawed in many ways, but two stand head and shoulders above the others. First, it has failed to provide finance for anything beyond the mega-multinational sector of our economies. And second, it has served a mad form of capitalism that insists growth is the only thing that matters, and credit is the only way it can be sustained. In sticking rigidly to these precepts, it has turned capitalist renewal into stagnation, business creativity into bottom-line bourse mania, and social stability into potentially explosive imbalance.

Ironically, the very tendency to create wealth inequity using this model has made it nigh on impossible to stage the very mass consumption-led recoveries it declares to be sacrosanct; and the same insistence on false wealth grown through untargeted lending has rendered banks unable to release risk business money that could restore a desire to restock. The inevitable result throughout the West has been the emptying of Sovereign Treasuries in order to assume that ‘bankrolling’ function on behalf of the banks. But such efforts in turn have been grabbed by greedy short-termist banking firm managements and big multinational companies as a means of delivering returns to partners and shareholders respectively. These bonus and dividend ‘results’ are a total confection, paid for in full by the already hard-pressed governments and their cash-strapped taxpayers. Net-net, under this suicidally myopic approach, the only possible result is middle-class impoverishment, zero credit, and thus economic slump.

The viciously circular nature of mythical wealth and hyped valuation has produced some extraordinary spectacles in recent months: tactics and ‘explanations’ have been put forward worthy only of a place in the sort of black satirical novel that even Swift never quite got round to writing. But perhaps the most striking contemporary example is that of Mario Draghi’s European Central Bank providing money to private eurobanks, in the hope that they will carry on purchasing worthless government bonds, and thus stave off the sovereign defaults caused by incontinent lending by those very same banks to those very same sovereign States. What turns something potentially comic into certain tragedy is that none of this money will go to stimulate either the output or demand that these sovereign EU member States need to recover.

If ever there was a clear signal that we are months away at most from the Tulip Moment, this is it. For if the US recovery isn’t real (and trust me, it isn’t) and the EU economy is grinding to a halt (and trust me, it is) and Chinese growth is disappearing in this context of falling consumption (and trust me, it is) then all those stock markets based on results that are a confection – and stocks kept artifically high by those results – will collapse.

That is going to create a demand for cash never even envisaged before in the entire history of Bourse capitalism. And it will be, without any shadow of doubt, the Tulip Moment.

99 thoughts on “CRASH 2: Why we are approaching The Tulip moment.

  1. Superb analysis. These derivatives have become money and there’s so much of it around that it’s worthless and it’s infecting what real money remains. I think that eventually UK will have to flush this stuff down the toilet and issue a new currency. And not bail out the holders of the rubbish either.

  2. It’s not difficult to see why no government has demanded that their banks provide a set of numbers based upon mark-to-market asset values. That would likely expose most of them as being insolvent. Much better to keep the fantasy asset values alive and flood the system with cash.

  3. Yup, pretty much spot on as far as I can see; but the bizarre thing is, no-one inside the Court of the naked king will dare pull the lever and flush it all out.
    They are going to be quite happy to prolong it as long as they can, no matter how much worse that makes the implosion.
    If, after 4 years, Ben Bernanke can’t see that printing paper forever still won’t get the US out of a hole, how on earth do we expect the little european idealists to face the facts. There is absolutely no leadership, for remember, as far as they are concerned, it isn’t their money.
    Merkel isn’t going to do it, she is going to safeguard Germany, and nothing more.

  4. The condensation of two comments on DMN – they just might be from a couple of Monty Python fans:

    “Had the daddy of Jesus opened an account for his son at the Judean People’s Bank when he was born, then paid in 1 Judean Peoples’ Cent, which would then bear interest at 6% per annum, what would have been the sum that his descendants could have picked up at the bank today?

    Capital: 1 Cent
    Interest rate: 6% p.a.
    Investment period: 2,012 years

    The answer = 1.06^2012 = 8,23002042 × 10^50

    In other words:

    € 823.000.000.000.000.000.000.000.000.000.000.000.000.000.000.000.000

    Man is not able to think exponentially! There is no fraud, we just need ever more money as a medium of exchange.”

    Could someone more mathematically inclined than I check it out? Apart from which, I don’t have that many spaces on my calculator! An eight-fold million – what would that be called; an octillion?

    • @Viking Jack

      the problem was that the Judean economy collapsed in the AD60s and the country defaulted. That is why the Romans sent in their troops to sack Jerusalem in AD66.

      In short, you don’t need a calculator at all. The piece of paper you have is worthless.

      • Meine Liebling Gemz,

        As usual, you haven’t got the point that is being made!

        Tell yer what, drag yer butt over to this video and take a look -

        Assuming that after about 9 minutes or so you are capable of perhaps understanding what Albert Bartlett is gibbering on about, then come back and try and tell me , and the other Sloggers, that the basic calculation in the above calculation is wrong.

        As for the Judean economy and all that crap, plus the Roman troops – as JW might say – ballocks! (Not a spelling mistake, I distinctly recall seeing it on a Bamforth postcard). It is a simple mathematical calculation – X years x Y % compound interest based on an initial investment of 0,01 JP or whatever the currency may have been at that time. Bartlett talks about 10 – 20 years – and his figures are bad enough – here we are talking about 2K years.

        As the commenter said,”Man is not able to think exponentially!”. This applies especially to banksters – and in particular with their pronounced ability of not being able to forsee the absolute catastrophe that their swinish greed may cause.

        Masters of the Universe – if they want to taste something appropriate, then I’ll offer them my lower anatomy as a “Salzlick”.

      • @VJ
        That I missed your point was entirely deliberate.

        I studied enough maths at uni to be able to solve Schrödinger’s Wave equation in three dimensions, I should be able to manage a simple exponential such as 2⁶³. (It is 9,223,372,036,854,775,808 by the way or around 9,2×10¹⁸)

        It is not much if you say it quickly; it is an awful lot if you have to pay 50% tax on it.

      • Lovely, and illustratative, example. And it may be why God’s people were given a law not to charge interest (or usury).

        I think you may be a factor of 10 out, not that it makes much difference to the image. I count 45 zeros and 2 spaces for tens, making 47 and there should be 50, minus the two spaces to change from cents to Euros.

        Not important in the scheme of things but it might help.

        As for the misery gutses who point to its impracticality, I reckon a bit of judicious time travelling starting with the money lenders in the temple then giving it to the Romans to avoid the problem below (and having a good history book to hand so you can avoid Weimar Germany) could amass plenty enough to get by in 2012. Physics might be against you realising your true worth since somewhere in the last century you had more cents than there are stars in the Universe (at about 10^11 or 12) and I wouldn’t be surprised if you now had more cents than there are atoms on earth (but I don’t know that figure off the top of my head.)

    • 3 thousand
      6 million
      9 billion
      12 trillion
      15 quadrillion
      18 quintillion
      21 sextillion
      24 septillion
      27 octillion
      30 nonillion
      33 decillion
      36 undecillion
      39 duodecillion
      42 tredecillion
      45 quattuordecillion
      48 quindecillion
      51 sexdecillion
      54 septdecillion
      57 octodecillion
      60 novemdecillion
      100 googol

  5. Something interesting on the TF Metals report. An audio interview with Jim Sinclair.
    http://www.tfmetalsreport.com/blog/3320/santa-out-front

    In 2008, AIG had sold CDS on CDOs. CDOs defaulted and AIG had to pay. AIG went broke. The counterparties to the CDS were GS, JPM et al and had to be made whole on their losses that they thought were insured by AIG.
    US Govt funnels TARP cash thru AIG to GS, JPM et al to cover losses
    IN 2012, Greece is about to default, just like the CDOs of 2008.
    ISDA (run by Big 5 banks) declares that 70% haircut on Greek bonds is not a default.
    Therefore, Big 5 do not have to pay off on CDOs bought by Greek bondholders. Big 5 off the hook.
    Greek bondholders who thought they had principal insurance are now screwed and left holding the bag.
    Greek bondholders (big Euro banks, big Euro govts, big hedge funds) will now be insolvent.
    Greek bondholders will need massive capital injection.
    Short term euro negative/dollar positive.
    Regardless, lots and lots of money printing to save Greek bondholders.

      • Um, Paul
        A little mordant, perhaps?
        I counted three. The worst thing about today is that nobody knows anything about what to do.

      • @ Paul Tredgett

        “Congratulations on the densest use of acronyms in the first half of your post that I have ever seen. Must mean you know lots more than me”

        Maybe Mr Tredgett, if you’d actually followed the link I included in my post, you would have seen that my post was pasted from the article it referred to. It was a quick summary of the audio delivered by Jim Sinclair. Someone I suspect that definitely does know lots more than you. In future, why not check out a link that was given in a post before making your sarcastic little comments.

  6. As long as they all believe that they are of some value, then they will be, because they all believe they are of value now, don’t they?
    So, what we are looking at is a mindset, a belief, and as long as they keep believing…..and, don’t forget, to disbelieve is “A vista too awful to contemplate”
    The pretence will have to be maintained somehow and I’m sure it will. It beggars belief how we have got this far without a crash but, we have, and the system will be patched and propped up until something else comes along, possibly war then, suddenly all will be null and void, and one problem will be exchanged for another but, a different problem can be met with a different solution, one that is achievable.
    It is indeed a brilliant analysis but, I think the Tulip Moment is always just around the corner and always will be, for everything is only worth what we think it is at the time.

    • @kfc:
      the system will be patched and propped up until something else comes along, possibly war then, suddenly all will be null and void…

      Yes, when I think about it there is probably only one event that could replace the financial crises in No.1 top slot: war. Carefully managed(!), it would allow the powers that be to reset the counters and start again.

    • @kfc:
      Indeed. And that would almost certainly drag in China & Russia. The nagging question that keeps coming to my mind is “who’s side would Obama be on”?

  7. The “astral plane money”carries interest which is like a canula inserted into the artery of real life.This interest is real money in the real world and no matter how small when the astral plane money is huge the real payment are similarly huge.We await the pain of the Tulip moment!

  8. Thank you John. I was thinking of tulips before I scrolled down to where you made the analogy. I have one severe criticism, that you ended a paragraph with “economic slump”. That should of course been ‘economic crash’. The rest of the post was spot on.
    I also would reduce ‘wealth’ to more basic units than even precious metals can represent. The roof over your head, the land to grow food and the loaf of bread on your table. Everything else is a medium of exchange or a token which you just hope will be exchanged for the bread.

    • I agree Paul. As I live down under where it is expensive to export to. I am stocking up on coffee which has avery long use by date and will be very tradable. Any other suggestions for easy to store and tradable would be appreciated. I think after WW2 it was mostly coffee, cigarettes, chocolate and stockings that were most tradeable. I think one can forget stockings
      these days.

      • Any dried goods like beans, rice and pasta, including dried egg and milk. Cans corned beef and sardines. Like kfc said, water purifying tablets. There are places on the Internet to find dried egg products.

        It brings to mind the gifts that we received in junior school from different countries after the war. We had really pale coloured chocolate chunks sent from Canada, which were delicious, and some rather smelly but sweet, crisp, long, brown dried beans from another country.
        I was on a mediterranean cruise once and in one port, I could smell that same smell of beans. My eyes rested on a gigantic pile on the dockside and I saw what appeared to be the same brown beans. On enquiry someone told me they were animal feed, waiting to be exported.

      • Salt, sugar & cooking oil.
        These are what the french population stocked up on in 1968 when the country closed down for a month during ‘Les evenements de mai’.
        We had first hand experience of the supermarket trolleys passing our window loaded up with these tradeable items.
        Oh, & don’t forget petrol, if you have somewhere safe to store it.

      • And get your gardens into shape for all the fresh produce you can grow! There is nothing nicer after a stale pan of baked beans than some fresh swiss chard :-)

    • In the siege of Paris, Pere Goriot made his fortune from stockpiled pasta (as I remember, haven’t read the book for some time).

  9. It always takes longer than you think to arrive – and it’s always a lot faster than you expect when it does.

    P.S. loving the Astral Plane of Money concept too…

  10. And on the subject of rune reading… Goldman Sachs (GS) weekly chart is one I like to use as an indicator: and you can see how all is clearly not well with the Squid; they have long-since diverged from the wider market (S&P 500, $SPX, coloured gold), with GS hitting lower highs as the $SPX made higher ones as far back as early 2010.

    Clearly in a down-channel then, but on a recovery upswing for the moment. You can perhaps watch for the sharks to encircle once more before needing to take to the Anderson shelter with the spam.

    http://stockcharts.com/h-sc/ui?s=GS&p=W&b=5&g=0&id=p92931027696&a=255824492

  11. If there was ever a better time for a Tulip Moment it would be now. Take the situation in Greece and the Hedgies et al.
    The IDSA will this week decide that a 30% return on your investment is not a default. Turkeys don’t vote for Christmas and all that…
    Oh, and did I mention with a straight face?
    What was learnt from the Tulip Moment was that ANY other option was better than the Tulip Moment so, it’s always option number two.
    Question: Will holders of worthless CDS’s be happy with this decision?

  12. Thank you John that is what I have been bleating on about for ages. The Masters of the Universe are taking the notes out of our pockets to pay for the cyber bets they have been allowed to place. Greenspan et all have a lot to answer for.
    It can’t go on but I would assume the Tulip Moment will be more aligned to an anthropological enlightenment rather than a change of heart by our politocrats.

  13. It’s very likely that the S&P500 has topped out at 1,333 and the crash is underway. There’s a lot of important economic figures coming out during the course of this week culminating in the non farm payrolls on Friday. Perhaps that will be the catalyst that will give John his very aptly named “tulip moment”?

  14. One the most perceptive and significant, to me anyway, articles you have written and I am off to Zerohedge to read the inspiration.

    Without going into any details I knew someone within the Icelandic diplomatic service who had to return to Iceland because the Embassy was shut.

    I asked them where the money had come from to light the fire, thinking it would have been a Mafia / Drug / Russki money laundering thing and yes it was but much much more was simply the Japanese carry trade.

    The discussion turned where it all had gone as the multiplier effect was significant. The answer was simple, nowhere because it never really existed.

    It was just bits of paper whose value was what somebody wanted to place on it, like an old stamp or a black tulip.

    I never really got round to taking that in properly until now.

    Thanks

  15. An interesting analysis.

    Can you define the conditions (or state) that means we have reached the ‘Tulip moment’? (And the month in 2012 by which time you think that state will be reached at the latest).

    If you are able to do that, then I would look to place a wager with you, depending on what you come up with. Of course, there may be stock market crashes – or corrections, although I suspect you are implying something more – as you used the word “collapse” – implying (say?) a 90% reduction in the FTSE? I appreciate you are not just talking about stock markets – so perhaps you could elucidate on that as well.

    Looking forward to your response John.

    • Cronshd
      If I knew that I’d be advising and betting professionally. Guessing about it is a mug’s game. But (there’s always a but…)
      What my piece was saying, in a nutshell, is that confidence is everything….but when people spot the confidence trick bigtime, after years of dozily muddling through, everything goes – whack – very quickly.
      The three biggest contricks at the moment are (1) Stock prices inflated by accountancy and QE rather than trading results (2) Banks exposed to astral ‘debts’ and overvalued insurance; and (3) stress tests that take no account of (2).
      The stress test has been found out by even quite ordinary folks. Bank exposure is going the same way….but is being headed off by Draghi – easily the brightest bloke in all of this. Stock prices will thus almost
      certainly be the catalyst.
      Ben has spotted this – hence hints about QE3.
      The problem then is nobody knows how much willpower the US has to keep the New Paradigm going. Also nobody knows who will win the Presidency. And nobody knows how much gold there really is in Fort Knox.
      In theory, the US could keep this going for years.
      Sorry the soothsaying ends abruptly there.

      • Understood. The thing is, not everyone will lose confidence in that ‘Tulip moment’ way imho. Why? Because we are not talking about something as tangible and identifiable as tulips!

        Try explaining your post to the man* on the Clapham underground and it won’t connect. Try connecting it with the thousands of engineers on their scooters on their way to work in Taipei – and it won’t happen. Unless and until we have hyperinflation and/or a run on high street banks, the average man* on the street will get on with their life……….

        Anyway, Monsieur Legland, Head of Research at Soc Gen was just on Bloomberg explaining that “technical analysis” is pointing to a major stock market correction. Perhaps he reads your blog.

        *man = man/woman

      • Obama will win A billion USD in his war chest and enough poor folks and dead folks on the electoral register to make it happen.

  16. The logic of this is, to survive the crash , buy land, buildings, manufacturing companies (which make thinks we all need and will continue to need, and precious metals or companies asset rich in the same.

    ?

    • I’d be careful about manufacturing unless it is something that can be done easily without machines and can sustain lots of manual labour (potential consumers)

    • I can’t help thinking that the value of land etc will fall as well as everything else if there is no money to buy it. Are you suggesting subsistence farming?

      • Of course you are right that the price of land and structures will also fall but they will still be there to be used and resold. Bank balances and folding money will / could collapse, which is what real inflation is.
        Things which are needed will hold their price and remember it all relative.

        The objective here is to maintain the buying power of your assets and thus your wealth. It doesn’t matter if it designated in £. new $ or coconut shells as long as you minimally break even, relatively so, at the end to the toboggan ride.

      • Phoebe, BTP
        The value of land will sky-rocket once it dawns on people that the UK’s future lies in self-sufficiency first and trade second. BY 2030, 3+ acres of arable will cost 20 times what it does today.
        There will be plenty of money around. It’s called the Yuan.

  17. Re. Tulips: The Netherlands did recover and went on to be a formidable force for commerce and power in the later 17c: Britain had a lot of trouble with them (read Sam. Pepys diary). Sailed up the Medway, even. History about to repeat itself?

    • “in the later 17c: Britain had a lot of trouble with them (read Sam. Pepys diary). Sailed up the Medway, even. History about to repeat itself?”

      No… We’ve now got Tilbury Fort manned by English Heritage… the Admission Fees alone would make any party think twice…..

    • Rowland: “The Netherlands did recover and went on to be a formidable force for commerce and power in the later 17c”

      That’s because the Dutch Government of the time didn’t try to bail out the bulb suppliers. The arse fell out of the market, and people lost money. The market corrected itself naturally, albeit at an unnatural speed. Holland recovered. Why contemporary Governments cannot or will not take this on board is worrying.

  18. JW

    Firstly thankyou for your long essay: it covers several aspects to me, so several answers from me – it also means that I can copy and paste without losing my place!

    If I want some money upfront from my crop or factory production, I can sell a certain derivative value of it to a third party.

    This is not the case: what you sell in this instance is a future. Any third party can then draw up a credit-debt contract against this future value which is then a derivative of that future value. A derivative is a form of speculation that in essence can make a bet on anything that moves – in the instance I gave in my blog, it was the White Star liner RMS Olympic.

    Until then speculation had been on transatlantic steamer’s timetables and one party bet on the ship coming in late, the other that it would be early. The problem with the Olympic was that it was pretty well always on time, and known as “Old Reliable” that all the derivatives placed were worthless.

    A derivative in this instance is not the timetable. It reflects the timetable.

    In modern times with a banking licence one can create the credit-debt agreement (not expensive to do) and start leveraging derivatives from that point onwards. The problem with derivatives, unlike futures which are traded on the open market is that they are not traded openly: they are traded “over the counter” and thus need not appear on the balance sheets of a bank. The profits go into bonusses (I am told).

    That is the knub of the problem: an asset worth millions (billions?) is made using contracts confirmed by faxing one another. I dread to think what they would do with email, after all a PDF is as secure as a fax.

    In short, the trading of derivatives has no natural counterpart, no natural brake in its system. With faxing contracts there is little hinderance to the speed with which they are created. It is a very dangerous situation. In October last year I mentioned that Bank of America had moved $76trillion of toxic derivatives onto a taxpayer backed bank. That is one bank, moving five times the US GDP, at one time. How many more are there?

    • @ GemzIn October last year I mentioned that Bank of America had moved $76trillion of toxic derivatives onto a taxpayer backed bank. That is one bank, moving five times the US GDP, at one time. How many more are there?
      A very valid point, followed by a very worrying question. And of course, all this under the watchful eye of the US regularity authorities. It’s comforting to know they’re there.

      • @Will
        the BoA transfer was done in broad daylight and in full view of the regulators.

        In short, with regulators as effective as they are, is it any wonder we have financial problems?

  19. On the value of a derivative.

    The value they have is notional. They are effectively a banker’s wet dream.

    The upside is that the profits you make for them will buy you several crates of Chateau de Mouton de Rothschild and an estate in Scotland to boot. The problem is that their effects are very, very real. Trading in naked CDSs (derivative contracts reflecting an otherwise sensible investment vehicle) have skewed the bond markets dangerously.

    Greece’s default would have been a piece of cake – paying off €300bn of outstanding CDSs would be reasonable in any person’s book. After all, why have them if a country might default?

    The problem is the myriad derivatives reflecting the payouts on CDSs – the derivative may only reflect the CDS, but its guarantees are just the same. If ISDA (or whoever they are) called a credit event the effect would be cataclysmic.

    If people then come back to me to say that the intention was not to pay out on them, then the traders really were selling snake oil, you wouldn’t even have a tulip in your back garden to enjoy this spring. Thinking of which, where did I plant my black one?

  20. This was a very good post! Thank you, John. You’ve strengthened my resolve to keep putting a substantial part of my puny savings into safer things than paper money.

    For some more insight into real money versus the “astral plane” of funny-money, I recommend FOFOA. He’s not always easy to understand, but you get that feeling of “this guy really knows what he’s talking about” when you read him, and everytime you reread one of his articles, another little piece of the puzzle clicks into place and you come closer to figuring it out. At least, that’s how it feels for me.

    In the context of John’s “tulip moment” post, maybe this FOFOA post would be a good place to start:

    Greece is the Word

    • Thanks, that’s an interesting view of the situation.
      FOFOA rightly confirms that the huge underlying flaw in the system is “debt”. And that has only been propped up by confidence which is now dwindling away. The political elites have allowed debt to get massively out of control and actually joined in the party themselves. What we now have is a giant global Ponzi scheme and there hasn’t been one of those (as far as I know) that hasn’t collapsed sooner or later. Timing is always the most difficult issue to predict.

  21. As ever, brilliant work! I rarely post here but checking in twice a day and seeing what’s new is one of my great pleasures. Thanks.

    The Zerohedge statement about ethereal money unable to find its way into real things reminded me of a quote: “The theatre was on fire but the doors were only so big”. (It’s from ‘The Zeroes: The decade Wall Street went Insane’… if you haven’t seen it, it’s on youTube and well worth a watch.)

    When the quantity of ethereal cash far exceeds the quantity of real cash that it’s trying to become, the doors are only so big and a lot of cash *is* going to get burned.

    It’s said that even if history doesn’t repeat, it at least rhymes; and those unable to understand are doomed to re-live it. Your tulip bubble parallel seems pretty spot on. Logic, history and math suggests that the whole edifice will at some point come tumbling, which begs the question why is everyone trying to prop the damn thing up.

    The system as-is kinda reminds me of a game of ‘ultimate’ jenga. We’ve built this unstable tower of finance and the only sensible thing to do before it falls is to reduce it in size and make it safe. Given the interconnectedness of real money and derivatives and the trip-wires of CDS and market behaviour, any block we remove could be the one that loses us the game. I’m guessing this is one reason why nobody seems in the mood for removing any blocks and instead lets business-as-usual continue to add more.

    Which begs the question: If those in control were to stop dicking around and accept that crash is inevitable, what should they do – and in what order – to most safely defuse this? Even with massive loss of ‘wealth’, some outcomes are more survivable than others.

    If you had to put together a point-by-point exit/repair plan, how would it run? Ok to ask? There seems to be a dearth of good ideas out there, but you – and the crowd here – seem to be far more switched on than the mainstream. I’d be really curious to hear some ideas.

    Thanks again.

    • At the risk of sounding too cynical, IMV the only event that could take the financial crises off the top slot of peoples’ attention is WAR.
      War would not only distract people from current events but would allow the debt counters to be reset to zero (read: the US defaulting on its $15 trillion debts) and provide the political elites (responsible for the financial crises) with a cast iron reason to play down and explain away the financial catastrophe. As several folks on The Slog post occasionally: the pressure is building up in the Gulf & Iran…

      • But is the meltdown really on the ‘high importance’ list of very many. When you mention the coming crash as being inevitable – man on the street mainly looks at you as though you are gaga. Some will ask why or what is happening – but mostly they will turn to discuss the latest x factor result or the transfer window action of the premier league.
        Then of course there is always another Olympic story taking top slot for the BBC to report on – because we would not want the Plebs to all rush out and stock up on the supplies they are likely to need when it all goes Boobus Erectus ! (No I have no – or very little knowledge – of Latin)

      • @Morningstar:
        I agree the financial mess is not top-of-the-list for the average Joe. But that is mainly because they don’t understand it and western governments are hiding it from them. The BBC & other MSM are the conduit for state propaganda/lies. However, should a serious crash occur in the markets or one or more banks fall over or consumer inflation become hyperinflation from all the money printing going on, things might change quite rapidly. Those who are not paying attention are destined to suffer…

  22. There will be a Tulip moment , the real questions WHEN ? The number of naysayers and doomsday mongers for 2012 probably means that such an event will be artificially ‘post-poned’ and will happen when the our guard is down . Certainly the usual Wall of Money has been flooding the markets this January so we will have nice high valuations from which to fall .
    I still feel the US will ave a big say in all this as they are the Real Lender of Last Resort , and we all know that the USD is about as Fiat as its possible to get .

    • I have a feeling that China and others are making their move to demolish the US $ as the reserve currency – by starting to use Gold as their currency of choice.
      That the $US Reserve currency is under threat is well likely to be the reason behind the current military threats underway with Iran. I seem to remember that Sadam in his time was going to threaten the Petrodollar by switching to payments in Euro’s – just before his come uppance was got and Gaddaffi was about to start trading oil in gold – when he got his ! One has to wonder what will happen now that Iran has started to do deals for oil in something other than US$. I see dark times ahead – but I do not think war in itself is likely to prevent meltdown financially.
      Anyone know whether China has fully developed its Ballistic Anti Ship capability – not read anything about this for a couple of years now – could be a real game changer for aircraft carriers and ‘force projection’ ?

  23. Re: any dash for cash… ‘I promise to pay the Bearer on demand…’ With what exactly? And is any such promise worth the paper it’s written on?

    • Did I say that? Don’t think so. But I do wonder whether the Facebook float will demonstrate that hype is still with us or that reality is starting to show.

      • @Jon
        But I do wonder whether the Facebook float will demonstrate that hype is still with us or that reality is starting to show.

        Indeed, and didn’t Goldman Sachs invest $400,000,000 in Facebook a little while back.

      • Did I say that? No. (I’ll change my name.) Watching the Newsnight discussion on the faceache flotation last night I was taken back to the dotcom bubble. Such naive tosh to talk up the price of a stock. The people advising the investors have no sense of how things work in the real world and no understanding of consumer behaviour. I once had a heated discussion with an analyst advising investors on the UK’s infant satellite TV business. In his wisdom he thought both BSB and Sky would flourish. When I told him what would happen (and subsequently did) he told me I didn’t know what I was talking about – because he worked in the City and I didn’t. Wonder which boards he’s sitting on now.

  24. I think this analysis is spot on. Now I have a practical question, I know it might not be the right place but there are a lot of sensible people on here.

    I am about to sell a small farm in UK ( Tesco and other supermarkets screwing us too much to make a living here ) to buy a bigger farm abroad,maybe France.

    I intended to transfer the money to Switzerland to keep it safe while I look for the ideal place to buy, it might take six months or a year. I can’t find the ideal farm before I sell because I’m working 7 days a week just to earn a poor living.

    Will it be safe as cash or could it inflated away to be worthless confetti ? What currency / currencies would be best. I would prefer to have some in physical gold or silver but not sure how easy it would be to get enough of it and store it safely.

    Will cash be king or confetti ?

    • Deposit it in multiple banks so you have the insurance protection covering you (if everything tumbles then nothing is safe), but i dont think the system will collapse. It is stronger than what we think.

      Can i ask how much you make per yr as a farmer ? If i could do anything it would be farming you see, but it is a dream and i cannot see it happening. I know the big cereal farms make a lot, but the smaller hill farmers have had a tough time.

      It has been said by jim rogers that the guys driving the labo’s and ferraris in the last 20 yrs have been the bankers. He reckons in the next 30 it will be the farmers.

      • Tesco serf
        2 things:
        1. Stay in farming, but grow a crop that’s currently imported.
        2. Be very wary of France: the agrarian mafia is something you have to join, because it can’t be beaten. And the local collectives always take a rake-off beyond the official level.

  25. So will gold have any real value, you cannot eat it, live in or burn it? Where do we find comfort and reassurance, I have a spread of bonds, equities and a little cash in Government schemes………and a few small pensions. Will they all be worthless if the Tulip moment comes?

  26. 20. Economic crises have been producer by us for the CATTLE by no other means than the withdrawal of money from circulation. Huge capitals have stagnated, withdrawing money from States, which were constantly obliged to apply to those same stagnant capitals for loans. These loans burdened the finances of the State with the payment of interest and made them the bond slaves of these capitals …. The concentration of industry in the hands of capitalists out of the hands of small masters has drained away all the juices of the peoples and with them also the States ….

    • Thanks for that link Col.
      Yes, Cynicus Economicus really is one of the folks who could see what went wrong, what was going on and the disaster that awaits us.
      I wish he would reconsider his decision to close his blog. But I guess you can only issue so many explanations and warnings; and he wanted to avoid becoming a daily event blogger. Not sure why because JW manages that very well.

      I (and in honesty many others outside of govt and MSM) have often said the cause of our financial crises is “debt”, which in many ways it is. But CE managed to see one step behind that interpretation of events by noting that the underlying cause of the West’s debt problem was our inability to create wealth. He explains it here perfectly in his final post:

      Wealth creation has been slipping from the developed world to the emerging economies, and the financial services industry just recycled the growing wealth creation from the rest of the world into developed world debt.

  27. A little bit of post creep but very relevant all the same…

    “A nation can survive its fools and even the ambitious. But it cannot survive treason from within. An enemy at the gates is less formidable, for he is known and he carries his banners openly against the city. But the traitor moves among those within the gates freely, his sly whispers rustling through all alleys, heard in the very halls of government itself. For the traitor appears no traitor; he speaks in the accents familiar to his victim, and he wears their face and their garments and he appeals to the baseness that lies deep in the hearts of all men. He rots the soul of a nation; he works secretly and unknown in the night to undermine the pillars of a city; he infects the body politic so that it can no longer resist. A murderer is less to be feared. The traitor is the plague.” Marcus Tullius Cicero.

    • Go 2 marketoracle.co.uk and find some article in february 15. This why Bama signed NDAA. Chicago april may 2012 conferences: ISDA,G8,NATO. Prepare 4 false flag op

  28. Nicole Foss, aka Stoneleigh at theautomaticearthblogspot.com has been saying much the same thing for some time now. Her analogy is a game of musical chairs, when the music stops, aka the “tulip moment” everyone will have to dash for a chair, aka converting notional money into something real. But in this version it will be the majority of the players who won’t get a chair, who will be sh*tting themselves, until realizing, luckily, that they at least have lots of paper.

  29. Pingback: EZONE BREAKING…..BANKER PANIC REVEALED IN PLEA TO EU REGULATORS | The Slog

  30. Pingback: CRASH 2: A GLOBAL MORTGAGE CHAIN IS REVEALED…. | The Slog

  31. Pingback: The value of cash when asset values collapse. « Nicholas Arrand

  32. Thnx! It would hard 2 find simpler explanation that folx in PIIGS countries R victims of Ponzi scheme. By this artticle U get into hall of Saints.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s