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Taking Money Back to 1492

Back to the Future

Back in the day, Spain was awesomely rich!

All Ferdinand and Isabella needed to do was to sends ships to America, pick up some gold and few slaves, bring the stuff back and … MONEY!!!

Having expelled the smart folks … the Jews and Muslims, the triumphant Spanish Chrsitians, figured this was a perpetual money machine and bought lots and lots of stuff.  Some of that, ships and canons, was spent getting even more money!

In the meantime, clever folks in Holland and England sold stuff to Spain and used the MONEY to build stuff … factories, farms, even universities. The Spanish Money became the Dutch and British Capital that funded the the modern age.

It seems to me we may be back in the 1500s, with America and Europe playing the role of Imperial Spain while China, India and Brazil have figured out capitalism. Mark Mobius, a hedge fund legend(1), says, “There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis.” Over at Forbes,  Mobious points his finger at derivatives, the financial hairball of futures, options, and swaps in which nearly all the world’s major banks are tangled up.

Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius’ guess of 10 times the world’s annual GDP. “Are the derivatives regulated?” asks Mobius. “No. Are you still getting growth in derivatives? Yes.” In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.

What could it be? We’ll offer up a good guess, one the market is discounting.

Seldom does a stock index rise so much, for so little reason, as the Dow did on the open Tuesday morning: 115 Dow points on a rumor that Greece is going to get a second bailout.

Let’s step back for a moment: The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn’t pay back 100 centimes on the euro?

That’s a rhetorical question, since the balance sheets of European banks are even more opaque than American ones. Whatever the actual answer, it’s scary enough that the European Central Bank has refused to entertain any talk about the holders of Greek sovereign debt taking a haircut, even in the form of Greece stretching out its payments.

That was the preferred solution among German leaders. But it seems the ECB is about to get its way. Greece will likely get another bailout — 30 billion euros on top of the 110 billion euro bailout it got a year ago.

It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.

And what of the derivatives sitting on the balance sheet of the Federal Reserve? Here’s another factor behind our heightened state of alert.

“Through quantitative easing efforts alone,” says Euro Pacific Capital’s Michael Pento, “Ben Bernanke has added $1.8 trillion of longer-term GSE debt and mortgage-backed securities (MBS).”

Think about that for a moment. The Fed’s entire balance sheet totaled around $800 billion before the 2008 crash, nearly all of it Treasuries. Now the Fed holds more than double that amount in mortgage derivatives alone, junk that the banks needed to clear off their own balance sheets.

“As the size of the Fed’s balance sheet ballooned,” continues Mr. Pento, “the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.

“Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out.”

Mr. Pento’s and Mr. Mobius’ views line up with our own, which we laid out during interviews on our trip to China this month.

(1) chief of the $50 billion emerging markets desk at Templeton Asset Management.

An Eye on the Next Financial Crisis by Addison Wiggin originally appeared in the Daily Reckoning.


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