The Shadowy Web of Collateral and War

August 30, 2013

It seems that few people have yet realized the possible scenario that a repo market failure will result in a liquidity freeze that can then spark off a full scale financial collapse.

The financial and economic system seems so vulnerable to just in time delivery on virtually everything that such a failure will cause social chaos in the short term and severe damage to confidence in the longer term.

Examples of delivery systems that will be impacted include the transport of key commodities for everyday life like fuel and food.

Also, as trading systems become more automated, they are becoming more and more vulnerable to glitches that can even cause flash crashes and market closures.

The Fed’s Need to Taper

The need to taper has nothing to do with the economy, jobs or inflation. Basically, the Fed will need to taper off its monthly bond purchases sooner rather than later because the repo market is rapidly becoming starved for quality collateral.

Because the Fed is currently buying 85 billion in bonds each month, a lack of collateral is left over for these giant day to day repo transactions, which no one seems to paying any significant attention to.

Add to this interference due to regulation changes, like bringing these repo transactions on to exchanges, for example.

The average turnover in the repo market amounts to trillions of U.S. Dollars each day, and if market instability becomes apparent or even a rumor that one of the primary dealers is in trouble, a Lehman style credit freeze could happen all over again.

Fiat Debt and the Welfare State - the Other Side of the Silver Coin

A similar issue is happening with gold that is also used as collateral for these transactions.

A recent surge in physical demand is making metallic investment grade gold increasingly scarce and in strong demand for collateral purposes.

J.P. Morgan Chase is now rumored to be attempting a long corner in gold and is scrambling to find gold to put into its empty vaults.

More About Tapering

The U.S. budget deficit has fallen in recent years, which raises the effective amount of budget the Fed is currently monetizing. This in turn pushes on the confidence conundrum and the market has seen international purchases of U.S. debt from China and Japan sink sharply last month.

The tapering seems finally about to happen, and so short term rates are rising to discount this change. Nevertheless, because of the weak headline housing numbers, the market saw some buying ahead of support.

The Syria Story

The above all fits in well with the hyperinflation pathway, but this is where the recent threats of the United States going to war against Syria fit in.

Defense spending is down, and another foreign war would 'justify' increasing the defense budget. Of course, this would thereby 'necessitate' even more Quantitative Easing, that will result in greater money printing and hence money supply expansion that will dilute the paper U.S. Dollar’s already tenuous value.

Perhaps the best thing to do to prepare for this scenario is to continue accumulating hard monetary assets like silver and gold with your paper currency while it is still possible.

Indian gold demand muted at festival, buyers hope for lower prices