Curing the System's Fatal Flaw

And Profiting Meanwhile

by DeepCaster LLC, deepcaster.com | March 24, 2008

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Priest: O Ruler of my country Oedipus…you yourself have seen our city reeling like a wreck already…

Oedipus: I, Oedipus, whom all men call The Great…. came myself (to) learn…by what act or word I could “save this city.” Oedipus The King Sophocles, (R. Lattimore, Trans.)

The current ongoing takedown Of Precious Metals and Strategic Commodities in no way diminishes the increasing Systemic Threat about which we have often spoken. Indeed, it indicates that the Systemic Threat is increasing, as we demonstrate. Thus we have a Modest Proposal for a remedy, as follows.

Given the prevailing Hubris at the U.S. Federal Reserve and on Wall Street, the current Takedown of Precious Metals and Strategic Commodities prices that Deepcaster earlier Forecast, and a Bear Stearns-type debacle, both were bound to happen.

Similar events are bound to happen again.

But these are all reflective of increasing Systemic Risk. 

Yet, many commentators on the Bear Stearns debacle (which we consider first) - - a debacle which saw the shares of Bear Stearns drop from a 52 week high of $159 down to below $3 - - missed The Key Point.

The Key Point is that the Bear Stearns debacle was born from a Fatal Flaw in The Financial System which can be most appropriately characterized as a particular sort of Divorce from Market and Economic Reality by that Financial System.

Understanding this ‘Fatal Flaw’ can help one understand how such debacles could be prevented in the future (but not that they will be).

It can also help investors understand how to profit by taking account of that Flaw so long as it exists.

The Fatal Flaw

The Fundamental Flaw is reflected in the fact that Bear Stearns’ business is essentially a “paper” (or strictly speaking, and even more removed from reality, an electronic data) business, only remotely connected to the Tangible Economic Realities of the marketplace in the Real World.

In between Bear Stearns and such Tangible Realities were layers of “darkly liquid paper” and intermediaries.

Indeed, the current structure of the financial system “encourages” such a Divorce from the Tangible Realities of the marketplace and, indeed, reliance on, and a “marriage” to, such paper. A simple, and not too inaccurate, way to conceptualize The Flaw is to say that Bear Stearns and many other similarly situated businesses were (and are) built on “darkly liquid” paper.

What exactly is this “paper?” - - (the often overlapping categories of) Securitized Mortgages, Fiat Currencies, SIVs, CDOs, Securities, Commercial Paper, and dark Over-The-Counter (OTC) Derivatives (especially dark OTC Derivatives)…the list is nearly endless.

Divorce From Underlying Reality…Until…

An important characteristic of this Fatal Flaw is that the Paper Universe is structured so that the ultimate holder of the Paper is several intermediaries away from the ultimate economic reality or transaction(s) that the Paper represents - - in the case of mortgage-backed securities separated from the ultimate obligor - - the homeowner, for example.

But the Fatal Flaw of such Darkly Liquid Paper is that since it is several intermediaries removed from underlying tangible realities, its Market Value must therefore be primarily determined by confidence that the value it ostensibly represents is genuine.

But in the securitized subprime loan universe where the current crises began, confidence began to disappear several months ago. As defaults increased, this led to a credit freeze-up which ultimately resulted in the “run” on Bear Stearns assets, and the ensuing Fed-engineered bailout by JPMorgan Chase. [The Fatal Flaw of lack of confidence in “Remote Darkly Liquid Paper” is described in detail in Deepcaster’s February 29, 2008 Alert on Derivatives, Dark Liquidity and Systemic Risk entitled “Increasing Systemic Risk Portends Cartel “End Game” Attempt” See Archives.]

Zero Market Value

Another characteristic of that JPM takeover of Bear Stearns which reflected the Fatal Flaw was that it was a takeover which de facto valued Bear Stearns Paper Assets at approximately Zero. That was probably a correct valuation.

The Hubris of confidence in “Remote Darkly Liquid Paper” finally revealed itself in the essentially Zero Market Value attached to the Bear Stearns Paper Assets and shares.

In this case, and several other prospective cases, Bear Stearns’ problem ultimately resulted from the Dark Liquidity Syndrome reflected in its illiquid Derivatives (see Deepcaster’s January, February and March Letters regarding Derivatives, Dark Liquidity, and The Cartel End Game available at www.deepcaster.com). As Deepcaster has explained in detail in the referenced Letters, to the extent that the securitization business is conducted via non-public OTC derivatives, it is vulnerable to the high risks inherent in “Dark Liquidity.”

Failures of confidence in such derivatives quickly lead to illiquidity, that is, to Zero Market Value.

For example, illiquid OTC securitized mortgage bundles (e.g. CMOs) containing mortgages which have defaulted and some which are about to default are a reflection of the fact that no one knows what is in the bundled securities - - often not even the counterparties, and certainly not the market at large. The result is these “darkly liquid” OTC securities are quickly transformed into illiquidity with Zero Market Value. Prospective buyers of these securitized bundles understandably do not want to be buying a “pig in a poke.”

Since the Securitized Derivatives Bundles are typically Over-The-Counter, and thus neither Clearinghouse guaranteed nor subject to required full disclosure, “dark” securitized bundles raise suspicion in the eyes of prospective buyers, and thus become illiquid, and often completely illiquid. No one wants them at any price.

We reiterate: That which is completely illiquid has no market and therefore Zero Market Value. The Credit Market Freeze-Up which surfaced in August, 2007, and the Bear Stearns debacle both reflect this Fact.

More Casualties Coming

Moreover, since these dark derivatives are concentrated in the Financial Services arena, it is predictable that more financial sector entities like Bear Stearns will go down. Indeed, Thornburg Mortgage and Carlyle Capital already have.

More troubling unfortunately, (since these derivatives are laced through many Sectors) it is likely that other entities outside the financial arena will also go down.

Thus the Darkly Liquid OTC Derivatives Contagion has and will spread beyond just the Financial Services stocks. We recently referred to the case of Bristol Myers Squibb (a supposedly Safe Haven Big Pharma Company) which had to take a quarter of a billion dollars write down due to Derivatives problems. So much for Big Pharma as a “Safe Haven.”

In sum, problems which brought down Bear Stearns are widespread and seriously systemically threatening and are accelerating as we point out in our 3/6/08 Alert “Profiting From The ‘Main Event’ in which we describe how Intervention Risk Acceleration Provides a Profit Opportunity. The cause and character of these problems also allowed Deepcaster to correctly Forecast, in that Alert and elsewhere, Warnings that the Monetary Metals and Strategic Commodities would be taken down by The Cartel in “the second or third week of March.”

Given this brief background, we can now outline a Solution.

The Key To The Solution

The key to The Solution is to note that Bear Stearns’ main surviving genuinely liquid asset - - the rights to its building in New York City - - is a Tangible Asset.

That fact provides the clue to a Major Remedy for the larger Systemic Problem.

That larger Systemic Problem reflects The Fatal Flaw “in spades.” The large Systemic Problem is that the world’s Reserve Currency, the U.S. Dollar, is susceptible to the same Flaw that afflicted Bear Stearns: it is a Fiat Currency. It is not based on, or backed by, Tangible Assets. That is, it is backed only by the Full Faith and Credit of the United States Government (that is to say, by confidence alone). It is not linked to Gold, Silver, or any other tangible asset.

The existing system of Reserve Currency by Fiat is unsustainable. No Fiat Currency Regime in the history of the world has ever survived indefinitely.

So The Solution is apparent. We outline it as follows:

1) Re-link the world’s Reserve Currency (the U.S. Dollar) to Gold and Silver, the Monetary Metals which are both stores and measures of value, tangible value.

Failure to re-link currencies to Gold and Silver will allow a continuing massive and unsustainable inflation of the money supply by the Fed-led Cartel* of Central Bankers. The U.S. Federal Reserve is currently inflating the money supply (M3) by over 16% per year - - less than a 5-year doubling time (shadowstats.com). Unless such re-linking to Gold and Silver is accomplished, the U.S. Dollar is likely doomed, with severely negative consequences.

Money supply inflation ultimately leads to price inflation and this extraordinary rate of increase in the money supply, as several commentators, including Deepcaster, have pointed out, is leading us down the path to a hyperinflationary depression. (c.f. shadowstats.com). Or, more ominously, to an attempt to implement The Cartel’s “End Game” (see January, 2008 Letter at www.deepcaster.com.).

But the private for-profit U.S. Federal Reserve is not likely to give up its “un-backed” Fiat Currency and “un-backed” Treasury Securities Regime that easily - - they are the source of its Power. The Fed and associated International Financial Allies will strenuously resist.

Therefore the following recommendation should be implemented.

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*We encourage those who doubt the scope and power of Intervention by a Fed-led Cartel of Central Bankers to read Deepcaster’s January, 2008 Letter containing a summary overview of Intervention entitled “Market Intervention, Data Manipulation - - Increasing Risks, The Cartel End Game, and Latest Forecast” at www.deepcaster.com>LatestLetter. Also consider the substantial evidence collected by the Gold AntiTrust Action Committee at www.gata.org for information on precious metals price manipulation. Virtually all of the evidence for Intervention has been gleaned from publicly available records. Deepcaster’s profitable recommendations displayed at www.deepcaster.com have been facilitated by attention to these “Interventionals.”
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2) Legendary investor Jim Rogers recently neatly expressed The Solution to the problem of The Fed: “The Fed should be abolished and Chairman Bernanke should resign.” (March, 2008, CNBC)

A Good Idea. Indeed, The Fed is a private for-profit group of International Banks, whose main motivation is in providing profits for, and protecting the interests of, The International Bankers Cartel and related institutions, not in serving the needs of U.S. citizens (or most citizens of other countries for that matter). Just consider two recent Fed actions. At the beginning of the week of March 11, 2008, the Federal Reserve agreed to accept $200 billion of illiquid (i.e. Zero Market Value) mortgage-backed securities as collateral to prevent the implosion of major players in the mortgage finance industry - - “cash for trash” as Bill Murphy put it.

Yet all the Economic Stimulus Package that The Fed recommended for all the households in the United States was only $150 billion - - peanuts compared to what the Fed is doing, repeatedly, for the Big Money Center Financial Institutions.

In any event, the Private Ownership of the U.S. Federal Reserve is unsustainable (unless The Cartel can successfully implement its Ominous “End Game”) as we explain in our January 4, 2008 Alert: Understanding The Cartel’s ‘End Game’ Can Aid Investment Decisions. 

3) To replace The Fed, and in order to protect ordinary citizens interests, the U.S. Congress should create a genuinely National Bank as authorized by the U.S. Constitution. That truly National Bank should be the money issuer for the United States, not the private for-profit Cartel of International Bankers known as The Fed.

This is not such a radical idea. President Kennedy caused U.S. Notes to be issued late in his presidency as a replacement for Federal Reserve Notes. [He was killed soon after the issuance was started and the U.S. Notes disappeared from the market.]

If the U.S. Federal Reserve were acting in the interest of the American people it would act first to bail out households. Households are 70% of GDP. If households cannot pay their mortgages and cannot purchase the essentials and pay their bills, then households are not economically viable. If 70% of the economy is severely stressed, the economy cannot be healthy. In the long run, no amount of support The Fed provides to International Big Boys like Bear Stearns will suffice to save the economy because the very basis of the economy, the households (which operate, we emphasize, mainly in the world of Tangible Assets, not Darkly Liquid Paper), will be increasingly at great risk.

Of course the problem is that none of these above prescriptions are likely to be followed any month soon. Therefore, we will continue to see more darkly liquid paper-based businesses collapse and a steadily increasing Systemic Threat. Some will be rescued like Bear Stearns and others (like Thornburg Mortgage Co. and Carlyle Capital both of which de facto went bankrupt) will not. The list of casualties will grow.

Conclusion - - Profit and Protection

So how does one protect and profit from these what are sure to be these continuing developments. With only one major Caveat (see below), the closer one’s investments are to Tangible Assets and especially to those Tangible Assets which are in great and inelastic demand, the more secure and potentially profitable one’s investments will be, in the long-term.

This means, for example, that investors should focus on agricultural products, energy and similar Tangible Asset sectors, but considering the Caveat below. It is not an accident that, with rampant monetary inflation and an 80 million person annual increases in world population (and a 5 million annual mass-immigration-generated increase in the U.S. population), that these Sectors have been hitting records highs, and will continue to do so, except as follows.

The Important Caveat

Tangible Assets are the “Mortal Enemy” of the Fed-led Central Bankers as Deepcaster pointed out on several occasions. This is because if Tangible Assets become legitimate alternative stores and measures of value to the Bankers “Paper Assets” (i.e. Treasury Securities and Fiat Currencies) the Bankers lose power, influence and profit.

Therefore it is understandable that the Cartel of Central Bankers* periodically makes major and often successful attempts to take down the prices of the Monetary Metals, Gold and Silver, and Tangible Assets such as the Strategic Commodity Crude Oil.

Indeed, in this week ending March 21, 2008, they just did effect a major Tangible Asset Takedown with massive Market Intervention, as Deepcaster earlier Forecast. 

Therefore, in terms of timing one’s purchases of these assets, it is essential to consider not only the fundamental and technicals but also the Interventionals. Otherwise one and one’s Tangible Assets Portfolio can be caught in a Cartel-generated Takedown, with severely negative results.

The March 19 and 20, 2008 Takedown of Gold, Silver, Crude Oil, and Commodities in general are an Object Lesson in the still-potent Interventional Power of The Cartel.

And, given the exponentially increasing numbers of Derivatives required to implement each successive Takedown, it is also a clear reflection of the increasing Threat of Systemic Collapse. A Financial Regime built on Darkly Liquid Paper and Fiat Currencies is not indefinitely sustainable. 

Copyright © 2008 DeepCaster LLC
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