We Got Problems….


Greece and, for that matter, the rest of Europe are showing cracks again this morning.

The Dollar is screaming higher (how’s that “dollar collapse” thesis working out?)

Gold is around $1,200; up fractionally on the day, but in general not in good shape — and making a mockery of the “Gold to $5,000” callers.

Interest rates are again going up, while The Fed is trying to claim that they really didn’t say that they were going to taper.  But that’s a lie, because they have to stop the QE.  This isn’t about wanting to exit, it’s about being forced to exit.

The government cannot continue to expand permanently at a rate that exceeds actual economic expansion, or it eventually “swallows” the entire economy — and long before then collapse comes.  See Greece, which is just the latest example of many over the years.)

Many people do not understand how all of this ties together, so let me try to explain as there has been much hay made about the fact that the rapid plunge in one asset class (stocks) didn’t appear to be flowing elsewhere during the collapse.

That’s because what was being “invested” wasn’t actually capital — it was printed credit, and The Fed wasn’t the one doing the printing either!

Let’s take just one example — Treasury debt margin requirements.  Anyone who trades knows all about margin and most people understand it (more or less) on stock.  You must have 50% of the equity cost on initial margin in capital with most brokers and 30% for maintenance.  This means you can lever up approximately 2:1 initially and 3:1 on an ongoing basis.

But for Treasuries this is much higher — as much as 25:1 for debt under 2 years of maturity, and often as much as 10:1 for debt of 10 years of maturity!

10-Year Treasuries

10-Year Treasuries

Never mind some brokers who will lend you 4:1 or 5:1 margin for equities at (today) very low interest rates, leading people to do things like put up $200,000, buy $1 million in high-dividend stocks (yielding, say, 5%), pay 2% interest on the money and allegedly “pocket” 3% on the margined amount, thereby “earning” about 12% (before taxes) on their capital.

That sounds damn good, doesn’t it?  

What happens when the market goes down 20%?

You get a margin call, that’s what.  Your “3%” evaporates in the first minutes of the plunge and your entire $200,000 goes up in smoke, being transferred from your ownership to the broker’s.

Margin Call

But more importantly, from the market’s perspective, the $1 million that was out there representing buying interest doesn’t rotate somewhere else, it disappears because it never really existed; it was conjured out of thin air.

Note well — the actual impact on the market is five times the economic loss you took.

If that’s not enough to sober you up then you’ve been hitting something much stronger than the traditional bottle.

This is what creates bubbles — “boom and bust.”  It is why One Dollar of Capital is so damned important, and why violating it is an open, public and notorious fraud.  It is the central point in Leverage, (look to the right if you haven’t read it) and yet we continue to dance around the real issue rather than dealing with it head-on — as if we deal with this head-on then the over-bloated “price” in the asset markets will rapidly converge toward value, and that convergence will be downward — hard and fast.

And if consideration of that fact does not provide you with enough understanding of what is coming, why it’s coming, why it’s inevitable with margin debt at all-time record highs and the positive feedback mechanism that will play out as rates go up — a move that appears to have already exceeded The Fed’s ability to stop it, you ought not be in the market at all.

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