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Hera Final and Total Catastrophe

Hera Final and Total Catastrophe

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Published by: richardck61 on Oct 19, 2012
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11/15/2012

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Hera Research, LLC
7205 Martin Way East, Suite 72Olympia, WA 98516U.S.A.+1 (360) 339-8541 phone+1 (360) 339-8542 faxhttp://www.heraresearch.com/ 
1
AFinalAndTotal Catastrophe?
By Ron HeraOctober18,2012©2012Hera Research, LLCFamedAustrianeconomist Ludwig von Mises wrote inhis seminal work, Human Action (originallypublished bythe Yale University Press in 1949)
, that “
There is no means of avoiding the final collapse of a boom brought about by credit expansion.The alternative is only whether the crisis should come sooneras the result of voluntary abandonment of further credit expansion, orlater as a final and total catastropheof the currency system involved.
The collapse of a
historic credit bubbleoccurred in 2008.However,despite years offurther credit expansion,
afinal and total catastrophe
of theU.S. dollarsystemhas yetto occur. Prolonging theU.S. dollarsystem involves acombination of market interventions,directgovernmentcontrolover the economy and ongoing monetization by central banks. Of primary concern isthe probability that the U.S. dollar will collapse versusthesustainability andlong term effects ofwhatmight be described as aneweconomicparadigm.A stock market crash,economic recession or depression, sovereign default, widespread bank failures or asystemiccollapseof the financial systemareall logical, potentialconsequences ofan artificial boombrought about byexcessivecredit expansion. Arguably,policymakers cannot preventsome form of 
collapse
” but they can,
at least, prolong the process and shift the costs. Rather than a sudden,catastrophic collapse, the post 2008 period is defined by apolicy based status quo.Instead ofallowingbanks to fail and sovereign nations to default, and surelysuffering an economic depression, buying timehasallowedpolicymakersa window of opportunity in which todevelop longer term solutions. However,as theconsequencesof current policies, both intended and unintended, have mounted, longer termsolutions have not emerged. Measures that began as emergency interventions have become routine andtheir consequences suggest an emerging new economic paradigm.Leading up to the 2008 financial crisis, excessiveleverage and risk in the financialsystem, e.g., thehousingbubbleandunregulated over the counter (OTC)derivatives, resulted in bankinsolvencies, ahistoric stock market crash and a near collapse of the global financial system.Despite, massive marketinterventions, bankbailouts and debt monetization,a deep, global recession ensued.The2008 financialcrisis, the recession,and the policies used to manage them, required sharp increases in governmentspending while tax revenueswere in decline, bringing sovereign debt sharply into focus.As a result,Europe was engulfed in a sovereign debt crisis.In the U.S.,the residential real estate collapse and stock market crash represented a direct loss of household wealth while bank bailouts represented a transfer ofwealth from proverbial Main Street to
literal Wall Street. Deficit spending, debt monetization and the Federal Reserve’s asset purchases
expressedan inflationarymonetarypolicy involving numerousrisks and potentialconsequences.Although various monetary aggregates can have different effects, the overall increase in the supply of U.S. dollars is concerning.
 
©2012 Hera Research, LLC
2Despite the2008 financialcrisis,globalrecession and inflationary policies, confidence in the U.S. dollar,the U.S. stock market,theU.S.federalgovernment and the U.S. economy remained largely intact.Inflationary policies reduced certain risks, such as the risk of a deflationary collapse, whileincreasedliquidity from central bankmonetization lifted financial markets.More recently,investor confidencehasbeensupportedin Europeby the
European Central Bank’s (
ECB)outright monetary transactions (OMT)programandin the U.S.by the Fede
ral Reserve’s
quantitativeeasing III (QE3)program.In Europe, the risks ofsharply rising sovereign bond yields,sovereign defaultsand the potentialbreakup of theeurohave been muted by OMT while European leadersputativelymovetowarda fiscal union.
Thanks in part to the Federal Reserve’s ongoing “operation twist,”
U.S. Treasuryyields remainnear historiclows.
 
©2012 Hera Research, LLC
3On the surface, the fallout from the 2008 financial crisishas beeneffectively managed, but anotherfinancial crisisseemsinevitable.Developing mechanisms to manage a crisis similar to that of 2008 andpreventing another crisis are fundamentally different propositions. The basic causes of the 2008financialcrisis have not beenfully addressed.The lines between depository institutions and securities firms,erased in the U.S. by the final repeal of the Glass-Steagall Act in 1999, have not been restoredand the
U.S. Financial Accounting Standards Board’s (FASB) mark 
-to-market rulehas yet to bereinstated.Although bank capital ratios have improved, leverage remains excessive, balance sheet assets remaintroubled and, arguably, risk levels are higher than in 2008 because economic conditions have deterioratedcompared to the pre-crisis period.
Banks deemed “too big to fail” in 2008 h
avesincebecome bigger andthegross credit exposure associated withrisky OTC derivativesis nearly aslargeasit was before the2008financialcrisis.History has shown thatOTC derivativesincreaseleverageand riskin the financial system.OTCderivatives arelikely to result in bankor hedge fund failures andtocontribute to another financial crisis.According to the International Swaps and Derivatives Association (ISDA),OTC derivatives risk is widelymisunderstood becausethenet notional amountsof OTC derivatives, such as credit default swaps (CDS),total only about 10% of the gross notional amounts. In other words, grossnotional amounts, totalingroughly$700 trillion,are not a direct measure ofcredit exposure. Ifthe same percentages applyforall
OTC derivatives, the net exposure of market participants, e.g., “too big to fail” banks,
isless than $70trillion.Although$70 trillion is
approximately equal to the world’s total gross domestic product
(GDP),it is unlikely that all counterparties would fail simultaneously or that all losses would be 100%.Nonetheless, the failure of major financial institutions in connection with OTC derivatives risk could leadto another financial crisis which would accelerate the disintegration of the U.S. dollar system.While increased liquidity makes a stock market crash less likely, it remains unclearwhere earningsgrowth will come fromfor many U.S. companies.Ongoing monetization has elevated U.S. stocks aheadof the economic recovery and economic data have been disappointing, making a correction logical.
Additionally, by the end of 2013, the Federal Reserve’s balance sheet will have exceeded $3.4 trillion andthe Federal Reserve’s intention to eventually unwind its positions could become less cre
dible.
U.S. Leads Global Slowdown
For 2012, the International Monetary Fund (IMF) projects2.2% growth inJapan and the United Statesand3.5% growth globally.Based on the Baltic Dry Index (BDI), which reflectsthe price of movingmajor raw materials by sea, the global economy slowed significantlyin 2012and showed fewsigns of recovery. Nonetheless, there has been overall improvement in comparison to the depths of the globalrecession in 2009.

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