Wednesday, 10 December 2008 09:09

Way back in 2007 when I declared that the global banks were all bankrupt, many sniggered and laughed.

 They are not laughing anymore.

 Way bank in 2007, I advised many friends to dump the British £ and I got some wise cracks that the pound is one of the strongest currency. It has plunged!

 There are no more wise cracks.

 Way back in 2007, I said that the crisis is a systemic crisis – the entire global financial system is screwed-up big time, people cursed and called me a doomsayer and a conspiracy theorist.

 US$8.5 Trillion has been pumped into the system and still we are having a crisis.

 There are no more name calling.

 So why is it so hard to comprehend the economic fact that a country, any country for that matter, can go into default, even the mighty USA?

 In 1971, when President Nixon on the advice of Paul Volker (who later became the FED Chairman) took the dollar off the Gold Standard, was not the decision, a major default?

 The dollar was redeemable in gold and this was the foundation of the then global financial system – the lynch-pin of the Bretton Woods system.

 The US ran out of Gold when its wealth was drained by the humiliating Vietnam War and other misadventures. The US refused to honour its sovereign obligations. The US defaulted!  The US was bankrupt!

 There is another precedent in history. This was when “Mother England” went off the gold standard when her empire collapsed after ruinous wars. The mighty Great Britain defaulted!  “Mother England” was bankrupt!

 Defaults by nations take various forms, and when they do default, the consequences are usually ugly and global.

 In the private micro-sector of finance, investors hedge defaults by bond issuers by buying a kind of insurance called Credit Default Swaps (CDS) which have been mutated into another method of gambling. I will write more of that later, and in another article in due course.

 The point I am making is that people buy insurance to avoid a negative outcome which will impact on their investments and or revenues.

 The premium or the cost for buying such protection is calculated on the basis of how many basis points per $ Ten million for 5 years.

 Hence, if your bonds are rated AAA and therefore credit worthy, the risk of default is low and the cost may be 1 basis point and a basis point is valued at  $1,000.

 This is translated in money terms as follows:

 1 basis point = $1,000 for every $ Ten million for 5 years.

 So when a country issues bonds to global investors, there is always what we call a “sovereign risk of default”.

 Risks such as political instability (frequent coups), financial mismanagement, high levels of corruption, hyper-inflation, worthless currency etc. are factors which will determine the cost of the insurance / CDS. Banana republics pose the highest risks.

 The method for calculating the cost of insuring a default by a nation is the same.

 Therefore, when the cost of buying a CDS for any country goes up, it is a sure indication that these countries are in very deep shit. Higher risks are translated to higher costs!

 You should now be prepared to shit in your pants if you have high exposures to US and UK government bonds or other assets denominated in these currencies.

 I am not here to argue with anyone whether or when the US or the UK will default.

 Just study the numbers below and make your own conclusions.

 The price of CDSs has risen for all major economies (i.e. the Western economies).

 The fact that a country is part of the Euro zone is no comfort. Italy has the highest CDS price because its debt to GDP is now at 103 per cent.

 But what is more shocking and not many has got this fact in their radars is that the price for “Mother England” CDS (colonial subjects were previously compelled to refer to UK as such) has risen the fastest.

 The price of insuring £10million of UK debt against default over five years has risen from £8,000 last February to £60,000 in the middle of November and has now reached the unbelievable £110,000.

 Just imagine that you are a fund manager and you have invested billions. The cost will eat right into whatever profit expectations that you may have.

 Do you want a CDS or not?

 Ouch!!!!!!!!!!!!!!!!

 This is not a conspiracy theory. This is not Matthias Chang’s forecast of doom.

 This is the market pricing the risks! So all you free market pundits, stop your bloody name calling and arrogance and wake up. The market has spoken.

 “Mother England” has defaulted before and will do so again.

 The US has defaulted before and will do so again.

 What is uncertain is the nature of the default. As I have stated earlier, it can come in various ways and forms. When the default comes, it will be very, very ugly and painful. This is a given.

 Massive devaluation is one.

 I conclude with this financial gem – a real food for thought.

 Sir Samuel Brittain (please Google him, if you have not heard of him) wrote in the Financial Times as to how “Mother England” would pay her debts:

 “Where will the money come from? The short answer is: the Bank of England printing works in Debden. This is not just a debating reply. In a paper currency system, there is no fixed pot of money, but a total influenced by human action.”

 Uncle Sam, armed to the teeth is doing the same. Creating digits and toilet papers!

 Even if they keep on printing, I don’t believe that there will be sufficient toilet papers to wipe the shit off the arses of those who still remain in a state of denial, especially those idiots in the Badawi regime.

 I don’t have a crystal ball and unlike the Nobel Laureates who arrogate themselves the title “Master of the Universe” and have “financial models” to forecast odds and pricings and the future, but could not even see the coming waves of the Tsunami, all that I can bring to you, visitors to my website, are some hard facts and admissions by those in the know.

 You are forewarned!