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Financial Armageddon in Europe: Part Two

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Operation Disclosure | By David Lifschultz, Contributing Writer

Submitted on October 17, 2022

FINANCIAL ARMAGEDDON IN EUROPE PART TWO

Compliments of the Lifschultz Organization founded in 1899

Russian intel makes the following comments:

1. Last year 20 LNG factories were blown up in the US. This decreases the ability to bail out Germany. The US government has thus far withheld all information on these investigations.

2. All that means is that Brits did it also.

3. The North Stream Two was also blown up by Brits.

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4. [redacted] so far can only transfer a small amount of gas to Europe which means the heating of houses is all that the Europeans can achieve which will lead to the closing of most of the European industries. This has been carefully planned to avoid massive loss of life.

5. [redacted] will have a huge amount of the transfer payments through which they can pay for the war.

My own comments are what effect the natural gas shortage is going to have on the 2.5 quadrillion derivative markets. It is noted that in England a tax cutting budget led to such a crisis that the government bond market began to collapse causing the Quantitative Tightening of the Bank of England to reverse course and buy 50 billion dollars of bonds to support the market and later more. That is the reverse of quantitative tightening.

It would be ironic if the collapse of the bond markets stops quantitative tightening. The US Federal Reserve has sent nine billon dollars to Switzerland for undisclosed reasons but it may be part of the effort to hold up Credit Suisse. And we are hardly at the maximum stress level that we will visit within two to three months. It took 29 trillion Fed dollars to bail out the 2008 crisis. Will we be talking now about two or three quadrillion for this crisis? See footnote one, two and three.

We analyzed this in the next link in relation to the effect the closing of the Straits of Hormuz would have on the 2.5 quadrillion derivative market which can be applied to the German financial black hole plunge of the derivative markets being sucked in based on a German financial crisis triggered by a catastrophic shortage of natural gas.

Footnote One:

Oct 13 (Reuters) – The Swiss National Bank this week drew nearly $6.3 billion from the U.S. Federal Reserve’s currency swap line facility, roughly double the amount drawn a week earlier, New York Fed data released on Thursday showed.

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The SNB on Wednesday drew $6.27 billion in U.S. currency for a seven-day term at an annualized rate of 3.33%. A week earlier it drew $3.1 billion at the same term and rate.

The two transactions were larger than any of the draws the SNB made during the spring of 2020 when it and other central banks tapped the Fed for billions of dollars during the global market panic that erupted in the early days of the coronavirus pandemic.

Footnote two:

In the following study it says that the Fed used 29,616.4 trillion dollars in credit in 2008 in various created instruments to save the system. See the link below for how this was arrived at.

Footnote three:

GCC, the Great Collateral Crisis

Financial crises are all different. They start in different places. But they are also alike in that they then spread through the system. The global financial crisis started in the US mortgage market, and it ended up as a generalised crisis of global credit. That is not the problem now. The way we fixed this problem, through large scale quantitative easing, is now becoming the source of the next crisis. After the Great Financial Crisis, collateral borrowing has been on the rise. Up until then, banks lent to each other in the unsecured money markets. But when banks started to distrust each other for the safekeeping of their overnight deposits, they resorted to the collateralised repo markets, selling government bonds or other debt overnight, and buying it back the next day. The difference in selling and purchase price, suitably normalised, is the overnight interest rate. This is also the mechanism by which central banks provide liquidity to the financial system.

One of the reasons why central banks cannot simply jack up interest rates to the levels necessary to bring inflation down is financial dominance, where the stability of the repo markets themselves ends up coming under threat. If interest rates rise, the price of bonds fall, which means that the collateral we post no is no longer sufficient to secure our liabilities. Last week’s crisis in the UK pensions market is a harbinger of what might turn into a generalised collateral crisis. Actual interest rates are still low, even though they are expected to rise. But if they were to overshoot current expectations – think 8-10% instead of 4-6% at the peak – we could see collateral crisis occurring in many places. Or we could simply see inflation rising. Or both.

What happened in the UK pensions market last week is the following doom loop. Here is our simplified version. The original sin in the UK occurred decades ago, when companies put employees on so called defined benefits schemes, or otherwise known as final salary schemes. The agreed pension was a percentage of the last salary received. What can possibly go wrong, you might ask.

Defined benefits schemes constitute a risk for pension funds. They often hedge this risk by investing into liability-driven funds (LDI) – this is the subprime of our current crisis. A very typical hedging instrument used by an LDI would be a classic interest rate swap where the investor receives a fixed rate to cover the liabilities, and pays the floating rate. These instrument are then leveraged, so that whatever happens is amplified.

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If interest rates go up fast as they do now, those LDI schemes ask their investors, the pension funds, for more collateral because the positions are loss-making. Paying floating rates when market interest rates are rising in exchange for a fixed rate is not a great trade right now.

What we are seeing here is a classic collateral crisis. Its origin dates back decades. Our gilts, bunds, OATs and BTP are the grease not only for the wheels of our money market, but in the UK’s case, also of the pension system. If their value changes abruptly, so do all financial relationships.

Companies no longer run defined benefits schemes for their employees. New employers these days are on so-called defined contributions schemes, where what is guaranteed is not what they get out but what they pay in. Aside from housing, pensions are the other source of inequality between the old and the young. The problem of pension fund liabilities will sort itself out over time. But right now, UK pension funds still have £2tn of defined benefits liabilities on their balance sheets.

What happened last week in the UK’s gilt market was a near default on collateral calls, brought on by an abrupt rise in gilt yields after the mini-budget. This would have had a cascading effect through the financial markets, with huge spillovers other markets. Those at the other end of the interest rate swap would have been defaulted on. For all we know, this might have been another Dusseldorf-based bank or Norwegian state-owned fund, the dumb investors of the last financial crisis.

The main lesson is that collateral is the lubricant of our entire financial system. It is the source of financial dominance, a situation in which a central bank is constrained in its policy decisions by financial considerations. The ECB probably has the clearest-defined mandate of all central banks: the sole pursuit of price stability, which is defined at 2% annual HICP inflation. The reason why a transmission protection instrument became necessary is as an insurance policy against a collateral crisis. But it means more QE, when you really be pursuing QT: quantitative tightening through shrinking your balance sheet. Central banks are publicly denying that there are subject to a policy conflict. But clearly, they are.

And so is the Bank of England. We noted the absurdity last week when the Bank of England’s chief economist warned of QT after the government’s now infamous mini-budget. A day later, the Bank did the very opposite, QE, to bail out the pension systems. This is classic financial dominance. You want to fight inflation, but you are distracted with other battle you have to fight first.

Pensions are an obvious source of financial instability. In the euro area, there are several others, such as a corporate debt crisis, or a sovereign debt crisis. Euro area governments are piling on debt on top of debt to get through the spike in energy costs, just as they piled on debt during the pandemic. As we argued above, deficit rules are now in permanent suspension. Subprime mortages were a bubble. So are defined benefit pensions. And so are fiscal policies based on whatever-it-takes principles. There are many sources that could give rise to a generalized collateral crisis. The Bank of England prevented the worst of the pension crisis, but that crisis is not gone.

Our expectation therefore is that the fight against inflation will take a step back as central banks are trying to safeguard the financial system. That, too has its risks, not least politically. A turbulent decade lies ahead.

David Lifschultz
THE LIFSCHULTZ ORGANIZATION
DAVID@LIFSCHULTZORGANIZATION.COM

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