There Are No Markets, Only [IMF] Manipulation

Guest Post by Mark Nestmann

I can’t help but be reminded of the truism of this week’s article title, watching Chinese stock prices drop, day after day. In response, Chinese securities regulators have banned most short selling. They’ve pressured mutual funds to buy stocks and run advertisements that extol the virtues of buying stocks.

The Chinese central bank has even parceled out cash to brokers to make it easier for investors to buy on margin. As central banks do, it’s creating the cash out of thin air. The central bank also announced a surprise devaluation of the yuan, China’s currency.

So far, the intervention hasn’t worked. Chinese stocks continue to plummet. The latest interventions urge companies to buy back their shares and boost dividends. Perhaps the central bank will create more money to pay for it all.

That might stop the plunge. But then again, it might not.

China is hardly alone in overtly manipulating its markets. This blatant effort to manipulate stock prices is only the most recent desperate gamble by global governments to prop up markets. They’ll do just about anything to prevent a repeat of the 2007-2008 recession.

Their playbook comes from the International Monetary Fund (IMF), which advises governments to engage in “financial repression” to buoy up global markets.

The IMF’s recipe to avoid what former Fed Chairman Ben Bernanke calls “chaotic unwinding” includes bail-ins, higher inflation, negative interest rates, and capital controls. The IMF even proposes a “one-off capital levy” – outright confiscation of private savings – at a rate of 10% or higher.

But as world markets have demonstrated over the last few weeks, it doesn’t always work.

The cause of this chaotic unwinding is excessive debt combined with leveraged bets financed by more debt.

The world economy is floating on a gargantuan mountain of debt; collateralized, re-collateralized, hypothecated, and semi-hypothecated. Total world indebtedness now stands close to $200 trillion. That amounts to 286% of the global GDP of $70 trillion.

What’s more, according to the Bank for International Settlements, the total notional value of derivatives (i.e., bets on the value of something else, like a stock, bond, interest rate, etc.) traded over the counter was $630 trillion for the last six months of 2014. There’s another $600 trillion or so of exchange-traded derivatives, structured notes, and custom-designed derivatives. They include options, futures, and credit default swaps, along with securities backed by assets (many of dubious value, such as high-risk mortgages).

That amounts to about $1.2 quadrillion, or 1,868% of global GDP.

At its heart, the economic collapse of 2007-2008 didn’t occur because people made stupid investment (and especially borrowing) decisions. They did, but it was mainly caused by the collapse of the derivatives market. The collapse of Bear Stearns in 2008, for instance, came about as a result of the collapse of hedge funds it operated stuffed full of collateralized debt obligations consisting primarily of bets on high-risk mortgages. Credit default swaps wiped out insurance giant AIG, until US taxpayers ponied up for a $180 billion bailout.

Could it happen again? Of course… that’s why governments worldwide are pulling out all the stops to prop up global markets.

As I’ve pointed out before, financial repression works only as long its targets – individuals, families, and businesses that have built up capital over years or decades – don’t catch on. And here governments have a big problem. They no longer have the trust of their wealthiest and most productive citizens. That’s a big reason over $20 trillion of private wealth now resides outside the countries where it was generated.

Increasingly, a big chunk of this wealth is being invested in “real” physical assets, not financial assets that can be bailed in, hypothecated, or hyper-hypothecated. That’s one reason why in an auction last May, a painting by Pablo Picasso sold for an astounding $179.4 million.

It’s not just art, by the way. Prices for classic cars, rare wines, numismatic coins, and other collectibles are all soaring. But personally, I prefer more traditional stores of wealth: gold, silver, and real estate owned without a mortgage.

If you can hold these assets outside the country you live in, and (in the case of precious metals) in a private vault (not a bank), so much the better. You’ll be much better prepared for the next chaotic unwinding than most other people. And since you actually own these assets (rather than being an unsecured creditor for assets you hold in a bank), you’ll never be bailed in.

What are you waiting for?

Mark Nestmann
Nestmann.com