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U.S. derivatives market . . . JPMC Bank alone has derivatives
approaching four times the U.S. Gross Domestic Product of $11.5
trillion. Next come Bank of America and Citibank, with $14.9
trillion and $14.4 trillion in derivatives, respectively. The OCC
[Office of the Comptroller of the Currency] reports that the top
seven American derivatives banks hold 96% of the U.S. banking
system™s notional derivatives holding. If these banks suffer serious
impairment of their derivatives holdings, kiss the banking system
Martin Weiss envisions how this collapse might occur:
Portfolio managers at a major hedge fund bet too much on
declining interest rates and they lose. They don™t have enough
capital to pay up on the bet, and the counterparties in the
transaction “ the winners of the bet “ can™t collect. Result: Many
of these winners, also low on capital, can™t pay up on their own
bets and debts in a series of other derivatives transactions.
Suddenly, in a chain reaction that no government or exchange
authority can halt, dozens of major transactions slip into default,
each setting off dozens of additional defaults.
Major U.S. banks you™ve trusted with your hard-earned
savings lose billions. Their shares plunge. Their uninsured CDs
are jeopardized.
Mortgage lenders dramatically tighten their lending
standards. Mortgage money virtually disappears. The U.S.
housing market, already sinking, busts wide open.5

Derivatives 101

Gary Novak, whose website simplifying complex issues was quoted
earlier, explains that the banking system has become gridlocked
because its pretended “derivative” assets are fake; and the fake assets
have swallowed up the real assets. It all began with deregulation in

Web of Debt

the 1980s, when government regulation was considered an irrational
scheme from which business had to be freed. But regulations are
criminal codes, and eliminating them meant turning business over to
thieves. The Enron and Worldcom defendants were able to argue in
court that their procedures were legal, because the laws making them
illegal had been wiped off the books. Government regulation prevented
the creation of “funny money” without real value. When the
regulations were eliminated, funny money became the order of the
day. It manifested in a variety of very complex vehicles lumped
together under the label of derivatives, which were often made
intentionally obscure and confusing.
“Physicists were hired to write equations for derivatives which
business administrators could not understand,” Novak says.
Derivatives are just bets, but they have been sold as if they were
something of value, until the sales have reached astronomical sums
that are far beyond anything of real value in existence. Pension funds
and trust funds have bought into the Ponzi scheme, only to see their
money disappear down the derivatives hole. Universities have been
forced to charge huge tuitions although they are financed with huge
trust funds, because their money has been tied up in investments that
are basically worthless. But the administrators are holding onto their
bets, which are “given a pretended value, because heads roll when
the truth comes to light.” Nobody dares to sell and nobody can collect.
The result is a shortage of available funds in global financial institutions.
The very thing derivatives were designed to create “ market liquidity “
has been frozen to immobility in a gridlocked game.6
The author of a blog called “World Vision Portal” simplifies the
derivatives problem in another way. He writes:
Anyone who has been to Las Vegas or at the casino on a
cruise ship can understand it perfectly. A bank gambles and
bets on certain pre-determined odds, like playing the casino dealer
in a game of poker (banks call this “hedging their risks with de-
rivative contracts”). When they have to show their cards at the
end of the play, they either win or lose their bet; either the bank
wins or the house wins (this is the end of the derivative contract
For us small-time players, we might lose $10 or $20, but the
big-time banks are betting hundreds of millions on each card
hand. The worst part is that they have a gambling addiction
and can™t stop betting money that isn™t theirs to bet with. . . .

Chapter 32 - In the Eye of the Cyclone

Winners always leave the gambling table with a big smile
and you can see the chips in their hand to know they won more
than they had bet. But losers always walk away quietly and
don™t talk about how much they lost. If a bank makes a good
profit (won their bet), they would be telling everyone that their
derivative contracts have paid off and they™re sitting pretty. In
reality, the big-time gambling banks are not talking and won™t
tell anyone how much they gambled or how much they lost.
We™ve been hoodwinked and the game is pretty much over.7
The irony is that derivative bets are sold as a form of insurance
against something catastrophic going wrong. But if something cata-
strophic does go wrong, the counterparties (the parties on the other
side of the bet, typically hedge funds) are liable to fold their cards and
drop out of the game. The “insured” are left with losses both from the
disaster itself and from the loss of the premium paid for the bet. To
avoid that result, the Federal Reserve, along with other central banks,
a fraternity of big private banks, and the U.S. Treasury itself, have
gotten into the habit of covertly bailing out losing counterparties. This
was done when the giant hedge fund Long Term Capital Manage-
ment went bankrupt in 1998. It was also evidently done in 2005, but
very quietly . . . .

A Derivatives Crisis Orders of Magnitude
Beyond LTCM?

Rumors of a derivatives crisis dwarfing even the LTCM debacle
surfaced in May 2005, following the downgrading of the debts of Gen-
eral Motors and Ford Motor Corporation to “junk” (bonds having a
credit rating below investment grade). Severe problems had appar-
ently occurred at several large hedge funds directly linked to these
downgradings. In an article in Executive Intelligence Review in May
2005, Lothar Komp wrote:
The stocks of the same large banks that participated in the 1998
LTCM bailout, and which are known for their giant derivatives
portfolios “ including Citigroup, JP Morgan Chase, Goldman
Sachs, and Deutsche Bank “ were hit by panic selling on May
10. Behind this panic was the knowledge that not only have
these banks engaged in dangerous derivatives speculation on
their own accounts, but, ever desperate for cash to cover their

Web of Debt

own deteriorating positions, they also turned to the even more
speculative hedge funds, placing money with existing funds, or
even setting up their own, to engage in activities they didn™t
care to put on their own books. The combination of financial
desperation, the Fed™s liquidity binge, and the usury-limiting
effects of low interest rates, triggered an explosion in the number
of hedge funds in recent years, as everyone chased higher, and
riskier, returns. There can be no doubt that some of these banks,
not only their hedge fund offspring, are in trouble right now.8
Dire warnings ensued of a derivatives crisis “orders of magnitude
beyond LTCM.” But reports of a major derivative blow-out were be-
ing publicly denied, says Komp, since any bank or hedge fund that
admitted such losses without first working a bail-out scheme would
instantly collapse. An insider in the international banking commu-
nity said that “there is no doubt that the Fed and other central banks
are pouring liquidity into the system, covertly. This would not become
public until early April [2006], at which point the Fed and other central
banks will have to report on the money supply.”9
We™ve seen that when the Fed “pours liquidity into the system,” it
does it by “open market operations” that create money with account-
ing entries and lend this money into the money supply, “monetizing”
government debt. If it became widely known that the Fed were print-
ing dollars wholesale, however, alarm bells would sound. Investors
would rush to cash in their dollar holdings, crashing the dollar and
the stock market, following the familiar pattern seen in Third World
countries.10 What to do? The Fed apparently chose to muffle the alarm
bells. It announced that in March 2006, it would no longer be report-
ing M3. M3 has been the main staple of money supply measurement
and transparent disclosure for the last half-century, the figure on which
the world has relied in determining the soundness of the dollar. In a
December 2005 article called “The Grand Illusion,” financial analyst
Rob Kirby wrote:
On March 23, 2006, the Board of Governors of the Federal Reserve
System will cease publication of the M3 monetary aggregate.
The Board will also cease publishing the following components:
large-denomination time deposits, repurchase agreements (RPs),
and Eurodollars. . . . [These securities] are exactly where one
would expect to find the “capture” of any large scale
monetization effort that the Fed would embark upon “ should
the need occur.

Chapter 32 - In the Eye of the Cyclone

A commentator going by the name of Captain Hook observed:
[T]his is as big a deal as Nixon closing the “gold window” back
in ™71, and we all know what happened after that. . . . [I]t almost
looks like the boys are getting ready to unleash Weimar Republic
II on the world. . . . Can you say welcome to the “People™s
Republic of the United States of What Used to Be America”?. . .
[W]e just got another very “big signal” from U.S. monetary authorities
that the rules of the game are about to change fundamentally, once
again. 11
When Nixon closed the gold window internationally in 1971 and
when Roosevelt did it domestically before that, the rules were changed
to keep a bankrupt private banking system afloat. The change in the
Fed™s reporting habits in 2006 appears to have been designed for the
same purpose. The Fed was soon rumored to be madly printing up $2
trillion in new Federal Reserve Notes.12 Why? Some analysts pointed
to the festering derivatives crisis, while others said it was the housing
crisis; but there were also rumors of a third cyclone on the horizon.
Iran announced that it would be opening an oil market (or “bourse”)
in Euros in March 2006, sidestepping the 1974 agreement with OPEC
to trade oil only in U.S. dollars. An article in the Arab online maga-
zine Al-Jazeerah warned that the Iranian bourse “could lead to a col-
lapse in value for the American currency, potentially putting the U.S.
economy in its greatest crisis since the depression era of the 1930s.”13
Rob Kirby wrote:
[I]f countries like Japan and China (and other Asian countries)
with their trillions of U.S. dollars no longer need them (or require
a great deal less of them) to buy oil . . . [and] begin wholesale
liquidation of U.S. debt obligations, there is no doubt in my mind
that the Fed will print the dollars necessary to redeem them “
this would necessarily imply an absolutely enormous (can you
say hyperinflation) bloating of the money supply “ which would
undoubtedly be captured statistically in M3 or its related
reporting. It would appear that we™re all going to be “flying
blind” as to how much money the Fed is truly going to pump
into the system . . . .14
For the Federal Reserve to “monetize” the government™s debt with
newly-issued dollars is actually nothing new. When no one else buys
U.S. securities, the Fed routinely steps in and buys them with money
created for the occasion. What is new, and what has analysts alarmed,
is that the whole process is now occurring behind a heavy curtain of
Web of Debt

Total M3 Money Stock at Calendar Year End
1901 (10 billion) - 2--5 (10 trillion) and Part Year 2006


secrecy. Richard Daughty, an entertaining commentator who writes
in The Daily Reckoning as the Mogambu Guru, commented in April
There was . . . a flurry of excitement last week when there
was a rumor that the Federal Reserve had printed up, suddenly,
$2 trillion in cash. My initial reaction was, of course,
“Hahahaha!” and my reasoning is thus: why would they go
through the hassle? They can make electronic money with the
wave of a finger, so why go through the messy rigamarole of
dealing with ink and paper and all the problems of transporting
it and counting it and storing it and blah blah blah?
But . . . this whole “two trillion in cash” scenario has some,
um, merit, especially if you are thinking that foreigners dumping
American securities . . . would instantly be reflected in
instantaneous losses in bonds and meteoric rises in interest rates
and the entire global economic machine would melt down.
So maybe this could explain the “two trill in cash” plan:
With this amount of cash, see, the American government can pretty
much buy all the government securities that any foreigners want to
sell, but the inflationary effects of creating so much money won™t
be felt in prices for awhile! Hahaha! They think this is clever!15

Chapter 32 - In the Eye of the Cyclone

It might be clever, if it really were the American government buying
back its own securities; but it isn™t. It is the private Federal Reserve and
private banks. If dollars are to be printed wholesale and federal securities
are to be redeemed with them, why not let Congress do the job itself
and avoid a massive unnecessary debt to financial middlemen?
Arguably, as we™ll see later, if the government were to buy back its
own bonds and take them out of circulation, it could not only escape
a massive federal debt but could do this without producing inflation.
Government securities are already traded around the world just as if
they were money. They would just be turned into cash, leaving the
overall money supply unchanged. When the Federal Reserve buys up
government bonds with newly-issued money, on the other hand, the
bonds aren™t taken out of circulation. Instead, they become the basis
for generating many times their value in new loans; and that result is
highly inflationary. But that is getting ahead of our story . . . .

The Orwellian Solution

The Fed had succeeded in hiding its sleight of hand by concealing
the numbers for M3, but inflation was obviously occurring. By the
spring of 2006, oil, gold, silver and other commodities were skyrocket-
ing. Then, mysteriously, these inflation indicators too got suppressed.


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