Saturday, September 16, 2006

Our Monetary System - Part II - Market Volatility

It's been about eight months since I wrote the post on our monetary system (Our Monetary System – How Central Banks Control the World’s Economy). Obviously, a lot has happened since that first article. Over the past two months (September and October), we’ve seen the U.S. economy begin to contract and we’ve also seen extreme volatility in stock markets around the world. In this post, we’re going to review how our monetary system is currently impacting the world’s financial system and why we are seeing such extreme volatility in the world’s markets.

Let’s start by reviewing the Chicago Board Options Exchange Volatility Index (VIX). This is a widely used measure of stock market volatility. It is a measure of the implied volatility of S&P 500 index options. A higher VIX value reflects more volatility in the market. As a baseline to what we’re seeing today – the VIX index briefly moved above 40 a couple of times in 2001 and 2002 during the dot com bust – reflecting high volatility as technology stocks declined. From 2003 through 2007, a value of 30 indicated a fairly volatile market – it typically moved in a range between 10 and 20. High volatility typically corresponds with stocks moving significantly lower as many investors issue sell orders. As you can see from the chart below, the index has not moved below 30 since the middle of September (2008) and briefly moved above 80 around October 27th. Obviously, it’s not hard to see that stock markets have been extremely volatile. It hasn’t been uncommon for the Dow Jones Industrial Average to swing 500, 600, 700 – even 1000 points in one day. I’m guessing that there are stock traders around the world eating a lot of antacid these days.

So, the 64,000 dollar question is – what is causing this volatility? Is it just the economy showing signs of weakness or is something more ominous at work here? Before we answer this question, let’s take a look at a couple of other things happening within the world’s financial system.

VIX: 6 Months

(Source: Yahoo! Finance)

As in previous years where volatility has been high, we again see that stocks are also showing significant declines. As we see from the chart below – the Dow Jones Industrial Average (DJIA) has declined as volatility has increased. This really shouldn’t be surprising – as prices become more volatile, people begin to lose confidence that their investments are stable/safe – so they move more of their money into investments that are perceived to be safer and less volatile – leading stocks lower. As we’re going to see – what the world perceives as ‘stable’ or ‘safe’ – isn’t safe at all. Take note of what the DJIA chart of the past 2 months looks like (below) – because you’re going to see the same pattern again and again.

Also note that the DJIA tracks 30 ‘blue-chip’ stocks – large companies like American Express and Bank of America (Banking & Finance), IBM and Intel (Technology) and Chevron and ExxonMobil (Energy) – a wide range of companies and industries.

DJIA – 2 Months (includes Volume & Volatility)

(Source: Wall St. Journal Online)

Let’s now look at the NASDAQ composite index. This is an index of all the stocks listed on the NASDAQ stock market. These are typically technology companies - companies like Apple Computer, Microsoft and Oracle. As you view the graph below – notice anything similar to the DJIA graph above? Although the values are different – they are both moving in the same direction, by approximately the same percentage - at the same time. So, an index that encompasses a wide range of large companies in many different industries (DJIA) is moving in tandem with an index (NASDAQ Composite) that is comprised of almost 3,000 technology companies. Is this a coincidence or will we see the same pattern continue across other stock markets?

NASDAQ Composite – 2 Months (includes Volatility)

(Source: Wall St. Journal Online)

Let’s take a look at the S&P 500 stock index. The S&P 500 includes 500 large cap U.S. stocks – and like the DJIA – includes companies across many different industries. 3M, AllState, Amazon, Monsanto are a few of the companies included in the S&P 500.

S&P 500 Index – 2 Months (includes Volatility)

(Source: Wall St. Journal Online)

At first glance, it appears that I’ve copied either the DJIA or NASDAQ graph above – because all three look almost exactly the same. The values of each index are different (reflecting the different overall dollar values of each index), but they are all moving in the same direction, by the same percentage – at the same time. You’ve probably noticed this yourself at times, but didn’t think much about it. We should pay close attention – because this is indicating another fundamental flaw inherent in the world’s financial system. We’ll get to this after a few more graphs.

Let’s look at the NIKKEI Index – an index that tracks the Tokyo Stock Exchange. Once again we see that although the values are different – Japanese stocks are moving in the same direction, by approximately the same percentage – at the same time as their American counterparts.

NIKKEI Index – 2 Months (includes Volatility)

(Source: Wall St. Journal Online)

We see the same trends in European stocks. The following is a Dow Jones stock index for European companies.

DJ Stoxx 50 – 2 Months (Europe – includes Volatility)

(Source: Wall St. Journal Online)

….and the same trends in Australia.

Australia ASX Index – 2 Months (includes Volatility)

(Source: Wall St. Journal Online)

The Dow Jones World Index (a composite of the world’s stock markets) looks almost identical to all of the stock indexes above. What do these graphs show you? Are you diversifying your portfolio by investing in different stock markets around the world? No – you’re not. The world’s financial system is now so closely interconnected – that all of the world’s stock exchanges are moving in tandem - acting like one big stock exchange. Stocks around the world are moving up together and moving down together - and are all very volatile and declining in value. Is stock market volatility a good thing? Absolutely not. Stocks are the most volatile investments on the planet and continued volatility can cause panics – which we’ve already seen in October. When the stampede out of stocks begins sometime in the near future – it’s going to be a worldwide stampede.

DJ World Index – 2 Months (includes Volatility)

(Source: Wall St. Journal Online)

If stocks are going to significantly decline in value, where do we invest our money? The next investment option is usually bonds. Bonds are less volatile – right? Not in this current crisis. Let’s look at one of the most widely purchased bonds – the 10 year U.S. Treasury bond.

The graph below shows the yield on the 10 year T-bill over the past 2 months.

10 Year Treasury Yield – 2 Months

(Source: Wall St. Journal Online)

Stock market volatility is spilling over into bonds (even bonds considered safe – U.S. T-bills) because investors have gotten into and out of bonds as stock markets have gone on a rollercoaster ride. When stock market volatility rises – investors will tend to move to ‘safer’ investments – which is why you see the swings in the 10 year t-bill above. Prices for T-bills have also been volatile – they move inversely to yields.

10 year Treasury Yields over the past year look just as volatile.

10 Year Treasury Yield – 1 Year

(Source: Wall St. Journal Online)

Look at the 3 month Treasury yield below. When stock market volatility began to rise significantly in September, investors fled to T-bills – driving the yields to almost nothing. This means that investors were willing to buy t-bills with no yield in exchange for safety. Investors were investing their money in something that paid them nothing in return. This would be like parking all of your money in a checking account with no interest – simply because you trust the bank and fear any of the alternatives. What would cause the world’s investors to do such a thing? One word – fear. Not a good thing for financial/stock markets.

3 Month Treasury Yield – 3 Months

(Source: Wall St. Journal Online)

The index below tracks municipal bond prices (comprised of 40 municipal bonds rated A or better). Once again, we see more volatility.

Bond Buyer Muni Index – 3 Months

(Source: Wall St. Journal Online)

The Dow Jones Corporate Bond Index is an equally weighted basket of 96 investment grade corporate bonds. Do you see any stability here? Nope.

DJ Corporate Bond – 3 Months

(Source: Wall St. Journal Online)

The Dow Jones Chicago Board of Trade Treasury Index (DJ CBOT) is made up of CBOT 5-year, 10-year and bond futures contracts. See any stability here? Again, the answer is no.

DJ CBOT Corporate Treasury – 3 Months

(Source: Wall St. Journal Online)

What about the convertible bond market? You may have heard about convertible bonds recently in the news – corporations and hedge funds often use this market for short term financing needs. What is a convertible bond? As stated by the Wall St. Journal:

“Convertible bonds are part stocks, part bonds. They act like bonds and usually pay interest. But, as an added kicker, they give holders the right to convert the securities into stocks at a certain price. The market is normally less volatile than stocks, but the securities can have the same upside if a company rebounds.”

How has this market fared this year? The following excerpt from the Wall St. Journal says it all.

“Overall, the $200 billion convertible-bond market has lost 36% so far this year, a bit more than the stock market, according to Merrill Lynch. But the average convertible-bond hedge fund has lost about 50% in that time, including a 35% plunge in October, according to Hedge Fund Research Inc.”

We see more volatility and more wealth evaporating.

So, we now see that both stocks and bonds have been extremely volatile and we see both stocks and bonds declining significantly in value. If you add up the declines in the graphs above – you see trillions of dollars vanishing.

Until the recent crisis – money market funds have been considered as safe as cash. Not now – the following excerpt from an article on CNN sums up the risks with money market funds:

“A soured investment in Lehman Brothers Holdings Inc. debt slashed two-thirds of the asset value of the oldest money-market fund in the United States, exposing clients to losses despite investments in a financial product seen as a safe haven even in volatile markets.

The sudden setback at the Reserve Primary Fund caused it to "break the buck" -- leaving investors unlikely to get back all the cash they put in because the fund failed to maintain assets of at least $1 for every dollar invested.”

In a previous post I discussed how the market for Auction Rate securities has also collapsed – commercial and investment banks have recently agreed to pay billions to investors who felt they were misled into believing these securities were as safe as cash.

If we also consider that banks are struggling with rising loan defaults (17 U.S. banks have failed to date this year), it is becoming clear that even our checking and savings accounts are at risk. You may think that the FDIC will insure your deposits – but the FDIC has funding for approximately 1% of current bank deposits. Not exactly reassuring.

It is becoming increasingly clear that there are no safe havens in the world’s financial system – except maybe your mattress – and it’s not really part of the financial system.

The next stop on this journey is commodities. Let’s take a look at prices of some of the most widely traded commodities. Let’s start with oil. The following shows the price of oil over the past 3 months. After climbing above $140 a barrel this summer, the price has now dropped rapidly below $70. In approximately two weeks, the price of a gallon of gasoline in Atlanta has dropped from $4 to $2. It’s easy to cheer such a drop in gas prices – until you study why it’s dropping so dramatically.

Crude Oil – 3 Months
(Source: Wall St. Journal Online)

It’s easy to see that market volatility is not isolated to stocks, bonds and financial derivatives – it’s also present within commodity prices. We’re going to see that this volatility and price deflation present in oil also exists across all types of commodities. The question we’re going to explore is – why?

Let’s take a look at metals. Copper prices have dropped over 40% in three months as demand has declined dramatically.

Copper – 3 Months

(Source: Wall St. Journal Online)

Even gold has been volatile – as investors buy and sell gold to cover margins in other investments and diversify their holdings. I believe that although gold has been somewhat volatile – it’s still the best investment in an uncertain financial system since its value is not tied to interest rates and it can always be used as money. Try buying some actual gold – it’s hard to find. The U.S. mint has even stopped minting certain gold coins since demand is far exceeding supply.

Gold – 3 months

(Source: Wall St. Journal Online)

What about agriculture? We see the same trends. Corn prices have declined over 30% in three months.

Corn – 3 Months

(Source: Wall St. Journal Online)

Same situation with Soybeans – prices have declined over 30% in three months.

Soybeans – 3 Months

(Source: Wall St. Journal Online)

Wheat prices are down almost 40% in three months.

Wheat – 3 Months

(Source: Wall St. Journal Online)

What about livestock? The same trends are present everywhere. Hog prices are down over 25% in three months.

Lean Hogs – 3 Months
(Source: Wall St. Journal Online)

Cattle prices are down over 15% in three months.

Live Cattle – 3 Months

(Source: Wall St. Journal Online)

The obvious question is – why are we seeing such widespread price deflation in the world’s financial markets? If you read my first article on our monetary system, then you know that I initially believed we would probably see some type of hyper-inflation as Central Banks pumped more and more money into the system. If you’ve been following the crisis – then you know that inflation has been a concern for Central Banks for some time as prices increased dramatically for a wide range of products and services. We can see this in the chart below. If we measure inflation using the standard measure used by our government until the early 80’s – we see inflation approached almost 14% before beginning to decline recently.


So, what is happening to tame inflation? Why are prices declining at such a rapid pace? The biggest pieces of the puzzle are (once again) our money supply and debt. Take a look at our money supply growth rates.


We are seeing money supply growth slow considerably. Why is this happening? Because the world’s private banking system is failing. Banks have dramatically reduced lending due to rising defaults and borrowers have dramatically reduced taking on more debt – because their debt levels are already at unmanageable levels. The current debt of governments, corporations and individuals is crushing the world’s economy. Central banks are now attempting to revive the world’s economy by lowering interest rates (again), lowering reserve requirements and recommending that governments continue with economic ‘stimulus’ packages. Someone must continue creating debt (and therefore – money) or the system will begin a freefall collapse. As I’ve said before – they are only delaying the inevitable. You can only service debt at these levels for so long – before something catastrophic happens.

What happens when a debt-based monetary system begins to collapse? You’re watching it happen everyday now – extreme volatility ripples throughout the financial system as the entire system shudders under the weight of the debt it has created. The world simply can’t sustain the debt creation necessary to keep the system going. Very few people understand what is happening – so we’re seeing wild swings in prices and volumes as people are blindly looking to somehow save their money from vanishing.

Prices for everything are now rapidly declining because we don’t have the money – or access to needed credit - to buy things. Our economy actually began contracting in 2004 (when viewing real data) – but as you can see – it appears that we are now falling off the cliff.


This is why auto-makers the world over are now reporting drastically reduced sales numbers (and financial results) and why 3rd quarter earnings from all kinds of companies in all kinds of industries around the world are showing serious declines and/or issuing guidance warnings. We simply don’t have the money and/or access to credit to keep the system running.

This is why we see abysmal economic data like this:

We hear economists talk a lot about ‘bubbles’ – asset bubbles, stock bubbles, housing bubbles, etc. As you will see below – the world’s financial system has created one, very big bubble across the entire system – and it’s about to pop.

It’s easy to see that stocks are on the way down from the top of the mountain.

World Stock Index (DJ World Index):

(Source: Wall St. Journal Online)

U.S. Stocks (DJIA):

(Source: Wall St. Journal Online)

European Stocks (DJ Stoxx 50) :

(Source: Wall St. Journal Online)

Japanese Stocks (NIKKEI):

(Source: Wall St. Journal Online)

Latin America (DJ Americas):

(Source: Wall St. Journal Online)

Much of the blame for the current crisis has been placed on the U.S. and U.K. housing market collapse. A housing bubble has certainly been created in both countries, but as you will see – this is a worldwide problem.


The following excerpt is taken from the website:

(Source: IMF)

“WHERE are house prices most overvalued? As the rest of the world watches the bursting of America's housing bubble, that question should be at the top of everyone's mind. The answer is not comforting: many countries have had far hotter housing markets than America and are also suffering from tightening lending conditions thanks to the credit crisis.

In the latest World Economic Outlook, Roberto Cardarelli of the IMF calculates the share of the increase in real house prices between 1997 and 2007 that cannot be accounted for by fundamental factors such as lower interest rates and rising incomes. This “house-price gap” is greatest for Ireland, the Netherlands and Britain, where prices are about 30% higher than can be justified by fundamentals. France, Australia and Spain have house-price gaps of around 20%. In America, where prices were already falling in 2007, the gap is just over 10%.” –

Energy prices have certainly been through a bubble:

Crude Oil:

(Source: Wall St. Journal Online)

Natural Gas Henry Hub Pit (Nymex):

(Source: Wall St. Journal Online)

Food prices across the board have gone through a bubble:


(Source: Wall St. Journal Online)


(Source: Wall St. Journal Online)


(Source: Wall St. Journal Online)

Let’s look again at what is behind all of this: our money supply.


Our total money supply (M3 - dollars) is now approximately $14 trillion, but the rate of growth is now slowing. If we see a dramatic decrease in lending from banks, what is sustaining the money supply growth? Here’s the answer:

The total amount of money (dollars) controlled by the Fed & Treasury has more than doubled in 2008 to over $4 trillion dollars. As I’ve said before – someone has to keep the supply of money growing – which is why we see Central Banks pumping billions of dollars into the system and telling governments to provide additional economic stimulus packages.

Is there anything else that has contributed to these bubbles and all of this volatility? The Federal Reserve (and mainstream media) tells us that they adjust the Fed Funds Rate in response to economic conditions. The truth is that the Fed drives the economy (and behavior) with interest rates (coupled with reserve requirements). The Fed isn’t responding to a rollercoaster ride – it created the rollercoaster.


What happens when volatility finally cause the bubbles to burst completely? We’ll need a new, heavily regulated, worldwide financial system.

If you were wondering if the Fed really does own a large portion of our debt – this pie chart should answer the question. The Federal Reserve owns over 50% of the U.S. Federal debt. Remember – this is a cartel of private international bankers. I wonder why we never hear this on the nightly news?


What does the Bible say about the relationship between a lender and a borrower?

‘the borrower is servant to the lender’ (Proverbs 22:7)

“Do not be a man who strikes hands in pledge or puts up security for debts; if you lack the means to pay, your very bed will be snatched from under you.” (Proverbs 22:26-27)

And here we see the impact on the Fed’s balance sheet from all the recent ‘bailout’ activity. Notice that their ‘assets’ are increasing substantially.

(Source: Federal Reserve)

The Lord has warned humanity for thousands of years about the very thing happening to us today – and our nation has joined a growing list of nations throughout history - that have ignored His warnings.

Here’s a good parable to summarize what is happening. Our Father tells us that He will build us a nice house – not too big, not too fancy – but it will shelter us and provide us all that we need – a good, stable house that will last. It won’t cost us anything – we only need to believe that He will provide for us and to trust Him. Our Father also warns us about other builders in the world. While we’re thinking about this, another builder makes us an offer. We don’t know this builder – but He promises to build us the nicest house the world has ever seen. It will require a little bit of debt, but it will be far nicer than the home our Father said He would build for us. We begin thinking about how nice it would be to have the nicest house in the world – so we reject our Father’s offer, we choose not to heed His warnings - and we hire the builder. We think this new mansion is complete with everything we could ever ask for – built with the finest fixtures, the finest furniture, the most beautiful lawn – the nicest looking house in the world. The world envies our home because it’s so big and beautiful. There’s only one problem – we didn’t lay a good foundation for our house. Unbeknownst to us – the builder of our home built it on sand – because he is devious and we weren’t paying attention. We noticed after moving in – that every once in awhile – the whole house shakes. We pause – wondering what is causing the problem – but the shaking subsides and we don’t take the time to find out what is causing the problem – we’re too enamored with the beauty of our home. Eventually, one day the whole house comes crashing down – and we all look around – wondering what could have caused such a thing. Now – we don’t even have a roof over our head. Now - we no longer care about how beautiful our home is – we just want some shelter. The same devious builder then tells us that he’ll build us a better, more secure house this time – just trust him. It will only cost us a little bit more than the first home. Even though we rejected our Father the first time – He comes to us again – and again offers to build us a house with a solid foundation that is not too big, not too fancy – but will last our entire lives. He only asks that we humble ourselves, ask for forgiveness for following the world – and to trust Him. Who will we choose to build our next house?

What does all of this mean? It means we better not put our faith and hope in the world – because the world is lying to us.

I’ll finish this with one of Chris Martenson’s blog posts. Pay close attention – because we’re watching history repeat itself – once again.

jg – Nov 5, 2008
Tuesday, October 28, 2008, 3:06 pm, by cmartenson

Below, I've liberally excerpted from an article I read a couple years back that always stuck with me.

Since our challenge today is to know whom to trust and which story to believe, I thought I'd bring this one back to the forefront, because the parallels are so striking between the late 1920's and now.

Below is a graph of the Dow Jones during the years of the 1920's bubble, the stock market crash of 1929, and the onset of the Great Depression. The numbers in bubbles indicate when one or more quotes from a famous expert were captured.

I happen to believe that we are somewhere between points #8 and #18.

I get chills every time I re-read them...

Link to original article at

Number 7:
"The decline is in paper values, not in tangible goods and services...America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin." - Stuart Chase , NY Herald Tribune, November 1, 1929

"Hysteria has now disappeared from Wall Street."
- The Times of London, November 2, 1929

"The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."
- Business Week, November 2, 1929

"...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation..."
- Harvard Economic Society (HES), November 2, 1929

Number 8:
"... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall."
- HES, November 10, 1929

"The end of the decline of the Stock Market will probably not be long, only a few more days at most."
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929

"In most of the cities and towns of this country, this Wall Street panic will have no effect."
- Paul Block (Pres. of the Block newspaper chain), editorial, November 15, 1929

"Financial storm definitely passed."
- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929

Number 9:
"I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress."
- Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929

"I am convinced that through these measures we have reestablished confidence."
- Herbert Hoover, December 1929

"[1930 will be] a splendid employment year."
- U.S. Dept. of Labor, New Year's Forecast, December 1929

Number 10:
"For the immediate future, at least, the outlook (stocks) is bright."
- Irving Fisher, Ph.D. in Economics, in early 1930

Number 11:
"...there are indications that the severest phase of the recession is over..."
- Harvard Economic Society (HES) Jan 18, 1930

Number 12:
"There is nothing in the situation to be disturbed about."
- Secretary of the Treasury Andrew Mellon, Feb 1930

Number 13:
"The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
- Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

"... the outlook continues favorable..."
- HES Mar 29, 1930

Number 14:
"... the outlook is favorable..."
- HES Apr 19, 1930

Number 15:
"While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us."
- Herbert Hoover, President of the United States, May 1, 1930

" May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..."
- HES May 17, 1930

"Gentleman, you have come sixty days too late. The depression is over."
- Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930

Number 16:
"... irregular and conflicting movements of business should soon give way to a sustained recovery..."
- HES June 28, 1930

Number 17:
"... the present depression has about spent its force..."
- HES, Aug 30, 1930

Number 18:
"We are now near the end of the declining phase of the depression."
- HES Nov 15, 1930

Number 19:
"Stabilization at [present] levels is clearly possible."
- HES Oct 31, 1931

Number 20:
"All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
- President F.D. Roosevelt, 1933

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