Thin Paper Line
Keith Hazelton
May 09, 2007
A recent study funded by the Pentagon concluded the U.S. Army was stretched to its limit, a “thin green line” as the media have taken to calling the controversial conclusions of this report, referring to James Jones's 1962 novel The Thin Red Line. The novel's title is derived from an old Midwestern saying that “there's only a thin red line between the sane and the mad.” War, accurately portrayed in his book and the 1998 movie, seems to stretch that line almost to the breaking point, as any combat veteran would know.
Our thin paper line is the world's financial and monetary system – in reference to the paper-based nature of world financial markets. It's what separates global economic prosperity from catastrophic financial depression.
If energy is the world's blood supply, its complex monetary system and sophisticated financial markets make up the world's nervous system. It is becoming increasingly apparent that there exists only a thin paper line between the sanity of economic stability and the madness from a breakdown of the world's nervous system.
The world is awash in paper assets: stocks, bonds, mutual funds, IRAs, 401(k)s, pension funds, insurance policies, currencies, options, futures, swaps, derivatives, commodities, bank deposits and money market funds to name a few, the values of which each day are measured by the prices and terms to which buyers and sellers have agreed.
Perhaps the best example is in your wallet. Pull out a dollar bill. It is worth $1.00 only because we currently agree that it is worth a dollar, which is because we currently agree on the amount of goods or value of services that we are willing to exchange for that piece of paper. Back in the day, U.S. currency represented a specific amount of gold or silver for which the paper certificate could be redeemed. The U.S. abandoned the gold standard in 1933 and silver in 1968, although in the 1900s only silver certificate dollars represented a like amount of silver actually held by the U.S. Treasury to back the currency. Today, nothing backs up the value of a paper (fiat) dollar save our collective belief that it can be converted into its face value of goods and services.
And how significant are the world's paper-based financial markets? The word “trillions” immediately comes to mind, as in hundreds of trillions of dollars. For example, the face value of interest rate and currency derivative contracts, financial products that didn't exist 20 years ago, now top $200 Trillion. $17 Trillion in credit-default swaps, an even newer development. And that's only some of the esoteric stuff. Start adding up the value of global stock markets, bank deposits, government and corporate bonds, insurance contracts, and such, and maybe we're talking about a number that begins with a “Q” as in quadrillion, and it's all paper.
So as we painfully are made aware from time to time, our paper-based financial markets represent the largest confidence games known to humankind, and are subject to negative repercussions of tsunami strength arising from what may seem only as pebbles falling into a pond, now at the speed of light, the pace at which the electrons of the technological underpinnings of our economic system traverse the globe.
It's the “butterfly effect” of chaos theory illustrated, in which seemingly minor, inconsequential events have major, widespread, profound effects, such as: “a butterfly in China flaps its wings and tornadoes break out in Oklahoma.” When applied to financial markets, it's more like: “a second cup of coffee results in currency trading losses in Singapore which causes a major London bank to fail, ultimately unemploying and bankrupting thousands of workers in America whose employers' loans and personal loans were called after stock market and real estate markets crashed.”
Our financial markets are so tightly wound, so finely tuned, so fragile, that only the hint of trouble sends the buyers packing. Look at every stock-market downturn, correction, retreat or crash in the last hundred years and never was there a shortage of sellers – only buyers - which, of course, is true of a correction in any commodity: bonds, gold, real-estate, Beanie-Babies, you name it. And when it comes to our nation's treasury bonds, we need those buyers.
China and Japan, in particular, and other foreign-country “investors,” now own more than half of this country's privately held treasury debt – more than $2 Trillion, thanks to our insatiable appetite for imported goods. The United States now is the largest debtor nation in the world. We need our foreign investors to keep our economy afloat – perhaps someday, if not already, more than they need us to buy their cars and consumer electronics and baskets and cookware and sporting goods.
Imagine if China, Japan and the Middle-East announced they merely were thinking about scaling back their purchases of U.S. Treasury obligations which they now buy with all the dollars they receive from us in payment for imports ($310 billion, half of the 2004 total annual trade deficit). Our bond markets would crash, resulting an immediate surge in interest rates (bond yields), a stock-market sell-off and a drop in the value of the U.S. Dollar compared with other currencies. And that would be only the first domino to fall.
What if China, who historically has been very friendly to our new favorite enemy Iran, and today perhaps more so as a necessary source of oil, suggested to the United States that it would not be in our economic interest to be the Middle-East bully or to aid Israel if attacked by its neighbors? And if we ignored China's thoughtful advice, what then?
The impact on global financial markets would be immediate and catastrophic. Values of all paper assets would evaporate in runaway deflation, while real assets such as gold and commodities (but not real estate) would soar in price until it became evident that no “paper” currency in any amount would be sufficient to exchange for a “real” asset. At that point, like the Weimar Republic of pre-Nazi Germany, paper assets become worthless and barter – real assets for real assets – takes over.
We may believe with misplaced confidence that other nations would not harm themselves by harming us financially. It's an updated economic version, if you will, of the Cold War concept of why neither the United States nor the former Soviet Union would be first to turn the missile launch keys because of the likelihood of the “mutual assured destruction” of each country. We cannot, however, assume that these other nations would play be the same, outdated rules that governed the half-century after World War II.
The debacle of Hurricane Katrina in 2005 has offered a glimpse of the tenuous threads that comprise the fabric of easy life in the United States, and how quickly “civilized” humans descended into a survival mode that encompassed lawlessness and violence under the cover of unaccountability and self-preservation.
Perhaps we should be glad some state legislatures have seen fit to insure that our guns cannot be illegally confiscated by law enforcement during a period of declared emergency. We may need them for our our protection and self-preservation if the thin paper line ever is stretched to the ripping point.
But what do I know? Send me an email.
Our thin paper line is the world's financial and monetary system – in reference to the paper-based nature of world financial markets. It's what separates global economic prosperity from catastrophic financial depression.
If energy is the world's blood supply, its complex monetary system and sophisticated financial markets make up the world's nervous system. It is becoming increasingly apparent that there exists only a thin paper line between the sanity of economic stability and the madness from a breakdown of the world's nervous system.
The world is awash in paper assets: stocks, bonds, mutual funds, IRAs, 401(k)s, pension funds, insurance policies, currencies, options, futures, swaps, derivatives, commodities, bank deposits and money market funds to name a few, the values of which each day are measured by the prices and terms to which buyers and sellers have agreed.
Perhaps the best example is in your wallet. Pull out a dollar bill. It is worth $1.00 only because we currently agree that it is worth a dollar, which is because we currently agree on the amount of goods or value of services that we are willing to exchange for that piece of paper. Back in the day, U.S. currency represented a specific amount of gold or silver for which the paper certificate could be redeemed. The U.S. abandoned the gold standard in 1933 and silver in 1968, although in the 1900s only silver certificate dollars represented a like amount of silver actually held by the U.S. Treasury to back the currency. Today, nothing backs up the value of a paper (fiat) dollar save our collective belief that it can be converted into its face value of goods and services.
And how significant are the world's paper-based financial markets? The word “trillions” immediately comes to mind, as in hundreds of trillions of dollars. For example, the face value of interest rate and currency derivative contracts, financial products that didn't exist 20 years ago, now top $200 Trillion. $17 Trillion in credit-default swaps, an even newer development. And that's only some of the esoteric stuff. Start adding up the value of global stock markets, bank deposits, government and corporate bonds, insurance contracts, and such, and maybe we're talking about a number that begins with a “Q” as in quadrillion, and it's all paper.
So as we painfully are made aware from time to time, our paper-based financial markets represent the largest confidence games known to humankind, and are subject to negative repercussions of tsunami strength arising from what may seem only as pebbles falling into a pond, now at the speed of light, the pace at which the electrons of the technological underpinnings of our economic system traverse the globe.
It's the “butterfly effect” of chaos theory illustrated, in which seemingly minor, inconsequential events have major, widespread, profound effects, such as: “a butterfly in China flaps its wings and tornadoes break out in Oklahoma.” When applied to financial markets, it's more like: “a second cup of coffee results in currency trading losses in Singapore which causes a major London bank to fail, ultimately unemploying and bankrupting thousands of workers in America whose employers' loans and personal loans were called after stock market and real estate markets crashed.”
Our financial markets are so tightly wound, so finely tuned, so fragile, that only the hint of trouble sends the buyers packing. Look at every stock-market downturn, correction, retreat or crash in the last hundred years and never was there a shortage of sellers – only buyers - which, of course, is true of a correction in any commodity: bonds, gold, real-estate, Beanie-Babies, you name it. And when it comes to our nation's treasury bonds, we need those buyers.
China and Japan, in particular, and other foreign-country “investors,” now own more than half of this country's privately held treasury debt – more than $2 Trillion, thanks to our insatiable appetite for imported goods. The United States now is the largest debtor nation in the world. We need our foreign investors to keep our economy afloat – perhaps someday, if not already, more than they need us to buy their cars and consumer electronics and baskets and cookware and sporting goods.
Imagine if China, Japan and the Middle-East announced they merely were thinking about scaling back their purchases of U.S. Treasury obligations which they now buy with all the dollars they receive from us in payment for imports ($310 billion, half of the 2004 total annual trade deficit). Our bond markets would crash, resulting an immediate surge in interest rates (bond yields), a stock-market sell-off and a drop in the value of the U.S. Dollar compared with other currencies. And that would be only the first domino to fall.
What if China, who historically has been very friendly to our new favorite enemy Iran, and today perhaps more so as a necessary source of oil, suggested to the United States that it would not be in our economic interest to be the Middle-East bully or to aid Israel if attacked by its neighbors? And if we ignored China's thoughtful advice, what then?
The impact on global financial markets would be immediate and catastrophic. Values of all paper assets would evaporate in runaway deflation, while real assets such as gold and commodities (but not real estate) would soar in price until it became evident that no “paper” currency in any amount would be sufficient to exchange for a “real” asset. At that point, like the Weimar Republic of pre-Nazi Germany, paper assets become worthless and barter – real assets for real assets – takes over.
We may believe with misplaced confidence that other nations would not harm themselves by harming us financially. It's an updated economic version, if you will, of the Cold War concept of why neither the United States nor the former Soviet Union would be first to turn the missile launch keys because of the likelihood of the “mutual assured destruction” of each country. We cannot, however, assume that these other nations would play be the same, outdated rules that governed the half-century after World War II.
The debacle of Hurricane Katrina in 2005 has offered a glimpse of the tenuous threads that comprise the fabric of easy life in the United States, and how quickly “civilized” humans descended into a survival mode that encompassed lawlessness and violence under the cover of unaccountability and self-preservation.
Perhaps we should be glad some state legislatures have seen fit to insure that our guns cannot be illegally confiscated by law enforcement during a period of declared emergency. We may need them for our our protection and self-preservation if the thin paper line ever is stretched to the ripping point.
But what do I know? Send me an email.