Fed's Cancerous Policies Will Kill the Patient

Graham Summers / Gold Seek

Many commentators consider what the Fed has done to be akin to providing stimulus, morphine, juice to an ailing economy.

We believe Fed’s actions would be more appropriately described as permitted cancerous beliefs to spread throughout the financial system, thereby killing Democratic Capitalism which is the basis of the capital markets.

Today we’re going to explain what the “final outcome” for this process will be. The short version is what happens to a cancer patient who allows the disease to spread unchecked (death).

In the case of the Fed’s actions we will see a similar “death” of Democratic Capitalism and the subsequent death of the capital markets.

We are, of course, talking in metaphors here: the world will not end, and commerce and business will continue, but the form of capital markets and Capitalism we are experiencing today will cease to exist as the Fed’s policies result in the market and economy eventually collapsing in such a fashion that what follows will bear little resemblance to that which we are experiencing now.

The focus of this “death” will not be stocks, but bonds, particularly sovereign bonds: the asset class against which all monetary policy and investment theory has been based for the last 80+ years.

Indeed, basic financial theory has proposed that sovereign bonds are essentially the only true “risk-free” investment in the world. While history shows this theory to be false (sovereign defaults have occurred throughout the 20^th century) this has been the basic tenant for all investment models and indeed the financial system at large going back for 80 some odd years.

The reason for this is that the Treasury (US sovereign bond) market is the basis of the entire monetary system in the US and the Global financial system in general. Indeed, US Treasuries are the senior most assets on the Primary Dealers’ (world’s largest banks) balance sheets. To understand why this is as well as why the Fed’s policies will ultimately destroy this system, you first need to understand the Primary Dealer system that is the basis for the US banking system at large.

If you’re unfamiliar with the Primary Dealers, these are the 18 banks at the top of the US private banking system. They’re in charge of handling US Treasury Debt auctions and as such they have unprecedented access to US debt both in terms of pricing and monetary control.

The Primary Dealers are:

1. Bank of America
2. Barclays Capital Inc.
3. BNP Paribas Securities Corp.
4. Cantor Fitzgerald & Co.
5. Citigroup Global Markets Inc.
6. Credit Suisse Securities (USA) LLC
7. Daiwa Securities America Inc.
8. Deutsche Bank Securities Inc.
9. Goldman, Sachs & Co.
10. HSBC Securities (USA) Inc.
11. J. P. Morgan Securities Inc.
12. Jefferies & Company Inc.
13. Mizuho Securities USA Inc.
14. Morgan Stanley & Co. Incorporated
15. Nomura Securities International Inc.
16. RBC Capital Markets
17. RBS Securities Inc.
18. UBS Securities LLC.

You’re bound to recognize these names by the mere fact that they are the exact banks that the Fed focused on “saving” thereby removing their “risk of failure” during the Financial Crisis.

These banks are also the largest beneficiaries of the Fed’s largest monetary policies: QE 1, QE lite, QE 2, QE 3, QE 4, etc. Indeed, we now know that QE 2 was in fact was meant to benefit those Primary Dealers in Europe, not the US housing market. The same goes for QE 3 and QE 4.

The Primary Dealers are the firms that buy US Treasuries during debt auctions. Once the Treasury debt is acquired by the Primary Dealer, it’s parked on their balance sheet as an asset. The Primary Dealer can then leverage up that asset and also fractionally lend on it, i.e. create more debt and issue more loans, mortgages, corporate bonds, or what have you.

Put another way, Treasuries are not only the primary asset on the large banks’ balance sheets, they are in fact the asset against which these banks lend/ extend additional debt into the monetary system, thereby controlling the amount of money in circulation in the economy.

When the Financial Crisis hit in 2007-2008, the Fed responded in several ways, but the most important for the point of today’s discussion is the Fed removing the “risk of failure” for the Primary Dealers by spreading these firms’ toxic debts onto the public’s balance sheet and funneling trillions of dollars into them via various lending windows.

In simple terms, the Fed took what was killing the Primary Dealers (toxic debts) and then spread it onto the US’s balance sheet (which was already sickly due to our excessive debt levels). This again ties in with my “cancer” metaphor, much as cancer spreads by infecting healthy cells.

When the Fed did this it did not save capitalism or the Capital Markets. What it did was allow the “cancer” of excessive leverage, toxic debts, and moral hazard to spread to the very basis of the US, indeed the entire world’s, financial system: the US balance sheet/ Sovereign Bond market.

These actions have already resulted in the US losing its AAA credit rating. But that is just the beginning. Indeed, few if any understand the real risk of what the Fed has done.

The reality is that the Fed has done the following:

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