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
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)
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)
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)
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)
….and the same trends in Australia.
Australia ASX Index – 2 Months (includes Volatility)
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)
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
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
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
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
DJ Corporate Bond – 3 Months
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
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:
Crude Oil – 3 Months
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?
Copper – 3 Months
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
What about agriculture? We see the same trends. Corn prices have declined over 30% in three months.
Corn – 3 Months
Same situation with Soybeans – prices have declined over 30% in three months.
Soybeans – 3 Months
Wheat prices are down almost 40% in three months.
Wheat – 3 Months
What about livestock? The same trends are present everywhere. Hog prices are down over 25% in three months.
Lean Hogs – 3 Months
Cattle prices are down over 15% in three months.
Live Cattle – 3 Months
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 [updated through July 2010].
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 [updated through July 2010 - money supply is now contracting].
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):
U.S. Stocks (DJIA):
European Stocks (DJ Stoxx 50) :
Japanese Stocks (NIKKEI):
Latin America (DJ Americas):
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 Economist.com website:
“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%.” –Economist.com
Natural Gas Henry Hub Pit (Nymex):
Food prices across the board have gone through a bubble:
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)
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.
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.
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.
"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
- The Times of London, November 2, 1929
- Business Week, November 2, 1929
- Harvard Economic Society (HES), November 2, 1929
"... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall."
- HES, November 10, 1929
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929
- Paul Block (Pres. of the Block newspaper chain), editorial, November 15, 1929
- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929
"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
- Herbert Hoover, December 1929
- U.S. Dept. of Labor, New Year's Forecast, December 1929
"For the immediate future, at least, the outlook (stocks) is bright."
- Irving Fisher, Ph.D. in Economics, in early 1930
"...there are indications that the severest phase of the recession is over..."
- Harvard Economic Society (HES) Jan 18, 1930
"There is nothing in the situation to be disturbed about."
- Secretary of the Treasury Andrew Mellon, Feb 1930
"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
- HES Mar 29, 1930
"... the outlook is favorable..."
- HES Apr 19, 1930
"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
- HES May 17, 1930
- Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930
"... irregular and conflicting movements of business should soon give way to a sustained recovery..."
- HES June 28, 1930
"... the present depression has about spent its force..."
- HES, Aug 30, 1930
"We are now near the end of the declining phase of the depression."
- HES Nov 15, 1930
"Stabilization at [present] levels is clearly possible."
- HES Oct 31, 1931
"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