Thunder Road Report 18 17th December 2009

8/14/2019 Thunder Road Report 18 17th December 2009

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report

17th December 2009

Phase II of the crisis waiting for the

Creditanstalt moment

It was the failure of Austrias Creditanstalt bank in May

1931 which brought on the second phase of the Great

Depression. Capital ows led to the transmission of the

crisis in terms of cascading debt defaults from smaller,weaker economies to the rest of the world, just when

many commentators thought the corner had been turned.

Fast forward to today and the Dubai news, together with

problems in Greece, Ireland, Spain and now Austria,

conrmed that the current debt crisis is alive and well and

spreading to sovereign nations. The European banking

system (especially in Austria, Germany, Italy, France)

is horribly over-exposed to nearly bankrupt nations on

Europes periphery. Despite this, there has been no change

to the normal modus operandi for generating consensus

expectations, i.e. extrapolating current conditions, trends,

hopes, etc, in a linear way into the future.

What has been missing so far is a Creditanstalt moment

and I would put more money on this being a when

rather than if event. It almost happened at the weekendwith the failure of Austrias (again!) Hypo Group Alpe

Adria (HGAA) bank. HGAA posed systemic risk and was

nationalised just in time, but Austria is in a terrible mess.

Hungary, Romania and Ukraine are on IMF life support,

Contact/additions to distribution:

Paul [email protected]

This issue is dedicated to:

Martin Armstrong

Imprisoned for being the bestnancial analyst of us all
mailto:[email protected]:[email protected]


2/272 Thunder Road Report - 27 December 2009

Greece and Ireland remain horribly vulnerable, while the UK and Spain are getting close to

the edge. How long can the obscene bailouts and decits continue without government bond

markets raising the white ag? Yields are nally beginning to edge up.

Powerful inationary and deationary forces remain locked in combat an incredibly dangerous

and volatile scenario and a result of policy makers attempting to defy economic gravity. I expect

the next phase of the crisis to be characterised by massive global capital ows as hot money

traverses the planet in response to shocks, moving from currency-to-currency and asset

class-to-asset class, looking for security and/or asset price ination. The remonetisation of

gold continues to unfold and the recent acceleration in capital concentrating in the gold market

is, above all, a huge vote of no condence in the economic stewardship of the major nations.

One of the enduring aspects of the nancial markets for me is the existence of asymmetric information/

understanding and the need for its continual pursuit in order to gain that all-important edge. With the

proliferation of information these days, the search for new angles or ideas seems to take more sifting from

an ever widening number of sources, while my physical library gets ever bigger (a neurosis according

to my wife). It has also led to me to largely dispense with sources in the mainstream media, apart from

having Financial Entertainment TV (CNBC) on in the background.

Looking back 3-4 years, the crucial asymmetric information in the nancial markets was an understanding

of credit bubbles, debt/GDP ratios, Kondratieff waves, the dysfunctional US mortgage market and (as

always) a good knowledge of nancial history. That said, just because I saw it then doesnt mean Ive got

a handle on the key themes right now but I hope youd be disappointed if I didnt have a go. Here are a

few in no particular order - the prolonged nature of debt crises, lessons from the cascading debt defaults of

1931-33, Martin Armstrongs model, the wrecking ball of global capital ows, ination and crack-up booms,

etc.

Talking of asymmetric information in general, it fascinates me how few people have been aware of the huge

debate regarding the end of the Mayan calendar on 21 December 2012. The Mayans were the keepers of

time and Ill allude to this again later. Dan Brown referred to the end of the Mayan calendar in his latest

novel, The Lost Symbol, and the 2012 movie has recently premiered, so it should begin creeping into



peoples consciousness to a greater extent. I was chatting to one of Londons smartest fund managers and

he remarked how hed love to be able to:

Buy shares in 2012 awareness!

So would I and would also add awareness of the works of Joseph Campbell and Carl Gustav Jung. Not

surprisingly, the 2012 movie takes an apocalyptic approach to 2012 in line with the common usage of the

word. However apocalypse can also mean an unveiling according to Dan Brown or, just as interestingly, arevelation. I expect the nancial markets will deliver a revelation, for these really are strange times when:

B Grown men enthusiastically advocate quantitative easing and near zero interest rates on the part of

insolvent governments in the hope of a quick x, little realising that they are literally just papering

over the cracks; and

B Experienced nancial professionals genuinely believe that we have dodged the bullet with regard to

the debt crisis and things will be okay going forward, even if the recovery is slower than normal, blah,

blah, blah.

John F. Kennedy said:

Too often we enjoy the comfort of opinion without the discomfort of thought.

While portfolio manager John Hussman nailed it in his article, Reckless Myopia, from two weeks ago:

I should have assumed that Wall Streets tendency toward reckless myopia - ingrained over the past

decade - would return at the rst sign of even temporary stability. The eagerness of investors to chase

prevailing trends, and their unwillingness to concern themselves withpredictable longer-term risks, drove

a successive series of speculative advances and crashes during the past decade - the dot-com bubble,

the tech bubble, the mortgage bubble, the private-equity bubble, and the commodities bubbleIn part,

the markets increasing propensity toward speculation reects the increasing lack of scal and monetary

discipline from our leaders. Policy makers who seek quick xes and could care less about long-term

consequences undoubtedly encourage investors to embrace the same value system.

Its truly staggering really when one of the biggest lessons of nancial history, and very recent nancial

history no less, is that prolonged periods of cheap money lead to asset bubbles and eventual disaster.

Weve seen it time and time again, but the majority always fall into line with the reassurances of central

bankers and politicians no matter how bad their track records.

In this vein, Doug Noland in his Credit Bubble Bulletin highlighted how the majority of commentators dont

forsee the disastrous consequences of current US monetary policy:

The sources of acute systemic fragility are generally not easily or commonly recognized during periods

of excess. The risks wrought from Fed-induced market distortions and mis-pricings during the mortgagenance bubble were not apparent to most until it was much too late. The perception today is that our post-

bubble systemic backdrop is not vulnerable to either excesses or inationary pressures. The bulls scoff at

the notion that there are domestic risks associated with sticking with ultra-easy monetary policy. The risks

are there but not so visible.

Theres been a procession of Fed big cheeses, who didnt see the debt/real estate bubble coming, reassuring

us that they arent creating another one now. According to Ben Bernanke

Its not obvious to me in any case that theres any large misalignments currently in the U.S. nancial

system.

Oh yeah? How about a bubble in your currency even though its value is declining? That really is economicsturned on its head! But my favourite comment from the Federal Reserve recently was San Francisco Fed

President, Janet Yellens comment about identifying asset bubbles:



Further research into the connections among monetary policy, the banking and nancial sectors, and

systemic risk is needed to help answer this question.

You want to do MORE research, give me strength! You (the Fed) had 22,000 employees on the case in

2005-06 and couldnt see the bubble developing. It seems that the Fed hires people who, in nancial

analysis terms, couldnt hit the back of a donkey with a banjo.

Excuse me. Do you know anything about nancial analysis?

Not really

Excellent.

Repeat 22,000 times. Ive always liked the way that the high-living, hard drinking, Dean Martin was

introduced as Direct from the bar in the Rat Packs Las Vegas shows. Well Direct from his prison cell in

Fort Dix New Jersey, here is the worlds greatest nancial analyst, Martin Armstrong, who called the 1987

Crash TO THE DAY as well as the Japanese crash in 1989, the Russian crisis in 1998 and the current crisis

almost to the day in each case (talking of track records!):

Ayn Rand would be buying a ticket to China about now to ee what appears to be on the horizon.On that note, its interesting that legendary investor, Jim Rogers, sold up in New York and moved with his

family to Singapore 2007. As he said:

If you were smart in 1807 you moved to London, if you were smart in 1907 you moved to New York City,

and if you are smart in 2007 you move to Asia.

It makes you think, doesnt it? A trafc warden where I live is no longer called a trafc warden - he has a

badge saying Civil Enforcement Ofcer. How Orwellian is that? In the meantime, all we can do is trade

what is in front of us and identify the sectors where capital will concentrate next while the economic

policy (mis)managers do their thing. This has been the basis of my Global End of Normal thesis and the

Badlands pieces on the impending dollar crisis (and other currencies) in which Ive argued that the bestasset classes are gold/silver, food/agriculture, energy and network infrastructure.

I think a current example of asymmetry is an understanding of ination. The view propagated incessantly

by central bankers and many nancial commentators is that the risk of ination is low because of the

output gap. This is monumental disinformation in an environment of massive government decit spending,

ludicrously low interest rates and money printing. But we had Bank of England governor, Mervyn King,

commenting recently on the recession:

it has opened up a margin of spare capacity that will continue to bear down on ination looking ahead.

Hes in good company. Here is SocGens equity strategy team, which is normally very good on big picture

issues (although this looks like a Parisian production rather than a London one), in its Outlook 2010

report:

ination risks should remain low due to the size of the output gap. Even if the recovery proves stronger

than anticipated, it should still take a few years to close the gap and for ination to materialise in the

economy.

This sort of thinking is only true as long as the value of the currency doesnt decline sharply. The people

of Iceland know this only too well - ination there soared to over 14% last year - even if the head of the

Bank of England doesnt. Does he really not know, or does he just not say? The Greek people might have

had an Icelandic inationary experience already if Greece wasnt part of the Eurozone. At the moment, its

like watching tracer bullets slamming into the Euro from almost every nation on the European periphery!The question is whether one eventually proves fatal? Its even making the US dollar look relatively good

for now.



You may have heard the great comment from Marc Faber (MF) on the Financial Sense news hour a few

weeks back in response to a question from portfolio manager, Jim Puplava (JP):

JP: A deationist would argue that because we have a weak economy, we will have deation.

MF: Look, the deationist will tell you, essentially, we have an output gap it means that GDP is below its

full potential. Would you please ask the deationists to call Mr Robert Mugabe in Zimbabwe and ask him

by how much his economy is below potential? It is below potential by at least 90% and where do we haveination?

Brilliant!

A point Id make is that ination takes time to incubate as it also requires people start to lose condence in

the purchasing power of money. In the words of the Austrian (school) economist, Ludwig von Mises:

The rst stage of the inationary process may last for many years. While it lasts, the prices of many goods

and services are not yet adjusted to the altered money relation. There are still people in the country who

have not yet become aware of the fact that they are confronted with a price revolution which will nally

result in a considerable rise in all prices

As Ive said in previous Thunder Roads, we have both ination and deation it just depends where you

look and how you dene them. This is the result of the extreme inationary measures (in the sense of

decit expansion) being taken to counteract what would otherwise be a natural deationary process (lower

consumer, commodity, equity and housing prices and credit contraction), whereby western economies

would purge themselves of excessive debt. Obviously, the needed (but painful) debt reduction is being

offset by the shift in the debt burden to governments. Central bankers believe that they can truly manifest

an economic free lunch while, in reality, it will be shown as nothing more than a time preference for

current comfort versus future discomfort.

Back in 2007, I argued that by circumventing the deationary process, central bankers (and the Fed in

particular) would likely create the conditions for an inationary crack-up boom. What I got wrong backthen was the length of time it would take for this to develop. I thought that if the western nations ramped

up decits and printed money to the tune of trillions of dollars to bail out the doomed nancial system

then condence in the value of paper currencies would suffer. I have to acknowledge that my pre-crisis

expectation was too hasty compared with post-crisis events and that it takes considerably more time for

condence in currencies to erode.

By the way, I found out recently that crack-up boom translates beautifully as KATASTROPHEN HAUSSE

in German. I cant get rid of this image of the Federal Reserve building collapsing around Ben Bernankes

ears. Here is more of Ludwig von-Mises explanation of a crack-up boom:

But then the masses nally wake up. They become suddenly aware that ination is a deliberate policy andwill go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his

money against real goods, whether he needs them or notWithin a very short timethe things which were

used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give

away anything against them. It was this that happened with the Continental currency in America in 1781,

with the French mandates territoriaux in 1796, and with the German mark in 1923. It will happen again

whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion

must not believe that the quantity of this thing will increase beyond all bounds.

Obviously a crack-up boom is an extreme inationary event as Martin Armstrong has elucidated:

We must understand that the hyper-ination outcome involves the sheer collapse in public condence.We are still a long way from that just now, but if the inationary forces really start to prevail Doug Nolands

(of the Credit Bubble Bulletin) comment that Liquidity loves ination will be reminiscent of Blue Horseshoe

loves Anacott Steel from the Wall Street movie. There might also be a rush to buy Costantino Bresciani-



Turronis book on the Weimar period The Economics of Ination A Study of Currency Depreciation in Post

War Germany, which was rst published in 1931.

Its not exactly light reading and you really can judge this book by its cover. It amused me because I

was reading Marc Fabers Tomorrows Gold Asias Age of Discovery and I realized hed beaten me to

Bresciani-Turronis book by two decades (note to self: try harder). This is the rst sentence of Chapter 10

from Marcs book:

About 20 years ago, my friend Gilbert de Botton, who founded GAM, suggested I read the Economics of

Ination, a 1931 book by Professor Costantino Bresciani-Turroni, an Italian economist and member of the

German Reparation Commission during the Weimar hyperination years. We highly recommend this bookto anyone interested in investing because it is the most comprehensive analysis of the causes and effects

of ination

In addition to real assets, there have also been substantial capital ows into the stronger emerging

nations. Doug Noland articulated the difference between the current global reation and previous ones

in his 4 November 2009 piece, About a Half Paradigm. Ive quoted some of Dougs key points at length

because I think they are so insightful. In addition, his thesis sounds every bit like a crack-up boom, but

without naming it as such:

The Bernanke Fed has now locked itself into a policy course that will ignore global reation dynamics and

instead xate on specic US. economic indicators. Instead of adopting a more hawkish posture and layingthe market groundwork for withdrawing extraordinary monetary stimulus, the Fed ew even farther into

uncharted dovishness. This adds to a long series of (compounding) errors from our central bank.

So, from a macro perspective, a clearer view is coming into focus a new paradigm is emerging. New

global reationary dynamics have gained important momentum. Credit systems in China, India, Asia, Brazil

and the developing world the periphery - are today signicantly more robust than they are here at

home (the core). Powerful global nancial ows to the inating periphery (monetary processes) also

work to ensure market and economic outperformance. The rising periphery with its billions of consumers

and rising demand for commodities has realized a robust and self-reinforcing inationary bias. Moreover,

secular dollar weakness has increased the investment and speculative merits of commodities and other

hard assets when contrasted to dollar securities. Dollar weakness begets global reation that begets dollar

underperformance that begets a new paradigm.

I will humbly suggest that a momentous global economic transformation is at this point About Half a

Paradigm. Powerful global economic and inationary forces have decisively shifted to the periphery



What Doug Noland is describing is a key theme of Martin Armstrongs work, i.e. global capital ows and the

concentration of that capital which leads to booms and busts. As Martin said:

What makes one sector or nation rise is the concentration of capitalin a oating exchange rate system,

capital will be attracted on a dynamic basisWhat became obvious was that capital will concentrate

even globally. After the 1987 Crash, the Japanese pulled back foreign investmentThey started to invest

domestically. The Nikkei Index rose sharply into December 1989The Bubble in Tokyo was caused bycapital concentration. When it burst, it moved to Southeast Asia, then it moved back to Europe for the birth

of the Euro.

One could add that it then moved into the US technology sector, then US real estate, etc.

While there have been substantial capital ows into gold, commodities and the stock market in recent

months, the ows into several emerging nations, the periphery as Doug Noland calls it, are posing severe

problems for these nations as a result of US monetary largesse. Brazil and Taiwan have already taken

actions to limit inows of hot money and the Indonesian central bank indicated that it was considering

limiting foreign investment in its short-term debt, although it has subsequently played this down.

The dysfunctional nature of the global nancial system and, critically, its vulnerability to the movementin massive hot money ows, is becoming ever more apparent. The head of the Hong Kong Monetary

Authority, Norman Chan, commented several days back that:

With interest rates exceptionally low and with abundant liquidity around the world, Hong Kong faces the

potential risk next year that asset prices may go up sharply and become increasingly disconnected from

economic fundamentals,

According to Reuters:

Hong Kong attracted a record HK$567.5 billion (US$73 billion) in fund inows between Oct. 1 2008 and

Nov. 13, 2009, according to the HKMA. That has helped Hong Kong stock prices soar 57 percent this year

and property prices surge nearly 30 percent.

In the interview with Chan, he went on to explain the Catch-22:

In theory, these economies could of course raise interest rates to contain ination and increases in asset

prices. But the fear is that once interest rates are raised the carry trade will become even more active,

attracting even more fund inows. Asian economies are therefore facing a dilemma.

The ow of hot money into emerging markets is also raising concern in Russia as the WSJ highlighted:

Russian authorities escalated their campaign to discourage speculative investments, which have been

ooding the country and risk driving up the value of the ruble and destabilizing the economy. The Russian

central bank said it would to boost its intervention in the currency markets, increasing ruble sales in arecently tightened trading range.

Then theres the even bigger issue of China. Here is Dan Norcini on Jim Sinclairs jsmineset.com website

on 19 November 2009:

For the Chinese to go out of their way to formally rebuke the US ruling elites and monetary ofcials about

the commodity bubble that is occurring courtesy of the collapsing US dollar, is quite remarkable given their

penchant for etiquette and tact. One can easily discern just how irritated not only China, but all of Asia is

with the US. At some point, this tension is going to erupt in a much larger way. Heaven help us all when

it does because it will be marked by a period of soaring interest rates as a buyers strike occurs in the US

Treasury market.

Heres a VERY telling anecdote about a meeting with the Chinese in the aftermath of the Asia crisis from

Martin Armstrong:



When I sat down with the Central Bank of China, I was completely stunned. It was like sitting down with

a bunch of traders. These were not academics nor bureaucrats (unlike our lot, Paul). The people I met with

were real. They then explained that to qualify to work at the central bank, they had to work on trading

desks in the West at major banks. These were people who had hands-on experience. I was so impressed for

we got right to the heart of the problem CAPITAL FLOWS. They understood what I was writing at that time

and how capital was shifting to Asia and starting to move back from 1994 toward Europe in anticipation of

the coming Euro. That is why they called upon me. They had understood my explanations of how the world

had changed and that the key was now a new way of analyzing trends CAPITAL FLOW ANALYSIS.

And wait for this

China also gave me a tour of a most interesting installation. I was taken to a building surrounded by major

huge (sic) satellite (dishes) pointed at the sky and guarded by tanks and troops. I was taken inside and saw

a room with several hundred people who were surng the internet gathering knowledge. I was then taken

to a meeting room where every piece I had ever written was stacked in piles on the tableI was shown that

they were monitoring every price in China on everything.

Do they read Thunder Road??? And this:China was doing what I had always hoped would be done in the West. Just for once let us look, observe,

and learn, instead of the constant effort to manipulate and change the economy forcing ones will and

desires even if they are insaneChina understands there was (sic) a cycle and that they could not prevent

the change. Instead, they have gone with the ow. While this is not a complete step yet, it is a step in the

right direction that could make China the new center of the world economy the new Rome.

Sticking with the China theme, there was an interview with Jim Rickards on CNBC. Rickards is a lawyer

turned investment adviser and was the senior negotiator in the rescue of Long Term Capital Management

back in 1998. He argued that with the US consumer at on his back, weak business investment and

unsustainable government spending, the only hope for US GDP is to increase exports, which will require an

even weaker dollar. This is where the asymmetric interests of US and Chinese national interests rear their

ugly head in relation to the Yuan/US dollar exchange rate. Rickards explained:

Heres the Catch-22, China has got the same problem in reverse. Their exports are down 20% in the last

year. They are not economic players they are political players. Theyre communists and theyre worried

about political stability and the perpetuation of the regime. Theyve got ten million people a year walking

into cities saying Give me a job. Theyve got to provide those jobs. So heres the Catch-22. Chinas saying

in effect Well revalue the Yuan when we see exports pick up and a little action in the US economy. The US

is saying Youre not going to see those things unless you revalue the Yuan. Bernankes trying to break the

Bank of China. This reminds me of Soros and the Bank of England in 1992 where they were trying to defend

Sterling. Soros said Im selling Sterling, selling Sterling. The Bank of England bought it until they nallybroke. Bernankes saying Were just going to keep selling dollars, run the printing presses 24/7 and Chinas

sitting there buying all the dollars. The difference is, in order for the Bank of England to defend Sterling,

they had to sell dollars and they had a nite supply of dollars. So Soros just said I can short Sterling

longer than you can provide dollars so Ill break you and he did. (For) China, whats the short when you

are buying dollars? Its the Yuan. They can print it and they can force it on their own people. So they have

an unlimited supply, an unlimited capacity to go short. So this is basically a game of chicken between the

two biggest economies in the world. The irony is that each country is shorting its own currency. Bernankes

selling dollars, Chinas selling Yuan. I dont want to be in that trade. Id rather just buy gold and let these

guys ght it out.

A severe warning is implicit in Martin Armstrongs Economic Condence Model. A bit of background in

case you havent heard of him, Martin is the imprisoned nancial genius and former Chairman of Princeton

Economics who has predicted numerous turning points in nancial markets often years before they

happened. Curiously, the charges against him for comingling investment funds occurred shortly after he



refused to give the US government exclusive access to his work. He spent 7 years in jail, WITHOUT TRIAL,

for contempt of court, before pleading guilty in 2007 when he was sentenced to a further ve years.

In my opinion, Martins work is a huge example of asymmetric information existing in nancial markets.

As Ive said several times in Thunder Road, his report, Its Just Time, which he typed from prison on an

old-fashioned typewriter is probably the best piece of nancial analysis Ive ever read (see here). I asked

a portfolio manager whod just sent me a piece written by Martin:

Can I ask whether you are aware if many brokers are following/talking about Martin Armstrongs work?

Or is it just people like us???

His reply was:

to tell you the truth most of them care only about making fast money and advancing their careers...

and not to know/read people like Armstrong.

To my knowledge, Martins Economic Condence Model has NEVER been wrong on a major trend and the

major trend implied by his model remains down for another year and a half. The consensus view is that the

economic outlook is slowly improving, but as Jim Sinclair said:

I have learned not to argue with Armstrong on cycle timing.

While I also believe that economic conditions will be considerably worse than expected, what I think or

other commentators think is not the point. In my opinion anyway, Martins track record necessitates that

all nancial professionals, and investors in general, digest his work.

The chart below shows how Martin Armstrongs model implies that we will remain in a downturn until the

turning point in 2011.45, i.e. the 13th June 2011 - and note how key turning points in the global economy,

including the crisis which began in early 1997, were all predicted back in 1997!

The proponents of near zero interest rates and money printing (QE) believe that their implementation can

mitigate the impact of a downturn, essentially implying some degree of free lunch. I tend to take a more

proportionate view of the impact of the downturn compared with the bubble that preceded it. Reading

over Martin Armstrongs work recently, I thought he captured this idea perfectly in discussing the genesis

of his own cycle work:



it is the motion of pendulums that fascinated me because I saw the economy and markets as a pendulum

swinging between the two most extreme points of highs and lows. I saw the markets were propelled by

these movements that often the further extremes in one direction caused a massive swing with an equal

and opposite energy taking it in the other direction; the boom & bust cycle.

One of the messages from Martins work is that bear markets take time to play out. As he says:

Perhaps it is like frying an egg. It just takes a certain amount of time to cook.

He goes on to point out that from the intra-day high of 386.1 on 3 September 1929 to the intra-day low of

8 July 1932 of 40.6 took 33 months. For the Nikkei, the time from the peak closing high in December 1989

to the July 1992 low was 31 months. Martin acknowledges, however, that the July 1992 low was penetrated

in the wake of the LTCM crisis in 1998 which led to a further downward move with the market eventually

bottoming in January 2003. For the NASDAQ, the time from the peak in March 2000 to the trough in

October 2002 was 31 months. He argues:

Look at major collapses from all bubble tops and this is what you will nd. The minimum amount of time to

complete the fall and decline is this 31-34 month time period except in the waterfall events (i.e. complete

and utter collapse, Paul)

This brings us to an intriguing possibility. If history repeats itself in this regard, we could be approaching

another major leg down in world nancial markets, at least several of them anyway. The Economic

Condence Model predicted the high in the current cycle almost to the day - 2007.15 or 24 February

2007 - when the sub-prime problems rst came to light in the US (with HSBCs announcement) and when

the BKX Index of US banking stocks peaked. Moving forward by 31-34 months from 2007.15 takes us to

September-December 2009, i.e. now. If we look at the recent performance of the BKX, it certainly seems

to be treading water at this point:

BKX Index of UK Banking stocks (2 years)

Source: Yahoo nance

In addition, the problems in Dubai, Greece, Ireland and Austria have obviously come to the fore in the last

few weeks.

Alternatively, if we take the 2007.15 peak and add Pi in years, i.e. 3.14159 takes us to 2010.29 or 16

April 2010. While pi gures in equations of the motions of pendulums, it also gures in the structure of

Martin Armstrongs model. For instance, 8.615 years is equal to 3,144 days, i.e. almost identical to Pi x1,000 = 3,142 days. Martin has highlighted 2010.29 or 16 April 2010 as potentially signicant in his work,

commenting that:



The more pronounced lows would be due on a timing basis between December 2009 and April 2010.

But does April 2010 only relate to economic events? Im just going to go off on a tangent here, because

what follows freaked me out slightly, so please bear with me. If you are studying Martin Armstrongs work

in depth, or if you are studying the Mayan calendar and the 2012 phenomenon, you are, to an extent,

studying the nature and geometry of time itself (And no I havent gone mad!).

Now if you go back from his 2007.15 peak to the peak of Martins previous 8.6 year cycle you arrive at1998.55. Adding 3.14159 years takes you too 2001.692, i.e. 10 September 2001, which was just one day

before 9/11. Martin has highlighted this, but from delving into his model, more coincidences seem to

pop up. For example, if we go backwards in time to the next peak in Martins 8.6 year cycle, we arrive at

1989.945 or 11 December 1989. Adding 3.14159 years takes you to 1993.077, i.e. 28 January 1993. This

was less than a month before the rst World Trade Center bombing.

Another genius, in my opinion, is Gerald Celente of Trends Research, both in what he says and how he

says it (e.g. the two-headed, one party system). He had this to say a few days back about what will be

amongst his top trends for 2010:

We are very concerned because one of them is going to be Terror 2010 and people better be preparedfor it, because the last time terror struck in the United States they closed down Wall Street. Next time it

comes, with economic conditions being so fragile, they may close down the banks. So this is a time to really

prepare for the worst, (we) could always move back from that point if the worst doesnt happen, but if you

make no plans at all, theres no escape plan at all.

Celente was quoted in USA Today in December 2000 predicting terrorist attacks against US citizens in 2001.

I nd all of this makes me feel uneasy and I want to mention one more thing. Ive spent quite a lot of time

working through and trying to understand the different layers of Martin Armstrongs model. In the Thunder

Road of 8 April 2009, I mentioned the interim high of 2009.3, i.e. 20 April 2009. I wrote:

there just might be more to this period in late April 2009 than initially meets the eye...However, I wonderif he (Martin) is holding things back...In fact, from my deeper study of Armstrongs work, the period 15-30

April 2009 could be quite signicant and disturbance in nancial markets may only be part of it

Remember what happened? This is from Wikipedia:

In late April (2009), Margaret Chan, the World Health Organizations director-general, declared a public

health emergency of international concern under the rules of the WHOs new International Health Regulations

when the rst two cases of the H1N1 virus were reported in the United States, followed by hundreds of

cases in Mexico.

I bet youre not convinced, so back to the story:

Martin Armstrong has pointed out that the concentration of capital, which led to the current crisis, was in

the debt and real estate markets and not in the stock market. This is potentially very signicant for global

capital ows going forward. It was only tting, therefore, that the recovery in so many asset prices this

year was interrupted by the potential default by Nakheel subsidiary of the state-owned Dubai World an

overly indebted property company. Stock markets fell sharply, with the Footise down 3.2%, China down

3.6%, crude oil down 2.4%, etc. The US was closed for Thanksgiving but fell 1.7% in the shortened session

on the Friday.

One of my themes is that while most commentators either see ination or deation, I would assert that

we are experiencing both simultaneously. Furthermore, the inationary and deationary forces are likely

to remain locked in combat for an extended period. Before the Dubai news, the ination scenario had beenmore ascendant as global capital ows moved into commodities, equities and some emerging markets and

out of the US dollar. To an extent, what was happening to the US equity market in the last couple of months

was the classic Paradox of Value to use Martin Armstrongs term, i.e. the rise in the equity market was

largely compensating for the decline in the value of the US dollar.



In spite of this, it seems that rising stock markets were giving great cause for optimism about the global

economic outlook in general misguided in my opinion. But thats the markets for you! Two people watch

the same events unfolding but they see completely different things. Have you heard Lady Gagas recent

single, Bad Romance? Its really good and right up there with Poker Face in my opinion. More importantly,

have you seen the video for Bad Romanceon MTV or youtube? To most people, the video probably seems

like some whacky, futuristic *rgy of musical surrealism. In contrast, if youre reasonably well read in the

esoteric eld, its immediately and strikingly obvious that the video is absolutely dripping with all manner

of occult(i.e. hidden knowledge) symbolism. Im not saying that there is any sinister intent, but you know

it when you see it.

For example, notice in the main body of the video Miss Gagas sequence of costume changes - from black

to white to red - in that order. Carl Jung would have spotted it - nigredo, albedo, rubedo - in an instant. So

should any Hollywood screenwriter worth his salt these days as theyve moved on from Joseph Campbells

work, so ably used by George Lucas in Star Wars, to Carl Jungs work (right Dave V. equity trader and

screenplay writer!). And all that focus on Miss Gagas spinal column, can anyone say KUNDALINI? Theres

a lot more in the video but, in essence, the plot symbolizes an alchemical transformation. C.S. Lewiss

Chronicles of Narnia are also laden with occult symbolism, but how many realize that? And theyresupposed to be for children!

When the events in Dubai occurred, four things were immediately apparent:

B The news conrmed that the global debt crisis is still very much alive and well and that the battle

between inationary and deationary forces is ongoing and on a knife-edge;

B With Dubai World being state-owned, the debt crisis has now got to a level where it is beginning to

impact sovereign nations;

B There was a sudden, albeit brief, movement of hot money ows out of equities, commodities and

emerging markets back into US Treasuries and the dollar, i.e. the deationary trade briey returned. This

was the paradox of value once again, with a brief resurgence in the value of money vis--vis other asset

classes (not gold which is real money).

B The major western banks remain vulnerable to a second phase in the debt crisis. In the case of Dubai,

it is mainly UK banks with HSBC, Standard Chartered, Barclays and RBS having combined exposure of

some US$50bn. The RBS share price, for example, fell 7.8% after the Dubai announcement.

Whats interesting to me about Dubai is the timing of the announcement on 25 November 2009. The

property company, Nakheel, was just over two weeks away from having to repay a US$3.5bn bond. Sheikh

Mohammed had said this as recently as 8 September 2009:

I assure you we are alright, the UAE is alright, and we are not worried,

This comment resulted in the price of the Nakheel December 2009 bonds jumping 8.2% afterwards. Can

you sue a Sheikh? My questions are twofold.

B Given human nature, how many other struggling corporations are leaving it to the last minute to

acknowledge insolvency in the hope that something turns up. A lot of those LBOs from 2004-07 come

to mind?

B How many weak corporations are going to nd it difcult to roll over loans coming due because they are

crowded out by a combination stronger borrowers and banks in retrenchment mode?

The Dubai news is likely to have sent a further tremor through the banking system, making banks even

more cautious on lending policies. Is another Catch-22 developing? The banks wont lend because theyare technically insolvent at this point, i.e. if they marked-to-market. However, if they restrict credit too

severely, economic growth will be restrained, more of their borrowers will be bankrupted, and it will all

come back and bite them!



I remain of the view that the banking system remains extremely vulnerable and that a good deal of the

supposed improvement in its outlook is a mirage. Look at whats happening in US commercial real estate,

for example. It was obvious that the US$3.0trn commercial real estate (CRE) is a huge problem for US

banks when the FDIC issued Guidance on Prudent Commercial Real Estate Loan Workouts on 30 October

2009. Basically, it avoided the need for write downs even if the value of the underlying collateral had

declined as long as interest payments are still being made. Extend and pretend as someone described

it recently. A spanner in the works, however, is that defaults on CRE mortgages keep rising. According to

Bain & Co.:

The current long-term average default rate is 4.5%; as recently as 2007, it was just under 1%. These

failures are not limited to small or marginal rms; they are happening at large companies with at least

$100 million in assets

Donald Trump was on CNBC last week explaining the stand-off position of the banks in CRE:

I can tell you if you have an IBM lease or if you have a prime tenant lease and take that lease to the bank,

the bank still wont loan you money. So all of the money the government gave the various banks, they are

not putting out money at allI see they come out and they say weve loaned money. Theyre not loaning

money no matter how prime you are, no matter how rich you are, no matter how good your development...

Frankly, this economy can never come back until the banks are forced to loan money and its really the

money they were given by the government.

If banks wont even lend to prime borrowers, they cant be that healthy. What are the banks doing if they

arent lending. My suspicion is they are going to the central bank trough and borrowing money at almost

zero percent and buying a heck of a lot of government bonds, especially US Treasuries, to take advantage

of the interest rate differential. If its not the banks buying them, then who is? It will be ironic if the banks

get killed on the value of those government bonds too, when sovereign yields rise down the road.

What about UBSs big investor day on 17 November 2009? Analysts came away discussing the managements

bold target for medium term (3-5 years) EPS, as though the crisis is over and done. The analysts seem

to have already factored in a steady global economic recovery during these 3-5 years a giant leap of

faith after the popping of a bubble which, in debt/GDP terms, was even bigger than the one which ended

in 1929. Both UBSs management and the analysts will both ultimately be at fault in my opinion. A false

sense of security seems to have developed, notwithstanding Dubai.

My suspicion is that nancial stocks will be hit badly in the next correction in the stock market. It would

also be poetic justice after Goldman CEO Blankfein claimed that he is doing Gods work. I liked Gerald

Celentes response:

Can anybody imagine the arrogance of this guy, Lloyd Blankfein, the CEO of Goldman Sachs, telling us that

hes doing, quote, Gods work? If hes doing Gods work, were all going to h*ll.

The consensus view is that we can look forward to a steady, albeit slowish, recovery and that the systemic

risk is now behind us. I think this is too optimistic and there is a lot further to go in order to work through

this debt crisis. This is clearly the message from the problems in Dubai, Greece, Ireland and now Austria,

etc. The sub-prime problems became apparent in February 2007 although it took until October that year

for the stock market to peak and until March 2008 before people really woke up with the collapse of Bear

Stearns. At the time, it was reminiscent of the writer George Gurdjieffs assertion that most people spend

their lives in a kind of hypnotic waking sleep.

Maybe its me whos half a sleep this time, but I think that the next phase of the debt crisis will draw in

sovereign nations in a major way and the banking system (again) especially the European banking systemat rst. If Im correct, it will be the catalyst for massive ows of hot money traversing the globe, from

currency-to-currency and asset class-to-asset class, looking for security/price ination. As the economists,

Milton Friedman and Anna Schwartz, noted:



nancial panic is no respecter of national frontiers.

The initial realisation that Houston, we (still) have a problem will likely lead to a correction in equity

markets, but the medium-term direction will then depend on the response of the monetary authorities.

However, and this is critical, I would still expect any renewed strengthening of deationary pressures

to trigger a reexive response of even greater spending and monetary accommodation on the part ofdesperate governments and central banks - its what they do. It doesnt have to happen, but as Martin

Armstrong argued:

In order for the deationary spiral to unfold, as was the case in the crash of 1929, the currency must be

of a steady quantity and perceived to be a preservation of capital.

I dont see that and, as far as I can tell at the moment, the beast of debt/credit expansion will continue to

be fed until it literally falls over. The majority of students of Hindu scriptures characterise the current world

age as the Kali Yuga the dark or iron age symbolised by a bull standing precariously on one leg. To

the Hindus, this bull, or dharma, is representative of morality on the earth. Morality was also linked to

money by Ayn Rand:

If you want to know when a society is set to vanish, watch the money. Whenever destroyers appear among

men, they start by destroying money, for money is mens protection and the base of moral existence.

And lets not forget Greenspans comment all the way back in 1967, before he changed tack:

Decit spending is simply a scheme for the conscation of wealth. Gold stands in the way of this insidious

process. It is the protector of property rights.

So if the response is more bailouts and money printing, there is a risk of triggering a crack-up boom. Gold

remains the go-to asset because it outperforms in both ination and deation what it hates is benign

economic conditions, but I still dont see that. If the end-game really is a crack-up boom, then equities

should also rise as capital ows into real assets and shuns paper assets like currencies and bonds.

In light of these comments, I want to look back to the period of 1931-33 during the Great Depression. My

recent study of the years was prompted by Martin Armstrongs comment that:

what is not looked at closely was the glaring fact that all of Europe went into default

A key point back then was how the second phase of the Great Depression emerged in one of the smaller

and weaker European economies, i.e. Austria. Ultimately, it spread to the larger economies and even the

US which, back then, was the worlds largest creditor, and far from the sorry, insolvent state it nds itself

in now.

The ability of hot money to ow on a global basis, or at least an intercontinental basis, i.e. between theUS and UK/Continental Europe - was already well-established 80 years ago. Fast forward to today and the

capital ows are potentially even more powerful now that China, India, the Arab nations, Russia, Japan and

the Pacic Rim nations will all be involved in the fray.

As we know, current Fed Chairman, Ben Bernanke, is hailed as one of the worlds experts on the Great

Depression. In his book, Essays on the Great Depression (thanks Ben F. in Boston) he comments:

By late 1930, the downturn, although serious, was still comparable in magnitude to the recession of 1920-

22; as the decline slowed, it would have been reasonable to expect a brisk recovery.

The recovery never came as the next phase of the downturn unfolded in the wake of the Creditanstalt

failure in May 1931. Victor Aguilar at Axiomatic Economics put it in perspective:

This more than any other event, extended the depression throughout Europe.



And then back to the US.

It would just be too cute if history repeats, but the collapse of Creditanstalt in May 1931 coincided with the

completion of what was back then the worlds tallest building, the Empire State Building. The ribbon was

cut to open the building on May 1, 1931.

Here is Wikipedia on the new pretender to the crown of worlds tallest building:

Burj Dubai (Dubai Tower) is a supertall skyscraper nder construction in Dubai, United Arab Emirates,

and is the tallest man-made structure ever built, at 818 m (2,684 ft). Construction began on 21 September

2004, and the tower is expected to be completed and ready for occupancy on 4 January 2010.

In the run-up to Creditanstalts collapse, foreign capital had moved into Austria to take advantage of high

interest rates. The discount rate set by the Austrian National Bank was 10% compared with more like 5-6%

in other major nancial centres. As former British Ambassador to Germany and France, Sir Eric Phipps,

argued:

extensive short-term credits given to Vienna banks by lenders in London, Paris, Amsterdam, New York and

elsewherereally formed the economic lifeblood of this country.

Since the money was then typically lent out on a long-term basis, there was a maturity mismatch across

the Austrian nancial system which was not perceived in early 1931. In the third volume of his history ofThe City of London, David Kynaston quotes from a report on Creditanstalt published by the merchant

bank, Lazards, for the Westminster Bank on 7 January 1931:

The leading bank in Austria and most important bank in Central Europe, perfectly good for its engagements.

How quickly things changed!

According to Aurel Schubert in his denitive work, The Credit-Anstalt crisis of 1931:

Insolvency, not illiquidity, was the initial problem of the bank

Ben Bernanke again:

The insolvency of the Creditanstalt, nally revealed when a director refused to sign an optimistic nancialstatement in May 1931, sparked the most intense phase of the European crisis.



In Aurel Schuberts book, there is an anecdote which is eerily reminiscent of the mark-to-model/myth

being employed by banks in their nancial statements today. He recounts a director of Creditanstalt saying

that:

it was best to buy shares of rms that were not quoted on the stock exchange, as one did not then have

to lower the book values according to their quoted values.

Creditanstalts insolvency was due to both bad debts and losses on its large securities portfolio. Once theseproblems became known, there was a run on the bank as deposits were withdrawn. The Governor of the

Bank of England, Montagu Norman, warned the new head of the Fed, George Harrison, that:

a monetary breakdown in Austria might quickly produce a similar result in several countries.

As an aside, what makes me laugh is that Norman made the cover of Time magazine in August 1929 and

we all know what happened two months later. Guess who was just named Times Person of the Year for

2009. Oh wouldnt the irony be something to behold!

Back to the story and Norman established a creditors committee and proposed a loan to the Austrian

central bank in order to precipitate withdrawals. About forty international banks gathered on 29 May 1931

in London, but it was to no avail. Indeed, a really interesting point about the Creditanstalt failure is how it

could have been averted as The Economist explained:

It was clear from the beginning... that such an institution (as the Creditanstalt) could not collapse withoutthe most serious consequences, but the re might have been localized if the re brigade had arrived quickly

enough on the scene. It was the delay of several weeks in rendering effective international assistance to

the Credit Anstalt which allowed the re to spread so widely.

(At least the Austrian government acted quickly in the case of Hypo Alba last weekend see below)

Then politics got in the way. According to Brad DeLong, the former Deputy Assistant Secretary of the US

Treasury during the Clinton Administration:

The substantial loan to Austria was not made because French internal politics entered the picture. At the

beginning of his political career French Premier Pierre Laval had styled himself a politician of the left: the

Clarence Darrow of France. But by the early 1930s he was shifting to the position of a strong nationalist.He blocked the proposed international support package for Austria, insisting that if France was to contribute

France had to get something out of it. The price that Laval demanded was made up of a series of diplomatic

concessions, most important of which was the renunciation of a prospective customs union with Germany



(by Austria, Paul). To Laval, playing the nationalist card in French politics, nothing that beneted Germany

could be allowed by FranceIn the long run France lost too: what might have been a chance to moderate

the Great Depression was lost. The ultimate consequences for France were dire. The rise of Adolf Hitler in

Germany is inconceivable in the absence of the Great Depression. Nine years after the Credit-Anstalt crisis

the French government surrendered to the Nazis.

The run on Creditanstalt was followed by runs on other Austrian banks. However with support from

the Austrian central bank and deposits transferred from Creditanstalt, the situation stabilised briey.

Unfortunately, it was quickly overwhelmed by a currency crisis for the Austrian schilling. In his book, Aurel

Schubert quotes an article by N. Kandor in 1932:

It is clear that the state and the national bank have thus involved themselves in obligations from which

ination can be the only way out.

Foreigners, and even the Austrian public remembering the hyperination of the early 1920s, quickly moved

out of Austria. The Creditanstalt failure was the rst in a line of dominoes in central Europe and then, very

signicantly, Germany. Quoting from David Kynastons book:

nancial instability in Austria spread rapidly to Hungary and Germany. The latter, owing to Londonsparticularly high exposure there, was crucial crisis erupted in July with a run of foreign withdrawals from

German banks.

As with Austria, the problem was the rapidity with which capital suddenly exited the German economy

which was already weighed down by reparations from World War I. As the Japan-based entrepreneur and

writer, Bill Totten, explains:

For many of Germanys banks, including the fourth-largest, Darmstadter und Nationalbank Kommandit-

Gesellschaft (Danat), dependence on short-term New York and London capital borrowings had become

substantial, and at punitively high interest rates. The Weimar hyperination had largely destroyed the

capital and reserves of major German banks during the early part of the decade. Thus the expansion ofGerman bank lending during the late 1920s was by banks with a precariously small capital base in the event

of loan default or other crises. Germany stood unique among major European industrial countries by the

time of the 1929-30 New York stock market collapse. She owed international bank creditors an estimated

sixteen billion Reichsmarks in such short-term debts. This unsound banking structure required only a small

push to topple it in its entirety.

As Londons clearing banks and merchant banks established a joint committee to represent their German

interests, crisis was also brewing outside Europe as Kynaston explains:

India, to Normans considerable anxiety, appeared to be on the brink of insolvency; the situation in Chile

was critical; and to Brazil, following its upheaval the previous Autumn, a trusted lieutenant was sent in

order to seek to impose nancial stability.

With part of the British banking systems capital frozen in Germany and the Dutch banks, which were also

heavily exposed to Germany, withdrawing capital from London, the focus of the crisis shifted to sterling.

Compounding these difculties, Britain had a severe balance of payments problem and the publication of

the Macmillan Report showed that London was a net short-term debtor of some 254m (US$1.2bn at the

time).

On 20 September 1931, the British government announced that it would suspend the Gold Standard Act of

1925, and no longer meet its debt obligations in gold. In the worlds of His Majestys Government:

Undoubtedly the bulk of withdrawals has been for foreign accountsduring the last few days internationalmarkets have become demoralized and have been liquidating their sterling assets regardless of their

intrinsic worth.



It turned out that the speculators made a smart move since sterlings value immediately fell by more than

20% versus the US dollar. Webster Tarpley, in a thought provoking view of the 1929 crash and the Great

Depression, argues that Britains default was a deliberate policy on the part of Montagu Norman. Britain

had trapped its creditors who would be repaid in devalued pounds. The position of the US and the dollar

today springs to mind! This view is supported by Frances nancial attach at its London embassy at the

time, Jacques Rueff, who later (as President de Gaulles economic advisor) became the man who broke the

dollar by smashing the London Gold Pool in 1968:

(the) Bank of England defaulted intentionally in order to damage the creditor central banks, the Bank of

France in particular.

After Britain defaulted and quit the gold standard, it was quickly followed by Canada, India, Sweden,

Denmark, Norway, Egypt, Austria, Portugal, Finland, Bolivia, Japan, Greece, Chile, Peru and others during

the next few months.

Less than a week after Sterlings default, the Economist commented:

The sterling bill enters so deeply into the whole mechanism of world trade and so many foreign banks,

including central banks, have been accustomed to keep a large portion of their reserves in the form ofsterling balances in London, that the shock caused by the depreciation of sterling to some 80 per cent of

its value has necessarily been profoundthe depreciation of the pound means that the currency reserves

of many countries which are kept in the form of sterling balances have been seriously impaired, and the

pre-existing strain on the banking system of many centres is bound temporarily at least to be aggravated

by the universal shock which condence has suffered.

Sterling losses exported deation to other parts of the world and the imposition of import duties on foreign

goods by Britain and British Empire countries further exacerbated the collapse in world trade already hit

hard in the rst phase of the Great Depression and US import duties with the passing of the Smoot-Hawley

Tariff Act in 1930. Between 1929 and 1933, US exports fell 61% while unemployment surged to 25%.

Despite being the worlds largest creditor nation, the US was still clinging to the gold standard. A combination

of fear that the US would be the next country to devalue and to cover losses on sterling, many countries

began to convert their dollar holdings into gold. According to Milton Friedman and Anna Schwartz:

Anticipating similar action on the part of the United States, central banks and private holders in a number

of countriesnotably France, Belgium, Switzerland, Sweden, and the Netherlandsconverted substantial

amounts of their dollar assets in the New York money market to gold between September 16 and October

28.

Within six weeks of the British default, the US had been drained of US$700m of gold.

This panicked holders of US bank deposits who began to withdraw cash from the banking system. BetweenAugust and the end of 1931, a total of 1,860 banks closed down. The banking crisis was still continued in

the run up to the Hoover/Roosevelt US election of November 1932. In Once in Golconda: A True Drama

of Wall Street 1920-1938, John Brooks noted:

The public started to withdraw money from banks and beginning in October 1932, some states, like

Nevada, Michigan, Maryland, etc, were declaring bank holidays.

Roosevelt won the election in a landslide based on his New Deal, together with the campaign song, Happy

Days Are Here Again, but things got even worse before he was inaugurated on 4 March 1933. John Brooks:

A conviction that Roosevelt would devalue the dollar led currency speculators and rms with international

interests to exchange United States currency in large quantities for gold and foreign money, causing theTreasury to lose gold at a frightful rateIn February 1933, it got completely out of control with almost one

sixth of all money in circulation being withdrawn from the banking system.



Talking of cycles (since it would not be out of place today), here is a bit of what Roosevelt said in his

inauguration speech:

Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by

the hearts and minds of men. . . . The money changers have ed from their high seats in the temple of our

civilization.

Roosevelt sat down in the Oval Ofce and immediately shut every bank in the US for eight days. Hereorganised the banking system and by the end of the year, 4,000 small banks had either been shut or

merged with larger competitors. Depositors in failed banks received 86 cents on the dollar. Government

employees were hit with pay cuts, prohibition was repealed and the US left the gold standard. John Brooks

again:

The stock market leaped in wild trading. That was logical enough; if the dollar was going to be cheaper

and leaving the gold standard could mean nothing else then it made sense to transfer ones assets out

of dollars and into stocks.

Dollar down, stock market up sounds kind of familiar! As well all know, Roosevelt also famously conscated

gold from US citizens at US$20.67/oz and subsequently devalued the US dollar to US$35/oz a blatantexample of theft from his own citizens.

One nal point Id like to make about this period, which is also relevant to today (just substitute the dollar

for sterling), is how the situation was complicated by sterling being in the death-throes of its use as the

worlds reserve currency. At the same time, the dollar was still not ready to take over the mantle. Brad

DeLong explains:

Before World War I the international gold standard was kept on track because there was a single, obvious,

dominant power in the world economy: Britain. Everybody knew that Britain was the hegemon, and so

everyone adjusted their behavior to conform with the rules of the game and the expectations of behavior

laid down in London. Similarly, after World War II the hegemon for more than a full generation was theUnited States. And once again, the existence of a dominant power in international nance--a power that

had the capability to take effective action to shape the pattern of international nance all by itself if it

wished--led to a relatively stable and well-functioning system.

But during the interwar period there was no hegemon: no power could shape the international economic

environment through its own actions alone. Britain tried, attempting to restore condence in the gold

standard by the restoration of sterling, and failed. America might have succeeded had it tried--but successful

policy requires that the hegemon recognize its leading position, which the interwar US did not do. Thus

resolute, coordinated action to expand demand and halt the depression did not emerge from the leading

industrial power. And it was very unlikely to be generated by any committee operating via consensus.

If you look at the situation today and try to decide what could be the falling domino that marks the

beginning of the next phase of the current debt crisis, it is hard not to feel spoiled for choice. If its not

Dubai, the nations of Central and Eastern Europe are looking particularly vulnerable at this moment, with

high prole problems in the likes of Hungary, Romania, Bulgaria and the Baltic states of Estonia, Latvia and

Lithuania. These nations all showed up in Moodys External Vulnerability Indicator, albeit the most recent

one Ive been able to nd is for end-2008. The External Vulnerability Indicator attempts to measure a

countrys vulnerability to foreigners suddenly withdrawing capital by taking account of short-term external

debt, currently maturing long-term external debt and non-residents deposits, etc.



Source: Moodys

If we look at the current situation in some of the larger ones, they are essentially on external life support:

B Hungary is being supported by a loan from the IMF/EU/World Bank. Hungarys GDP is expected to

decline by around 7% this year and see a further modest fall in 2010.

B The Ukraine, which has already borrowed US$11bn from the IMF, is demanding a further US$2bn in an

emergency loan to meet external obligations. The IMF withdrew a US$3.8bn loan two months ago after

the country failed to implement budget cuts. Ukraines economy is likely to contract by about 15% this

year and the political situation is in ux with an election next month.

B Romania was granted a Eur20bn loan from the IMF/EU/World Bank earlier this year, but Eur1.5bn waswithheld last month until budget cuts are agreed. The country is now in turmoil after a narrow election

victory for incumbent President, Traian Basescu, contradicted exit polls. GDP is expected to decline by

7-8% this year.

The most recent data from the Bank for International Settlements for end-June 2009 showed that foreign

banks have US$1.4trn of exposure to CEE:

Foreign claims on Emerging Europe (end-June 2009)

Country Claims (US$bn)

Poland 269

Russia 216

Czech Republic 178

Turkey 157

Hungary 152

Romania 119

Croatia 83

Bulgaria 44

Ukraine 41

Lithuania 40

Latvia 34Total (incl. other nations) 1,417

Source: BIS



European banks have almost all of it, i.e. a massive US$1.3trn, with Austria, Germany, France and Italy

particularly vulnerable.

Foreign claims on Emerging Europe by nationality of reporting banks (end-June 2009)


Austria 224

Germany 196

Italy 179

France 160

Belgium 112

Sweden 100

Netherlands 95

Switzerland 44

UK 36

European banks total 1,284

US 56

Total (incl. other nations) 1,417

Source: BIS

Looking at the table above, the irony of ironies is that the next phase of the current crisis could emerge

from Austria, just like in 1931. The BIS data shows that Austrian banks have loans of US$223.7bn to

the emerging nations of Central and Eastern Europe (CEE), equivalent to 54% of its GDP. This lending is

signicantly higher than loans made by other much larger countries such as Germany with US$196.2bn

and Italy with US$179.2bn.

Breaking down the Austrian banks lending by country, about US$90bn is to potential basket cases like

Romania, Hungary and Ukraine. Fortunately, they have minimal exposure to Estonia, Latvia and Lithuania.

Austrian banks exposure to Emerging Europe (end-June 2009)


Czech Republic 56

Romania 43

Hungary 37

Croatia 25

Russia 18

Poland 14

Ukraine 10

Total (incl. other nations) 224

Source: BIS

If Austrias exposure to CEE causes it problems, foreign banks had US$331.4bn of exposure to Austria in

mid-2009, of which two thirds was accounted for by Germany and Italy.



Foreign claims on Austria by nationality of reporting banks (end-June 2009)


Italy 117

Germany 104

France 26

Switzerland 11Netherlands 9

Belgium 9

UK 8

European banks total 300

US 9

Total (incl. other nations) 331

Source: BIS

Only this Monday, the Austrian bank, Hypo Group Alpe Adria, had to be rescued due to losses on its leasing

business in Croatia, Bulgaria and Ukraine. The bank was 67% owned by the German state of Bavaria, viathe Bayerische Landesbank. Back on 1 December 2009, the FT reported:

Horst Seehofer, state premier in Bavaria, said last week that Hypo is a system-relevant bank in Austria,

not in Germany and the responsibility to rescue it lay in Vienna. However, Josef Prll, Austrian nance

minister, repeated this weekend that he did not intend to make Austrian taxpayers pitch in.

Despite Prolls comment, he was forced to eat his words and Austria nationalised the bank with Bayerische

Landesbank contributing an additional Eur825m of capital. Reuters reported Proll as saying:

The risk situation of this bank has created an enormous threat to Austria in the past days

And the head of the Austrian central bank, Ewald Nowotny, argued that the rescue had avoided:

a massive risk to the entire Austrian economy at a critical point,

So much so, apparently, that even the President of the ECB, Jean-Claude Trichet, was involved in the

negotiations. I am not surprised because it represented a systemic risk not just to Austria but the rest of

Europe, although I dont think this was widely appreciated. I even bought the Financial Times to see how

much coverage it was given nothing on the front page, nothing in Lex you had to turn to page 5 in the

second section.

The current poster child for potential sovereign bankruptcy is obviously Greece. Having been warned of

possible debt downgrade on 7 December 2009 by Standard & Poors, Fitch actually cut Greece to BBB+ the

following day. Every day, it seems, someone insists that Greece isnt bankrupt, which is kind of reminiscent

of US ofcials assuring everybody that the sub-prime crisis would be contained. Its usually the Prime

Minister, Georges Papandreou, but Angela Merkel and Jean Claude Juncker, the chairman of the Euro-zone

nance ministers, have pitched in too. This is in spite of the EU refusing to come to Greeces aid unless it

sorts out its public nances.

The 2009 budget decit is expected to be about 12.7% of GDP and is forecast to fall by about 4% in 2010.

What makes the outlook potentially even worse is the growing civil unrest. There have been strikes by

public sector employees and there were two days of civil unrest on the anniversary of the police shooting

of a 15-year old boy.

Looking at the BIS data on foreign bank exposure to Greece, we see that France, Switzerland and Germany

are most exposed.


23/27



Foreign claims on CEE, Austria, Greece & Ireland by nationality of reporting banks (end-June

2009)


Germany 522

France 330

Italy 327UK 260

Austria 235

Belgium 199

Netherlands 148

Switzerland 129

Sweden 108

Total (incl. other nations) 2,917

Source: BIS

It does make me very concerned about the European banking sector in general and Austria, Germany andItaly in particular. Another potential worry for the banking sector is rollover risk as shown in this IMF chart

on banks bond debt maturity structure in June 2009 versus June 2007:

Source: IMF

According to the IMF:

Banks that issued record volumes of debt during the credit bubble lost the capacity during the crisis to

manage their maturity proles. As a result, rollover volumes now peak around two to three years ahead

(versus a much atter prole prior to the crisis) with an unprecedented $1.5 trillion of bank debt due to

mature in the euro area, the United Kingdom and the United States by 2012.

But its not just the banks, governments face increasing rollover risk as well especially the 800lb debt-

ridden gorilla which is the US government in 2010. Here is a great chart from SocGens recent piece on

Greece:



Sovereign rollover risk in 2010

Source: SocGen

The old saying is that if something seems to good to be true, then it probably is! The continuing very low

levels of government bond yields in the face of obscene decits and money printing t into this category.

The last couple of weeks have been very interesting with condence in government bond markets taking a

hit almost across the board. While the focus has been on a sharp rise in yields on Greek bonds, with 10-year

government bond yields rising from 4.99% to 5.30% last week, the UK 10-year gilt yield also rose 25bp

last week During the last two weeks, US 10-year yields rose by 35bp from 3.20% to 3.55%. If government

bond yields, especially in highly leveraged economies, including the US and UK, continue to rise, it willobviously be:

Game over

Last words from Doug Noland:

Meanwhile, the Federal Reserve still retains remarkable dominance over global market yields. I believe we

are in a transition period, with the Feds power over global yields waning over time (or perhaps abruptly

in a future crisis backdrop). In the meantime, however, global yields are mismatched to the reationary

backdrop. This predicament implies ongoing market distortions, a rather extraordinary global mispricing

of the cost of nance, along with all the myriad nancial and economic costs associated with unrelenting

Monetary Disorder (i.e. assets bubbles, imbalances, mal- and over-investment, nancial and economic

fragilities, etc.).

Each month, the US credit system and economy become only more vulnerable to a rise in yields (mortgage

and Treasury borrowing costs, in particular). Imagine the U.S. housing market in an environment of much

higher mortgage rates and then ponder the scope of the Fannie/Freddie/FHLB/FHA bailouts in the event of

a spike in yields. Picture the dilemma faced by Treasury if its borrowing costs jump signicantly. How about

the scal position of state and local governments? Could our frail banking system handle a surprise rise in

rates? And imagine the corner policymakers would nd themselves boxed into when the Fed loses control

over market yields.

But a nal thought for Martin Armstrong:

And for each unharmful, gentle soul misplaced inside a jail,

We gazed upon the chimes of freedom ashing



Lyrics by Bob Dylan (although the best version is by Springsteen)

Read Martins stuff at www.martinarmstrong.org, I cant recommend it highly enough

Brief message to Martin: this goes to 4,000 people (mainly buy-side institutional investors) and I hope it

highlights awareness of your plight, as well as the genius of your work.

From the Princeton Economics website:

UPDATE December 1st 2009...thanks to all (especially the organizer of this protest - Kris over at Scribd.

com) who sent emails, phoned, faxed etc. to help Martin and stop him from being transferred to a rough

prison where he feared he could lose his life. The prison authorities backed down on their attempted

violation of US law after the bright light of public scrutiny was pointed at them

Mr. Armstrong says, the court told him they knew he did not steal money and he says the government

knows that Republic Bank employees did illegal trading in his Princeton Economic accounts but apparently

the government cannot admit to being wrong so Armstrong remains in prison going on 10 years now! What

gives these bureaucrats the right to ruin a mans life!


27/27

Author: I started work the month before the stock market crash in 1987. Ive worked mainly as an analyst

covering the Metals & Mining, Oil & Gas and Chemicals industries for a number of brokers and banks

including S.G. Warburg (now UBS), Credit Lyonnais, JP Morgan Chase, Schroders (became Citibank) and,

latterly, at the soon to be mighty Redburn Partners.

Charts: Thanks to barchart.com, LME, timingcharts.com, kitco.com, kitcometals.com, Sony Pictures, ebay

Disclaimer: The views expressed in this report are my own and are for information only. It is not intendedas an offer, invitation, or solicitation to buy or sell any of the securities or assets described herein. I do not

accept any liability whatsoever for any direct or consequential loss arising from the use of this document or

its contents. Please consult a qualied nancial advisor before making investments. The information in this

report is believed to be reliable , but I do not make any representations as to its accuracy or completeness.

I may have long or short positions in companies mentioned in this report.

Documents

Thunder Road Report 18 17th December 2009