Canadian Gold Reserves.

Firstly let’s look at the now non-existant Bank of Canada gold reserves. As of last month the Bank of Canada sold off its gold and now has a zero balance forgold reserves.  This is a situation which has purportedly not occurred since 1935.

On the face of things, this isn’t a huge issue. Canada has ample gold mines and can dig up and purify more gold dust into bullion if they wish to but the behavior behind selling the reserves off hints at something else.  Quite simply, this hints at an inability (or unwillingness) on behalf of the central bank to auction debt to foreign holders.

If faced with a choice in the face of tricky financial headwinds, they can: issue more debt to  creditors (sell debt for cash), or sell assets for cash.  It seems, for whatever reason, the Bank of Canada elected to do the latter. More on this later.

Japanese Flash Crashes.

There have allegedly been two flash crashes this week in futures contracts trading on Japanese Government Bonds (JGBs). In fact, as Zero Hedge reports, circuit breakers kicked in and halted market trading for a number of seconds  just this week.

This hints at decreasing liquidity issues in markets, especially those linked to debt.  This lack of liquidity seems to be on the buy side of the market- suggesting market participants are extremely wary of this asset class.

The ECB Announcement.

This week the ECB announced an interest rate cut to zero percent as well as further monetization of debt through scaling up their QE program by 33% from 60 billion Euros to 80 billion Euros a month.  The Euro initially dropped against other floating currencies, but then reversed, strengthening.  The reverse was seen in European stocks- an initial strengthening, followed by a drop. This volatility is an unusual response for such an announcement and hints that faith in central banks, particularly in Europe, may be wearing thin.

Interest rates reached their previous peak in the 1980s, and have declined ever since- a positive thing for debt issuance. The face value of debt is inversely related to the interest rate.  Textbook finance would report that as as rates decline, previously issued debt with higher yield is more valuable. (Please be aware, that there is likely to be an inflection point at some stage, where market participants simply will not buy new debt issued despite lower interest rates because repayment becomes unlikely.)

So what is going on?…

In general the lack of liquidity, volatility on central bank announcements and sale of low-yielding assets by some banks suggest that the Sovereign Debt Crisis is not far away. It is becoming increasingly hard for governments and central banks to issue debt- buyers are not present in the market on the other side of the trade. Furthermore, what goes up must come down- the 30 year bull run in fixed income (part of a larger 70 year cycle) is coming to an end.

…And why the picture of the black hole?

What Just like a black hole, forcing the creation of more outstanding debt, without first letting the market clear, will destroy liquidity, destroy savings and destroy the overall markets.  Forcing the creation of debt on market participants (as central banks and their allies have been doing) without any underlying real economic growth, sucks increasing amounts of liquidity out of the markets through extracting increasing interest.  Therefore, without defaults on the debt, this acts very much like a black hole, sucking more and more capital in as it grows.

This might go some way to explain why German Banks were told to hoard cash.


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