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Msg  225 of 258  at  1/31/2012 10:17:42 PM  by


Greek restructuring, gold and fiat currencies

"Fiat:"  an arbitrary decree or pronouncement, especially by a person or group of persons having absolute authority to enforce it: The king ruled by fiat - dictionary.com
The big topic of discussion in the cyberworld today was an interview with Jim Sinclair, who discussed an imminent ruling by ISDA - the board of OTC derivatives rules and enforcement - which would pronounce that any massive haircut in value taken by Greek bondholders would not constitute an event of default.  This is not new information, as it was reported as far back as October that ISDA would make this declaration once the a Greek restructuring occurred.  And it will occur despite the poker game going on, because if Greece defaults, then ISDA will have its fiat powers stripped by market forces when Greek sovereign paper goes offered without any bid (i.e. worthless).  You can hear Sinclair's interview at http://www.jsmineset.com/

What bothered me was that Sinclair made ISDA sound like some dark, mysterious force out there that was largely hidden but imbued with supernatural powers.  ISDA has been around forever.  I used ISDA documents when we would engage in high yield bond swaps with funds like Harvard Investments in order to hide positions from the back office risk Nazis at year-end.  It was de rigeur back then.  It's rampant beyond control now.

The problem with ISDA is that it is governed by the same banks that stand to benefit the most from ISDA rule declarations:  the big banks that have been declared by fiat as "too big to fail" by Team Bernanke/Obama (really, just Team Bernanke, but Obama reads the script off the teleprompter like a good circus animal).   

So, in the Greek bond situation, what you have is a situation where big hedge funds and money market funds have loaded up the boat with short term Greek sovereign paper at high yields (and Italian/Spanish/Portuguese, etc), and bought OTC derivative credit default protection in the even of default.  The way this works, if Greece is unable repay its bonds at a minimum of some small discount to face value, or if Greece defaults outright, the issuer of the credit derivative - the big bank in most cases - has to make the investor whole.  On $10's of billions in Greek debt with credit protection issued, it can get expensive for the big banks.

To make matters even more interesting, there has been been outright speculation on Greek debt in which a hedge fund will bet on a Greek default by buying a fancy derivative from a big bank such that the hedge fund doesn't even have to own any bonds and it will still get paid.  It's like buying a put option on a stock betting it will go down without actually owning the stock.  Again, in the event that Greece has to "restructure" its debt at 30-50 cents on the dollar, or outright defaults, the big banks would have to cough up $10's of billions in "default insurance" payments.

But there's a way around this.  It's called rule by fiat (see the above definition of "fiat").  Since the banks control the rules and procedures of ISDA, if they determine that a Greek restructuring which requires a 50-70% haircut on the debt held by investors is not really a "default" event, so be it.  The Greek bond investor will be coerced into receiving a new bond that will be in the range of 30-50% of the face value of the original bond, thereby getting hammered on its investment, and the big bank who got paid a handsome premium to underwrite default insurance on that paper will get to keep the money it was paid and it will not have to make obligatory restorative payments to the investor.  Isn't it good to be King in a completely fiat system?

The problem with the fiat currency and financial system is that eventually it turns into one giant Ponzi scheme.  The politically/socially correct term for this would be "a fractional banking and financial system."  It's a system based on "full faith and trust."  When the trustworthiness of this system starts to fade, investors will start to move "fiat" money into hard asset currency - that is, gold and silver, the world's oldest and most trustworthy hard asset currency.  It's happening now, only it's a lot more prevalent in the eastern hemisphere countries like China, Russia and India.  In our own backyard, Venezuela demonstrated this movement by recalling nearly 100% of its sovereign gold that was being "safeguarded" by big banks in NY, London and Zurich: Hugo Chavez, love him or hate him, is one smart hombre.

Gold and silver are on the cusp of another big explosive move higher.  James Turk in his latest commentary on King World News said it best: 
Regarding gold, I don’t think people realize that gold could explode from current levels.  I think the potential for explosion is there and what you are going to see is not only silver on the move, but you will also see gold smash through the $2,000 level
If you don't understand why Turk makes these comments, re-read my commentary above.  If you still don't understand why, so be it.  Unfortunately, by the time the masses understand this, gold and silver will likely be too high in terms of fiat currency price for them to buy enough to matter.  It is what it is...

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