For some months, I have been writing my thoughts on what has been happening around the world both politically and economically. Surely the motto for the past year must be, “If anything can go wrong, it will.”

The day before Thanksgiving, on November 26th, I warned FallenRepublic’s readers about the dangers of Credit Default Swaps. This, unfortunately, seems only to be the tip of the iceberg. There are many more items out there, with financial dollar amounts making the CDS catastrophe seem small as a mouse in a warehouse. For those who have not read my previous commentary on the dangerous nature of Credit Default Swaps, here is a most useful video explaining the problem and quantifying the CDS portion thereof.

Now, this is not the only problem. As I stated before, CDS were only the tip of the iceberg, tipping in at a whopping $50-60 trillion dollars. You normally would not look at $60,000,000,000,000.00 and find it to be a trivial figure, however; you have not yet seen how large the problem actually is. In the following article, I wish to describe the issues directly facing us financially which do explain Washington, D.C.’s haste to prevent bank failures.

First, let us look at risk. Initially we saw risk begin to blow up the CDS market when roughly 6% of the mortgages in the US began to falter. CDS were no more than a repackaged insurance instrument, as the above video states, however; calling them Swaps instead of Insurance allowed the banks to bypass insurance regulations and therefore, not to have funds on hand to pay these Swaps in the event of mortgage failure.

That was just the mortgages. That bubble has now burst. People struggling to pay for expenses, including their homes, do not have surplus money for large ticket items. You can see this in the trends where fancy stores are seeing sales decline while Wal Mart and other discount stores are posting larger sales. The reason is simple – People are trying to save what little money they have, and when they do purchase, they do so at the largest discount(s) that can be found.

As people save money and struggle to pay their debts, sellers of large ticket items, like cars, are being financially obliterated. This, of course, has led to the domestic auto makers begging Congress for any fiscal crumbs which may fall from the bailout tables. Auto makers are not alone here, many companies are announcing layoffs, AT&T alone will lay off 4% of its workforce – some 12,000 people soon.

Here is the rub: People being laid off cannot pay mortgages they already have trouble affording. As a result, the process will begin to accelerate, in spite of the now $7.6 trillion dollars in bailouts.

The bailout of the banks did not work in the 1930′s, what makes us think it will work now? Let us consider some numbers in order to properly understand the $7,600,000,000,000.00 in bailouts which have been promised and/or supplied. Let us adjust some historical numbers for inflation and commence to adding them up. You see, the current $7.6 trillion bailout is larger than:

The Marshall Plan ($115,300,000,000.00)
The Louisiana Purchase ($217,000,000,000.00)
The Moon Race ($237,000,000,000.00)
The Savings & Loan Crisis ($256,000,000,000.00)
The Korean War ($454,000,000,000.00)
The New Deal ($500,000,000,000.00)
The Iraq War ($597,000,000,000.00)
The Vietnam War ($698,000,000,000.00)
NASA’s budget history ($851,200,000,000.00) and
World War II ($3,600,000,000,000.00)
COMBINED! ($7,525,500,000,000.00)

The bailout has cost so far: $7,600,000,000,000.00, or 74,500,000,000 more than all of the above programs combined.

So you see, we have spent enormous sums of money on this problem and still have not found a solution. Credit markets are still frozen, sales, production and job creation have all stagnated or declined in spite of the monies spent on this issue. The stock market is stagnated around the 8,300 point level – for now.

The next question becomes what will be the next shoe to drop?

I believe the answer to this lies in the health of emerging economies. You see, emerging economies are cash hungry, frequently borrow to finance expansion and infrastructure development, yet they still are very fragile in turbulent economic times. This tells us that there will be economic failures in places like Argentina, Ecuador and other places where economies are young, inexperienced and ill-equipped to handle the slowdown.

First, let’s consider Ecuador. On November 15th Ecuador, who uses the US Dollar as their currency, missed a loan interest payment on the government’s $4,000,000,000.00 debt. On December 15th, they must pay the interest payment from November plus the interest payment from December, otherwise they are in default.

Argentina also has a large debt which was refinanced following a deflationary spiral which occurred from 1995 through 2001. Given the current state of the world economy, Argentina may well be at risk to default once more.

This raises an interesting question: Since emerging economies owe so much, someone must be lending to them. With this in mind, the question becomes, Who is most vulnerable to defaults in emerging markets? A newsletter article produced by Money and Markets suggests that Europe will take this fall as they have lent far more to emerging economies than the US and Japan combined. I predict this means the US dollar and Japanese Yen will perform better than the Euro for the coming months. I furthermore predict that this puts more EU banks in perilous risk of failure. As early as 2003, the IMF was warned by one of their own about the risks of emerging markets.

In order to explain how this risk of default is most devastating, remember the video above, which shows that bankers bought Credit Default Swaps as insurance mainly for the riskiest of investments. Credit Default Swaps are a class of unregulated, privately traded commodities known as Derivatives. A Derivative is basically nothing more than a bet on something happening or not happening. There are numerous kinds of Derivatives and such bets have even been made on such silly outcomes as whether or not the weather will be nice on the day of an event, presumably in order to recoup event costs in the event of bad weather.

So, just how big is the Derivative bubble? (now if you are reading this, please strap yourself to your seat so you do not fall down when you faint)

Currently, the most recent numbers on the size of the Derivative bubble were provided in 2007 by D.K. Matai, Chairman of the ACTA Open at the staggering sum of $1,144,000,000,000,000.00 (1.144 quadrillion dollars). This is $190,000 for every man, woman and child on Earth. Additionally, by comparison, if you wanted to time 1.144 quadrillion seconds, it would take you 36,251,172 years and 168 days in order to do so.

Remember, Derivatives are bets made on a condition, generally through a financial contract where the condition is known as the “underlying”. Such bets often are placed based on rational assumption, steady growth curves and the status quo. Events, such as the current economic downturn are frequently unforseen in derivatives purchased before the event and exasperated by derivatives purchased after the event, which bet on the downturn to continue. Derivatives can get quite confusing, however; I would like to provide the following audio interview of author Ellen Hodgson Brown, J.D. whose book, “The Web of Debt” explains the issues well.

Just like the Credit Default Swap market, a receding economy will also wipe out the Derivatives market, probably claiming the $548 trillion Credit Derivative market as its first victim, post CDS crash. Unfortunately, the main media ignores these issues, however; they most likely do so because of misunderstanding or the fear of creating a panic.

Considering what we now know and the scope of the problem, one must be prepared to survive. Such times will be at the very least, unpredictable. My advice here will simply be, don’t be in a city, have access to arable land where you can grow your own food, and be ready to protect yourself in the event that a bankrupted state or federal government cannot.

It seems we are indeed headed for interesting times. If you have questions, comments or suggestions, I welcome you to talk back using the comment button below, or you can email me at nero@fallenrepublic.com.

“The question is: how bad do things have to get before you will do something about it? Where is your line in the sand? If you don’t enforce the Constitutional limitations on your government very soon, you are likely to find out what World War III will be like.” – Michael Badnarik (Libertarian candidate for President, 2004)

Tags: bailout, Bank failure, Credit Default Swap, Derivatives, Ecuador, emerging economy