Up next: Global Financial Lockdown?

The response of authorities to next financial emergency

Issues contributed:

• Emergency measures established for the banking sector.

• Emergency measures established for financial markets.

• The procedure for a global financial lockdown.

I studied financial crises in the academia for a decade (from 2008 till 2017). They have certain common characteristics, which we have been detailing recently. When a banking crisis hits, you can expect the following to happen:

1. Your access to your funds will be restrained.

2. Availability of credit will see a drastic decline.

3. Bank runs appear with people queuing for access to their funds (deposits).

4. Bank closures (bankruptcies) are likely to emerge.

These banking crisis ‘characteristics’ have applied basically as long as there have been banks.

First known banking crises date to Roman Imperium, which nurtured a sophisticated banking system. The first banking crisis of the modern banking system occurred in the U.S. in 1819. During the ‘Panic of 1819’, people queued outside banks in long lines to change their new financial innovations, bank notes, to metallic currency (silver or gold).¹

The crisis was precipitated by President Thomas Jefferson buying Louisiana from Napoleon in 1803 with debt obtained from domestic and foreign investors. A rather dysfunctional national bank, the Second Bank of the United States, or BUS, founded in 1816 was assigned to handle the first installment in gold to France in December 1818. There was also an U.S. land bubble driven by a massive eruption of a volcano in Indonesia creating “the year without a summer” in 1816. The number of banks in the U.S. exploded to finance the speculation on land.

During the Summer of 1818 it became clear that the BUS had instituted bank notes way beyond its metal specie leading the branches of the bank declining state-chartered banknotes. State banks unable to provide the specie required started to call in loans on heavily mortgaged lands. Mass liquidation of farms and land ensued with money in circulation contracting heavily. In January 1819, news broke that the price of cotton had collapsed, and the panic ensued.

This is the way banking crises usually proceed. That is, there’s a ‘run’ for the liabilities of a bank(s). Like described by a prominent financial historian, Professor Gary B. Gorton, a banking crisis is "an event where holders of short-term debt issued by financial intermediaries withdraw en masse or refuse to renew their loans".² Hence the name: a bank run.

In practice, a banking crisis is a massive (over-whelming) demand for holders of bank debt to convert it to cash or other liquid forms of assets in excess of the reserves of the bank. In addition to deposits, this bank debt can be bonds, derivatives or inter-bank funding obtained from inter-bank markets. Thus, there can be two kinds of bank runs: normal (or historical), where depositors queue outside of bank offices to obtain cash, and silent, where other banks and/or financial institutions cash out from the equity, bonds, derivatives or inter-bank liabilities of a bank.

A bank run threatens the very fabric of modern economies through various channels, but especially by contracting the availability of credit in the economy, with banks hastily calling in their loans. This leads to diminution of money in circulation, as the balance sheet of banks decrease rapidly. As explained above, this can also occur “silently”, what, for example, happened during the financial crisis of 2007-2008, or the Global Financial Crisis, GFC (please see a detailed explanation on banking crises).

The GFC scared the global political establishment, thoroughly. It led them to establish regulations that allow for a freezing of the global financial system in a crisis. Authorities can issue the lockdown at will, and many people do not understand such a system exists.

In this post, I will detail what it means for you. Guidelines for crisis preparation accounting the threat of a global financial lockdown, can be found here and here.

The ‘Ice-Nine’ for the banking sector

James Rickards, a facilitator of the first-ever financial war games conducted by the Pentagon and a senior adviser of the now defunct, and notorious, Long-Term Capital Management, has gone through the building blocks of global financial lockdown, which he calls “Ice-Nine” (a reference to imaginary substance able to freeze all world’s water supplies in a 1963 novel Cat’s Cradle), in his book The Road to Ruin. I have to say that, while I knew on the bail-in policies put in place after the GFC before I read the book, it opened my eyes on how wide-spread the coming financial lockdown could be. It was a shocking discovery.

The whole idea of freezing bank deposits and using them to re-capitalize banks rests on the idea of stopping (freezing) bank runs. If you cannot withdraw your money, banks will not fall into insolvency, because there will be no run on the liabilities of the bank. With the bail-in, that is, depositor funded re-capitalization, authorities guarantee that threat of wide-spread customer insolvencies, i.e., bankruptcies and defaults, are less likely lead to insolvency of the bank.

In practice, this means that none of the money in your bank account is in your control. When you deposit your money to a bank, it seizes to be your money, but you used to have some control over it.

Bank is an exceptional entity in a sense that while, for example, the output of a tractor company is tractors, the output of a bank is debt.³ This debt is given out as an IOU or, more precisely, as a bank deposit. Basically the bank gives a promise that whatever sum you deposit there, you get it back whenever you want; a contractual warranty of short. In the modern, fractional reserve banking system only a small portion of the liabilities, like deposits, and assets, like loans, are covered by the reserves or the capital of a bank. Thus, while you have (had) control over your money, only a fraction of it has been available for a withdrawal at any given point in time. This is the main problem of the fractional reserve banking system: only a fractional share of this bank debt is covered in each point in time.

Now, however, the “Ice-Nine'“ solution has changed this, because now authorities can, at will, subject you to arbitrary withdrawal restrictions and make you lose some of your savings. Effectively, you don’t have control on your bank deposits anymore. And, it gets worse.

The ‘Ice-Nine’ for the financial sector

In late-September past year, a global financial crisis came closer than ever before, after the GFC. I have explained the process in detail in my Epoch Times column, but the main culprit for this were the rapidly rising prices of government bonds, driven by re-started programs of quantitative tightening, threatening the solvency of fixed income investors.

Alas, in late September British pension funds were faced with major margin calls, which threatened to cause a rapidly cascading run on their liabilities, as trust in their liquidity and solvency would have become questioned by a widening circle of investors and customers. On Sept. 28, around noon, the Bank of England stepped (back) into the gilt markets and started buying government bonds with longer maturities to stop the collapse in their value. Moreover, in early October presumable ‘silent-run’ on the liabilities of Credit Suisse threatened to topple the venerable Swiss banking giant. The Swiss National Bank and the Federal Reserve orchestrated a dollar-liquidity driven bailout of the bank with the help of the Saudi National Bank. If these actions would have failed in stemming the panic, we could have seen a global financial ‘Ice-Nine’, or lockdowns, enacted.

Mr. Rickards discovered the plan for a global financial lockdown during a dinner in Manhattan restaurant in June 2014.⁴ He was accompanied by his daughter, a retired top adviser of Barclays Global Investors and a consigliere to CEO of BlackRock CEO Larry Fink. At the course of the dinner, the consigliere told Mr. Rickards that the U.S. government wanted to gain power to stop BlackRock from selling their assets. BlackRock is the biggest asset management company in the world, with an asset portfolio of around 10 billion U.S. dollars. This meant that the U.S. government was seeking powers to stop panic selling, i.e., “fire-sale” of assets of largest asset managers. They assumably obtained it, and now such a ‘financial lockdown’ procedure applies also to money market funds of the U.S.⁵

The global financial lockdown

It’s not known, does the financial market lockdown procedure apply beyond U.S. based firms. We do know, however, that the banking sector lockdown procedure applies at least in G8 countries. Bank lockdowns and depositor funded bail-ins were enacted, e.g., during the banking crisis of Cyprus in 2012/2013.

Let’s now assume that the BoE would have been unable to stem the fall of the price of gilts in late-September (this is unlikely, but let’s assume). A fire-sale of assets (around $3 trillion) of British pension funds would have commenced in a scramble to meet the margin calls. Because pension funds are considered among the most-safe financial institutions, panic would have gripped the global financial markets. Moreover, in a matter of days, the problems of Credit Suisse would have emerged.

Then, we could have entered a scenario, where:⁶

1. Global investors would have begun a frantic run to safety, i.e., out of equities, cryptos and speculative (junk-rated) corporate debt to ‘safe-heave’ bonds (U.S. Treasuries and possibly, e.g., to German bunds), and gold.

2. Counterparties in the inter-bank markets would have started to withdraw credit lines on all banks and financial institution considered un-safe (rumors would have played a great role).

3. Depositors would have panicked all-over the world and actually visible bank runs with people queuing for cash would have emerged.

4. There would have been a mad scramble for physical gold.

We could have seen the collapse of the modern financial infrastructure in a matter of days, at max weeks. Banks being unable or unwilling to provide financing to the economy at large, major liquidity shortages would have started to affect the real economy. To quell this, a global financial lockdown would, most likely, have been enacted.

Such a maneuver would, probably, consist of:

1. Strict cash withdrawal limits (e.g., $50 per day) or in an extreme yet unlikely case banning them altogether for a limited period of time (e.g. during the most-acute phase of the crisis).

2. Major institutional asset managers (like BlackRock) would be stopped from selling the assets, freezing the funds of investors in place (at least in the U.S.).

3. Depositor bail-ins, probably subjected to all deposits above the deposit-guarantee limit, would be enacted to prop up the ailing banks.

4. Investors having to accept the “frozen” asset values, once institutions again are allowed to give them access and transaction rights.

5. Banks would be given extra-ordinary powers to withdraw their credit lines, also from households.

These would lead to a seizure of majority of economic activities and major suppression of business activity. This is, naturally, a grave and unfortunately a very real threat.

I, and we, will continue to dwell on the matter in the coming weeks (see preparation guidelines from GnS Economics’s newsletter).

In the meantime, raise cash.

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Disclaimer:

The information contained herein is current as at the date of this entry.  The information presented here is considered reliable, but its accuracy is not guaranteed.  Changes may occur in the circumstances after the date of this entry and the information contained in this post may not hold true in the future.

No information contained in this entry should be construed as investment advice.  Readers should always consult their own personal financial or investment advisor before making any investment decision, and readers using this post do so solely at their own risk. 

Readers must make an independent assessment of the risks involved and of the legal, tax, business, financial or other consequences of their actions. GnS Economics nor Tuomas Malinen cannot be held i) responsible for any decision taken, act or omission; or ii) liable for damages caused by such measures.

1. Gorton, Gary B. (2012, p. 34). Misunderstanding Financial Crises: Why We Don’t See Them Coming. New York: Oxford University Press.

2. Gorton, Gary B. (2012, p. 43). Misunderstanding Financial Crises: Why We Don’t See Them Coming. New York: Oxford University Press.

3. Gorton, Gary B. (2012, p. 5). Misunderstanding Financial Crises: Why We Don’t See Them Coming. New York: Oxford University Press.

4. Rickards, James (2016, p. 18-22). The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis. Penguin Random House.

5. Rickards, James (2016, p. 27). The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis. Penguin Random House.

6. I wish to thank Dr. Peter Nyberg for his insightful comments on this section. Remaining errors are my own.