Warranty chains are the real crunch


Barely a month ago, OPEC+, the group of major oil-exporting countries, announced a slight increase in production. The global economy was suffering from extreme pressure on oil prices. President Joe Biden traveled to Saudi Arabia, one of OPEC’s biggest producing members, to personally deliver his plea for help on behalf of just about everyone. All he extracted from the Saudis was a measly 100,000 barrels per day (bpd) raise.

Partisan politics aside, the reason Biden didn’t get more than that token gesture was widespread producer concern about the same economy. Recession fears have risen for good reason, as oil prices are swinging wildly, unsettling the market.

The small increase in production was a compromise, ironically, between recognition of the demand-destroying potential of high oil prices, Biden’s advocacy, and the very real possibility that price destruction is already happens as the raw benchmarks crumble.

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In response, the OPEC+ cabal just gave up on even supplying 100,000 bpd, not wanting to commit to any supply reduction. Demand concerns have now completely overtaken the severe production constraints that prompted Biden’s calls in the first place, and the world’s oil shortage still remains unresolved (especially in the United States itself).

We see this very clearly, as I wrote about in my last column, in the reshaping of the curve in the domestic oil futures market. National gasoline use (demand) is seen (by the government) to be, on average, as dismal right now as it was in the summer of 2020, when a much of the country was still recklessly imprisoned by pandemic politics.

As a result, the West Texas Intermediate (WTI) market is increasingly approaching contango – that is, when the futures price of a commodity is above the spot price – flattening out on its forehead, which represents greater fears on coming demand trouble ahead.

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Although this is relatively simple, the recession is not the only factor weighing on this curve and many others.

Crude oil futures are the link between the real world and the monetary world, with the physical needs of supply balancing demand against global liquidity. What had driven oil prices up from 2020 was all about supply, that is, too little. Since around February and March 2022, the balance (or imbalance) has reversed, but not just towards demand fears.

From early June to mid-July, it was the other of these fundamental forces, liquidity (i.e., money), that had set crude oil prices at their initial plunge, the one that gave OPEC so much pause on Biden’s call that they had only offered him a small token. Since mid-July, both the lack of liquidity and all-too-reasonable concerns about a drop in demand helped to bend the curve and drive prices as a whole much lower.

Shouldn’t the president have visited Federal Reserve Chairman Jerome Powell instead of the Saudi Crown Prince?

If Biden had done that, it would have been just as much a waste of everyone’s time. According to the prevailing convention, we are told that if something happens in the markets or in the economy, the Federal Reserve must be behind it. This “don’t fight the Fed” myth persists, despite decades of experience having long since debunked it (in fact, the myth has never really been established by anything other than unsubstantiated assertions, including quantitative easing).

In the event of monetary tightening, this sounds just like what President Powell did to the Fed. Not only that, Powell raised benchmark interest rates mainly due to the president’s prior request (the pair visited not too long ago in late May) that Powell “do something” against inflation.

But like OPEC’s brief output hike, the rate hikes are just as symbolic (and still very expensive to be brief). Effective monetary tightening is simply not something the Federal Reserve actually does. Instead, we can easily establish the actual US monetary conditions punishing the WTI curve starting with… Italy.

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Unbeknownst to most people, including those who work at the Fed or the European Central Bank (ECB), Italian governments are a huge source of useful currency for the entire global system. How do bonds become money? As collateral in all kinds of monetary transactions, from repos and derivatives to swaps and collateral-to-collateral transformations.

In short, since Germans are known to be fiscally cautious, there simply aren’t many “virgin” German government bonds being issued, especially short-term maturities coveted by global currency players. that engage in securities financing transactions. As a result, the fiscally spendthrift Italian government has unfortunately filled this crucial monetary void.

This, of course, introduces a potential fracture point – exactly the same one that was already the main source of the second global currency crisis more than a decade ago, in 2010 and 2011. Any real prospect of a recession in Europe is a wrong combination, with Italian bonds already trading on shaky ground as the Italian economy never recovers from any of the previous contractions.

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Growing concerns about the situation in Italy, which still carries an unhealthy dose of related political instability, translated into volatility in Italian bonds. There is nothing collateral takers in repos despise more than price volatility and uncertainty. We can see this pressure mounting in the dangerously widening spread between Italian bonds and their German counterparts.

And as it becomes more difficult for the Italian debt to fulfill its role of primary European interbank currency, the ripples of instability and illiquidity spread across the rest of the world, leading to second-order effects like in crude oil since mid-June.

The ECB, aware at least of the politics surrounding Italy’s precarious position, promised more than two months ago to do something about it. Announcing a frankly ridiculous “anti-fragmentation” idea (buying more Italian bonds while selling German bonds, theoretically narrowing the spread between them, this quickly fell out of favor with the market as it was the usual nonsense of the central bank (which the financial media ate up, the real policy objective).

Despite the ECB’s promise, or because it is not a useful solution, Italian spreads are exploding again.

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Epoch Times Photo

Epoch Times Photo

We can see the consequences in settings such as the failure of the US dollar repo using US Treasury collateral. These failures are an indirect measure of warranty deficiencies, or worse, increase, sometimes precipitously, indicating significant warranty issues across the overall monetary system.

So, as the Italian government spreads, this instability forces the system to rush to other, more usable forms of collateral, creating an imbalance in the demand for alternatives, such as US Treasury bonds, to the point that it leads to more and more of these repo failures. .

As the collateral squeeze spreads, it also leads to the most visible harbingers of a dangerous tightening of the global money supply – a rising exchange value of the US dollar (also erroneously assumed to be the result everything the Fed does). With the dollar hitting multi-decade highs against many major currencies, this is actually a systemic monetary warning!

In this regard, OPEC+ and the Fed, the President or any politician, all pretend to have a clue.

The real clue, however, is the rise of the dollar, as guarantees and their fingerprints are everywhere in the current state of the world. And this is our biggest problem.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.

Jeffrey Snider


Jeff Snider is chief strategist for Atlas Financial and co-host of the popular Eurodollar University podcast. Jeff is one of the foremost experts on the global monetary system, in particular the Eurodollar reserve currency system and its intricacies and grossly misunderstood inner workings, particularly the repo/securities lending markets.