Financial System is Broken

This is a missive from my mentor Jim Sinclair. I've been following him for many years, and although his commentary has always been off the mainstream, his authority on the subject of finance is quite high in my opinion. The OTC derivatives that he references comprise the bulk of derivatives that the BIS estimates:

"...positions in the OTC market have increased at a rapid pace since the last triennial survey was undertaken in 2004. Notional amounts outstanding of such instruments totalled $516 trillion at the end of June 2007, 135% higher than the level recorded in the 2004 survey. This corresponds to an annualised compound rate of growth of 33%, which is higher than the approximately 25% average annual rate of increase since the current format of the survey was established in 1998."

(https://www.bis.org/press/p071210.htm)


What follows is no different than what Warren Buffett was proclaiming way back in 2003, that "derivatives are financial weapons of mass destruction."

(https://news.bbc.co.uk/2/hi/business/2817995.stm)



https://www.jsmineset.com/ARhome.asp?VAf ... _ARID=5795

The System Is Broken

Author: Jim Sinclair




Dear Comrades in Golden Arms (CIGAs),

There is no question about this fact regardless of the camouflage spin. The system has been derailed by the popular and profitable OTC derivatives that are now melting down, taking institutions and people along with it.

Let me explain to you why there is so much fear and distrust between financial institutions, then you will see why the one time hand out of money and interest rates dropping to zero have no hope of doing much more than giving one month of some improved statistics and a decade of hyper-inflation.

Lets assume you have entered into an OTC derivative whereby you own (long) the Dow Jones index at 10,000. You are still in the position. Today’s action is your last straw. You decide to take your $1 billion profit.

There is no OTC derivative clearinghouse. You do not get paid every day as a winner, nor do you pay out every night when losing. No one in an OTC derivative has a margin maintenance requirements. You just hold a special performance contract upon which the financial integrity depends on the loser in the arrangement.

Lets assume you have an OTC derivative that results in owning the profit between the Dow index at 10,000 and tonight's closing of that index. Tomorrow you inform the party obligated to deliver you the Dow index at 10,000 that you wish to close the obligation. You would anticipate the other side would simply buy you out of the obligation, having hedged their obligation somewhere else.

The problem arises when the party to the arrangement required to perform simply cannot because of outrageous markdowns and the flight of capital. They have quite simply lost the ability to make good on these many obligations.

So there you are with a one billion dollar profit, marked to model, taken into your earnings statement that does no exists.

As a result both you and your counter-party have problems financially with the need to restate your financials.

I have simplified this so that it is understandable.

As a result of this problem with derivatives triggered by the meltdown of real-estate structured products, no financial institutions trust any other or their paper.

The OTC derivative merchants have turned out to be the merchants of financial death, hidden carefully from the eyes of the public.

Now everyone holding a derivative contract either with a profit or loss fears for its consequences. The loser fears the bankruptcy judge. The winner fears his winnings are phantom gains never to be realized. Every financial entity fears every other financial entity to the tune now of a notional value of over $500 trillion.

I recently did an article that demonstrated when a derivative fails, notional value becomes total value. That means the potential problem is over $500 trillion.

No reduction of interest rates, even to zero, can make those that distrust each other believers again.

No one-time gift of money to the hypnotic public will make those that distrust each other believers again.

The CDO market no longer exists. The commercial paper marker is in shambles.

The credit markets are trembling over the needful reduction in the rating of the entities that have guaranteed trillions of dollars of debt in many forms. These entities granted OTC derivatives named default derivatives that are soon to be publicly worthless.

Today it was announced rating companies are considering their methods of rating to distinguish firms that granted derivative products. That might fool the public, but not the skeptical international banking firms. Therefore this game will not make those that distrust each other believers again.

The problem has no practical solution. The methods to make the hypnotic public think the problem is now solved or will be soon will solve nothing and will, without regard for the level of business activity, bring hyper-inflation.

I have told you for months that “This is it” and it certainly is.

Gold will go to $1650 and the US dollar to .5200.