Dear Friends,
This post by my friend DK Matai reveals the full extent of this economic crisis. The language may be too technical for some ,and the numbers hard to fathom, but it suggests that the current bailout strategy may be of little more help than a band-aid on a corpse. Apparently the derivatives markets were a means to perpetrate theft and deception on the world's wealth on an unprecedented scale. It is unlikely that we can expect a quick-fix solution to this catastrophe anytime soon.


The Quadrillion Playing Submerged Elephant in the Room

by DK Matai

It is fashionable at present to condemn bank bailouts and to ruminate on hidden
losses: billion dollar losses here and billion dollars there! When bloggers and
so called 'expert' commentators are being bold -- from Huffington to
Taleb and from Ferguson to Roubini -- they talk about a few trillion dollars of
bank losses and reference each other. With respect, they are all missing the
Quadrillion Playing Submerged Elephant in the Room! This elephant has spawned
Eight Bubbles that are collapsing simultaneously as another Giant Bubble --
Government Debt -- is inflated to take away the full buffeting of their simultaneous burst!

It is worth noting that the trans-national play of derivatives has grown from
USD 1.144 Quadrillion to USD 1.405 Quadrillion, ie, +22% worldwide. This is a
staggering increase and most of it is seen in the Over-The-Counter (OTC)
category as opposed to exchange traded derivatives. As a result, the global size
of the derivatives bubble which was calculated last year at USD 190k per
person-on-planet, has risen to USD 206k per person-on-planet. The ever rising
commitment of governments for the repeated bailouts of financial institutions is
partially linked to various flavours of derivatives exposure settlements and
"black hole" losses emanating from off-balance-sheet vehicles.

The traditional argument has been to discount derivatives altogether: "On
one side of the equation there is a loss, on the other side there is a gain.
Nothing disappears. It is just one big shuffle of wealth and assets."
However, if this is the case, why has the US tax-payer had to bail out AIG
repeatedly in excess of a hundred and fifty billion dollars so that AIG could
settle the Credit Default Swap (CDS) and other derivatives claims of the largest
trans-national financial institutions in the world?

In the ATCA briefing, "The Invisible One Quadrillion Dollar Equation"
published in September 2008 we discussed the main categories of the quadrillion
dollar derivatives market as partially quoted by the Bank for International
Settlements in Basel, Switzerland. Since then the quantum has grown
significantly in certain crucial categories and the latest revised numbers

1. Listed credit derivatives stood at USD 542 trillion, about the same as
before; however

2. Over-The-Counter (OTC) derivatives stood in notional or face value at USD
863 trillion (UP +44%) and include:

a. Interest Rate Derivatives at about USD 458+ trillion (UP +16%);
b. Credit Default Swaps at about USD 57+ trillion (DOWN -1%);
c. Foreign Exchange Derivatives at about USD 62+ trillion (UP +10%);
d. Commodity Derivatives at about USD 13+ trillion (UP +44%);
e. Equity Linked Derivatives at about USD 10+ trillion
(UP +17%); and
f. Unallocated Derivatives at about USD 81+ trillion (UP +14%).

The myth of the single bubble behind The Great Unwind -- manifest as the global
credit crunch -- has essentially been dumped in the last few months and subprime
mortgage default, a USD 1.5 trillion challenge within the USD 5 trillion
mortgage based assets envelope, is seen as a component of a much larger
overwhelming global crisis with unprecedented scale, speed, severity and
synchronicity. The global crisis has wiped a staggering USD 50 trillion off the
value of financial assets - currency, equity and bond markets worldwide - last
year, according to the Asian Development Bank.

The truth that there are as many as "Eight Bubbles" [ATCA] at play
and in the process of bursting together is understood to a greater extent now
than in the past. We have gone from being able to "rescue the world"
with less than USD 1 trillion in October 2008 to USD 11.6 trillion commitments
in the US alone along with a further announcement of USD 1.2 trillion of
quantitative easing by the US Fed in March 2009. There is a realisation
worldwide including the G7 + BRIC + MISSAT that this is a USD 20 trillion
problem and growing. As time goes by, the full extent of the collateral damage
from the Quadrillion Play and 8 Bubbles burst is being revealed.

The bursting process is taking the form of deleverage on an unprecedented
scale. Even 1929 pales in comparison because the industrial production collapse
witnessed over five successive years in the 1930s in the US is now taking place
in five to six months, most notably in Japan. At a follow-up on recent ATCA
roundtable we posed the following questions for Socratic dialogue:

I. If the Dow Jones Industrial Average has fallen from above 14,000 to below
7,500 as a result of some of the 8 bubbles collapsing, ie a 6,500 points drop or
46% decline, where will the equities market reach by 2010 as other larger
bubbles burst?

II. If the world government bond market is around USD 35 trillion, how can
governments rescue the eight bubbles bursting step by step with an ever larger
quantum and momentum?

III. How can Quantitative Easing (QE) defy the laws of financial gravity
without devaluing paper currencies significantly?

IV. What ought to be the focus at the G20 Summit in April to bring about stability in regard to the rising derivatives exposures and use of off-balance-sheet vehicles?

We discussed "Eight Bubbles" in play worldwide in November 2008 and
their approximate scale, based on latest information in 2009, is as follows:

1. Subprime Mortgage linked Loans & Assets (USD 1.5 trillion) within
Mortgage backed Assets (USD 5 trillion);
2. China, India, Eastern Europe and other Emerging Market Loans (USD 5 trillion);
3. Commodities (Commodity Derivatives at about USD 13 trillion);
4. Corporate bonds (USD 18 trillion);
5. Commercial (USD 22 trillion) and Residential property (USD 45 trillion);
6. Credit Cards Outstanding Debt (USD 4.5 trillion);
7. Currencies (Foreign Exchange Derivatives at about USD 62 trillion); and
8. Credit Default Swaps (USD 57 trillion) as a subset of all Derivatives (USD 1,405 Trillion).

The relative scale of the world's financial engine is as follows:

1. The entire GDP of the US is about USD 14 trillion and falling.
2. The entire US money supply is also about USD 14 trillion with rising Quantitative Easing in trillions.
3. The GDP of the entire world is USD 45 trillion and falling. USD 1,405 trillion is 31 times world GDP.
4. The real estate of the entire world is valued at about USD 65 trillion.
5. The world stock and bond markets are valued at about USD 70 trillion.
6. The trans-national universal model financial institutions own about USD 150 trillion in derivatives.
7. The population of the whole planet is 6.8 billion people. So the derivatives market represents about USD 206,000 per person on the planet.

Assuming a 10% conservative default or decline in asset value, this could be a
USD 100 trillion challenge on the base of the Quadrillion Playing Submerged
Elephant in the Room! USD 50 trillion of asset decline is already manifest. What
are the likely outcomes? "Four Scenarios" have already been suggested
by ATCA. We are keen to receive your answers and solutions. Please note that the
numbers quoted are a rough guide.

Published at is

More must read financial analysis from DK Matai, Chairman of the ACTA Open.

The Invisible One Quadrillion Dollar Equation — Asymmetric Leverage and Systemic RiskAccording to various distinguished sources including the Bank for International Settlements (BIS) in Basel, Switzerland — the central bankers’ bank — the amount of outstanding derivatives worldwide as of December 2007 crossed USD 1.144 Quadrillion, ie, USD 1,144 Trillion. The main categories of the USD 1.144 Quadrillion derivatives market were the following:

1. Listed credit derivatives stood at USD 548 trillion;

2. The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion and included:

a. Interest Rate Derivatives at about USD 393+ trillion;

b. Credit Default Swaps at about USD 58+ trillion;

c. Foreign Exchange Derivatives at about USD 56+ trillion;

d. Commodity Derivatives at about USD 9 trillion;

e. Equity Linked Derivatives at about USD 8.5 trillion; and

f. Unallocated Derivatives at about USD 71+ trillion.

Quadrillion? That is a number only super computing engineers and astronomers used to use, not economists and bankers! For example, the North star is “just” a couple of quadrillion miles away, ie, a few thousand trillion miles. The new “Roadrunner” supercomputer built by IBM for the US Department of Energy’s Los Alamos National Laboratory has achieved a peak performance of 1.026 Peta Flop per second — becoming the first supercomputer ever to reach this milestone. One Quadrillion Floating Point Operations (Flops) per second is 1 Peta Flop/s, ie, 1,000 Trillion Flops per second. It is estimated that all the data found on all the websites and stored on computers across the world totals more than One Exa byte of memory, ie, 1,000 Quadrillion bytes of data.

Whilst outstanding derivatives are notional amounts until they are crystallised, actual exposure is measured by the net credit equivalent. This is normally a lower figure unless many variables plot a locus in the wrong direction simultaneously. This could be because of catastrophic unpredictable events, ie, “Black Swans”, such as cascades of bankruptcies and nationalisations, when the net exposure can balloon and become considerably larger or indeed because some extremely dislocating geo-political or geo-physical events take place simultaneously. Also, the notional value becomes real value when either counterparty to the OTC derivative goes bankrupt. This means that no large OTC derivative house can be allowed to go broke without falling into the arms of another. Whatever funds within reason are required to rescue failing international investment banks, deposit banks and financial entities ought to be provided on a case by case basis. This is the asymmetric nature of derivatives and here lies the potential for systemic risk to the global economic system and financial markets if nothing is done.

Let us think about the invisible USD 1.144 quadrillion equation with black swan variables — ie, 1,144 trillion dollars in terms of outstanding derivatives, global Gross Domestic Product (GDP), real estate, world stock and bond markets coupled with unknown unknowns or “Black Swans”. What would be the relative positioning of USD 1.144 quadrillion for outstanding derivatives, ie, what is their scale:

1. The entire GDP of the US is about USD 14 trillion.

2. The entire US money supply is also about USD 15 trillion.

3. The GDP of the entire world is USD 50 trillion. USD 1,144 trillion is 22 times the GDP of the whole world.

4. The real estate of the entire world is valued at about USD 75 trillion.

5. The world stock and bond markets are valued at about USD 100 trillion.

6. The big banks alone own about USD 140 trillion in derivatives.

7. Bear Stearns had USD 13+ trillion in derivatives and went bankrupt in March. Freddie Mac, Fannie Mae, Lehman Brothers and AIG have all ‘collapsed’ because of complex securities and derivatives exposures in September.

8. The population of the whole planet is about 6 billion people. So the derivatives market alone represents about USD 190,000 per person on the planet.

The Impact of Derivatives

1. Derivatives are securities whose value depends on the underlying value of other basic securities and associated risks. Derivatives have exploded in use over the past two decades. We cannot even properly define many classes of derivatives because they are highly complex instruments and come in many shapes, sizes, colours and flavours and display different characteristics under different market conditions.

2. Derivatives are unregulated, not traded on any public exchange, without universal standards, dealt with by private agreement, not transparent, have no open bid/ask market, are unguaranteed, have no central clearing house, and are just not really tangible.

3. Derivatives include such well known instruments as futures and options which are actively traded on numerous exchanges as well as numerous over-the-counter instruments such as interest rate swaps, forward contracts in foreign exchange and interest rates, and various commodity and equity instruments.

4. Everyone from the large financial institutions, governments, corporations, mutual and pension funds, to hedge funds, and large and small speculators, uses derivatives. However, they have never existed in history with the overarching, exorbitant scale that they now do.

5. Derivatives are unravelling at a fast rate with the start of the “Great Unwind” of the global credit markets which began in July 2007 and particularly after the collapse of Freddie Mac and Fannie Mae in September this year.

6. When derivatives unravel significantly the entire world economy would be at peril, given the relatively smaller scale of the world economy by comparison.

7. The derivatives market collapse could make the housing and stock market collapses look incidental.

Three Historical Examples

1. The so-called rogue trader Nick Leeson who made a huge derivatives bet on the direction of the Japanese Nikkei index brought on the collapse of Barings Bank in 1995.

2. The collapse of Long Term Capital Management (LTCM), a hedge fund that had a former derivatives and bond dealer from Salomon Brothers and two Nobel Prize winners in Economics as principals, collapsed because of huge leveraged bets in currencies and bonds in 1998.

3. Finally, a lot of the problems of Enron in 2000 were brought on by leveraged derivatives and using derivatives to hide problems on the balance sheet.

The Pitfall

The single conceptual pitfall at the basis of the disorderly growth of the global derivatives market is the postulate of hedging and netting, which lies at the basis of each model and of the whole regulatory environment hyper structure. Perfect hedges and perfect netting require functioning markets. When one or more markets become dysfunctional, the whole deck of cards could collapse swiftly. To hope, as US Treasury Secretary Mr Henry Paulson does, that an accounting ruse such as transferring liabilities, however priced, from a private to a public agent will restore the functionality of markets implies a drastic jump in logic. Markets function only when:

1. There is a price level at which demand meets supply; and more importantly when

2. Both sides believe in each other’s capacity to deliver.

Satisfying criterion 1. without satisfying criterion 2. which is essentially about trust, gets one nowhere in the long term, although in the short term, the markets may demonstrate momentary relief and euphoria.


In the context of the USD 700 billion rescue plan — still being finalised in Washington, DC — the following is worth considering step by step. Decision makers are rightly concerned about alleviating immediate pressure points in the global financial system, such as, the mortgage crisis, decline in consumer spending and the looming loss of confidence in financial institutions. However, whilst these problems are grave, they are acting as a catalyst to another more massive challenge which may have to be tackled across many nation states simultaneously. As money flows slow down sharply, confidence levels would decline across the globe, and trust would be broken asymmetrically, ie, the time taken to repair it would be much longer. Unless there is government action in concert, this could ignite a chain-reaction which would swiftly purge trillions and trillions of dollars in over-leveraged risky bets. Within the context of over-leverage, the biggest problem of all is to do with “Derivatives”, of which CDSs are a minor subset. Warren Buffett has said the derivatives neutron bomb has the potential to destroy the entire world economy, and is a “disaster waiting to happen.” He has also referred to derivatives as Weapons of Mass Destruction (WMD). Counting one dollar per second, it would take 32 million years to count to one Quadrillion. The numbers we are dealing with are absolutely astronomical and from the realms of super computing we have stepped into global economics. There is a sense of no sustainability and lack of longevity in the “Invisible One Quadrillion Dollar Equation” of the derivatives market especially with attendant Black Swan variables causing multiple implosions amongst financial institutions and counterparties! The only way out, albeit painful, is via discretionary case-by-case government intervention on an unprecedented scale. Securing the savings and assets of ordinary citizens ought to be the number one concern in directing such policy.


To reflect further on this, please respond within Facebook’s ATCA Open discussion board.

We welcome your thoughts, observations and views. Thank you.

Best wishes

DK Matai

Chairman, ATCA Open

– ATCA, The Philanthropia, mi2g, HQR –

This is an “ATCA Open and Philanthropia Socratic Dialogue.”

The “ATCA Open” network on Facebook is for professionals interested in ATCA’s original global aims, working with ATCA step-by-step across the world, or developing tools supporting ATCA’s objectives to build a better world.

The original ATCA — Asymmetric Threats Contingency Alliance — is a philanthropic expert initiative founded in 2001 to resolve complex global challenges through collective Socratic dialogue and joint executive action to build a wisdom based global economy. Adhering to the doctrine of non-violence, ATCA addresses asymmetric threats and social opportunities arising from climate chaos and the environment; radical poverty and microfinance; geo-politics and energy; organised crime & extremism; advanced technologies — bio, info, nano, robo & AI; demographic skews and resource shortages; pandemics; financial systems and systemic risk; as well as transhumanism and ethics. Present membership of the original ATCA network is by invitation only and has over 5,000 distinguished members from over 120 countries: including 1,000 Parliamentarians; 1,500 Chairmen and CEOs of corporations; 1,000 Heads of NGOs; 750 Directors at Academic Centres of Excellence; 500 Inventors and Original thinkers; as well as 250 Editors-in-Chief of major media.

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Noah, you have written very intelligently on the market/credit crisis and asked good questions, speculating in a reasoned way as to what the effects of the gov purchase of toxic assets, bailout actions and Fed’s interest rate policies will be, what the endgame will be (deflation, inflation, stronger/weaker dollar and so forth), and where the economy and local RE market as a subset is going. I truly appreciate your honesty and efforts at trying to keep people ahead of the curve. Few if any other RE brokers in NY are doing anything like what you do. You do it well.

You and your readers may be interested in the work of DK Matai, who is a business consultant in London, but also has formed a forum for discussing in an open, honest Socratic manner the scope and magnitude of the problems, in not only the US, but in the world’s financial/banking structure. His is a heroic effort I think, worth at least an honest look. For those interested, below is a summary and overview of everything, the essence of the scale of the problem as of Nov 8th -- see The Eight Bubbles at under Latest News, Articles section.

There are at least eight bubbles in play worldwide and their approximate scale is as follows:

1. Subprime Mortgage linked Loans and other Assets (USD 1.5 trillion);
2. China, India, Eastern Europe and other Emerging Market Loans (USD 5 trillion);
3. Commodities (Commodity Derivatives at about USD 9 trillion);
4. Corporate bonds (USD 15 trillion);
5. Commercial (USD 25 trillion) and Residential property (USD 50 trillion);
6. Credit Cards Outstanding Debt (USD 2.5 trillion);
7. Currencies (Foreign Exchange Derivatives at about USD 56 trillion); and
8. Credit Default Swaps (USD 58 trillion) as a subset of all Derivatives (USD 1,144 Trillion).

The 1.144 Quadrillion derivatives market is further broken down (as quoted by the Bank for International Settlements in Basel, Switzerland):

1. Listed credit derivatives stood at USD 548 trillion;
2. The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion and included:
a. Interest Rate Derivatives at about USD 393+ trillion;
b. Credit Default Swaps at about USD 58+ trillion;
c. Foreign Exchange Derivatives at about USD 56+ trillion;
d. Commodity Derivatives at about USD 9 trillion;
e. Equity Linked Derivatives at about USD 8.5 trillion; and
f. Unallocated Derivatives at about USD 71+ trillion.

The relative scale of the world's financial engine is as follows:

1. The entire GDP of the US is about USD 14 trillion.
2. The entire US money supply is also about USD 15 trillion.
3. The GDP of the entire world is USD 50 trillion. USD 1,144 trillion is 22 times the GDP of the whole world.
4. The real estate of the entire world is valued at about USD 75 trillion.
5. The world stock and bond markets are valued at about USD 100 trillion.
6. The big banks alone own about USD 140 trillion in derivatives.
7. The population of the whole planet is about 6 billion people. So the derivatives market alone represents about USD 190,000 per person on the planet.

Matia asks: assuming a 10% conservative default or decline in asset value, this could be a min. USD 100 trillion challenge on the base of a Quadrillion. What are the likely outcomes?

His answer in the form of questions/food for thought: “It would appear that there are four distinct global economic scenarios that may unfold towards the tail end of this year, 2009 and 2010”:

Scenario 1: Debt Deflation

Most product, service and asset prices keep falling and the vicious circle of deleveraging causes many businesses, factories and support sectors to shut down. This in turn causes rising and out of control unemployment and falling living standards quarter-in, quarter-out with a severe and ongoing headache for some governments to provide stimulus in the face of declining revenues. This is a similar scenario to the US in the 1930s post the 1929 Wall Street crash.

Scenario 2: Hyperinflation

Some governments print money to try to stave off a recession / depression and end up stoking large scale inflation in a similar way to the Weimar Republic in Germany around 1923 post the first world war's conclusion in 1919. Hyperinflation is the flip side of currency collapse, which then leads to multiple domestic and trans-national black swans.

Scenario 3: Quadrillion Play

The invisible one Quadrillion dollar derivatives equation underpinning the hundred trillion dollar plus debt pyramid manifest as "Eight Bubbles" (Ref: ATCA briefings) continues to experience trillion dollar black holes in which capital on the balance sheet vaporizes without warning, month-in month-out. Governments via central banks try to hyper inflate and levitate the system by pumping trillions of dollars of liquidity into the system. The net impact is manifest via two opposite north and south directional vectors -- hyperinflation and deflation. The two vectors collide continuously to create several vortices as the markets change direction nearly every day exhibiting high volatility. The consequence of being caught up in the resultant eddy currents of those vortices is that some asset classes levitate and give the impression of rising, albeit temporarily, and other asset classes fall or simply cease to exist as their underlying asset-base vaporizes within the gravitational pull of the nascent financial black holes.

Scenario 4: Muddle Through

Given that fiscal stimulus is one component of GDP over which there is direct policy control, the muddle through is another possible scenario. However, government spending is always far too slow and occurs at some point in the future so we can expect a lunge towards cutting taxes or offering tax holidays, which is the high velocity component. The massive public sector borrowing requirement may have an adverse impact by way of currency devaluation. There is some probability that the governments' massive stimulus packages and central banks' interventions, after a while of uncertainty in the minds of people, act as a partial, deferred offset to the ongoing global financial system deleverage. Then markets may revive, although some of the eight bubbles are only partially deflated. Life goes on in a new muddled way as new and larger bubbles are created. Politicians stop panicking and get re-elected and a new bigger set of bubbles prepare themselves for collapse a few years later, say, 2015 or 2020. This is similar to the scenario post the dotcom and 9/11 crashes in 2000-2001 and the muddle through which occurred until 2007 on the back of extremely low interest rates, credit card, car and housing loans and the other eight bubbles. There is, however, one caveat. Countries without reserve currencies -- of which there are really only two -- and in particular those with large financial sectors given the base of their GDP, can practically prime the pump only in a very limited way and in doing so risk moving from a banking crisis via a currency crisis on to sovereign default. That would mean expectations from fiscal stimulus are far too high, and not all countries would be able to muddle through.


Whilst the fear is that we may be heading for Scenario 1 and the way to avoid it is via a benign form of Scenario 2 coupled with Scenario 4, it may be important to ask, what if, Scenario 2 has already happened and the Weimar Republic's printing of money is manifest in this broadband internet and high performance computing age, via the complex securities and instruments that private financial institutions created and sold between 1995 and 2007. This has been manifest via the invisible Quadrillion dollar derivatives equation and the associated hundred trillion dollar plus debt securitization pyramid. Banks and brokers were, in effect, printing their own proprietary issues of "money" via complex securities and as a result their supply of money grew to exceed by at least one order of magnitude the money printed by central banks. Central banks failed to recognize this phenomenon and continued to focus on monetary growth and money velocity utilizing old metrics rather than acknowledging the wider spectrum of public (central bank / government) and private money taken together. How could the central banks possibly fail to recognize this new phenomenon while securitization and derivatives, the tools of liquidity creation, were a central obsession of the financial industry? In fact, the central banks played along, humming the mantras of privatization and deregulation.

These quadrillion dollar worth private currencies -- paper assets -- have fuelled the globalization process, massive and unprecedented world GDP growth, mergers and acquisitions, and large scale industrial / infrastructure projects, until natural boundary conditions kicked in, ie, the earth ran out of raw materials and natural resources in sufficient quantities. Scenario 1 started as commodity prices -- food, fuel and raw materials -- went into hyper drive to trigger the catastrophic demand collapse we are now witnessing. Now what we may be heading towards is in fact Scenarios 3 or 4, which are post the Weimar Republic's hyperinflation manifest in most assets' pricing and Scenario 1, which is yet to play its full course. In a nutshell, "1923" already happened up until "2007", "1929" happened in 2008, and the 1930s equivalent is now unfolding. Given that the Great Unwind is happening near the speed of light because of the internet, mobile and satellite communications, as well as high performance computing, it is possible to move to Scenarios 3 or 4 and out of Scenario 1, much faster than was practicable before World War II.

In parallel, the central bankers would like us to believe that they have been and are still in charge because they can print fiat currency at will and set monetary policy at near zero rates if they like. This is governance by magic. What if they can no longer exercise sufficient control and have become co-dependent on the parallel printers of money -- manifest as paper assets -- which happen to be the private financial institutions? What if the central bankers and regulatory authorities are encumbered by what the private financial institutions have done during 1995 and 2007, during which time the policing of the global financial system was inadequate and cross-border arbitrage opportunities exploded? This may mean that we are still living within a myth that central bankers can resolve the mess in the real economy and actually they can't because the paper fuelling the real economy was not issued by them and large quantities of it resides off-balance sheet in a non-transparent way. Yet, the central banks have to mop up the ongoing toxic liabilities and black holes, which may or may not be possible ad infinitum given the unprecedented scale of this challenge. The quantum of asset price deflation underway post the collapse of the Weimar Republic type Quadrillion dollar paper asset bubble is so large that all the kings’ horses and all the kings’ men may not be able to put Humpty Dumpty together again. The power of central bankers may have been permanently eroded given that the centre of gravity has now shifted. It lies with the financial markets and their participators who transact the deflating quadrillion dollar plus paper asset equation of which fiat currency is a much smaller quantum.

His final question for readers to ponder: “Which scenarios do you think we are heading towards and in what sequence?” In my opinion it seems ultimately the currency obligations and debt instruments (that now have little or no value) the unregulated system has created are going to lead inevitably to a serious depression/collapse of some sort. I don't think any of us can yet get our minds around the true size and nature of the problem. We may be witnessing the Black Swan effect Nassim Nicholas Taleb wrote about.

Now, we must keep in mind the level of destruction in the shadow banking system as hundreds of billions of dollars worth of write-downs took place so far since the credit crisis began. The fed has been taking on risky assets as collateral for short term repos and for other credit lending facilities, trying to re-liquefy the credit markets. But banks seem to be still unwilling to lend like mad. Can you blame them?

The purpose of this is to understand that as the fed tries to pour water on a forest fire, there will eventually be a price to pay for this medicine! There are no free lunches and it seems to me at least that the fed is printing like crazy in an attempt to stop a deflationary spiral of asset prices. What will endgame bring? When I talk about endgame, I mean the final chapters of this story AFTER the economy is past the worst of the credit crisis, the rising unemployment, the GDP contractions, the manufacturing contractions, etc.. What will the price be that we have to pay in exchange for all this fiscal & monetary stimulus? If its inflation, where will it show up? Its just hard to see inflation re-emerge in housing prices as the credit markets will not revert back to the free-flowing days of 2002-2006! With regulation coming, securitization gone for now, and plenty of damage done, investor appetite for risky mortgage backed securities is likely never to reach the peak seen during the housing boom. And without this system of credit in place, I just don't see a new housing boom.

For now, its a race to debase and the fed's desire is for a weaker dollar; their fight is against deflation and the dollar swelling that comes with debt-deflation.

So, while deflation is king now and asset prices adjust, the question is will endgame bring inflation and if so, in what form? Housing? Stocks? Commodities? Precious Metals? Of these choices, I would have to say precious metals. I just don't see the new-age heavily regulated credit engine and the banks that lend off it, supporting another housing bubble anytime soon. Besides, after this housing deflation cycle, the asset won't be as 'sexy' as it was once perceived and in fact, a house will be viewed as an investment to save up for and live in; rather than a speculative asset that could be flipped for 50% profit in two years!