THE MONETARY SYSTEM IS COLLAPSING
(The following testimony was submitted on April 13, 1994 to the
Committee on Banking, Finance and Urban Affairs, of the U.S.
House of Representatives. It was written by Christopher White,
contributing editor of Executive Intelligence Review [EIR]
magazine, and Richard Freeman, of EIR's economics desk.)
[From the May 30, 1994, *The New Federalist*.]
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It is now just over one year ago since Lyndon LaRouche, the
editor of our magazine, put forward a March 9, 1993 proposal to
levy a 0.1 percent tax on the sale of all the various mutations
of financial transactions known as "derivatives."
The intent of this proposal was to permit constitutionally
mandated institutional authorities to regain control over
"runaway" deregulated electronic financial market places. The
proposal will determine what the magnitude of the threat posed to
the generality by derivatives is; and, to create the
circumstances in which the structure of derivatives markets might
be properly investigated. Moreover, the tax constitutes a precise
means to surgically lance and dry out the derivatives bubble, to
eliminate it within weeks.
The derivatives market, in which there are $16 trillion in
derivatives holdings held by commercial banks and financial
institutions in the United States, with an annual turnover
trading volume of $300 trillion, is the greatest bubble in
history. It dwarfs the Mississippi Bubble in France and the South
Sea Island bubble in England. This bubble, like a cancer, has
penetrated and taken over the entirety of our banking and credit
system; there is no major commercial bank, investment bank,
mutual fund, etc. that is not dependent on derivatives for its
existence. These derivatives suck the life's blood out of our
economy. Our farms, our factories, our nation's infrastructure,
our living standards are being sucked dry to pay off interest
payments, dividend yields as well as other earnings on the
Need for action has long been evident. In testimony by these two
authors to this committee on October 28, 1993, entitled, "Tax and
Dry Out the Derivatives Market, Don't Regulate It," we stressed
the necessity of the 0.1 percent tax. On March 28, 1994, the
chairman of this committee, Rep. Henry Gonzalez [D-Texas],
stated, "I think ultimately the only way you could stop, in fact,
overnight [derivatives trading activity, is] if you imposed a
1/10th of 1 percent tax on those transactions. You'd see an
However, what the violent events over the first three months of
this year prove, is that while LaRouche's March 9, 1993 proposal
is still vitally essential, it, by itself, will not be sufficient
to control the emerging situation. Events have far advanced. *The
derivatives transactions which are subject to taxation are in the
process themselves of collapsing. What is needed now is an answer
to the question: Is there life after the derivatives bubble has
been and gone?*
That which was feared, is in progress. That which the proponents
of derivatives insisted could not come to pass, because of their
sophisticated methods of "risk assessment" has come to pass. The
supposed liquidity of the market, allegedly proved by computer
simulations, dried up overnight. The mere catalogue of wreckage
shows losses of the size that even a few years ago would have
been unthinkable: from the $600 million lost by speculator George
Soros's Quantum Fund on one day, Feb. 14, 1994; to the $1 billion
loss of Steinhardt Management's hedge fund; to the early April
bankruptcy liquidation of the entire market holdings of the $600
million in assets, exotic mortgage securities derivatives of the
David J. Askin's Hedge Funds. This same process of mega-losses is
occurring around the world.
To those who congratulate themselves that they "got through" this
period, we offer this timely warning: Those whom the gods would
destroy, they first make mad. *This is a systemic crisis; we are
now in the midst of an ongoing, snowballing systemic collapse, of
which the events of the first quarter of 1994 are merely a tiny
It is time that Congress, through its appropriate committees,
begins to discuss the question of how our national monetary and
financial affairs might be reorganized such that national life
can continue, after the collapse of the biggest financial bubble
in human history has run its course.
For which reason we append to this statement the vitally
necessary draft legislation intended to reorganize the Federal
Reserve System, through the re-establishment of a National Bank,
the Third such National Bank in the history of the Republic. This
is the first order of business.
Such a proposal is consistent with Article 1, Section 8 of the
Constitution, in which Congress is allotted the power to raise
taxes and create money and credit.
With an ongoing financial collapse, the time has come to
reappropriate those powers which from the beginning were
allocated, for cause, to the constitutionally created branches of
government, that the General Welfare provisions of the
Constitution might once more inform the laws of the land in
substance as well as intent.
What is now under way can only be efficiently addressed by act of
government. There is no private agency which can provide the
volume of credit required to ensure the continued functioning of
national life. There will shortly be no private agency with
credit anywhere in any case. Federal government must again become
the sovereign source of credit, in the form of Treasury note
issues, providing banking agencies with the means of issue to
finance the economic activity of the country, thereby eliminating
the subversive "discounting" practices of the Federal Reserve,
and the so-called "Keynesian multiplier" methods of money
creation through manipulation of federal debt.
The destruction of inflated financial assets over the first three
months of the year to date exceeds the havoc wrought by the stock
market crash of October 1987. The nominal bill for such "losses"
during the first quarter will, in the not-too-distant future, be
confirmed to start at about $2 trillion. Such "losses," under
detailed investigation, will turn out to be about 14-15 percent
of the notional value of all derivatives contracts traded,
swapped, or whatever else it is they do with them.
If we, as a country, were not so idiotically attuned to the day-
by-day, minute-by-minute jerking around of the "Down-Jones" Index
as our basic indicator of the economic health of the universe as
a whole, this elementary reality would have been grasped already.
The initial losses of the first quarter are only the beginning.
There is the proverbial other shoe left to drop. The "blow off"
of the remainder of the bubble is going to make clear that this
country has been living in the equivalent of "loud cuckoo land"
for about a generation. Over the course of that generation, there
have been no "recoveries," there has been no "rebuilding of
There has been looting and asset stripping. There has been
economic depression. That is shortly to come to the fore in the
kind of rude way which our accumulated national fantasy life, and
its televised mirror image, will find impossible to ignore.
Obviously those who most violently dispute this now will soon
find themselves among the ranks of the most rudely shocked.
The turmoil of the last three months is not a "market
correction," despite all the analysts and investment strategists
who proclaim about their proverbial 10-15 percent decline blowing
the froth off an over-heated "bull-run." Nor is it merely a
matter internal to the market. What is going on is without
precedent in human history.
There is a global financial collapse in progress -- a global
financial collapse which was already in progress before the
beginning of the year. From 1993 onward, from Chile, and the case
of the Codelco raw materials company; to Argentina, and its bond
and stock market; to Venezuela and the case of Banco Latino; to
Spain and the multi-hundreds of millions loss of that country's
fourth-largest bank, Banesto; to the United Kingdom and the Hong
Kong and Shanghai Bank-owned Midland Bank; to France and the case
of the multi-billion dollar loss at Credit Lyonnais; to Germany
and the $1 billion plus loss at Metallgesellschaft; to the
reputed several billion dollar losses at Malaysia's central bank,
and the banks of Indonesia.
What is developing is global in scope. The losses are all related
to derivatives trading. Sound companies and industrial concerns
are being sacrificed to the vagaries of derivatives. Germany's
Metallgesellschaft, the country's 14th largest industrial
concern, will now lay off one-fifth of its work force, and asset-
strip its operations to pay for the loss.
This committee is correct to highlight the activities of the
hedge funds. They engage in the most wildly speculative behavior.
Hedge funds are, for the most part, offshore, unregulated
gambling casinos, relying on mountains of leverage. They are
specifically constituted, by having 99 or fewer U.S. investor
partners, to circumvent the Investment Company Act of 1940, which
would otherwise regulate them. Hedge funds work on anywhere from
5 to 1, up to 50 to 1 leverage. That means for every $1 billion
of the hedge fund's own money which it has under management, it
borrows from $5 to $50 billion. The over-300 hedge fund's have
$75 billion in assets under management, meaning they could
control an astounding amount of publicly traded bonds and stocks
of anywhere from $375 billion to $3.75 trillion in value. By
comparison, the average trading volume on the New York stock
exchange is but $11 billion daily.
But every congressman should ask the obvious question: If for
every $1 billion the hedge fund puts up, the hedge fund is
getting from $5 to $50 billion from someone else, isn't that
other party, lending the $5 to $50 billion, far more important?
The answer is, of course. The committee must note the dominant
role of the commercial banks, especially the Morgan banking
group, and the investment banks, who lend the money to the hedge
funds, and use the hedge funds as their "bird dogs," having the
hedge funds make the speculations that the commercial and
investment banks would be too embarrassed to make on their own.
Not only that, but every congressman should know that the
commercial banks put money from their own accounts into these
hedge funds, and it is claimed, put money from the banks' trust
departments into these hedge funds.
The largest derivatives trading banks are: Chemical, Citicorp,
J.P. Morgan, Bankers Trust, Bank of America, Chase Manhattan,
First Chicago, and Republic National Bank of Edmund Safra. Morgan
Bank, and the Bankers Trust which it set up in the 1903-07
period, and controls to this day, control together 31 percent of
the $12 trillion of derivatives holdings of the major commercial
banks. Morgan dominates derivatives trading. Among the investment
banks, the largest derivatives traders are: Morgan Stanley;
Goldman Sachs; Salomon Brothers; Lehman Brothers and Merrill
Lynch. These are the institutions that control the hedge funds.
These are the institutions whose activities, above all, must be
investigated and controlled.
Moreover, there is an equally huge scandal. It is open knowledge
that the entire financial market structure of the United States
has been artificially rigged for the last three and a half years.
Short-term interest rates were set at 3 percent and long term
rates at 6.5 to 7 percent, the largest spread in post-World War
II history, to benefit and enrich the commercial and investment
banks who made derivatives plays on this spread. The losers on
this operation were the American population, which paid dearly to
"bail out" the banks. [CN Editor -- This sweet deal for bankers
was also covered on the Saturday, June 11, 1994 "News From
Neptune" show. I will try to feature excerpts in an upcoming
Oversight on the markets must begin with how the Federal Reserve
Board of Governors, and the Federal Reserve Bank of New York,
working with the Treasury Department, starting in the Bush
administration, rigged this hideous operation.
Thus, the danger of derivatives trading and its damage is not
limited to headline catching speculative excesses, and failures,
of some outfits like the now notorious, U.S. legal-code-evading
"hedge funds." There may be the financial, or electronic,
equivalent of dead bodies left by the side of the financial
version of the electronic superhighway. But they are the result
of a pile-up, not its cause.
The cited cases all involve the use of financial derivatives.
Our estimate of losses sustained during the first quarter of 1994
is not, however, based on adding up reports of losses sustained
by individual banks, corporations or funds. The whole so-called
asset base on which the derivative bubble depends has been
devalued. The ongoing devaluation of assets has set in motion a
collapse which proceeds as the so-called leverage, or pyramiding,
of the derivatives transactions unwinds. In this it is not only
the most egregious which are affected, but all, for all financial
assets are being devalued.
The ongoing financial collapse is characterized by the
application of "reverse leverage" against those institutions and
banks which had resorted to the use of leverage or pyramiding to
inflate their so-called gains, or nominal so-called assets.
The increase of interest rates, long-term as well as short-term,
has been the trigger for the process by which the bubbled assets
have been deflated, and the effects of reverse leverage,
For example, there are over $3 trillion of U.S. government
securities held by what the Treasury and the Office of Management
and the Budget are accustomed to call the "public." Bond yields
have risen by almost 20 percent since the beginning of the year,
25 percent since October 1993. Since prices and yields move
inversely, it is merely conservative to assume that the face
value of the bonds has shrunk by as much as the yields have
increased -- $600 billion on that account alone. This would be
100 times what George Soros's Quantum Fund reported its losses to
be over the days between Feb. 10 and Feb. 12.
The same approach can be taken to inspect "collateralized
mortgage obligations" in their "principal only" and "interest
only" strip form. Mortgage rates have risen as fast as have the
yields on the Treasury's debt. Municipal bonds, too, and more
exotic such instruments as, for example, the secondary market in
so-called "emerging country" debt.
Now, U.S. Treasury bonds, whose world-wide daily trading volume
was estimated at $300 billion one year ago, increasing by 100
percent and more in the twelve months to February and March in
exchanges in Chicago, London and Paris, are the core of the
"hedging" operations undertaken by derivatives dealers. Borrow,
against bonds, borrowed or held, to finance positions for or
against various currencies, "hedged" back into something else,
and so on.
It was less than one year ago that the International Swap
Dealers' Association began to insist that "notional value" was
not a useful way of looking at derivative exposure. Better, they
insisted then would be "replacement" cost. This because, even a
year ago, the notional sums that had been generated out of
whatever electronic device they employ had grown to mind-boggling
proportions. "Replacement cost" shrank the numbers back to more
The difference between the two was a measure of the leverage, or
pyramiding, applied from original "position," at cost, borrowed
or not, to notional value.
The 20 percent increase in bond yields [CN Editor -- Apparently
this means, in other words, the decreasing of the actual value of
the bonds.] has undone a lot of the accumulated leverage that has
been built into the world monetary system. For example, "hedge
funds" can be leveraged up to 100 times, in which case, a 1
percent movement is sufficient to wipe out the collateral or
"margin" position. "Hedge funds" disposing, according to "Mar-
Hedge" and others, of around $100 billion in total assets, are
typically leveraged 10 to 15 times. A movement against them of
6.6 percent to 10 percent on the notional values at stake, wipes
out all their margin or collateral.
The matter is not the unwinding of leverage against hedge funds
alone, but the whole accumulated mass of some $16 trillion
notional so-called value in the United States -- and $25 trillion
worldwide -- unwinding against everything else.
The bubble has been premised on a perpetuated fraud about the
growth of the earnings of the U.S. economy. There has been no
growth in the earnings of the U.S. economy. There has been no
growth, not in the U.S. economy, not in the world economy, since
the period 1967-70.
The country needs a reorganized, constitutional credit system. It
needs such, so that we can begin to do the things which most
living Americans are too young to remember their country ever
having done. We need to create qualified employment for our
people, through rebuilding our basic economic infrastructure in
transportation, power generation, and water supply, and in our
attenuated capabilities for capital goods production.
Credits issued for such purposes will generate more wealth than
their original cost. We can create 6 million productive and
decent-paying jobs in infrastructure and manufacturing and
agriculture. The world economy must likewise be reorganized
around development programs, which Mr. LaRouche has specified.
This includes the "Productive Triangle" for the development of
the Eurasian land mass, and the "Oasis Plan" for the development
of the Middle East. This latter plan, which includes irrigation,
and cheap abundant nuclear power, would provide the rock-solid
basis for the praiseworthy Israeli-PLO peace process to succeed.
The collapse of the biggest financial bubble in history requires
urgent action; it also provides the opportunity to put the
country back on its feet, and under its own law.
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