Friday, February 28, 2014

The Silent Scream Of The Plunging $/Yuan: A Derivatives Bomb Detonated

Anyone who denies that the Fed is engaging in unprecedented intervention in all of the markets - especially the gold and silver markets - is guilty of either ignorance or willfully intentional denial.  But the Chinese can play the intervention game as well.  We are seeing that giant footprint of intervention in the dollar/yuan relationship, as the Chinese yuan has just experienced it biggest weekly plunge ever:

Briefly, this graph (edits in white/red are mine) shows the $/yuan relationship.  It plots the amount of Chinese yuan needed to buy one U.S. dollar. When the ratio declines, it means the yuan is increasing in value vs. the dollar.  As you can see, there has been a steady decline in the $/yuan ratio, which means that Chinese Government has been letting the yuan rise in value.  That is, until about a week ago.

What most market observers tend to overlook is that there are likely $10's of billions worth of OTC derivatives that have been issued by the big Too Big To Fail banks tied to the trading relationship between the $/yuan. In fact, Morgan Stanley estimates the amount to be at least $150 billion:  $/yuan Derivatives Bomb Detonated?.  They also show a table in that link which estimates possible losses to the banks if this is the case to be well in excess of $1 billion.  Morgan Stanley should know, it was one of the biggest beneficiaries of the 2008-2009 Bush/Obama bailout of Wall Street.  MS also has one of the highest net exposures as a percent of bank capital to derivatives accidents.

In my view, that spike up in the $/yuan you see in the chart above has probably triggered a massive derivatives "explosion" because typically, in their keen foresight and wisdom, the bank rocket scientists never account for the risk of a big move like the one above in a such a short period of time.  If they were to price in this possibility, the derivatives contracts upon which they make $10's of millions in selling profits would be too expensive and the banks would miss out on that easy income.   But hey, we haven't seen a move like that in the history of the $/yuan contract so why should the banks ever expect it to happen?  And the Fed and Government has their back if they're wrong.

Of course, this was same Nobel Prize winning wisdom that cause the Long Term Capital collapse and bailout (remember that one?) and that caused - more catastrophically - the 2008 collapse of the U.S. financial system (AIG/Goldman) and the subsequent joint Republican/Democrat 100% approved taxpayer bailout.

Many analysts are wondering why the Chinese Government, which has a tight control over the trading level of the $/yuan, has enabled the above spike up to occur.  If you think about the ramifications of what I just laid out above, it leads to one possibility (hint: think about the big blow that was just delivered to western bank balance sheets if I'm right about a behind the scenes derivatives accident having just occurred).

I see this as another big cruise missile just fired by China in the global currency war.  The first big missile being the massive accumulation of gold by the Chinese (as has been documented ad nauseum).  There's also another benefit to the Chinese.  Think about the massive size of China's dollar reserves.   The dollar has just become significantly more valuable vs. the yuan and so has the value of China's dollar reserves.  This gives China more buying power to buy gold using dollars.

One other point, and this is tied to China's ultimate goal:  to unload its massive hoard of dollar reserves while making as little noise about it as possible.  Last night, a few hours after the yuan dropped precipitously against the dollar, the US dollar index (the yuan is not part of the dollar index) plunged in cliff-dive fashion, losing 36 basis points in about 30 minutes.  While that may not sound significant, in currency trading terms that is considered to be a mini-crash.  Oh, it also dropped below key 80 line of support that has been drawn in the sand by the U.S Government, slicing through that level with ease.

I would suggest, and there's no way of telling without having access to the inside books - the books which contain the numbers for which the banks spend millions to make sure Congress helps the banks keep them hidden - that the Chinese have unloaded another truckload of dollars behind the all the smoke emanating from the holes created by the Chinese Government motivated $/yuan crash and the related derivatives explosions:

The greatest trick the devil ever pulled was convincing the world he didn't exist.


  1. Nice work, keep it up Dave! I had another thought, possibly a complementing one. What if China, the now biggest buyer of physical gold on the planet, did this on purpose to give the impression/re-enforce the gold breakout in yuan? If the gold buying in China was strong with decreasing prices, what will it do to an officially depreciating currency? Re-enforce even more physical buying possibly by the public?? What would/could that do to the gold-market in general???

    1. Thanks. I agree with your analysis there but my piece was already long so I didnt' go into that aspect. Wanted just to focus on the likely derivatives explosion that's occurring because no one in the mainstream media will report on it.

  2. Thanks Dave,

    What are the consequences assuming your analysis is leading to the correct conclusion?

    A Lehman/08 type event but on a worldwide scale? Maybe you can write an article on the endgame. Will it be derivatives (called and not paid) that bring the whole house of cards down as you speculate is starting now? Not a gradual debt overhang like that of Greece that everyone focuses on, but a sudden event like in 08 but global?

    How will the dominoes fall?

    How best to hedge? Hit the bunker w some food and water, etc? Or will it be that bad everywhere?

    1. How best to hedge? Either move as much money as you can out of the financial system - including and especially IRAs - and buy as much gold as you can take and not lose sleep at night. The other hedge is suicide.

    2. The other hedge....not to worry, the gov't is way ahead of you.

      FDA-approved painkiller 'will kill people'

      A new FDA-approved painkiller isn't set to hit pharmacy shelves until next month, but critics are already warning it could kill — with just two pills.

      Zohydro, which the FDA gave the green light in October against the advice of its advisory panel, will serve as a powerful pain pill for those who can't get relief from what's already out there.

      It contains the same basic ingredient (hydrocodone) as Vicodin, but it has 5 to 10 times the power, Forbes notes, and without the added acetaminophen.

      As an expert on the advisory board who voted "no" tells NBC News, that acetaminophen deters savvy addicts from loading up on Vicodin for fear of liver damage.

      "It's a whopping dose of hydrocodone packed in an easy-to-crush capsule. It will kill people as soon as it's released," says one of those experts.

      But one doctor points out that "it all depends on how doctors monitor it. It could be lifesaving. But if used the wrong way, like any medication, it can cause trouble."

      On that front, Forbes reports that experts say someone unaccustomed to opioids could overdose with as little as two pills, and that a single pill could kill a child.

  3. "Either move as much money as you can out of the financial system - including and especially IRAs"

    thank you for the article...lots of food for thought! i'm wondering why you say, "especially IRAs?"

  4. the 2nd biggest psyops this century, already...

    orwelian fellow state subjects, what's your response?

  5. Cause you are going to see your pensions evaporate, thats why

  6. Interesting hypothesis. If the Chinese are pricing Gold Bullion in yuan in Shanghai, they will price it in yuan strong in Gold. The usd is not invited to that party, and the yuan is moving to disengage the usd from riding on its coat tails. The Chinese would happily live with the yuan strong in Gold and the usd weak in Gold.

  7. 2.32 pm: Moscow warns US of dropping dollar as reserve currency

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