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[ Can economic instruments and systems based on growth, and faith in growth, adapt to an era of contraction? Will peak oil be the begining of a smooth transition down the energy curve or will economic instabilities exaggurate the bad news, leading to extreme fluxuations, or a new great depression?

At best, without major financial restructuring, it seems economic cycles will be deepened post-peak, as high oil prices lead to recessions, which in turn drop oil prices, leading to a short growth cycle, leading to higher oil prices, and so on… Each cycle never reaching as high as the last.

At worst, the loss of confidence in the highly leveraged financial markets could lead to quite catastrophic economic collapse. With or without peak oil there seems to be some danger of that.

The recent $6.5 billion collapse of the Amaranth hedge fund has brought back into the light one of the key instabilities in the global economic system. As Henry C.K. Liu argues below, “the housing bubble burst, while a heavy load, is not going to be the straw that will break the camel’s back. The straw will be the hedge funds.”

In 1998, the LTCM hedge fund collapse, while it went largely unnoticed by the general public, came frighteningly close to bringing down the global financial system. The headlines below illuminate the issue of hedge funds and the dangerous credit-derivative markets.
-AF ]

Amaranth Advisors lose billions on gas futures

The Economist
..A young, though by no means junior, energy trader in Calgary made some very big bets on natural-gas prices that went spectacularly wrong. They have cost his employer, a Greenwich-based hedge fund called Amaranth Advisors, $6 billion since August 30th. That is more than half of what not long before was $9 billion it had under management.

Meanwhile, investors in America and abroad—including the sort of pension funds that have recently stocked up on their hedge-fund investments—are smarting. The pension fund at 3M, an American manufacturer, and the San Diego County employees’ retirement fund were among those exposed to Amaranth. Funds of hedge funds run by Goldman Sachs and MAN Group expect to see losses of 2% to 3% as a result of its troubles. Funds run by Credit Suisse and Morgan Stanley were also hit.

Meanwhile, investment banks have been assessing their losses as a result of lending to Amaranth through their prime-brokerage arms. ..
(21 Sept 2006)

The Wizards of Money: House Lever-Edge at the Derivatives Casino

‘Smithy’, Wizards of Money
In this, the 11th edition of Wizards, we are going to take a look at the wild and crazy world of financial derivatives through examining the role and dangers of leverage in our modern society. Our adventure will end with a story called “Because a little Bug with the Asian Flu went Ka-CHOO”. You might have heard a similar story when you were a child, but in this case the star of our story is the Long Term Capital Management Fund or LTCM. LTCM was an unregulated hedge fund, addicted to risk and high on derivatives, that could have easily sent us crashing into the next Great Depression in 1998, but for the intervention of the Federal Reserve.

The quiet rescue of LTCM by our federally insured banks, combined with the fact that LTCM was a private equity fund and hence shielded from public scrutiny, aided in this potential catastrophe being confined to discussion among the financial elite. That we came very close to a global financial collapse went almost unnoticed by the general public. The ability to sweep this embarrassing incident, revealing the true nature of risks emanating from the derivatives casino, under the rug thus prevented the regulatory spotlight from being shone on either the casino or its most secretive dealers – the private, unregulated hedge funds.

The keeping of the derivatives wizards behind the curtain has enabled them to come up with newer, and potentially deadlier, games. The newest game on the block is called the Credit Default Swap. Even the International Monetary Fund (IMF) is getting a bit worried about this one!

But before we step in to discussion of derivatives and leverage, lets discuss the “House Edge”.
A highly recommended audio series for starting from basics and exploring the big ideas of the financial world. Also available as transcripts. This episode introduces the concepts of leverage, hedge funds, derivatives and Credit Default Swaps and background on the Long Term Capital Management saga. Earlier episodes start with the basics of how money is created, and a history of the banking system, money trading, and speculation. Smithy, an actuary by training says:

“Wizards” grew partly out of the observation that activists’ concerns were all too often dismissed by economists and financial professionals on the grounds that, according to them, the activists “didn’t understand” economics or finance. Perhaps of more concern to me was the fact that I often saw activists internalize such criticism by qualifying their concerns with statements like “Well, I am not an economist, but …”. In my opinion no such qualification is needed.

Economics is a SOCIAL SCIENCE! The monetary system is a SOCIAL SYSTEM! Therefore in a democracy everyone is an economist and should be able to participate in financial discussions. Unfortunately, for far too many years finance and economics have masqueraded as “hard sciences”, thinking they are like mathematics and physics – the real hard sciences.

Highly recommended for anyone with an interest, but overwhelmed by the lingo. Episode 15: Homeland Securitizations & Overseas Vacations is also especially relevant, taking us deeper into the ‘twilight zone’ of “off balance sheet” Special Purpose Vehicles, and explains highly significant concept of securitizations.

Hedge funds: The Coming Showdown

Henry C.K. Liu, A-List
A major showdown is shaping up between hedge funds, investment banks and commercial banks. Unlike LTCM, whose trouble was one fund being too big to exit without massive loss, the current Achilles heel is the proliferation of funds all imitating each other, with aggregate sums that defies orderly liquidation.

Instead of one big fat man on a small row boat, no matter which side he moves, the boat overturns, we now have three thousand guys all moving together from side to side on a ferry boat in a storm, each move rocking the boat harder until its capsizes.

The investment bank power houses are looking to make a killing from the demise of the hedge funds on the theory that someone’s loss is someone elses’ gain in any market. The do this by having more capital than any one single hedge fund. The commercial banks are looking to high profits from trading credit derivatives derived from the debts.

The game is a three-legged stool that needs a cooperative symbosis among the three components to stay afloat. When anyone of the three starts to seek gains at the expense of the other two, the game implodes and guickly transforms into a game of survival of the earlier exit, which in financial terms is a systemic rout.

When the hedge fund industry loses $100 billion, that money goes to the parties betting against them, which are the investment banks. The flow of funds is intermediated by commercial bank loans. The hedge fund investors as a group loses $100 billion and the investment bank share holders get $100 billion less investment bankers’ take. No big deal in the macro picture.

The trouble is leverage. Most hedge fund strategies rely on leverage to reap high profit and a loss of over 10% can be fatal, leaving the other two components in the game with uncollectable collectables. And the meltdown begins with margin calls that distorts the flow of funds.

The housing bubble burst, while a heavy load, is not going to be the straw that will break the camel’s back. The straw will be the hedge funds.
(19 Sept 2006)
Henry C.K. Liu writes for The Asia Times and coined the term “dollar hegemony”.

For more on Amaranth see A Hedge Fund’s Loss Rattles Nerves.

Henry had some further interesting comments on Amaranth.

Amaranth’s losses came on the back of recent downturn in US natural gas prices, thanks to a mild summer and quiet hurricane season. In recent years bullish energy price bets have been paying off for some hedge funds, particularly for peak oil proponent T. Boone Pickens who personally made a staggering estimated $1.5 billion in 2005.

Financial Wizardry & Collapse

Jeff Vial, Theory of Power
Bear with me for a second here. This isn’t an easy topic. That’s because no one understands Credit-Default Swaps (CDSs), or other complex credit-derivatives, but it is important that we try to understand the implications of their exponential increase.

Sure, some people claim to understand: hedge fund managers, investment bankers, etc. They understand the derivatives marketplace just like neuroscientists understand consciousness—they know the component parts, they can use them as tools barely under their control, but when it comes to understanding exactly how the greater dynamic emerges from the component parts they are in the dark.

No one really understands the credit-derivative market, but everyone is impacted by it. Credit-derivatives represent the creation of money out of thin air, like some act of financial wizardry.
(29 Sept 2006)
Jeff also has a shot at explaining the credit-derivative market. The point he makes is that credit-deriviates spread risk out very effectively, helping the global economy to weather relatively minor shocks well, however if a more serious crash comes, this interlinking may spell an all out global financial collapse.

Collapse For And By The Elite

Tim Boucher, Pop Occulture
TEXTI’m sure a lot of people are growing tired of the seemingly endless debates we’ve been having here about the so-called “crash” of civilization. But I just feel like there are too many important threads we still haven’t explored. Maybe thanks to some of the groundwork we have laid here, we will be able to navigate our way through waters such as these. I originally read this on Jeff Wells’ blog over a year ago and it has stuck with me ever since. It is a piece about Maurice Strong, a head muckety-muck in global affairs, even though his name is not widely known. Unfortunately, the only source we have on this is essentially a quote of a quote of a quote, but the source site says this comes from “an interview entitled “The Wizard Of the Baca Grande,” which Maurice Strong conducted with WEST magazine of Alberta, Canada May 1990,” And that this is a “story from a novel he says he would like to write.” It goes a little something like this:

Each year the World Economic Forum convenes in Davos, Switzerland. Over a thousand CEOs, prime ministers, finance ministers, and leading academics gather in February to attend meetings and set the economic agendas for the year ahead. What if a small group of these world leaders were to conclude that the principle risk to the earth comes from the actions of the rich countries? And if the world is to survive, those rich countries would have to sign an agreement reducing their impact on the environment. Will they do it? Will the rich countries agree to reduce their impact on the environment? Will they agree to save the earth?

The group’s conclusion is “no.” The rich countries won’t do it. They won’t change. So, in order to save the planet, the group decides: isn’t the only hope for the planet that the industrialized civilizations collapse? Isn’t it our responsibility to bring that about?

This group of world leaders form a secret society to bring about a world collapse. It’s February. They’re all at Davos. These aren’t terrorists – they’re world leaders. They have positioned themselves in the world’s commodity and stock markets. They’ve engineered, using their access to stock exchanges, and computers, and gold supplies, a panic. Then they prevent the markets from closing. They jam the gears. They have mercenaries who hold the rest of the world leaders at Davros as hostage. The markets can’t close. The rich countries…?

(23 Sep 2006)
The journalist adds, “and Strong makes a slight motion with his fingers as if he were flicking a cigarette butt out of the window. I sat there spellbound…. He is, in fact, co-chairman of the Council of the World Economic Forum. He sits at the fulcrum of power. He is in a position to do it.”

While there’s no direct source of those quotes available online, Strong is also quoted several years later as saying “If we don’t change, our species will not survive… Frankly, we may get to the point where the only way of saving the world will be for industrial civilization to collapse.” From the September 1, 1997 edition of National Review magazine, cited at the National Center for Public Policy Research. So they seem likely true to me.

I couldn’t help adding this article here, even though I see it somewhat as a curiosity. I doubt his ‘bring it down on purpose’ thinking has very much influence. What the article illuminates is how one person, close to the gears of financial power, is well aware of both financial and ecological fragilities as well as the relationship of financial growth to ecological destruction.

There’s also a kind of finality to his thinking, an implication that a financial collapse of this order would have long term effects. Strong is an interesting character, Canadian businessman, environmentalist and described as ‘international man of intrigue‘, who identifies as “a socialist in ideology, a capitalist in methodology”, and takes interest in new age religions. He was involved in the Oil-for-Food scandal.