The fundamental significance of the Chicago Mercantile Exchange’s 10-K filing with the Security and Exchange Commission

The March 3rd filing with the Securities and Exchange Commission (SEC) last year, which can be seen on,

shows that the Chicago Mercantile Exchange (CME) has central banks as clients and gives them volume discounts for the trading of futures. A letter addressed to the Commodity Futures Trading Commission (CFTC) is even more explicit about the breathtaking range of futures contracts in which central banks regularly trade in high volume. This can be seen at:

These disclosures clarify that Western Central Banks are leading the investment banking community on Wall St and the City of London to bet against a rise in the prices of gold, oil, base metals, soft commodities, and anything else that might be deemed an indicator of inherent value, in order to deprive the independent observer, in other words the average thinking citizen, of any reliable benchmark against which to measure the eroding value, not only of the US dollar, but of fiat currencies across the board. At the same time, this in fact denies this very citizen, now as an investor, the opportunity to hedge against the fragility of the financial system by resorting to such freely traded markets as there are for non-financial assets.

These two aspects of post-1980 Western Central Bank policy, the withdrawal of a “stable numeraire” and of a proper market in real assets, were described by economist Peter Warburton in his book “Debt and Delusion: central Bank Follies that Threaten Economic Disaster” (published by Penguin UK in March 1999). Open link:

The question that all this raises is: why intervene in real markets in this strange way?

The new post-Volker institutional environment

Warburton’s book describes all this as part of Western governments scurrying to cover their tracks in their continued addiction to profligacy.

The book begins in the aftermath of Paul Volker’s triumph over the 1970s stagflation malaise. The conundrum facing governments at the time was: how to enable governments to continue to live beyond their means, without suffering inflationary consequences?” The old mechanism of “printing money” for commercial banks to buy government debt had failed. The new trick would involve issuing deficit finance bonds to be sold to private investors through bond markets, such that they would end up on the books of investment funds, rather than commercial banks, 

As public bond issues grew exponentially: $1 trillion in 1970; $23 trillion by 1997 and nearly $43 trillion by 2002, Western savings rates were on the decline.  As government debt has grown, there has been no corresponding domestic savings expansion. Nevertheless inflation has stayed low, if one takes financial assets out of the equation. Nobody cared until recently to ask how this trickery was possible. What was happening?

The institutional character of the markets was changing, and clearly Thatcher’s “Big Bang” (1986) and Clinton’s repeal of Glass-Steagall (1999) was the legislative context within which this plan was unfolding. We see clearly that 80s, 90s, and 00s inflation differed in the nature from that of the 70s, such that price changes following money quantity changes were expressed in the rise of stocks and bond prices, rather than in rises wages and the prices of consumption goods.

Under this new system, newly created money was injected into capital markets, to be immediately spent on the purchase of bonds.  Low yields in government bonds meant that even high quality corporate bonds and low dividend-yielding equities were attractive in competition with bonds.  So there was a knock-on effect as  inflationary price adjustments leaked out of government bonds into other financial assets. However, the question was: how come a multiplier didn’t progress through secondary and tertiary recipients of money to be spend on consumption goods, leading to an inflationary leak out of the financial markets?  The answer was that, in recent years, while vast sums of money have been injected into financial markets. nevertheless the resulting price effects were contained within it, through the use of 4 mechanisms:

(1) Interest Rate “Arbitrage”

In the new institutional framework, interest rates do not rise with increased loan demand to reflect actual scarcity, since the Fed creates whatever amount of money borrowers wish to borrow, to hold interest rates below market-clearing levels. Then, as long as a rate differential between short term and long term bonds remains, an essentially risk-free profit opportunity (known as the “carry trade”) will persist no matter how much “arbitrage” occurs between short and long dated stock. As banks and their clients borrow from the Fed at short-term rates to purchase bonds of longer maturity, profit is assured.

Warburton, in his book, locates the source of financial inflation in the ability of large bond buyers thus to borrow vast quantities of newly created money from the Fed at a fixed price.  Because the interest rate does not rise to meet increasing quantities of lending, this arrangement generates volumes of “synthetic demand” for the government bond markets at longer maturities.  Enough bonds are purchased to maintain their prices above, and their yields below true, market-clearing levels.  Warburton calls this “the illusion of an unlimited savings pool” and notes that this illusion “has grown more and more powerful and is matched by a new confidence among prospective bond issuers.” (Debt and Delusion : 136)

In such an environment, the term “arbitrage” clearly becomes a misnomer as borrowing and lending no longer represent a market-driven price adjustment process, and trading mainly recycles debt from the central bank to government borrowing.

(2) Gearing through derivatives

A second mechanism of financial asset inflation is the use of derivatives to create additional purchasing power.  Derivatives are financial contracts between two parties, where the value of a derivative contract is determined by some mathematical relation to the price of an underlying asset or commodity.  Derivatives on government bond interest rates are a large component of the total market volume of these instruments. For little money, assets can be controlled using this means.

Warburton writes: “Derivatives are used to secure the control of a more expensive asset from a much smaller commitment of capital.  The use of derivatives by hedge funds and the proprietary trading desks of large banks in relation to government bond markets represents itself as a grossly inflated demand for the underlying bonds.  This acts as an artificial support mechanism for both bond and equity markets, keeping yields lower and asset values higher than would otherwise be the case.  This synthetic source of demand is critically dependent on the downward progression of bond yields and on the slope of the yield curve.  While there is a sense in which all demand for financial assets are contingent on their expected performance, this is especially true of geared and unhedged derivatives positions.” (Debt and Delusion : 191)

These leveraged contracts are used to generate an additional “synthetic” source of demand for financial securities. (Debt and Delusion : 121)

So it becomes “…  possible to use unrealized gains in financial assets (including derivative contracts) as collateral for further purchases.  The persistent upward trend in underlying asset prices has amplified these unrealized gains and has enabled and encouraged the progressive doubling-up of ‘long’ positions, particularly in government bond futures.  It is easy to envisage how the cumulative actions of a small minority of market participants over a number of years can mature into a significant underlying demand for bonds.  While financial commentators are apt to attribute a falling US Treasury bond yield to a lowering of inflation expectations or a new credibility that the federal budget will be balanced, the true explanation may lie in progressive gearing. (Debt and Delusion : 120)

The initial injection of new money into the bond market explains why the effects of inflation would show up there first. The continued containment of inflation within the financial sector as money is spent, and then re-spent on financial securities, is created by the leveraging available through derivatives.  The funding of these derivatives is complex, but again it ultimately relies on borrowing at fixed low yields from the central bank.  The process circulates the newly created purchasing power over and over through the financial sector, rather than allowing it to leak out into wages or consumption goods.

(3) The Management of Expectations

Inflationary expectations are self-feeding. Recent history suggests that people attribute more importance to recent price changes in consumption goods, when they form expectations about the future trends in those prices. Similarly, consumers attribute look at price trends in financial assets to form opinions about the future price trends in financial assets.

To the extent that any price increases at all leak out of financial assets into consumption goods, the deliberate distortions in the measurement of the Consumer Price Index (CPI) have been introduced in order to create a false consensus that “there is no inflation.”  A variety of questionable price adjustment stratagems have been instituted in the CPI computation: the exclusion of food and energy, the use of lower “quality-adjusted” prices, seasonal adjustments, and the replacement of home prices with rental rates.  The index incorporates only consumption goods, when most of the price increases occur in financial assets.

It is in this context that we need to understand central bank intervention in the commodity futures markets, both on the level of preventing financial outflows from the government bond sector to other sectors, and on the level of seeking to preempt rises in commodity prices that will feed through to consumer goods and inflationary expectations.

So successful has been the management of expectations that inflation has disappeared from public discussion. But Warburton writes: “The impressive reduction of inflation is a dangerous illusion; it has been obtained largely by substituting one set of serious problems for another.” (Debt and Delusion : 25). The fact is that we live in a highly inflationary environment, which however is one where inflation as a statistic has been “managed” away. This is delusional.

(4) The Corruption of Savings

A peculiar feature of the social psychology of financial asset prices is their self-reinforcing character.   The upward trend in stock and bond prices has served to enhance the respectability of capital markets and their perceived safety as repositories of capital, which in turn has aided their cause of attracting even more of the increasingly meager savings in the private sector. Warburton documents a long-term trend of investment funds essentially chasing price inflation: shifting their cash out of low-yielding bank accounts, CDs, and money funds into bonds of longer maturities, and eventually, equities. (Debt and Delusion : 135)

Some commentators reason that inflation must now be quite low because the credit markets are patrolled by astute traders ever alert to punish central banks for their inflationary indiscretions, ready to dispense rough justice in the form of higher interest rates.  This analysis assumes that inflation is reflected primarily in consumption goods, and that bond yields are free to move on their own to convey meaningful information about changes in the value of the monetary unit. These assumptions are more or less the reverse of reality: the funneling of inflation into bonds as described above provides a floor under bond prices and hence a ceiling on bond yields, and there is no call for astute investing.

Another popular argument is a stock market that is expensive measured by P/E ratios is cheap or at least fairly valued because the low interest rate environment that we enjoy, justify higher multiples.  Stocks appear to be cheap in a dividend discount model that uses the current bond yields to discount future earnings.  However, this view fails to take into account of the overall argument here, namely that the bond bull market is really a symptom of high inflation, not of low inflation.  Inflated prices for bonds might make stocks look relatively cheap in comparison to bonds, but in the absolute sense both are inflated.

Conclusion: poor investment and the advancing destruction of the real economy

Many people think that none of this matters, but when one reflects on the inescapable fact that the economic purpose of capital markets is to provide a nexus between savers and borrowers for the financing of productive investment, and that venture capitalists, traders, and speculators, are essential in forecasting the best uses of available savings and bearing the risk in an uncertain world, we have to admit that such purpose is now entirely disrupted.

A typical example of the new type of dislocation in the real economy is the massive investment in essentially unprofitable shale oil and shale gas exploration and production, with the creation of an energy sector which is deficit-ridden from the start, with never any reasonable hope of getting its head above water. This has had remarkable and dangerous economic and political ramifications as it led to the recent collapse in oil prices. On the economic front, Saudi Arabia’s natural desire to keep its market share in the global oil market and drive all these unnecessary marginal producers to the wall, has led it to reinforce these trends. On the political side Saudi Arabia perceives that the US non-Congressional establishment is gradually turning towards an accommodation with Iran as its principal ally in the Gulf region. As result, the new US self-sufficiency in oil, resulting from new shale production, has to be put in question with the aggressive oil price policy they have decided to pursue.

This is but one example of current economic dislocation. More generally, what more disastrous dislocation can there be than the continuous channelling of resources into the Ponzi vortex of government debt and away from the real economy, where savers are being crushed by the financial repression, and where consumption is being subsidised? Is it surprising that the West is in decline? Is it surprising that China is on the rise if its raw material imports are being subsidised by this Western central banking scheme? We have to remember that the initial leg of China’s drive in the 80s and 90s had also been driven by Western governments through their manufacturing outsourcing strategy, which had been developed in order to keep inflation down. So it isn’t really hard to see why the global trends are the way they are.

So then, is a collapse due? There will definitely be new crashes. But as we saw in the 2008 sub-prime meltdown, and in a number of crashes before in 1987, 1992, 1995, 1998, 2000 etc… all that ever transpires is that Western governments double down on any crisis and simply monetise their way out. We see with the greater role of FACTA and the sanctions bureaucracy, that there is definitely a desperate need on the part of Western Central Banks, headed by the US Fed, to try to control the international financial system completely, in order for this one-way Ponzi scheme to continue to succeed.

The problem lies now in how long the majority of world trade can continue to be denominated in US dollars, under the control of US Federal Reserve, the US Treasury and the Justice Dept. At such time as a significant breach is made that takes world trade values effected in US Dollars to beneath 50% of global trade, cumulative capital flows will get under way which will undermine the whole house of cards. While all this may take some time, the more time it takes the taller the house of cards will be, by the very nature of Ponzi schemes.

By the time the tipping-point becomes inevitable, we will see US foreign policy change dramatically. The US will be forced to approach China, Russia and India to try to bury Bretton Woods, and attempt to rejig the international financial system. Meanwhile, if the US knows this, it is still trying to make as many gains on the ground in its favour as possible, ahead of the inevitable event.