Here’s What the “Experts” Are Missing

It’s the Derivatives, Stupid Were you forwarded this email? [Sign-up to The Daily Reckoning here.]( [Unsubscribe]( [Daily Reckoning] If there’s anything you’ve missed as part of your membership to The Daily Reckoning, make sure you check out our website where you can find archives, updates, and everything else that's included in your subscription. You can access it by [clicking here now](. Here’s What the “Experts” Are Missing - Why you could be a direct victim of sanctions against Russia… - It’s the derivatives, stupid… - Then Jim Rickards shows you why the sanctions against Russia will strengthen the dollar — for now at least… Recommended Link [**Urgent Note From Jim Rickards – Response Is Requested By 03/22**]( [Read more here...]( I’ve just made a [massive change]( to Strategic Intelligence. This is one of the biggest changes to a newsletter in the history of our business… As far as I know, nothing like it has been done before. What’s going on? In short, I’m adding 3 exciting new additions to [this all-new “Pro level”]( of Strategic Intelligence. And as a current subscriber, I don’t want to see you miss out. That’s why — for a very limited time, until the timer below hits 0 — [you’ll be able to upgrade your subscription to this new “Pro level” by clicking here.]( Seriously. [Just click here now to see how to claim your upgrade.]( Once the timer hits 0, however, it’ll be too late… you’ll miss out. I’d hate to see you left behind. [Click Here Now]( Portsmouth, New Hampshire March 22, 2022 [Jim Rickards]Dear Reader, We’ve all followed the cascade of financial and economic sanctions the U.S. and its allies have piled upon Russia in the past few weeks. The assets of the Central Bank of Russia (about $600 billion) have been frozen. Major Russian banks have all been kicked out of the global financial telecommunications system called SWIFT. High-tech and luxury exports to Russia have been banned. Meanwhile, Western banks are not allowed to trade Russian securities. The assets of Russian oligarchs from superyachts to multimillion-dollar townhouses in London are being seized. The list goes on. That all sounds draconian (it is) and possibly even effective (it isn’t), but it begs the question of who bears the losses. If I’m a debtor and you tell me I’m not allowed to pay my debts, I might say, “Thank you, that’s a relief.” In those circumstances, the loser is not the debtor. It’s the creditor who was expecting to be paid and now he finds that’s impossible. All of these Russian banks and borrowers were doing business with investors in the West. When you freeze Russian payments, some Western bondholder is not getting paid, and some investor will end up taking the loss. That investor could even be you. If you look inside your 401(k), you might find an emerging-markets ETF or fund that just happens to hold some Russian debt. Russia has about $100–150 billion of dollar-denominated debt, about half of which is owned by investors outside of Russia. If only part of that defaults, it could be $50 billion or more in direct financial losses to ETFs, mutual funds and even small holders in 401(k)s who may not know what’s inside the products that Wall Street cooks up. Mega-asset manager BlackRock has already lost $17 billion of its investors’ money with bad Russian stock and bond bets. Still, Russia is trying to pay. The head of the Central Bank of Russia is Elvira Nabiullina, who’s one of the smartest central bankers in the world and perhaps the only one who understands how to do her job. She’s trying to pay the debt in rubles even if she is not allowed to pay in dollars. Despite the sanctions, she still controls Russia’s ruble printing press and could create enough money to pay the debt. Still, if this ruble work-around does not work, we’re looking at massive losses for Western investors. But it gets worse. In addition to outright bondholders, there are billions of dollars of derivatives linked to the bonds. This means that actual losses can be many times the losses on the bonds themselves. This is exactly what happened in the subprime mortgage crisis in 2008. There were about $1 trillion in subprime mortgages at the time. A 20% default rate, which is sky-high compared with usual default rates of less than 5%, implied $200 billion in losses. That’s a huge loss but manageable in the financial system. What most analysts missed is that there were $6 trillion of derivatives written on the $1 trillion of subprime mortgages. This meant that actual losses were more on the order of $1.2 trillion than $200 billion once derivatives were taken into account. Something similar is at play with regard to Russian bonds. The exact identities of the holders and the scope of derivatives are almost completely opaque. No one really knows how far the financial distress may spread. The point is that it’s easy to slap on sanctions, but it’s almost impossible to ascertain exactly where the losses will fall and how great they’ll be. This phenomenon is called “contagion.” It works exactly like a virus. One creditor loses money, and that causes him to default to another creditor, and so on. It’s exactly the way a virus spreads from one victim to another. The most famous case of this also involved a Russian default. That was in 1998. That financial crisis started in Thailand in 1997, spread to Indonesia, Malaysia and South Korea before hitting Russia. From there, the next victim was not another country but a hedge fund in Greenwich, Connecticut, called Long Term Capital Management (LTCM). The Fed had to organize a $4 billion bailout to save world markets. I negotiated that bailout on behalf of LTCM. Now it’s happening again. Russia is on the brink of defaulting on its debt. Then contagion takes over. There will be some initial losers, but those losses could cascade out of control as they did in 1998. Banks, brokers and hedge funds are all at risk. The best advice is to expect the unexpected. You can get ahead of that by reducing equity exposure and increasing allocations to cash and gold now. Below, I show you why sanctions against Russia will actually strengthen the dollar in the short run, despite the high inflation we’re seeing. Read on. Regards, Jim Rickards for The Daily Reckoning P.S. Governments around the world and large institutional investors are stocking up on gold. That’s why I recommend that you get your hands on some gold if you haven’t already. When the panic hits, demand will explode and supplies will vanish. But I also recommend that you NOT invest in gold until you see my urgent message. That’s right. Don’t even buy a single ounce of gold [until you see this message.]( That’s because we’re witnessing a rare occurrence in the gold market that we haven’t seen for years, and it has serious implications… [This could be the most important message you see all year if you are serious about securing your financial future.]( What am I talking about? And why is it potentially so important to you? [Click here to see my urgent briefing.]( Recommended Link [Angel Investor: Buy “The Ethereum Killer” Now!]( - Backed by a famous Shark Tank Investor - Processes 20,000 transactions per second (as opposed to Ethereum’s 13) - Gains Projection: 1,000% In 12 Months [Click Here To Learn More]( The Daily Reckoning Presents: “The greater the extent of Russian defaults, the more bullish is the outlook for the dollar”… ****************************** Sanctions Will Strengthen Dollar – for Now By Jim Rickards [Jim Rickards]The world has a densely connected and complex financial system. It’s impossible to completely isolate any part of world trade and finance without affecting other parts. You can impose financial sanctions on a particular country — as the U.S. and allies have done to Russia — but those sanctions will inevitably come back to bite the sanctioning countries in mostly unexpected ways. That’s where the linkage between major markets and the Russia-Ukraine war comes into play. Ready for some 4D chess? Let’s begin with the question of whether Russian debt will go into default. It’s not particularly useful to discuss “Russian debt.” You have to make a series of distinctions first: 1. Is the debt owed to Russians (internal) or to foreign creditors (external)? 2. Is the debt denominated in rubles, or is it denominated in dollars or euros? 3. Is the debt corporate or is it issued by the Russian government? 4. Is the holder of the debt in a sanctioning country or not? (Sanctioning country is the English translation of the Russian term for those countries that are imposing sanctions on Russia including the U.S., the U.K., Japan, EU members and others). Those four factors with two sides each give you an eight-dimensional matrix. You could be analyzing Russian corporate debt denominated in U.S. dollars issued to a holder in a non-sanctioning country. Or you could be looking at Russian government debt denominated in rubles and held by Russian banks and citizens. Some of this debt would default, some not. The answer depends on which combination of these factors applies. For example, there’s no reason for a Russian issuer to default on ruble debt owed to persons in Russia. The central bank can print the rubles or commercial banks can lend them to the borrower so the internal creditor can easily be paid. At the other extreme, dollar-denominated corporate debt owed to parties in sanctioning countries has a near 100% chance of default. Russia has imposed exchange controls, which prohibit outbound dollar transfers generally. There’s a separate Russian government ban on any payments to parties in sanctioning countries. Even if the issuer wanted to pay the debt, those capital controls and government bans make the payment impossible. Still, U.S. dollar-denominated government debt might get paid if the holder is not in a sanctioning country. The challenge here would be to find a payment channel that is not blocked by the U.S./EU sanctions. You would have to work around SWIFT and avoid any reliance on U.S. banks. But it might be possible to make a payment if you worked through Chinese or Indian banks. For example, if you owed U.S. dollars to a lender in China, you might send the lender an amount in yuan (CNY) equivalent to the dollar amount owed. This payment could be routed through the Russia/China payment system (not SWIFT). After the transfer, the recipient could sell the yuan for dollars in a separate transaction that would not necessarily be detected by the U.S. There are many such work-around techniques available. Based on the distinctions outlined above, an analyst could set up a scale of likely default factors as follows: External debt is more likely to default than internal debt. Dollar debt is more likely to default than ruble debt. Corporate debt is more likely to default than government debt. Debt held in sanctioning countries is more likely to default than debt held in non- sanctioning countries. Recommended Link [It's Your Lucky Day!]( [Read more here...]( Crypto expert, James Altucher, has found a little known website that allows you to collect up to $167 FREE crypto! He’s put together a short 2 minute video clip walking you through the easy process on how to get yours. [Click Here To See How To Claim Your Free Crypto]( Using those factors as a guide, you can infer that external dollar-denominated corporate debt held by a party in a sanctioning country has a near 100% chance of default because it’s “0 for 4” on our checklist. It has no favorable factors going for it. Likewise, internal ruble-denominated government debt held by Russian citizens is highly likely to be paid. It’s “4 for 4” on our checklist. It possesses every favorable factor needed for repayment. Therefore, payment depends on where the holder is, what the currency is, who the issuer is and what sanctions are in effect. In summary, some of the debt will definitely default, some not, based on these factors. How does this analysis relate to the dollar? If Russia defaults, the dollar will get stronger. The greater the extent of Russian defaults, the more bullish is the outlook for the dollar. Since other major currencies trade inversely to the dollar, a Russian default that strengthens the dollar will weaken the euro, sterling and yen. The reason is that holders of defaulted Russian debt will have losses that have to be covered either through more borrowing, reduced leverage or some other financial arrangement. Every trade has two sides. A default by a borrower means a loss (and an uncovered position) for the lender. That lender must then cover its position in the marketplace using credit or derivatives backed by collateral. This dynamic plays out behind the curtain in what is called the eurodollar system. Still, the result is more demand for dollar-denominated collateral (mostly Treasury bills), which makes the dollar stronger despite the fact that the U.S. has fiscal problems of its own. This is a good illustration of a new financial maxim: What happens in Russia doesn’t stay in Russia. But a strong dollar will be a shorter-term effect of the sanctions. Long term, it’ll be a different story. Adversaries of the U.S. such as Russia, China, Libya and Iraq have held large portions of their reserves in U.S. dollars. Libya and Iraq were both invaded by the U.S. and their leaders were killed. Russia is now under severe sanctions. China has suffered steep tariffs on its exports. All of these actions have been imposed because of U.S. control of the dollar and the global dollar payments system. How long before the targets step out of the way and try to leave the dollar system? The ultimate cost may be a steep decline in confidence in the role of the U.S. dollar as the leading reserve currency. That reserve currency status is more valuable to the U.S. economy and U.S. citizens than many realize. It means we can print our way to prosperity by using money we create to pay for imported goods and services and by forcing trading partners, including adversaries, to buy our debt because there’s not much else to do with the dollars we send them. In short, our trade deficit, our fiscal deficit and our lifestyle based on imported goods and oil are all based on the unique role of the dollar as the global reserve currency. The dollar’s demise won’t happen immediately. But in markets and economics, everything happens at the margin. A move away from the dollar can begin in small ways but gain momentum and turn into a collapse. If our enemies are diversifying away from the dollar, shouldn’t investors consider some diversification also? Some allocation to gold right now is a smart move to preserve wealth. If events spin out of control, you may not be able to get gold in the future at any price. Regards, Jim Rickards for The Daily Reckoning P.S. Governments around the world and large institutional investors are stocking up on gold. That’s why I recommend that you get your hands on some gold if you haven’t already. When the panic hits, demand will explode and supplies will vanish. But I also recommend that you NOT invest in gold until you see my urgent message. That’s right. Don’t even buy a single ounce of gold [until you see this message.]( That’s because we’re witnessing a rare occurrence in the gold market that we haven’t seen for years, and it has serious implications… [This could be the most important message you see all year if you are serious about securing your financial future.]( What am I talking about? And why is it potentially so important to you? [Click here to see my urgent briefing.]( --------------------------------------------------------------- Thank you for reading The Daily Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [James Rickards][James G. Rickards]( is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. 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