Debtor's Prison

Greetings fellow inmates:

Last week, yet another bizarre story in this never-ending parade of financial and economic freak-shows that we call the GCC circulated all over the world. As you can notice, the news link is to an Asian article since the mainstream US media has conspicuously ignored the story. This is especially noteworthy when you consider the nature of the story.

One week ago, Italy’s financial police seized $134.5bln in US bonds from two Japanese nationals that were trying to smuggle them into Switzerland in a false-bottom suitcase. The bonds included 249 Federal Reserve bonds worth $500mm each plus ten Kennedy bonds and other government securities worth $1bln each. Think about the size of this for one second, the amount is gargantuan. As you might imagine, there are several very interesting points about this story.

For starters, their authenticity is yet to be determined. Initial coverage reported that the bonds were of such a high-quality as to be indistinguishable from the real ones. Italy’s financial police in conjunction with the US secret service are in the process of evaluating the securities. If they are fake, they would undoubtedly mark the largest counterfeiting operation ever. Naturally, this brings many questions to mind. Who would have the capacity to counterfeit such enormous proportions of such high-quality bonds and who were they selling them to? Moreover, it seems very outlandish to think that you could sell $500mm bonds without any verification from the part of the buyer. The sheer size of the issues and the amount of bonds would throw all sorts of red flags at the moment anyone tried to cash them in. This alone seems to make the exercise of counterfeit in such denominations a futile one. If for some reason, there is a counterfeit ring where such securities do circulate, then we have a troubling situation where an unknown amount of bonds circulating the global financial system are fake. This could even spark a distrust of genuine securities and would certainly contribute to the further deterioration of the USD.

Other nuances of the case seem very strange to us. In the first instance, what is the probability that two individuals carrying this amount of bonds (fake or not) in a false-bottom suitcase are actually stopped at a train-station and thoroughly searched? If we assume that the probability is extremely low, then we could hypothesize that someone was tipped off. If so, then why didn’t the authorities simply tail these individuals in order to determine the final destination of the bonds thus catching both parties to the fraud? If on the other hand, you assume that the probability of such a seizure is higher, then it implies that this is happening frequently and only now did the authorities get “lucky” snatching two of the smugglers. Again, this brings up the troubling question of how rampant this counterfeiting actually is.

One feature of these bonds that complicates their authentication is that they are so called bearer bonds. These bonds are not registered and possession of the bond certificate is proof enough of ownership. Once they are issued by whatever entity, their registration is not required, thus cutting the “trail” of most modern-day securities. In this sense, bearer bonds are effectively the same thing as money. Since they can be had in very large amounts, bearer bonds have historically been a darling of illegal operations. Issuance of bearer bonds became illegal in 1982, sans an exception in 1985 due to high deficits. The natural question to ask then is how many bearer bonds are still outstanding. We are not privy to this information, though the following article states that historically, most public bonds were bearer bonds. This would certainly make it plausible that a large amount of such bearer bonds is still out there. If we had concrete data on the outstanding amount of bearer bonds and this showed this seized amount was impossible, this would seem to indicate that they are in fact counterfeits. The sheer amount of this seizure however, does beg one to question who would have such a large concentration of such bonds and why were they trying to dispose of them. This brings us to the case where they are actually genuine, which is when things get really interesting.

If the bonds are real, as the German media seems to believe, only countries would have a cache large enough to hold such an exorbitant amount. To get the appropriate context for the size of the seizure, $135bln equals to 20% of the total amount of US debt Japan legitimately owns. The implications are perhaps even more hair-raising when one considers the situation under this “authentic” scenario. What country would be secretly trying to unload such a massive amount of debt? Japan seems like a natural candidate given the nationality of the suspects and the size of its holdings. Regardless of their exact provenance, it would certainly indicate an almost desperate attempt by some country or group of countries to unload this US debt. Think about it, a country using special agents to secretly unload sovereign debt, a truly absurd scenario. If this were the case, then major powers are playing a huge game of double speak; publicly expressing their support for that debt while secretly unloading debt through covert channels. It is very interesting to note that right around the time that this news story began circulating, Japan’s Finance Minister, Kaoru Yosano, said his country’s trust in US Treasuries is “absolutely unshakable”. Whoa! Those are big words. We’ll see just how unshakable that trust is come the USD event horizon.

There are other implications if the bonds are real. Quaintly, Italy has a law where unreported financial assets in excess of EUR10,000 are subject to a 40% confiscation. This would be a wonderful $40bln windfall for Italy as it struggles with fiscal deficits. Obviously, the original owner of the bonds would take all the loss of that 40%, if not the full 100%. It is unclear what would happen in terms of restitution if their authenticity and provenance are confirmed. Again, even if we assume that the bonds came from Japan, the second largest holder of Treasuries, this seizure would represent 20% of their whole portfolio. Clearly someone has a lot to lose if the bonds are real.

Now imagine the case where they are real, but are labeled counterfeits nonetheless. The original owner of the bonds would take the whole loss but the US would make out fantastically, with $135bln of its debt essentially evaporated. We expect that this will be the case. In spite of the lack of evidence either way thus far, we believe that it is more likely than not that they are real due to their denominations, amongst other reasons. You might ask, why wouldn’t the original owner just step up and vouch for the authenticity rather than take all the loss. A couple of reasons. For starters, the repercussions would be incendiary and this hypothetical owner would have to answer many thorny questions. Also, perhaps a deal was reached behind the scenes where this debt was meant to be “cancelled” in exchange for something else. In the case of Japan, it could be the continued military backing of the US, especially in the face of a belligerent North Korea. Though this might seem like a mighty big price-tag for any deal, it really isn’t when you are dealing with sovereign capital. Moreover, high-level officials could well be perfectly aware that it’s only a matter of time before that debt becomes worthless, thus making the deal a little “easier”.

Note that in our last hypothesis, we are tacitly assuming that this event could have been “staged”. To be perfectly frank, we believe that this is entirely within the realm of possibility. The fact of the matter is that much of the global financial system is but a shell, an enormous house of cards where paper backs more paper and more paper. The plethora of accounting chicanery, deceptive practices and outright fraud that goes on certainly makes this a possibility. As always we ask you to critically and rationally consider the role the media plays in information dissemination. Either way you cut it, whether they are real or not, this event has huge ramifications. It certainly shows us in jaw-dropping fashion how empty and shallow even the most trusted securities are where they can be easily and reliably counterfeited in such large amounts or where covert operations can so quickly dispose of them if they are in fact real. It’s all paper, it’s all it ever was, and we are approaching a time when a lot of this debt will become just paper. Certainly, during the extreme times that lie ahead of us, curious cases such as this will become more and more likely. Take this as a potential canary call. If, as we suspect, the bonds are real and they are claimed as counterfeit, this shameless and blatant violation of law and trust is but another brutal slap to the face by the powers that be to any rational and inquiring mind.

We will follow up on this story and hope against hope that the truth is actually reached and disseminated, unlikely as this may be.

May your capital be safe and your investments prosperous,

MAAA