Gold Forecaster
- Global Watch
The Crisis
Julian D.W.
Phillips
Gold Forecaster snippet
Mar 14, 2008
As with so many crises in history,
the consequences of certain situations are not foreseen, or if
they had been foreseen were downplayed to either inaction, or
insufficient action. So it has been with the "sub-prime"
crisis that is now a full blown liquidity crisis that is spreading
like a gangrene into other aspects of the credit market. You
may still wonder why this crisis is causing such a threat to
the entire financial system so as to cause the Fed to 'throw
money from helicopters'? The problem is essentially due to the
functioning of collateral.
Banks have to keep a relatively
small percentage of their capital as a base for all their lending
activities. Firms that raise finance in the fixed interest market
have to ensure that their assets cover such loans or top-up these
if their values fall below the required levels. With the value
of many of these previously 'sound' mortgage related assets falling
like a stone, such collateral became inadequate to meet the legal
requirements so forcing institutions to provide capital as a
top-up. Then their own debt related securities dropped in value
making it more difficult to effect such top-ups. As the 'spreads'
on such borrowing rose the borrowing became more and more difficult
until anything to do with either a mortgage related security
or the institutions that issued them or used them as collateral
became unacceptable as collateral. Effectively then, the capital
that such securities represented 'disappeared' to the extent
that prices had dropped leading to some bankruptcies and to a
contagious effect that the disappearance of further value caused
as other institutions holding these companies now distressed
debt, suffered the same fate. As the credit cancer spreads so
the crisis grows. A look at the Weimar republic's hyperinflationary
beginnings point to a similar situation.
Tragically, the longer short-term
expedient measures are put into place the 'contagion' will continue
to spread. And each step of the spread of the disease the more
likely it is to effect more and more parts of the financial system.
Clearly the solution, deemed as unacceptable still, is to restore
value to such securities in such a way as to convince all that
the mortgage market is healthy again and likely to resume growth
again. If interest rates fall to the extent that the housing
market recovers, foreclosures cease on those who hold mortgage
bonds, whose rates are set to climb, are moved to a healthy zone
the market will recover its confidence.
Last year when we first talked
about the crisis we used an illustration of a firm retrenching
one worker. The confidence lost in such actions can only be restored
by the employment of two workers. Such is the case in the credit
markets now. For the Fed to accept mortgage-backed collateral
for 28-day loans does not do it. It simply tells the market that
they are providing short-term bridges for the industry, but not
rectifying matters. This can only be done if interest rates fall
to the point where the fear of mortgage foreclosure on the more
than 1 million potential victims is halted and those mortgages
regarded as sound enough to be used as solid collateral.
This is not happening and such a solution goes against the grain
for lenders. As such, the only likelihood of an effective solution
will come up when the crisis is likely to cause systemic failure!
If the Fed does not accept
such collateral as solid security for loans and be seen
to be doing so the crisis will spread. This will mean a situation
such as is seen in Japan, where interest rates are not far from
zero. Until then it doesn't matter what the state of the economy
is, 'disappearing money' will have the same effect as raising
interest rates, issuing bonds by government and any move intended
to drain liquidity out of the system, such as rising oil prices
and trade deficits. Doing nothing or not enough will cause the
contagion to spread. The process of pumping money, not only into
the U.S. monetary system, but the globe's, has to continue and
grow until the crisis stops, with the Fed holding all those dubious
securities.
The money has to come not just
from the Fed or the European banks but from, trade surpluses,
Oil producers reinvesting back into the U.S. and Chinese and
other Asian surpluses being invested back into the U.S. If this
capital does not return it disappears from the U.S. economy and
gives a whole new dimension to the 'liquidity crisis", with
foreigners taking a proportion of ownership of the U.S. it may
well not be ready for?
Add to this gangrenous problem
the bleeding trade deficit and you have a suppurating wound infecting
the U.S. with a recession and unless properly handled with the
transfusion of huge more amounts of additional liquidity, will
lead to a depression. It is too late for academic discussions
on whether it is a recession or not. It is time for action time
to stop the bleeding! A healthy U.S. economy can be one where
prices are forced to keep stable, but a relatively sound economy
in a considerably depressed condition is disaster.
The fact that Bernanke felt
obliged to ask the banks to increase lending is clear evidence
that the banks have not increased credit to the degree the Fed
would like them to. Effectively, the Fed can influence the cost
of credit by changes in interest rates and other tools, but it
cannot directly influence the supply of credit. If banks continue
to be reluctant to increase the supply of credit, the financial
markets will come under considerably more strain, vastly increasing
the attractiveness of all hard assets, including gold.
There are rumours of the potential
collapse of a large financial institution which are further exacerbating
the situation, despite the injection of a further $200 billion
by the Fed. To quote, "there is a de-leveraging spiral of
credit removal, asset price destruction, capital debasement...
ad infinitum that is occurring". But the most disturbing
facet of this is that the liquidity crisis is accelerating.
A rapidly accelerating inflation will counter this causing
the monetary systems and currencies to embark on their
own destructive dramas. This is not a gradual decay, it is one
that is hampering most traditional methods of spurring growth
and has to receive emergency room treatment or it will become
a crisis that could take a decade or so to repair.
And what are we seeing to make
us say this? The $ is dropping like a stone, the oil price is
irrepressible, Asian growth is ensuring commodity prices, metals
and food [supported by speculation] will stay high and higher
for as far as we can see ahead. The defensive measures that are
being taken, so far, are Central Banks protecting national interests
through exchange rate management to retain international competitiveness
with key trading blocs. Sadly this removes all obstacles to tsunami-like
movements of capital flowing across the globe creating systemic
damage of its own.
These can only to be stopped
by Capital Controls and Exchange Controls. It will be easier
to stop such capital flows than impose trade barriers, harming
those prevented from free trade but also those imposing them
[until local production replaces imports]. Such protectionism
will fragment the global economy. Moves against "speculation"
may precede such moves.
Can the world cooperate sufficiently
to ensure the global economy in its present state does not fragment?
Only hyperinflation in isolated areas and an environment where
the control of money moves into the political arena lies ahead
unless the crisis is properly tackled now.
In conclusion, we are moving
to a level of decay, that sits in an inflationary environment,
which could move to unforeseen and eventually exponential levels
as it did in the past in Germany, but this time moving into connected
nations. Such an environment will see a plethora of national
Exchange and Capital Controls across the globe preventing this
infection. How can gold and silver not rise far higher in such
a climate?
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Mar 13, 2008
-Julian
D.W. Phillips
email: gold-authenticmoney@iafrica.com
321gold Ltd
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