By Cheryl Grey, on April 9th, 2009
The rout—at the time, a welcome one—began in commodities, where historic high prices drove up inflation around the world. As prices for crude oil, copper, gold, and multiple foodstuffs began falling in mid-July, consumers as far apart as China and Chattanooga breathed sighs of relief.
Unfortunately, commodities were followed by global stock markets. As the summer gave way to autumn, consumers and investors watched in shock as the Hang Seng Index on the Hong Kong exchange plunged as much as 59% from its most recent high, the Dow Jones Stoxx 600 of Europe collapsed 46%, and the Icelandic ICEX rolled off the table, losing 77% of its value in one day on October 14 and 93% by the end of that week. In the U.S., the S&P 500 lost 44% and Nasdaq 45%, much of it bitten from retirement accounts and small traders. All told, estimates of the amount of wealth chopped from global equities are currently around US $31 trillion.
Seasoned traders who withstood the crash of 1987 have admitted they’ve never seen anything like this. The worldwide collapse of commodities, stocks, currencies, and just about every other investment vehicle out there has brought uncomfortable images of 1929 to the forefront of everybody’s minds.
Is it really that bad?
It’s a truism that investment markets are driven by two emotions: fear and greed. However, since the Lehman bankruptcy that’s been changed to fear and terror.
As investors realized no vehicle was immune to the downturn, they panicked, yanking their capital from anything riskier than a mattress and repatriating funds to the safe havens of Japan and the U.S. Interestingly, this flight to quality has not generally included Switzerland, the other traditional port in financial storms, perhaps because of Swiss banks’ exposure to emerging economies, the ones currently being supported by the World Bank and International Monetary Fund.
Official Treasury International Capital (TIC) data shows that US $143.4 billion flowed into the U.S. for indirect investment in September 2008 alone, and this is even more interesting when placed in context. International investors had been limiting or removing their funds from the U.S. on fear of a domestic downturn, only to reverse course dramatically when the recession turned global, as shown below:
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month
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TIC (in U.S. billions of dollars)
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June 2008
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13.3
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July 2008
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−25.1
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August 2008
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21.4
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September 2008
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143.4
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The demand for U.S. Treasuries, considered the safest of all safe havens, has been so high among investors both domestic and foreign that the yield has fallen to 0.01% on a three-month note. Right now, nobody cares about earning a profit; investors just want to keep what they already have.
The Volatility Index (VIX), which measures fear in the markets, averaged below 20 between its inception in 1993 and September 2008. Since then, it’s climbed as high as 89.53, with average readings consistently two to four times above normal.
We get the picture
That said, there are tentative signs of a bottom forming both in markets and the economy. Credit remains ferociously tight in consumer and commercial markets, but thawing has appeared at least between banks and should trickle down the wholesale-retail pipeline in time. The VIX remains high, but there are no signs of it climbing higher, although that could change overnight with another shock to the system, such as a bankruptcy for one of the auto makers or another major financial institution needing a bailout.
As central banks around the world slash interest rates with machetes, and governments initiate economic stimulus packages and loosen fiscal policies, the current call for the U.S. economy is a continued decline in gross domestic product through the first six months of next year. The fourth quarter of 2008 is expected to register the poorest performance, with a contraction of around −5% in comparison with the third quarter. If this call is correct, for the U.S. the worst is now, and the turn of the year may see economic indicators slowly climbing out of the basement.
Because other central banks, including the Bank of England and the European Central Bank, were behind the curve in initiating interest rate cuts (as late as June 2008, the ECB was still raising rates), the economic recovery will probably be slower on that side of the Atlantic. Canada and Australia may escape a technical recession, but the specter of deflation still hovers over Japan.
It’s not a pretty picture. But it’s still a far cry from 1929.
By Thersites, on April 9th, 2009
Regulators
We regulate any stealing of his property
And we damn good too
But you cant be any geek off the street,
Gotta be handy with the steel if you know what I mean, earn your keep!
Regulators!!! mount up!
The epic words of Warren G in many respects seem to sum up our government’s regulatory regime. Guys like Barney and Timmy clearly are “handy with the steel,” in their ability to influence businesses. They also in many respects do regulate stealing, ultimately robbing investors and businessmen in creating moral hazard for the bond and shareholders and all sorts of barriers to entry for the firms.
Yet recently amidst the market fallout there have been calls left and right for some sort of even more powerful “super-regulator.” After all, given that our regulatory architecture seems to have failed us this time, why not create an even bigger and stronger one to prevent the crisis next time?
Just like all government attempts to stop future crises, be it in healthcare or food and drugs, regulation always perpetuates the problems, creating greater ones down the road. In the financial system, we see perhaps the greatest case AGAINST regulation. Let us examine my seemingly counterintuitive claim.
The first and most obvious reason against regulation is that it creates a significant amount of moral hazard. If one has the SEC there to ensure that financial institutions are seemingly playing by the rules, or the FDIC there to ensure that even if a bank is insolvent, one will be able to receive his deposits (up to a point), then this encourages one to take far greater incremental risks than they otherwise would. After all, with the seal of approval of a government institution, why would you ever get your hands dirty in analyzing the institutions in which you entrust your money?
This problem is especially pervasive when it comes to the credit ratings agencies, namely Moody’s, S&P and Fitch, who are designated “Nationally Recognized Statistical Rating Organizations” by the SEC. Individual investors and institutional investors alike had become reliant on these agencies to gauge the risk of default of individual companies and securities, only for many of these companies and securities to blow up in their faces during this crisis. Had people actually gone in and done the risk analysis themselves, as opposed to relying on ratings assigned to companies largely by government decree, I would argue that people would have taken far more prudent positions with their capital.
Further, without this pseudo-cartel of agencies, I would imagine there would grow hundreds if not thousands of competing private firms to do independent analysis, greatly benefitting the investor without the time or knowledge to do financial analysis. Sure some of these companies might partake in fraudulent activities themselves, but they would either lose credibility and have to fix up their act to compete, or be prosecuted for the fraud they perpetrated. I admit that in this case, you do need a police force to enforce the law when it comes to fraud, but it is far more likely (given all of the times that private companies for example had uncovered the Madoff scheme before the regulators ever did anything) that the authorities would be able to react were market participants able to signal fraud to them. Still, at the very least the consumer would have far more choice in determining which analysis was best.
This brings us to another problem with government regulation – the fact that it is done by government monopoly. Government officials just like businessmen are prone to error. Unlike businessmen however, they lack a profit motive to work efficiently and prudently. To this end, if we see how ineffectual the DMV is, why should the SEC or FDIC or SIPC or any of these other alphabet-soup agencies be any more trusted? Sure, many of the people that work for these agencies previously worked in private industry, but remember that this in itself creates many a conflict of interest. Madoff himself had ties to the SEC, which may have helped him keep his Ponzi scheme alive for so many years.
Government regulators also create problems in that they make costly work for businesses and investors. SARBOX and other forms of compliance cost businesses small and large millions each year, while the regulators’ decisions to allow off-balance-sheet financing in many ways incentivized companies to hide the risks that should have been plain as day to investors. All of this is bad for transparency and efficiency, two things regulators are supposed to encourage.
On the other hand, there is the crazy idea of letting the market serve as the regulator. I would argue that discerning, self-interested investors have the best judgment when it comes to the valuation because they are responsible for their money. For it is the market that assigns a price to securities – riskier ones command a higher risk premium. Companies that make mistakes, be it through poor compensation standards that reward incompetence, poor investment projects, etc will face prohibitive borrowing costs and lower stock prices, and ultimately if the market so chooses be taken under. It is this playing field that ensures regulation. The mercy of the market will hold people accountable. Government regulators, government-empowered ratings agencies and others merely create the moral hazard that stop this system from functioning properly.
When government regulators set a precedent of bailing people out for bad behavior under the guise that a company is “too big to fail,” you further destroy the regulation of the market. You encourage excessive risk-taking; you encourage striving for short-term gains at the cost of long-term sustained profitability. You hurt the investors who are trying to signal through bond and share prices that a firm is in bad shape, and ultimately hurt taxpayers if you make the private problems of some investors into the public problems of all Americans. To let bureuacrats go in and say that a company is stable, often disingenously, as opposed to letting investors speak with their money is as arbitrary as it is abominable.
The fact of the matter is that government doesn’t want to let the market work as it did in blowing up companies with worthless assets (even if it was the moral hazard built into system and intervention that caused creation and investment in these assets), because it will destroy the interests that prop the elected officials up, destroy their own wealth, undermine their power (wouldn’t want to waste a crisis) and further cause unrest amongst the populace.
But the short-term dislocation versus the long-run fiscal and moral decay of the country is incomparable. The former will lead to an economy and a nation made stronger; the ladder to tyranny. The problem in our system is that if you are a politician and trying to get reelected, you make this calculation and hope that things don’t collapse at the wrong time, namely under your watch. Interestingly, this sacrifice of long-term sustainability for short-term gain is just the calculation made by many at the banks who played with essentially free house money (courtesy of the Fed), leading us to the crisis today. But let these same government officials who in large part mucked things up the first time around gain even greater control over the economy. I dare you.
By Trace Mayer, on April 9th, 2009
Quantitative easing appears to be the new fad among central bankers including the Bank of England, Japan, Switzerland and the Federal Reserve. Quantitative easing is a tool of monetary policy. The effect is an increase in the quantity of currency without regard to maintaining its quality.
CANADIAN QUANTITATIVE EASING
Bloomberg has reported that the Bank of Canada Governor ”Carney has pledged to lay out a plan that would flood banks with cash to halt the hoarding of capital and expand lending.” Consequently, the Loonie has been sliding against gold.
GLOBAL QUANTITATIVE EASING
Out of the G-20 meeting came the joint cooperation for global quantitative easing. Here are a few key points: ”To treble resources available to the IMF to $750 billion, to support a new SDR allocation of $250 billion, to support at least $100 billion of additional lending by the MDBs (multilateral development banks), to ensure $250 billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for concessional finance for the poorest countries.”
This creation of an additional $250B of SDR illusions to form the foundational capital for lending will only hasten the evaporation of the current system because the SDR has only limited liquidity and no intrinsic value. This is classic inflation by increasing the illusion supply. Because the SDR is a composite asset, a basket composed of the FRN$, Euros, Pounds and Yen, the effect is simply more chicanery of no economic substance. The IMF gold sales will be like a single piece of sushi appetizer to a starving dragon. The market’s reaction will be: ”That was nice. Seconds please.” But who will these measures help?
MAJOR BANKS AND THEIR VASSAL POLITICIANS
Bloomberg has reported that the Single Digit Midget Bank of America, with a market capitalization of $45B, needs $36.6B in capital to bring it in line with peers. If Bank of America cannot use the new FASB mark-to-market changes as creatively as its peers that enable fair-value lying to poof an extra $36.6B of fake capital onto its balance sheet then it must have serious intrinsic problems. There are places for worthless corporations like these: bankruptcy court.
How many other worthless, or worse than worthless, banks are having trouble conjuring capital onto their balance sheets? How long will it take other banks like Wells Fargo, US Bancorp or Credit Suisse Group with their approximately $14.90, $14.40 and $31.40 share price respectively and below $63B, $25B and $36.5B market cap to report earnings? The Treasury is delaying the reporting of the results of the federal report stress tests until Q1 earnings have been reported. Hopefully it shows up on Wikileaks like a recent whistleblower leak about JP Morgan’s insider trading program.
While fair-value lying may help the stock prices in the short term; the fundamentals are horrific for value investors. Most likely the longer the information is delayed and the less details the Treasury provides then the worse the true results are regardless of the faux official numbers.
The new FASB changes may enable profitability for a quarter, or even a few, but those profits are bogus. What purpose do these FASB changes and bailouts serve? To funnel bailout money through AIG to Goldman Sachs, JP Morgan, and European banks like Deutsche Bank. After all, Deutsche Bank, assisted by the ECB, has most likely been extremely helpful in perpetuating the gold price suppression scheme.
Why else would the ECB sell 35M ounces of gold the exact same day Deutsche Bank had to deliver 850,000 ounces of gold or risk a failure-to-deliver on the COMEX (Part 1 and Part 2)? The gold and silver markets, along with their shadow of the interest-rate market, are enveloped by the thickest part of the derivative illusion. As securities attorney Avery Goodman observed, “But, simply put, you cannot legitimately or legally hedge against another hedge, which is what the derivatives dealers appear to be doing, and which CFTC seems to be allowing them to do.”
The sociopaths manipulating interest rates, which according to Austrian business cycle theory regulate production over time, has caused and will yet cause catastrophic damage to the world economy and result in tremendous human suffering.
WORLD RESERVE CURRENCY
The world already has a world reserve currency of last resort: gold. Gold has a definition under the periodic table and is not the same as paper gold, derivative gold, problematic ETF GLD gold, or other forms of fools gold. Unlike SDRs and other illusions like the FRN$, Euro, Pound, Yen, etc. gold is a tangible asset, no-one’s liability and not subject to counter-party risk.
The next round of derivative shocks may come from a bankruptcy of the condemned General Motors triggering massive credit default swap payments. This will likely be a very stressful event for the banks and may result in tremendous solvency pressure.
Investors are becoming increasingly aware of risk and as the system continues evaporating the importance of seeking the safest and most liquid assets, with physical gold and silver at the tip, becomes increasingly desirable. While the price of gold and silver fluctuates their value does not and both gold and silver will still be there for the next credit expansion. That assertion cannot be made for the Z$, Bear Stearns or GM stock, money market accounts, the SDR or FRN$ and other places where capital was or is allocated. Carney and his fellow miscreants will not succeed in trying to force capital up the liquidity pyramid because the great credit contraction has begun.
Disclosures: Long physical gold and silver with no position in WFC, BAC, C, USB, GM, GLD, SLV, GS, JPM and CS.
By Bron Suchecki, on April 9th, 2009
Tom Szabo of silveraxis.com has followed up on my post yesterday with some further detailed comments and a new category – Pool Allocated. he is right to split my Segregated Allocated into Allocated and Pool Allocated, as this can be important in some countries as to whether the “foreign account” is reportable to tax authorities. I interpret what Tom is saying as essential that in both the gold is physically put aside in a vault and title is with the holders (ie it is not on the balance sheet of the custodian), the difference being in whether this gold is then further separated by client.
I think it be best be thought of with the example of a person A buying 10 x 1oz coins and 10 x 10oz bars and person B buying 5 x 10z coins, both of them storing with the same custodian. In Tom’s “Allocated”, the custodian puts person A’s coins and bars together in a pile/box with their name of it and then a separate pile/box for person B’s coins.
In “Pool Allocated”, the custodian has a pile of 15 x 1oz coins and a spearate pile of 10 x 10oz bars and has a ledger indicating that person A has 10 of the 15 coins and person B owns the remaining 5 and that all of the 10 bars belong to person A. As Tom points out, this can only be done with products that are the same, and not with 400oz bars or 1000oz bars, or indeed with 1oz legal tenders coins as they have different years on them (but can be done withing each year, to further confuse).
Most will see little difference between the two, as the key thing is that everything is 1:1 backed and not in the assets of the custodian. As Tom notes, Pool Allocated is more operationally efficient so should have lower costs (there is no difference in insurance cost for the custodian). It can matter, however, in how some tax laws define a reportable account. Some may be very specific that any “mixing” as in Pool Allocated makes it an account. Other may simply require the physical and title separation from the custodian’s other business (if any).
With this further categorisation clarification, Tom also asks what the Perth Mint’s “Allocated” is? For the most part it is Pool Allocated. I should point out that in respect of our legal tender coins, the segregation is by year. This means that if you buy 10 coins in 2005 and 10 in 2007, we have those years in storage because we make the coin in that year and put it in the allocated vault. Once put in, it stays there. But it is pooled in that if there are 10 clients with 10 2005 coins each, there is a pile of 100 2005 coins.
It gets a bit messy with numbered bars and the LBMA bars, because Tom says that “pool allocated accounts aren’t possible with good delivery bars”. When you buy a numbered bar (whether consistent ounces like kilo bars or odd weight like LBMA bars), we put that specific numbered bar into the vault and allocate that number to you. But again, for practical storage purposes, the numbered bars are stored together. For example we will have a 1 tonne pallet of 80 x 400oz bars of varying weights, but even though they are together, if you pulled a specific bar out we know exactly who owns it.
Once we’ve worked all these variations out, maybe we need some agreed industry storage taxonomy so investors know exactly what they are getting. Marketing can sometimes get in the way of strict legal definition.
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