Train Wreck Imminent?

[FRED]

http://www.itulip.com/images/Paul_Tustain.jpgTrain Wreck Imminent?

by Paul Tustain, CEO Bullionvault (http://www.bullionvault.com/from/itulip)

We learned yesterday that the British government's guarantee to bail out the creditors of Northern Rock Bank is worth a staggering £100 billion. That's £5,000 [$10,000] per British household. This week the European Central Bank made $500 billion available through money market operations. And only last week $110bn of new money was created by central bank loans with artificially low rates and reduced-quality security. This is money creation on an epic scale.

Why is this happening now? Here's my theory: 31 December is a major day on the financial calendar. If you take a sample of bonds you'll find that a disproportionate number of them are due for interest and/or redemption on 31st December. Redeeming bonds is very cash intensive, and cash is not freely available in the banking system right now.

So it seems likely that some frantic finance directors will be working long hours to find the cash that will enable them to avoid a default next week.

If that's right the festive season could see the announcement of some nasty shocks. June 30th won't be much fun either, for the same reasons. The credit crunch is deepening, and will go on doing so until at least next summer.

For those of us who like to take responsibility for ourselves (it's called freedom by the way) it's getting just a little tiresome that money creation is diluting our savings, and making us pay - again - for the excesses of the buy-now-think-later generation. Some of us would prefer to see the government react with a shrug and a sympathetic "bad luck" to the losers in the next financial train wreck. But it's not the mood of the nation. Politicians have begun one of their competitive caring phases, and they're rescuing victims everywhere. Every clapped out bank, every busted pension scheme, every industrial zombie, and absolutely every government department will be nurtured in the warm embrace of the public purse.

This causes a natural backlash. Issuing new money reduces depositors' returns, prompting savers to switch to better stores of wealth. This capital flight should be easy to spot, but modern economic statistics can obscure it. You see, the main way economists measure economic health is by counting the money spent in the economy, and now that savers are dumping currency (and buying better wealth stores) the effect is tough to distinguish from the economist's beloved GDP growth. Our healthy GDP figures are a distortion, and the economy is not making a steady booming noise but an ominous hissing - the noise of savers abandoning the currency.

You can see this at the key entry points to the real economy.
Oil is multiplying in price.
All the grains are multiplying in price.
All the base metals are multiplying in price.
Gold is multiplying in price.
Producer prices are through the roof.In spite of this the monetary authorities are racing to issue more money, and economists are clamouring for cuts in interest rates. They're caught 'twixt the devil and the deep blue sea, because although they could address these serious inflationary indicators, doing so risks the revenge of a giant economic threat - a rout in the housing market. And that would mean depression.

So it looks increasingly likely that low rates are staying, and the hot global investment money, sucked in by Britain's recent and comparatively high interest rates, is about to quit Britain and send the currency into a tailspin. This produces higher prices for imported goods. At the same time our public finances are in a serious mess, and the biggest contributor to our service-based economy - the City - is the main victim of current turbulence. And please don't ask about the trade figures because they're just ugly.

It is becoming genuinely possible that people will refuse to hold sterling for more than a fleeting moment. Inflation could turn so severe that the 'hyper' prefix is justified.

I know - it's too far-fetched to be believable. Or is it? For 150 years the values of Western currencies have stayed way above purchasing power parity levels with Asia. Being a developed country is what drove this premium, as money flowed down a one way street to our advanced economies. These were the only places where sophisticated products could be built or bought.

Today things are different. You could measure circuit board production in two factories in Indonesia and in Britain, and get the output per worker priced in local currency. Multiply both by their conversion rate into US dollars, and the British factory seems to have produced 5 - 7 times more US dollar denominated output. So our GDP looks good, but only through the distorting lens of a western currency conversion. There's another way to measure that same output: simply count the circuit boards. Do that and you'll see there's no material difference in productivity between a British
and an Indonesian worker. Perhaps the root cause of western currency premium has evaporated, and the anomaly is now that sterling really is 5 - 7 times overvalued against Asian money.

You could switch to euros. But looking at their policy they're creating as much money as the Bank of England. And the US Federal Reserve is doing it too, while all of Asia is battling to hold down their currencies so that their exports can continue apace. It's a bizarre race to the bottom for the world's currencies.

It's time to sidestep the financial consequences of this largesse. What can we savers do?

If you're as bothered as I am, then currency should be struck off your Christmas list and replaced with something more reliably rare. I think gold could soon look so highly priced in sterling that many of us will be too frightened to buy it. But it isn't there yet, so perhaps buy just a little now, and if it makes you a small profit it will be easier to buy a little more next month. If that makes you a profit too, then allow yourself to build a proper stash. I'm not sure we'll ever again be able to buy it for much under £400 an ounce.

I have just instructed my bank to transfer all my remaining cash deposits to BullionVault, and I look forward to spending 2008 long gold and completely sterling free.

Paul Tustain, CEO Bullionvault
December 2007

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[Robbie O]

Is there new money being created or is this just some kind of shell game being played by the FED and ECB along with the help of the financial press?

Vanishing Act - Are the Fed and the ECB Misleading Investors about "Liquidity"?

Link: http://www.hussmanfunds.com/wmc/wmc071224.htm


Does anyone have any further comment about this contradiction?

[Jim Nickerson]

Is there new money being created or is this just some kind of shell game being played by the FED and ECB along with the help of the financial press?

Vanishing Act - Are the Fed and the ECB Misleading Investors about "Liquidity"?

Link: http://www.hussmanfunds.com/wmc/wmc071224.htm


Does anyone have any further comment about this contradiction?

Look at Finster's last comments, main page of forum, or search Hussman for references to him this week.

[donalds]

Regarding the U.S., P. kasriel shows how commercial credit is contracting (destruction of new credit creation).

http://web-xp2a-pws.ntrs.com/popups/popup.html?http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0712/document/dd121907.pdf

Liquidity injections from the Fed have not amount to much of a net gain.

http://www.gmtfo.com/RepoReader/OMOps.aspx

As Hussman has demonstrated, same is true with ECB.

Time we get past this notion of CB money printing.

[c1ue]

It is true the CBs are not printing money in the traditional sense.

It is also true, however, that the CBs are trying to restart the engine which was creating 'money' - banks and their lending.

You will need to spend more time researching the older links here in iTulip to understand the differences between money and credit, and also why bank loans are different than CB loans.

As for Bullionvault, hyperinflation might not happen, yet Tustain may still be right: in a deflationary environment, cash is king.

Gold is not cash, but will likely be much closer than almost anything else you might name, and further has less issues (though still real) concerning storage and perishability.

Another area (naturally enmeshed with the rest) is currency depreciation.

Again, Tustain could be right for the wrong reasons - there is not inflation per se but currency depreciation.

For me, I've voted via moving money out of the US$ (not into EU or Sterling either) and by starting a cash flow generating business.

[FRED]

Regarding the U.S., P. kasriel shows how commercial credit is contracting (destruction of new credit creation).

http://web-xp2a-pws.ntrs.com/popups/popup.html?http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0712/document/dd121907.pdf

Liquidity injections from the Fed have not amount to much of a net gain.

http://www.gmtfo.com/RepoReader/OMOps.aspx

As Hussman has demonstrated, same is true with ECB.

Time we get past this notion of CB money printing.

Hussman et al are playing catch-up, are about 2 years behind iTulip. At least they are starting to comprehend the difference between asset and all-goods price inflation. See this comment today from EJ (http://itulip.com/forums/showthread.php?p=23164#post23164).

[donalds]

"You will need to spend more time researching the older links here in iTulip to understand the differences between money and credit . . . "

Capital is being destroyed faster than credit is being created. Looking at M1 and M2 reflects money moving from CP to bank deposits and money markets.
This is NOT new money.

Credit contraction reflects deflation. I've never quite understood the gold bug fascination, but under a deflationary scenario, it seems all the more perplexing, to me at least.

[grapejelly]

Cash is king...

Yes, there will be massive debt writeoffs and liquidations. When money is lent, that is inflationary. When money is paid back, that is deflationary. But when money is written off, that is not deflationary.

But then the central banks come to the banks' rescue with hundreds of billions in new "loans".

That is inflationary.

So the result is inflationary. And cash becomes worth less against oil, gold and other tangibles.

Real estate is an exception. Yes it is a tangible and will therefore thrive against cash in the long long term.

But real estate depends upon the credit markets for much of its valuation.

That "credit market premium" is roughly the difference between a valuation based upon fair return on rents, and the current valuations and will disappear in the next few years.

So commodities will rise in value and we can expect another precious metals mania. Stocks will also do quite well as a refuge for cash. The central banks will want to inflate the stock market at any cost.


.

[donalds]

"But then the central banks come to the banks' rescue with hundreds of billions in new "loans"."

This is the crux of the matter: the inflationist presume the power of the Fed to inflate, while the deflationists presume that the shadow finance economy's ability to create credit/debt has far exceeded that of the Fed (in generating new credit/debt) and has come to a likely end . . . and Fed injections will fall far short of being a substitute for, or be able to make up for the credit destruction. The inflationist also presume fiscal bailouts, itself also unlikely (though less so) due to existing federal deficit, requirements of war spending, pressures to maintain existing welfare expenditures (especially during an election year when Dems aren't about to let go of their mantle as 'progressives'), reduced sales tax revenues that come with a recession, and that, during an election year, raising taxes is just out of the question.

[Chris Coles]

What has happened is that monetary authorities have lost control of their primary tool; the creation of new money. In the past, before big bang, the only way the banking system could add new money to the system was through the central banks effectively "printing" new money. What has happened is that their enthusiasm for the short term benefits of the expansion of the banking system into the world of hedge funds blinded them to the perils.

What everyone could see, but either failed to acknowledge, or, refused to believe, was that, in allowing the hedge funds to take the already leveraged funds of the ordinary, normal banking system, (the savers £1 lent out to borrowers say, 7 or 8 times), and by turning a blind eye to the fact that the hedge funds in turn were creating a, Quote "Wall of Money" Unquote, by taking the already leveraged normal bank loan and again leveraging that another 15 or 20 times...... in the process spewing out all those lovely CDO's.......... that the CDO's were in fact new money.

The hedge funds have been issuing completely new money into the banking system.

And not just new money, but 15 or 20 times more new money than the system was designed to cope with; and not temporarily, just for a week or two, but for nearly a decade, year in year out. THAT was the first problem, but it gets worse, much, much worse.

The second problem, the one no one is talking about is that the governments' at the heart of the system here in the West, must have, I repeat, must have..... bought CDO's. Our governments are as deep in the mess as anyone.

So the third problem is obvious, the true value of the CDO's cannot be more than the true value of the original money in the system BEFORE they were issued. So the true imbalance is the full value increase in asset values since this new money creation process started.

That leads us to the fourth problem which we can see happening right in front of our eyes. In trying to prevent a complete collapse, the central banking system is trying to prevent the collapse of the new asset values back to normal values by replacing the valueless CDO's with new issued money in the old traditional sense. They are printing money on a scale never ever seen before.

There is no way out of this. Common sense tells us that we either have a collapse of asset values, or we have inflation in the only "real" assets worth holding in such times, Gold, Oil, Food, and all those very tangible assets that are normally the base against which the whole banking system is lodged up beside for stability.

The central banks have shown their hands by taking the inflationary route and it will be quite some time before the overall effects stabilise. My guess will place a timescale of two or three years before we can be certain that we will have hit full bottom. Cash is very certainly king in the resulting Downwave and Robert Beckman author of The Downwave has at long last been vindicated. The Downwave has started.

If Beckman is correct in his assumptions, house and land prices will return to pre 1939 values. But as others have already noted, this time holding cash as currency is not possible as the underlying problem is the collapse of the banking system and thus the value of the currency. On that basis, gold might well reach $8,000. Food for thought.