GoldMoney Alert - 15 September 2007

"A House of Cards"

The following picture of people lining up to withdraw their money from a bank was not taken in the 1930's. It's from Thursday in Preston, England.

The above picture may not look too worrying because there aren't too many people, but that's because it's a small branch of UK's Northern Rock Bank. Here's a picture of the turmoil at a larger branch of this bank, which is teetering on the brink of insolvency.

London's Daily Telegraph explained this run by bank depositors by saying the "fears were prompted by the revelation this morning that [Northern Rock] Britain's fifth-biggest mortgage lender had to ask the Bank of England for emergency financial assistance."

One pensioner told the Daily Telegraph: "I am 65 and my husband is 72. We are queuing because we have substantial amounts of money invested in Individual Savings Accounts with Northern Rock. They say don't panic but it will be too late if things go wrong. I know that you need to keep level headed about these things, be we are not youngsters who can afford to lose this money." Actually, nobody wants to lose money, which explains why the above pictures show people of all ages.

Northern Rock is probably insolvent. The Bank of England in effect has said as much by announcing a bailout of this bank. Their bailout is an egregious example of how governments intervene to disrupt the market process, particularly when it comes to banks.

Northern Rock is just the latest victim as the global credit crunch widens its reach, and it is indeed widening. The Baltimore Sun reports: "Checks sent out by the troubled American Home Mortgage Investment Corp. to pay the property taxes of more than 70 homeowners in the Baltimore metropolitan area have bounced", which puts those properties at risk if the homeowners cannot manage to pay the taxes themselves. It goes on to quote one observer who "suspects that some lenders short on cash have dipped into escrow funds [held to pay taxes] to cover operating expenses." Clearly, the housing collapse is beginning to deepen.

The most vulnerable are the first to fail. Northern Rock like countless other banks before it - and no doubt many other banks not yet in Northern Rock's dire position - caught the fatal disease that has relentlessly sunk banks throughout the ages. These are the banks that 'lend long and borrow short', and nearly all of them do. In other words, banks that have loans with long maturities funded by short-term deposits are learning how fickle people can be with their money.

This lethal mismatch of assets and liabilities that arises by borrowing short and lending long appears to be a good strategy on the face of it. Taking advantage of lower interest rates on funding with shorter maturities generates extra margin for lenders during the good times. But alas, the good times always end don't they? And as sure as night follows day, the bust inevitably follows the boom.

I've taken the title of this alert from the following piece written by Murray Rothbard in March 1991 after the last real estate crisis. I say "last" purposefully because the uncertainty surrounding bank solvency that we are witnessing today is not new or unique. It is just the latest outbreak in a recurring pattern of bank crises. The crisis to which Rothbard refers is the collapse of the 'savings & loan' industry in the U.S. nearly two decades ago, but his words clearly describe today's problems as well.
http://www.mises.org/resources/d4363f84-fe3e-4bc7-95f2-4e17be9a3418

"What is the reason for this crisis? We all know that the real estate collapse is bringing down the value of bank assets. But there is no "run" on real estate. Values simply fall, which is hardly the same thing as everyone failing and going insolvent. Even if bank loans are faulty and asset values come down, there is no need on that ground for all banks in a region to fail.

Put more pointedly, why does this domino process affect only banks, and not real estate, publishing, oil, or any other industry that may get into trouble?...The answer is that the "bad" banks are vulnerable to the familiar charges: they made reckless loans...or their managers were crooks. In any case, their poor loans put their assets into shaky shape or made them actually insolvent. The "good" banks committed none of these sins; their loans were sensible. And yet, they too, can fall to a run almost as readily as the bad banks. Clearly, the "good" banks are in reality only slightly less unsound than the bad ones.

There therefore must be something about all banks...which make them inherently unsound. And that something is very simple although almost never mentioned: fractional-reserve banking...Only if all the deposits were backed 100% by cash at all times (or, what is the equivalent nowadays, by a demand deposit of the bank at the Fed which is redeemable in cash on demand) can the banks fulfill these contractual obligations.

Instead of this sound, noninflationary policy of 100% reserves, all of these banks are both allowed and encouraged by government policy to keep reserves that are only a fraction of their deposits...that results in our system of permanent inflation, periodic boom-bust cycles, and bank runs when the public begins to realize the inherent insolvency of the entire banking system.

That is why, unlike any other industry, the continued existence of the banking system rests so heavily on "public confidence," and why the Establishment feels it has to issue statements that it would have to admit privately were bald lies...That is, everyone would find out that the entire fractional-reserve system is held together by lies and smoke and mirrors, that is, by an Establishment con...The banking system, in short, is a house of cards."

I expect that the present crisis will deepen as the "house of cards" is further shaken. The excesses of the last 'boom' have not yet been purged, so the current 'bust' has further to run. As it does, continue to focus on counterparty risk, and to avoid counterparty risk completely, own precious metals and not national currencies - own tangible assets and not promises.

Gold closed the week up 1.3% at $709.60, less than $1 below the multi-decade high reached in May 2006. The pattern formed on the following chart of weekly closing prices indicates that gold looks ready to climb higher from here and challenge its record weekly closing high of $812.00 reached on January 18, 1980.

Silver meanwhile continues to underperform. It actually declined -0.4% this past week. I cannot explain silver's relative weakness. It is perplexing. Nevertheless, its weekly chart remains bullish because silver continues to move within the ongoing pattern of accumulation marked by the green lines in the following chart.

It will be important for silver to exceed the $13.12 high reached this past July. Once it does, both precious metals will be moving higher, confirming the upside breakout already underway in gold.

Published by GoldMoney
Copyright © 2007. All rights reserved.
Edited by James Turk

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