Credit Implodes, Bankers Print, Gold Wins

1. “Once more l will shake the heavens and the earth, the sea and the dry land. I will shake all nations, and the desired of all nations will come, and I will fill this house with glory,” says the Lord Almighty. “The SILVER and GOLD is mine”, declares the Lord.

2. ‘The words “once more” indicate the removing of what can be shaken – that is created things – so that what cannot be shaken may remain.’

In the second scripture quoted above, the writer of the New Testament Book of Hebrews comments on three verses he extracts from the Old Testament Book of Haggai, labeled as the first scripture. The sentence ‘The Silver and Gold is mine’ appearing in the portion taken from Haggai, follows immediately after reference to a ‘shaking’. The writer of the Book of Hebrews explains the purpose of the shaking. He says it indicates ‘the removing of what can be shaken – that is created things – so that what cannot be shaken may remain.’

The writer was led to choose these two scriptures because taken together they relate so readily to the ‘financial shaking’ currently afflicting the global banking system. The deliberate proximity of the reference to the ‘Silver and Gold’ being ‘His’ suggests that His people might be wise to diversify part of their savings out of the ‘fractional reserve banking system and worthless paper currencies’ into ‘His’ physical holdings of Gold and Silver.

The purpose of this article will be an attempt to analyze some of the causes and consequences of the ‘shaking’ which is in the making.

In letter No.79, entitled: ‘PRESSURE MOUNTS ON JUMPING JACK’, the opening paragraph drew attention to near-identical figures appearing in a recent edition of The Privateer. The first referred to a US Budget Deficit approaching $700 billion, the second to proposed US military spending for 2008 as being $647,2 billion.

The writer’s focus in this letter will be to demonstrate the significance of recent Central Bank interventions in the global currency and credit markets and explain why they are rapidly approaching the massive sums detailed above. The figure already exceeds $500 billion and a senior European banker has suggested it could easily treble again. Once one understands the significance of what is happening, it should be possible to attempt to assess the overall likely impact of these ongoing and increasing interventions – first and foremost on the market for GOLD.

The Scots are generally credited with having ‘discovered’ the business of ‘modern banking’ more than three hundred years ago. It began with the formation of the Bank of Scotland in Edinburgh, back in 1695. Although the Bank of England was founded a year earlier, credit once again goes to a Scot. His name was William Paterson. For the first thirty-odd years of its existence the Bank of Scotland enjoyed a monopoly in the north of Britain. It only lapsed with the founding of The Royal Bank of Scotland, in 1727. The two were initially bitter rivals and not beyond deliberately attempting to trigger ‘runs’ on each other’s banks to drive the other party out of business. The ever-present danger kept both institutions prudent when it came to lending money. Later competitors were not so fortunate. Some were destroyed.

What is this thing called a ‘bank run’? It’s a ‘financial crisis’ which occurs when large numbers of a bank’s customers – fearing the insolvency of their institution - simultaneously attempt to withdraw their funds. In the old days it could only be done by forming a queue in front of the teller’s window. Today electronic withdrawals are more normal but queues form just the same. See a recent dramatic example below:

Desperate customers of British bank Northern Rock in Croyden, South London, queuing to withdraw their money, despite assurances the bank is solvent. 14/9/07

More often than not a ‘run’ is self-fulfilling. As it gathers momentum withdrawals rapidly exceed available cash on hand. The reason was first experienced by English Goldsmiths of the early seventeenth century. One of their roles was to act as ‘depositories’ of gold for customers. In exchange they would issue ‘promissory notes’ signifying their customer’s gold was held ‘in safe custody’ and could be claimed at any time.

As and when the gold was required, customers would return, present their respective promissory notes, and retrieve their savings. Goldsmiths soon discovered that, on average, no more than 10% of customers ever required their gold at any one time. They could therefore ‘lend the balance out against interest’, and effectively on a semi-permanent basis. Whenever a customer returned to claim his gold, he would be given different coins or bars, but of identical weight and value. Problems only arose if they lent out too much for too long, and to people who were subsequently proven incapable of paying them back. Once word got out that a particular goldsmith was experiencing difficulty returning customers’ gold, it would trigger a run. Invariably it spelt the end of the man’s business. Goldsmiths had to learn through bitter experience the importance of being prudent and not too greedy. The professional bankers who succeeded them found the clever thing to do was to ‘pay interest’ to depositors for fixed time periods arranged in advance, in order to match loans and deposits.

Modern-day bankers soon discovered it was more profitable to ‘borrow short’ and ‘lend long’. It made for bigger margins but it only became possible on a regular basis when occasional shortfalls were able to be secured on a temporary basis by borrowing from sister banks. In time nations set up what they called ‘central banks’ and this became one of their prime functions – settling temporary inter-bank differences.

While the Gold Standard was still in operation, even Central Banks were subject to ‘runs’. These took place when a nation itself was suspected of ‘running out’ of gold and was deemed unable to pay its international debts. This occurred on a notable scale in 1971 when the US - under President Nixon - was forced to close its ‘Gold Window’ to foreign creditors. Individual members of the public had already lost the right to own gold as early as 1933/1934. Their holdings were confiscated on the instructions of President Roosevelt, prior to the US Treasury raising the fixed price from $20 an ounce to $35. Talk about insider trading!

The so-called National Banking Era of the United States lasted from 1863 to 1913. During that fifty-year period severe bank panics were a regular feature, occurring in 1873, 1884, 1890 and 1893. Jon Moen of the University of Mississippi helps one understand why they occurred on such a regular basis.

“The New York money market faced seasonal variations in interest rates and liquidity, resulting from the transportation of crops from the interior of the United States to New York and then to Europe. The outflow of capital necessary to finance crop shipments from the Midwest to the East Coast in September or October usually left the New York City money market squeezed for cash. As a result, short-term interest rates in New York City were prone to spike upward in autumn. Seasonal increases in economic activity were not matched by an increase in the money supply because existing domestic monetary structures tended to make the money supply ‘inelastic’. Usually GOLD would flow into the United States from Europe in response to high seasonal interest rates, increasing the monetary base of the United States and easing the liquidity squeeze.”

The Bank Panic of 1907 also occurred during an autumn period. It was triggered by a run on the Knickerbocker Trust – controlled by Augustus Heinze - following the latter’s failure to corner the stock of the United Copper Company. During the aftermath:

“The collapse of Heinze’s scheme exposed an intricate network of interlocking directorates across banks, brokerage houses, and trust companies in New York City.”

The discovery of these close associations between bankers and brokers sparked a panic amongst nervous depositors at Knickerbocker. Apart from seasonal stresses and strains, the incident took place at a time when the economy was slowing, the stock market was sliding, and credit was considerably tighter than normal. Instead of the UK and Europe being able to assist by supplying their usual seasonal inflow of gold, they too were experiencing tight credit. The Bank of England had recently raised its own rates. In his next sentence Jon Moen takes a step too far. He uses the crisis to justify the founding of the Fed:

“Because there was no Central Bank or reliable ‘lender of last resort’ during the National Banking Era, there was no … way to expand the MONEY SUPPLY.”

No wonder there was little or no inflation! They were unable to expand the money supply! As the crisis deepened, it spread to trusts in general. They were far less regulated than the banks and had begun to specialize in underwriting security issues, writing mortgages and investing directly in real estate. These were then all no-go areas for banks. In addition, the New York City trusts had a far higher proportion of ‘collateralized loans’ than did their banking colleagues.

“Conventional…wisdom associated collateralized loans with riskier investments and riskier borrowers.”

The banks themselves found the wider scope of activities available to trusts so convenient and attractive that they frequently sought to gain control of their own through holding companies. Failing that, they would place associates on a trust’s board of directors.

Banks operated through a ‘clearing house’ system which ensured that each participant was able to obtain detailed knowledge of the quality of a competitor’s assets. It also helped shield members from runs on deposits. JP Morgan effectively acted as their ‘lender of last resort’ – not just through his bank’s own funds but by collectively arranging contributions from those in the system.

No such facility was available to trusts. Worse than that, the low level of knowledge as to the nature and quality of their assets, created an expectation that the risk of default was higher. Despite these perceptions, it did not prevent JP Morgan from exercising his talents during the panic of 1907. The total cost of the rescue was a miserable $35m. How inflation has destroyed paper currencies! Despite their success on this occasion, Moen says New York Bankers were no longer willing to do it again. This eventually led a group of them to push for the establishment of the Federal Reserve. First step was for Congress to pass the Aldrich-Vreeland Act to set up a National Monetary Commission whose purpose was to investigate the Panic of 1907 and propose legislation to regulate the banking industry.

Little did the voting public realize what it was letting loose. In 1913 the Federal Reserve Act was passed. How did it happen? It is reliably recorded that, after several previous attempts were blocked, a group of bankers funded and staffed Woodrow Wilson's campaign for President. In return he committed to sign the act. Nelson Aldrich, maternal grandfather to the Rockefellers, pushed the Federal Reserve Act through Congress just before Christmas, when much of the House had already left on vacation.

Referring to the role he played in creating the Fed, Wilson later ruefully conceded:

He had helped establish a massive, secretive, privately-owned institution which now had the right to print money at no cost to shareholders, ‘money’ which would subsequently be LENT at considerable interest to the rest of the country.

The situation which led to the Panic of 1907 is little different to the crisis which reigns throughout the global monetary system today. Once again the culprits have been institutions borrowing and lending outside the banking system, on-selling packages of ‘sub-prime’ mortgages of dubious value to unsuspecting buyers. The Federal Reserve failed to prevent a crisis. In fact as readers will shortly discover, it was the previous Chairman of the Fed, Alan Greenspan, who helped create the problem in the first place.

Bill Clinton, when running for election as President for the first time, sought to highlight an issue which would attract the attention of voters. He coined a famous phrase:

Some financial commentators now acknowledge that in the wake of the ‘tech’ crash of March 2000, Greenspan deliberately created a countervailing ‘asset bubble’ in the housing market. His purpose was to boost domestic consumption to offset the recessionary effects of an accelerating slump in equities. He faced a tough set of circumstances. By the end of 2000 the NASDAQ had halved. A year later the Dow followed suit, sliding 38%. Between January 2001 and June 2003, the Fed Chairman responded by dramatically cutting interest rates from 6.5% to1%. This was the lowest they’d been since 1959. The sudden appearance of artificially cheap mortgage rates encouraged home ownership. House prices began to rise sharply. Within a short space of time lenders were successively making bigger and bigger loans against the same properties as they flipped from one owner to the next. As values soared first-time buyers were being offered bonds which exceeded 100% of the price to give scope for alterations.

Existing home owners soon discovered they could regularly access their mortgages as if they were ATM’s – drawing cash whenever they felt the desire to spend. Lenders encouraged them to take holidays overseas, buy motor cars, and make alterations – whatever struck their fancy.

Greenspan drove his audience further over the cliff of recklessness with a speech he made on 23rd February, 2004. He was addressing the Credit Union National Association in Washington and used the occasion to tell them of a Fed study into the cost of servicing mortgages. He said investigation showed many homeowners could have saved tens of thousands of dollars in the last decade if they had switched from high-cost fixed-rate mortgages, into ‘ARMs’ (‘adjustable-rate mortgages’). Under ARMs, which then made up only 28% of mortgages, borrowers could usually expect lower initial rates but ran the risk of higher payments down the line if rates in the broader economy went up. These were his words:

“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”

Joseph McKenzie, Deputy Chief Economist at the Federal Housing Finance Board, then elaborated on the choices now available:

“There are lots of innovative programs, especially targeting low-income and first-time buyers.”

Amongst these ‘innovative products’ was the so-called ‘teaser bond’. They offered low introductory ‘teaser rates’ that reset substantially higher after a period of time – usually two years. First-time buyers were often incapable of understanding the full impact of the medium-term monthly costs of financing this type of mortgage. They had even less chance of grasping the compounding effect of what would happen in the event of a sharp rise in the general level of interest rates. These so-called ‘Teaser bonds’ were officially termed ‘2-year hybrid ARMs’. First-time buyers were in for some nasty shocks, hence the sharp rise in defaults in the last twelve months. From when Greenspan made his speech, the popularity of adjustable-rate mortgages rose sharply. Up to 75% of first-time buyers eventually fell for his ploy.

In recognition of the pain these practices have, and are, causing, REUTERS now reports that many large mortgage originators have decided to stop offering ‘teaser ARMs’ which:

In retrospect Greenspan’s advice proved disastrous. He failed to tell avid listeners what would happen if long term rates went up in response to economic recovery and rising inflation. Four months after delivering his pearls of wisdom to an unsuspecting audience, the then Chairman of the Federal Reserve began RAISING rates. The first hike took place on June 30th, 2004. Between then and June 29th, 2006, he and his recent successor, Ben Bernanke, lifted rates 17 times, taking the Fed Funds discount rate back up to 5.25% from its starting point of 1%. Bernanke only took over from January 2006 so most of the damage took place under Greenspan’s reign. Looking back, one can probably pin point the start of the latest housing crash to exactly the month the Fed announced its last rate rise – June 2006.

As the writer begins to pick through the ashes of the present credit crisis, one thing is clear: The world’s three major Central Banks - the Fed, the ECB, and the Bank of England, have by no means covered themselves with glory. Yet much of the original cause of their problems can undoubtedly be laid at the door of the Fed’s previous Chairman, Alan Greenspan. A week ago he published a 531-page memoir of his life, entitled:

In it he warns his successor at the Fed to be cautious about aggressively cutting rates back down again, to stave off the present crisis. He says:

“The risks of an inflationary resurgence are greater now than when I was Chairman.”

In the same breath he coldly predicts that house prices are headed lower. In the writer’s opinion BOTH the above two forecasts are directly attributable to way he mismanaged the Fed. But, until the latest crisis broke, his reputation was untarnished. Most considered him an intellectual genius and a man of integrity. What makes his actions more reprehensible is that this is the very same man who years ago wrote a brilliant article called:

This was in the days when he was an ardent admirer of free market economist Ayn Rand, author of “Atlas Shrugged”. How the mighty have fallen. In his latest book he predicts the Fed may eventually have to raise interest rates into DOUBLE DIGITS in order to keep inflation at bay. This, he says, could result in the Fed having to face powerful political pressures not to raise borrowing costs to ‘draconian levels’. However, if the Fed then does what it ought, he further predicts:

“We could see a return of populist, anti-Fed rhetoric, which has lain dormant since 1991.”

The writer’s response to Greenspan last statement is unapologetic. Why should he be surprised? Having gained control of the Fed in 1987, much of the subsequent deterioration in America’s financial status can be attributed to his poor performance as Chairman. It all began with a now famous boast he made some years earlier when, despite his anti-government Ayn Rand roots, he was beginning to savor the prospect of power:

“I look forward to being Fed Chairman and printing my way out of the next Kondratieff winter.”

Within months of actually being appointed to the very position for which he hankered, he faced the crash of 1987, perfectly timed to coincide with the beginning of the long-predicted Kondratieff down-draft. Instead of allowing discipline to run its course, he intervened with all available monetary guns blazing – exactly as he’d said he would. He even slipped in a sly scheme for the Treasury to hammer gold. Eleven years later he was still at it, but by now the Fed and Treasury’s methods had become more sophisticated. Instead of ‘selling’ gold they were ‘leasing’ it. On 24 July, 1998, while giving testimony to House Banking Committee, he unwittingly – and to his great regret – offered the following admission:

“Central Banks stand ready to lease gold in increasing quantities should the price rise.”

What did he mean and why would Central Banks do such a thing? “Leasing’ is a form of ‘lending’. Central Banks lend gold out to bullion banks like Goldman-Sachs, J.P. Morgan Chase, Barclays and Citigroup at a nominal 1% return. The bullion banks then sell it into the market, investing the proceeds in Government Bonds for a 3-4% return. What happens if the price subsequently goes up? They either protect themselves in the futures market by purchasing call options, or they go bust, or the Government eventually lets them off the hook. Why would Government do such a stupid thing? It is certainly not to earn a miserable 1% with all the attendant risks of inevitably seeing the price of gold go up! The end result of substantial Central Bank leasing has been to hold the price of the metal down. JD Hargreaves of Silver Monthly explained their actions this way:

“In the absence of gold leasing, government FIAT currencies would appear virtually worthless as they rapidly depreciate against gold.”

Despite the growing strength of the EURO and the ECB (European Central Bank), with the former at record highs, the dollar is still the most widely used international FIAT currency and the US Fed similarly the most powerful Central Bank. This being the case, which institution has most to gain from the suppression of the price of gold? Without any doubt it is the US Fed. When investigating who could possibly have committed a criminal act lawyers have a favorite Latin phrase – ‘Cui Bono’. It means ‘in whose interest?’ In other words, who could possibly have had a motive for committing the crime of artificially suppressing the price of gold to the detriment of South African miners and international investors? Thank you Uncle Sam!

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The full report is 35 pages and includes a full analysis of the Credit Implosion and implications for the Dollar, gold, bonds and equities. The report goes on to give updates on our ‘pick six’ shares Goldfields, Randgold (RANGY), Afgold, Sallies, Uranium One and Sasol.

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