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Wealth can take
two forms as either a tangible or financial asset. By
extension currency can be either money or a money-substitute. The value
of financial assets is ultimately tied to some-one’s promise and their
financial capacity to fulfill that promise. Thus financial assets, such
as checking, saving and sweep accounts, stocks, bonds and federal reserve
notes (US$) are subject to counter-party risk. Cash (currency) can be
either a money which must be a tangible asset (gold) or a money substitute
which is a financial asset (US$, Euro, Peso, etc.).
Counter-Party
(Credit) risk is the risk of loss due to a debtor’s non-payment of a
loan or other line of credit (either the principal or interest (coupon) or
both). For example, when a dollar is deposited into a bank account the
depositor becomes an unsecured creditor of the bank and the value of
that dollar is equal to one dollar minus the counter-party (credit) risk of
the bank. The price of the dollar may still be a dollar.
By contrast
tangible assets have intrinsic value and can never be worthless.
If you own a tangible asset such as gold there are two ways to hold it.
Either store it yourself or work with a custodian to store it for you.
But do custodians of tangible assets held in allocated storage have
counter-party risk? The answer is no if the contract is constructed
properly. However, their customers do have performance risk. The
customers accept the custodian’s promise to complete expected tasks.
So in summary,
there is a big difference between counter-party risk and performance
risk. In today’s uncertain financial environment avoiding
counter-party risk wherever possible is prudent. For example, the
Federal Deposit Insurance Corporation that insures most accounts held with US
banks has recently increased their staff in the Division of Resolution and
Receivership, the bank failure division, by 60% from 220 to 360 people.
Bear Stearns was
subject to over $13.5 TRILLION of derivative liability which was added to JP
Morgan’s $93 TRILLION. Combined derivatives exceed $500 TRILLION
of risk.
We can expect more Bear Stearns ‘events’ with other
national or local banks such as Citigroup, Citibank, Washington Mutual,
Wachovia, Lehman Brothers and only time will tell whether or not they will
end in ’soft landings’. Why take any exposure to
unnecessary risk?
Trace Mayer
RuntoGold.com
Trace Mayer,
J.D., holds a degree in Accounting from Brigham Young University, a law
degree from California Western School of Law and studies the Austrian school
of economics. He works as an entrepreneur, investor, journalist and monetary
scientist. He is a strong advocate of the freedom of speech, a member of the
Society of Professional Journalists and the San Diego County Bar Association.
He has appeared on ABC, NBC, BNN, many radio shows and presented at many
investment conferences throughout the world.
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