In
1871, a large portion of the city of Chicago burned to the ground. The Chicago
Tribune attributed the fire to a cow owned by a Mrs. O’Leary. The Tribune
stated that the cow kicked over a lantern as she was being milked, burning the
barn and much of Chicago.
Whether
the story is accurate is of little concern. (Somebody always has to be found to
take the blame for catastrophe.) Whatever started the barn fire, a seemingly
minor event resulted in a major conflagration.
And
so it is with economic events. Bankers are expected to maintain a fractional
reserve of 3 – 10%, depending on the level and type of liabilities, but, not
surprisingly, they often drop below the official level, especially in times of
economic difficulties. Bank managers assume that they can always increase the
reserve when good times return. Trouble is, they’re at their most exposed at a
time when a substantial reserve is most critical.
But,
why would bankers take such a risk? Aren’t they fearful that they’ll get caught
out if a crisis occurs?
Not
really. Their assumption is very often that their indiscretion exists
in isolation. They assume that if they
alone cheat the system a bit, they can always catch up later. For whatever
reason, it rarely occurs to them that, in a struggling economy, each of their
associates in the industry is also cheating the system. Since each one keeps
his activities under wraps, it doesn’t become apparent that the whole system is
a house of cards until a black swan jolts the system, which, due to its overall
instability, self-destructs.
Similarly,
in shaky economic times, there’s quite a bit of fiddling that’s done in the
stock market. As the public begins to lose their confidence in the system, they
offer their shares for sale. In order to cover up the loss of confidence, these
shares may be bought up by central banks, governments, and/or the corporations
themselves – buying back their own shares.
Of
course, this is risky, as crashes are caused by loss of confidence. Papering
over that loss of confidence by papering over the cause of the problem only
means that when the crash comes, it will be worse than if it had been allowed
to collapse earlier.
Pensions
tend to be heavily invested in the markets, which tends to put them at risk as
well. The foremost mutual fund in the US is invested in 507 companies –
commodities, energy, financials, industrials, IT, etc. To be sure, these will
not suffer equally in a crash, but all will be affected – some severely.
If
an investor gets skittish about being tied so heavily to banks and the stock
market, he might decide to buy some precious metals, as he’s hearing it bandied
about that precious metals provide a hedge against stocks. But, knowing little
about metals, he’s likely to be “prudent” and call his broker, rather than
visit the coin shop to buy some physical gold. Most likely, his broker will do
what’s easiest for him – buy metals online. This is termed, “paper gold” – a
certificate that confirms ownership of gold that’s stored, most often, in a
financial institution. Trouble is, the paper gold industry has also been on the
fiddle for quite a few years. The institution doesn’t actually buy the gold, it
simply promises to buy it if the client decides to cash in. It’s estimated
that, at present, institutions have sold roughly 150 times the amount of gold
that actually exists in the world.
Again,
if only one institution were to be in on this scam, it might be able to save
itself if caught out. However, when an entire industry is in on it, the crash,
when it comes, will wipe out virtually all the value that the client assumed he
had.
So,
what does this mean to the investor who has sought to be diversified in a time
of impending economic crisis? It means that he is, in fact, not at all
diversified. His investments, whilst having the appearance of diversification,
are tied up almost entirely in banks and the stock market.
In
the US (in 2010), Canada (in 2013) and the EU (in 2014), governments have
passed legislation allowing banks to confiscate (steal) depositors’ funds,
should they (the banks, not the government) decide
unilaterally that they have an “emergency situation.” This, of
course, is like placing a steak on the table, asking the dog not to eat it,
then leaving the dog in the kitchen alone, with no supervision.
Since
all the above conditions are in existence
now,
what can the investor expect the future holds for him?
Well,
let’s say that there’s a sudden spike in the gold price and a significant
number of people (5%) holding gold decide to take delivery or cash out. Sellers
would be unable to deliver, which almost certainly would result in a run on
paper gold. A crash in paper gold would result.
Or,
if the Chinese were to sell a significant amount (again, say 5%) of their US
treasuries back into the American market, we might expect to see a crash in the
dollar.
Or,
if, say, Italy were to default on its debt, we could expect a crash in the
euro.
If
another “Lehman” failure were to occur, we might be looking at a bank panic,
causing a freeze on deposits, coupled with confiscation.
If
the world, much of which has already agreed to pay for oil in currencies other
than the dollar were to begin major settlements in, say, the yuan, the era of
the petro dollar would end abruptly, bringing on a crisis.
Any
of the above occurrences could trigger a crash that could wipe out what is now
perceived as wealth. But these aren’t the only possibilities. If major players
suddenly liquidated their ETF’s, if a tariff war were to unfold, as in 1930, or
if interest rates were to rise significantly … well, you get the picture. There
are many possible triggers out there, each one capable of fomenting a crash.
An
event as minor and as arbitrary as Mrs. O’Leary’s cow kicking over a lantern caused
a city of rickety structures to burn. But, today, the economic barn is full of
cows. Each is standing next to a lantern. And the economic structure is
very rickety.
The
reader can decide whether he feels comfortable tying his wealth up in bank
deposits, the stock market, pension plans, gold ETF’s, etc. If he concludes
that it may be time to “Get out of Chicago,” he would be in the minority.
Historically, the great majority tend to believe in the status quo and assume
that “planning for the future” means following the advice of bankers and
brokers. But, with so many aspects of the economy so close to the edge, the
odds of a spark setting off a conflagration are
very high.
Of
two things we can be certain. The resultant damage caused by the crash will be
far more extensive than in the Chicago fire.
And In the age of computers, the destruction of wealth will spread far
more quickly than the fire.
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Jeff Thomas is British and resides in the Caribbean. The son of an economist and historian, he learned early to be distrustful of governments as a general principle. Although he spent his career creating and developing businesses, for eight years, he penned a weekly newspaper column on the theme of limiting government. He began his study of economics around 1990, learning initially from Sir John Templeton, then Harry Schulz and Doug Casey and later others of an Austrian persuasion. He is now a regular feature writer for Casey Research’s International Man (http://www.internationalman.com) and Strategic Wealth Preservation in the Cayman Islands.
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The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.
