|
|
----- Original Message -----
From: victorthecleaner
To: FOFOA
Sent: Wednesday, March 02, 2011 11:23 PM
Subject: question about bullion banks
Dear FOFOA,
I have read a few of your postings with great interest although I admit by
far not all of them. I have one question concerning the claim that it is the
allocation of unallocated gold accounts that will put the bullion banks out
of business. I shall be most grateful if you will help me with this question.
You may know some detail about the history of the London bullion banking that
I am missing.
In order to understand how a bullion bank operates, let us open one. We put
down
1 US$.
assets:
cash: 1 US$
liabilities:
shareholder equity: 1 US$
Our first happy customer Alice walks in and deposits her 10 oz. Our balance
sheet expands.
assets:
cash: 1 US$
bullion: 10 oz
liabilities:
unallocated gold accounts: 10 oz
shareholder equity: 1 US$
Note that we have neither credit risk nor exchange rate risk (bullion/US$).
The purpose of our bank is to lend. Luckily, customer Bob walks in and asks
us for a loan of 5 oz. Our balance sheet expands again.
assets:
cash: 1 US$
bullion: 10 oz
accounts receivable: 5 oz (loan to Bob)
liabilities:
unallocated gold accounts:
10 oz (Alice)
5 oz (Bob)
shareholder equity: 1 US$
We still have neither credit nor exchange rate risk. We are neither long nor
short gold.
Bob needs most of this gold to purchase a new motor bike. He withdraws 4 oz,
i.e. he has 4 oz allocated and then shows up at the vault
and takes them home. Our balance sheet shrinks.
assets:
cash: 1 US$
bullion: 6 oz
accounts receivable: 5 oz (loan to Bob)
liabilities:
unallocated gold accounts:
10 oz (Alice)
1 oz (Bob)
shareholder equity: 1 US$
Still, we do not have any exchange rate risk, i.e. we do not make any profit
or incur a loss if the price of gold in US$ changes. We are neither long nor
short gold. Our balance sheet is 'balanced' in each of the two currencies
(US$, gold) independently. But we do have credit risk because Bob may not
return the gold.
Now Alice wants to go shopping for furniture and withdraws 5 oz.
assets:
cash: 1 US$
bullion: 1 oz
accounts receivable: 5 oz (loan to Bob)
liabilities:
unallocated gold accounts:
5 oz (Alice)
1 oz (Bob)
shareholder equity: 1 US$
Again, no exchange rate risk. We are neither long nor short. The credit risk
is also unchanged. Note that our reserve ratio has become a bit stretched.
Our customers have a balance of 6 oz in their accounts, but we have just 1 oz
of physical bullion left in our vault.
There are two ways in which we might get into trouble.
1. Losses on our loans. If Bob defaults, we lose 5 oz of equity. Since the
loss is in bullion, we suddenly have exchange rate risk - if the price of
gold increases, our loss of equity (in US$) increases, too. We need to raise
equity and do so in the form of bullion.
Default of one of our debtors is a solvency problem.
2. If Alice showed up again and withdrew another 2 oz, we would have to think
for a minute. In order to hand out her 2 oz, we would need to recall the loan
to Bob.
If our assets and our liabilities have matching maturities, this cannot
happen. If the maturities are mismatched, i.e. if we have borrowed short and
lent long, we have a liquidity problem. We need to borrow bullion in the
market, for example, borrow US$ from the emergency lending facility of the
Fed and swap these US$ for gold, which we can then give to Alice. Once Bob
has paid back the loan, we can return the borrowed gold and close the swap.
The message here is that bullion banking is not at all different from
commercial banking if you view gold and US$ as two different currencies. As
long as we engage only in lending as opposed to proprietary trading, our
risks are the same as in commercial banking: default of our debtors or
mismatch of maturities. And the solutions are also entirely analogous:
raising capital or a liquidity injection from the Fed.
Now you say that the allocation of accounts at the LBMA will end in the same
way as the game of musical chairs. Why do you think that?
Do you know that the bullion banks had losses on their gold loans? Losses
about which the public does not know? Who is it who borrowed gold from the
bullion banks and then defaulted?
Do you know that the bullion banks have a systematic mismatch of maturities?
Who has the long-terms loans? Who would borrow gold for the long run? We know
that the gold mining industry is essentially
unhedged now.
I hope you have time to read all this and I thank you for your comments. If
you like to answer in your blog and copy this email, this is also fine with
me.
Victor
----- Original Message -----
From: FOFOA
To: victorthecleaner
Sent: Thursday, March 03, 2011 2:45 PM
Subject: RE: question about bullion banks
Hello Victor,
What you are describing is a typical model of fractional reserve banking. The
bank's liabilities are demand receipts so the bank is always vulnerable to a
run on its reserves. It relies on public confidence in its ability to cash
out any customer that wants cash (or in this case physical gold). And today
there is likely no lender of last resort for a bank run on bullion,
especially from the Bullion Banks. The best they can hope for from the CBs is
a cash backstop. And that's exactly what they will get.
No, I don't think the BBs had losses on their gold loans. In fact, most of
the time when a BB loans gold, it is only loaning paper gold (bank
liabilities), so it creates new liabilities on its balance sheet to make the
loan, just like your local bank creates new dollar liabilities on its balance
sheet to make a home loan. In the miner hedging days, the BB would lend gold
to the mines which the mines would sell to market (with the BB as the sales
agent). It was an all-paper deal. The mine was borrowing paper gold (BB
liabilities) and was selling that paper gold into the market. So it was
essentially a dollar cash loan with repayment denominated in ounces. So the
BB had to sell paper gold liabilities for dollar cash to be net neutral.
There's no exchange rate exposure there because the liabilities created (out
of thin air) are backed by the mine's repayment contract on the asset side.
Gold denominated liabilities and assets, backed by fractional reserves. There
is also little risk to the actual physical reserves from a default because no
physical left the building… yet.
As far as the maturity mismatch issue goes, think about a bank that makes a
home loan. It creates liabilities (demand deposits) in exchange for a 30-year
note. Does it have a physical dollar bill for every liability it creates? Of
course not. It relies on the fact that most people prefer bank credit money
over cash.
It is not my position that the Bullion Banks are exposed to net short
positions like the silver crowd (and most of the gold bug community)
believes. If you like to equate Bullion Banking with commercial banking, then
think about it like this: The unallocated gold, the reserves, are analogous
to physical cash in your local bank. The big difference being that more cash
can be printed in a pinch. Would you say that your local bank has a net short
position on dollars just because it has very little physical cash? Of course
not. But it can operate with very little cash in reserves as long as
the public is confident that cash will be there when they want it.
Based on your email, I think you need to view (gold, not silver) Bullion
Banking a little more "holistically" than you do. If we look back
to the gold standard, all banks were "bullion banks," because gold
bullion was international base money. Silver wasn't base money. It was a
metal used in coinage, much like zinc, copper and nickel today, but it was
not "a currency" in and of itself. Gold was. And it is still used
that way today.
The problems with gold bullion banking in the 21st century are deep, wide and
deadly. Bron posted a good quote yesterday: "Banks undertake risks on their
books that they can only cover so long as they continue to have access to
liquidity (funding, deposits, repos or central bank support). Bank capital is
never enough to ensure performance without market liquidity for reserve
assets. Banks are generally much less cautious about taking on risk, rely
overmuch on incomplete models to price risk, and manage capital to optimise returns rather than ensure survival."
"Market liquidity." Now there's the real risk, isn't it? And
therein lies the exchange rate exposure. A bank run
on gold bullion in the 21st century will mean that all offers to exchange
physical for paper have been withdrawn as zero supply confronts infinite
demand. The price of physical will run to Freegold
levels in the hidden backrooms and dark pools of real price discovery.
I'll give you one example of the depth I'm talking about. And this is by no
means the whole story.
The genesis of my blog is that it is a tribute to ANOTHER. (Clearly stated at
the top!) ANOTHER was most likely a European-CB insider described well by
Michael Kosares: "ANOTHER
offers one of the more plausible hypotheses for why the financial markets
have acted as they have in the past few years, and therein lies
his immense value to the reader, no matter who he is. Again, knowledge as is
conveyed in his series of "THOUGHTS!" is rarely to be found outside
the highest levels of international finance…"
The genesis of ANOTHER's writing, which started in Sept. 1997 and ran through
2001, was a revelation (leak?) by the LBMA in Jan. 1997. You can read about
it here:
http://www.gold-eagle.com/gold_digest/baron907.html
Here's the Red Baron index: http://www.gold-eagle.com/research/redbaronndx.html
The revelation was that the LBMA was clearing more than 30 million ounces of
gold per day. This was previously unimaginable in the gold market. Notice
that these records only began in Oct. 1996 and were first made public in Jan.
1997.
http://www.lbma.org.uk/pages/index.cfm?page_id=50&title=clearing_-_statistical_table
Here are a few excerpts from the Red Baron series:
It is relevant to notice gold's average trading size
per transaction, which was 29,140 ounces -- nearly one tonne
per trade (32,150 oz. equivalent to a tonne). This
is approximately $10 million per trade. This suggests (at least to me) the
trades are non-Central Bank transactions - and more probably commercial
operations related to CURRENCY TRADING. Interestingly, the average trading volume
for ALL INTERNATIONAL CURRENCIES IS ABOUT $1.2 TRILLION PER DAY.
[…]
The LMBA revelations show
that gold is a global currency of some substance and liquidity.
[…]
It appears that, when gold is
used as a currency (and not a store of value) it is not important what LEVEL
the monetary (i.e. gold price to the dollar ) unit has......only that it
maintains a reasonable amount of its value in the short run; long enough to
make your next transaction.
[…]
Remember, these huge volumes
on the LBMA are NOT from hoarders.... these are the numbers of merchants
using gold as a CURRENCY.
[…]
The LBMA change to
"transparency" is a definite power play. This could be their move
to push gold into a de facto currency.
[…]
It has been reasonably
estimated that world volume would be 3 to 5 times this daily amount. Again,
there is a huge undercurrent of gold volume, and no one is listening,
especially the paper markets.
This volume is paper gold, obviously. At least I hope that's obvious. And
paper gold is BB liabilities (in demand form). It's got to be someone's
liability. And that's what keeps it credible, that it is a
Bullion Bank's liability. Mine or corporate gold liabilities are
usually time repayment contracts, "accounts receivable," not
tradable demand receipts. All demand receipts are potential claims against BB
unallocated gold, just like your bank's credit money is a potential claim on
its physical cash.
If world volume was four times the daily LBMA clearing volume, that would
have been 160 million ounces of gold trading per day back in Feb. 1997. This
30-40 million ounces per day range rose to its peak of 43.7 million ounces in
Dec. 1997. At 5x world volume that would have been close to the trading of
Fort Knox every single day in the global paper gold OTC arena. It was this
explosion in BB credit gold liabilities that prompted the 1999 WAG as a
warning from the CBs to the BBs to chill out, IMO. ANOTHER hinted at this
problem in his very first appearance which was, incidentally, two years
before the WAG:
From Red Baron 5 -
Posted on the Internet September 14, 1997 by
"ANOTHER"
(an answer?):
This could be an answer directed to the "Red Baron"?
The CBs are becoming "primary suppliers" to the gold market.
Understand that they are not doing this because they want to, they have
to. The words are spoken to show a need to raise capital but we knew
that was a [smoke] screen from long ago. You will find the answer to the LBMA
problem if you follow a route that connects South Africa, The Middle East,
India and then into Asia!
Remember this; "the western world uses paper as a real value, but oil
and gold will never flow in the same direction." -Big Trader
The daily LBMA clearing turnover has dropped to 18 million ounces today. But
even at today's lower amount, if the 3 to 5 estimate
above holds, it is still likely to be more than global ANNUAL gold mine
production that is traded (OTC) every single day. And what do you
think is actually being traded as if it were simply another foreign currency?
Bullion Bank liabilities! BBs make money like any other bank, on their
ability to issue "liabilities" as if they were real money, willy-nilly.
How many of these "BB liabilities" are outstanding at any given
point in the 24 hr. cycle? And do you think these liabilities have any LESS
of a claim on the BB physical reserves (unallocated gold) than any other? The
answer is that all BB liabilities have an EQUAL claim. Whether you deposited
2 tonnes of physical yourself 30 years ago after
your rich grandfather died or if you called in a currency exchange order last
night. Equal ability to demand allocation.
Think about it this way. Think about Eurodollars. Think about European banks
outside of the Federal Reserve System making dollar denominated loans or
simply issuing dollar liabilities to FX traders. Sure they have a few
physical dollars in reserve. But they don't have direct access to the Fed
lending facilities. So if they find themselves short on reserves, they will
have to go into the market to buy some dollars, just as you say. Which, in aggregate, could drive up the price of the dollar
versus the euro. Which is why Ben arranged a $500B
currency swap in 2009. To keep the dollar from spiking. Unfortunately,
though, Mother Nature is not quite as accommodating as the Bernank.
If you've got $100 million in a FOREX account at one of the Bullion Banks,
call them up and transfer it into gold.[1] Let me
know the exchange rate they give you. Then tomorrow, call the bullion desk
and ask for allocated storage of your account. And be sure to let me know the
runaround they give you. If it's bad enough, you might just make the news!
Sincerely,
FOFOA
From: victorthecleaner
To: FOFOA
Sent: Thursday, March 03, 2011 10:19 PM
Subject: Re: question about bullion banks
Dear FOFOA,
Thank you so much for your time and for your detailed reply.
> If you've got $100 million in a FOREX account at one of the
> Bullion Banks, call them up and transfer it
into gold. Let me
> know the exchange rate they give you. Then
tomorrow, call
> the bullion desk and ask for allocated storage
of your account.
> And be sure to let me know the runaround they
give you. If
> it's bad enough, you might just make the news!
I think I get it. You are saying that when I call the FOREX department, they
do not purchase spot gold on my behalf, but rather the bullion bank offers me
an open-ended paper gold loan (strictly speaking it is an open-ended swap
against US$). Well, this is maturity mismatch par excellence.
Very nice. I think, now I do understand your point:
* fractional reserve lending against a non-fiat reserve will blow up one day
* bullion banking was never intended to make sense, it is simlply
an anachronism and a relic from the times of the gold standard
* the bullion banks forgot to unwind it when it was still possible
* for some reason they keep extending new loans to new customers (just called
their FOREX desk, got $1427.20, tomorrow I will call the bullion desk, not
sure you will read about me in the Financial Times though)
* once there is a period of strong demand for physical bullion, the system
will blow up
* the time is probably now
Thanks again for your time,
Victor
[1] "At Royal Bank of
Canada, we trade gold bullion off our foreign exchange desks
rather than our commodity desks," says Anthony S. Fell, chairman of RBC
Capital Markets, "because that’s what it is – a global
currency, the only one that is freely tradable and unencumbered by
vast quantities of sovereign debt and prior obligations.
In short, says Fell,
"don’t measure the Dollar against the Euro, or the Euro against
the Yen, but measure all paper currencies against gold, because that’s
the ultimate test." [Source]
Sincerely,
FOFOA
FOFOA is A
Tribute to the Thoughts of Another and his Friend
Donations are most appreciated, just click
here
|
|
