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WINTER
INTENSIFIES
The
deflationary credit contraction, or as some call a Kondratieff Winter, is intensifying. For the time
being the worldwide financial and monetary systems have taken a step back
from complete oblivion. The usual measurements such as the TED spread,
three-month LIBOR and the two year swap spread have shown improvement.
This improvement should not be mistaken for a miraculous healing
because the fiat currency fractional reserve banking system is terminal.
Eventually it will be replaced by a commodity currency with 100%
reserves and no counter-party risk.
The
system does not so much collapse as evaporate and these
measurements only show a decline in the rate of the evaporation. For
the most part the financial crisis of 2008 only affected Wall
Street. 2009 will be the beginning of Main Street being
affected. With unemployment at 17.5%, according to John Williams of ShadowStats, the
Greater Depression has arrived and only begun.
U.S.
TREASURIES ARE THE BIGGEST BUBBLE OF ALL
A few
weeks ago I explained why U.S. Treasuries are the Biggest Bubble of All. In
summary, gold is the ‘risk-free asset’ and the normal and natural
way for money and currency to function is with gold and silver or some other
physical commodity. This allows for useful and accurate value calculation instead of the current derivative illusion. Financial historians may very
well view the 95 year FRN$ bubble as an unusual anomaly and wonder
how so many people were so ignorant much like we view the culture who thought
the earth was flat or that the sun revolved around the earth.
Currently
as evidenced in the M1 Money Multiplier the velocity of the FRN$ is slowing
tremendously. As Ludwig von
Mises predicted decades ago in chapter 20 of Human Action, ‘The boom can last only as long as
the credit expansion progresses at an ever-accelerated pace. … But
then finally the masses wake up. … A breakdown occurs. The crack-up
boom appears.’ Which begs the question:
HOW
AND WHY THE U.S. TREASURY BUBBLE WILL BURST
As
long as the U.S. can pay and issue debt the currency event of hyperinflation
cannot happen. Because the U.S. has no internal savings the debt must
be absorbed by foreigners. When foreign demand for U.S. debt subsides
then at least two scenarios can happen: (1) printing the money with
hyperinflation or (2) a default which may not result in hyperinflation.
But what I want to do is focus on the liquidity pyramid.
Seeking
safety and liquidity capital has moved from derivatives to real estate to
commodities to MUNI bonds to listed stocks to Treasury bills to gold and all
the assets either financial or tangible in between. The liquidity
pyramid is not set in stone but mainly a large scale roadmap. Most
assets can easily be placed in the liquidity pyramid somewhere.
At all
times and in all circumstances gold remains money. Therefore,
the Ancient Metal of Kings belongs at the very tip of the pyramid. Gold
has been and is in tight supply because holders of capital do not want
counter-party or custodial risk. Finding a trusted third party, like GoldMoney, to
hold one’s bullion in a proper way is extremely hard. As a
result, spreads on both coins and bars have risen significantly. People
want physical possession of the ’sweat of the sun’ and not
‘paper gold’ like the problematic GLD or SLV ETFs.
COUNTER-PARTY
AND CUSTODIAL RISK
An
essential element of counter-party risk is the reliance on the financial ability
of the counter-party. For example, if you house burns down then
receiving proceeds to rebuild the house is contingent upon the insurance
company’s financial ability to pay. By contrast, if you drop off
a suit at the dry cleaners and they go bankrupt then you get your suit back
and do not get in line with the other creditors because the suit was held in
bailment.
As
counter-party risk increases holders of capital develop
more suspicion of their brokers, custodian banks and on through the
food chain. As holders of capital seek safety and liquidity they
decrease the layers of risk between them and their purchasing power.
WHY
TREASURY BILLS WILL BURST
People
run to Treasury Bills seeking safety and liquidity because they are lower in
the liquidity pyramid. However, as more capital piles into them it
drives rates lower and lower. Eventually Treasury Bill rates reach 0% or even go negative.
This presents a problem.
Why
hold a Treasury Bill with a bank, broker, custodian bank or the Federal
Reserve itself when you could take possession of physical Federal Reserve
Notes?
Taking
possession eliminates at least two types of risks. First, is any
potential counter-party risk with whoever is holding the Treasury Bill for
you. Second,
‘political risk’ which is a much larger threat. For
example, what if the Treasury Bills cannot be rolled over? What if the
government does not redeem the Treasury Bills? What if the government,
like other governments have done, decides to transmute the Treasury Bills
into 1-2% perpetual bonds?
HOW
TREASURY BILLS WILL BURST
As the
yields on Treasury Bills approach 0% they have the return of cash but do not
have the benefits of cash as they may be impregnated with
counter-party risk or have decreased liquidity. In other words,
Treasury Bills and cash have the same benefit profile but not the same safety
and liquidity profile. This analysis also applies to demand deposits with the
bank such as checking accounts or CDs. All the downside but none of the
upside.
Holders
of capital seek to eliminate their downside while maintaining the same upside
resulting in less demand for government debt. To entice capital up the
liquidity pyramid rates must rise but cannot because so much capital is
moving down the pyramid. To date, enticements up the pyramid have
failed as MBS, Auction Rates Securities, ABCP, the DOW, S&P 500, etc. all
show as asset price deflation continues and intensifies.
When a
house of cards collapses there are at least cards left on the table. In
the current case, there are no cards left on the table. As we see the current
system is not collapsing but evaporating.
CONCLUSION
The deflationary credit contraction is intensifying. Holders
of capital seeking safety and liquidity have driven down yields on
Treasury Bills. Treasury Bills have the same upside as physical Federal
Reserve Notes but additional downside. As holders of capital seek to
eliminate the downside for which they are not being adequately compensated
demand for government debt will decline. For these reasons the U.S.
Treasury Bubble is destined to burst.
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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