The
bail out of Bear Sterns has validated all the worst fears and forecasts
expressed in these newsletters over the past few years. The Fed has once
again verified that it will create whatever new liquidity is required to
prevent any particular crisis from developing into a deflationary debt
implosion.
The bail out was
undertaken not because Bear Stearns was “too big to fail”. It was
done because of something called “inter-connectivity”.
What does this
mean? It is Fed-speak for concern about the $600 Trillion notional value of
derivatives outstanding, with just about every bank in the world
participating to greater or lesser extent. By far the biggest player in the
derivatives market is J P Morgan.
The problem with
derivatives is that these are individual transactions between 2 or more
parties. Often the transactions are arbitraged onwards to several other
players. Everyone in the chain relies on all the other parties to meet their
obligations. If one party in the chain goes bankrupt, it can cause a domino
like collapse of all the other parties in the chain – if the bankrupt
party is a large player in derivatives. They are all
“inter-connected”.
Bear Stearns is
known to be a big player in the derivative markets and must have been a major
counter party to many transactions with JP Morgan, given Morgan’s huge
derivative positions. Hence Bear Stearns had to be rescued because of
“inter-connectivity”; to prevent a melt down in the derivative
markets. It can hardly be a coincidence that the bail out was routed through
J P Morgan.
Let us be clear
about where this will end. It will end with the Fed and/or the US Government
owning or guaranteeing all the bad debts and losses from all sources in order
to preserve the existing system. It has serious implications for the value of
the US Dollar, the international monetary system and for inflation. The vast
quantity of new liquidity that needs to be created will almost certainly
result in runaway inflation.
The initial
stage of this developing crisis created a change in sentiment from “what
is the return ON my
investment” to “how do I get the return OF my investment”.
That change in
sentiment caused a rush to buy US Government bonds and short dated Treasury
Bills. Holders of these assets are assured of the eventual return of their
capital in nominal terms, i.e. in
current US Dollars. This would be a smart move if the crisis was developing
into a deflationary debt implosion. It is not a smart move in a runaway
inflationary event.
The next phase
in this crisis is likely to involve a further change in sentiment to “how
do I protect the value of my capital in REAL terms?”
When that change
of sentiment occurs, there will be a rush out of bonds into tangible assets
that offer protection in real terms. The bond markets are several multiples
bigger than the stock market. Consequently when this change occurs, very
large amounts of money will be chasing relatively small amounts of those
assets that provide protection in real terms. Expect very large and rapid
gains in the precious metals, base metals and mining company shares as a
consequence of the coming rush out of bonds.
We can now
consign Government Bonds to the upper layers of John Exter’s
inverted asset pyramid that has been referred to several times in these
newsletters. For ease of reference, the description the inverted pyramid is
appended:
“Imagine
an inverted pyramid consisting of layers of various investment asset classes
where the least secure (and most prolific assets) are in the very wide top
layers. The inverted pyramid then narrows down through layers of increasingly
more secure assets to the small point at the base which consists of the most
secure (and least prolific) assets. The theory is that in times of financial
crisis investors will cause their investments to devolve downwards through
the different asset layers in the inverted pyramid as they search for greater
security. This move to assets representing greater security is already happening
in the current crisis.
The asset in the
most secure category at the tip of the inverted pyramid is gold. Platinum and
silver bullion lie directly above gold. Precious metals have performed the
function of protecting wealth throughout the ages. In the layer above the
precious metals are base metals, uranium and the minor metals. Above them are
the companies that mine and hold large deposits of metals. The least secure
assets in the envisioned environment, which form the broad layers at the top
of the inverted investment pyramid, will be financial and paper money
assets.”
Bottom
line: It is time to part from your debt.
Alf Field
Disclosure and Disclaimer
Statement: The author is not a disinterested party in that he has personal investments
gold and silver bullion, gold and silver mining shares as well as in base
metal and uranium mining companies. The author’s objective in writing
this article is to interest potential investors in this subject to the point
where they are encouraged to conduct their own further diligent research.
Neither the information nor the opinions expressed should be construed as a
solicitation to buy or sell any stock, currency or commodity. Investors are
recommended to obtain the advice of a qualified investment advisor before
entering into any transactions. The author has neither been paid nor received
any other inducement to write this article
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