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Politics, Astrophysics, Missing

Money & Finance > The Money Window is Open
 

The Money Window is Open














GoldMoney Alert
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The Window is Open
The money creation window of the Federal Reserve is wide open, but
it doesn't seem to be doing much good. The share price of countless
financial institutions continues to crater, as the market senses that
these overleveraged behemoths have assets on their balance sheet that
do not reflect today's reality. The boom has passed, and we are now in
the bust, just like night follows day. Wealth destruction is today's
prevailing force as assets of all sorts are marked down in value.
What the Federal Reserve wants to make us believe is that the
liquidity it is providing through its various lending schemes is
sufficient to make solvent those financial institutions that have
become insolvent. Unfortunately, economics doesn't work that way.
Capital - and not newly printed dollars - is needed to make insolvent
banks solvent, and given decades of over-consumption and under-saving,
capital is in short supply.
Last year the Treasury and the Federal Reserve told us the sub-prime
crisis was "contained". Then they told us that bailing out Bear Stearns
would end the financial meltdown. They told us that Fannie Mae and
Freddie Mac had sufficient capital and liquidity and would not need a
bailout. What else are they going to tell us trying to make us believe
that today's over-indebted financial structure will not collapse?
The point is that financial assets are based on promises, and
promises are being broken right and left. It is no surprise therefore
that bank balance sheets no longer reflect reality, and that many
financial institutions are trading below their book value. The market
understands the nature of today's wealth destruction and is therefore
taking a prudent 'hair-cut' to bank balance sheets. The result is that
a firm's market cap is probably a better reflection of a financial
institution's real value than its quarterly reports. In short, the
assets of many financial institutions are overstated.
In the 1930s wealth destruction resulted in deflation because the
dollar's fixed link to gold led to a contraction in the money supply.
As promises increasingly came to be doubted, wealth moved out of
financial assets into tangible assets. As the most liquid tangible
asset, gold benefited the most, and its purchasing power soared as a
consequence, even against the dollar, which was devalued 69% against
gold from $20.67 to $35 per ounce. In a deflation, the value of money
increases, and in the 1930s, the value of gold increased the most of
any money.
There is wealth destruction now, but the value of dollars and all
national currencies is decreasing because of inflation. The cost of
living is rising today even by the government's own measure, which many
people including me believe understates the true loss of dollar
purchasing power. Of course, gasoline prices have fallen over the last
couple of months, but compare today's gasoline prices to where they
were a year or two ago. In fact, to get a true measure of the loss of
purchasing power in all national currencies, compare the price of
nearly everything to a year or two ago. With the notable exception of
real estate, the price of most everything is going up.
Real estate is a special case. Its price is going down because it
had become way overvalued a year or two ago, and prices at that level
were unsustainable. Consequently, we are today seeing wealth
destruction, but to get the true picture, we need to keep in mind that
we are measuring the decline in house prices and other real estate
assets with a currency that keeps inflating. And the prospects are that
the dollar will keep inflating because the Federal Reserve's 'window'
remains wide open, as is the 'window' at every central bank around the
world.
In short, the wealth destruction of the 1930s resulted in deflation
because national currencies had a fixed link to gold, and the quantity
of dollars shrunk as insolvent financial institutions went bankrupt.
This time around wealth destruction is leading to inflation because
central banks are creating 'money' out of thin air to try plugging the
black holes on the balance sheets of insolvent financial institutions
in an attempt to keep them out of bankruptcy. It won't work. They will
still go bankrupt because central bank liquidity does not help bank
insolvency.
All central banks can do is postpone for a while the final
reckoning. As more and more promises are broken, increasing amounts of
wealth will exit financial assets to avoid counterparty risk. This
wealth will go into tangible assets, and gold in particular because it
does not have counterparty risk.
So why did the price of gold drop last week?
It's a good question, particularly given the fact that the Dollar
Index was unchanged from the week before. I could and will point to the
usual culprits, including governments and over-leveraged hedge funds.
But the price of most things dropped last week, including crude oil and
other commodities too. So here's the important point.
Have the reasons for owning gold and silver changed in the last week
or last month? I don't think so. We are witnessing significant wealth
destruction today that is undermining the solvency of financial
institutions. Yet the cost of living today is rising because the dollar
and other national currencies are being inflated as central banks
around the world try to make insolvent institutions solvent by pumping
money out their lending 'window'. But there is something even more
worrying than inflation.
National currencies come with counterparty risk. They are based on
promises, and promises are becoming increasingly unreliable. One does
not have to rely on promises and accept counterparty risk when owning
tangible assets like gold and silver, which in my view have become
exceptionally undervalued.


Published by GoldMoney
Copyright © 2008. All rights reserved.
Edited by James Turk, alert@goldmoney.com

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posted on Sept 14, 2008 2:04 PM ()

Comments:

Just saw that Bank of America is going to buy Merrill Lynch for 25 a share. Barclays backed out of talks to buy Lehmann Freres. Now watch out for AIG and Washington Mutual. They're next to go under.
comment by jondude on Sept 14, 2008 3:48 PM ()

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