Friday, April 22, 2011

What is that chewing sound?

I’ve been getting comments from people pointing out that I was “wrong” when I told people not to rush out and buy gold when it was 1200 and now its 1500. First off I don’t give financial advise except to buy canned goods because all advice is wrong eventually. That is it’s like the weather, “if you don’t like it, wait ten minutes”. I’ve always said about gold, if you have extra money and you want some insurance against the worst possible scenario, then sure, buy some. But don’t kid yourself that you know the future price of anything.

When gold was 1200/oz the Fed hadn’t printed a trillion USD and pumped it into the markets by buying Treasuries from rich people. It was their stated intention to create inflation to avoid massive deflation. There was no consensus that it was going to work, we could be looking at 300 dollar/oz gold now instead of a $300 gain.

It’s easy to say we are going to have lots and lots of inflation because hardly anybody can remember anything else, it has been 80 years since 1930. For most people the Great Depression is as remote as the crusades.

I’m going to explain deflation again and I’ll try not to put you to sleep. Drink some coffee or maybe just keep these images in mind to stay awake. Empty store shelves, food riots, mass panic, cities burning and indiscriminate warfare coming to a town near you.

The USD and in fact all modern currency is just an accounting sheet that tallies debt. We call this the fractional reserve banking system where almost all money is created by the issuance of debt. If debtors begin to default in a systematic way like they did after the sub-prime collapse in 2008 it can take so much money out of the system so fast that the system collapses. Most dollars then disappear as they only existed on the balance sheets of the suddenly extinct banks and the remaining dollars must cover more assets and prices plummet uncontrollably searching for equilibrium. (keep in mind the plastic credit/atm card in your wallet is just plastic)

The problem is that our economy has been systematically stripped of all of its productive components that have been sold to China for a quick buck. What economy that we have left is dominated by people making hundreds of billions a year from pushing paper around. In order to maintain the level of income that they have become accustomed to they continue to  hollow out what is left like termites in the wall.

The sub-prime crisis by comparison only represented a small fraction of the loans that are based on inflated asset prices. Most of the rest of the US is similarly leveraged and it will all start coming due in 2012. There are still trillions of sub-prime loans that haven’t hit the balloon payment stage. There are trillions in commercial loans that are all coming due less than 5 years after the crash. Add trillions of corporate junk bonds left from all the mergers and acquisitions that sold 50,000 factories to China. All of this starts coming due in a matter of months.

The majority of US financial assets are controlled by five large banks, there used to be quite a few more banks, in case you don’t remember before 2008.
The ones that were bailed out were called the “too big to fail” banks and they have only gotten bigger and more unsound since then. Giant Termite Colonies would be a better name, six legged Wall Street bankers just nibbling away at the beams that hold everything up. A deflationary collapse could still happen despite all the new money being printed by the Federal Reserve because even the “new“ money is just debt based on collateral of no real value.

The Dodd-Frank Law does in theory give the Obama Administration the tools to step in and take control before everything collapses completely. The Gold Bugs (people who think that gold is the answer to all things) are predicting $8000/oz for gold but deflation could just as easily result in $80/oz gold instead. Do you listen to the Gold Bugs or the Termites chewing in the ceiling beams. Your guess is as good as mine.


ickenittle said...

So many people are still chasing the 'get rich quick'scheme.

Have they already forgotten the house flipping fiaso?

When all the fish swim one way-swim the opposite way.

Always works-always will.

Duke said...

Honesty trumps all. Good on ya brother, just wish my TBT as a hedge didnt suck so far LOL

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