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European Bank Runs And Underestimated Physical Gold Demand

by Trace Mayer, J.D. on December 5, 2011 · 17 comments

Reading time: 6 – 10 minutes

The demand for gold is vastly underestimated. About 18 months ago I wrote about Euro Gold and the Euro Zone and Euro Evaporation Leading To Credit Default Swaps and IMF Gold. One key excerpt was:

The Euro is broken. This was its destiny. This is the destiny of all fiat currencies. These bureau-rats cannot stop this anymore than Cnut the Great could command the tide to halt.

And here we are.

THE GREAT CREDIT CONTRACTION

The Great Credit Contraction has been in relentless advance for years. This is a massively deflationary period as capital, both real and fictitious, burrows down the liquidity pyramid into safer and more liquid assets. The fictitious capital that does not move fast enough evaporates. Poof goes trillions of wealth!

In the Information Age bank runs happen with the click of a mouse and not lines outside the physical branches.

FRACTIONAL RESERVE BANKING

Fractional Reserve Banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder while maintaining the simultaneous obligation to redeem all these deposits upon demand.

Fractional reserve banking occurs when banks lend out any fraction of the funds received from demand deposits. Despite being a form of embezzlement and fraud this practice is universal in modern banking.

This mismatch between time, borrowing short-term and lending long-term, is what creates the potential for a bank run. But an even larger looming problem lurks in ‘cash and cash equivalents’. Yes, those pesky Tier I, II and III distinctions.

As a bank’s assets evaporate their ability to make new loans, even extremely short-term loans like overnight, becomes impaired. When an entire banking system knows that all the major players have assets on their balance sheets, assets which are not accurately priced or accounted for, then there is an extreme reluctance to lend.

This is what happened when Lehman Brothers evaporated. The credit markets seized up. People acting in their own self-interest according to principles of praxeology moved into safe and liquid assets and refused to lend.

Liquidity dried up overnight. Mortgage backed securities, auction rate securities and plenty of other assets which had for decades been treated as ‘cash equivalents’ were suddenly shunned. The bid evaporated from a loss of confidence, the prices plunged, investors were snookered and bank balance sheets were massively damaged.

The gears of industry are seizing up.

EUROPE’S WORTHLESS BANK DEPOSITS

The European banks have balance sheets with trillions of Euros in value recorded but assets which every rational non-ignorant person knows are severely impaired. The credit markets are freezing, trust is evaporating and as a result liquidity is drying up.

Sure, the central banks of the world have joined in a massive illegal effort to lubricate the system but it will fail. Years ago when QE1 was announced I wrote The Federal Reserve Will Fail With Quantitative Easing. They are still failing just on a grander scale.

To recapitalize and lubricate the European banking and financial system would take at least €25 trillion and maybe upwards of €100 trillion. The failure is a mathematical certainty. The gears of industry are seizing up.

The Greek and Italian democracies were assassinated by banksters Lucas Papademos, Mario Monti and Mario Draghi who will attempt to prolong the failed banking and financial system by privatizing the gains and socializing the losses with inflationary tactics and bailouts in a vain attempt to prevent the credit liquidation. They will only succeed in prolonging and exacerbating the necessary correction.

What holders of capital should understand is that European bank balance sheets are caught in an unrecoverable credit contraction spin, the appropriate emergency maneuver is to Run To Gold and only a few will make it with their purchasing power intact.

The vast majority of assets will become charred wreckage as their purchasing power evaporates into worthlessness. Sure, there may be a few near miss recoveries between now and the ultimate failure but why take the risk?

LATENT GOLD DEMAND

There is massive latent gold demand as a ‘cash or cash equivalent’ asset. Why should a holder of capital store their wealth in bank deposits with counter-party risk when they can completely eliminate it by moving into unencumbered physical gold bullion?

Plus, by moving into physical gold bullion they eliminate the risk associated with fiat currency becoming worthless through the deflationary event called hyperinflation. Really, hyperinflation is just the next step in The Great Credit Contraction after capital has moved almost entirely down the liquidity pyramid.

The money managers allocating trillions of FRNs, Euros, Yen, etc. have not even begun moving into the monetary metals. In most cases it is only beginning to become acceptable to speak of them. Some fallaciously argue there is not enough gold to go around.

Sure, there is enough gold for it to be used as the world reserve currency but it is only a matter of price. A price that Jim Rickards argues the case for in Currency Wars of being between $8,000 and $54,000+ per ounce.

CONCLUSION

The European banking and financial system is imploding before our eyes in a massive credit contraction which is just the latest wave in The Great Credit Contraction. The European banks are in an unrecoverable deflationary spin. There is only one acceptable emergency recovery procedure and that is to Run To Gold.

Because so few have, therefore, the real gold demand is completely hidden and obscured from view. It will come when people lose confidence in the current banking and financial system by turning to and using alternatives that do not possess the same kinds of risks. In the Information Age bank runs happen with the click of a mouse and not lines outside the physical branches.

DISCLOSURES: Long physical gold, silver and platinum with no interest in DOW, S&P 500, the problematic SLV ETF, gold ETF or the platinum ETFs.

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17 comments

ABOUT THE AUTHOR: Trace Mayer, J.D., author of The Great Credit Contraction holds a degree in Accounting, a law degree and studies the Austrian school of economics. He works as an entrepreneur, investor, journalist and monetary scientist. Follow him on Twitter. This is merely one article of 241 by .
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{ 17 comments… read them below or add one }

1 acjitsu December 5, 2011 at 5:38 pm

Trace,

What concerns me is something Rickards eludes to in his book as a 90% tax on Gold. The only way for me to rationalize this is that it may be more risky holding dollars. What is your take on this? Thanks.

Anthony

2 Manupupule December 5, 2011 at 6:38 pm

In the insane artificial economy that is all pervasive in modern societies around the world, artificial scarcity and the resulting greed become the engine for centralization of power. The natural world in contrast is full of abundance beyond the needs or practical wants of all humanity for all time. We have everything we need to thrive harmoniously on this planet forever even while sustaining growth, it seems that isn’t enough for some people who seek something beyond our planet and are willing to subjugate and suppress the entire population to meet those ends. We may never know what exactly motivates these evil men but we do know that the ends do not justify the means and their is always another option than the apparent choices before us. For the rest of us we need only ignore the system that limits our potential and pursue decentralization and self sufficiency on an individual family and mass scale, the result will be peace and prosperity. Fiat money may be the root of all evil but barter is the root of all good.

3 Trace Mayer, J.D. December 5, 2011 at 9:33 pm

Anthony, I think a windfall tax has a greater probability than outright confiscation. Already the gold price suppression scheme keeps the devaluation so the 28% collectible tax, a barrier to entry in the currency market, makes gold unattractive alternative. With all the foreign financial asset reporting requirements, disclosures, etc. it could be difficult to legally avoid a windfall tax liability.

I do think the tax deferral for foreign corporations that do not have US-sourced income will remain viable though because so many of the large multinational corporations use those vehicles to shelter trillions of earnings. Thus, there may be some room for some creative planning like using a Hong Kong company to hold bullion in a GoldMoney account, or hawala into something like Bitcoin, etc.

Or there could be outright evasion or an increase in the ‘other economy’. Many people already understand there is ‘what you see and what you do not’. Invisible equity will get more valuable.

Real estate will likely remain a vehicle to store large amounts of wealth relatively anonymously. It will be assets in the formal banking system, bonds and publicly traded equities, that will pose the largest risk. One reason I recommend taking physical possession of certificates. Even better I like private companies. We are in an era where it is wise to reduce the layers between you and your assets. Not even clearing firms, like MF Global, are safe.

We are in for a wild ride!

4 Trace Mayer, J.D. December 5, 2011 at 9:34 pm

Manupupule, I agree. I do not understand the lust for power that some of these crazy and evil people have. Perhaps it is a reason that under Section 19 of the 1792 Coinage Act the death penalty was provided instead of a bailout.

5 joe December 6, 2011 at 12:06 am

Hi Trace,

Good article. A note: 1000+8100+900=10,000 in the money supply slide above (says 11,000 new money created).

Regarding your conclusion about the only one emergency recovery procedure, ie, run to gold for the Europe crises, at some time to be a US crises as well, I think there will be other attempted procedures before they get to running to gold. Rickards says they will probably try SDR (special drawing rights) in his book I believe and probably others before they make their way to gold. I agree with you that at the bottom of the final crises we will see power money (gold and silver) coming back.

I think there will be a war (other than the current currency wars noted by Rickards) coming and possibly orchestrated to distract from the financial crises. You see the US now posturing over IRAN nuclear hype just as we saw with IRAQ and also tensions building between Japan and China over the oil in their common oceans.

Dangerous times in my opinion. I suggest holding mostly silver in case they do confiscate in a crises, they most likely will hit gold before silver and silver is going extinct in 9 years so it has to go up in price because of this simple fact if your time horizon is 10 years.

6 Charli December 6, 2011 at 3:18 am

Trace, very sobering indeed. Already being long on gold and silver, my next concern – like others have mentioned – is that this tactical avoidance of currency deflation / hyper-inflation could itself be completely obviated by some blanket increase in capital gains tax or draconian precious metal taxes drafted in without public vote under “emergency powers” (FDR ’33 redux).

If this were to be the case what % chance would you give this of occurring, in Europe as well as US, and to what extent? (further 5-10% on CGT? / 50% tax? / 90% tax?), and when approx in the bubble price- spike-panic would it be most likely to occur?

i.e. is there ANY chance (greater than a few hours or couple of days) to exit the market and move into another asset class before such a tax becomes law, let alone avoid the cliff-drop in bullion prices which will occur once precious metals have peaked and there’s a rush to the exits.

Any view on when the peak/pop will come?

Regards

Oppressed citizen of Orwell’s Eurasia :-(

7 Trace Mayer, J.D. December 6, 2011 at 2:32 pm

Joe, good joke eh?

I think war will be a good cover for the coming price inflation. The saying will be oil is at $250 per barrel because of the war with Iran not because of all the bailouts and currency printing. This collapse of the fiat currency and fractional reserve banking system could take another 15-25 years as we transition into the Information Age. One of my more liked articles was How To Attack The Fiat Currency And Fractional Reserve Banking Conspiracy.

8 Trace Mayer, J.D. December 6, 2011 at 2:32 pm

Charli, on a similar note to the repsonse to Joe, I do think a capital gains tax or even a net worth tax could be in the works. I think many Europeans may be complacent because even if they are not residents they are not taxed on worldwide income just for being a citizen like US citizens are. I think this could be changed because of all the TIEAs. I think the windfall tax has a higher probability with Americans than Europeans though.

Since this could drag on for another 15-25 years and because there is no real alternative to the current worldwide monetary and financial system therefore I think a ‘peak/pop’ may be a lot further off than many suppose.

9 Charli December 7, 2011 at 3:00 pm

Trace

Thanks, very interesting. You think it will really take that long though? – what if the Euro falls apart inside 12 months, or breakaway countries revert to old currency and start defaulting?

What do you make of this perspective from Seeking Alpha who posit the bubble is already bursting (albeit based on a 3 month swing pattern of gold vs S&P)?

http://seekingalpha.com/article/311124-is-the-gold-bubble-popping-3rd-quarter-update

The markets (particularly gold) do seem unusually volatile at present. But then, civilisation in general is unusually volatile right now!

Regards

Charli

10 Trace Mayer, J.D. December 7, 2011 at 8:48 pm

Charli, Yes, it really could take that long. The current fiat currency system, a barbaric relic built over the last 500 years, is not going away anytime soon. With the Information Age here what I am suggesting is the trading of stocks, bonds, commodities, etc. priced and settled in gold on major markets. The creative destruction of the current system will happen but not very quickly. Want to buy a newspaper, telegraph company or wagon maker? How about a Spinning Jenny?

Gold can become expensive but there cannot be a ‘gold bubble’ because physical gold can neither become worthless nor have a negative value and is no one’s liability. If anything the world is currently experiencing the first stages of the collapse of the fiat currency bubble. This is the chief cause, if not the only cause, of the unusually volatility in society and because of the involvement of the State the resultant price controls have impacted the pricing signal which has been so severely disrupted that value and price are now bifurcated. Nature and natural law will not be violated continually though and a correction is happening. A correction that is destroying the capital saved over billions of lifetimes.

The article does get near a key point though and that is negative real interest rates. One problem with watching the CPI is that it is a blatant fabrication. I will stick with Prof. Jastram’s The Golden Constant when it comes to how gold performs in inflation or deflation along with its effect on other commodities.

11 Bea December 12, 2011 at 3:42 am

Thank you for your articles. I have question(s) that will sound unintelligent, but I will ask them anyway since I don’t know the answers: since Congress voted to have the Fed, what if Congress voted to no longer recognize the Fed? Besides losing the interest and principal it makes on the loans to the government, what types of impact would that have? And with countries owing IOUs to one another, wouldn’t canceling each other’s debts lower the debt owed to one another and ease some of the strain on the global economy? If the Fed were to waive the debt the government owed for one year, would it help ease the strain on our economy? I know it sounds a fairy tale, but I’ve never heard anyone touch on these… it’s always “What happens if a country defaults on its payments?”

And since the economic problems are global, as governments get desperate to the point of confiscating gold, how do we know that they won’t try to confiscate the gold that’s sitting in, for example, vaults in Hong Kong, Switzerland or London, where GoldMoney stores customers’ metals?

12 Trace Mayer, J.D. December 12, 2011 at 10:23 am

Bea, that is actually a very complicated batch of questions. Yes, Congress could pass or repeal legislation that could limit or eliminate the Federal Reserve. They have done it in the past with the First Bank of the United States and the Second Bank of the United States. Depending on how it was done and over what time frame there would be many different effects that would affect the domestic economy and global economy. Overall, it would be good because it would restore the essential check and balance that sound money provides to the political machinery and it would eliminate the price control as expressed through the interest rate which has resulted in a complete distortion of the pricing mechanism and the current system where price and value are completely bifurcated. Without the Federal Reserve America would likely enter another golden era like 1840-1890.

As far as a second domestic gold confiscation I think the probability is fairly low. I think it is more likely the US will confiscate the gold of other countries, but not of individuals, that have it vaulted in the United States, like Germany for example.

13 Charli December 13, 2011 at 8:36 am

Trace, what do you make of the 5% intra-day peak to trough spikes and plunges going on with bullion prices at the moment? – Is there any risk that central banks, investment banks or others that are either dumping gold to fund margin calls, knee-jerking to political news and selling out on short term speculation, or (in the case of government puppet banks) covertly trying to depress the bullion price by strategically shorting the market, will actually have the medium term (Q1-Q2 2012) effect of putting bullion on a permanent slide back down?

Or are these just (increasingly spikey) volatility blips in an inevitable creep up over $2,000 oz in 2012 in your view?

Do you see a natural “plateau” in the event that hyper-inflation or massive deflation DOESN’T occur (the ponzi-plaster-plan just kicks the can again for another year or few), and if you had to stake a few kg in bullion on it, what would that $ value be?! ;-)

Cheers

Charli

14 Trace Mayer, J.D. December 13, 2011 at 9:50 am

Charli, I think the volatility is part of the game and 5% is not that much. The real volatility is with people who, like Bloomberg reported on, have statements from broker dealers that say they have 10 bars of gold when in reality they do not have anything. That is a 100% swing. MF-Global is just the tip of the iceberg. The entire worldwide financial and monetary system is compromised and being looted.

I passed over this topic of actually having something briefly in a Sep 2008 interview. I do not think people, including you, truly understand what is happening. I think a lot of the volatility is because the big smart money is starting to really panic. Big smart money is more concerned with return OF capital than return ON capital. Price and value are completely bifurcated which is why there is a need to use gold, preferably the 200dma of gold, as the numeraire. Don’t catch an FTD. Poof!

The hyperinflation issue is continuing and massive deflation has already occurred so I am not sure why you are speaking in hypothetical; probably because you view gold as a portfolio asset and not as the numeraire. If anything we are currently in a ‘natural plateau’.

The way to play this depends on your risk tolerance. If you are fairly conservative then one method I would recommend is to sit on a lot of physical bullion as cash with something like GoldMoney (yes, I would trust them with million of FRN$s of value), buy productive cash flowing assets like real estate, Canroys, airplanes, etc. and leverage on those assets with non-recourse fixed interest rate balloon payment debt denominated in their cash flow. So if you rent the real estate for FRN$ then have FRN$ debt.

I have a buddy who bought some US real estate with a 7 year balloon fixed rate YEN mortgage. Not my idea of a good idea; I would probably have done US real estate with a 7 year balloon fixed rate LEV or ARS mortgage if I could find someone dumb enough to give me one at a good interest rate. The FRN$, YEN and Swiss Franc are the carry trade currencies so those are what you’d want your cash flow stream in while borrowing in the currency where the purchasing power is declining faster than the stated interest rate (where CPI, GDP, etc. is being grossly mistated for political purposes).

15 Charli December 13, 2011 at 12:41 pm

Trace, thanks, very insightful.

You are absolutely right when you say you think most people, inc myself, don’t truly understand what is happening. I understand enough to already have major investments taken intuitively in all the asset classes you mention. And understand the difference between the PRICE of precious metals and the VALUE of precious metals as compared to ratios against other asset classes and market indices.

What I don’t truly understand, but am trying to learn (I just bought your book on Kindle) is what the many layers of catalysts are that keep poking the markets, inc the activities of the ponzi & shadow banks. Plus if historical paradigms are super-cycles destined to repeat, albeit with modern varience. Or if a completely new paradigm shift is emerging (in part due to collective intelligence from web / social media) and unprecedented derivative debt, from which historical prognosticating has limited relevance?

To the lay investor, which is what I am, the continual discoveries via the REAL media such as websites like this, Kaiser, Celente and others (versus both sides of the political spectrum of the lame-stream-media, which are a total ignorant joke) is a never-ending, eye-opening revelation. History is a lie. It’s like the Matrix!

You summed it up neatly in your video piece at GATA a while back when discussing the original research for a college paper you were doing and just discovered the “rabbit hole” and how deep the entire fabrication and deception of modern economics is.

The reason most people don’t realise this, or at least not in a sudden epiphany (and also the “rationale” behind my statement of not PERCEIVING hyper-inflation (bread does not yet cost $50 a loaf, in currency terms, but in other asset terms it might)) is that the global financial situation for joe public is akin to the “boiling a frog slowly” analogy.

When the temp is ratcheted inch by inch, year by year, decade by decade, it’s pretty imperceptible to the average, busy, non academically (economics) versed person to realise that with a 30,000ft view the $ (and most other fiat currencies) is actually worth 2% of what it was 100 years ago. Only “Shock Doctrines” to use Naomi Klein speak are sufficient jolting of the temperature to make a small percentage (like myself) wake up and say “hang on, there’s much more to this that just boom-bust free-market cycles – what is REALLY going on?”.

Thankfully people like yourself, sites like this, and others are propogating real financial education which is just non-existent in the “bread & circuses” mainstream (for obvious control reasons).

Thanks & Regards

Charli

16 Trace Mayer, J.D. December 13, 2011 at 3:46 pm

Charli, thanks.

Not sure if you read my persuasive argument for the FRN$ being in hyperinflation and a podcast discussion on the topic. I should revisit the topic since it has been over two years since I first wrote about it.

I think one of the reasons most people do not get it is because of asymmetrical information which leads to specialization and the division of labor. There are so many branches of human knowledge that are so deep that the economy is incredibly complex. People can spend an entire lifetime studying just one tiny leaf in the tree of human knowledge. Even worse and a waste to spend a lifetime studying a false branch of knowledge like models explaining why the sun revolves around the earth.

If I were to bet I would propose that even the vast majority of people operating at the highest level of the financial game probably do not understand what is going on. For all his flaws I do think Alan Greenspan had a very comprehensive view. But even so the conclusions he drew and applications he made were and are still flawed.

Plus, as you bring up, now humanity has this new tool called the Internet. From a UCLA study:

“The study, which involved fMRI scans on 24 neurologically normal volunteers ages 55 – 78, showed that the portion of the group that had very little internet experience were able to change their brain activity patterns and increase function after just 7 days of one hour sessions searching the web.”

One thing I am confident in is that the Internet has changed the economics of violence, is allowing the truth to rise like the sun and we are transitioning into a new age; from the Industrial to the Information. As a result, there will be a lot of change; from the fundamental atomic unit of finance to the largest organizations. We can only do our best to see things as they really are.

17 Max January 10, 2012 at 5:56 pm

I really think Goldmoney is an excellent way to buy GOld. But do you think the FBar reporting requirements kill it? Because if you buy physical and hold it in your house, go sell with your local coins shop, well nothing gets reported tax wise,

Now with these forms and reporting it is not as private as holding bullion your self

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