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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 242 by .
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