Categories:
General Market Commentary
/
Precious Metals
Topics:
General Market Commentary
/
General Precious Metals
Global Insanity Prevails
Sector expert Michael Ballanger uses storytelling and personal experience to unpack the myths and machinations behind the precious metals and financial markets.
"Destroyers seize gold and leave to its owners a counterfeit pile of paper." —Ayn Rand
Why don't we start things off a tad differently this evening? Let me relate to you all a parable from the Book of Quantitative Easing where all is good and noble in the world of government oversight, the most widely used oxymoron in the history of mankind.
Granny Smith, now in her late nineties, wakes up one morning and finds that her dear husband for nigh-on seventy years has gone on to meet his Maker. But alas, as distraught as one would expect her to be, she is covertly delighted because, well, old Egbert Smith was not exactly the man she married and being forced to change his diaper and his bedsheets each night had grown both tiresome and difficult.
When the lawyer had finished probating the will after eight meetings that could have been just as effective with one, it was learned that Granny was in possession of a sizeable pool of capital, on the order of US$5,000,000. She immediately ordered a meeting with that nice young man from the bank that "smiles at me and always smells good" in an effort to determine what she should do with her money.
You see, for the past fifty years, husband Egbert handled the family finances because, well, women were not expected to understand money. But prior to marriage, Granny had a job in a bank and was quite proficient in helping "customers" (as opposed to "clients") understand how the bank was trying to screw them. She understood fully the "Power of Compounding" long before some wannabe-evangelist-cum-motivational-speaker windbag decided to sell a million copies of his latest (plagiarized) book. However, I digress. . .
She enters the mahogany-walled offices of the bank CEO with her handbag full of post-it-note reminders of just how he is going to try to make her $5,000,000 work for him instead of her and sits down in the largest, plushest, most expensive, high-backed chair in banker history.
"Five mil is a lot of money" is the opening salvo of this former drug-dealer-car-salesman-turned-bank-CEO as he shows her a chart of the five top banks' CD (certificate of deposit) rates. "The range for a 5-year CD is minus 0.23 to minus 0.29 with the our bank, highlighted in yellow. Remember, we value your money," he says and then asks his "administrative assistant" to fetch them some tea and cookies. "And I want you to know that safety is paramount."
Granny Smith looks at Mr. Bank CEO and says, "Forgive me, Mr. Morgan, but I am an old lady trying to understand your business so please describe to me what is meant by the minus sign before those figures."
"Well, Mrs. Smith, it's pretty simple. We protect your money from thieves and corporate raiders and the government so that you can live the rest of your life stress-free."
Granny looks up at him quizzically from a half-knitted tea cozy and two very intimidating needles as she says, "Well thank you, but what I meant to ask was what return I will have on my money if I deposit it at your bank in your government-insured Certificate of Deposit?"
At this point the banker starts fiddling with his tie and perspiring heavily as he goes on for another fifteen minutes about "global uncertainty" and "government guarantees" and "bank safety," and at the exact moment he decides to launch into his "final close," to get $5,000,000 cash into his bank, which desperately needs to shore up the $6 billion in bad car loans, little Granny Smith interrupts him with this, the most innocent of all questions: "Mr. CEO, if I give you and your wonderful bank all of my five million dollars, how much will I get back after five years?"
Now choking on the ramifications of a truthfully answered question, Mr. Bank CEO pivots into the "You-don't seem-to-understand" defensive formation, followed by yet another twenty minutes of diatribe.
At this point of the early evening, Granny has been transformed from an "innocent and quite defenseless elderly lady" to "totally pissed off and ready-to-rumble granny-goon," and decides to ask the banker the ultimate question. Holding a Hewlett Packard financial calculator in her left hand while pointing one of her knitting needles at his throat with her right, she snarls "How much freakin' money do I get back on September 12, 2024, if I give you my $5 million today?"
The banker stands up; he straightens his tie; he wipes his brow; and he says to the now openly hostile granny, "$4,290,435, my dear, but with the full safety and security of our bank."
Granny: "So, let me get this straight. I give you five million dollars today and five years from now, when I’m 103, you give me back less than i started with???"
The banker CEO smiles bravely and says, "Welcome to the New World Order, Mrs. Smith."
She grabs her bag, rising quickly from the high-backed chair, and says with the utmost of decorum, "Welcome to the World of f-you, Mr. Banker." And leaves the building.
And so ends the first parable.
Why, pray tell, would anyone in their right mind, let alone a fiduciary entrusted with the prudent stewardship of client capital, ever buy a financial instrument from a high-risk institution (remember subprime?) that guarantees a negative yield to maturity? Now, I don't pretend to be a balance sheet genius, nor do I profess to understand all the financial engineering that is practiced these days but it seems to me there is a checklist of possible reasons. Here are but a few:
- You have borrowed money from the financial institution and they demand you put up collateral in the form of a bond yielding negative returns. In other words, they layer a second level of "fees" on you, jacking up your effective cost of borrowing to inflated levels;
- Your financial institution uses government securities as a reserve requirement in order to soften the interest expense to the government. Since the government regulates your financial institution, they are forced to play ball and the added inconvenience is passed along to the customer,
- You are a professional money manager that sees rates going from –1% to –2%, thus opening up a potential capital gain in the price of the bond. As there is an inverse relationship between yield and price, declining yields are accompanied with rising price, hence the rationale for playing the "Greater Fool" game. The early idiot sells the useless bond to a bigger idiot and banks the gain;
And finally,
- You were walking to work this morning and were hit on the head by a falling quote machine thrown by an incensed gold trader and were senseless when you made the decision to buy a bond that ensures that you will lose money.
I am sure there are many, many more reasons someone buys a negative-yielding financial instrument, and reasons that are quite possibly more sophisticated than the ones listed above. The point I make is that when you really think about the symptoms of a collapsing global banking system, one needs look no further than the 65% of all global bonds that are delivering a negative yield.
Strong economies are found in regions and countries that are sporting strong balance sheets, just as strong companies are able to cover interest costs from existing cash flow with ease. After several decades of mercantilist behavior fully supported by governments across the globe, with the exception of those countries (Russia, China, Cuba, Zimbabwe, and now Venezuela) that attempted to function under socialist/communist systems of government, we have now arrived at the ultimate tipping point, where government spending now not just exceeds, but dwarfs, tax receipts.
In the case of China, where the shadow banking system cloaks much of their toxic debt, they do not have the additional burden of entitlements, which are the Achilles heel of the American government, military, and banking system. Whenever I look around and try to find a country living within its means, I am hard-pressed to find one. Maybe the Sultan of Brunei could offer lessons as his country sports the lowest debt-to-GDP (gross domestic product) ratio on the list, and while Japan is the worst offender, their total debt at $9 trillion pales in comparison to United States' $19 trillion debt load. What the U.S. dollar bulls fail to take into consideration is that the entitlements of Medicare, Medicaid and Social Security have to be added to that figure, and the reason they don't is that they can't figure out the numbers.
Falling into the realization category of The Emperor's New Clothes, I contend that we are today at the precipice of a massive drop in global living standards brought on by the final reconciliation of debt. Individual citizens who take advantage of generous lending practices and pile on layer after layer of debt always encounter that point in time where bankruptcy arrives first slowly, then suddenly (thanks to Ernest Hemingway), because cash flow from earnings or dividends and interest falls disastrously short of cash outflow.