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Unambiguous Wealth 2 – The MF Global Chronicles

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Published : December 12th, 2011
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Category : Gold and Silver





Sometimes I write post-length comments that would be more useful as actual posts. Here's one…

Hello Edwardo,

Thank you for the ZH link. I suppose I need to be more specific when I refer to "the ZH/GATA CB thesis." First let me state that Zero Hedge and GATA both provide a great service and they both do fantastic work, ZH comments section notwithstanding. It is their underlying thesis about fiat currencies and central banks in general that I have a problem with. And this is not a problem with only ZH and GATA, it is a problem with the entire hard money camp.

Their foundational thesis is that fiat currencies and the CBs that manage them are the most fundamental flaw in today's system from which all other problems flow. This directly conflicts with my thesis that using the same medium in both the primary and secondary monetary roles is the fundamental flaw from which all other problems flow. My thesis applies to both hard and easy money systems. Their thesis points to the CBs as the bad guys. My thesis holds up a mirror and says, "We have met the enemy, and it is us."

One of the biggest struggles I observe in newish visitors to my blog is that they instinctively try to reconcile everything they learned from the hard money camp—ZH and GATA being two bright stars there—with what they read here. Their effort inevitably leads to contradictions that cannot be resolved. And because ZH, GATA and the rest of the hard money camp is so much more ubiquitous than my little blog, they win by default in minds that are unable to think for themselves.

Here are a couple of the irreconcilable concepts found on this blog that noobs must either reject or ignore in order to hang on to their ZH/GATA CB thesis.

1. Remember when Aristotle wrote
this? "In working on this project, I was personally shocked when I discovered that we absolutely NEEDED paper currency in order to set Gold free. In the perfect world you lapse into in your comments, everything you say is well and good. We don't live in that world, however. My biggest challenge in piecing together my proffered solution was to accept what this real world had to offer and avoid foisting my own preferences onto the world like a square peg in a round hole."

Have you ever seen anyone in the hard money camp write anything like this? Or can you imagine them ever doing so? Yet this is one of the core fundamentals necessary to understanding Freegold.

2. And FOA wrote this: "Several years ago, many gold bugs and gold advocates missed the path as the trail turned." "Yes, the war now is between the Euro and the dollar! The Washington Agreement [a Central Bank agreement] placed gold 'on the road to high prices'." "The war between gold and the dollar has been over for a while now… Leaving gold bugs with a lot of questions that ask why this: both systems will strive for a higher currency price for gold; one doing it because they have to; the other doing it because they want to! The casualty on this battlefield will be the world gold market as we know it. A market caught between how Western perception thinks gold's price should be "discovered" and at what price level trading in physical gold craters the entire paper structure… This paper gold market will be cashed out at prices far below real bullion trading so as to inflate further the books of the Bullion Banks,,,,,, not destroy them. At least this is how the US side will proceed."

Again, have you ever seen anyone at GATA or ZH write anything like this? Or can you imagine them ever doing so? This view is so completely antithetical to their most fundamental thesis. And whenever we see the price of the paper gold market fall under the force of short-term manipulation, their instinctive explanation is that the CBs are puking up physical to suppress the price of gold.

This particular
ZH article you linked, Edwardo, is superb with regard to this blog, and especially to the topic of this post, Unambiguous Wealth. Tyler notes:

"…there should never be any debate over who owns a given physical asset, as replicated ownership (note - not liens) effectively means someone stole the gold (or there was counterfeiting involved) and was never caught... until MF Global finally expired of course."

This is, of course, the problem with holding your "wealth" in the system. This is an extreme example, where the wealth being held in the system was presumed to be unambiguous—and physical—and yet the system itself imputed ambiguity onto the ownership of that asset, which was only discovered once someone went bankrupt. Possession is the timeless attribute of wealth because true possession is unequivocal. But the system apparently equivocates its own illusory version of possession when it comes to bankruptcy. Therefore nothing held within the ($IMFS) system can be unconditionally qualified as "wealth" under FOA's definition.

This guy, Jason Fane of Ithaca, New York, simply wants to get his gold out of the bank vault and into a non-bank vault at Brinks. Remember, this is one of GBI's big selling points. Your gold bars and coins are stored in non-bank vaults that have no reason or even ability to use them for other purposes like rehypothecation. But even better than that, with gold, you can actually take true possession of your wealth yourself! A million dollars in gold can easily fit into a small box. If that sounds dangerous or risky to you, just take a look at what's happening inside the system today! HSBC's hands are tied until a judge rules on whether Jason can move his own gold that he thought he already "possessed."

This MF Global bankruptcy is like a shockwave spreading out over the whole marketplace. It's like an EMP that could fry the matrix in a flash, once people begin to understand its implications. It's already had far-reaching consequences.

One group that has so far been disproportionately affected is the non-bank physical gold dealer network. Many large and small, retail and wholesale gold dealers used the COMEX paper market to hedge their physical business. Say someone walked in and sold a dealer a thousand ounces of krugerrands. That dealer would immediately go to his MF Global online account and short ten COMEX futures contracts worth 100 ounces each.

So these dealers often have large cash balances sitting at the ready so that they can earn the spread from any customer without taking the price risk. It was not their contracts or COMEX positions that disappeared when MF Global went bankrupt, it was their large cash balances. Active positions were rolled over to other clearing houses, but the cash disappeared.

I have heard about one large gold dealer that had $5M in cash at MF Global. Many smaller dealers had hundreds of thousands sitting there. And they were all with MF Global for one reason and one reason only, Lind-Waldock. "Lind-Waldock was the Charles Schwab of commodity brokers" according to one of my readers who trades commodities. It was the longest-standing discount commodity broker in the world. It had been around for more than 40 years and many big names used Lind-Waldock. It was bought by MF Global's parent company back in 2005, but up until a few months ago, the commodity trading website still said Lind-Waldock at the top.

So for whatever reasons, word of mouth, residual credibility or whatever, the physical bullion dealer network was disproportionately with MF Global when it filed for bankruptcy. And ever since this went down on October 31, it has had an impact on the physical market in the United States. The liquidity these dealers used to hedge their business is not available right now.

So imagine that you walked into a dealer to buy or sell 50 gold eagles today. When he makes that deal with you, he is now taking on position risk. So he's going to have to pay you less for your eagles—or charge you more if you're buying—in order to lower his risk. Previously he would have hedged that risk on his MF Global account. So if you've noticed that the buy-sell spread on physical has gotten wider over the past month, that's why.

(Turd Ferguson
reports today that: "Sources tell me this is already happening as bulk physical gold is currently being sold and delivered at $1950/ounce." h/t burningfiat)

And now that you've got that picture in your mind, imagine the dealers' conundrum with intraday $200-$300 price swings, or if the market mechanism for paper gold price discovery breaks down entirely. Some of these dealers have already said they will never go back to paper hedging, period, even if they get their money back! Paper gold is nearly finished.

I'd like to mention now that Jim Sinclair has been absolutely ON FIRE talking about the implications and the shockwave of consequences emanating from the MF Global bankruptcy. In his latest great
interview he says that by putting the OTC derivative positions of a bankrupt clearing house ahead of its client's deposits, this case will ultimately break the very market mechanism for price discovery. He says the system ($IMFS) is already broken, but whereas Lehman Bros. was the "Lehman event" for Main Street, MF Global is the "Lehman event" for the insiders. When your clearing house becomes a questionable counterparty, it's over.

He says the only reason it's still working at all (the clearing system necessary for settlement and price discovery) is "rank ignorance" on the part of the participants as to the implications of this MF Global bankruptcy case. And he's not just talking about gold and commodity trading. He says that virtually any money held anywhere within the system right now exists only insofar as the insiders have yet to figure out the dire implications of MF Global. This is a crisis of confidence. Remember where I said demand/velocity can turn on a dime?

Jim says there's no way to know if the clearing house being used by your broker or money manager is using your funds as collateral for gambles on its own behalf. And the way the law is written, the bank that is lending money to your clearing house apparently has the primary claim to your funds, ahead of you, in bankruptcy.

Most people, when they sign up with a money manager, don't read all the small print. And so they don't know about these clauses that are in virtually all of these types of agreements, or if they do read them they either don't understand them or they simply live with them. Here is the clause from the MF Global agreement:

"7. Consent To Loan Or Pledge

You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control."

The term hypothecate comes from your creditor's "hypothetical control" over your asset until you pay your debt. To "rehypothecate" an asset, your creditor is giving "hypothetical control" of your asset to a third party, another creditor, in exchange for what is essentially a gambling loan to himself. This is technically legal, and if your broker or clearing house is international, it may be rehypothecating your entire account, even if you haven't borrowed a dime.

As I said, most people don't even know about this. But the big hedge funds have teams of lawyers that go through these contracts and strike out such clauses before they ever fund an account. And those that did got their money back right away. This happened with Lehman Brothers as well. And with Lehman, some hedge funds that failed to strike out these clauses are still fighting to get back some of their money.

As sick as this all sounds, it's not only technically legal, it's rampant! Here is what
Reuters found as to the proliferation of what they termed "hyper-hypothecation"…

"Engaging in hyper-hypothecation have been Goldman Sachs ($28.17 billion re-hypothecated in 2011), Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets), Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging), Oppenheimer Holdings ($15.3 million), Credit Suisse (CHF 332 billion), Knight Capital Group ($1.17 billion),Interactive Brokers ($14.5 billion), Wells Fargo ($19.6 billion), JP Morgan($546.2 billion) and Morgan Stanley ($410 billion).

Nor is lending confined to between banks. Intra-bank re-hypothecation is also possible as evidenced by filings from Wells Fargo. According to disclosures from Wachovia Preferred Funding Corp, its parent, Wells Fargo, acts as collateral custodian and has the right to re-hypothecate and use around $170 million of assets posted as collateral."

Here's a question. Say you have your money with Conservative Wealth Management in Los Angeles who is churning you a nice, conservative 3% a year on your $200,000 retirement account. Where did "Conservative" put your money to get that return? And whoever Conservative put it with, where did they put it? Where is your money right now? How many different entities are using your assets as collateral to churn themselves a high-risk return? And does anyone else have "hypothetical control" over your money in the event one of the counterparties in the chain goes bankrupt? Jim says you'd have to be a "past master of actuarial accounting" to know.

It is very difficult for shrimps to think like Giants. Usually we just follow in their footsteps. But there's something very important that you really REALLY need to understand—right now—about people with really big money. And that is that they are much quicker to panic than we are. Big money is nervous money. Always. They live much closer to the panic end of the panic-calm spectrum. While we shrimps sleep soundly, big money wakes up in the middle of the night with cold sweats.

We talk about making a return on our money. But the truly wealthy are first and foremost concerned with preserving their capital. Earning a return is a secondary concern. Big money stays invested mainly because they are not losing money. How many fund managers beat the index in the long term? Nary a one. Yet their clients stay "invested" as long as (at least) they aren't losing money.

MF Global and rehypothecation will move these people ever closer to the panic button. It merely requires time for the implications to sink in. Apparently they are not invested in the location they think they are. Their wealth is not parked where they think it is parked. Think of it like a valet. What if you took your claim ticket and tried to fetch the car yourself? What if you found an empty space where your Bentley was supposed to be parked?

I was emailing with a friend yesterday about this whole MF Global thing, and he had a great analogy for this. Compare these big money folks to the average guy who rides the bus. You miss a bus, so what? It's inconvenient but another bus will come. It takes a long time to sink in that another bus isn't coming. It's not until there is such a big crowd waiting at the bus stop for the next bus that people start thinking "even if a bus comes there are too many people to fit on one bus." In that mindset the surest way to cause a riot is to send one bus i.e., not enough buses. You have to fight to get to the front of the queue. This is a bank run mentality.

And this is a key difference between the average guy and the big money. Big money isn't used to being kept waiting. Big money owns the "bus company". They know the buses aren't going to run before the little guy. They panic early. There was an electronic bank run around the time of the Lehman collapse. That was one of the reasons why governments around the world stepped in with fresh deposit guarantees. But there were no lines outside the banks to alert the average guy to what the Giants were up to.

Right now gold is $1,712 per ounce. If you have $200,000 in ambiguous claims floating through system-space, your account is right now worth 116 one-ounce gold coins of unambiguous wealth. But here's the thing. You are never going to beat the big money to that panic button. There are enough gold coins on the market right now that you could get your 116 of them without affecting the price. But if you're waiting for the first signs of panic, you're not going to get anywhere near 116. You'll be lucky to get six or seven.

There's only one way to beat the Giants to the gold, and that is to run in front of them. Jim ended his interview by saying, "Take care of yourselves, because nobody else is gonna do it for you. Have what you own, otherwise you don't own it." What a great interview!

But, unfortunately, Jim also subscribes to the hard money camp CB/fiat thesis. And with this view, he comes across as colorblind to the difference between the ECB and the Fed/BOE, the difference between the euro and the dollar, the difference between a gold standard and Freegold, and the future system that is already unfolding. The problem with his view is that, while it does deliver solid individual advice, it leads to poor macro conclusions and predictions.

For example, Jim and I both agree that the $IMFS is kicking the can down a dead end road. The system is basically dead already, and the MF Global bankruptcy case may very well turn out to be the last nail in the confidence coffin. But he concludes that this obviously means a return to a commodity currency based on historically similar occurrences.

Like others in the hard money camp, he envisions this reversion to a commodity base being crafted by some of the same people running the failed current system through a revision of the unit of account function at the super-sovereign level. Jim says, "When things become extraordinarily difficult, you'll find that any attachment to gold, even if it's via a virtual reserve currency, and a global Western-world M3 for valuation, it will be considered to be a solution and probably will be a road out."

"Virtual reserve currency" means something—like the SDR—that's primarily a unit of account for the purpose of providing monetary stability. But with the primary and secondary media of exchange becoming separate but symbiotic counterparts, stability will be automatically achieved, and a "commodity-based" super-sovereign unit of account comparing fiat M3 with a centrally managed gold price will be completely superfluous and unnecessary (i.e., as unused as the SDR).

Eric King: "So that's where we're headed basically? The destruction of our current system?"

Jim Sinclair: "You can fix a market, but wait 'til you see what you have to do to fix a whole system."

Eric King: "One final question, Jim. We've talked about gold being revalued. When that day comes, and there is a gold-backed currency once again, will the world be able to turn itself around here?"

This is two people discussing a possible solution to a serious problem at the 11th hour. What they don't understand is that this very scenario—$IMFS collapse—was faced 32 years ago and a solution was crafted at the highest levels. That solution took 20 years to launch (at great cost, mind you) and today it stands at the ready. If you read too much ZH and thereby think the European debt crisis changes things in some way, guess again. The European debt crisis is a symptom of the dying $IMFS, not the Eurosystem. In every way this is true.

Jim talks about the sociopathic bond vigilantes (a relic of the $IMFS) who can take entire countries down through the debt markets. He talks about them waging WWIII in the bond markets every day. If you want stability, insulated from these sociopathic traders, you don't want some slipshod unit of account basket solution patched together by the IMF at the 11th hour. You're more likely to fall back on the long-line plan that took two decades to implement and another decade to season.

The Achilles' heel of the $IMFS is that debt is the system's official store of value and foreign exchange reserve. And bearing this flaw, savers, currencies, banks, governments and even entire countries are all vulnerable to the inevitable failure of the debt.

The problem with debt performing these functions is that debt is a derivative of the currency itself. Currency moves opposite the flow of real goods and services. And with a derivative of the currency acting as the only counterbalance to uneven trade, there emerges the exact opposite of a natural adjustment mechanism for correcting trade imbalances.

With debt as the store of value and official reserve asset, the party producing more real goods has no way to record his net production (savings) other than lending that excess currency back to the consuming party, encouraging him to consume more, and recording the new debt. A true adjustment mechanism makes the balance swing back and forth. But the debt system requires an infinite debtor. So the system is designed to fail. The debt backing the system is designed to fail. And as the official store of value and reserve asset, the savers, currencies, banks, governments and even entire countries are destined to fail in the end… under the $IMFS.

Enter the euro. According to the ECB website, the road to the euro began in 1962, shortly after the launch of the London Gold Pool which aimed to keep gold cheap in support of the $IMFS. The French were the first to pull out of the Gold Pool and also the first to mark their gold reserves to market in 1975. By 1997 even the Germans were marking their gold reserves to market in anticipation of the euro launch date.

Today the Eurosystem still operates under the same $IMFS, yet it declares proudly on line 1 of its weekly statements that gold is its primary currency reserve, marked to market every quarter. And anyone can download the data from its website and plug it into a spreadsheet. If you chart it, it looks like this:

(Please see my
Euro Gold post for more.)

The point is, there's a turn-key problem-solving system waiting in the wings. So whenever you hear anyone in the hard money camp or the Anglo-American press talking about something that sounds like the SDR with "gold backing" (watch out for that word "backing") don't buy it for a second. They simply don't have the full picture and, therefore, don't know what they're talking about when it comes to macro solutions. But even so, they're still right when they recommend that you get your butt out of that reclining black office chair and take personal responsibility for your wealth. Hear hear Jim:

"Take care of yourselves, because nobody else is gonna do it for you. Have what you own, otherwise you don't own it."


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