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As the
precipitous drop of the Dow Jones index of industrial stocks to the 8600
level on Thursday shows, the $700 billion bailout is an exercise in futility.
The rescue effort administers one wrong medicine after another. Shunting
rotten assets to the balance sheet of the central bank is not the way to go. Consolidating
banks through forced mergers is not the way to go. Cutting interest rates is
not the way to go. These measures make the problem worse, not better.
All the remedies
to check the burgeoning credit crisis that have been proposed or put into
effect are based on misdiagnosis. This is not a sub-prime crisis or a real
estate crisis. It was not caused by loose lending standards, or by the banks
recklessly and aggressively increasing their assets.
This
crisis was caused by shriveling capital ratios due to the destruction of bank
capital through 28 years of falling interest rates. As I have been saying
again and again, falling interest rates destroy capital by increasing the
liquidation value of debt -- an insidious process that has been missed by all
other observers. Ignoring capital dissipation is possible only so long as
capital lasts. As soon as capital is exhausted, dissipation stops. There is
nothing left to dissipate. The problem at once becomes painfully noticeable.
The term
'liquidation value of debt' is self-explanatory, meaning the lump sum that
will liquidate it before maturity, should it be necessary in case of a
takeover, merger, shot-gun marriage, bankruptcy, or outright nationalization
of the banking system. The point is that when the rate of interest falls,
the liquidation value of debt rises. Why? Because the stream of
interest payments is now discounted at a lower rate of interest. Therefore at
maturity it will fall short of liquidating the debt.
Here is a
familiar example. When the rate of interest falls, the market immediately
bids up the price of bonds. This is the same to say that the liquidation
value of the debt underlying the bond is raised. Debtors wanting to liquidate
their bonded debt before maturity are not let off the hook on the same terms.
The market demands more than the pound of flesh originally agreed upon for
releasing the debtor from his bond. This example clearly shows that a
fall in the rate of interest, far from alleviating the burden of debt,
aggravates it.
Bank
capital is debt, and it has been eaten away by persistently falling interest
rates. Impairment of capital has been ignored and, after 28 years of
negligence, the global banking system now stands denuded of capital. Those
shareholders who can read balance sheets see through the fancy values banks
are putting on their assets, and they dump the stock before bank capital goes
all the way to zero.
The only
way this crisis can be resolved is through recapitalizing the banks with
gold. Contrary to Keynesian propaganda, gold is not a barbarous relic. It
is not for decoration purposes. Nor does gold serve for the purpose of
window-dressing in the balance sheet. Gold is unique among financial assets
in that it has no counterpart as a liability in the balance sheet of others. It
follows that gold, and gold alone, will survive any consolidation of bank
balance sheets. Gold will not be netted out like paper assets are in case of
mergers, acquisitions, and takeovers, or the nationalization of the banking
system.
The fatal
weakness of the present rescue effort is precisely this: consolidation of
banks, just as consolidation of the derivatives monster, far from stopping
the rot, will accelerate it. For example, if you consolidate the derivatives
monster, claims and counter-claims through credit-default swaps will cancel
out, and all risks will be exposed as being uncovered. Recapitalization with
more fiat money will not work. It takes something more solid than
irredeemable promises to pay. It takes gold.
Unfortunately
our political leaders and policy-makers are lacking the moral fortitude to
admit that they have been wrong all along about gold and its role in the
financial system. Nor do they have the wisdom to realize that in cleaning up
the train wreckage they have to go back all the way to the point where the
train was derailed: to the insane decision to discard gold from the monetary
system in 1971. Politicians and their academic sycophants will stick to their
pet-rock, TARP, the Troubled Ass Relief Program (if you pardon my pun of
cutting off the tail of the word 'asset'). This is their cover-up of
the fact that the credit-crisis is their own making.
The first
of the Twin Towers, the Derivatives Tower of Babel, has now toppled, although
you cannot see it yet as the dust is still settling. The toppling of the
second, the Debt Tower of Babel, will follow in due course -- unless banks
are recapitalized with gold with all deliberate speed.
The
collapse of the Debt Tower of Babel would spell a disaster of the first
magnitude, adversely affecting everybody. It would trigger the Great Grand
Depression of the twenty-first century, making the Great Depression of the
twentieth look mild in comparison.
Calendar of events:
New York City, October 16, 2008
Committee for Monetary Research and Education, Inc., Annual Fall
Dinner.
Professor Fekete is an invited speaker. The title of his talk is:
The Mechanism of Capital Destruction.
Inquiries: cmre@bellsouth.net
Santa Clara, California, November 3, 2008
Santa Clara University, hosted by the Civil Society
Institute
Professor Fekete is the invited speaker. The title of his talk is:
Monetary Reform: Gold and Bills of Exchange.
Inquiries: ffoldvary@scu.edu
San Francisco, California, November 4,
2008
Economic Club of San Francisco
Professor Fekete is the invited speaker. The title of his talk is:
The Revisionist Theory and History of the Great Depression -- Can It
Happen Again?
Inquiries: ifkbischoff@yahoo.com
Canberra, Australia, November 11-14, 2008
Gold Standard University Live, Session Five. This is the last session
of GSUL since our sponsor, Mr. Eric Sprott of Sprott Asset Management, Inc.,
has withdrawn his support saying that in his opinion the results do not
justify the expenditure. Come along and judge for yourself. This 4-day
seminar is a Primer on the Gold Basis -- Trading Tool for Gold Investors,
Marketing Tool for Gold Miners, and Early Warning System for Everybody Else.
A more detailed description of this seminar is found at the end of my article
Cut Off Your Tail to Save My Face!September 1, www.professorfekete.com
Inquiries: feketeaustralia@yahoo.com
In view of the extraordinary events
unfolding in world finance and on the banking scene right now, there will be
an extra meeting to answer questions from participants and to have a
discussion from our distinctive point of view, namely, that this is not a
sub-prime crisis, not even a dollar crisis. This is a gold crisis that
cannot be solved by continuing to muzzle gold.
Canberra, Australia, November 15, 2008
Panel Discussions: The chickens of 1933 and 1971 are coming home to
roost and take out bank capital.
Inquiries: feketeaustralia@yahoo.com
Antal E. Fekete
Professor,
Intermountain Institute of Science and Applied Mathematics, Missoula, MT
59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
DISCLAIMER AND CONFLICTS
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
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SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
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