No More Bringing Forward

–If you want to know what we think about Europe’s dire situation, please take a look at the note we sent out on the weekend. It’s a short explanation of what a “Permanent Portfolio” is and how it might be able to help you protect your wealth in the coming Euro wipeout.

–Before we get to Europe, remember all that nonsense a few years back about “bringing forward demand” for housing with the First Home Buyer’s Grant? All it produced was a lot of activity – which shows up in GDP numbers – and a lot of debt. The end result was higher debt, house price inflation, and the conditions for an inevitable correction.

–That kind of describes where Europe finds itself today. In fact, it kind of describes where the whole world finds itself today. Two decades of debt growth has “brought forward” GDP growth. But it turns out the growth that was purchased with debt was mostly in house prices and government bonds. Now there’s a problem. There’s no more growth to “bring forward” with new debt.

–Assets purchased with debt are also liabilities. If those assets don’t produce a return, you have a problem. The world has a problem. The market value of bank assets is probably a lot lower than the current book value. This puts banks everywhere in an awkward position.

–As our old friend Dr. Marc Faber put in a US television interview, “Most banks worldwide are bankrupt. Bankrupt because if they had to mark to the market their assets there would be no capital left. And that’s reflected in the new lows of bank stocks today.” There is also the issue of European banks requiring as much as $3.6 trillion in short-term US dollar funding, according to the Bank of International Settlements (see page 12).

–Of course one thing we’ve learned over the last few years is that if financial rules cause unpleasant consequences for vested financial interests, they’ll just change the rules. Banks don’t have to mark assets to market value. They can continue the fiction that those assets will pay off.

–Another example of changing the rules in mid-stream is the hike in gold and silver margin requirements by the CME group on Friday. CME runs the New York Mercantile Exchange. It hiked margins on Comex gold futures contracts by 21.28% and on silver futures contracts by 15.63%.

–The CME action contributed to silver’s 13.1% fall on the day. For the week, it was down 17.7%. Gold was down 5.9% for the week. And, in fact, gold had its worst week since 1983. These moves prompt an obvious question: are gold and silver really the safe havens we’ve said they are?

–We can’t wait to buy more at lower prices. Precious metals prices communicate information about the stability of the world’s financial system. Right now, that system is unstable. Gold and silver prices can fall just like any other asset. But we reckon they’re going to be better places to ride out the coming storm than most other asset classes.

–A few more thoughts. First, CME is trying to do its job and wring out speculation and volatility in its exchange. Raising margin requirements makes it more expensive for speculators to “bet” on higher gold prices. You can attribute nefarious motives to higher margin requirements. But in the end, it does shake out the weaker hands.

–Second, you can bet lots of investors who’ve been playing in the stock market with borrowed money got margin calls last week. To meet a margin call you need more cash. If you don’t have the cash, you have to sell something to get it. This definitely hurt gold and silver last week.

–Falling stock markets last week may have forced traders to take profits on gold and silver positions in order to raise cash. Keep in mind that at US$1689, gold is up 21.6%, year-to-date. Silver’s fall to US$32.90 means it’s given up nearly all its gains for the year, although it’s still up 7.27%.

–By comparison, Aussie stocks are down over 20% year-to-date. What all this means is that you should definitely be thinking about how you want to divide your assets and protect your wealth in the future. This is what the “Permanent Portfolio” is all about.

–Now, stock markets are obviously discounting very low global economic growth. And investors obviously gave a big “thumbs down” to the Federal Reserve last week. But none of what happened last week in markets fully “prices in” a debt default in Europe. How likely is such an event?

–The latest stories in British papers tell of a $2.8 trillion bailout plan, backed by the Germans and the French. It would work in three parts. Banks would be recapitalised. A bail-out fund would be increased in size. An orderly Greek default would be arranged. This is Europe’s last roll of the interventionist dice before…whatever comes next.

–G-20 finance ministers met over the weekend in Washington DC with the leaders of the International Monetary Fund (IMF) and the World Bank. They ate fine food and made a few announcements. No problems were solved.

–World Bank president Robert Zoellick said, “Europe, Japan, the US must act to address their deep economic problems before they become a bigger problem for the rest of the world. Not to do so would be irresponsible.” New IMF head Christine Lagarde said, “Forty million people could be put back into poverty if we don’t succeed…The current economic situation is entering a dangerous phase.”

–She got that right. The trouble is, there’s no more money left. With what will Europe re-capitalise its banks? How is Europe going to fund its bailout plan? We wrote about the charade two weeks ago in Australian Wealth Gameplan. Our contention was that the big agreement between five central banks to provide short-term wads of US dollar cash to banks was designed to give the European Central Bank time to sort itself out:

“The ECB also needs time for Europe’s political establishment to approve the structure of the European Financial Stability Facility (EFSF). This is the $640 billion bailout fund that’s been set up to directly loan money to European banks that need it. The ECB wants to get rid of that job and get the funding of the EFSF off its balance sheet.

“The funding of the EFSF is a bit of mystery anyway, considering Europe is nearly as broke as America. But perhaps the ECB hopes that having the bailout fund removed from its balance sheet will eliminate questions about how the EFSF is funded. It appears the bankrupt are bankrolling the broke to loan money to the undercapitalised.

“Technically, the EFSF is authorised to borrow as much as €400 billion to finance its lending operations. But if you just back that statement up a second, you realise how absurd it is. The EFSF funds its emergency operations by borrowing money. From whom?

“That is the question. If the ECB is funding deficits in Spain and Italy and Greece and Ireland by buying government bonds with money it doesn’t have, how does it help to have the EFSF borrow yet more money to loan to governments and banks? Where does the money come from if everyone is broke?

“This is Europe’s last-ditch effort to avoid having to go hat in hand to China for a loan or having to post European gold as collateral for that loan. Such a result would give China the whip hand in whatever global currency arrangement emerges from this mess. It would also amount to a transfer of central bank gold reserves from Rome, Madrid, and Brussels to Beijing.

“Europe wants to avoid this. So last night’s agreement with the Fed gives Europe time to sort out how the ESFS will work. In any event, the EFSF still needs political approval by EU member states. Spain, Luxembourg, France, Italy, and Belgium have already given their approval. Germany has not.

“The EFSF is starting to look a lot like the Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF). TALF allowed borrowers to post non-traditional types of collateral in exchange for short-term loans. TALF was necessary because the borrowers who really needed money didn’t have the kind of collateral you or I would need to get a loan from a bank. TALF borrowers had mortgage-backed securities, the ones no one else wanted.

“You can see how the EFSF might work, then. European banks would be able to post government bonds as collateral and receive dollars, via the Fed, via the ECB in exchange. Europe would swim in dollar liquidity while the EFSF would hold its nose and accept the risky collateral.

“Mind you, the EFSF may need as much as a €1 trillion in bailout funds, according to some estimates. If no one in the world wants to buy European government bonds, how in the world is the ESFS going to sell a €1 trillion in bonds to fund bank bailouts?

“Would you loan the EFSF €1 trillion? Do you think China will? In exchange for what security?

“The only organisation on the planet stupid/deceitful enough to loan Europe that much money is an organisation that can create money at no cost: the US Federal Reserve.

“Last night’s agreement between the five families paves the way for the back-door funding of the EFSF via the Fed. It’s QE3 one week early, and especially for Europe.

“It should not be surprising that the Fed is willing to take so many risks on behalf of a bankrupt Europe. After all, it’s not real money anyway. And more importantly, the Fed is literally fighting for the life of a dollar-based world fiat money system. It will spare no expense to do so.

“Absolutely none of this does anything to improve the quality of the debts on the asset side of bank balance sheets. Not one bit.

“That shows you what a titanic charade all of this is. Europe is proposing, with the Fed’s collusion, to create a €1 trillion fund, funded by new bonds bought with money no one has, to recapitalise banks that refuse to take losses on government bonds.

“The main goal in all of this is obvious: avoid taking a loss on bad debts at all costs.

“No one wants to take any losses. At all. On anything. So it’s all being moved to vague, newly constructed, financial vehicles…for which the public bears the ultimate responsibility.

“If my analysis is right, the risk of a European blow up hasn’t diminished one iota. It’s just been pushed back in time. Some investors will see that as a reprieve and a chance to buy stocks.

“I would encourage you to think of it as a stay of execution for the stock market. It gives you additional time to formulate your own plan and execute it.

“If you see a group of doctors huddled around a patient, jabbing syringes full of adrenaline into his heart, and shocking him with paddles to restart that heart, you don’t say to yourself, ‘Looks like they saved him alright’. You say, ‘That guy is toast. His heart has stopped beating.’

“Credit is the lifeblood of the financialised world. The fiat-money issuing central banks and their counterparts in the banking sector are the heart that pumps the blood.

“The patient – the global financial system – is bleeding out. The heart is broken.”

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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15 Comments on "No More Bringing Forward"

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I’m 47 and when I was a kid, being a millionare meant you were rich. Not just wealthy, I am talking really really rich. Obviously Billionares are the new Millionares. So just to clarify the absolute dilusion of wealth that the rampant inflation (yes even a mean of 1-2 or 2-3 percent as has been claimed by the new Worldwide standard CPI), in the 80’s Banks profits were measured in Millions. It was in the late 80’s that the first bank made a million dollars a day in profits. Nowadays, they all regularly make Billions in profit. Soon (and not… Read more »
Alexander Malejew

I’d rather be a ‘goldbug’ than a ‘paperbug’ any day!

Audrey McMillan

Hello When do you think the property market can be entered? If you had a pauper’s $1m in cash now what would you do with it if renting?


Great article, and great questions Audrey there for Dan and all.


That dilution might also be referenced against Dan’s current push for PMs to be just one quarter of one’s portfolio, Joe(!) ;)

You’re correct that the term ‘millionaire’ is almost meaningless in wealth assessment today. Funnily enough, it appears to still mean something in the US right now! And here in Canada, 6.5% return on cash-in-savings-accounts sounds unbelievable to investors. :D

Denninger is saying that they are trying to create an Enron styled off balance sheet SPV to fund the EFSF. Debt to solve debt doesn’t work but it has been effective in delaying the reckoning because fiat isn’t being undermined by anything much else which is also valued by leverage created out of smoke collateral. Food is inching up, but that is about it. Capital calls must eventually be made mandatory to reverse the redistribution created by leveraged betting and fake collateral. If you don’t reverse the redistribution and sezie the assets of “investors” there will be physical chaos in… Read more »

FSB says APRA and the RBA’s “no worries mate” all b/s ….

NZ banked on AU ADI’s and creating their house price bubble was a ponzi scheme (APRA annual report cited from 2004 already made that clear, and our corrupt executive decided – do nothing).


Interesting read, Ross. Hadn’t seen this comparison before:

“Non-conforming housing loans (the closest Australian equivalent to “sub-prime”) accounted for only around 1% of the mortgage market in mid-2007, compared to around 13% in the United States….”

…but I ‘guessed’ we might be different… . ;)

If you have a substantial amount of Aud, Audrey McMillan, put it into interest rates, you are lucky getting 5% or more in Australia. Here in Europe, UK, the max for one year deposits is about 2%, yes 2%.Whereupon the banksters lend it out at 10% or more, and if you understand fractional reserve banking, you will know what a fraud it is.To cover yourself, spread it over several accounts to benefit from the government guarantee.I sold gold sovereigns for a nice profit before the price went pear shape.I shall stay out of gold for a while. As for real… Read more »

Shortchanged: “Whereupon the banksters lend it out at 10% or more…”
Amusing. :D

The property market cannot fall without two things: – The maximum amount of leverage and buyers are involved in the market. I’m pretty sure we’re close to that. Even here in Sydney’s Yuppie Inner west my formerly optimistic peers(merc drivers) are scaling down, one has sold the Audi Q7 and getting rid of the nanny, another trading in his waterfront mansion. The first home buyer only adds a floor to the low end of the market, just about everyone else who want to be in property already is. – Second, we would need to reduce the number of employed people… Read more »
Advice which might align with ‘hide the money under your mattress’, Chris, except that your belief that paper currencies are doomed supports your faith in PMs. Wouldn’t attempt to advise AUDrey what to do with her AUD. If she buys AU and it falls, you’re unlikely to compensate her, anymore than Kris might have when silver tumbled, or uranium crashed. And I imagine Steve has gone door-to-door commiserating with Sydney tenants who took his well-meant advice and sold, too. ;) Let’s leave advice giving, at the ‘millions’-level, to professional journalists, who are not just expert analysts, but answerable to the… Read more »
@Chris, RBA can’t do my friend. There is a thing called reverse carry. Remember when the Japanese were forced to take their money home? What happened to mortgage interest rates then? Already the wholesale funding market is frozen for the banks. CBA says it can last a few months. CDS rates plus market rate on current spread equals 100’s of basis points rise in home loan rates new and old. Neither the RBA nor the nations savers can fund the $100b per year delta that would be created on foreign wholesale funding as currently required to keep old mortgage loans… Read more »
One of those rare moments when we _completely_ disagree, Ross. Consider the Japanese scenario you raised. While landlords’ equity was damaged in the nipponese crunch, their holding costs fell to virtually zero. Income, by way of rents, has continued to rise. Would-you-believe-?-section: We just investigated rents in Bologna, Italy, with the intent of spending 2013 in northern Italy. Rent for a _one-room_ apartment? $A500+ per week, not-negotiable. This is debt-ravaged Italy, mind you. We’ll probably still go, but that’s more than we’re getting for most of our beach-side 4X2X2s in Oz, in a suburb with a 1% vacancy rate! Gotta… Read more »
Audrey: “If you had a pauper’s $1m in cash now what would you do with it if renting?” There are a wealth of opportunities for those with cash, Audrey. Some might put it under the mattress. There are downsides to that… If you take the Bonner-Sayce view, you’ll buy PMs every time they fall. A few think they can pick-the-winners in the sharemarket. They seem to be the same crew preaching Armageddon, so if we’re nuked as they expect, you’ll need to be able to pick the highs before The Big Hit… ! ;) We’re overweight in property, OK… Read more »
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