“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.”
-- Henry Ford, founder of the Ford Motor Company, 1930's
Amen, brother. What's worse, is that it's gotten worse!
I had a customer come into my precious metals store the other day, and we got to talking about our monetary system. The conversation wandered into the US gold reserves. He made a comment along the lines of, "Well, at least the dollar is still backed by the tons of gold we've got in reserves."
I sighed. Deeply.
I explained to him that we effectively came off the Gold Standard in 1934, and all semblance of precious metals backing our money was dissolved in August of 1971 when Richard Nixon made it official. Tricky Dick said that, going forward, the dollar would only be backed by the full faith and credit of the US government.
That faith has not served us well. A dollar from 1971 is now worth 19 cents. When compared to the dollar from 1934, it's worth 4 cents.
So, how'd we get into this inflationary mess, and how do we get out of it?
Most people think that the money supply is soley created by the Federal Reserve Bank. Not so. The majority of dollars are created by banks.
Yep. Let's say you deposit $10,000 into your bank. When you make a deposit at a bank, they are able to lend out 90% of that to a borrower. That borrower then takes that money, deposits it, and the second bank can lend out 90% of THAT money. This repeats again, and again.
After about 100 "turns" of this "lend 90% of the amount deposited" occurs - presto chango - that $10,000 turns into $100,000!
It's called the Fractional Reserve System - banks only need to have a fraction of the amount they lend be held in reserve. Nice scam, huh?
You may say, "Not every dollar that is lent is then deposited - companies spend it on goods, services and salaries." True, for a short period of time. But eventually, every dollar gets deposited in the bank.
The only exception to this are freaks like me who bury dollars in jars in the backyard! And even those are eventually re-introduced into the monetary base, and end up in someone's deposit account. Ready to be lent yet again.
The problem with this system is that the borrower base must continually grow. Yeah, it's just like a Ponzi Scheme. What would happen if people and businesses stopped borrowing? Worse yet, what if they also started paying off their loans?
Obviously, it would be bad for banks, as they'd have fewer dollars lent out (people spending their savings to pay down debt), and that would be a reduction in their interest income.
Surprise! That's what's happening. This is exactly why we're seeing most (if not all) of the Too Big To Fail banks doing massive cuts in their mortgage origination departments. Many regional and local banks are in the same boat.
It's called 'deleveraging' - America is trying to get out of debt. The message that Debt is Death is sinking in.
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This is doubly bad, as the interest paid on federal debt is paid by us with our taxes. Yep, more of your money being taken to pay someone else. Such a deal.
What sucks even more - for the Treasury - is that people and governments are starting to shy away from buying our debt. This is happening at the very same time that the Federal Reserve Bank (the Fed) is instituting The Taper of its Quantitative Easing (QE) program.
With QE, the Fed literally creates money at a keyboard, and buys Treasury bonds. The Taper is the Fed slowing down the amount of Treasury debt they buy.
The Fed had been buying $85 billion a month (about $1 trillion a year) in Treasury debt. The federal government used this money to fund the trillion dollar annual budget deficit. In round numbers, the US brings in $2.5 trillion a year in taxes, and spends $3.5 trillion. They need that trillion dollars a year in debt to pay for all the crap they give away each year.
The Taper dropped that monthly amount down to $65 billion, and new Fed Head Janet Yellin just announced this week that it's being further tapered down to $55 billion a month. Oh, and only half of that will go to Treasury debt.
How is the federal government going to fill that budget deficit hole?
They must either reduce their spending (yeah, right), increase taxes (a distinct possibility) or borrow more money. Since raising taxes takes payoffs, negotiations and time - time Barry O doesn't have - they MUST borrow.
Ok, but who will do the lending? Interest rates suck butt, so there aren't a lot of takers outside of the US. The Fed may temporarily allow interest rates to rise to attract more money, but not for long. That means the Treasury will have to pay higher interest payments to fund Barry's extravagances, and that can't last for long.
It's going to fall to the current Lender Of Last Resort - the Federal Reserve bank. They will have to dump the Taper, and start QE4 (or will it be QE5?). There's no other realistic option.
What will that do?
As we saw this week, when Yellin announced a more aggressive Taper, the precious metals markets took a hit. Theoretically, by the Fed producing fewer dollars, those that currently exist will not lose any more buying power. Thus, a strong dollar equals weak precious metals prices. We saw gold drop over $50 an ounce this week.
So, if they reverse course later this year, logic says precious metals should rise. Will that happen - for sure?
Hell if I know, but I'm personally betting my own money that's what's going to happen. I don't see the Treasury being able to hold out much longer than late-summer or early-fall before the Fed's got to crank up the keyboard and start buying low-interest rate Treasury's.
Here's a scary scenario: As the Fed dicks with interest rates - upwards - over the next few months, it could spin us into a deflationary cycle. Yeah, deflationary.
As we've seen, people aren't borrowing now, and with rates going higher, even fewer will be able to afford to do so. Economic momentum could come screeching to a halt, and we could swirl downwards like a turd in the bowl. The only way out would be a renewed QE program. Even more aggressive than the current version. The intent would be - as it is now - to offset a deflationary economic trend with inflation monetary policy.
The only potential saving grace would be that the entire world is sucking wind, and many countries are kicking up noise for their own brand of QE. That would make their currencies weaker against the dollar.
That'd make us the cutest dog in the ugly dog contest, and the dollar wouldn't take such a bad beating.
My bet with precious metals isn't a short-termed one. I'm in this for the long haul, as eventually, real economics will come to bear, and this whole house of cards WILL come tumbling down.
The only real wealth will be that carried in tangible assets - real property, equipment, supplies and precious metals. My intent is to convert my fiat currency into these tangible assets during the coming dip (deflationary cycle).
To you: Talk to me. Tell me I'm wrong, and why I'm wrong. What economic or political event could crash this party? We've got the Russian crap going on right now, but I don't get the sense it's going to escalate. It seems more like peacocks strutting, than like rams getting ready to really butt heads.
I think the only way that happens is if Russia and the US see economic value in going to war with each other. I just don't see that happening, and if it does, the form in which I keep my money will likely be irrelevant.
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Copyright 2014 Bison Risk Management Associates. All rights reserved. Please note that in addition to owning Bison Risk Management, Chief Instructor is also a partner in a precious metals business. You are encouraged to repost this information so long as it is credited to Bison Risk Management Associates. www.BisonRMA.com