While the first blush of Mr Bernanke's novel move to lower the US Discount Rate (instead of the Fed Funds rate) was being absorbed by global markets this week, Gold did absolutely nothing whatsoever. the paper markets, on the other hand, gave a whole new meaning to the term "volatility". The classic example of this took place on Monday, August 20. No sooner had US markets opened on that day than the stampede began. Rich and poor, market "savvy" and market neophyte, pillar of the "establishment" or mug punter, the destination was the same.
With a huge "sucking sound", "liquidity" was drained away and pushed en masse into short term government (US Treasury) debt paper. At one point in early trading on that day, the yield on the three-month Treasury bill had plummeted by over 130 basis points (or 1.30 percent). It closed on the day down 81 basis points, a reaction which had not been seen since the crash of October 1987.
The difference this time is that there was no "crash". US markets had rebounded over the previous trading day in reaction to the Fed's announcement of the Discount rate cut. And on the day, US stock markets didn't do much (the Dow was up 42 points) and both Gold and the US Dollar hardly budged at all.
What HAD happened on the previous trading day (Friday, August 17) was the emergence of reports that bank customers in California were actually lining up in front of the bank's ATMs and even at the tellers' windows to pull out their deposits. Some of them even wanted CASH! This is NOT the kind of "liquidity" that Central Banks have in mind when they "inject" it into the system. Such "liquidity" is supposed to facilitate the vital lending and borrowing practices which keep the system functioning. It is not supposed to be hauled OUT of the system.
And, of course, the vast amount of "liquidity" that was shoved into short-term Treasury paper on August 20 was not hauled out of the system, it was merely pushed into what the SYSTEM regards as "cash". Treasury debt is the ultimate form of perceived "safety" within the modern debt-based and "backed" financial system. It carries the ultimate government "guarantee". It can NEVER go belly up because the government (any government, not just the US government) will always be able to tax and/or print enough to cover both principal and interest. In a fiat money sytem, the government can never go "broke" because the government has the exclusive and jealously guarded monopoly on issuing the means of payment.
Not that this line of "reasoning" went through the minds of those who were stampeding into Treasuries, they just wanted to be "safe".
Of course, as the week wore on and the head of the Senate Banking Committee assured Americans that Mr Bernanke stood ready and able to use all the "tools" at his disposal, the "liquidity" began to flow back out of Treasuries and into the markets themselves. US and world stock markets recovered, many of them with amazing rapidity. The gross imbalance between short and long term Treasury yields were "rectified". The US Dollar regained an comparatively even keel. Gold prices in the US did nothing at all.
Meanwhile, the rest of the investment world tried to wipe the egg off their faces as more and more investment entities in more and more countries owned up to the "difficulties" they were experiencing as a result of their dabbling with what used to be called US "subprime" debt and is now called "toxic sludge". Pension funds in Germany came clean, as did investment banks in China and even municipal governments in Australia.
Then, on August 24, the US government announced a "big" jump in durable goods orders in July and US stock markets leaped again. Only one problem, the US Dollar dived a full half point on the trade weighted $US index (USDX) and Gold suddenly shot up by $US 9.00 in late trading in New York after having done nothing at all in the preceding day's trade in London. In London, the PM "Fix" for the day was a whole $US 0.10 above what it had been the previous day.
In the background of all this, the global credit crunch has not loosened its grip one iota. ALL reports from all responsible reporting bodies from whatever source derived indicate that it is still worsening. Ordinary commercial paper from companies of the highest standing and with impeccable repayment records is not finding buyers, both inside and outside the US. Credit ratings are not even being taken into account, the ratings agencies themselves having come under attack for their failure to mark down the ratings of the "toxic sludge" which has led to this mess. If it isn't government "guaranteed" debt, nobody wants to buy it.
While yields on government paper, especially in the US, have plummeted, yields on the short-term debt of companies which actually produce something of economic value have soared. The Fed lowered the Discount Rate for the express purpose of enticing the banks to borrow directly from it in order to get the credit flowing back into the US economy. And while it is true that four large New York banks did go to the Fed window (to encourage the others) this week, the amount they borrowed was derisory, to say the least.
What started as a rush to "liquidity" has now become a rush to perceived "safety". It has become a rush to acquire paper issued and/or guaranteed by the government. It has become a rush OUT of any paper with any connection with REAL economic goods and into paper which can only be serviced/repaid by means of confiscation and/or outright PRINTING. "Wrong Way Corrigan" - the fabled American football player who ran 100 yards to score in his own team's "end zone" - has got nothing on the global investment community at present.
So far, there are two signs of what is to come. The first is the under-reported bank runs in California last Friday (August 17). The second is the sudden jump in the Gold price - and fall in the US Dollar - this Friday (August 24). Not since the 1970s have investors had the experience of government-guaranteed debt paper being a one-way ticket to the poorhouse - the 1970s were a HORRIBLE decade for global bond holders/traders. With the substitution of fear for greed on most (China is the exception - so far) global investment markets over the past two weeks, the perpetuation of borrowing necessary to stave off a global recession is going to be an impossible task. Mr Bernanke does NOT want to lower interest rates to do it. He risks a crash dive in the US Dollar and the horrendous prospect of "pushing on a string".
In any fiat money economy which equates economic "growth" with an ever increasing demand for credit, the ultimate form of "toxic sludge" is always government debt paper. The last time the investment world caught the impact of that fact in regard to the government debt of the nation which provides the world's "reserve currency" was at the end of the 1970s. As the reluctance to lend for any productive purpose grows, the same situation, which has been dormant throughout the great post-1982 paper asset inflation, rises slowly but surely.
The Fed in concert with the other major Central Banks will do anything and everything they can to prevent or at least postpone it. But any lender stands helpless in a situation where nobody wants to borrow. And if you want a financial asset which is NOT somebody else's liability, you really don't have much choice any more but Gold.
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