Sunday, February 03, 2008

Another Reason Silver and Gold Prices in Fiat Tokens are Going to Continue Up

Here is just another reason it looks like that silver and gold prices in fiat tokens are going to continue up and up and up.

The Fed lowered the overnight rate (Fed Funds Rate) 2 times in a little over 2 weeks. Talk about panicking! Lowered by 1.25% so that the rate went down to 3%. This may start a new carry trade.

The boyz, the privileged few, have been able to borrow Yen from Japan at 0-.5%, then sell the Yen for USD, then take the USD and buy US Treasuries paying say 4-5%. A no brainer, thus profiting from the difference.

Some might be tempted to do that with the dollar now.

Borrow USD at 3%. Sell it for Euros (or other fiat digital bits of other countries with higher interest rates). With the Euros, buy higher paying European debt instruments. If this happens, it will increase the flow of USD out of the US and into the "money"/"currency" exchanges. This increases the already huge supply of USD outside of the US, which would make them even less valuable. This is part of the incentive for this carry trade. Profit can now be made from the interest rate plus the increased value of the Euro vs. the USD. If I have a Euro denominated bond and sell the Euro denominated bond after the Euro has gone up relative to the USD; I make a gain because the Euro proceeds from the sale of the bond will now buy me more USD, plus I was making the interest gains, also.

For this to happen, the Fed has to increase credit (create digital bits of USD out of thin air) and get them loaned to "money" center banks. This may be the US government's strategy to try to bail out, or at least keep operational, the "money" center banks. But, this could be hugely inflationary because of the massive amounts of USD that would have to be created out of thin air by the Fed. Amounts needed are probably in the amounts of tens and tens of trillion USD.

The BIS has notional value of otc derivatives in the world at over $500 trillion. These are a zero sum games, like futures and options. So some group of entities has to, eventually, loose half that amount roughly speaking since most are tied to interest rates, and interest rates are going up due to the increasing risk of lending, and the devaluation (loss of purchasing power) of the "money"/"currency" lent. So, tens and tens of trillions does not seem to be an exageration. The world's net worth by some estimates is aroung $140-150 trillion. The world's GDP is around $40-50 trillion by some estimates. There doesn't seem to be enough wealth, net worth in the world to back up one half of all those otc derivatives.

It is going to get ugly.

This new carry trade can benefit existing holders of USD denominated debt, particularly if the borrowed USD was immediately sold for local fiat token for some productive wealth creating operation. Later, when it is time to pay of the US denominated debt, it will take less Euros, for example, to buy the amount of USD that was originally borrowed. Over time, in Euro terms, the debt could turn out to have been cheaper than originally estimated.

So, there are reasons for this new carry trade to get started. We'll see. Of course if you are a USD holder, it could end up being awful for you. Since it would drive the USD down in purchasing power, thus driving up the USD price of the same amount of gold or silver as before it started.

Doug Nolan's Credit Bubble Bulletin quotes Mr Ricardo Hausmann in the UK Financial Times on January 31, 2008
"The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis. Interest rates should be slashed quickly and $150bn put into taxpayers’ pockets by April at the latest, they say. The goal seems to be to avoid a 2008 recession at all costs. As Larry Summers, former Treasury secretary, put it, failure to act would make Main Street pay for the sins of Wall Street."

What is Buckler's response?

"What Mr Summers knows but is not about to say in public is that Main Street HAS been paying for the "sins of Wall Street" for decades. But be that as it may, the point made by Mr Hausmann in this quote is a good one. The US controlled IMF has "presided" over financial and monetary crises affecting almost every nation on earth over the past two decades or so. The "formula" presented to the afflicted government was always the same. Cut spending, raise interest rates, balance budgets, take the downturn. Now, it is the turn of the US government. And what is THEIR formula? RAISE spending, CUT interest rates, BLOW OUT budgets, AVOID the downturn. After all, it is an election year."

Heck, they'd do the same thing even if there was no elections coming.

This new possible carry trade could increase the speed at which the USD loses its value. Of course if you are a gold or silver holder, what happens to you is the opposite of what happens to USD holders.

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