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Currency Chaos and Financial Collapse

Part 2

November 21, 1997

Financial Gods

Throughout history, with regards to politics or economics, one fundamental rule has always applied, "Those that have power take away from those that do not have power." No analysis of today's financial situation is complete without discussing central bankers. These are the people to whom society entrusts their financial future, to ensure that their money is safe and sound, and that economy's grow in a sustainable manner. Today's central bankers believe that they are so powerful that they can defy all economic principles. When governments in debt their citizens beyond their capacity to repay, they see no problems. As banks lend the savings of depositors on speculative loans with no source of repayment, they call it growth. When these banks have trillions of dollars in loan losses, they say all is well, your money is safe. As country after country goes bankrupt, they have the answer, more debt in IMF loans. Their powers are so great that they can create debt at will and solve all financial problems.

Today, in Japan, sound money is based on;

--- where a government whose direct and indirect liabilities now total 150% of GNP and no one dares question how this will ever be repaid

--- where a government whose deficit runs at 7% of GNP and the financial industry asks it to spend more

--- where most of the banks equity base consists of the value of its share holdings in the stock market, values of which are falling rapidly, and on whose loan losses, which total trillions of dollars in Japan and hundreds of billions of dollars in South East Asia, will leave depositors with only a fraction of their funds.

--- where life insurance company's cannot meet their obligations, and with land values and stock markets continuing to fall will see only further losses

--- where public pension plans have invested heavily in the stock market to prop it up and who will incur substantial losses as the banking system implodes and shares in company's reflect their economic and not speculative values

In the United States, sound money is based on;

--- a government that is over 5 trillion dollars in debt.

--- a stock market that trades at 5 times book value

--- a consumer that is so over indebted that personal bankruptcies are at record levels at the height of a long economic expansion

Whether we look at China, Korea, Thailand, Indonesia, Malaysia, Brazil and numerous other counties, we see example after example of the sound money promised by these financial gods, the central bankers of the world. Now these central bankers, having created their world of sound money based on massive debt that can never be paid back know that they no longer need gold. They are so powerful that they can defy all economic fundamentals.

These financial gods threaten to sell gold, thus creating fear. Then they loan their gold to speculators who sell it into the market to depress the price. Once the price is depressed we are told they will sell the gold that they have loaned to the speculators, ensuring that they get a low price for their gold and huge profits for the speculators. This is a logic only a financial god can understand. Or maybe these financial gods do not wish to sell their gold, but only depress the price. It has been estimated that total gold loans may now be as high as 8000 tons. Given the years of production most gold company's have sold forward and the huge short position of the speculators, this figure is not unreasonable. With physical demand for gold far above mine supply, with many miners expected to close mines further contracting supply, have these central bankers asked the source of repayment for this 8000 tons of gold that they have lent out? To these gods, it seems that debt never has to be repaid.

Today, the market is afraid of the central banks selling their gold. What few seem to understand is that central banks could sell 8000 tons of gold and not increase the supply of gold on the market. This gold has already been sold. The only question is who will profit or lose from an uncompleted loan transaction. The dynamics of today's gold market are really quite basic. Supply exceeds demand by a wide margin and the short position is reported to be 8000 tons.

To maintain the present price, central banks must loan into the market the shortfall between supply and demand. To decrease the price further, they must loan even more. As mines close down, they will need to loan even more. Someday, central banks will reach the limit of the gold they will loan. Demand now exceeding supply will cause the price to rise.

A rising price and no supply to short the market will cause short sellers to cover. With short sellers now needing several years mine production to cover, the price will skyrocket. When Asia collapses financially, all this is academic. Central bankers have now created a massive short position in gold at a time when demand far exceeds supply. That they have chosen to do so at the very time they destroy their fiat currencies will change the world in a way not many now understand.

Let me review some basic economics. I do not wish to debate which is better, commodity money or fiat money. The reality is that fiat money has been used for many years. In a system of fiat money, money is first created by the government and then multiplied by the banking system. While the money created by the government gives the government "free money", this has the parallel of gold miners finding more gold in a commodity money system. As long as governments create just the right amount of money, the system can operate satisfactorily. Problems only arise when too much money is created, as it destroys the value of money, just like finding a huge amount of gold would have a similar effect in a currency system based on gold. In the context of a global financial markets, should one country issue what becomes the world reserve currency, it will have the benefit of this free money which it issues and other countries hold. Essentially, the country with the reserve currency will print money which it exchanges for the goods of other countries. These countries now have reserves on which to base their currencies, and the issuer of the reserve currency now has the goods. The issuer of a currency has many obvious political and financial advantages and will fight very hard to maintain this advantage. The United States has had this benefit for much of the last 50 years.

Once money is created, it enters the banking system. Once in the banking system, it does not matter whether it was created by a fiat system or a commodity system, as it ceases to be currency and becomes credit money. The ability of a depositor to re-exchange this credit money for currency is dependent on the financial strength of the bank. Banks in theory can create unlimited amounts of credit money through the creation of loans. When a customer obtains a loan, the bank creates a loan account for the amount of the loan and deposits a similar amount of credit money in the customers credit account. In theory, banks can create an unlimited amount of loans and similar amounts of credit money, though in practice governments restrict the amount of loans that can be issued to a percentage the banks capital base. Now whether this monetary system works well depends on how well the money from the loans was utilized. In the case of a loan being utilized to build a factory to produce a valuable commodity, there are immense benefits. Jobs are created for new factory workers, society gets a valuable commodity, the factory owners earn profits to repay the loan and reinvest or build savings, and the bank earns a profit while maintaining a strong balance sheet. It is a good example of a win-win situation. When a loan is made to build a factory to produce a product that there are too many of, we have a different effect. While initially there are some positive effects due to construction jobs and the hiring on new factory workers, things soon change around. Losses result in the loan being unable to be repaid which will result in the loss of factory jobs as well as loan losses at the bank. This now reduces the banks ability to make new loans as well as repay funds to depositors. As long as banks make loans that can be repaid from the income of the borrower, the financial system functions well. It is only when loans are made that cannot be repaid from income that the system breaks down.

Japan, in the 1980's wanted to substantially increase its manufacturing capacity. Their plan was very simple and quite successful. Japanese banks had large holdings in the shares of Japanese company's as well as land holdings. By substantially increasing the value of stocks and land, Japanese banks were now worth a lot more which increased their capital from which they could lend. Japanese companies, because the value of land and shares they owned also increased, now had the security to pledge for bank loans. Most of these loans were not based on the income of the borrowers, but on the value of the security pledged, which had been artificially inflated. In addition to the loans to increase manufacturing capacity, loans on real estate and stock market speculation further leveraged the banks. Today, Japan has the manufacturing capacity, it also has a mountain of bad debts that will never be paid back. The ultimate price of this increase of manufacturing capacity will be the destruction of its financial system. Japanese banks now do not have the resources to repay their depositors, and it is the depositors who will ultimately lose. Depositors now have the mistaken belief that their government will not allow their banks to fail. As mentioned in Part I, direct and indirect liabilities of the Japanese government now stand at 150% of GNP, making the government technically insolvent. They do not have the capacity to bail out the banks. When the Japanese realize that the government will be unable to bail out the banks and is itself insolvent, we have a major financial and currency crisis. The Japanese example has been followed by Korea, China, and most other country's in Asia, and all will ultimately see a similar fate. It is a system where lending was by government degree, not sound economics. It is important to realize that the real wealth of a nation is in its productive capacity and a financial crisis does not change this. Some may even argue that the cost of a financial crisis is worth the increased manufacturing capacity, forgetting that increased capacity based on sound economics supports and does not harm a country's financial system.

The financial crises that will engulf Asia will wipe out most of this debt, whether it be corporate or sovereign. The losers will be the holders of the debt. The winners will be those who end up owning the manufacturing capacity, which they will own without debt. Millions of people will be ruined financially. The question that then arises is what type of financial system will replace the one that has collapsed. Will it be based on the U.S. dollar, or on a system backed by gold, or by a new world wide currency backed by either gold or government decree. Will people be able to choose what they accept as currency, or will the law givers dictate that all transactions must take place through a currency that they define?

Since 1995, there has been a continuous flow of money out of Asia and into the United States as investors have looked for a safe haven. With concern about what the real value of the EURO will be, money has also flowed out of Europe into the United States. As the crises in Asia intensifies, money will continue to flow to the U.S. Gold has seen increased purchases, though by driving the price of gold lower through large gold loans, central banks have kept the bulk of the funds seeking a safe haven going into U.S. dollars. However, once Asia collapses totally, there will be a massive move out of U.S. dollars. Some money will move out to help pay for the massive losses in Asia, and other funds will be used to buy factories now selling at a fraction of pre-crash prices. All of Asia will be on sale and money will rush in. Once the Euro is introduced in 1999, the European central bank will be sitting with hundreds of billions of U.S. dollars that will be surplus to its needs. Do they sell these putting additional downward pressure on the U.S. dollar?

These financial changes will have a major effect on corporate America. Now, decreasing import prices and reduced export sales to Asia, will substantially erode profitability. However, the major impact will likely occur after the financial crash. America will have to compete with corporate Asia having overbuilt manufacturing capacity, no debt, and a hungry work force.

It is at this time that America, being the most indebted country in the world will be most vulnerable. It simply will not be able to compete. To avoid this, the U.S. has two options open to it. It can attempt to purchase the manufacturing capacity in Asia to give it monopoly pricing, or it can spread its debts to the rest of the world by issuing a world reserve currency.

The problems in Asia can not be solved by any government policy. Only a deflationary recession wiping out the excessive debt can correct the imbalances. It does not matter if the debt is eliminated by default or by a massive increase in the money supply. The end result is the elimination of debt and the destruction of currencies.

World wide currency values are presently extremely unstable. Fluctuations will increase until most currencies in Asia are destroyed. Will commerce then take place in U.S. dollars, or a currency backed by gold? Possibly, the financial chaos in the world will be blamed on too many unstable currencies, the only solution being a common world wide currency.

Whoever issues money has many economic and political advantages. We are presently seeing a hidden battle between gold and the U.S. dollar. This battle will continue to intensify until the crash in Asia is complete. The key to financial independence is to know who will win this battle.

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