Where next for the global banking crisis?
Posted on 16 October 2008 with no comments from readers
What does public ownership, or at least vast government shareholdings mean for the global banking sector? It would be nice to think that this is the end of the global banking crisis.
But since when does state support for a collapsing industry have a happy ending? You generally end up backing a loser and hobbling the potential winners. Say you assist a bankrupt US car maker, that supports it unfairly against its superior German rival, and if the market shrinks they both lose even more money.
Will it not be the same with the banks? Stopping systemic collapse means that a chain reaction of counter party risk is eliminated. But a literally bankrupt system is preserved with good and bad banks treated equally. The bad loans remain on the books to drag down profits for years.
Already the signs are not good. Many UK banks will not pay a dividend for five years as buying back shares from the government gets priority. But they will have to stay in business and compete against banks without their problems – keeping profits lower for banks with good loans.
Stages to come
But there are still big problems ahead from the fall-out of the current crisis that can not be avoided.
In the 1930s banks were not bailed out and thousands failed, precipitating the Great Depression as a downward spiral developed. But there were two more stages to the banking crisis – we have only seen the credit implosion so far this time.
The next stage is partly a result of the first. In order to pay for the $3 trillion global bank bailout there will have to be a huge issuance of US dollar bonds. Now the credit markets have frozen between banks and are only thawing very slowly.
So why should investors stump up large amounts of money to invest in treasury bills at a lower rate of interest than they can get on the inter-bank market? Why indeed should they continue to hold low paying treasury bonds and not go into cash, and deposit it in a bank with a government guarantee?
Is a bank deposit paying a high rate of interest with a state guarantee not better than a bond whose capital value can, and will fall? When are capital markets going to understand this obvious reality and sell down the bond market?
Bond prices falling
In fact, 10-year T-bonds have been falling in value during the recent stock market crash, the reverse of what you would expect – so it looks as if some insiders have already got it and are cashing out while they can. What starts as a trickle could quickly become a rush to exit the bond market.
Where will the funds for the bank recapitalization come from then? Governments will have to resort to printing money – which is highly inflationary – or raise interest rates in a recession.
In the meantime, bank lending is hardly going to be a thriving business as companies hunker down for a recession and individuals rush into cash. So banking will be a low profit public utility. And in order to bail itself out, the cost will be higher interest rates paid to savers.
However, there will be a third stage of the banking crisis, if we follow the 1930s precedent. This saw a gradual withdrawal of cash and the purchase of gold. State deposit guarantees and state shareholdings should go some way to maintaining confidence in the banking system this time.
Gold and silver
But there is a very clear reason why the banking system’s nationalization still ends with a rush into precious metals, and that includes silver which will cease to be an industrial metal as soon as gold begins to take off and will likely outperform because of its more limited supply.
Meet inflation, probably a mild form of hyper inflation, that is the inevitable result of the trillions of dollars being injected into the global financial system. That might indeed be saving us from the worst effects of the 1930s banking collapse but the general pattern can still be used as a historical guide to the near future.
What I am less clear about is how long this banking crisis will take to mature from credit crisis to bond crisis to precious metals boom. Markets do move a lot faster than the 1930s and are globally integrated (although arguably globalization was stronger in 1930, it was the backlash of nationalism that destroyed it in the depression years).
But it could be that the speed and substantial size of the response by global governments is enough to freeze the impending crash for a while, or alternatively the indigestion it causes will produce an immediate systemic reaction of similar size in the opposite direction.
Everything has changed
All I am quite certain about is that the world has changed in the past two weeks, and that hoping to get back to ‘business as usual’ is totally unrealistic. The late 2000s banking crisis will now go into stages two and three, and we must be prepared for some nasty shocks along the way.
Commodity prices could slump along with share prices in anticipation of a deep recession. Hedge fund casualties could be even bigger than feared. The dollar could move from being the currency of choice to one nobody wants. Any weak business will fail. Unemployment is going up. House prices are going even lower.
That is what happens in the wake of a banking crisis, even if you nationalize the banks.
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Do you have any comments in Jim Sinclairs latest comments on silver?
# Sliver will demonstrate the fact that it is more industrial a metal than precious.
# Silver is not a currency because it is simply too HEAVY to settle debts or to be universally fungible.
# Silver performs best when there is reasonable industrial demand and distrust of currency. When this happens rounding up the gang and their money will have a lot to do with which party is elected.
Remember Jim Sinclair is a celebrated gold bug and not a silver fan. But I think we could reasonably argue:
- silver has suffered a 50% correction since March, most of it by alleged illegal shorting by two US banks now under investigation
- gold is also very heavy, when silver reverts to its long term 15:1 ratio to the gold price it will weight less
- in a hyper inflationary environment there can be reasonable industrial demand and distrust of currency – is that not where the $3 trillion (more after the Europeans today) bank reflation is taking us?
- Not sure exactly what he means by the last sentence – but I have written to the man investigating silver and suggested to him that public officials who take a stand against the greed of Wall Street are likely to gain promotion after the election of President Obama.
Excellent points, could not agree more. This is bad news for most, but for those of us who understand investing, it’s the perfect time to buy.
Peter:
I agree with your premise regarding precious metals manipulation, & the need for CFTC integrity in taking a stand. As we all know (and as I indicated in my correspondence to 5 CFTC officials), there is a crisis in confidence and trust, between and within the financial community, but also between the American people and the fiduciaries of US banks. I hope that this crisis in confidence does not spread to the members of the CFTC. The only CFTC member who responded to me (on 2 occasions!) was Bart Chilton. He also promised that he would let me know of their findings, as soon as their investigation is completed.
If CFTC tells it like it truly is, and “takes a stand”, I also believe that the new President-Elect Obama will reward them in some way.
Richard D.
On 3. No it is not a good time to buy the banks – you get me wrong. The financial sector is as bust as the Nasdaq after 2000. You never make money by buying into a failed sector just after it has really crashed. Find the one that is next due to boom. All these people buying into the banks now are just going to get burned. Mark these words!
Can you not see that the banking sector has had it – the old days of big profits are gone for good. That is what nationalization means. In a sense all the banks have lost by what has happened – the biggest losers will eventually disappear, but trying to pick winners now is utterly foolish. They are all losers.
# Silver will demonstrate the fact that it is more industrial a metal than precious.
# Silver is not a currency because it is simply too HEAVY to settle debts or to be universally fungible.
# Silver performs best when there is reasonable industrial demand and distrust of currency. When this happens rounding up the gang and their money will have a lot to do with which party is elected.
I have the utmost respect for Jim Sinclair but I am afraid his reasoning is faulty
in this instance.
I am in my mid 50’s now and I can state based on my experience growing up in Canada that I have never once seen gold used as money in an everyday commercial transaction. On the other hand, silver was plentiful and was easily obtainable at any bank in exchange for paper currency up until April of 1968. A ten dollar bill could just as easily net 10 silver dollars as it could a roll of quarters.
If silver is an industrial metal then why has inflation removed it from worldwide circulation for 40 or more years? The industrial metals such as nickel, copper, aluminum, and iron still circulate freely but silver does not.
I think the last point quoted above reflects Mr. Sinclair’s opinion that in a time of recession, silver will lose value due to the lowering of demand from industrial requirements. Self styled economists such as Robert Chapman seem to think silver will do poorly during a time of deflation. I tend to discount both viewpoints because the historical record of silver is quite clear. Silver has been viewed as money since the fourth millennium BC.
The stockpiling of silver by the US government starting with the discovery of the comstock lode did skew the supply of silver and it did outstrip demand but that above ground stockpile has been mostly used up and the supply situation now favours silver.
I don’t consider silver to be an investment but I do notice that a silver quarter exchanged for fiat currency will still more or less purchase a loaf of bread and a silver dime will still purchase a small bag of potato chips as I remember it did when silver still circulated.
Since money is a store of wealth and wealth is the ability to purchase essentials, then it follows that silver continues to function as money indirectly as gold also functions indirectly as money since it is usually fairly simple to exchange silver or gold for the circulating currency of the time.
At this point with the world’s circulating currencies about to saturate markets it is more important to store value than to worry about trying to call bottoms and do all your buying. Using that strategy may leave you with no precious metals to show for your patience.