Goldman Sachs in trouble as US banks face armageddon again

News that Goldman Sachs has hired a top lawyer to fight its mounting legal challenges was enough to bring the S&P 500 mini-rally to a halt yesterday, while the Bank of America’s moves to sell its huge Chinese banking interests is underlining the seriousness of the crisis at the biggest US bank.

These domestic problems might be less of a bother if it was not for the storm brewing up across the Atlantic in Europe. British banks have seen their market caps decimated over the past month due to their exposure to sovereign nations now on the brink of debt default. It has been the same story for banks all over the eurozone.

Fortress America

You might imagine the US financial sector is somehow protected inside fortress America. But in this inter-linked world that is not the case, and actually it was no different in 1931 either when the collapse of the Credit Anstaldt Bank in Austria led directly to the failure of thousands of US banks and then the Great Depression really got started.

Will it be any different this time? To be sure the central bankers of the world have written PhD theses on the Great Depression. They think they know how to do things differently.

However, even they will concede that this is still untried and untested territory. The scale of macro-economic manipulation required has not been attempted before. The intended consequences may not happen, let alone the unintended consequences.

What if instead of mild devaluation and modest inflation we get another big deflation like in the autumn of 2008? What if that happens after the Fed launches a QE3 rescue package at the end of this week? What does it do then?

Some seriously out-of-the-box thinking is going to be required to really save the global banking system. But this will not be life as we have known it. Another financial crisis will downsize the banks for a generation and result in a massive consolidation and job losses on an unbelieveable scale.

New system please!

Picking up the pieces and putting Humpty Dumpty back together again will be essential but very difficult. A completely revamped IMF reserve fund or a gold backed reserve currency or both are the kind of solution that will have to emerge. The banks will be modest depository and lending institutions, not masquerading as wealth managers.

Readers of the ArabianMoney newsletter got the tip to buy leveraged short US bank ETFs last month. That is one way to make money out of the banking collapse until short selling is banned as it has been in parts of Europe.

Otherwise holding gold and silver in a major banking crisis presently looks a winner with gold topping $1,912 last night. But this is a crisis unfolding before our eyes in real time, and not some intellectual abstraction, and the time to get some protection against it is running out.