The end of fiat?

Darryl Rober Schoon just posted this interesting piece courtesy of 321gold.com about what he feels is a looming crisis of such epic proportions, that fiat money in its entirety could collapse. It seems extreme but its well worth the read.



Correction or the Collapse of Gold
Darryl Robert SchoonApr 7, 2008


Conduct your victory as a funeral-
Tao Te Ching, Lao-tzu


Gold's recent sell-off from a high of $1033 has sent once-jubilant gold investors to the sidelines to reassess gold's present malaise. Rest assured, gold is going higher, much higher. While there will be corrections along the way, gold will someday break out and explode upwards towards yet to be reached heights.

But when gold does reach that record level, it will not be an occasion for celebration - on that day there will be no dancing in the streets, there will be misery.
$1000 gold is a milestone - on the road to hell-Professor Antal E. Fekete

In How To Survive The Crisis And Prosper In The Process, I describe the 5 stages of gold that precede and occur during what I call The Time Of The Vulture. We are currently in stage 3:
STAGE 3: THE PRICE OF GOLD BECOMES INCREASINGLY VOLATILE. The price of gold is subject to increasing highs and lows as large investment funds move in and out of gold as global economic uncertainties wax and wane, a sign that gold is increasingly a haven in uncertain times. -How To Survive The Crisis And Prosper In The Process, page 92

This is where we are today. Macroeconomic factors such as the decline of the US dollar, the collapse of credit markets, the deflating of the world real estate bubble, the failure of banks and hedge funds, etc., are now joined by rising tides of speculative money moving in and out of gold seeking short term gain, thus subjecting the price of gold to increasingly volatile price swings. Until stage 3 ends, gold's volatility will continue.

Nonetheless, gold's determined rise over eight years confirms that a system of paper assets, irredeemable paper money and increasing levels of credit and debt is doomed and bound to collapse; and, so we buy gold and silver as insurance against that coming day and wait for the inevitable trajectory of the precious metals.

The inevitable will come but when it does, it will not be a time of rejoicing; for the collapse of paper assets and the rise of gold and silver will come at a horrific cost. Those who invested their family's future in stocks, bonds, property, and paper assets will suffer greatly when the collapse occurs - and the magnitude of that suffering will affect us all.

THE FINGER OF GOD

On November 17, 2006, Martha and I were at the University of Chicago to hear Professor Antal E. Fekete deliver a talk before the MBA class of 2007. When we heard Professor Fekete had been invited to the University of Chicago, we knew we had to go; for the University of Chicago was synonymous with Milton Friedman, the Nobel Laureate, with whose theories of monetarism Professor Fekete strongly disagreed.

That Professor Fekete was to speak on gold at the University of Chicago was similar to Martin Luther speaking on the Reformation at the Vatican. But Professor Fekete did not deliver his intended address - the day before he was to speak, on November 16th, Milton Friedman, the father of monetarism, died.

I told Professor Fekete that Friedman's death the very day before the professor was to speak at Friedman's academic home was evidence of the finger of God denoting a shift, a cosmic sign that presaged the end of monetarism and the beginning of another era in which the professor would play a critical role.

Out of deference for Friedman's passing, Professor Fekete did not deliver his prepared talk which was highly critical of Friedman's theories (his original speech is included in the appendix of How To Survive The Crisis And Prosper In The Process; instead Professor Fekete addressed the MBA class on the increasingly fragile nature of the economic world which they were about to enter.

The professor's words of warning, however, did not deter the student's belief in the world of paper money and paper profits that Friedman's theories proffered. The MBA students had studied too hard for their chance at the wheel of fortune, the wheel to which MBA graduates from the University of Chicago and other top programs were privy - the wheel which was to unexpectedly falter when credit markets were to suddenly collapse nine months later in the summer of 2007.

Today, 17 months after Professor delivered his cautionary words to the MBA students, their intended destination - the credit markets, the crap table of investment bankers and the trough of government largesse - are still frozen and remain locked in a now life and death struggle for survival

THE SLAVERY OF MONETARISMDEBT - THE COLOSTOMY BAG OF CREDIT

During his life, Friedman was awarded a Nobel Prize for his contribution to economics and was a distinguished member of the prestigious Mont Pelerin Society. Instead, Friedman should have been knighted by the ABA, the American Bankers Association and given special recognition by the BLA, the Bankruptcy Lawyer's Association, the real beneficiaries of his life's work.
Markets dependent on credit-based paper money produce increasing levels of debt until the amount of debt becomes unsustainable. This is where we are today.

The growth, contraction and coming collapse of debt based credit markets is Friedman's legacy, not free markets. Friedman's theories gave bankers the intellectual cover they needed to indebt America beyond its ability to repay and indeed survive. Hailed as the champion of the free market, Milton Friedman was instead, its leading assassin.

CORNERING GOLD

At Session III of Gold Standard University Live (GSUL), Professor Fekete made a stunning prediction - that gold would be cornered. The professor noted that although speculators have attempted to corner markets in the past and failed; this time, with respect to gold, it will be different.

The professor said that gold will be cornered not by speculators, but by widely dispersed market forces. The corner will be a true black swan event, spontaneous and unexpected, driven by a sudden overwhelming need of the marketplace for a safe haven for savings and wealth, the safe haven of last resort - gold.

When this happens, most speculators will be locked out, as they will have waited too long to buy in, as they attempted instead to try to coax a few more dollars out of their favorite paper dollar dispensing machine.

When this occurs, Professor Fekete predicted gold will disappear off the market. The collapse of paper will be so catastrophic that gold will not be exchanged for any amount of paper money, sic money, paper, government denominated coupons with ascribed units of value printed on their face denoting face-value.

When paper money begins to quickly lose value, the collapse of debt-based assets will gather speed and Professor Fekete's predicted corner on gold will spontaneously occur. On that day, The Time Of The Vulture will have arrived and gold will be literally priceless


Darryl Robert Schoon
emailmedrs@yahoo.com

Everything you Needed To Know About a Crisis in The Making - by John Mauldin

After reading John Mauldlin's weekly newsletter this morning I thought you might want to read through his summary of the current credit crisis, the US employment data and his usual nod to the historical inevitability of these events unfolding. You can find his weekly articles at his website http://www.frontlinethoughts.com/.

Its on the long side but well worth the time.



Thoughts on the Continuing Crisis
by John Mauldin


There is so much that is happening each and every day as the Continuing Crisis moves slowly into month 8, so much news to follow, so many details that need to be followed up that it can get a little overwhelming.

Where to begin? Maybe with a "minor" change of the rules on how we value assets, then a look at the proposed changes in regulations, some comments to my hedge fund friends, a quick look at the employment and ISM numbers which are clearly showing we are in a recession and then finish up with some thoughts as to what it all means. There is a lot of ground to cover, so we will jump right in without a "but first" today.

If the Rules are Inconvenient, Change the Rules

Several times in the past few months I have reminded readers of the problem that developed in 1980 when every major American bank was technically bankrupt. They had made massive loans all over Latin America because the loans were so profitable. And everyone knows that governments pay their loans. Where was the risk? This stuff was rated AAA. Except that the borrowers decided they could not afford to make the payments and defaulted on the loans. Argentina, Brazil and all the rest put the US banking system in jeopardy of grinding to a halt.
The amount of the loans exceeded the required capitalization of the US banks.

Not all that different from today, expect the problem is defaulting US homeowners. So what did they do then? The Fed allowed the banks to carry the Latin American loans at face value rather than at market value. Over the course of the next six years, the banks increased their capital ratios by a combination of earnings and selling stock. Then when they were adequately capitalized, one by one they wrote off their Latin American loans, beginning with Citibank in 1986.

The change in the rule allowed the banks to buy time in order to avoid a crisis. It did not change the nature of the collateral. They still had to eventually take their losses, but the rule change allowed both the banks and the system to survive. I have made the point that the Fed and the regulators would do whatever it has to do to manage the crisis.

All the major new multi-hundred billion dollar auctions at the Fed where the Fed is taking asset backed paper as collateral for US government bonds does not make the collateral any better, of course. It just buys time for the institutions to raise capital and make enough profits to eventually be able to write off the losses.

Thus it should not come as a surprise to you, gentle reader, that the rules have been changed in much the same way as in 1980. In an opinion letter posted on the SEC website last weekend clarifying how banks are supposed to mark their assets to market prices is this little gem (emphasis mine): "Fair value assumes the exchange of assets or liabilities in orderly transactions. Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability."

(The full letter is at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm.)

So, now banks can simply say that the low market prices for assets they hold on their books are actually due to a forced liquidation or distress sale and don't reflect what we believe is the true value of the asset. Therefore we are going to give it a better price based on our models, experience, judgment or whatever. In today's Continuing Crisis, nearly every type of debt and its price can be classified as a forced liquidation or distressed sale.

Does this make the asset any better? Of course not. But it buys time for the bank to raise capital or make enough profits to eventually take whatever losses they must. And who knows, maybe they will get lucky and the price actually rises?

There are two problems with this rule. First, it clearly creates a lack of transparency. The whole reason to require banks to mark their assets to market price rather than mark to model was to provide shareholders and other lenders transparency as to the real capital assets of a bank or company. Second, can a forced liquidation or distress sale be from a margin call? Obviousy the answer is yes. But as Barry Ritholtz points out, this opens the door for some rather blatant potential manipulation. If a bank makes a margin call to hedge funds or their clients to make the last price of a similar derivative on their own books look like a forced liquidation, do they then get to not have to value the paper at its market price? Is this not an incentive to make margin calls? One price for my customers and a different one for the shareholders? If a hedge fund was forced to sell assets and then they find out that the investment bank is valuing them differently on their books than the price at which they were forced to sell, there will be some very upset managers and investors.

Cue the lawyers.

Is this a bad ruling? Of course. But is it maybe necessary? It just might be. My first reaction was that this tells us things are much worse than we think. The struggle to get the mark to market ruling only to abrogate it in certain circumstances less than a year later has to gall a lot of responsible parties. It seems like it is 1980 and Latin America all over again. Let me repeat: The Fed and the Treasury (who oversees the SEC) will do what it takes to keep the game and the system going.

So, let's sum it up. The problem is so severe with the financial companies assets that the SEC is going to allow some of them to "cook the books" so they can survive. That means there are going to be large and continuing write-downs for many quarters to come. There is a minimum of another $3-400 billion in write-downs (and maybe a lot more) coming from mortgage related assets, not to mention credit cards and other consumer related debt. And the investment banks may be forced to reduce their leverage and thus their profitability?

Putting money in the major financial stocks is not investing. It is gambling on a very uncertain future. There is simply no way to know what the value of the franchise is. There are other places to put your money.

More Fun in the Unemployment Numbers

Payrolls tumbled by 80,000 today, more than forecast and the third monthly decline, the Labor Department said today in Washington. The unemployment rate rose to 5.1%, the highest level since September 2005, from 4.8%. The household survey shows the number of unemployed people rose by 438,000. (That is not a typo!) In March, the number of persons unemployed because they lost jobs increased by 300,000 to 4.2 million. Over the past 12 months, the number of unemployed job losers has increased by 914,000.And of course, when you look into the numbers it is worse than the headlines implies.

Prediction: we will see 6% unemployment before the end of the year.

There were negative revisions totaling 67,000 job losses for the last two months, making those months even worse. This means that the Bureau of Labor Statistics (BLS) is clearly over-estimating the number of jobs in the first announcement. That is because they have to extrapolate based on recent past data. And as I continually point out, as the economy softens, they are going to continue to overestimate the number of jobs. It's one of the problems of using past performance to predict future results.

Job losses since December are now at 286,000 in the private sector and 232,000 overall, counting for growth in government. What was up? Health care (23,000) and bars and restaurants (23,000 also). Initial unemployment claims are up by almost 25% for the last four weeks over last year, and this week were over 400,000. Given the job losses, this is not surprising.

This month the BLS hypothecates 142,000 jobs being created in their birth/death model. You can guarantee this will be revised down. For instance, they assume the creation of 28,000 new construction jobs as the construction industry is imploding. Total construction spending has fallen for the last four months in a row. Somehow they estimate 6,000 new jobs in the finance industries. Does anyone really think we saw a rise in employment in mortgage and investment banks?

Buried in the data is a picture of a squeezed consumer. Inflation is now running ahead of the growth in wages. As the chart below shows, average hourly earnings were up just 3.6%, but inflation was 4.5%. That means consumers must struggle to maintain their standard of living. No wonder retail stores shed 12,000 jobs last month. Light vehicle retail sales are down by 20% form last year. This all paints a picture of a very challenged consumer.

A Muddle Through Recession

The business sector is clearly in recession. The ISM manufacturing index came in at 48.6. Anything below 50 means manufacturing is in decline. There was a sharp drop in new orders. New orders have been below 50 for four months. Employment has been below 50 for four months. Backlog of orders has been well below 50 for six months. Yesterday the ISM service index was again below 50 for the month of March.

Given all the data, why then do I still think we will not see a deep recession? Because corporate America is in much better shape than in the beginning of past recessions. Lower inventories, better cash to debt ratios, not as much as excess capacity, and so on. As Peter Bernstein notes in his latest letter, nonfinancial corporate debt is at its lowest level in 50 years, and four standard deviations below the average from 1960 to 2000.

The recession we are now in is a consumer spending led recession driven by a falling housing market which is infecting the entire country. Can anyone still claim that the subprime problems would be contained as many did just last summer? Consumer spending is going to fall even more as credit becomes harder to get.

The situation is neatly summer up by Bernstein:

"The debate over whether we are or are not in a recession continues.
There is, however, no debate about resumption of rapid economic growth in the
near future. That's without question the most unlikely outcome. Yes, there are
some bright spots, such as exports in the governmental largess that lies just
ahead - and the likelihood of additional government assistance in some form. The
Federal Reserve is also doing its part to lubricate the snarls in the financial
markets.

But the household sector is in deep trouble and will remain in trouble
for an extended period of time. The combination of falling home prices, the
complex problems in the mortgage area, limited financial resources and high debt
levels, new constraints and higher costs on consumer installment credit, and
probably rising unemployment already sluggish growth and jobs tend to restrain
spending by the largest and most important sector of the economy.

"Imagine what would happen if all of these adverse forces struck a business
sector stuffed with inventories, busy installing a massive amount of new
productive capacity, with labor costs rising and productivity falling, and an
overload of new debt to service. A difficult situation in the rest of the
economy could be rapidly converted into a deep recession. But the business
sector has kept inventory accumulation to a moderate pace, has limited in
capacity growth, and has been conservative in adding to debts outstanding. How
lucky can you get?

"Some observers are convinced that we are heading toward a
deep depression in any case. We are not so sure. We believe the likely duration
of these troubles is a greater concern than the depths the system might reach.
The condition of the business sector as pictured above is the primary reason for
this more hopeful outlook."

I continue to predict more disappointment for corporations that are tied to consumer spending and industries that are associated with housing.

S&P analysts continue to project earnings to be up by 15% in the third quarter of this year and by almost 100% for the fourth quarter this year over last year. Yes, I know there are a lot of one time charges and write-offs in the last two quarters of last year which make comparisons difficult. But in a recession and a slow recovery, how likely is it that we will not see even more "one-time" write-offs. And as noted above, there are more than twice as much subprime losses in our future as we have written off as of yet.

As I have written about at length in past issues, bear markets are made by continued earnings disappointments. It typically takes at least three difficult quarters to truly disappoint investors. We are just in the early stages. The recent drop in the stock market has been primarily caused by the Continuing Crisis in the credit markets, and only modestly by disappointing earnings. We need a few more quarters of disappointment to really get to a bottom in the stock market. It could be a long summer