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THE
ROCKET SCHOOL OF ECONOMICS


An Inherent Flaw
by Professor von Braun

September 16th, 2005

Most of us have realized by now that the US financial system is in an 'interesting' situation. Various postulations and explanations have been formulated as to what's going to be the straw that breaks the camel's back. Back in the late 1990's it was of course the stock market boom, and in particular the tech bubble -- which did burst -- and here we all are 5 years later with no seemingly devastating effects. Now it's either the housing bubble or the trade deficit or the US dollar collapse. The same pundits have merely changed horses and are still calling for a crash -- the crash, any old crash, as long as there is a crash.

Bob Prechter (www.elliottwave.com) still touts his book 'Conquer The Crash' and in a recent 'Special Edition' of the Elliott Wave Theorist he postulated, "Every asset class except cash and safe debt is poised to break down". In recent issues of EWT he has also taken to task other commentators such as Marc Faber and more recently Jim Rogers for presenting apparently wrong opinions about gold and commodities respectively, seemingly because their opinions don't coincide with Mr. Prechter's own views.

But one has to ask the question as to what 'cash' is, and what is 'safe debt'? According to Mr. Prechter they are an 'asset' class. So what is an asset? One would like to think that an asset is something you can rely upon to perform when you need it.

The banking system today is the clearing agency for payments made for assets that are bought and sold, payments eventually ending up in people's individual or companies' corporate accounts, thereby providing a balance upon which checks can be written or cash can be withdrawn. Cash is the folding stuff you have in your pocket; it is not the balance in your check account. I hope for the sake of Mr. Prechter's readers that he understands this subtle point when he refers to cash being an asset.

Most banks carry little actual 'cash' as in the folding stuff. And if you want to cash a check for $50,000 it is wise to let the bank know a day or two in advance so they can arrange to have funds made available. Then there are the reporting requirements that you will need to comply with, the forms that need to be filled out and the transaction recorded.

What is safe debt? That one is a bit of a mystery because as there is nothing to back up the currency in the first place what could be 'safe' about a debt instrument that is already contaminated by virtue of the currency that it's written in??

It could be said that Swiss government bonds are safe debt instruments, but how do you convert those into actual cash? To the best of my knowledge Walmart does not take Swiss Francs at the checkout register. Obviously one would have to sell these 'safe debt' instruments which means you have to find a buyer who has the means to pay for them and then you need the proceeds transferred to your account. But that still does not give you 'cash'. You then have to withdraw cash from that account which would be difficult to do if you are in the US and the bank is in Geneva.

I have not researched the amount of cash within the Swiss banking system but the Federal Reserve website will tell you that the amount of printed dollars in circulation is estimated to be $750 billion, with half of that being off shore, as in outside the US. That leaves $375 billion in cash in circulation within the entire US banking system which is slightly in excess of $1,000.00 per head of population.

People talk about being 'liquid' but do they really understand what liquidity is? Should there be an increased demand for cash, banks would have to sell 'assets' (as in liabilities) to obtain the cash that you might need to obtain back from the bank where you have these 'liquid' funds on deposit. These 'liquid' funds the bank has of course are deemed to be a liability, and having lent them out several times over, they now classify these lending's as 'assets'. These 'assets' are other people's liabilities, whether it's a mortgage, a government bond or a federal government guaranteed instrument, it still requires somebody to repay it.

So once again one has to ask "what is a safe debt instrument?" I do not believe that Walmart will currently accept 10-year US Treasuries at its checkout register either.

The other option, perhaps the safest option, is to hold something that has no liability attached to it whatsoever, and the safest form of that is gold and silver. But Mr. Prechter informs us that these, too, are an asset class, set to slide into oblivion.

What happens to the banking system if there is an event that compromises the banks ability to liquidate its liabilities to meet cash withdrawals? How could the banking system -- the very entity that's fueled the coming financial debacles, regardless of what form they take -- give you back the monies you have on deposit in cash, when they would need to liquidate their 'assets', other peoples liabilities, to do so?

Given what we have seen in New Orleans of recent weeks, Nature has the ability to lay havoc to the best (and not-so-best) laid plans. Electronic banking may be a wonderful thing but it's not very helpful when your ATM is under eight feet of water or has no electricity.

The financial industry relies on electronic money, or digits; numbers in a monetary system that really doesn't mean anything when it comes to holding cash. They far outnumber the printed counterpart, and that's fine -- as long as things continue to hold together. But to conquer the crash one should not be relying on them.

Should 1% of the population decide to go to cash and they wanted $50,000 apiece, that's about $150 billion, which is nearly half of the available cash in circulation.

Personally I would much prefer to be holding something that might decline in price, but retains its inherent value as in an ounce of gold being an ounce of gold, than I would be to hold 'safe' debt instruments denoted in an unsafe (and as yet untested under pressure) fiat currency.

Where are the buyers going to come from to purchase from the banks their 'assets'? Could the Federal Reserve step in and start buying US Treasuries and give the banks the liquidity they might need should you want your cash in the hand rather than in digits? Well they could, but the printing presses would be working 24 hours per day for quite some time I suspect.

What would maintain the value, the purchasing power of the dollar, when it became known that the lender of last resort was now accumulating debt that could never be repaid as a last resort?

What would that do to the 'price' of real assets?

One needs to be very careful about the idea of conquering the crash since crashes are usually not explainable until after they happen. The venerable Richard Russell (www.dowtheoryletters.com) said it best in a recent commentary when he said that it's those that lose the smallest amount that remain in a position of strength. He also recommends accumulating gold and silver.

Meanwhile as long as the bullion dealers are happy to accept electronic digits as payment for physical gold and silver one should be accumulating a supply while one can. Safe harbors and safe havens may have their place, but at a distance may not be one of them.


The Prof can be contacted by email at profvonb2@aol.com

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

Return to the The Gilded Opinion Index Page

The Rocket School of Economics -- The Lecture Series Index

  • 22 May 2009 -- An Often Overlooked Issue!
  • 28 Mar 2009 -- Problematic Banking Systems!
  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
  • 31 Mar 2008 -- The Broken Watch -- Part 2.
  • 27 Mar 2008 -- The Broken Watch -- Part 1.
  • 06 Feb 2008 -- The Financial Equivalent of Faulty Towers.
  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
  • 30 Mar 2006 -- What came first?
  • 11 Mar 2006 -- An Unanswered Question.
  • 08 Jan 2006 -- Where have all the projects gone!
  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
  • 14 Jun 2005 -- The Two Greater Fools Theory.
  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
  • 30 May 2005 -- Real Money, Funny Money and YOU -- Part 3.
  • 26 May 2005 -- Real Money, Funny Money and YOU -- Part 2.
  • 21 May 2005 -- Real Money, Funny Money and YOU -- Part 1.
  • 09 Nov 2002 -- Carrying a Big Stick.
  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
  • 10 Jun 2002 -- Gold Bugs Beware!
  • 06 Apr 2002 -- Currencies versus Gold.
  • 26 Jan 2002 -- Bear Market Strategies.
  • 01 Jan 2002 -- 2002 -- A Perspective.
  • 20 Oct 2001 -- The Storm Clouds are Gathering.
  • 30 Sep 2001 -- What to Say?
  • 01 Jul 2001 -- ...Said the Fly to the Spider.
  • 14 Jun 2001 -- Upward and Downward!
  • 28 May 2001 -- Volatility Time, Again!
  • 14 May 2001 -- The Coming Bull Market in Gold Stocks?
  • 24 Feb 2001 -- High Hopes, Wishful Thinking & The Absurd
  • 20 Feb 2001 -- Who Put the Holes in the Swiss Cheese?
  • 22 Jan 2001 -- US Dollar Admits Identity Crisis!
  • 16 Jan 2001 -- Dear George W.
  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
  • 02 Nov 2000 -- Gold Stocks
  • 29 Oct 2000 -- Oh The Tangled Web We Weave ...When We Set Out to Deceive
  • 24 Oct 2000 -- A Mystery!
  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
  • 10 Oct 2000 -- The Unfolding
  • 30 Sep 2000 -- What's Wrong with THIS Picture?
  • 25 Sep 2000 -- Buy Gold Now!!
  • 23 Sep 2000 -- The Times, They Are a' Changing
  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
  • 06 Aug 2000 -- The Indian Summer
  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
  • 08 Apr 2000 -- Really, Sir Aldot!
  • 25 Mar 2000 -- Where To From Here?
  • 18 Mar 2000 -- The Gnomes of Zurich
  • 12 Mar 2000 -- The "New" Economy??
  • 06 Mar 2000 -- Two Questions
  • 04 Mar 2000 -- Iceberg Dead Ahead!
  • 28 Feb 2000 -- The Wizard of Oz
  • 06 Feb 2000 -- Here We Go Again!!
  • 15 Jan 2000 -- Comments on the Gold Market
  • 29 Dec 1999 -- No Raw Ingredients Required
  • 28 Dec 1999 -- No Way Out
  • 14 Dec 1999 -- Ho, Ho, Ho!
  • 07 Dec 1999 -- Greenspan's Bubble
  • 03 Dec 1999 -- Early Warning Signs


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