Deleveraging Is Not A Dirty Word

THE PILLARS OF BORROWING AND HOW THEY WERE PUSHED ASIDE

Borrowings from time immemorial have been supported by two pillars - equity and serviceability. For at least the last decade or so these pillars were largely ignored as lenders simply required that a borrower have a pulse and be able to sign his or her name on the documentation. The fact that these loans were more often than not securitised, i.e. passed on to some other investor, only provided an additional incentive to ignore traditional lending standards and to simply pick up the commissions.

With all that has transpired it is clear that serviceability and therefore equity have been impaired and are therefore beyond the scope of rehabilitation by Federal Reserve Bank and Government initiatives. In fact their initiatives have simply added more debt to the system and hence more exposure to foreign creditors and greater burdens on future citizens.

It is my opinion that the process of deleveraging through liquidation has not been allowed to take place quickly and deeply enough. Let me explain with the use of an analogy.

THE BOUNCE BACK EFFECT OF DELEVERAGING

Suppose you are holding a tennis ball 5 feet from the ground. If you let it fall from that height on its own it will bounce back up probably to a height of 3 feet. And if you slowly lower it to 2 feet before letting it fall, then it might bounce back only a foot. But what if you were to slam it downwards? Well then it would bounce back higher than 5 feet into the air.

When the global financial crisis struck, the immediate reaction of consumers was to pull back on consumption and pay off debt. Banks also re-discovered lending standards and began to hoard any cash that crossed their path whether it was from the Federal Reserve or anywhere else.

On the surface the 'slam down' reactions of banks and consumers were exacerbating the downturn when in fact it was nothing more than the prelude to a big bounce back. These reactions have to date been greeted with panic by the Government in concert with the Federal Reserve and it is superfluous for me to reiterate all their efforts to arrest and reverse the deleveraging process.

By slowing down the process of deleveraging the Government has only succeeded in delaying the day of reckoning with only more cataclysmic consequences to come as a result. This has been said many times by many commentators but it is either ignored or not understood by our political masters.

In a speedy deleveraging (i.e. liquidation) it is only paper values that suffer. The hard assets, whether they are land, homes, shopping malls, offices and commodities etc are not in themselves destroyed. Only the paper figures attaching to them change. In such a process assets go from weaker hands to stronger hands which in turn have both the requisite equity as well as the requisite cash flow to ensure that their values are retained and loan obligations met. Many may call this deflation but I call it revaluation and re-invigoration.

There are of course those that argue that deleveraging on a broader scale could drive asset prices down and create solvency issues which in turn could hurt the real economy (see the Paradox of Deleveraging by Paul McCulley). My view is that at some point the astute and well capitalised investor/entrepreneur will jump back in with plenty of unencumbered capital and stop the process at the right time.

THE ROLE OF GOLD AND SILVER IN DELEVERAGING

There are a great many people with solid cash holdings too scared to borrow and not tempted enough to buy at the present time because they perceive further weakness ahead. So everything remains encumbered and on the verge of collapse.

Two of the few unencumbered assets are the physical holdings of gold and silver held by big and small investors. Not only are these assets unencumbered, they are also idle.

Why is it that the Federal Reserve (and I have asked this question before) chooses to exchange toxic assets for Treasuries when it could instead exchange gold and silver for interest free cash with a promise of redemption in gold or silver if the cash is returned by the person placing his gold or silver holdings with the Federal Reserve?

This is the type of liquidity the system needs - one kind of money in exchange for another type of money. A true gold standard, only that it is in reverse to the usual situation of handing over paper for gold.

DELEVERAGING IS NOT ENOUGH

For the deleveraging process to succeed the government must pull in its expenditures and allow individuals to take up that slack without more debt creation.

The third requirement is that a debt moratorium be declared by the USA. In other words, it will not pay any interest on Treasuries held by foreign owners till it is in a position to do so.

Fourthly, the USA must run a balanced trade account. This is an aspect that receives only spasmodic attention as leaders consistently skirt around this issue. Failure to deal with this sooner rather than later will only cause the problem to mutate into a default.

Fifthly, treasuries can only be redeemed by foreigners if they are used to pay US corporations for goods and services. Perhaps only a certain amount can be redeemed in this way each year.

JOBS IS THE ULTIMATE GOAL

All of the above are but a preamble to the creation of jobs. No matter how much diplomatic language is used, the reality is that Americans must make and do more things for themselves. This may entail fewer and dearer goods but at least it will ensure a stop to the haemorrhaging that is experienced through loss of jobs and income which has now been in process for quite a few years. To make matters worse there has also been a "dumbing down" whereby people losing jobs usually find that the next job pays less and probably is also less skilled.

FREE TRADE v OPEN SLATHER

Free trade has many pluses but can only survive when BOTH sides MAKE and EXCHANGE goods and services in roughly similar quantities. Is anyone under an illusion that the current modus operandi of free trade will lead to prosperity in the long run rather than trade wars?

Anyone advocating free trade with the bill being paid by overseas borrowings, is nothing but an opportunist seeking to maximise profits, or a globalist who sees the reduction of US wages and conditions down to overseas levels as nothing more than a prerequisite to turning the world into one "happy" little factory. I doubt that the people of the USA want to be one giant Wal-Mart operation on $10 per hour but then again who knows what plans the big boys have.

It is perhaps interesting to note that Dr Mahathir of Malaysia had advocated a type of netting off of trade obligations using gold while he still held office. Either the political will was not there or the timing was not right for such a proposal to be implemented. It is worth a revisit.

GOLD & SILVER CAN'T BE FUDGED AND ONE VALUATION FITS ALL

When nations begin to maximise trade through the security, transparency, uniformity and integrity of a gold and silver system, then people will follow in those same steps. And believe me, when people have to part with their gold to foreign shores they will think twice about what they buy and what they make. This will be in stark contrast to the 'charge it' philosophy the US has had both as a government and as individuals.

In the meantime, gold and silver make their way nimbly across the tightrope of calamity. It may look scary but in reality this is where they walk best. Never forget that gold and silver will continue to defy those that defy honest money.