Gold News

An Elegant Scam

How the US feds made the 2008 bail-outs look like a smart investment...

GOLD is hitting new record highs, writes Bill Bonner in his Daily Reckoning.

Gold's telling us that there is something very wrong with the world's Dollar-based money system. But most investors don't notice. Gold is still a "kooky" thing to buy. And the feds have no idea what is going on.

You gotta hand it to the feds. They're cool. They're incompetent. They could pass a lie detector test no matter what they did.

Over at the US Treasury, they've been crowing about how much profit they've made. They rushed to save AIG and Citi by buying their toxic bonds. Then, they flew to the side of Fannie and Freddie when they were in trouble.

As a result of these selfless rescue efforts, they came to hold a huge portfolio of securities; the Fannie and Freddie portion alone is worth $142 billion, say the papers. The Treasury has already sold its AIG and Citi paper – at a profit. And now, it is getting set to unload its hoard of Freddie and Fannie paper.

Can you believe it; its eggs haven't been sold yet, but it's already counting on profits between $15 and $20 billion. Are they investment geniuses at the Treasury, or what?

Well, in a way, they're a lot smarter than we are. We could have bought those notes and bonds too. We should have had more faith in the feds. We could have looked ahead and seen that they would get away – for a while, at least – with one of the biggest financial scams in history. We could have made a profit on it too!

Let's look at how it works. The borrowers – AIG, Citi, Freddie, Fannie – make bad bets. By all rights, they should go broke and their bondholders should lose money. But as Mr. Market is doing his work – marking down junk debt of all kind in anticipation of a clean up – in come the feds. No need to sell that stuff, they say. We're behind it 100%. Thus did they pledge the full faith and credit of the United States of America to guarantee that bondholders wouldn't pay for their own dumb mistakes.

We should have bought then; the fix was in. But we had doubts about the credit of the US. Still do. We worried that the fix may not stay fixed long enough to make money. We were wrong.

As to their ability to refloat the financial sector, we should never have doubted the feds. The Fed went out and bought every stray dog and cat of a mortgaged-backed security it could find – $1.4 trillion worth of them. It also lent money to the financial industry at 0.5%. That's about 8.5% below the real rate of consumer price inflation – according to John William's "Shadow Stats" estimate. And if that weren't enough, the banks were guaranteed profits – by allowing them to borrow from the Fed at 0.5%, use the money to buy US Treasury bonds, yielding between 3% and 4%...and sell them back the Fed. Not taking any chances, the Fed is also printing up an extra $4 billion per day, money coming out of nowhere, to buy Treasury bonds. Not only is it financing more than America's entire monthly leaves the financial industry free to use its own (borrowed) money to speculate on other things.

Naturally, when you have this kind of racket going, you're not going to bother making risky loans to the private sector. Instead, you're going to go where the fix is're going to gamble on debt – buying more "junk" bonds...and pushing up bond prices!

Oh, Dear Reader, we hate a scam, but we admire an elegant scamster. In other words, the feds gave the financial sector the money to bid up its own paper...the very paper that the feds themselves held in great quantity.

And now they claim to have made a profit from this operation.

How about this? We'll start a phony baloney business. We'll sell shares all over town. When people realize that the business is a loser, the shares will fall and our business will be in danger of collapse. Then, the feds can come to our aid too. They can buy up our shares, guarantee that we'll never go bust, and give us money so we can buy shares too. The price of the shares will go back up...and the feds can sell their shares, quietly. Hey, this will be profitable for the feds too – if they ignore all that money they gave us to make the flimflam work.

But here's a question: why couldn't they make this sort of razzmatazz work in Europe? Didn't the Irish have a boatload of bad mortgage debt? Didn't the government step in to guarantee the lot of it? And now look. Not only is the original mortgage debt getting marked is the Irish government's debt.

Why can't the Irish get the hang of this? Well, a couple of reasons.

First, the Irish have much more debt to deal with; they've already given their banks an amount equal to 1/4 of the nation's entire GDP. That would be like reflating the US financial sector with $3.5 trillion.

Wait a minute. You say the US financial sector has gotten nearly that much? Hold on...maybe you're right...

The money printing from the Fed is the aforementioned $1.4 billion, right? Okay... Another $200 billion or so in asset purchases from the Treasury. And surely handling all those US Treasury bonds didn't hurt – what's that, about $3 trillion there, but you can't really count that as a bank bailout.

But the big difference is that the US can print money; Ireland can't. Ireland has to borrow the money with which to bail out its banks. And the more it borrows, the more investors worry that it won't be able to pay it back.

And they're right. At current yields, the Irish can't borrow at all – not on the open market. Two-year bonds issued by Ireland now yield more than 10%. So, the Irish have to beg loans from the Euro-feds. And even they are charging them 6%. Even at that subsidized rate, Ireland can't go on much longer.

Ireland is more like California or Illinois. It doesn't print its own money. And it doesn't have a central bank that will lend at zero per cent.

In the long run, this is a good thing. They can't destroy their entire economies with make-believe money, while claiming to make taxpayers' a profit.

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Bill Bonner has co-authored a number of New York Times Bestsellers including Financial Reckoning Day, Empire of Debt and Mobs, Markets and Messiahs. In his own opinion, Bill's most recent title, A Modest Theory of Civilization: Win-Win or Lose, is his best work yet. Bill also founded The Agora, a worldwide community for private researchers and publishers, in 1979. Financial analysts within the group have exposed and predicted some of the world's biggest shifts since that time, starting with the fall of the Soviet Union back in the late 1980s, to the collapse of the Dot Com (2000) and then mortgage finance (2008) bubbles, and more recently the election of President Trump.

See full archive of Bill Bonner articles

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