Gold News

What Can Stop Inflation?

With this much money, and such little gold, just what can stop $10 lattes arriving with $2,000 bullion...?

WELL, WELL, WELL, isn’t this curious? asks Eric Fry in The Rude Awakening. The “finance sector recovery” of January and February seems to have yielded to a March swoon and an uncertain April. Let’s connect a few distinct data points from the recent headlines and see what sort of an image emerges.

First up, US Treasury Secretary Timothy Geithner warned the lumpen-investoriat yesterday that many of the nation’s banks will still require “large amounts” of government assistance.

Mysteriously, this warning seemed to come as a shock to many folks. Apparently, the 1,400-point Dow rally of the last three weeks had calcified the delusion that an actual recovery was at hand. A bona fide recovery seemed plausible...or at least as plausible as reality TV.

Sometimes, it is true, hope triumphs over substance. But more often, hope merely anesthetizes the adverse effects of substance and – like most anesthetics – induces nausea once the subject revives.

Not surprisingly, the financial sector led the ensuing decline. The shares of Swiss banking giant, UBS AG, dropped 11% on news that the ailing firm might slash an additional 8,000 jobs and continue writing down billions of dollars worth of additional losses.

“Yeah, but those Swiss banks are much worse off than the big American banks,” the stock market bulls assure one another. “The big American banks said they are doing okay, didn’t they?”

Yes, that’s right, they did. But this is where our review of yesterday’s headlines takes an interesting turn. JP Morgan and Citigroup, to name two (very) large banks, admitted late last month that March has been much more challenging than January and February.

“J.P. Morgan had a ‘tougher’ month in March,” Bloomberg news reports, “and Bank of America is trading book ‘was not as good’ as in the first two months of the year, the banks’ chief executive officers Jamie Dimon and Kenneth Lewis told CNBC last week.”

Hmmm...seems like an odd turn of events in the midst of a recovering financial sector, doesn’t it?

Well yes, unless you believe that there may be some shred of truth to one of the fascinating rumors circulating on the Internet yesterday – the essence of which was that AIG has been unwinding various derivatives positions in such a way that AIG receives adverse pricing and the counterparties receive favorable pricing.

Are you confused? You should be. The theory, as presented on the “Zero Hedge” blog, is that the government is intentionally using AIG to funnel capital to other financial institutions. I guess the reasoning would be something like: Better one humongous, high- profile disaster like AIG, then hundreds of other multi-billion- dollar disasters.

After presenting a series of complex details, the Zero Hedge source concludes:

“Let me explain in layman's terms: AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam…

“What this all means,” Zero Hedge continues, “is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary. (To read the entire acronym-filled scuttlebutt, click here.)

We have no idea if this blogger’s “AIG Conspiracy” theory holds water or not. In fact, the blogger may simply be giving the AIG traders more credit than they deserve. For example, if the hotshot traders at AIG were capable of amassing $1 trillion worth of losing trades, could they not also be capable of losing billions more dollars by incompetently unwinding these trades?

Conspiracy or not, the simple observation remains that AIG distributed several billion dollars worth of aberrational profits to its counterparties during January and February. Without additional aberrational profits in March, therefore, the big banks would have been reduced to trying to derive profits from their vast array of unprofitable business lines and activities.

Hence, the cautious remarks from Messieurs Dimon and Lewis.

As our review of recent headlines climbs from 10,000 to 30,000 feet, we are compelled to wonder once again, “What possible act of God, event of nature, or twist of fate could possibly prevent a resurgence of inflation here in the United States?”

Whether by intentional conspiracy or unintentional incompetence, the Treasury is tossing hundreds of billions of newly minted dollars into the financial system. The Treasury is, in fact, inflating the supply of dollars. The only question that remains is whether this inflationary act will produce a visible inflationary result? In other words, how long until a Starbucks double latte costs $10...or an ounce of gold costs $2000?

Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.

See full archive of Eric Fry articles

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