Wednesday, November 18, 2015

Bitcoin Will Be Ready When The Next Credit Crisis Hits - Get Some

Take a look at this video for a glimpse at what's in store when the next credit crisis hits.

This credit cycle started in the 1970's when Paul Volker put interbank inerest rate up to 21% to reign in inflation. Since then interest rate have dropped until it is at zero and trending negative. Many countries of the developed world already have negative interest rates. This is because central banks have not allowed the system to correct itself. Negative interest rates are unnatural and sends the wrong signals to the market. The time will come when it will correct. We have to be prepared.

Look at German bond rates at the last bond auction 18 November 2015

Two year and five year bonds have negative yields. This means that investors are expecting that rates in the next five years will go negative further. That is if the politicians will let this state of affairs continue. What happens if central banks decides that enough is enough and allow bond markets to correct ?

Look at this next graph which shows the monetary base go nuts from quantative easing.

The reason why QE never resulted in inflation is because that money never made it to the general economy. All it did was shored up bank balance sheets, kept deflation at bay and inflation just above zero. Interest rates were kept low to negative. This led to distortions in the economy and runaway assets prices. We now have huge asset bubles in stocks, housing and collectibles, except precious metals. Zero interest rates in the US also led to that money finding it's way into developing economies in a carry trade looking for positive returns. This is economics in the twilight zone. We are in Lala land!

So why is gold and silver exempt from this asset bubble. Why has it gone down from a high of $1900 in 2011 to $1070 today.

The fact is pysical gold is hard to come by. Any offer of minted gold coins are quickly snapped up. What is left is paper gold. This is not the real metal just a promise to deliver the real metal. Gold and silver markets are manipulated with paper gold because if gold prices were to go up, the public will percieve that the economy is in trouble. Economics is all about perception and herd mentality.

So what will the next credit crisis look like ?

No economic text, courses or diplomas can prepare us for what is happening now and tell us what will happen next. Nobody knows. Perhaps we can look at what happened in 2008.

Basically overnight, the assets in the bank books were not what it says. When the bank makes a loan the entry is :

Debit : Loan Owed By Customer ( Asset, backed by Property )
Credit : Customer Current Account. ( Liability, Just a Book Entry )

The amount of liability (money) it can create is limited by the reserve ratio and the amount of cash it must keep with the central bank. Now if the value of the property it holds is less than the loan owed, the bank is technically insolvent. It must make up the reserve ratio and can no longer make any new loans. If the bank must 'Mark To Market', it is bankrupt. If all the banks face this same problem, the whole financial system is frozen. The economy as we know it, is dead. Only cash works.

In 2008 the reserve bank printed the money in the form of QE and gave it to the bank to shore up it's balance sheet. This rescued the banks from being insolvent. MAGIC. It is the same as your father giving you the cash to make up the negative balance when your housing loan exceeds the value of your house.

How did the bank repay it's loan to the reserve bank? They sold all the underperforming loans to the reserve bank and waited for the housing market to pick up. Of course you and I do not have this luxury. Our houses will be foreclose in a mortgagee sale, and we will be thrown out on the streets.

So when the next credit crisis hits, asset prices will go south. The trigger will be interest rates going up. People can no longer afford the huge mortgage on very low interest rates. Everyone will try to sell their properties that they can no longer afford to service, at the same time. The carry trade will go in reverse. This is why the reserve bank will find it very difficult to increse interest rates. Even a little bit.

Will this ever happen? Will the government let it? Problem is that interest rates are already zero and they can't reduce it further, as long as we have cash. Negative interest rates will not work if cash is an alternative, people will just keep their cash out of the banks. Banks will limit the amount you can withdraw like in Greece recently. This is why there is a push to outlaw cash and Sweden is now the first cashless economy. Others will follow.

What Can We Do ?

Life will still go on. Unemployment will increase and will hit the young hard. Business confidence will be low and most businesses will have to cut cost to conserve cashflows. House prices will be down so will the stock market.

Your bank account may be frozen and access to cash withdrawal will be curtail. This will be hard for businesses as they will be unable to pay their creditors especially for overseas purchases. However if they have access to bitcoins they can circumvent such difficulties.

Bargains are to be had if you have CASH or BITCOIN. Bitcoin is the first truly global currency.
The price of bitcoins will go 'to the moon' as the demand for it will come from all over the world as a hedge against currency devaluations.

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