Bank Runs and a Recession

In the period following the Crash of 1929, it was a common sight to see depositors desperately lined up outside banks that were rumoured to be about to fail.

As the market failed to recover from the Crash, and the economy declined, 40% of all US banks failed. Bank runs occurred during 1930-1933, accelerating during this period.

The Federal Reserve (formed in 1913 to regulate the banking system) cut interest rates gradually over a two year period but failed to re-ignite the economy and there followed a decade of declining living standards, known as the Great Depression.

In September British mortgage lender Northern Rock faced the worst bank run in the UK in 140 years, as depositors wanted to cash out their deposits NOW. It saw 1/3rd of its deposits withdrawn in a few days. After first declining to intervene, the Bank of England had to step in with guarantees in order to protect the banking system (Northern Rock had $ 8 billion in deposits).

This had already happened in the US with Countrywide Financial (the nation's largest mortgage lender) in August and when the economy enters a recession, expect to see a lot more of this.

As an example, consider the story of Bill Ashmore, who drove his Porsche to Countrywide's Laguna Niguel office and waited half an hour to cash out $500,000, which he then wired to an account at Bank of America.

"It's because of the fear of the bankruptcy," said Ashmore.

"It's got my wife totally freaked out," he said. "I just don't want to deal with it. I don't care about losing 90 days' interest, I don't care if it's FDIC-insured — I just want it out."

(Ironically, Ashmore is the President of Impac Mortgage Holdings, which escaped bankruptcy itself recently by shutting down virtually all its lending and laying off hundreds of employees).

Ben Bernanke, the Federal Reserve Chairman, is a student of the Great Depression (he did his doctoral thesis on this topic) and is keenly aware of the risks of a depression unfolding. He believes that the Fed acted too slowly in 1929, which is why the Fed provided an unexpectedly large cut in the Feds Fund Rate.

The decline in U.S. home prices accelerated nationwide in July, posting the steepest drop in 16 years, according to the S&P/Case-Shiller home price index released Tuesday.

Home prices have fallen every month since the beginning of the year. Consumer confidence in September dropped to its lowest level since Nov. 2005 when Hurricane Katrina hit.

Was it only a year ago that a poll of US homeowners expected housing prices to rise by 20% every year for the next decade?

According to the Office of Federal Housing Enterprise Oversight, between 1979 and 1982, housing prices declined by 16% in real terms in the US, and this time the correction may be worse because the boom was so extreme to the upside.

Without the wealth effect of rising housing prices and with a net job loss in August payroll data, a recession is clearly looming. Stock markets will have to fall as corporate earning slow (the S&P still trades at 17.9 P/E, compared to 14 as its historical average) and bank runs may become a more common sight in the future.

The US $ and Gold

The US Dollar has fallen below its all-time low on the US Dollar Index. It currently sits at 78.19, below its 1992 low of 78.33.

Watching the US dollar break below its all-time low was a truly remarkable event to behold. The dollar has been the primary global currency in the world since World War II. It is used by governments and businesses to price oil and gold, settle trade deficits, to launder money and as a currency that is preferred to the local currency in countries such as Panama and Afghanistan!

We are witnessing the end of an era, just as when the pound sterling lost its global reserve currency status sixty odd years ago.

While the dollar may bounce here as it is oversold, it is likely to continue to decline in the coming months and years as the Federal Reserve will be forced to cut rates to stimulate the economy and foreigners come to realise that the dollar's global reserve currency status has been irrevocably compromised.

The dollar declined sharply in recent days as the Saudi government did not reduce its interest rates when the Fed did, creating fear that it was prepared to un-peg from the US $, as Kuwait did earlier this year. The reduction of petrodollars being recycled into US Treasuries has major ramifications for US markets.

Gold broke out to a 27 year high as the Dollar fell. It may retrench over the next couple of weeks, but it is now poised to challenge its all-time high of $ 850 by the end of this year.

With the market turmoil in August, gold and gold mining shares were sold along with all other assets as panic set in.

Since then, all the major Gold ETF's have reached record levels as investors continue to pour money into gold as a safe haven for their capital.

In coming months, we are likely to see more turmoil as bad economic news continues to pour in. I believe that gold, while intrinsically volatile, will benefit from US dollar declines, demand supply imbalances and as a store of value as other asset categories decline in value.

It is my conviction that gold will soar to unprecedented heights in the coming years, probably peaking at about $ 3,000 an ounce, from its current price of $ 730.

Greenspan's Legacy

Former Federal Reserve Chairman Alan Greenspan, 81, is doing the chat show rounds to peddle his memoirs.

History will show him to be a major causal factor in the coming long -term decline of the US economy.

A close friend of Dick Cheney and Donald Rumsfeld when he served in President Ford's administration, Greenspan has always sought public adulation. Like Tony Blair, who despite being Labour Prime Minister liked to vacation with billionaires whenever he could, Greenspan was always trying to please Wall Street rather than protect the interests of the average American.

His response to any crisis was always to turn on the faucet, providing massive liquidity at the slightest sign of trouble. This happened in 1987 (Black Monday), in 1997 (Asian and Russian crisis), 1998 (Long Term Capital Management), 1999 (Y2K), 2000 (Nasdaq), 2001 (9/11) and then routinely till the end of his term.

Since 1980, the US MZM money supply has increased 9.1 times, far in excess of the growth of the US economy and mostly due to Greenspan's belief that all problems could be solved by increasing money supply.

This is truly ironic since as he wrote a paper in 1966 defending the gold standard because he believed that without it, there would be no checks and balances on Central Banks to print endless amounts of fiat (paper) currency, thus tremendously reducing the value of the currency over time.

As head of the Federal Reserve, this is exactly what Greenspan himself has done to the US Dollar.

I find it incredulous that he has been treated like a megastar by the media over the years. By pushing off the normal business cycle and providing easy money throughout his tenure, Greenspan created the internet bubble and now this housing bubble, for which the US economy (and probably the global economy) will pay a very high price in the coming years.

Mandated to ensure the stability of the financial system, he has testified that he did not recognise the Internet bubble while it happened, and that the housing bubble was a surprise to him.

He said it was a conundrum as to why the US dollar did not fall as US trade deficits mushroomed (though it was obvious that China and Japan were supporting the Dollar to keep their exports priced competitively).

He is highly critical of the Bush administration's fiscal policy now but when Congress sought his advice on whether to oppose the massive tax cuts proposed at the time (which did much to create massive federal deficits) Greenspan clearly endorsed them in his testimony (though he now denies this in his book).

And finally, despite the obvious mandate to provide transparency and direction to the markets, Greenspan took glee in the fact that he was so obscure when giving testimony to Congress that no-one was able to actually tell what he meant at the time.

Capitalism requires creative destruction to periodically cleanse itself of excesses. This is one of the strengths of the system. By providing so much liquidity that the Dow Jones rose from 878 in 1982 to over 14,000 today, while total credit market debt has reached its highest levels in US history, Greenspan prevented the system from regulating itself and the housing crisis that is transpiring will hurt most Americans in a very profound way. Too much excess has been built up to be resolved in a typical business cycle recession.

I believe that in another decade, Greenspan's legacy will be truly reviled by those who will pay the price for his profligate actions

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