Courtesy of Mish 

Courtesy of Mish

Inquiring minds are interested in the terms of the European Stability Mechanism (ESM) accord scheduled to replace the EFSF. The following video highlights the key sections of the proposed treaty.

Link if video does not play: Treaty of debt (ESM) – stop it now!

There are comments on The Telegraph article A German view of the bailout deal which is where I found the video.

Key Details of ESM Accord

• Article 8 says “Authorized Capital stock 700 billion Euros”
• Article 9 says “ESM members irrevocably and unconditionally undertake to pay capital calls on them within 7 days”
• Article 10 allows the ESM board of governors to “change the authorized capital and amend article 8 accordingly”
• Article 27 says ESM shall enjoy “immunity from every form of judicial process”. Thus the ESM can sue member countries but no one can challenge it. No governments, parliament or any other body or laws apply to the ESM or its organization.
• Article 30 says “Governors, alternate governors, directors, alternate directors, the managing director and staff shall be immune from legal process with respect to acts performed by them (…) and shall enjoy inviolability in respect of their official papers and documents”

There are no independent reviewers and no existing laws apply. Thus Europe’s national budgets will be in the hands of one single, unelected body that is accountable to no one and immune from all legal actions.

Is this the future of the EU or will the German supreme court and other governments put an end to it?

Mike “Mish” Shedlock

by Tyler Durden

A few days ago China telegraphed it refuses to continue to be seen as the world’s rescuer and the dumbest money in the room. Many assumed China was only kidding: after all how would China let its biggest export partner flounder? And furthermore, all China does is provide vendor financing, right? Well, as it turns out, wrong, because to China the current state of Europe is far from the terminal crisis Europe is trying to make it appear. This is happening even as a thoroughly desperate and grovelling Europe, kneepads armed and ready, has said via the EFSF’s Regling that it will even consider issuing Yuan-denominated bonds. Alas, China is less than impressed. As AFP reports, “China’s state media Sunday warned that the country will not be a “savior” to Europe, as President Hu Jintao left for an official visit to the region including a G20 summit. Hu’s visit has raised hopes that cash-rich China might make a firm commitment to the European bailout fund, but in a commentary, the official Xinhua news agency said Europe must address its own financial woes. “China can neither take up the role as a savior to the Europeans, nor provide a ‘cure’ for the European malaise. “Obviously, it is up to the European countries themselves to tackle their financial problems,” it said, adding that China could only do so “within its capacity to help as a friend.” A friend, who at this point is quite sensible, and realizes far better deals are to be had down the line if one merely waits. That said, we are certain China is not the only one out there with an instant notification pending the second Santorini, Ibiza or the Isle of Capri hits E-bay.

More:

China’s Vice Foreign Minister Cui Tiankai said Friday that the G20 should focus on the sovereign debt crisis in “developed countries” and the growing pressure of global inflation.

 

He added that members should make efforts to stabilize financial markets and restore investor confidence.

 

For its part, G20 partners will also be looking to China to stimulate domestic demand, diversify its export-led economic model and allow the yuan currency to appreciate more freely so as to slim down its massive trade surpluses.

 

Another Chinese official has played down hopes of a breakthrough at the G20 meeting. Vice Finance Minister Zhu Guangyao, also speaking Friday, said investment in the European bailout fund was not on the agenda.

 

Beijing fears the financial risk of a major investment, which could also spark a domestic backlash as the Chinese public asks why they should bail out wealthier nations.Already, opposition to such a move is being expressed on the Internet, on China’s hugely popular weibos – microblogging sites similar to Twitter – and in state media.

The bold says it all. And for those to whom it is still confusing:

“China will only participate in a global program that is defensible to the Chinese people. So don’t expect a ‘bailout’ or ‘rescue’ from China,” China Macro Strategist for brokerage CLSA, Andy Rothman, told AFP.

 

China has been burned before on overseas investment. It bought stakes in investment bank Morgan Stanley and asset management firm Blackstone only to see values collapse in the 2008 global financial crisis.

 

“China was taken in. Once bitten, twice shy,” said independent economist Andy Xie, former chief economist for Morgan Stanley.

So, about that magical European box full of promises and quite empty of money…

I am not one to discuss fundamentals or macro views, but this situation in Europe is beginning to morph into a media frenzy. Price action in the marketplace is changing rapidly in short periods of time based on the latest press releases coming from the Eurozone summit.

I cannot help but comment on the seemingly arbitrary actions coming from this high profile meeting. Nothing has happened that market participants were not already privy too. The European Union is going to strengthen their EFSF fund by levering it up roughly 4 : 1. I have yet to hear how exactly they plan on doing this, but this action was no surprise to anyone that has read an article about the sovereign debt crisis in the past month.

There was also discussion about backstopping European banks’ capital position. Since European banks are holding billions (Euros) of risky sovereign debt instruments, it would make sense that their capitalization is a primary concern of Eurozone leaders based on current fiscal conditions. I would argue that the banks should be well capitalized regardless of economic or fiscal conditions in order for a nation to have a strong, vibrant economy that has the potential to grow organically.

The final piece of this week’s political nonsense involves write-downs on Greek debt in the neighborhood of 50% – 60% in order to stabilize Greece’s debt to GDP ratio. Apparently Eurozone leaders want to structure the write down so as to avoid payouts by credit default swaps which act as insurance against default. How does a bond take a 50% – 60% valuation mark down without a creating an event that would trigger the payout of CDS swaps?

If a write down of that magnitude does not trigger the CDS swaps, then I would argue they are useless as a tool to hedge against the default risk carried by sovereign debt instruments. If the CDS swaps do not payout as projected by European politicians, the risk assumed by those purchasing government debt obligations around the world would be altered immediately.

The impact this might have on the future pricing of risk for government debt instruments could be extremely detrimental to their ability to raise funds in the private market. Additionally, the write downs would hurt European banks’ capital positions immediately. If the CDS swaps were to pay out, bank capital ratios would suffer as those who took on counter party risk would be forced to cover their obligations thereby straining capital positions even further potentially.

Price action today suggested that the equity markets approved of the package that European leaders were working on. However, the biggest push higher came when news was released that China was interested in purchasing high quality debt instruments as a means to help prop up poorly capitalized banks and sovereign nations in the Eurozone through an IMF facility.

The market did an immediate about-face which saw the Dollar selloff while the S&P 500 rallied higher into the close reversing a great deal of Tuesday’s losses. Inquiring minds wish to know where we go from here? I would be lying if I said I knew for sure which direction Mr. Market favored, however that did not stop me from looking for possible clues.

It has been a while since I checked out the short-term momentum charts that are focused on the number of stocks in U.S. domestic equity markets that are trading above their 20 & 50 period moving averages. The charts below illustrate the current market momentum:

Equities Trading Above the 20 Period Moving Average

It is rather obvious that when we look at the number of stocks trading above their 20 period moving average that momentum is running quite high presently. This chart would indicate that in the short-term time frames equities are currently overbought.

Equities Trading Above the 50 Period Moving Average

A similar conclusion can be drawn when we look at the number of stocks trading above their 50 period moving averages. It is rather obvious at this point in time that in the short to intermediate term time frames, stocks are currently at overbought levels. This is not to say that stocks will not continue to work higher, but a pullback is becoming more and more likely.

Additional evidence that would support the possibility that a pullback is likely would be the  recent bottom being carved out in the price action of the U.S. Dollar Index. The U.S. Dollar has been under selling pressure since the beginning of October, but has recently started to show signs that it could be stabilizing and setting up to rally higher.

The daily chart of the U.S. Dollar Index is shown below:

The U.S. Dollar Index is sitting right at major support and is oversold based on historical price action. If the Dollar begins to push higher in coming days and weeks it is going to push equity prices considerably lower. Other risk assets such as gold, silver, and oil would also be negatively impacted by higher Dollar prices.

Members of my service know that I focus on several sectors to help give me a better idea about the broader equity markets. I regularly look at the financial sector (XLF), the Dow Jones Transportation Index (IYT), emerging markets (EEM), and the Russell 2000 Index (IWM) for clues about future price action in the S&P 500.

During my regular evening scan I noticed that all 4 sector/index ETF’s are trading at or near major overhead resistance. With the exception of the Dow Jones Transportation Index (IYT), the other 3 underlying assets have yet to breakout over their August 31^st highs. The significance of August 31^st is that is the date when the S&P 500 Index put in a major reversal right at the 1,230 price level before turning lower. It took nearly two months to regain the 1,230 level and its significance continues to hold sway.

The daily chart of IWM is shown below illustrating its failure to breakout over the August 31^st highs:

The chart above illustrates clearly that IWM has failed to breakout above the August 31^st highs. I am going to be watching IWM, XLF, & EEM closely in coming days to see if they are able to breakout similarly to the S&P 500. If they start to rollover, it will not be long before the S&P 500 likely follows suit.

Currently the underlying signals are arguing for lower prices in the short to intermediate term. While it is entirely possible that the S&P 500 rallies higher from here, it is without question that current market conditions are overbought in the short to intermediate terms.

Key sectors and indices are not showing follow through to the upside to help solidify the S&P 500′s recent break above the key 1,230 price level. Additionally, the U.S. Dollar Index is currently trading right at key support in addition to being oversold. At this time I am not playing the S&P 500 in either direction, but I will be watching the underlying price action in the U.S. Dollar Index closely. I will be watching for additional clues in the days ahead.

Market and headline risk is high presently.

Subscribers of OTS have pocketed more than 150% return in the past two months. If you’d like to stay ahead of the market using My Low Risk Option Strategies and Trades check out OTS athttp://www.optionstradingsignals.com/specials/index.php and take advantage of our free occasional trade ideas or a 66% coupon to sign up for daily market analysis, videos and Option Trades each week.

By: Chris Vermeulen & JW Jones

by Tyler Durden

Earlier today we presented Bloomberg’s Chart of the Day which represented the GDP and Debt per capita on a historical and projected basis, and we hysterically, and tongue-in-cheekly, dubbed it “the scariest chart ever” because it confirmed that at some point, very soon, US Debt will surpass GDP and never look back. We decided to dig into the actual numbers (cancelling out the per capital denominator as it is the same on both sides of the equation) and came to a very disturbing revelation: as of today, total US Debt, is $14.942 trillion (source), obviously an all time high. Q2 GDP as was reported by the BEA three weeks ago, was $15.012 trillion in current dollars. In other words, the spread between total GDP and total debt has now collapsed to an all time low $70 billion. Incidentally, this number was $1.8 trillion at the beginning of 2010. Then we decided to take a quick look at the upcoming bond issuance and find that tomorrow the Treasury will announce approximately $99 billion in 2, 5 and 7 Year bonds to be auctioned off October 25 through 27… With a very appropriate settlement date: October 31, elsewhere known as Halloween. Yes, ladies and gentlemen: All Hallows E’en will be doubly scary this year: for the first time since World War II, US debt will officially surpass GDP on Halloween 2011.

By Marin Katusa, Casey Research

In the last few weeks a slow slide in commodity prices – metals in particular – has turned into a full-scale nosedive.

All through 2011 copper had remained essentially between US$4 and $4.50 a pound, but on September 11 it dropped below that range and didn’t really stop falling until October 4, when it bottomed at $3.05. Aluminum gained ground in the first half of the year to reach $1.24 per lb. in April, but after losing 10% in the last 30 days it is back below that, at $0.96. The spot price of nickel lost 19% in the last month; zinc prices fell 17%. Precious metals were not spared either: The price of silver shed a whopping 33% in 30 days, while gold is currently down 15% compared to its price on September 6.

Grouping the commodities together really shows how rough the last few months have been. The Standard & Poor’s GSCI – an index of raw materials that tracks 24 commodity prices – is down 24% since April, when it hit a 32-month high. On October 4 it touched 572.92, its lowest level since November 26, 2010. Falling metal prices were the main culprit: Silver closed at its lowest price since February, and copper saw its cheapest settlement in 14 months.

The slide in commodity prices ends a period of discord between a global economic story of frailty and impending doom and commodity prices that were holding their ground at or near record highs. The disparity stemmed in large part from opposite outlooks for the world’s developed and emerging economies – Europe and the US are struggling to maintain any kind of economic momentum but emerging economies have continued to grow, led by China. Investment actions (encouraged by the printed money stemming from QE2) then heightened that difference, as investors turned to commodity prices to profit from emerging-market growth.

The investments that fed the disparity came from a very broad base. It used to be that investing in commodities was only for institutional players and real market participants, but over the last decade a slew of retail investors have jumped on board the “good-times commodities train.” Since the start of the current commodities supercycle in the early 2000s, investing in raw materials shifted from a risky, hard-to-access game to a commonplace portion of most portfolios.

Before, most ordinary investors were only exposed to commodities by owning shares in oil or mining companies. Now, a broad range of commodity-based exchange-traded funds (ETFs) spanning agriculture, energy, and metals have given investors access to direct exposure to raw-material price swings… and the sector has provided such consistent rewards that many financial advisors and pension managers now believe that all ordinary investors should have some slice of their long-term money parked in commodities. The assets of ETFs and similar investment products that hold baskets of commodity futures have increased sixfold since 2007, reaching a value of $37 billion this summer.

In recent months, however, the tide has turned in a major way. Investors and advisors are beating a hasty retreat from all risky holdings, and for many that includes commodities. Current global economic uncertainty is pushing investors toward very low-risk options, starting with US bonds and ending with dividend-paying utilities. Commodities, which were previously better-insulated from retail investor panics, are feeling the pain.

Of course, retail investors abandoning ship only account for a small part of the pressure on commodity prices. Commodity prices are complex beasts, with annual variations relating to contract talks, stocking seasons, de-stocking seasons, currency ratios, and speculative action.

Take copper as an example. China accounts for something like 40% of global copper demand, and its unceasing demand growth helped copper prices rebound quickly after the 2008 recession. Whether this demand growth will continue is a topic of much debate.

The bears point to tightening monetary conditions and a global slowdown to argue that China’s economy will grow just 5% this year – a sluggish rate, compared to its double-digit expansions over most years in the last decade. They also point to reports of very large speculative stockpiles in China, accumulated in part as a way to skirt bank lending restrictions imposed by the Chinese government. The copper bulls, on the other hand, argue that demand is holding up well. Volumes at most companies are still up year on year; even in Europe, Germany is still showing reasonable growth; and in the United States the copper rod market is expected to register 3% growth – that would be down from 6% last year, but it’s still growth. As for China, the bulls expect 8% economic growth and say it is merely a matter of time before the Chinese return to the market and restock heavily. Minmetals stoked that fire somewhat last week with its C$1.3-billion bid for Anvil Mining (T.AVM), a copper company.

In addition to all of those factors and arguments, the scrap market plays a role. The “urban mine” of recycled metals accounts for roughly one-third of global supply, but as prices fall scrap flows slow down significantly. That tightens the market even if demand also weakens. Many scrap dealers are holding on to their copper until prices recover; they did the same in 2008-‘09, helping to push prices up.

So commodity prices are complicated and difficult to forecast at the best of times, which is not exactly how we would describe things at present. Yes, that’s our lead-in to saying that predicting where prices are going from here is a challenge, to say the least.

Again, let’s use copper as an example. Copper price forecasts now range from below US$6,000 per tonne (from the head of the copper department at Minmetals) all the way through to $10,075 (from Barclays Capital). Goldman Sachs, Credit Suisse, and Standard Bank are closely aligned in their outlooks, all expecting copper to sit just under $9,000 per tonne through 2012.

Certainly, the fundamentals of the copper market remain very tight. Based on current demand predictions, the International Copper Study Group expects to see a deficit of 250,000 tonnes in the global refined copper market in 2012, before moving closer to balance in 2013. To put 250,000 tonnes into context, global demand for refined copper products in 2010 averaged 19.4 million tonnes. And it is important to remember that current and forecast copper prices all sit comfortably above the break-even point for producers. The marginal cost to produce a tonne of copper averages between $4,000-US$5,000, creating a solid floor for spot prices.

But as one Credit Agricole analyst pointed out, “the fundamentals just won’t matter in a financial panic.” We’ve already seen some of that irrational movement: Copper’s lowest point this week, of $6,635 per tonne, represented a 33% decrease over just two months. The metal boasted a spot price just below $10,000 at the start of August.

Really, commodity prices from here will depend on whether Greece defaults in an orderly, supported manner or goes down in an uncontrolled inferno, torching Europe’s books for years. Both are still options. A planned default has its downsides – as German Chancellor Angela Merkel puts it, “If we tell a country ‘We cancel half of your debt,’ that’s a great deal. Then the next guy will immediately show up and say he wants the same.” Nevertheless, the only way Greece can survive its suffocating debt levels is through some kind of default, and if the European Union can come up with a default management plan, then the other countries of the Union could be protected from the worst of the fallout.

An unplanned, “oh-my-God-how-did-this-happen?!” style Greek default, on the other hand, could decimate numerous European banks and in doing so create exactly the same maelstrom that gave birth to the 2008 recession in America.

Despite some bearish indicators and a lot of nervous investors, a recession is not necessarily in our future. Goldman Sachs, the permabull of commodity price forecasters, remained committed to its prediction that commodities will continue to outperform. While reducing its oil and copper forecasts for 2012, the bank reiterated an “overweight” recommendation on commodities over the next 12 months, explaining that the turmoil in Europe will take away “some of the upside” to commodity prices, but will not reverse prospects.

“With recent GDP revisions by our economists falling hardest on Europe but with emerging market growth expectations still relatively solid, we continue to believe that demand growth in 2012 will be sufficient to tighten major commodity markets,” lead analyst Jeffrey Currie wrote. The group sees potential for commodity prices to climb as much as 20% over the next year. Goldman did reduce its forecasts for oil and gas: The bank now expects Brent crude to average US$120 per barrel over 2012, down from an earlier prediction of $130, and expects copper to trade near $9,500 per ton, down from $11,000.

Barclays Capital added its voice to the chorus that is trying to remind frantic investors that a recession is not guaranteed, agreeing with Goldman that emerging markets could still save the world from a significant recession while also limiting further commodity price slides.

Many people are still hopeful that that chorus is singing the truth: These days any and every sign that we can avoid a recession sparks a bull market day. On October 5, the day after copper, oil, and silver all hit multimonth lows, commodity prices across the board gained ground after Federal Reserve Chairman Ben Bernanke said the central bank would take further measures to prevent a recession if necessary. Bernanke said the Fed could ease monetary conditions further, following the launch of Operation Twist in September.

We think it is likely that the commodities which fell in September and early October were following the example set by oil in early August. Crude prices were too high, having failed to fall in response to increased stability in Libya and weakening demand. So they corrected: Brent crude fell about 8%, while WTI crude lost roughly 14% in late July and early August. Since then crude prices have been fairly stable; they dropped somewhat while other commodities were flailing in September, but not dramatically.

So perhaps the metals realized they were overvalued, like oil had been given the global economic climate, and corrected. If they are following oil’s footsteps, things should remain relatively stable from here. But, as mentioned, that would require an orderly Greek default. And given that the Greek debt “crisis” has now been going on for two whole years and Europe’s leaders have continued to respond with solutions that are too little, too late, a significantly proactive step such as planning for Greece’s default may be too much to ask. And in the case of a frantic and disorganized default, commodity prices could easily drop further.

[Commodity price uncertainties… OPEC supply uncertainties… investing in energy may appear to be too complicated to attempt right now. Learn more about how to get started.]

In May of 2010, immediately following the flash crash many investors started to become bearish (nervous) regarding their position in gold and equities. Once the general public became aware that the stock market could fall 10% in a matter of minutes, investors became very cautious. Suddenly protecting their capital and current positions was at the forefront of their investment process.

A couple days later the market recovered most of its value, but it became clear that investors were going to sell their long positions if the market showed signs of weakness. It was this fear which pulled the market back down to the May lows and beyond over the next couple months which caused investors to panic and sell the majority of their positions. It is this strong wave of panic selling that triggers gold and stock prices to form intermediate bottoms. Emotional retail traders always seem to buy near the top and sell at the bottom which leads to further pain.

Now, fast forward to today…

This past August we saw another selloff similar to the “Flash Crash” in May of 2010. (I warned followers that gold was on the edge of topping and that stocks would take some time for form a base and bottom – Click Here To Read) Over the past couple months gold, silver, and stocks have been trying to bottom but have yet to do so.

Just a couple weeks ago we saw gold, silver, and equities make new multi-month lows. This has created a very negative outlook among investors which I highlighted in red on the chart below. Since the panic selling low was formed just recently we have seen money pile back into gold and stocks (more so stocks).

This strong bounce or rally which ever you would like to call it may be the beginning stages of a major bull leg higher which could last several months. Before that could happen, I am anticipating a market pullback which is highlighted with red arrows on the chart below.

Chart of SP500, Gold and Dollar Index Looking Back 18 Months

Reasons for gold and stocks to pullback:

• Stocks are overbought and generally retracements of 50% or 61% are common following large rallies.
• The dollar index looks ready to bounce which typically means lower gold and stock prices.
• Gold continues to hold a bearish chart pattern pointing to lower prices still.

Weekly Trend Trading Ideas

A few weeks ago I warned my followers that stocks and gold are forming a bottom and that we should be on the lookout for further confirmation signs. I also mentioned that I was not trying to pick a bottom, rather that I was looking to go long once the odds were more in my favor.

This is a potentially very large opportunity unfolding and there will be several different ways to play this. However, right now I continue to wait for more confirming indicators and for more time to pass before getting subscribers and my own money involved.

From August until now (October 17) the SP500 is down -6.3% and gold is down -8.1%. Subscribers of my newsletter have pocketed over 35% in total gains using my simple low risk ETF trading alerts.

I can email you my bi-weekly reports and videos by joining my free newsletter here:www.GoldAndOilGuy.com

By Eric McWhinnie

It is no secret that precious metal miners have lagged behind bullion prices.  While gold is up 16% this year, gold miner ETFs such as the Market Vectors Gold Miners ETF and Market Vectors Junior Gold Miners ETF are actually down 8% and 24%, respectively.  Newmont Mining, one of the world’s largest gold producers, has been returning value to shareholders by offering a gold-linked dividend.  Furthermore, the miner announced last month that it may consider a share buyback program if the disparity in bullion and equity prices persist.  The situation in silver is similar.  Silver prices are down about 3% for the year, while the Global X Silver Miners ETF is down about 16%.  However, the recent earnings report fromEndeavour Silver could spark the long overdue rally in precious metal miners.

Endeavour Silver is a mid-cap silver miner that is focused on the growth of its silver production, reserves, and resources.  On Tuesday, the company reported impressive third quarter results.  Revenue surged 93% for the quarter to $38.8 million.  The surge was a result of both higher silver and gold production, and also higher realized metal prices.  Last week, the company’s CFO Dan Dickson explained, “We’ve seen seven consecutive years of production, reserve, and resource growth, and four consecutive years of revenue cash flow and earnings growth. In that time, we’ve seen falling cash costs, and we expect to continue that for a while and see our profit margins improve even further.”

Hot Feature: What Does the Unemployment Picture Mean for Precious Metals?

Rising input costs are one of the possible explanations as to why precious metal equities are lagging bullion price increases.  Rising oil and labor costs are major expenses for miners. However, Endeavour is overcoming these obstacles.  The company has increased gross margins for the past four consecutive years.  Cash costs on a by-product basis have decreased from $9.38 in 2007, to only $5.71 in 2010.  Dan Dickson elaborated, “We can’t focus on where the price is when we’re operating, all we can do is focus on the cost. That’s where we put all of our time and effort into at the operations, to make sure we keep tight controls on cost.”  Miners may also be underperforming because investors fear falling gold and silver prices.  However, those closest to the mining industry expect higher prices going forward.  Last month, at the annual Gold Denver Forum, Newmont Mining announced that it expects gold prices to hit $2,300 by next year, while AngloGold Ashanti expects $2,200 gold.

The success of undervalued miners has caught the attention of Sprott Management.  The company said in a September article, “The fact remains that both gold and silver continue to trade well below their inflation-adjusted highs in nominal terms, and the market is now beginning to acknowledge the profit potential that precious metals equities offer at today’s bullion prices.  We believe the equities will offer more upside than the bullion over time.” Endeavour started to receive recognition earlier this year when its shares were first listed on the NYSE.  After the most recent earnings report, shares of EXK traded nearly 3% higher, even though bullion prices were mostly flat.  Today, shares are up another 5% as investors realize the growth story taking place in miners.  Endeavour’s ability to overcome cost issues and industry doubts will prove to investors that miners can be very profitable, despite volatile gold and silver prices.

Investors should realize that pull backs in precious metals do occur, but these declines offer great buying opportunities.  In our September 26 Gold and Silver Premium Newsletter we warned, “Shares of Endeavour look poised to test $7.50-$8.00.” On October 4, shares reached $7.55 before finding support.  After testing our support level, shares have rebounded more than 25% to $10.20.

Why Thousands of TRADERS are using my Trading Signals for ETF’s, Stocks and Commodities

by Karl Denninger
This is an outrage.

Yglesias tells us that some Occupy Wall Street protesters have picked up Ron Paulish monetary ideas — although some know better. I thought I’d say a word about one particular idea that sounds plausible to some people but is actually quite wrong: banning fractional reserve banking.

I know that’s a popular theme among some Austrians. But it’s actually neither a good idea nor even feasible.

The crucial thing is to understand what banks do. And it’s not mostly about money creation! Instead, what banks are for is helping to improve the tradeoff between returns and liquidity.

That’s a very quaint notion.  But were it true there wouldn’t be any such thing as systemic risk!

Why?

Simple: If you only loan against actual asset values there is no systemic risk possible; if you get in trouble you simply sell down the assets until you no longer are.  Since you’ve never “created money” there’s no systemic risk that can arise.  Ever.

Of course this isn’t how it works in the real world today.  That’s the “Bailey and Biddle” model from It’s a Wonderful Life, but pretending that we live in that world today is beyond fanciful.

For proof one need only look at the Credit Card in your wallet – or, for that matter, the student loan.  If you wish to get more esoteric you can look at the Credit Default Swap.

None of these are backed by capital in today’s banking system, but all should be – dollar for dollar.  Why?  Because all are claims on something that does not, today, exist!

That is functionally the precise same act as a naked short.  You put into circulation that which does not exist “on the come” that it will in the future.  In the case of stock that is naked shorted you’re counterfeiting the stock of the corporation in question – you’re representing that you have something to deliver (the stock) but only the company in question has the right to create (by issuance in exchange for capital) that stock.

In the case of naked credit creation unbacked by an asset the bank is effectively naked shorting the currency, betting “on the come” that production will in the future cause the government to issue actual currency with which to make the bet good!

That’s an outrage!  It’s also how we get massive asset inflation.

Krugman knows this, of course.  After all, he has a Nobel Prize and a PhD, right?  He can’t possibly be so ignorant as to claim that banking as currently practiced actually encompasses (mostly) lending against actual assets - that is, liquidity matching for a price – can he?

After all, were this the primary function of banks these days there could never be systemic risk, since lending against assets can’t cause it, as if the person who borrowed doesn’t pay you simply seize the asset and resell it into the market, extinguishing the debt without systemic consequence (the borrower, of course, goes broke by such a process, but that’s the risk of borrowing that which you can’t pay back!)

The claims of charlatans must be matched against the factual record of not only what has occurred before but what threatens to occur now.

PS: This is why I support – strongly – a “One Dollar of Capital” LAW for banks, and why you should too.

Tim Iacono

If yesterday’s big rally did signal that markets have put in their lows for the year, someone should tell retail investors to get on board because, according to this Gallup poll , they were pretty shaken up last month, investor confidence plunging to early-2009 levels.

It should come as no surprise that two-thirds of the survey respondents said they feel “little or no control in their efforts to build and maintain their retirement savings in the current environment”, but Fed Chief Ben Bernanke’s low interest rates have forced many of them to hold their nose and stay in the market in hopes of higher returns.

The potential good news here is that markets last reached current levels in February 2009 just before one of the biggest stock market rallies in history that began in March.