I received the following email the other day, from
Paul Tustain, Director of BullionVault. I think it
contains some valuable insights into the current
economic situation – what caused it and the way out
of it – as well as some insight as to where gold
stands in all of this, so I decided to pass it on
— begin quote —
Britain’s Prime Minister, Gordon Brown, says the current mess is
the fault of “irresponsible” bankers. Well, he would say that,
Let’s not forget that Mr.Brown claimed the credit for 10 years
of unbroken growth. For those 10 years he copied Alan Greenspan
by holding interest rates unusually low to encourage investment
and demand, which is a near-sighted economist’s way of avoiding
But this low interest rate medicine stimulates both the supply and
the demand for those products which Mr.Brown now blames bankers
for promoting. It leads directly to a world of crazy finance,
because low rates punish caution.
In a time of state-sponsored easy credit all projects get financed
by incautious banks with cheap, centrally supplied money. There is
no market for cautiously lent money, priced correctly for the risk
involved. Why would anyone pay more for funds from a cautious bank
when cheaper funds from an easier source are available?
This is why the profits of incautious banks grew, and why their
stock prices multiplied.
Meanwhile careful bankers sunk. As Brown (and Greenspan) injected
ever more money into the economy the cautious banks began to lose
their customers, their managers, their share values, and their
independence. This Darwinian extinction of caution is the direct
result of a monetary environment which was hostile to cautious
bankers; one which favoured those banks with an appetite for
So be in no doubt about the cause of the credit crunch. It was too
much cut-price credit, and the blame for the supply of it rests
squarely on the likes of Gordon Brown and Alan Greenspan.
Let’s hear no more from Gordon about anyone else’s
So much for the blame. What now? It seems almost everyone – from
both the right and the left of the political spectrum – agrees that
we need more government intervention in the form of bailouts and
Yet once we have grasped that the underlying cause of the disaster
was credit creation by governments themselves we should perhaps be
a bit wary of putting them ever more in charge. Governments operate
a cheap credit policy in order to defer pain, stay popular, and get
re-elected. The US bank rescue is intended to create and promote a
higher volume of cheaper and easier credit than the market really
wants. Hmmm. They want more of the wretched stuff which got us here
in the first place. Is that really so wise?
If we allow governments to control finance through regulation we
give them extraordinary power over the direction of the economy,
because they can (and will) deny finance to some projects and grant
it to other, more politically appropriate ones. They have repeatedly
shown themselves to be much worse than our imperfect marketplace at
handling the power of economic direction, both in this case, where
their efforts at economic stimulation are the root cause of the
fiasco, as well as in recent history – particularly with communism.
This proposed bailout, and its associated higher regulation,
pushes us further towards the socialized ‘command’ economy, which
is bad. There is a better way rapidly to re-configure our economies
in the right way. More than ever we need to trust the market. Let
interest rates rise (without government interference) and allow the
market to kill off those institutions whose functioning depends on
limitless supplies of cheap credit.
Yes – there would be pain, but it would right a long list of
wrongs. It would make houses affordable for younger working
people. It would make saving worthwhile again. It would make
borrowing less attractive. It would increase the use of equity in
the financing of enterprises, and significantly decrease their use
of debt, making all of them much safer in future downturns. All of
these moves in the right direction are the moves which yet another
dose of rescue money will certainly suppress. Sadly this won’t
be understood by our politicians, so we will get our patched-up
bailout – and lots more regulation with it.
Did you notice that while the America, the UK, the Netherlands and
Australia were banning short selling, the Chinese were relaxing
restrictions on it? This is enormously telling. Asians – suppressed
by the command economy for decades – aspire to a world of free
enterprise. Unlike us they are now prepared to accept the costly
consequences of the errors which the free enterprise system lets
people make. When we finally wake up under the yoke of our new
government regulator we will have lost the privilege of benefiting
from free and highly profitable financial centres. It’s the turn
of Hong Kong, Mumbai, Shanghai, and Singapore. Oh well – it was
nice while it lasted.
I now move to gold, and an avowedly selfish point of view.
I think it is almost certain that the proposed bailout will
be good for me personally, because it will be good news for
BullionVault. That’s because I believe we will be avoiding the pain
of a sharp correction. Instead we will get many years of miserable
underperformance in shares, bonds and deposits.
With no bailout, gold would probably rocket. Within a few months
it would have fully appreciated and it would be time to exit gold
and start buying bombed-out productive assets. The speed of such an
ascent in gold prices would be highly profitable for gold owners
– including me – but it would probably prevent BullionVault from
aggregating more than a few thousand new customers, and my personal
ambitions for BullionVault would never be met.
Instead, with a bailout, I anticipate some temporary relief and then
a long, slow, miserable slide in mainstream investment performance,
accompanied by a steady rise in gold. Every month of it will cause
a few thousand more people to join BullionVault.
So – entirely hypocritically – I believe one outcome is required,
yet hope for another!
I must say something about our bank. This is important because
although your BullionVault gold is absolutely safe from all these
ructions, your uninvested money is deposited in a Client Bank
Account – at Lloyds TSB.
Lloyds TSB has been one of the UK’s more cautious banks, and has
almost completely avoided the US sub-prime crisis. It has had
the highest available credit rating, and I have been so confident
of Lloyds TSB that I have been happy to buy shares in it on these
falling prices. These have been my first share purchases for several
years. After all I can’t put all my money in gold!
The board of Lloyds TSB has recently agreed to take over HBOS,
which is a hybrid of the ancient Bank of Scotland and The Halifax –
one of the largest providers of mortgage finance in the UK.
So with Lloyds now accepting a much larger dose of exposure to
housing finance can we still trust it?
Trusting banks requires a little more awareness than it used
to. A bank’s problems start when analysts look at the detailed
accounts and uncover hidden risks in its assets. If those are seen
as especially weak then the bank’s share price starts to fall, and
this itself triggers the run on deposits, which might precipitate
an urgent rescue.
But that run simultaneously strengthens the liquidity of other banks
– because the withdrawn deposits have to go somewhere. That’s why
our biggest and strongest banks currently have huge piles of cash,
as they have told me themselves.
Moreover they are keeping themselves very safe by refusing to lend in
the inter-bank markets. They don’t want the exposure to the financial
assets of smaller outfits, so they choose to lend directly to the
Bank of England, and let the central bankers lend it on and accept
the mildly toxic collateral which is available from the lightweights.
Because of this Lloyds TSB is apparently awash with cash. For it
to fail from here a number of things look like they would have to
happen. Firstly the deal with HBOS would probably have to go through
– by no means a certainty. Then the housing situation would have
to deteriorate – more than likely. Then the analysts would have to
decide Halifax’s mortgage book was toxic – which looks possible
too. Then the share price would need to come under pressure, and
then the depositors would have to find a stronger bank – not so
easy – and start to move their money.
Given all those things it is possible that my recently acquired
Lloyds TSB shares adopt the long run value of most stocks, which
is zero. Damn!
Yet even if this were to happen it is nearly unthinkable that
depositors would not be rescued. If AIG is too big to fail in the
USA then Lloyds TSB + HBOS is surely too big to fail in the UK.
These, then, are my conclusions. Firstly the danger does not appear
to be immediate – it is deferred at least until HBOS is actually
owned by Lloyds. This deal is not expected to go through until the
end of this year by which time this crisis may be receding. Secondly
I believe a run on Lloyds TSB would be forewarned by a falling share
price. Without that I think Lloyds will remain a net recipient of
cash, and get stronger, not weaker.
But as our business is about offering a safe home for your savings
I am just completing the opening of accounts at another very major
bank. As a matter of policy we have always put all your money at
call, so we stand ready to move the entire sum of BullionVault
Clients’ money to an alternate bank if we detect serious relative
weakness in Lloyds TSB’s shares.
I hope and believe this will never happen. But we are living in
extraordinary times, and it’s right to plan for contingencies.
Finally may I wish you good luck over the coming weeks and months. I
think this horrible situation is what many of us have feared,
and I think most of us are reasonably well prepared.