The Black Market for Easy Money

Gold finally cleared $1,900 in the market this morning. It's been a spectacular run. Gold has doubled since the beginning of the credit crisis in 2008. Or, more accurately, the US dollar has halved against gold as the Federal government ran up enormous deficits and the Federal Reserve created a black market in easy money.

--There's no doubt the Fed played a role in yesterday's gold move. That role began in the crisis days of 2008. The Fed made over $1.2 trillion in emergency loans to dozens of international banks, financial firms, and even a few industrial conglomerates over a period of three years. Over 29,000 pages of documents obtained by Bloomberg revealed the details.

--The details are indeed revealing. Morgan Stanley borrowed as much as $107 billion from the Fed at the peak of the crisis. At one point, Fed cash was the sole source of Morgan's profits. Citibank borrowed $99.5 billion. Bank of America borrowed $91.4 billion.

--If you ever needed proof that the Fed is run by and for its member banks, there you go. Just 10 banks received 56% of all the loans made by the Fed, a total of $669 billion. Without Fed backing, the American banking sector would have collapsed under the weight of its own liabilities and bad risks. The Fed saved Wall Street's bacon.

--There were dozens of other firms that needed Fed cash in order to survive. National Australia Bank put its hand out for $1.5 billion at one point. Westpac received $1 billion. These are modest numbers compared to the amounts required for survival by American banks. But if anything, yesterday's report shows just how thoroughly monetary policy is being run entirely for the benefit of the banking sector.

--Of course, you might counter that it's a good thing the banking sector didn't implode. That would lead to a general worldwide implosion. Isn't it better to have prevented that? Didn't the Fed save the world?

--What investors are starting to realise is that the Fed habit of bailing out bad risk takers is precisely what's created such an unbalanced, unstable financial system. Now the whole system is so heavily encumbered by debt that it's too big to survive without more loans from the Fed or the European Central Bank. That doesn't seem like a long-term survival strategy.

--And you wonder why the gold price is making record highs.

--The gold price would have to be making Ben Bernanke nervous. Gold is telling everyone that it thinks monetary policy is bad and getting worse. It's reminding everyone that fiscal policy - huge government deficits as a percentage of GDP in the Western World - aren't much better. Gold's price communicates this information.

--Will central bankers try to silence gold? Central bankers have been net buyers of gold so far this year, adding 198 tonnes to their vaults. What they do is more important than what they say. But watch out for what they say.

--The annual Fed confab in Jackson Hole, Wyoming takes place this week. Poor old Bernanke. He knows that investors are desperate to hear what he's going to do next. Is he going to buy more bonds? Maybe longer-term bonds? Maybe corporate bonds? Is he going to buy stocks? Is he going to buy gold mines? What is he going to do to get the unemployment rate down and GDP growth back up?

--Our guess is that anyone who thinks the Fed may have a real plan is going to be bitterly disappointed. Markets rallied in New York for no apparent reason. If we were a betting man we'd expect to see another two to three days of 4-5% losses in financial markets, once everyone realises the Fed has no plan.

--One note of caution if gold has you excited: it can correct too. Gold's recent run is pretty breathtaking. And given the revelations about how close the financial system was to a meltdown in 2008, the appetite for gold isn't surprising. But keep in mind a great deal of liquidity in the gold market comes from the various exchange traded funds (ETFs) that now own over 2,000 tonnes of gold.

--Institutional gold buyers can become sellers in the blink of an eye. So prepare yourself. A 15% correction in gold from these levels would see it back around $1600. It wouldn't surprise us to see that. And we'd absolutely love a chance to buy down there again.

--In such an unbalanced financial system - huge amounts of debt on one side, with unreliable counterparties, and real assets like precious metals and energy on the other side - you'd think having an institutional bias toward growth would be a big liability. At least we'd think that. But hey, what do we know?

--Nonetheless, most Aussies who own the default balanced fund option via Super are still heavily biased toward growth. We wrote on the dangers of owning what you don't know last week. Adele Ferguson reports in today's Age:

'Most people think a balanced fund is 50 per cent growth (shares, property, alternatives, private equity, infrastructure) and 50 per cent defensive (cash, fixed interest, bonds).Some funds masquerade as balanced but they are 85 per cent growth and 15 per cent defensive, according to financial adviser Matthew Ross from Roskow Independent Advisory.

'Ross cites a few super funds that he believes are not offering balanced options, but say they are. "This is an issue that really gets under my skin ... Australian Super's balanced fund is 85 per cent growth, 15 per cent defensive. This is not balanced. Host Plus balanced fund is 76 per cent growth. REST Core Strategy is 75 per cent growth and Catholic Super is 68 per cent growth," he says. "They're high-growth funds, calling themselves balanced. Higher risk equals higher reward. So the more risk they take in the balanced fund, the more return they can boast about - but they're taking risks consumers aren't aware of."

'But even the defensive category might not be as conservative as some funds claim. When it comes to cash, some funds that invest in cash-plus and cash-enhanced funds, are investing in things other than cash. Such funds offer better returns than straight cash by investing in shares and property as well as bank bills and fixed-interest securities, but they are much higher risk - and some investors don't realise this.

'Fixed interest can also be deceptive. While some fixed interest products might be AAA-rated Australian government bonds, others are junk bonds, including insurance linked securities, which are a euphemism for catastrophe bonds.'

--Did someone say catastrophe? More on how to survive one tomorrow.

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