How Central Bankers Attempt to "Cure" Insolvency

Like trying to patch a nuclear reactor with scotch tape and chewing gum, the central banks of the world’s leading economies are trying to Spackle over cracks in the global monetary system with a variety of desperate tactics and measures.

Unfortunately, hiding the cracks does nothing to strengthen the underlying infrastructure. To the contrary, hiding the cracks dupes individuals into believing all is well, even as the monetary system is crumbling around them.

Many European governments, for example, are spending much more money than they can possibly confiscate through taxation. These guys are broke… plain and simple. But so is the United States, based on any intellectually honest assessment of the facts.

According to the US Treasury’s own data, the US ended 2011 with total debt of $15.2 trillion, which means the US debt-to-GDP is now more than 100%! Move over Greece! Make way for Uncle Sam.

Bankrupt governments usually default…at least they used to. In the modern era of faith-based currencies and Ivy League educated central bankers, bailouts and shell games are the cogs and wheels that drive the global monetary machinery. But this machinery does not actually power anything…other than a massive fraud. It merely sputters along, chugging out massive plumes of toxic theories and misguided manipulations.

And whenever a central bank cannot provide direct, overt assistance to a specific insolvent investment bank or government, not to worry, a central bank can still provide indirect, covert assistance.

The recently announced “backdoor bailout” of European financial institutions illustrates the point. The European Central Bank (ECB) cannot directly bail out the insolvent governments of Greece, Italy, Spain, Portugal, et al. Meanwhile, the US Federal Reserve cannot directly rescue Europe’s insolvent banks.

Enter the indirect bailouts… Here’s how they work:

The Fed extends unlimited lines of credit to the ECB under so-called swap agreements. The ECB, in turn, provides dirt-cheap capital to Europe’s struggling banks. Then, the banks — understanding an unspoken quid pro quo — use the dirt-cheap financing to buy the high-yielding bonds of Greece, Italy, Spain, et cetera.

So if you follow the money, the Fed is lending money to Greece… and all along the way, the insolvent European banks are making money they don’t deserve to make, while taxpayers lose money they don’t deserve to lose… and also stand first in line to lose even more money as these various coddled banks and governments eventually default anyway.

Does this characterization of the Fed’s activities sound like an exaggeration?

Consider this fact, courtesy of The Wall Street Journal: As recently as a few weeks ago, the amount of dollar swaps — i.e., loans — with the ECB was only $2.4 billion. “For the week ending December 14, however, the amount jumped to $54 billion,” the Journal reports. ”For the week ending December 21, the total went up by [another] $8 billion… No matter the legalistic interpretation, the Fed is, working through the ECB, bailing out European banks and, indirectly, spendthrift European governments. It is difficult to count the number of things wrong with this arrangement.”

Thus far, the Fed’s indirect bailout of Europe is relatively small, at a mere $62 billion. But we should expect that number to grow…a lot. And as that number grows, the Federal Reserve will be providing yet one more reason to buy gold, silver and other hard assets.

No modern central banker can seem to resist the urge to “cure” insolvency with more credit — credit that comes not from a store of accumulated capital, but from the mouth of a printing press.

Gold is a buy, perhaps now more than ever.

“2011’s close for gold marks the 11th year for higher year-end gold closing,” observes Richard Russell. “To my knowledge, this is the longest bull market of any kind in history in which each year’s close was above the previous year. This fabulous bull market will not end with a whisper and a fizzle. I continue to believe that the upside gold crescendo of this bull market lies ahead. We are watching market history. Below are the last day of the year quotes for gold:

2000 — $273.60
2001 — $279.00
2002 — $348.20
2003 — $416.10
2004 — $438.40
2005 — $518.90
2006 — $638.00
2007 — $838.00
2008 — $889.00
2009 — $1096.50
2010 — $1421.40
2011 — $1566.80

“I note the frustration and anger of the anti-gold crowd,” Russell continues. “To miss twelve years of rising prices is enough to make any investor furious with himself. I would guess that 99 percent of Americans have never participated in the gold bull market. Thus, sour grapes is the sentiment of the gold-haters…”

But there’s no sense being “a hater” or to continue sucking sour grapes. If the gold bull market is merely resting, rather than dying, there will be plenty of opportunity to become a gold-lover.

“Jeff Clark, editor of the S&A Short Report, sees the best opportunity to trade gold stocks of the past three years,” the S&A Digest reports. “After the end-of-the-year rout in the sector, one of Jeff’s favorite indicators dropped to its lowest level since October 2008 — one of the most pessimistic times in history for gold stocks. But after the indicator flashed ‘buy’ (as it is doing today), the average gold stock doubled over the next 10 weeks.

“Take a look at this chart of the gold sector bullish percent index, which shows the past two times Jeff’s indicator flashed buy (in June and October of last year)… Gold stocks rallied 20% over the following month in both instances.”

The Gold Miners Percent Bullish Index Hits Lowest Level in 3 Years

Longer term, the precious metals seem even more compelling.

“Gold stocks will have a great year,” predicts Chris Mayer, editor of Mayer’s Special Situations. “The market hated gold stocks in 2011, especially the juniors. The MarketVectors Junior Gold Miners ETF (GDXJ) is made up of small mining stocks. It fell 38% in 2011. This, despite gold itself finishing the year modestly up.

“Brigus Gold (BRD), for example, is dirt-cheap,” Chris continues. “In 2012, it is still targeting 100,000 ounces of production from its Black Fox mine. In the meantime, during 2011, Brigus boosted the total resource at Black Fox by 50% with high-grade ore extensions. So, the stock is now very cheap on reserves and trades for about 4x prospective cash flow at 100,000 ounces… So even if it gets a peer multiple of 8x, the stock could double. And that’s if gold goes nowhere!

“The market is offering low multiples on gold stocks right now,” Chris winds up. “Price-to-cash-flow multiples, for instance, linger near generational lows. Gold doesn’t have to go up for these stocks to make a lot of money. However, I think gold will make another run at $2,000 an ounce in 2012 — and exceed it. All the factors that drove gold to new highs in 2011 are still in place. The world’s monetary system is still a mess. And its leading brand, the US dollar, is not well. Combine a rising gold price with low multiples and you have a kind of financial rocket fuel.”

Eric Fry
for The Daily Reckoning