To Trust, or not to Trust, The Banks are in Question!

Gold’s rise have some investors dancing in the street, singing the yellow metal’s praises – while others, who don’t hold physical gold bullion are banging their head against the wall.

Things are getting so weird that even my Extreme Mogambo Paranoia (EMP) seems oddly inadequate. For example, gold is going bananas! Several people asked me what this could possibly mean, but as usual, I have no idea.

I do know that there are a hell of a lot of people sitting on some big, big, big positions on the short side of gold (and mining shares), and these hapless chumps are getting crushed, I mean freaking crushed, with gold is soaring like this. The statistic that keeps pounding, pounding, pounding in my Tiny Little Mogambo Brain (TLMB) is that there is, reportedly, a short position in gold, measured in umpteen jillions of ounces, that is 78 times as big as all the gold in the whole damned world! That means that one guy has some gold, and 78 guys think that they own some gold, but they don’t. All they have is a slip of paper that says, "I owe you gold," and signed by somebody. Somebody who does not, obviously, have any gold to give!

What I am confessing is that that people who sent money to The Mogambo Gold Depository (actually a shoebox in the back of my closet) and think that they have some gold, just because I promised that I would store gold for them, are screwed. I always meant to go out and get some gold like I said I would, but one thing led to another, and then there was that drunken brawl at Paula’s Passion Pit of Prancing Princesses that I take full responsibility for, and am still paying for all the damages. So, don’t get me wrong, but the gold you thought I was storing for you…sorry. Bummer, huh?

Fortunately, I have taken the wise precaution of wording the deposit contract to mimic the Comex rules, and now, since I am on the hook to lose a lot of money, I can merely cancel their stupid contracts and give them their original money back! Without interest! Hell, I might just keep the money for myself to make up for my looming losses from the lawsuits that will soon be filed. It’s the American Way!

Gold Bullion: Celebrating Prematurely

But the point is that people who erroneously think they have gold safely stored away someplace, and who have not seen the 60 Minutes show where they expose this dirty little Mogambo scam of mine, are all out dancing in the streets, thinking they are rich, rich, rich, and they’re buying drinks for everybody. They’re all laughing and having fun. And every time gold goes up by another few bucks, everybody is even happier and they start having even more fun!

So, in a strange yin-yang thing, you can bet that this rise in gold has lots and lots of other people (namely the people who are short all that gold, and the central banks who lent all that gold to bullion banks, who sold it long ago at prices far below this, and are now net short in gold) are in a real panic. Now all those shorts are rushing about in desperation and panic, including elected officials, banks, bullion banks, central banks and especially the Federal Reserve, which is also nervous about all that gold belonging to the United States that has been lent out to guys who can’t pay it back! Yow!

The only guys who are NOT rushing around in panic are the guys who have taken possession of physical gold bullion. They know exactly where their gold is, and we have enough firepower to keep it, too. One of these days real soon, there will be lots and lots of guys who will ring our doorbells ("ding dong!"), who will say things like, "Please please, please, please, please, please, please sell me some of your gold!" and who also want to buy it at absurdly high prices. If you are buying gold right now, then one day that will be your doorbell ringing, and you can decide for yourself if you will sell them a little of your gold for some big, big money, or chase them off with a mighty shotgun blast and your laughter ringing in their ears.

But this is not about how I let off a few warning shots at a neighbor’s kid who was acting a little too suspicious to suit me, but about how this is just the weird, scary stuff that always happens at the end of long, credit-fueled booms, especially ones where the government is the major buyer of goods and services, like now. In short, there are a lot of desperate rats trapped in a lot of corners, and they are ferociously lashing out in fear and panic, which is, if you have seen any horror movies at all involving rats, a very bad situation, indeed.

Gold Bullion: The Bank Itself Owns the Gold

I bring this up because a guy who likes to be an "anonymous source" reports, "If a bank has physical possession of some gold which it owes you as its creditor, the bank itself is the current owner of the gold." An interesting thing to consider! On the other hand, if the gold you deposited at the bank has your name on it as the owner, then you have what is known as "allocated gold." But if all you have is a deposit slip showing that some ounces of gold were deposited, then you have, unfortunately, unallocated gold. He goes on to say, "Unallocated gold is the most widely traded form of gold in the world. While this gold remains unallocated to you, the regulator considers it part of a bank’s liquid reserve." He figures that 99% of gold deposits are in unallocated form, and therefore all the deposited gold is, in effect, in a big commingled pile in the basement of the bank.

Another way of looking at this stunning fact is, "This makes unallocated gold an attractive way for the bank to maintain its regulated liquidity, because you have paid for your gold, and the bank is free to use your money, while it is also able to add your unallocated gold holding to its own reserve."

Being stunned to speechlessness at the revelation, I nevertheless raise the Bony Pointing Finger Of The Mogambo (BPFOTM), and tap on your computer screen so that you pay special attention to where he says that the bank uses your gold as part of its reserves! If you are not impressed by the use of the exclamation point, or if you are not likewise impressed and horrified by the actual words, then I know that 1) you are still young and trustful, and 2) I also know that you don’t realize that bank’s reserves are the assets that the bank can legally use to offset its own losses. My mighty Mogambo Super Brain (MMSB) detects a sudden disturbance in the fabric of the cosmos, as you you are saying to yourself, "The banks can protect themselves and their owners by confiscating and selling the assets of the depositors? Yow!" Yow indeed, young grasshopper!

So, your unallocated gold could, and would, be sold if the bank were in need of cash. If the bank went bankrupt and insolvent, then you would be put in the line with all the other creditors, and you would divvy up what is left, if anything, after the bondholders have been paid and the secured creditors have been paid and lots, and lots of other people have been paid and the furniture has been repossessed. Hahaha! Trust the banks? Hahaha!


The Mogambo Guru
for The Daily Reckoning

December 19, 2005

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter, and a vocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

"It’s over."

Thus began yet another conversation about real estate. The man speaking was a real estate developer and investor from Florida. The man listening was a writer from Maryland. The man recording the conversation was your editor.

"I have been trying to sell my house for two months," responded the man from the Old Line state. About 20 people looked at it, but not a single person made an offer."

"You’re going to have to lower your price," said the Sunshine State man. "People still think they can get bubble prices for their property. But it’s over. I mean, the bubble is over."

Prices may not crash, opined the developer, but the bubble-rate rises are finished. We knew they would come to an end someday. If our friend is right, the precise day was the 16th of December 2005. Why that day? We don’t know. Perhaps it was the 13th rate increase from the Fed; it had an unlucky sound to it. Maybe it was the spike in the price of gold. Or maybe it was nothing at all. When things need to be tipped over, there are always points when they will be. Maybe the tipping point for U.S. real estate prices came last week. Maybe it will come next week.

But what will happen?

To this question we have no better answer than anyone else. We notice that the tipping point for bubble gains has already come and gone in both Britain and Australia. Both economies seemed to count on further bubble gains in order to keep going. But when the gains ceased…the economies kept going anyway. Go figure.

In Britain, house prices rose 22% in 2004. So great were the increases, and so used to them had the British lumpenhouseholders become, that we predicted doom for the whole limey race when they came to an end. Well, along came 2005. House price increases dutifully came to a stop – just as we said they would. There is still a dispute as to how much of a stop they have come. Some analysts think they are still creeping ahead…just at a very slow rate. Others think they are going backward, but no one doubts that the house-price bubble is over in Britain.

Along with the end of the bubble came many of the expected signs of despair and funk. The number of people going broke is higher than it has been since Britain itself went broke in the 1970s. So are there more houses being repossessed than there have been for a dozen years.

Similarly, in Australia, the line that described house prices had been almost vertical in recent years. Then, more recently, it had begun to flatten out…and most recently it was even sloping downward, with house prices slightly lower than they were a year ago. Similarly too, the economic situation has darkened for many Diggers, but for most of the folks Down Under, life goes on just as it does for the residents of the British Isles from which so many came.

That is the part that puzzles us. We understand the bankruptcies. We get the foreclosures. We saw them coming. What we didn’t see coming was so much nothing. That is, we saw the economies of all three Anglo-Saxon countries – Britain, Australia, and America – dangerously dependent on house price increases. When house prices stopped rising, we expected a lot more trouble than has so far revealed itself. We have not been to Australia for many years, but our people on the ground tell us that things seem perfectly normal. If the end of the world has come, it is news to the Aussies. They are still spending money. The economy is still expanding. No worries, mate.

Likewise, in Britain, there is no sign of calamity. Elizabeth was there only the day before yesterday. "Is the economy collapsing?" we wanted to know. "Are investors jumping off Blackfriar’s Bridge? Are hedge fund managers lining up for hot soup? Are homeowners packing up and moving to the New World?"

"If they are, we saw no signs of it," came the reply.

So, dear reader, there is life after the real estate bubble after all. What kind of life remains to be seen.

More news from our currency counselor…


Chris Gaffney, reporting from the EverBank currency desk:

"Why is this deficit important? Many popular think tanks have been saying that ‘deficits don’t matter’ and that we are in a ‘new economy,’ where globalization and new investment parameters have made deficits less important."


Bill Bonner, back in Nicaragua with more thoughts….

*** Ahh, irony. It’s a lost art, no? "Just when we find ourselves extolling the ironies of the market on the air," writes Addison "we get this juicy nugget." We have oft pointed out that in order to "make the world safe for democracy" the United States must borrow extensively from, among other countries, Communist China.

But now Addison points out: "Bush declared a grand success in the War on Terror last evening from the Oval Office. ‘The [Iraqi] election will not mean the end of violence, but it is the beginning of something new: constitutional democracy at the heart of the Middle East. And this vote, 6000 miles away, in a vital region of the world, means that America has an ally of growing strength in the fight against terror.’

"But in our own offices," Addison continued, "we have been following an entirely different story. Recent research coming out of Universities of Maryland, Johns Hopkins, and Rice say that our democracy at home is being questioned… rather the widely used Diebold electronic voting machines that were the subject of much scrutiny in the last two elections are ‘a threat to democracy’."

Our own Whiskey & Gunpowder editor Greg Grillot was contacted unexpectedly by ABC news late Friday afternoon as we prepared for our holiday fete. They wanted to know why we issued a warning on the shares of the company. Here’s what Greg drummed out: "Diebold’s in for a huge public relations nightmare and they’re likey to get sued by shareholders and county election boards.

"For instance, Leon County Florida has recently asked Diebold to repay the funds spent on their voting machines. If Diebold doesn’t repay, you can count on a lawsuit. A demonstration in Leon County showed that a hacker could infiltrate a voting machine’s memory card and change votes – in less than a minute. Apparently, a non-profit group has trained a monkey to hack into these memory cards. Ouch. Furthermore, in a Georgia gubernatorial election, Diebold illegally installed software patches that hadn’t passed official inspection.

"Miraculously, nearly 60% of Georgia’s electorate switched parties in that election. This also seems ‘funny’: in an Ohio election this November, the actual results of certain propositions diverged as much as 40% from the usually accurate exit polls. So there’s little trust in the ability of these machines to yield accurate election results. Add that to the dubious actions of the company in installing illegal software patches. And finally, the security of these machines was proven suspect, so anyone with access to them could hack in and steal an election. That’s where the ‘threat to democracy’ comes in.

"On top of that, the Republican fund-raising CEO stepped down recently, amid allegations of insider trading and class action lawsuits based on deceiving shareholders on the security of the voting machines. All of these factors combine for a bleak outlook on Diebold’s share price."

*** We have come to warm Latin America for Christmas. The family is spread out…nearly half and half, split between the New World and the old. So, we are all traveling this holiday season.

*** Elizabeth brought sad news:

"You know, poor little Rafael’s mother died. They knew she was dying. But they didn’t think she’d go that fast. I went to the funeral mass. I saw Rafael. I felt so sorry for him."

Rafael, 12, now lives with a burden heavier than empire, and more crushing than debt.

*** "You know," said a friend, "Everyone worries about not having money, but not having money is the smallest problem a person can have. It is a situation that is easy to change. And it makes no difference anyway."

The Daily Reckoning