Sunday, January 25, 2009

Funneling down the pyramid

Exeter's liquidity pyramid, that is. The deflationary/contractionary rout is intensifying. Small snippets of the truth are leaking out piece by piece and they are not pretty. Do you believe bank holidays cannot happen in the U.S.? How about Great Britain? Read this link and think about it for a minute (thanks to the Financial Ninja blog for scooping this one).

The key item from the article in my opinion: "The Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals." Let's review Exeter's liquidity pyramid (stolen from the Long Wave Analyst):

Now, when the shit hits the fan, like it is doing now, every one looks out for number one. Wealth is not being destroyed, it is evaporating in waves. When this "digital" wealth leaves and trust rapidly decreases, people want to "get liquid" to preserve capital. Getting liquid or putting one's money into the safest asset class available makes sense if you have wealth to protect.

We have already seen this in real time with the flight to the perceived safety of government bonds. We are already near the bottom of the liquidity pyramid with U.S. Treasury bills at 0-1% interest. Next comes cold, hard cash, whether "stored" in banks or under the mattress. Banks are obviously suspect and growing more so by the day. If you think there was a banking panic before, wait until the British populace hears about the article linked to above.

When you can't trust banks, you're left with stuffing currency notes in a safe or under the mattress versus hoarding gold. But leaders around the world are jockeying to be able to claim bragging rights for debasing their currency the most in a desperate attempt to re-ignite inflation and punish prudent savers. Those who save by hoarding gold are protected from the whims of the political ruling class.

Of course, the government can "back stop"/guarantee all the banks, but that puts the currency at risk. The FDIC exists and can pay nominal claims in any scenario by printing money out of thin air, but this has exceptional risks associated with it. Take a look at a currency chart for the British Pound over the past 15 years:

So, if government bonds and bills yield close to zero, the currency is unstable, and all other asset classes are taking it in the shorts, where on earth can you put your money to preserve your savings? You should already know my answer to this question, but the answer is what's at the bottom of the liquidity pyramid: G-O-L-D!

How do you think British citizens who took their money out of the bank during the fall panic and put it into gold feel about their investment choice? Let's take a look at a long-term gold price chart denominated in British Pounds (i.e. $GOLD:$XBP or the futures gold price divided by the currency index for the pound sterling):

It's long past time to pretend that banking holidays cannot happen in the United States. Protect yourself by having at least 1-2 months' worth of expenses on hand in cash and put at least 10% of your savings into physical gold coins and/or bars. I think the next 1-2 weeks will provide another great buying opportunity for physical gold (as well as gold stocks).

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