As we have detailed in previous posts, the privately owned US central bank has fully implemented a policy of privatizing profits and socializing losses. The privatization of profits exclusively benefits the Fed's owning shareholders, the primary dealers. The socialization of losses affects anyone using dollars as a means of saving or transacting business, i.e., you.
The following image depicts a battle which is currently raging in the public's mind. Ironically, only objectivists can see that a winner has already been declared. It will take the public some time to notice the outcome and this is often the case when you seek to drink upstream from the herd.
Market participation in bond funds is at record high levels. Savings accounts and certificates of deposits are stuffed with excess cash as investors fear deflating asset values. A basic understanding of economics would suggest that near 0% yields would curb interest in debt instruments and deposit products. People have chosen return of their capital over return on their capital.
So What's The Problem?
The problem is that we are not in a traditional market-driven deflation. A select few market participants, primary dealer banks, have been allowed excess liquidity via treasury churning as a means to repair their damaged balance sheets. Remember that the damage was caused by their manipulation of traditional market activity. While you are dealing with the hangover from the past excesses, they are having a Monday morning Bloody Mary party and you are not invited.
This is not a problem until excess liquidity begins to seep into the economy. As long as the public perceives liquidity to be scarce, there is no problem.
What to Watch
We are beginning to see the effects of this central bank behavior in markets. While the government uses Soviet-era tactics to assure the public there is no problem, astute market participants see otherwise. Remember that government inflation numbers do not include food, energy or anything that has risen in price.
With the average savings account returning less than 1% per annum, before taxes, savers are losing more than 7% on their money. We continue to wonder how they can be unaware of this reality but, so far, the Fed's mission has been accomplished. Once the herd is awakened to this, we urge you to pay attention in order to avoid being trampled as they rush towards speculative investments in a cloudy, panic-filled haze.
When bonds are sold at the margin, we expect sheer panic to ripple through the ranks of owners. Today's bond buyer is effectively last to the party and, as we know, most likely to get slaughtered. He likely has no idea that bonds trade on price not yield and can go down in value creating a loss for the owner. We have heard them say they don't care because holding to maturity is an option. Let's see if they are calmly holding that 2% treasury coupon 9 years from now.
The consequences related to a reduction in savings account balances is more dire. Banks have used excess deposits to repair their capital ratios and boost lending in what has been the best yield curve imaginable. Paying depositors 0.50% and being selective about loaning to only the best borrowers at 5-8% has been a business that only a gangster could dream of. Throughout this era, holders of bank stocks have been hanging on hoping for valuations to rebound while being totally unaware of increasing costs associated with banking. The Dodd Frank Consumer Protection act has increased the cost of a free checking account to over $400 per annum. Combine this with the worlds most tedious anti-terror documentation and operating a retail bank becomes expensive.
As soon as depositors begin to connect the dots discussed above, we expect severe tremors to be felt in the banking sector. At the start of this downturn, there were more than 8,000 banks in the US. We expect that number to shrink by at least 1,500. That leaves another roughly 1,100 as only 421 have failed since the beginning of 2008. Holders of bank stocks are totally unaware that the central bank is privately owned and will always act in the best interest of its shareholders, the primary dealers. Only a fool would expect otherwise.
Once banks have to compete for depositors the game changes. Being forced to pay competitive rates on savings products will end the yield curve advantage which they have only as a result of the massive levels of fear present in markets today. The costs associated with banking today will act as a death knell for smaller banks forcing them to merge or fold under the pressure of a weight they refuse to notice. Bankers are notorious for using the rear view mirror to predict the future. They do not see what is coming which would require looking through the windshield.
What To Do
We suggest you spend some time thinking about the concepts that we have discussed above. Notice the behavior of the public. Remove yourself from any attachment to a specific outcome you might desire. Try to objectively see the circumstances and catalysts present in the market today.
We suspect there will be a rush to speculative assets once the public wakes up. Volatile shares with promising upside are a likely home for "hurry up" capital being deployed by unskilled savers. Gold remains a core holding in our management strategy. Rarely do you see a product that rises 20% per annum in price while demand remains pegged at 100%. In this case, we suspect speculative mining shares will attract significant quantities of hot money.
You must make up your own mind as to the likely course this issue will follow. Read, study, learn, and question everything in your efforts to protect and grow your own balance sheet.