Submitted by Simon Black of Sovereign Man blog,
Over the past several decades, people around the world have become so brainwashed that few people really give much thought anymore to the safety of their currency.
Its not something people really understand... theres apparently some Wizard of Oz type figure at the top of the hill pulling all the levers of the monetary system. And we just trust them to be good guys.
This is partially true. Todays financial system is dominated by central bankers who have been awarded nearly dictatorial control of global money supply.
In allowing them to set interest rates, they are able to control the price of money, thus controlling the price of... everything.
This power rests primarily in the hands of four men who control roughly 75% of the entire world money supply:
- Zhou Xiaochuan, Peoples Bank of China
- Mario Draghi, European Central Bank
- Haruhiko Kuroda, Bank of Japan
- Ben Bernanke, US Federal Reserve
Four guys. And they control the livelihoods of billions of people around the world.
So, how are they doing?
We could wax philosophically about the dangers of fiat currency. Or the dangers of the rapid expansion of their balance sheets. Or the profligacy of wanton debasement through quantitative easing.
But lets just look at the numbers.
In theory, a central bank is like any other bank. It has income and expenses, assets and liabilities.
For a central bank, assets are typically securities or commodities which have value in the international marketplace, such as gold or US Treasuries.
Central bank liabilities are all the trillions of currency units floating around dollars, euros, yen, etc.
The difference between assets and liabilities is the banks equity (or capital). And this is an important figure, because the higher the capital, the healthier the bank.
Lehman Brothers famously went under in 2008 because they had insufficient capital. They had assets of $691 billion, and equity of just $22 billion about 3%.
This meant that if Lehmans assets lost more than 3% of their value, the company wouldnt have sufficient cushion, and they would go under.
This is exactly what happened. Their assets tanked and the company failed.
So lets apply the same yardstick to central banks and see how safe they really are:
- US Federal Reserve: $54 billion in capital on $3.57 trillion in assets, roughly 1.53%. This is actually less than the 1.875% capital they had in December. So the trend is getting worse.
- European Central Bank: 3.69%
- Bank of Japan: 1.92%
- Bank of England: 0.843%
- Bank of Canada: 0.532%
Each of these major central banks in rich Western countries is essentially at, or below, the level of capital that Lehman Brothers had when they went under.
What does this mean?
Think about Lehman again. When Lehmans equity was wiped out, it caused a huge crisis. The companys liabilities instantly lost value, and almost everyone who was a counterparty to Lehman Brothers lost a lot of money because the company could no longer pay its debts.
Accordingly, if the US Federal Reserves assets unexpectedly lose more than 1.5% of their value, the Feds equity would be wiped out. This means that any counterparty holding the Feds liabilities (i.e. Federal reserve notes) would lose.
More specifically, that means everyone holding dollars.
Theoretically if a central bank becomes insolvent, it can be bailed out. It happened in Iceland a few years ago.
Theres just one problem with that thinking.
Icelands government wasnt in debt at the time. So they were able to borrow money in order to bail out their central bank. Today the government is in debt over 100% of GDP, but the central bank is solvent.
But governments in the US, Europe, Japan, England, etc. are all too broke to bail out their central banks. These governments are already insolvent. So if the central bank becomes insolvent, there wont be anyone to bail them out.
This is one of the strongest indicators of all that the financial system as we know it is finished. When central banks can no longer credibly issue liabilities, and their home government are too broke to bail them out, this paper currency standard can no longer function.
Such data really underscores the importance of owning real assets such as productive land and precious metals.
Given its nominal roller coaster ride lately, there has certainly been a lot of scrutiny and skepticism about gold.
But to paraphrase Tony Deden of Edelweiss Holdings, if you dispute the validity of gold as a hedge against declining fiat currency, that makes you, by default, a paper bug. Can you really afford to be confident in this system?