The Binary Circumstance

The Federal Reserve, apparently not satisfied with dumping the bad debt held by banks on the taxpayers, has invoked a little-used law to shift the bad debt held by a non-bank to the taxpayers as well.

From Bloomberg.com:

March 14 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke invoked a law last used four decades ago to keep Bear Stearns Co. from collapsing after the securities firm approached the central bank for emergency funding.

The loan to Bear Stearns required a vote today by the Fed’s Board of Governors because the company isn’t a bank, Fed staff officials said. The central bank is taking on the credit risk from Bear Stearns collateral, lending the funds through JPMorgan Chase & Co. because it’s operationally simpler to accomplish than a direct loan, the staff said on condition of anonymity.

Bernanke took advantage of little-used parts of Fed law, added in the 1930s and last utilized in the 1960s, that allows it to loan to corporations and private partnerships with a special Board vote. The Fed chief probably sought to stave off a deeper blow to the financial system from a Bear Stearns collapse, former Fed researcher Keith Hembre said.

Just three days ago, the Fed promised up to $200 billion in loans to banks also agreeing to take their bad loans as collateral. That news sent the stock market soaring over 400 points. Today’s news sent the stock market and the dollar down and saw gold trading solidly above $1,000 ounce for the first time in history.

In the latest sign that the global credit crisis is probably far worse than governments are letting on, Great Britain is nationalizing mortgage lender Northern Rock and apparently offering shareholders very little in return. That either means that the company really is worth very little, or the government is basically stealing it from private owners.

LONDON (AP) — Prime Minister Gordon Brown’s government faced accusations of mismanagement Monday as it began nationalizing stricken mortgage lender Northern Rock PLC — the first time in 20 years that a private company has been taken into public ownership.

The government repeatedly insisted a private sale was its preferred option. But after five months of intense speculation about the future of Britain’s most public casualty of the global credit crunch, Brown said that nationalization was the best choice until market conditions improve.

“We will, and always have, put the interests of taxpayers first,” he said.

The opposition Conservative Party said Britain’s reputation as a major financial services center had been dealt a serious blow.

“The nationalization of Northern Rock is a disaster for the British taxpayer, a disaster for this government and a disaster for our country,” said Conservative Party leader David Cameron.

[…]

Meanwhile, trading in the stock was suspended to make way for nationalization, leaving shareholders unable to sell their holdings after the government first announced its plan Sunday.

Under British rules on nationalization, shareholders will be offered compensation for their holdings at a level set by a government-appointed panel.

The panel will calculate a figure based on the bank’s value without government guarantees — a figure most analysts expect to be very little or nothing at all.

The stock closed at 90 pence ($1.75) Friday, valuing the company at 379 million pounds ($738 million). The price has fallen more than 80 percent since Sept. 13, one day before Northern Rock revealed it had sought the emergency funding.

It should be noted that Gordon Brown has not shown a talent for timing markets well in the past. In 1999, he sold off half the gold reserves of the Bank of England at the market’s bottom, and by announcing the sale to the world before it began he depressed the market by 10% before he sold the gold.

…But “the timing of the decision was ludicrous,” says Peter Fava, then head of precious metals at HSBC.

“We told them [the BoE] – you are going to push the price down before you sell it.”

That’s just what happened, of course. Gold sank by almost one-tenth on the back of Gordon Brown’s decision to announce his sales ahead of time.

“I was surprised they had chosen the auction method,” adds Martin Stokes, a former vice-president at J.P.Morgan. “It indicated they did not have a real understanding of the gold market.”

Clueless or not, however, it didn’t matter. The Bank of England had no say in the matter. It only got to advise the government on HOW to sell the gold. The fact of the sale itself had already been decided by the Treasury. And since then, says the Times, the government has defied all calls to release minutes and emails written at the time.

The paper says the government is now embarrassed by its decision to sell gold. But you wouldn’t know it from Gordon Brown’s behavior; the guy’s not embarrassed at having destroyed the UK pensions industry, for instance, or taxing dividend payments so badly that sales of mutual funds to private investors have collapsed. Why would he be embarrassed by selling gold at the end of the 20th century? Everyone else was doing it, after all.

Given his past, it’s very comforting to know he’s now working his magic on the global mortgage crisis. (Sarcasm intended.)

I would suggest that he may be a contrary indicator. Forcing the sale of Northern Rock shares might indicate the market has hit bottom. But this is different. He’s not selling Bank of England gold this time, he’s forcing private citizens to sell their shares to the government at a price determined by the government.

In his November 18, 2007 commentary, James Turk, the founder of Goldmoney.com comments on OPEC’s concerns about the falling dollar.

Late Friday afternoon - after the gold market had already closed - Bloomberg and other news services reported the discussions of a meeting of OPEC ministers intended to be held behind closed doors but accidentally broadcast on closed-circuit television to reporters in the media room. According to Bloomberg: “Saudi Arabia, the world’s largest crude oil exporter, rejected a proposal by Iran and Venezuela to discuss the weak dollar at this weekend’s OPEC summit in Riyadh, saying it didn’t want the U.S. currency to ‘collapse.’”

A Reuters article published by the Guardian in the UK quotes Price Saud al-Faisal Saudi Arabia’s foreign minister as follows: “My fear is that any mention that OPEC makes of studying the issue of the dollar, will in itself have an impact…Just indicating that we have charged finance ministers with studying this issue…would mean a decision taken by OPEC would have the opposite effect and the media would pick up on this point…And then perhaps we would find that the dollar had collapsed, instead of us having done something in the interest of our countries.”

Turk goes on to make this comment and illustrate his point with a chart, which clearly shows what the government has done to the purchasing power of the dollar:

If it wants a stable oil price, which is its stated aim, then OPEC should be pricing oil in terms of gold. This point is made clear in the following chart. When viewed in terms of gold, the price of oil has barely changed over the 62-years in this chart.

You will notice that the dollar maintained its value against both gold and oil until the early 1970’s which was when President Richard M. Nixon drove the final nail in the coffin of the gold standard, making the dollar 100% fiat. The government and banks have created so much money since then that other world leaders now openly discuss the possibility of a “collapse” of the dollar. Not only that, they see the dollar as so fragile they want to keep their discussions private.

The chart represents the increase in the price of oil relative to US dollars, which is the same thing is the decrease in the purchasing power of the US dollar in relation to oil.

Gold closed at $806.90/ounce today.

Its previous record weekly close of $812 was set in January of 1980.

It’s previous all-time record daily close was $825.50.

With the dollar decline showing no signs of letting up we should be breaking that record very soon.