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Why ZIRP/NIRP Is Killing Fractional Reserve Banking & Forcing Deposits Into Gold

Submitted by Gijsbert Groenewgen via Silver Arrow Partners,

Could zero/negative interest rates be the end of the fractional banking system and force deposit holders into gold and silver?

Would you give your money to a hedge fund that is 9x leveraged?

With the negative interest rates deposit holders might be opt for paper money (notes) instead of digital money (digital wallet, bank account)! Which could bring down the fractional banking system because as we know of every $100 you deposit in the bank $90 is subsequently loaned on. US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only to deposits by individuals! Banks have no reserve requirement at all for deposits by companies! Go figure.

Anyway the Required Reserve Ratio of 10% means that only a fraction or $10 of the $100 you have deposited at the bank is available for cash withdrawal. Your $90 that is loaned on is leveraged within the banking system to increase profits for the bank. A bank is basically a big 9x leveraged hedge fund. Excessive leverage by the banks was one of the main causes of the Great Depression and of the 2008 financial crisis. Under normal circumstance and normal debt levels the fractional banking system works though these are not ordinary times!

You have to ask yourself when interest rates are so low and don’t compensate you for inflation and with the risk that there could be bail-ins, considering the incredible derivative positions banks have, why keep your money at the bank.

All Governments have silently built in the “bail in” template for when the roof comes down. Where is the accountability of the politicians and bankers?

The US, UK, EU, and Canada have recently all built the new "bail in" template into their laws in order to avoid imposing risk on “taxpayers” (and politicians and bankers of course).  All taxpayers have bank accounts and therefore the avoidance argument basically is only important to get the government officials and the bankers off the hook i.e. their accountability! Under the new "template" all lenders (including depositors) to the bank can be forced to "bail in" their respective banks.  Most depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. And most account holders don’t know that by law, when you put your money into a bank account, your money becomes the property of the bank. Your title “downgrades” from owner of your money to creditor of your money with millions of other creditors. You become an unsecured creditor with a claim against the bank.  In other words if the bank goes bankrupt you share at pari (equally at fault) with other similar creditor/deposit holders. Great deal for the bank and bankers, no!

Deposit insurance is a fallacy with more than $1,000 trillion in derivatives

Before the Federal Deposit Insurance Corporation (FDIC) was instituted in 1934, U.S. depositors routinely lost their money when banks went bankrupt.  These days your deposits are “protected” only up to the $250,000 insurance limit, and “only to the extent that the FDIC has the money to cover deposit claims or can come up with it”. The question then is how secure is the FDIC? The FDIC has only about $25 billion in its deposit insurance fund, which is mandated by law to keep a balance equivalent to only 1.15% of insured deposits.

See here, based on data reported on 2014-09-30, just the 5 largest US banks by total deposits amounting to roughly $4.8trn

Rank    Total Deposits            Bank Name
1          $1,377,661,000,000    JPMorgan Chase Bank

2          $1,202,846,000,000    Bank of America

3          $1,171,956,000,000    Wells Fargo Bank

4          $947,975,000,000       Citibank

5          $284,226,575,000        U.S. Bank

Do you really think that the FDIC will have enough money to bail out all the deposit holders at $250,000 a pop? I don’t think so! Especially when you also take into account the $1,000trn derivatives exposure that is hanging over the markets. Subsequently people could argue that the Treasury will come to the rescue. I doubt it; I think at that stage it will be too late anyway to rescue the currency. In other words when the bigger banks threaten to fall over don’t believe the authorities when they say that everything is under control because it won’t be. And when the banks start to fall over also don’t put too much faith in the FDIC or Treasury. It will be a lost case anyway.

Why would you still have a bank account with all its pitfalls?

Nonetheless my point is as follows. Why would you still have a bank account considering their zero return, high fees and abysmal services? Next to that we don’t know what kind of black swans (or whales as in JP Morgan’s case) are hidden in the banks operations and we always are the last ones to find out what the exposure to the incredible amount of derivatives has been. So as a deposit holder you are always one or more steps behind. Therefore the most logical step would be to withdraw “your” money from the bank. This in itself could be very interesting because as discussed here above at the most the bank is likely to have only 10% of your money in cash, remember the remainder has been loaned on the basis of the fractional reserve system - how many dollars a bank lends out compared to the amount of deposits it has on hand. In other words if more and more people would demand their cash, following its negative return, it would cause a run on the bank because the banks won’t have enough cash.

Remember a while ago when deposit holders with HSBC in London, England were told that they needed to have a valid reason if they wanted to take out £5,000 in cash from the bank and otherwise they were declined to withdraw the money from their own account! That in the end was quickly reversed but these things tell you a lot about the thinking and culture within the banks. And this was the situation whilst there was “no stress” in the system! When and if there is stress in the system they will say, “it is not your money”!

With increasing negative real interest rates gold and silver look more attractive by the day

Hence, based on the abovementioned, why I believe, considering the ultra low and even negative interest rates, that physical gold and silver look more attractive by the day. The ongoing free-fall in long-term interest rates has significantly reduced the opportunity cost of holding gold. Gold and silver keep their purchasing power in times of devaluations (as we are witnessing at present) and don’t run the counter party risks or bail-ins that you are exposed to as a creditor/deposit holder of the bank or as a holder of the currency (declining purchasing power). In my point of view silver will show the way, silver is a much cleaner chart see below! In the run up silver normally takes the lead as a result of which the gold/silver ratio should keep on declining from today’s high level of 72.5.

Chart: Gold/Silver ratio

Chart: Silver price

Chart: Gold price

The geopolitical problems don’t seem to get solved only postponed with Israel upping the ante!

And then I have even not touched upon the potential geopolitical causes for gold and silver to go up. To name a few: Ukraine, ISIS (Al-Asad air base in Iraq, could be potentially very destabilizing), Greece and Iran. In case of the Ukraine and Greece the politicians say they have agreements! But the problems are not being solved they are just being postponed. It is all cosmetics. Do you think that when Greece gets a bridge loan or any other loan that the problem will be solved? Of course not! The defaults will only get bigger and thus the cost to the European taxpayers. Really how can any politician justify further financing of Greece? If you don’t understand that Greece has been a lost case already for a long time and even more now (how can Greece pay back $320bn?) you are not capable of leading a nation.

In the Middle East Prime Minister Benjamin Netanyahu said on Sunday February 8 that "world powers and Iran are galloping toward an agreement that will allow Iran to arm itself with nuclear weapons that will endanger the existence of the state of Israel," adding that he would do everything in his power to foil such an accord before the March 31 deadline. Elections in Israel take place on March 17. It is clear to me that there are huge differences between the Obama administration and the Netanyahu government how the Iran situation should be solved though we all know that the Israelis have attacked nuclear facilities in Iraq and Syria when they felt it was justified. Time is running out.

The introduction of solely digital money would put the government and the bankers in full control of your money

The only question I have left in the context of the currencies, and some food for thought, taking into account the emerging presence and adaptation of the digital age we are living in, is if the authorities might try to create digital money, and abate tangible dollar bills and coins, to circumvent the bankruptcy of the US dollar and solve the gold issue.

Digital money entails any means of payment that exists purely in electronic form. Digital money is not tangible like a dollar bill or a coin. It is accounted for and transferred using computers. Digital money is exchanged using technologies such as smartphones, credit cards and the Internet. It can “still” be turned into physical money by, for example, withdrawing cash at an ATM. Though we should be very conscious of the fact that digital money would give the government and banks total control of your money and thus the financial system. After all where else and in what form are you going to keep your digital money if you don’t trust the banking system!

Will the Japanese Yen lead the correction of the US dollar?

And as many people have alluded to that the Japanese market might be the first one to go……………..triggering a lower dollar because people that are playing the carry trade might have to cover their short positions in Yen when interest rates in Japan start to rise because traders don’t buy the Abenomics (QE) nonsense any longer!!! We just witnessed another weak bond auction (lowest bid-to-cover and biggest tail since 2013), which spiked JGB yields.

Chart: 10-year Japan Treasury Yield

The Bank of Japan (BOJ) triggered a currency war after it expanded its monetary stimulus program on Oct 31st 2014. Since then most central bankers across Asia and Europe have resorted to similar tactics, in order to counter the deflationary impact of strength in their currencies and weakening oil prices.

The Japanese Yen could potentially lead the correction in the USD index, which would propel gold and silver, as the Yen was the leader in competitive devaluation and appears more likely to lead the way on the high side now, especially after BOJ’s surprising move communicating that further monetary easing is seen as “counterproductive” and stated that further depreciation in the Yen would hurt sentiment. Next to that the US economic data in the recent weeks have consistently missed the market expectations. Moreover, the “strong jobs data” have already been priced-in by the markets. Additionally, further upside in the 10y yield appears capped around 2.1%, in which case the Yen is unlikely to rise beyond the 83 level. Recovery in crude prices is negative for the US dollar, as most advanced world currencies had weakened in response to weaker crude prices since H2 2014.

Chart: Japanese Yen versus the USD index

And have a look how much the gold price is correlated to the Yen.

Chart: Japanese Yen versus Gold

Conclusion: compared to bonds gold and silver are clearly the preferred assets

Finally when I look at the negative real yields on deposits and sovereign bonds, including the U.S. 10-Year Treasury, the conclusion has to be that in the gold and silver vs the dollar war gold and silver clearly are the preferred insurance against the wealth destruction currently taking place worldwide. As mentioned with historic low long-term interest rates the opportunity cost of holding gold and silver are close to zero or even negative, in other words you would “lose” money if you buy bonds (the benchmark) instead of gold and silver. Opportunity costs can be defined as the benefits you could have received by taking an alternative action. It will be just a matter of time before people realize the opportunity that gold and silver offer.

When people realize that their money is not “safe” with the banks they will start withdrawing cash from their accounts and buy physical gold and silver instead. Depending on circumstances this could possibly bring down the (fractional) banking system. Why keep money in an account that gives you a negative return? Swiss banks are already witnessing stronger than normal interest for physical gold.

It is important to stress that if you buy gold and silver that you buy the physical and not paper gold and silver (futures, ETF) because only the physical will shield you from counter-party risk and the loss of purchasing power.

And as mentioned in my earlier articles with respect to the “manipulation” of the gold and silver prices administered to “strengthen” the US dollar the moment the US dollar starts falling holders of paper (futures) contracts will demand physical delivery instead of cash (that is becoming worth less and less) settlement! At that moment the price setting of the physical will definitely take over from the bogus price settlement of the synthetic/paper contracts (at least 100+ the number of physical contracts). The same physical settlement is likely to happen when there will be not enough silver to satisfy the industrial users, who need the metal. Anyway I think that all these circumstances will ultimately converge. Interesting times!