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Serious Credit Collapse Could Strengthen Dollar and Hit Gold

By Chris Laird      Printer Friendly Version
Aug 28 2007 10:39AM

In the emerging credit crisis, the corporate paper market is in chaos. This IS a crisis.

What started as flight from sub prime mortgage derivatives, now has spread to flight from many of the largest credit markets in general. The CP market (corporate paper that rolls over every 90 days) is $2.2 trillion in the US alone. Banks, financial institutions, and companies use it to finance daily operations. That market is funded heavily by Money Market funds, who invest in the CP market to get better yields for their depositors than, say, an FDIC insured CD.

The trouble with the CP market developed when, first, investors fled the mortgage derivative market, but then, as revelations of widespread of losses started appearing, lenders started to pull back from rolling over CP to everyone. That is because no one knew who held secret losses in mortgage derivatives, so banks and institutions and investors decided not to roll over their CP when the time came. The entire CP market world wide froze in about a week. This situation continues in the EU and the US and Canada.

This is forcing banks, institutions, and companies to hoard cash. The initial rise in the USD, in the week after BNP Paribas revealed they were freezing redemptions from two funds they had which had large mortgage derivatives, was due to people madly dashing into cash and getting as much cash as possible so they could operate, because short term money was not available. The USD strengthened significantly the first week. The short term money markets are in a real crisis.

Alternately, there was flight into gold as well, (second week) after the initial dash into dollars. The USD also benefited from flight into dollars and US Treasures for safety.

Last week’s panic buying of US Treasures, where short term 3 month yields dropped up to 2%, but recovered later in the week.

But the credit crisis dynamic has been illustrated. First, when a new scare appears, there is flight into the USD. Then, in real fear, there is flight into gold. Short term credit markets totally freeze, and then we see the central banks madly flooding money into financial markets. Central banks hoped this would stabilize the CP markets, but found that quite hard to do, as lenders did not want to be stuck holding the bag, if they rolled over their new CP to borrowers.

Now, what concerns me is that we have not seen a total credit meltdown yet. Even though the CP markets are reeling still, the central banks managed to stop a stampede (so far) out of equities, after their initial falls. I suspect that the central banks, and the financial industry are colluding to hold equity markets together, to prevent the Real Crash that is possible.

The other reason equity markets have held up so far, is because I think all the funds sent frantic emails to each other saying ‘for goodness sake, don’t sell right now!’

How long they can delay is not known. We know funds of all types, including money market funds, are begging for new deposits, and have had large redemptions. There is a lot of pressure on markets to fall right now, as eventually, the funds will have to give in and sell.

The central banks are doing their part, buying everything in sight at book value from troubled institutions, letting Citi, BoA, and Morgan move up to $25 billion of their capital to their brokerage units, in a relaxation of banking restrictions, and flooding well over $500 billion into direct infusions to troubled financial markets. (These are just a few examples of what CBs are doing. Not the least of which is to support panicky markets with their ‘Working Group on Markets – the so called plunge protection teams in the US and Japan).

The present credit meltdown is severe, but, if we see a real equity collapse due to forced selling, as funds see redemptions, then we will also see:

  • Derivative losses for institutions on a scale far greater than seen so far

  • Massive forced selling for fund redemptions

  • A total credit freeze where banks, institutions, and companies cannot get any short term money, and have no alternative but to hoard cash (dollars) to operate.

  • A possible huge spike up in the USD and the Yen, and drops in some of the stronger currencies of recent times.

  • Forced Yen carry unwinding, as several weeks ago, the Yen strengthened significantly in the onset of the equity sell offs after the Paribas incident and the EU banking crisis. The EU banking crisis, and the US’s is still in progress, but can get much worse.

  • Eventual flight into gold as the best cash available

  • A world stock crash like we have never seen in our lifetimes, if central banks cannot stay ahead of things. I expect them not to- they barely staved off the latest problems that are still with us, and presently equity markets look weak, rising last week on low volume.

We at Prudent Squirrel have been talking about getting liquid for months. We anticipated the 3 big stop drops this year by up to two days for our subscribers in email alerts. You can view those alerts at the main page. Subscribers have said the alerts alone are worth subscribing for.  Our newsletter is about ten pages a week, with 44 issues a year published Sundays. The newsletter is financial and gold commentary.

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Christopher Laird



Chris Laird is not an investment advisor/professional. This article, and the PrudentSquirrel newsletter, is general market commentary only. It is not intended as specific advice. You should talk to your own investment professionals for specific advice.

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