The Big Bailouts: The Cure Could Kill The Patient

The unprecedented government intervention to save AIG rankles those of us who would prefer that the government refrain from intervention in the financial markets. Especially a government led by Republicans, who supposedly believe in free markets. But there is a good reason for the intervention: the size of AIG’s credit derivatives market is sixty-two trillion dollars, which exceeds the size of the entire world economy. Its failure would cause a domino effect of failures that would bring the world financial system to its knees. The infusion of $85 billion seems like a small price to pay to avert disaster.

And now Henry Paulson and Ben Bernanke want the government to shell out $700 billion to rescue the failing mortgage securities. Holy smoke!

Let’s assume for a moment that these interventions and others that may follow in the near future succeed in preventing a market collapse. The sight of the financial markets humming along with normal ups and downs would present a welcome relief to the precipitous drop that they took last week.

But should we all then breathe a sigh of relief? I’d say not. Even if the plan succeeds, the effects of the bailout on the monetary system will eventually come back to bite us in a serious way.

Consider this:

  • The multi-billioin dollar bailouts transfer ownership of the financial industry’s bad loans to the US taxpayer;
  • Since the government does not have the capital to finance this bailout, the Treasury Department will fund the transfer of private debt by issuing treasury bonds (in other words, taking on more debt);
  • The Federal Reserve will convert these obligations to dollars either by selling them to foreigners or through ‘monetization’ — i.e., by inventing the dollars out of thin air;
  • The net effect of this operation will be to erode the value of the dollar and effectively tax the US citizenry through inflation, or bring about a precipitous monetary collapse.

The net effect of these monetary machinations amounts to inflation. Governments that just print money willy-nilly to meet their debts (as happened to Weimar Germany in the 1920’s or, more recently, to Argentina in 1999) create hyperinflation. In the worst and most ludicrous scenarios, it takes wheel-barrows full of currency to buy a loaf of bread. In the end, the currency ends up having little more value than toilet paper as a medium of exchange. And as the example of Weimar Germany illustrates, the social and political effects of this kind of collapse can be horrific: it was this economic collapse that led to the rise of the Nazi party.

The value of the dollar has already fallen forty percent since the year 2000 when the Federal Reserve aggressively lowered interest rates to stimulate the economy in the wake of the tech bust and the economic effects of 9/11. Even without the mortgage bailout, the unending promises by politicians to reward voters with entitlements and pork barrel goodies ensure that the government will take on more debt and further erode the dollar. The current bailout only accelerates this process. When the dollar crisis strikes, it will make the value of dollar-denominated investments — especially passbook savings accounts and CDs — worthless. It might happen precipitously in a panic or it may happen over a period of time as it has been for the past eight years. It is the inevitable result of the government’s current course of profligate spending.

If the bailout plan does not succeed, and the financial system does collapse, it is theoretically possible a deflationary depression might happen. In that case, currencies or short-term bonds would be the best place to keep money because the value of everything (including the commodity hedges against inflation that I discuss below) would fall. Remember though that the only tool the government has to deal with financial crises is the monetary system. I believe with total confidence that all out market collapse would spur the government to print even more money than it proposes to print now.

Many of the authors whose articles you will find referenced below recommend buying commodities such as precious metals, land, oil, natural gas, and agricultural stocks. Such items maintain their value independent of the currency. When hyperinflation strikes, the price of these assets in dollars will rise, so that you to retain the purchasing value of your money. It is also possible that their relative value will increase as a result of their popularity when your next-door neighbor and brother-in-law understand what’s happening and start rushing to buy them. If you begin to accumulate these kinds of assets at a low cost (as you can now), you will even make a profit after inflation.

The complexity of navigating commodity investments can easily overwhelm the novice investor. They are not available in most 401k and state retirement programs. And their price volatility can give you quite a roller-coaster ride. In the past year, crude oil shot up to over $150 a barrel and then plummeted to under $100. A good deal of psychological preparation and technical understanding makes sense before plunging into this area.

I intend to elaborate on these topics in future articles. For now, I want to draw your attention to an easy and, in my view, sensible way to get into commodities: the purchase of silver coins. The cost of silver is denominated in the ‘spot price‘ per ounce. All forms of precious metals (specially minted one ounce coins or bullion bars) carry some premium over the spot-price. The least expensive silver coin is the pre-1965 US coins. Prior to 1965, dimes, quarters, half-dollars and dollar coins were made of 90% silver. When originally minted, a $1000 face-value bag of such coins contained 725 ounces of silver. Accounting for normal wear, such a bag today contains 715 ounces of silver. To know the silver content of such coins, you multiply their face value by 0.715. So three pre-1965 US quarters contain 0.53265 ounces of silver. At today’s spot price of silver, these three coins are worth $6.76. An advantage of these coins over the larger one-ounce silver coins or bullion bars is that when the currency collapses they can be used as a medium of exchange for small purchases.

You hear a lot about gold in the news, but silver represents a better value. Historically, when precious metals prices are high (like at the end of a bull market), the ratio of gold to silver is 1:16. That is, it takes 16 ounces of silver to purchase one ounce of gold. When the prices of precious metals are depressed, the ratio is more like 1:60. The price of silver, in other words, rises significantly faster than that of gold in a precious metals bull-market. Another way of looking at it is that silver relative to gold is much cheaper. And when the market is at its height, you can exchange your silver for gold and purchase significantly more gold than you could now.

There are many dealers of gold and silver The one with whom I am most familiar and trust is the The Money Changer. In times of ordinary uncertainty (times when a slow-burn on the value of the dollar is more likely than a precipitous collapse), I recommend that people start with small purchases of pre-1965 90% US silver coins in small quantities through the Money Changer’s monthly acquisition program. The advantage of this program is that you buy small amounts (as little as $100/mo.) at a commission level (about 3%) that would ordinarily require a purchase of thousands of dollars worth of silver. Think of it as a precious metals buying cooperative. If you can’t afford the minimum $100 a month, split the purchase two, three, or four ways with a group of people.

Since this is a time of extraordinary uncertainty (a collapse of the banking system or of the value of the dollar could happen rather immediately and precipitously), I recommend that you call Franklin Sanders immediately and purchase some amount of these coins. The amount you buy will depend on your means and on your level of concern about the current situation. You can then begin the process of regular purchases through the monthly acquisition program.

Some of you may have noticed that the price of gold, silver, and oil has recently undergone a dramatic drop in price. That’s ok because monetary inflation and shortages of energy supplies are part of a long term trend. By purchasing on a monthly basis, you apply the method of “dollar-cost-averaging” wherein the steady purchase of the item smoothes out the highs and lows of the market over time.

Finally, a few disclaimers. I am not a professional financial planner and have no credentials in this area. You should always review your long-term financial plan with a qualified financial planner. I recommend finding one who understands monetary inflation and peak oil. Also, I have no affiliation with or other reason to promote The Money Changer. Buy from someone else if you wish. My only purpose is to educate you about ways to protect your financial well-being in the face of the dark period of economic and social collapse that looms ahead of us in the next decade.

Suggested Reading:

AIG’s Dangerous Collapse: A Credit Derivatives Risk Primer, by Daniel R. Amerman
The Subprime Crisis Just Starting, by Daniel R. Amerman
A Day That Shall Live in Infamy, by Chris Martenson

© 2008 Philip Glaser


3 Responses to “The Big Bailouts: The Cure Could Kill The Patient”

  1. christianliberal Says:

    Good analysis, thanks!
    I just got this sinking, stinking feeling we are being robbed.

  2. BS Says:


    My greater worry is the heavily leveraged derivative market and all the other financial vehicles floating around out there that I don’t really understand. Add to the the national debt sitting in the hands of the Chinese and the huge amount of leveraged debt held by typical Americans in the form of home loans, school loans, auto loans and credit card loans. I’m not suggesting that you, Phil, are incorrect, but I am worried that we may be under-estimating the size of the problem.

    On the other hand, I wonder if all that paper debt in form of derivatives is relatively meaningless. At the base of all of that are these mortgages that were bundled and resold, and resold again. By buying up these bundles, the US Government is attempting to say to banks that we can absorb a small percentage of defaults, and make people believe that the things their money is invested in are relatively safe. And so this is an attempt to prop the dominoes back up by creating a basis of positive psychology that then trickles back up to the bankers making them want to lend which gets the economy back on it’s feet. Later we can create regulations that will solve the other big problems laying in wait.

    Is there an error in my analysis or is the error Paulson’s and Bernake’s? If their action helps in the short term, what do you think their next steps should be?


  3. Philip Glaser Says:

    Hi Bill,

    You describe the precarious situation of our economy quite well. Economic booms and busts are defined by the availability of credit. In the typical cycle, the central bank makes credit more available by reducing the price of money (i.e., ‘interest’). The availability of credit puts more money into the system. The increased velocity of money raises the prices of assets. Deluded by the high prices into thinking they are wealthy, people take on more and more debt. Eventually the bubble starts to burst and as more and more loans default, credit gets tighter, asset prices fall further, causing more defaults, in a downward spiral.

    “Prop the dominoes back up” to prevent a downward spiral is indeed what Bernanke and Paulson are attempting to do. Bernanke’s academic writings promote the idea that if the Fed has been more aggressive in putting “liquidity” into the credit market after 1929, the Great Depression could have been averted. It’s a theory that’s never been tested, but it’s about to be. It may succeed in preventing a major deflation of assets in the short term and give the appearance of things being ok. Whether or not the time thus borrowed serves the formulation of a solution to the problem is anyone’s guess.

    The reason that I suggest using precious metals to mitigate the risk of loss is because even if they succeed in the short term these policies are leading to hyperinflation. I will discuss the mechanics of hyperinflation in a future article.

    I recommend listening to Jim Puplava’s interview with Doug Nolan this weekend ( They discuss the credit crisis and what needs to be done in the future to put our economy on sound footing.

    Thanks for being in touch.

    From The Tower,


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