It’s Time To Hoard Some Cash

In constructing an intelligible picture of the unfolding global banking crisis, I came across a useful piece by Axel Merk, whose voice I have come to appreciate hearing on the Financial Sense Newshour. Aside from his typically clear (if rather technical) explanation of events, Axel suggests hoarding some cash along with precious metals. Notwithstanding the U.S. Dollar’s future as toilet paper, current events make me inclined to agree with this suggestion.

We need to understand the gravity of what might happen to our banking system.

In my discussion of counterparty risk last week, I touched upon the technical workings of the fractional reserve banking system. You tend to think of a bank as an institution that keeps your money safe and rewards you with interest.  A more useful description takes into account that the interest constitutes your share in the bank’s profit from lending your money. Really, the bank functions as a broker that lets you lend your money out to counterparties.

All of this works just fine as long as:

  1. You and the other depositors in the bank agree not to demand all your money all at once (remember, the bank’s borrower’s hold 90% of the bank’s assets); and
  2. The counterparties to whom the bank lent your money make payments on the money you lent them reliably until they pay the bank back.

In other words, the financial health of a bank depends upon the reliability of the creditors whose loans make up the lion’s share of the bank’s balance sheet. For this scheme to have integrity, the bank must be able to count the money owed to it as a viable asset. The credit crisis now in progress stems from point 2 above: The counterparties to a massive amount of debt cannot make their loan payments.  As creditors fail, the banks’ balance sheets look more and more precarious. Sub-prime mortgage holders make up the bulk of today’s failed counterparties. But the amount of this debt pales in comparison to the mountain of credit default swap “assets” that will fail as the recession deepens.

To avoid putting themselves deeper in the hole, banks have stopped lending. In our credit-driven economy, Axel Merk points out, many otherwise sound businesses depend heavily on short-term loans known as commercial paper in order to run their businesses. Unless the credit starts flowing through the system again, many companies risk going out of business. A wave of such failures could cause a downward spiral into a depression.

This past week, the central banks of the US and Europe lowered interest rates to make it easier for their member banks to get access to cash. The central banks want their member banks to use the inexpensive cash to compensate for the failing debt in their balance sheets. But the banks, rationally, have not taken up the central banks on their offer: Taking on more debt just makes their position more precarious.

In the solutions now being undertaken, the treasury departments of the United States and Europe would recapitalize the banks directly: rather than lend money to the banks, they would give them the money in return for an ownership stake.

This nationalization of US and European banks has a nauseating and unavoidable ring of socialism. Having grown up with the world’s two superpowers threatening to anihilate each other over a disagreement about distribution of wealth, I find this development hard to swallow. But preventing a cataclysmic failure of the banking system has to take precedence over ideology, for the moment. The global financial system has been breaking for a long time, but you don’t rearrange the deck chairs when the ship is sinking.

No one can predict the outcome of this crisis. But the risk of systemic bank failure should not be ignored. In the long term, the hyperinflation resulting from the governments’ attempt to save the system or to revivie it after it crashes will make precious metals the most reliable safe haven. But hyperinflation has not yet arrived, and an immediate and systemic bank failure would make it difficult to get your hands on plain old cash to buy basic necessities.

So, as Axel suggests, it’s a good idea to go to your local bank and get some dead presidents. Bury them under the proverbial matress or, preferably, in a more original hiding place. It would also be wise to stockpile some canned food and bottled water.

I apologize for sounding apocalyptic. But this is serious business. I’d rather act a little panicky now than end up unable to feed my family. I hope that in a few weeks you can justifiably accuse me of being a drama queen today. I’d prefer that embarassment to the outcomes that seem a bit too plausible at the moment.

© 2008 Philip Glaser

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4 Responses to “It’s Time To Hoard Some Cash”

  1. Valorie Says:

    Thanks, Phil, for this interesting material.

    I have to say I’m wary about stockpiling because it can distract us from what I see as a more central need – to work cooperatively with our loved ones for mutual support. Sure, we might be able to salvage our own savings, but if everyone else we know is homeless and hungry, who wants to live in a world like that?

    My suggestion would be that anyone thinking of stockpiling put together at least DOUBLE what they think their family would need, and then think about with whom they would share that money or those material things if push came to shove. For example, I doubt that most of us would let our young niece go hungry, or our best friend, or our next-door neighbor, if we still had food.

    The next step would be to reach out to those loved ones right now, and plan together what we’d do if hard times strike us – and even if things turn out to be not so bad as we might fear. As I see it, cooperation and helpfulness will be a winning strategy in any case.

    With good wishes for all of us, because we really are all in this together,
    Valorie

  2. Crystal Says:

    Personally, I’m investing my “dead presidents” in things that I can use or trade, such as coffee, rice, beans, and cans of pineapple chunks. If we don’t end up having to trade, well, I’ve only bought a whole bunch of food in advance.

    I’m not an economist, but I suppose that buying things, rather than hoarding cash, probably helps lubricate the economy somehow.

    BTW, I’m a bit skeptical of some of the doom and gloom about people not being able to get car loans and such. I just got approved for new credit despite my student status and all the people I know who have recently needed to get cars have gotten loans, even if they had to apply to 4 different banks, where before the first bank might have said yes. So, I wonder how many prospective car buyers are staying home because they’ve heard they can’t get a loan anyway.

    THIS seems like the right time for Bush to come out and say “Let’s go shopping!” But of course he hasn’t …

    Best wishes,

    Crystal

  3. Crystal Says:

    Oh, I forgot to mention a few things:

    1. After more than 3 years of trying to get people in my local area (including my family) to take this kind of disaster seriously, we finally have a small group together. It’s a subset of folks we’ve been seeing at potluck dinners and the first meeting is coming up in 2 weeks! (It’s maddeningly slow, but it is progress, I guess …)

    2. The supplies that I’ve been gathering include an assumption of many more mouths to feed than are currently in our household, since friends and family who pooh-poohed us before are likely to come knocking.

    3. Remember the native american prophecy “only then will you discover you cannot eat money”?

    4. Perhaps all the time I’ve spent obsessing over how people managed to survive the Holocaust will pay off in some fashion.

  4. Philip Glaser Says:

    Hi Valorie and Crystal,

    These are excellent points. I have been planning for a while to talk more about both the need for physically held commodities and strengthening our relationships to prepare for an uncertain future. Preserving the exchange value of money is just one piece of the whole picture. Increased reliance on family and community, and on down-to-earth core survival needs, is one of the potential benefits of hard times.

    The one thing I would point out is that when things get bad, while stockpiles of food and other necessities are vital, you will _still_ need to have some store of value and a medium of exchange for those parts of society that still function on money exchange as opposed to barter. I’ll say more about this in my next entry.

    Thank you for your comments.

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