When currencies do not serve as a long-term store of value, economic actors search for ways to preserve future purchasing power, which often mean purchasing commodities. But most commodities are not cheaply storable over long periods, so actors get forced into the few that do: gold, silver, etc. There is a problem here, stemming from dumb money. When dumb money shows up for purchase of generic “commodities” distortions follow: backwardation, large storage demand, and warped market incentives.
Eventually overproduction catches up, but the volatility when it breaks can be huge and self-reinforcing, with c0unterparties raising margin to protect themselves.? Extreme volatility causes exchanges to raise margin requirements substantially, which reveals which side of the trade is inadequately financed, which typically is the side that was winning, which leads to a reversal in price action.? The dumb money is revealed.
Now after a washout, the dumb money often assumes that powerful entrenched interests colluded against them to deny them their long-deserved free ride to prosperity through speculation.? The exchanges are in cahoots with the other side.? Well, no, the exchanges have two interests, which are solvency and transaction volume, which drives their profits.? Solvency is a more primary goal for an exchange, because the second goal can’t exist without it, and exchanges are not thickly capitalized.
Many different types of financial systems are subject to these risks.? Think of AIG: they were rendered insolvent by rising margin requirements as their creditworthiness was downgraded, largely because the rating agencies concluded they were going to lose a lot of money off of their many bets on subprime residential credit.? Think of all of the mortgage REITs that got killed as repo haircuts rose on all manner of mortgage-backed securities at the time that values for the securities were depressed.? Alternatively, think of Buffett, who entered into derivative trades where he received money and bore the risk, but his agreements limited the margin that he would have to post.
Commodity-linked exchange traded products serve four functions:
- Allow sponsoring financial institutions to get cheap financing through exchange traded notes.
- Allow sponsoring financial institutions to inexpensively hedge their commodity risks.
- Allow commodity producers to have cheap financing of their inventories via backwardation.? (And indirectly allow more clever speculators to earn extra profits from gaming the rolling of futures contracts.)
- Allow retail speculators who cannot access the futures market to make or lose money.? Scratch? that, that should probably read “lose money in aggregate.”
Wall Street does not exist to do small investors/speculators a favor.? It exists to make money off of the issuance of securities, and their trading in secondary markets.
As Buffett put it, “What the wise man does in the beginning, the fool does in the end.”? Yes, there is monetary debasement going on.? We should expect gold, crude oil, and other commodity prices to rise to reflect that.? But rises can overshoot, particularly in smaller markets like gasoline and silver.
So in answer to the question, “Which came first ? the margin call or the commodities mayhem?” my answer is simple: The cause of the bust is found in the boom, not in the bust.? The boom happened because of loose monetary policy, which led many people to adjust their risk posture up, whether in commodity speculation, or in high yield debts.? (Oh wait, there are ETFs for that now too.)? Eventually self-reinforcing booms have self-reinforcing busts.? The elites think they can tame this, but they can’t, because you can’t change human nature, which means you can’t change the boom-bust cycle.
James Grant, at a recent meeting of the Baltimore CFA Society said that we had exchanged a “gold standard” for “Ph. D. economist standard.”? And indeed, the value of our currency is manipulated by that intellectual monoculture at the Fed, who pass Einstein’s test of insanity: doing the same thing over and over again and expecting different results.? I say that because the Fed thinks that it can produce prosperity by reducing interest rates.? All that their policy does is produce an asset bubble, or price inflation in goods and services.
The Fed drove us into this liquidity trap through increasing application of an easy money policy.? It will take different ideas and different people, and a lot of pain to get us out, because the Fed is blinded by their bankrupt theories.
David — I want to throw a question out for you that is both a finance question and an ethics / morals question:
If people who’s mortgages are underwater and/or in default are not required to pay rent / mortgage — then why should the rest of us have to pay?
This isn’t just game theory, this is real life. Can the banks / GSEs absorb the massive losses if they are forced to realize (from an accounting standpoint) the losses on non performing loans?
On the other hand, if delinquent mortgagees are allowed to continue living rent free for an “indefinite future” (Bernanke’s lie) — then why do the rest of us have to pay?
Why do “responsible” home owners have to pay property taxes, when we know the delinquent borrowers are not? What happens to municipal debt once Joe Taxpayer realizes he is being played for a sucker while others live rent / tax free?
So gold will go bust when/if retail investors that are over-leveraged, or speculators that are taking too much risk, end up losing enough to require margin calls.
For silver, the collateral change was a clear cause, but, for gold for instance, how would one gauge where that point is? Is there market data somewhere that can tell you how much leverage exist in the market?
@ Greg –
It’s not that the people WHOSE (not “who’s”) mortgages are underwater “are not required to pay”. They are “required” to pay under the same contractual obligations as those who do pay their mortgages.
They are simply choosing to break this contract. This does not go without consequences. It just so happens that those consequences may be outweighed by the benefits, especially if the holder of their mortgage is found to have mangled the legal conveyance of their mortgage note / deed of trust.
@wsm – Thank you for the grammar lesson, but even more thank you for the ambulance chaser answer you gave instead of addressing the actual question.
If there are no consequences to breaking a contract (or if the benefits outweigh the consequences) — then WHY SHOULDN’T EVERYONE BREAK OUR CONTRACTS?
Enforcing contracts is the only reason to have a legal system. Fire all the police. Shut down the SEC. Shut down the Fed. Shut down the FBI. And God help us, get rid of these miserable attorneys who insist on debating what the meaning of “is” is (and WHOSE) instead of enforcing written law.
If we had an honest regulator anywhere in Washington, we could seize the houses of people who are not paying — put them in public housing if needed — and then level the delinquent houses (aka eliminate excessive inventory that arguably should never have been built)
Instead, the regulators lower interest rates and build MORE houses. Instead we raise property taxes on the stupid suckers that are dumb enough to keep paying. In short, we do everything in our power to shoot ourselves and our neighbors in the foot.
The question asked was, and still is: if some people don’t have to pay their mortgage / property taxes, why should anyone? There are no consequences either way
@ Greg –
To insist that there are “no consequences” is simply false. I’m sure I don’t need to link to any of the millions of articles profiling the massive headaches experienced by former homeowners being foreclosed upon – not to mention the obliteration of one’s credit.
And if you take a step back, the very fact that the vast majority of homeowners actually do pay their mortgage implies that there must by some motivation to do so. It seems irrefutable that consequences for failure to pay must have something to do with this.
@wsm –
Being kicked out of a home you didn’t pay for is a deserved consequence, not suffering or headache. These people are not “victims”, they are persons who, on their own volition, took on too much risk.
By and large though, most delinquent home squatters have *NOT* been foreclosed on yet, as the banks don’t want to recognize the losses.
Reduced access to credit is not a “consequence”. Many people with “perfect” credit histories cannot get access to credit either.
Banks prefer to borrow from taxpayers (via the Fed) at essentially zero percent, then lend it back to taxpayers at the 10yr Treasury rate (avg duration) … capturing 300bp for doing absolutely nothing at all.
Banks, despite assurances from TurboTax Geithner, are mostly insolvent and cannot afford to lend money even if a consumer has perfect credit.
Losing access to a non-functioning credit system is hardly a consequence.
As for the rest of us “suckers” that continue to pay our mortgages… most people have an inner sense of fairness (we know we really do owe the money, even if some inept lawyer didn’t file the right paperwork). We also know that, if everyone acted like Geithner and the deadbeat home squatters, western society would collapse.
The question is still on the table: WHY SHOULD ANYONE KEEP PAYING MORTGAGES AND PROPERTY TAXES WHEN 30% OF THE COUNTRY DOESN’T HAVE TO???
@ old Greg –
“Being kicked out of a home you didn?t pay for is a deserved consequence…”
Thank you for at least acknowledging that it is a consequence (and yes, it is deserved; but deserving or not was not part of this discussion and is irrelevant). This completely contradicts your previous postings that there are “no consequences”.
“Reduced access to credit is not a consequence…”
Then what is it, if not a consequence?
“most people have an inner sense of fairness…”
If that is your argument for why most people pay their mortgages, that’s fine. Obviously, I strongly disagree that that is the main reason, and look forward to David weighing in.
@old wsm –
being kicked out of a home **WOULD BE** a consequence, if it were to occur. Instead, we have ambulance chasers making stupid arguments about whether some paperwork was filed properly. No one disputes the home squatter took the loan and used it to speculate on the house; only that some bureaucratic formality wasn’t met. Hardly a reason to shirk responsibility to pay.
?Reduced access to credit is not a consequence?? You need reading comprehension lessons WSM. Everyone is getting reduced access to credit, not just the deadbeats who should get cut off.
I still say most people have an inner sense of fairness, and that is why most of us pay into the system in spite of many flaws. But we are being played for suckers by a corrupt political class and a lot of deadbeats.
And the question remains: why should we keep propping up Geithner’s scam?
@ Ol’ Greg –
So to summarize your arguments:
Upholding the rule of law amounts to “making stupid arguments”.
Reduced access to credit resulting from these defaults is not considered a consequence, simply because it applies to everyone.
Most people pay thousands of dollars “into the system” mostly due to their “sense of inner fairness”.
It seems that no further argument is necessary – these points stand on their own as sufficiently ridiculous.