We keep hearing about how the banks are writing off larges amount of of the structured investment vehicles underlying their balance sheets. Meryl Lynch is going to write off up to 15 billion dollars. Countrywide (er Bank of America?) is going to write off a few billion.
In a Fractional Reserve banking system, when the banks have losses does that reduce the overall amount of currency? Are they writing off losses against the 10% in reserve or the 90% fractional reserve amplification that is created by re-loaning the money under current US banking practices.
Let's do quick calculation with the two bank groups that have decided to announce their writeoffs. Merrily Lynch is going to write off $16.6 billion dollars. The fractional "amplification" of this would be a write off of $149.4 billion dollars of currency available to use. Citigroup is writing off 15 billion dollars. This is the equilivent of taking 135 billion out of the credit markets.
This is a total of 284.4 billion dollars being removed from the fraction reserve currency/credit market.
Amazingly, this is 82% of the amount dropped into the banking system last August by Bernanke and the other central bankers. In the August timeframe, the Federal Reserve and other central banks unloaded 350 billion in liquidity into the markets over a few short days. The other banks haven't reported yet, I believe it's due this week.
What does this mean? I think we are heading towards deflation (ala 29-33) as banking losses remove available capital from the system. This may also explain the tight credit markets that are not responding to stimulus. Watch It's a Wonderful Life to understand this impact.
If more major banks announce these huge write offs, I'm going to change my recently changed opinion on Gold. The fractional impact of this amount of money being removed from the system will cause the currency to deflate at a rapid value. Right now, the problem is tied up in the credit markets, but when it gets out (through the constriction of the credit market), we are going to see the gold drop.
Those of you who read and listen to my Back of the Envelope analysis know I prefer long term stored food over gold for reasons outlined in other blog postings.
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Here are the links I used to form my commentary.
http://online.wsj.com/article/SB120007661256784249.html?mod=googlenews_wsj
http://seekingalpha.com/article/60005-book-value-can-be-deceiving-for-financials?source=side_bar_editors_picks
http://www.guardian.co.uk/feedarticle?id=7217122
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1 comments:
First, what exactly does it mean when a bank "writes off" the SIV? Is the money really taken out of the system? Sorry if this is a dumb question, but I really don't know.
I understand what you are saying John, but this is very counter-intuitive to me. Assuming your rough estimates are accurate and 82% of Augusts injected amount was written off, 18% remains and thus the money supply is still greater than what it previously was. That's not even considering the following (and probably upcoming) rate-cuts that increase the money supply via credit expansion. Therefore, inflation.
At one point, you seemed to be thinking of a hyper-inflation scenario. Now it seems you have convinced yourself otherwise.
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