How BullionVault Sees the Credit Crunch

By Paul Tustain
03 October 2008

It's been a few months since I wrote. Here are some thoughts on the credit crunch, and an important bit about our own banking arrangements here at BullionVault.


The Crunch

Britain's Prime Minister, Gordon Brown, says the current mess is the fault of "irresponsible" bankers. Well, he would say that, wouldn't he?

Let's not forget that Mr.Brown claimed the credit for 10 years of unbroken growth. For those 10 years he copied Alan Greenspan by holding interest rates unusually low to encourage investment and demand, which is a near-sighted economist's way of avoiding mild recessions.

But this low interest rate medicine stimulates both the supply and the demand for those products which Mr.Brown now blames bankers for promoting. It leads directly to a world of crazy finance, because low rates punish caution.

In a time of state-sponsored easy credit all projects get financed by incautious banks with cheap, centrally supplied money. There is no market for cautiously lent money, priced correctly for the risk involved. Why would anyone pay more for funds from a cautious bank when cheaper funds from an easier source are available?

This is why the profits of incautious banks grew, and why their stock prices multiplied.

Meanwhile careful bankers sunk. As Brown (and Greenspan) injected ever more money into the economy the cautious banks began to lose their customers, their managers, their share values, and their independence. This Darwinian extinction of caution is the direct result of a monetary environment which was hostile to cautious bankers; one which favoured those banks with an appetite for cheap money.

So be in no doubt about the cause of the credit crunch. It was too much cut-price credit, and the blame for the supply of it rests squarely on the likes of Gordon Brown and Alan Greenspan.

Let's hear no more from Gordon about anyone else's "irresponsibility".


What's next?
So much for the blame. What now? It seems almost everyone - from both the right and the left of the political spectrum - agrees that we need more government intervention in the form of bailouts and increasing regulation.

Yet once we have grasped that the underlying cause of the disaster was credit creation by governments themselves we should perhaps be a bit wary of putting them ever more in charge. Governments operate a cheap credit policy in order to defer pain, stay popular, and get re-elected. The US bank rescue is intended to create and promote a higher volume of cheaper and easier credit than the market really wants. Hmmm. They want more of the wretched stuff which got us here in the first place. Is that really so wise?

If we allow governments to control finance through regulation we give them extraordinary power over the direction of the economy, because they can (and will) deny finance to some projects and grant it to other, more politically appropriate ones. They have repeatedly shown themselves to be much worse than our imperfect marketplace at handling the power of economic direction, both in this case, where their efforts at economic stimulation are the root cause of the fiasco, as well as in recent history - particularly with communism.

This proposed bailout, and its associated higher regulation, pushes us further towards the socialized 'command' economy, which is bad. There is a better way rapidly to re-configure our economies in the right way. More than ever we need to trust the market. Let interest rates rise (without government interference) and allow the market to kill off those institutions whose functioning depends on limitless supplies of cheap credit.

Yes - there would be pain, but it would right a long list of wrongs. It would make houses affordable for younger working people. It would make saving worthwhile again. It would make borrowing less attractive. It would increase the use of equity in the financing of enterprises, and significantly decrease their use of debt, making all of them much safer in future downturns. All of these moves in the right direction are the moves which yet another dose of rescue money will certainly suppress. Sadly this won't be understood by our politicians, so we will get our patched-up bailout - and lots more regulation with it.

Did you notice that while the America, the UK, the Netherlands and Australia were banning short selling, the Chinese were relaxing restrictions on it? This is enormously telling. Asians - suppressed by the command economy for decades - aspire to a world of free enterprise. Unlike us they are now prepared to accept the costly consequences of the errors which the free enterprise system lets people make. When we finally wake up under the yoke of our new government regulator we will have lost the privilege of benefiting from free and highly profitable financial centres. It's the turn of Hong Kong, Mumbai, Shanghai, and Singapore. Oh well - it was nice while it lasted.


And Gold?

I now move to gold, and an avowedly selfish point of view. I think it is almost certain that the proposed bailout will be good for me personally, because it will be good news for BullionVault. That's because I believe we will be avoiding the pain of a sharp correction. Instead we will get many years of miserable underperformance in shares, bonds and deposits.

With no bailout, gold would probably rocket. Within a few months it would have fully appreciated and it would be time to exit gold and start buying bombed-out productive assets. The speed of such an ascent in gold prices would be highly profitable for gold owners - including me - but it would probably prevent BullionVault from aggregating more than a few thousand new customers, and my personal ambitions for BullionVault would never be met.

Instead, with a bailout, I anticipate some temporary relief and then a long, slow, miserable slide in mainstream investment performance, accompanied by a steady rise in gold. Every month of it will cause a few thousand more people to join BullionVault.

So - entirely hypocritically - I believe one outcome is required, yet hope for another!