By Peter Schiff
More than just a mere liquidity or credit crisis, the current financial storm represents the death throes of the old global economic order, and perhaps the birth pains of a new one. The sun is setting on the borrow and spend culture that has all but defined us for a generation. Our long ride on the global gravy train is finally coming to an end, and once it does nothing will be the same. The sooner we come to grips with this the better.

Despite the myriad of proposals that are coming from Washington and other world capitals, we must understand that this crisis cannot be cured by governments. In the United States, credit is gone because savings are gone. Our shallow pool of savings has been depleted through bad loans, and we can no longer entice foreigners into lending us their available savings. Given that we are already too loaded up on existing debt that we cannot realistically repay, who can blame them for not wanting to lend us more?

As a result, the free market is trying to put an end to our spending spree. Without savings or home equity to fall back on, Americans struggling with rising prices are finally being forced to curtail their spending. This has terrified our leaders and is causing them to dismantle the remaining structure of our free enterprise-based economic system.

The intention of all these daily federal interventions is to keep the credit spigots open so Americans can go even deeper into debt to buy more stuff they can’t actually afford. This should be clear enough to anyone who listens to what our leaders are actually saying. When speaking about the need for an even larger fiscal stimulus package, Barney Frank, chairman of the House Financial Services Committee, said, “We have to prop up consumption.” He has it backwards. The government has been propping up consumption for far too long, and the best thing they can do now is remove the props so spending can be replaced by savings.

The sad reality is that we borrowed and spent our way into this crisis, and we are not going to borrow and spend our way out of it. Legitimate credit can only be supplied if there are genuine savings to finance it. Savings can’t be magically concocted into existence by a printing press, but can only be created by consumers who spend less than they earn. Efforts to fool the market will not work and will ultimately lead to a monetary disaster and runaway inflation.

Were the government to allow market forces to work, Americans would now have to pay cash for their consumption. That would mean no instant credit for new cars, plasma TVs, appliances, consumer electronics, clothing, furniture, etc. Unless buyers actually had the cash in their checking accounts these purchases would have to be deferred. From an economic perspective this is precisely what the doctor ordered. But for an economy based 72 percent on consumer spending, the medicine will go down hard.

Ultimately, a serious reduction in consumer and mortgage credit, combined with an increase in personal savings, would again provide a pool of needed capital for businesses to produce products and provide employment opportunities. However, the danger is that this potential credit could be completely crowded out by massive borrowing by the Federal Government. In addition, prices for such things as houses and college tuition will fall sharply, as the credit artificially propping them up disappears. People would still be able to buy houses and send their kids to college only they would pay much lower prices when they do.

However, if the government keeps creating inflation to artificially sustain consumer borrowing and spending, there will be no savings left to fund anything and prices will be so high that despite massive consumer spending there will be few goods that Americans could actually afford to buy.

By F. William Engdahl.

He is author of the book, A Century of War: Anglo-American Oil Politics and the New World Order

What’s clear from the behavior of European financial markets over the past two weeks is that the dramatic stories of financial meltdown and panic are deliberately being used by certain influential factions in and outside the EU to shape the future face of global banking in the wake of the US sub-prime and Asset-Backed Security (ABS) debacle. The most interesting development in recent days has been the unified and strong position of the German Chancellor, Finance Minister, Bundesbank and coalition Government, all opposing an American-style EU Superfund bank bailout. Meanwhile Treasury Secretary Henry Paulson pursues his Crony Capitalism to the detriment of the nation and benefit of his cronies in the financial world. It’s an explosive cocktail that need not have been.

Stock market falls of 7 to 10% a day make for dramatic news headlines and serve to foster a broad sense of unease bordering on panic among ordinary citizens. The events of the last two weeks among EU banks since the dramatic state rescues of Hypo Real Estate, Dexia and Fortis banks, and the announcement by UK Chancellor of the Exchequer, Alistair Darling of a radical shift in policy in dealing with troubled UK banks, have begun to reveal the outline of a distinctly different European response to what in effect is a crisis ‘Made in USA.’

There is serious ground to believe that US Goldman Sachs ex CEO Henry Paulson, as Treasury Secretary, is not stupid. There is also serious ground to believe that he is actually moving according to a well-thought-out long-term strategy. Events as they are now unfolding in the EU tend to confirm that. As one senior European banker put it to me in private discussion, ‘There is an all-out war going on between the United States and the EU to define the future face of European banking.’

In this banker’s view, the ongoing attempt of Italian Prime Minister Silvio Berlusconi and France’s Nicholas Sarkosy to get an EU common ‘fund’, with perhaps upwards of $300 billion to rescue troubled banks, would de facto play directly into Paulson and the US establishment’s long-term strategy, by in effect weakening the banks and repaying US-originated Asset Backed Securities held by EU banks.

Using panic to centralize power

As I document in my forthcoming book, Power of Money: The Rise and Decline of the American Century, in every major US financial panic since at least the Panic of 1835, the titans of Wall Street—most especially until 1929, the House of JP Morgan—have deliberately triggered bank panics behind the scenes in order to consolidate their grip on US banking. The private banks used the panics to control Washington policy including the exact definition of the private ownership of the new Federal Reserve in 1913, and to consolidate their control over industry such as US Steel, Caterpillar, Westinghouse and the like. They are, in short, old hands at such financial warfare to increase their power.

Now they must do something similar on a global scale to be able to continue to dominate global finance, the heart of the power of the American Century.

That process of using panics to centralize their private power created an extremely powerful, concentration of financial and economic power in a few private hands, the same hands which created the influential US foreign policy think-tank, the New York Council on Foreign Relations in 1919 to guide the ascent of the American Century, as Time founder Henry Luce called it in a pivotal 1941 essay.

It’s becoming increasingly obvious that people like Henry Paulson, who by the way was one of the most aggressive practitioners of the ABS revolution on Wall Street before becoming Treasury Secretary, are operating on motives beyond their over-proportional sense of greed. Paulson’s own background is interesting in that context. Back in the early 1970’s Paulson started his career working for a rather notorious man named John Erlichman, Nixon’s ruthless adviser who created the Plumbers’ Unit during the Watergate era to silence opponents of the President, and was left by Nixon to ‘twist in the wind’ for it in prison.

Paulson seems to have learned from his White House mentor. As co-chairman of Goldman Sachs according to a New York Times account, in 1998 he forced out his co-chairman, Jon Corzine ‘in what amounted to a coup’ according to the Times.

Paulson, and his friends at Citigroup and JP Morgan Chase, had a strategy it is becoming clear, as did the Godfather of Asset Backed Securitization and deregulated banking, former Fed Chairman Alan Greenspan, as I have detailed in my earlier series here, Financial Tsunami, Parts I-V.

Knowing that at a certain juncture the pyramid of trillions of dollars of dubious sub-prime and other high risk home mortgage-based securities would come falling down, they apparently determined to spread the so-called ‘toxic waste’ ABS securities as globally as possible, in order to seduce the big global banks of the world, most especially of the EU, into their honey trap.

They had help. In recent testimony under oath by Eric Dinallo, the Superintendent of the New York Insurance Department at the AIG Bailout Oversight Hearing, into the AIG rescue by Paulson, Dinallo testified that funding cutbacks in recent years directed by the Bush-Cheney Administration had reduced the responsible department that should regulate or watch over the $80 trillions in Asset Backed Securities (ABS), which included the toxic sub-prime and Alt-A mortgage securities and much more. The Bush Administration took the staff from more than one hundred people down to one---yes that was not a typo. One as in ‘uno.’

Was that just ideological budget cutting fervor, or was it deliberate? Was former Goldman Sachs man, the man who convinced the President to hire Paulson, Bush’s former Director of the Office of Management and Budget (OMB), Joshua Bolten, now the President’s Chief of Staff, responsible for insuring there was no effective government oversight on the exploding securitization of mortgage assets?

These are perhaps some questions which the good Congressmen ought to be asking people like Henry Paulson and Josh Bolten, and not such red herring questions as how large Richard Fuld’s bonus pay at Lehman was. Are Mr Bolten’s fingerprints on the corpse here? And why is no one questioning the role of Paulson as CEO of Goldman Sachs, then the most aggressive promoter of exotic and other Asset Backed Securitization products on Wall Street?

It now would appear that the Paulson strategy was to use a crisis—a crisis that was pre-programmed and predictable as far back as 2003 when Josh Bolten became head of OMB—when it exploded, to panic the more conservative European Union governments into rushing to the rescue of US toxic waste assets.

Were that to have happened, it would in the process destroy what was left of sound EU banking and financial institutions, bringing the world one step closer to a global money market controlled by Paulson’s cronies—US-style Crony Capitalism. Crony Capitalism is certainly appropriate here. Paulson’s predecessor at both Goldman Sachs and at Treasury, Robert Rubin, liked to accuse the Asian bankers of Thailand, Indonesia and other lands hit with the speculative attacks of US-financed hedge funds in 1997 of ‘crony capitalism,’ leaving the impression the crisis was home grown in Asia and not the result of a deliberate executed attack by US-financed financial institutions to eliminate the Asia Tiger model among other goals, and turn Asia into the funder of US debt.

Interesting to note is that Rubin is now a Director of Citigroup, obviously one of Paulson’s crony bank ‘survivors,’ and the bank which to date has had to write off the largest sum in toxic waste securitized assets.

If the allegation of pre-planned panic, a la the Panic of 1907 is accurate, and it is a big if, then the plan worked…up to a point. That point came over the weekend of October 3, coincidentally the national unification holiday of Germany.

Germany breaks with US model

In closed door talks well into the evening of Sunday October 5, Alex Weber the hard-nosed head of the Bundesbank, BaFin head Jochen Sanio and representatives of the Berlin coalition Government of Chancellor Merkel came up with a rescue package for Hypo Real Estate of a nominal €50 billion. However, behind the dramatic headline number, as Weber pointed out in a September 29 letter to Finance Minister Peer Steinbrück that has been made public, not only did the private German banks have to come up with 60% of that figure, the state with 40%. But also, given the careful manner in which the Government in cooperation with the Bundesbank and BaFin, structured the rescue credit agreement, the maximum possible loss, in a worst case scenario, to the state would be limited to €5.7 billion, not €30 billion as many believed. It’s still real money but not the blank check for $700 billion that a US Congress under duress and a few days of falling stock market prices agreed to give Paulson.

The swift action by Finance Minister Steinbrück to fire the head of HRE, in stark contrast to Wall Street where the same criminal fraudsters remain at their desks reaping huge bonuses, indicates as well a different approach. But that does not cut to the heart of the issue. The situation of HRE arose as noted previously, from excesses in a wholly-owned daughter bank of HRE subsidiary DEPFA in Ireland, an EU country known for its liberal loose regulation and low tax regime.

A British policy shift

In the UK, after the costly and foolish bailout of Northern Rock earlier in the year, the Government of Prime Minister Gordon Brown has just announced a dramatic change in policy in the direction of Germany’s position. Britain's banks will get an unprecedented 50 billion-pound (€64 billion) government lifeline and emergency loans from the Bank of England.

The government will buy preference shares from Royal Bank of Scotland Group Plc, Barclays Plc and at least six other banks, and provide about 250 billion pounds of loan guarantees to refinance debt, the Treasury said. The Bank of England will make at least 200 billion pounds available. The plan doesn't specify how much each bank will get.

That means the UK Government will at least partially nationalize its most important international banks, rather than buy their bad loans as under the unworkable Paulson plan. Under such an approach, costs to UK taxpayers once the crisis abates and business returns to more normal conditions, the Government can sell the state shares back to a healthy bank at perhaps a nice profit to the Treasury. The Brown Government has apparently realized that the blanket guarantees it gave to Northern Rock and Bradford & Bingley merely opened the floodgates of government costs without changing the problem.

The new nationalization policy is a dramatic contrast to the Paulson ideological ‘free market’ approach of buying the worthless bonds held by the select banks Paulson chooses to save, rather than recapitalize those banks to allow them to continue to function.

The battle lines drawn

What has emerged are the outlines of two opposite approaches to the unfolding crisis. The Paulson plan is now clearly part of a project to create three colossal global financial giants—Citigroup, JP MorganChase and, of course, Paulson’s own Goldman Sachs, now conveniently enough a bank. Having successfully used fear and panic to wrestle a $700 billion bailout from the US taxpayers, now the big three will try to use their unprecedented muscle to ravage European banks in the years ahead. So long as the world’s largest financial credit rating agencies—Moody’s and Standard & Poors—are untouched by the scandals and Congressional hearings, the reorganized US financial power of Goldman Sachs, Citigroup and JP Morgan Chase could potentially regroup and advance their global agenda over the coming several years, walking over the ashes of a bankrupt American economy made bankrupt by their follies.

By agreeing on a strategy of nationalizing what EU finance ministers deem are ‘EU banks too systemically strategic to fail,’ while guaranteeing bank deposits, the largest EU governments, Germany and the UK, in contrast to the US, have opted for what will in the longer run allow European banking giants to withstand the anticipated financial attacks from the likes of Goldman or Citigroup.

The dramatic selloff of stocks across European bourses and across Asia is in reality a secondary and far less critical issue. According to market reports, the selloff is being driven mainly by US hedge funds desperate to raise cash as they realize the US economy is going into economic depression, that they are exposed and that the Paulson Plan does nothing to address that.

A functioning solvent banking and interbank system is far the more strategic issue. The ABS debacle was ‘Made in New York.’ Nonetheless, its effects have to be isolated and viable EU banks defended in the public interest, not just the interest of Paulson’s banking cronies as in the US. Unregulated offshore vehicles such as hedge funds, unregulated banking, unregulated insurance all went into building the $80 trillion ABS Tsunami as I have called it. Certain more conservative EU hands are not about to buy the remedy being offered by Washington.

The coordinated interest rate cut by the ECB and other European central banks while grabbing headlines, in effect do little to address the real problem: banks fear to lend to each other until their solvency is assured.

By initiating state partial nationalizations across the EU, and rejecting the Berlusconi/Sarkozy bailout scheme, the governments of the EU, interestingly enough this time led by the German, are laying a more sound foundation to emerge from the crisis.

Stay tuned, it’s far from over. This is a fight for the survival of the American Century which has been bvuilt since 1939 on the twin pillars of American financial dominance and American military dominance—Full Spectrum, Dominance.

Asian banks, badly burned by Wall Street’s manipulated 1997-98 Asia Crisis, are apparently very little exposed to the US problem. European banks are exposed in different ways, but none so serious as in the US banking world.

Here's an important quote from a 7/10/2008 Financial Times article: "central banks... are not rolling forward old leases after maturity." This is clearly shown as panic on the gold lease chart above. At a time when cash interest rates are being slashed around the world, gold and silver lease (interest) rates are exploding. Why, because central banks are afraid of counterparty risk. They dont trust commercial banks to return their gold or silver. Think about this, central banks are willing to give paper money away to anyone, anywhere, anytime at lower and lower prices but they are hoarding their gold and silver - doesnt this tell you what central banks consider real money?

Anyway back to the lease rates. To understand what this is about, one must understand the basics of central bank gold leasing. The Gold Antitrust Action Committee (GATA) is convinced (and I accept their claims), that the US Treasury and its allies, including the European central banks, have been suppressing the price of gold for about a decade by strategically selling their gold. They do this, GATA claims, to limit gold's ability to supplant their fiat (not backed by anything) currencies (US$, GBP, Euro) while they continually debase these currencies.

Whether you accept GATA's claims or not, the fact is that the supply of gold (as seen by those buying and selling gold) has been increased by two central bank actions:

(1) Direct gold sales. The amount to be sold was negotiated four years ago by a treaty known as the Washington Agreement which expired in September 2008.

(2) Gold leases to third parties (at extremely low interest rates). Those third parties then sold the gold and used the proceeds to invest in other vehicles where they expected higher returns. When such a gold lease matures it must either be rolled over, or the lessee must obtain (buy) the leased amount of gold and return it to the central bank.

With this in mind we can see the importance of the following two quotes from the above article:

(1) "Central banks have all but stopped lending gold to commercial and investment banks and other participants in the precious metals market" - this eliminates a significant fraction of supply seen by the gold markets. It also implies that central banks have changed their view of the significance of gold and will probably not continue to sell it as they have in the past (again eliminating a significant fraction of gold supply, roughly equivalent to 20% of annual mine production).

(2) "central banks... are not rolling forward old leases after maturity." - this means that as these leases mature, the lessees must buy gold to return it to the central banks. This creates a significant new form of demand for gold.

Together this is a significant increase in demand relative to supply equivalent to something like a 20 to 25% reduction in gold mine production. This should, according to economics 101 and with all things being otherwise equal, push the price of gold significantly higher. Its interesting to note that what happened to the price of lead (Pb), the heavy metal, when it took only a 3% reduction of supply in the form of a mine closing in 2007. The price of lead (Pb) rose more than 100% (from $.80/lb to around $1.80/lb). Its a natural to conclude that the price of gold, based on this larger change in demand / supply dynamics, will react even more substantially. We'll see.

I have tried to inform you in a calm manner for several months now that the end game is near but you still had time to prepare. Hopefully you have done this by now. Unfortunately, the happenings of the last week indicate that we are heading toward a collapse of the financial system at a much faster rate than I anticipated. A real possibility of a banking holiday now exists, this means no open branches, no credit cards, no internet banking for a period of time determined by the government. Whilst I am confident our big 4 banks are strong you cannot under estimate the scale of the crisis that has this week spread to Europe and already bankrupted one country, Iceland. Whilst none of us can really know what this will mean in the near term it is not a time to bury your head in the sand and hope all will be OK. Take action now. Stock up on basic food items and withdraw enough cash to cover living expenses for 1-2 months. This takes little effort and the money can be re deposited once things settle down. If we get a meaningful relief rally in stocks over the next couple of days or weeks, offload any toxic financial stocks you may still own. Also now is not a time to bargain hunt stocks of any kind. This opportunity will arise but from much lower levels than today.

Whilst a little dramatic I think the article from Bill Holter of GATA summarises what is the most likely near term outcome:

"We are witnessing panic on the part of governments worldwide, they are fiddling while Rome burns. They might as well fiddle as there is no solution, the banking system missed the ditch and is going off the cliff. The news cycle is jamming up because more and more "solutions" are announced on a daily basis as the world turns and markets open [or try to]. The banking system worldwide is in a spiral stage that even if panic is stemmed, it will rear it's ugly head again a day, 3, or 7 later. Panic is the absolute outcome here, this has gone too far, too wide, and the infection is too deep to be reversed. Nothing goes straight down, and this is no different, so expect some rallies in stocks and currencies but make no mistake we are are witnessing the end of the banking system.

I don't think there are any band aids left that can last more than 3-5 days at a time. Gold and Silver [and the shares] will catch a bid that has never been seen before. Couple this bid with virtually no supply and the results will be a move to the upside in an asset class as has never been seen nor imagined before. I spoke over the weekend with a liaison to several European banks and he advised me that a waiting period of at least 3-4 weeks for Gold delivery is now the norm. He has never seen anything like this in his thirty years. As the banking system unravels, whatever little physical supply that is left will disappear. The jig is up, either you are out of the paper system or you go down with it. There will be NO paper survivors, either you are a charter member of the next banking system or you will be leapfrogged and left behind.

The Price of Gold will be beyond the reach of the common man. This has got to be the plan, the only way to recapitalize the banks is to revalue Gold up 10 fold, 100 or even 1000 fold. This is no joke, currencies will devalue and approach zero in many many cases. This is not 1929, it is WORSE for several reasons. The biggest being our currencies are bad. Back then the world had a hard and real currency, Gold. The level of debt back then looks highly conservative when compared with today's circus. The world went to sleep and woke up with more debt and more risk than all the previous asset bubbles combined. This IS the biggest financial BUST of all time, by multiples. This is it, it is over"

Maybe/maybe not..... but prepare yourself anyway!

From The Economist print edition

When banks find it hard to borrow, so do the rest of us

ANY good tradesman will tell you the importance of the bits of a house that you cannot see. Never mind the new kitchen: what about the rafters, the wiring and the pipes? So it is with financial markets. The stockmarkets are the most visible: as they soar or swoon, the headline-writers get to work. The money markets, however, are the plumbing of the system. Normally, they function efficiently and unseen, allowing investment institutions, companies and banks to lend and borrow trillions of dollars for up to a year at a time. They are only noticed when they go wrong. And, like plumbing, when they do get blocked, they make an almighty stink.

At the moment, these markets are well and truly bunged up. In the words of Michael Hartnett, a strategist at Merrill Lynch, “the global interbank market is effectively closed.” The equivalent of a run on banks has been taking place, without the queues of depositors seen outside Northern Rock, a British mortgage bank, last year. This stealthy run has been led by institutional investors and by banks themselves.

Many banks have had to be rescued by rivals or the state. This week the Irish government felt compelled to guarantee the deposits and some other liabilities of the country’s six largest banks. Surviving banks have become ultra-cautious—“just taking things one day at a time,” says Matt King, a strategist at Citigroup.

The effect has been most dramatic in the overnight rate for borrowing dollars. Bank borrowing costs reached 6.88% on September 30th, more than three times the level of official American rates, while some were willing to pay a remarkable 11% to borrow dollars from the European Central Bank (ECB). Banks have become so risk-averse that they deposited a record €44 billion ($62 billion) with the ECB on September 30th even though they could have earned more than two extra percentage points by lending to other banks. It was the last day of the quarter and, for balance-sheet reasons, banks were particularly keen to have cash on hand. (Overnight rates fell back on October 1st, but one-month rates rose further, indicating that the crisis had not eased.)

In the absence of private-sector lenders to banks, central banks have become vital suppliers in the money markets. With the help of the ECB, the Bank of England and the Bank of Japan, the Federal Reserve agreed to lend a further $620 billion on September 29th (see article). That package, though of similar size to the Bush administration’s $700 billion bail-out plan, did not need congressional approval or attract public opposition.

But central banks can only do so much. In particular, they tend to lend for short periods and then only against collateral with a high credit rating. That still leaves banks with the problem of financing their more troubled assets, an issue the Bush administration’s plan was designed to solve.

The money markets’ difficulties began in July 2007, when two Bear Stearns hedge funds revealed the damage done to their portfolios by subprime mortgages. Since August of that year, central banks have been intervening to keep them functioning, with a series of schemes like America’s Term Auction Facility. But the collapse of Lehman Brothers, followed by the long series of rescues in Europe and America, seems to have brought the money markets close to breakdown. Even immediate passage of the Bush plan would not solve all their problems straight away, because it would take time to put the plan into place.

Why do these markets matter? First, the rates on loans paid by many consumers (adjustable-rate mortgages, for example) and companies are set with reference to the money markets. Higher rates for banks mean higher rates for everyone. Second, if the markets are blocked for more than a week some companies may find it hard to get any finance at any price. That could mean more bankruptcies and job losses. Third, more banks could go bust if the blockage continues, making investors even more risk-averse. The downward spiral would take another turn.

“We are at the juncture where more widespread and permanent support is required to restore confidence in the banking sector,” say analysts at the Royal Bank of Scotland (RBS). “Without it, the banks will be aggressively trying to contract their books and will be unable to provide credit to retail and corporate clients.”

So it is safe to say that, until the money markets behave more normally, the financial crisis will not be over. And until the financial crisis is over, the global economy may not recover.

Liquid dynamite
First, the problem. It is widely assumed that central banks set the level of interest rates in their domestic markets. But the rate they announce is the one at which they will lend to the banking system. When banks borrow from anyone else (including other banks), they pay more. Every day, this rate is calculated through a poll of participating banks and published as Libor (London interbank offered rate) or Euribor (Euro interbank offered rate).

Normally, these are only a fraction of a percentage point above the official interest rates. But that has changed dramatically in recent weeks (see chart 1). Take the cost of borrowing dollars. On October 1st banks had to pay 4.15% for three-month money, more than two percentage points above the fed funds target rate. In theory, three-month rates could be that high because markets are expecting a sharp rise in official rates. But that is hardly likely, given the depth of the crisis.

Instead, the width of the margin reflects investors’ worries about the banks, not least because so many have faltered so quickly. Three months is now a long time to trust in the health of a bank. In addition, banks are anxious to conserve their own cash, in case depositors make large withdrawals or their money gets tied up in the collapse of another bank, as with Lehman.

One way this risk aversion shows up is in the “Ted spread” (see chart 2), the gap between three-month dollar Libor and the Treasury-bill rate. After being as low as 20 basis points (a fifth of a percentage point) in early 2007, the spread is now 3.3 percentage points. In other words, the relative cost of raising money for banks has risen 16-fold in the past 18 months.

Indeed, some banks argue that Libor and Euribor understate the full extent of the increase in banks’ borrowing costs. According to John Grout of the (British) Association of Corporate Treasurers (ACT), banks have started to talk to companies about invoking the “market disruption” clause in loan contracts. This would allow them to replace the two benchmarks with the “real” cost of their funds, which they say would be higher. (Companies usually pay Libor or Euribor plus a margin that depends on the riskiness of their finances.) One company, Hon Hai of Taiwan, an electronics manufacturer, says its banks have already invoked the clause.

This affects only debt facilities that have already been set up. Mr Grout says that when companies are negotiating new loans with banks, they are being asked to accept rates based on Libor plus a quarter of a percentage point. Unsurprisingly, the ACT is unimpressed with this tactic, since Libor is calculated from data supplied by the banks themselves.

Companies do not have to borrow from banks; they can raise money from the markets by selling commercial paper, a type of short-term debt. For much of this year, that was an attractive option. The preference of investors for debt issued by non-financial companies made commercial paper a source of cheap finance.

But in recent weeks even this has become more difficult. The volume of commercial paper outstanding fell by $61 billion to $1.7 trillion in the week ending September 24th. And investors are unwilling to lend for long: AT&T, a big American telecoms company, said on September 30th that the previous week it had been unable to sell any commercial paper with a maturity longer than overnight. The volume of asset-backed commercial paper maturing in four days or less ballooned from $32 billion a day to $104 billion during September (see chart 3), while the amount maturing in 21 to 40 days fell by 63%.

Where there is doubt about a company’s finances, it inevitably has to pay a higher rate. Worries about GE, one of America’s most prestigious companies, pushed up the premium on its credit-default swaps and made raising short-term debt dearer. According to the Wall Street Journal, the rate on its commercial paper had gone up by two-fifths of a percentage point. That might not sound much, but GE has $90 billion of paper outstanding, so it faced an extra interest bill of $360m a year. On October 1st the company announced a $12 billion public share offering and a $3 billion injection from Warren Buffett, a leading investor.

Why has commercial paper lost its shine? The explanation seems to lie back in the authorities’ willingness to allow Lehman to collapse. That move, designed to warn the markets that the authorities took moral hazard seriously, has had some unintended consequences.

Fund of surprises
The most severe was the loss imposed on the Reserve Primary fund, a money-market fund. Such funds invest in short-term debt and offer investors higher rates than on bank deposits. But they also aim to repay their customers at par. Because it had bought Lehman debt, the Reserve Primary fund was forced to “break the buck” (that is, to repay less than 100 cents on the dollar), only the second such instance in the industry’s history. This caused a crisis of confidence in money-market funds. “Prime” funds, which offer slightly above-average rates in return for higher risk, have lost about $400 billion out of $1.3 trillion in the past few weeks, as investors have switched to funds based on government debt. In turn that has made other funds more cautious and led them to steer clear of bank loans and commercial paper.

Illustration by David SimondsBuried among the many recent American regulatory initiatives was a scheme to insure money-market funds against failure. That scheme may have halted a stampede by retail investors out of the industry, but it has not restored the level of confidence of two months ago and new deposits do not qualify.

At the same time as they are struggling to raise money from outsiders, banks may face more claims on their capital. In the good times they promised to provide back-up loans to companies—which they thought would never be asked for. On some estimates, the value of these promises is $6 trillion. But with the commercial-paper market tightening and the economy deteriorating, more companies will be asking banks to keep their word.

Indeed, companies already seem concerned that banks will be unable to maintain promised loan facilities. So they are using those credit lines earlier than expected, in case they vanish. A prime example is Duke Energy, an American utility, which recently drew down $1 billion from a credit agreement. Chris Taggert of CreditSights, a research group, foresees a “funding blitzkrieg” by high-yield borrowers tapping their banks for cash if the mayhem does not abate.

“There’s a vicious-spiral element to the inability of companies to roll commercial paper,” says Ajay Rajadhyaksha, a fixed-income strategist at Barclays Capital. “Those that have back-up lines of credit with banks are increasingly drawing on them. This is hurting the banks, and making money-market funds even queasier about buying bank debt, and so on.”

CreditSights notes that it has become more common for companies to call on these loans amid “fears that bank lenders may not be able to honour commitments in the future.” Several of these companies, including General Motors, have cited the uncertain state of capital markets when asking for their money. Goodyear Tire & Rubber said it was drawing down its loans because some of its cash was locked up in, of all places, the Reserve Primary money-market fund.

Whatever the reason, the possibility of more calls from their corporate clients is another factor behind the banks’ desire to hold cash. That will mean any company without a back-up facility may struggle to raise new loans.

Luckily, most companies are not as exposed as they were when the dotcom bubble burst. Nevertheless, plenty of carmakers and retailers have mountains of debt or a strong need for cash. Then there are companies that underwent leveraged buy-outs. The private-equity groups that bought them may have been counting on refinancing their debts soon.

A lack of access to capital is sure to make companies cautious. “Your ability to plan for investment is obviously affected,” says Randall Stephenson, chairman and chief executive of AT&T. In addition, higher finance costs will eat into profit growth, a fact that seems yet to be recognised in buoyant forecasts for 2009. “The equity market is going through the slow process of realisation that a large proportion of earnings growth over the last 25 years was due to the falling cost of money,” says Kit Juckes, an economist at RBS.

Polonius’s revenge
Consumers have been going on a greater debt binge than companies and the impact on them may be more immediate. In particular, they may face higher mortgage and credit-card rates. Some may be denied new credit altogether.

The last survey of senior loan officers by the Federal Reserve was back in July. Even then 65% of banks were tightening their lending standards on credit cards, up from 30% in April. Consumers had not felt the effects by then: credit-card lending rose by 4.75% in the year to July, although other types of credit barely grew at all.

Mortgage costs have also been rising for those with variable-rate loans. On September 30th, American adjustable-rate mortgage rates were 6.13%, according to Bloomberg, compared with 5.92% at the end of August and less than 5.5% in the spring. In Britain three leading lenders raised rates by half a percentage point in the week to September 26th. And Moneyfacts, an information group, says the number of buy-to-let mortgages (used by private landlords) has fallen 85% over the last year.

These effects might teach voters that punishing the banks for their follies is sometimes cutting off their noses to spite their faces. “At some point Main Street will realise it lies on the same road as Wall Street,” says Mr Juckes.

It is not too difficult to imagine bank failures leading to job losses, further falls in house prices, bad consumer debts and further bank losses. “We may already be at the point where corporate fear and conservatism are baked in: even if things start to improve for the banks, companies have seen how bad things can get, and that can prove lasting,” says Torsten Slok, an economist at Deutsche Bank. “So there is a risk they’ll continue to hoard cash and mistrust banks for quite some time.” That is the kind of spiral which the Bush administration’s plan was designed to avoid.

Relying solely on ad hoc rescues of individual banks would only make investors more nervous about the banks that remain. The financial plumbing would stay bunged up. Unless something is done to unblock it soon, there will not just be a nasty stink in the markets. There will also be an unholy mess in the wider economy.

Gold is so ductile that an ounce of gold can be stretched to a length of over fifty miles or beaten into a sheet to cover a hundred square feet.

A cubic foot of gold weighs approximately half a ton.

Gold can be made into thread and used in embroidery.

The word gold derives from the Old English word 'gelo' meaning yellow.

Precious metals are measured in troy ounces. This comes from the French town of Troyes where this unit of measurement was first used. A troy ounce is approximately 10% heavier than an avoirdupois ounce.

A carat was originally a unit of mass based on the carob seed used by ancient merchants.

Gold bars were made as early as 4000 BC.

Since the 1880s South Africa has been the source for a large proportion of the world's gold supply. Production in 1970 accounted for 79% of the world supply, producing about 1,000 tonnes, however production in 2004 was 342 tonnes. This decline was due to the increasing difficulty of extraction and changing economic factors effecting the industry in South Africa.

A single gram of gold can be beaten into a sheet of one square metre, or an ounce into 100 square feet.

During the 19th century, gold rushes occurred whenever large gold deposits were discovered, including the California, Colorado, Otago, Australia, Witwatersrand, Black Hills, and Klondike gold rushes. Because of its historically high value, much of the gold mined throughout history is still in circulation in one form or another.

75% of all gold ever produced has been extracted since 1910. It has been estimated that all the gold in the world that has ever been refined would form a single cube 20 m (66 ft) a side.

The price of gold is fixed twice a day at 10.30 am and 3.00 pm at the premises of N M Rothschild by the five main Bullion Houses - Deutsche Bank, HSBC, NM Rothschild, ScotiaMocatta and Societe Generale. The first gold fix was on 12th September, 1919 and this tradition has continued in order to provide a publically quoted price as a benchmark to be used by producers and consumers. The Chairman, traditionally a representative of N M Rothschild, announces an opening price and the other members, who are connected to their dealing rooms, declare themselves to be buyers or sellers of a number of bars at that price. Each representative has a small flag on his desk and this is raised at a change of orders from his dealing room. If any flag is raised, the price may not be fixed. The price is moved until an optimum price is achieved to satisfy both buyers and sellers. Once the total buy and sell amounts from each dealing room are within 25 bars of each other, the gold price can be fixed. Immediately the price is fixed it starts moving again on the market.

Legend has it, that the method of raising flags to fix the price of gold began in the following way. There was a man named Amshel who collected coins and lived in the ghettos of Frankfurt in the late 1700’s. Owing to his specialised knowledge, Amshel became the seeker of old coins for William IX of Hesse-Kassel. In 1805, impressed with the financial insight of Amshel’s son, Nathan, William IX entrusted him with a large portion of his wealth. Rather than buying and selling coins as his father had done, Nathan decided to buy and sell gold bullion. Nathan allegedly commented that the only two people who understood the true value of gold were one of the directors of the Bank of England and an obscure clerk in the vault of the Banque de Paris and unfortunately they disagreed! Soon Nathan was receiving advance information from France through a series of carefully arranged flag signals from across the Channel. As he was receiving his information much more quickly than other traders, he soon amassed a great fortune and a few years later he was dubbed a Baron by Francis I of Austria. That is why representatives from each of the five major bullion houses meet twice a day to raise and lower flags, as they fix the price of gold. This takes place at the offices of NM Rothschild, which was founded by Baron Nathan Mayer de Rothschild.

Savers have been queuing in the street to buy gold bars and coins, as they search for a safe place to invest their money.

Traditionally, gold has been one of the safest investments during times of financial turmoil

London's two leading bullion dealers, ATS Bullion and Baird & Co, have reported a rush of interest from savers, many of whom have hundreds of thousands of pounds worth of savings they want to convert into the precious metal.

At least two customers have invested the entire proceeds from selling their houses into gold, each buying up more than £500,000-worth of gold bars, according to one dealer.

Savers have been queuing in the street at ATS Bullion, whose offices are just off the Strand in London's west end.

Sandra Conway, the company's managing director, said: "We've had to turn people away. The queues have been right out of the door and it's been really hectic at times.

"Ever since Lehman Brothers went bankrupt, the phones have been going off the hook."




Traditionally, gold has been one of the safest investments during times of financial turmoil. In 1973 gold cost just $60 an ounce and hit $850 in 1981.

However, since the summer the price of gold has fallen as the dollar has strengthened – the two are linked quite closely.

But the fact that gold has not performed well in recent months has not deterred thousands of investors.

"They don't think of gold as a way of making money. They think of it as a safeguard in these turbulent times. You can move gold quickly, in a way that you can not with shares or cash in a bank account," Ms Conway said.

The average investor is buying up between £10,000 and £50,000 in bars on each visit, but it is possible to buy as little as a half sovereign coin, which costs about £70.