Precious metals

Fourth article: passbook savings accounts and their "negative real interest".

According to the advertising, the savings account gives a certain return (interest paid each year) and is a safe investment (because it is not speculative). The truth is, however, that the opposite is true: the low interest generated by the passbook is insufficient to compensate for inflation, so the saver's purchasing power is inevitably eroded; what's more, there is a serious risk of total or partial loss, given that the banks are in a bad position.

To fully understand the situation, let's start with a few definitions. The word 'interest' comes from the Latin interesse and means the profit made from money lent or owed. Nominal interest" refers to the value in money, i.e. the amount expressed in a currency (euro, franc, dollar, etc.). Real interest" is the nominal interest eroded by the effects of inflation and the level of risk of default by the debtor:

=> real interest = nominal interest - inflation - risk premium.

To explain this formula, let's look at an example: in France in 2013, a passbook savings account does indeed earn a nominal annual interest rate of 1.25% (so €100 earns €1.25 in nominal interest); only, during that same year, the rate of inflation (depreciation of money) is higher (officially 2%, in reality at least 8%, given the swelling of the eurozone's "M3 money supply"), so the real interest rate is negative, i.e. the purchasing power of the sum deposited decreases. Note that inflation is always higher than the return on passbook savings, whatever the country or time! And remember that government statistics underestimate inflation in order to make people believe in monetary stability: "official" inflation is always much lower than actual inflation!

With a negative real interest rate of 0.75% for twenty years, the purchasing power of savings falls by 14%; with a negative real interest rate of 6.75% purchasing power falls by 74%, i.e. ¾ of the savings wiped out! The bankers are highlighting the positive nominal interest generated by the savings account, but they are ignoring the negative real interest due to the higher rate of inflation: this monetary erosion is wiping out purchasing power. Savers lose out year after year.

If, by some misfortune, inflation gets out of hand (this phenomenon is known as "hyperinflation"), savers are left with nothing but tears in their eyes. In Brazil, the price index doubled every year from 1980 to 1983, then tripled annually until 1986, after which it rose even faster, culminating in an inflation rate of 30,377% in 1990! One Brazilian family had saved up to buy a Volkswagen, and was just a small sum short of the sum needed to buy the car they wanted so badly. But hyperinflation set in and the price of the car went up; in the end, the savings account was barely enough to pay for a meal in a restaurant for the whole family.

An old woman in Sichuan, China, took 400 yuan to the bank in 1977. At that time, that sum would have been enough to buy a flat. After 30 years, the savings account had earned 438 yuan in interest, less 2.36 yuan in tax, giving a total available capital of 836 yuan. But because of inflation, the negative real interest had eaten away at the grandmother's purchasing power: with her nest egg, she was only able to buy a bottle of Chinese "maotai" liqueur (www.theepochtimes.com, 7 October 2013).

Real interest, as we said, is nominal interest adjusted for the effects of inflation and risk. What about the level of risk in the savings passbook?

Savings have already disappeared into other people's pockets

Savers leave their savings in the passbook without touching it, since the aim is to save. Only a small portion of the deposits must remain available at the bank counter in the form of cash, to meet withdrawal needs; the cash withdrawn is generally spent on purchases, then deposited back at the bank by the retailer, where it can be used for the next person's withdrawal, and so on. So, apart from this small circulating cash reserve, almost all the sums deposited in passbooks are available to the savings bank. It uses them to grant loans to individuals, companies and governments. It lends at a higher interest rate than the passbook rate, and the difference between the two rates constitutes its profit margin.

If you think about it, your savings have already disappeared into other people's pockets. Apart from the tiny reserve of cash at the bank counter, almost all your savings have been redistributed to various borrowers. You no longer hold hard cash, but only a claim on the passbook, because the funds have already ended up, for example, in Greece (government bonds), the United States (rotten subprime mortgages), the Caribbean (speculative hedge funds), and so on. A diagram drawn up by the leading newspaper La Tribune shows this redistribution of savings to others ("Épargne : où vont les 15'500 milliards d'euros collectés", www.latribune.fr, 3 April 2013). Your savings are no longer there, apart from the teller's small stash of banknotes.

The problem is that if too many savers apply to withdraw their money at once, the cash reserve will be insufficient and, above all, the bank will be unable to obtain additional liquidity in good time. It will not be able to demand that borrowers repay their loans in full immediately, given that repayments are contractually staggered over several years and that, in any case, borrowers have spent the money on the loan and no longer have it. For this reason, if around ¹⁄₁₀ of savers turned up at the counter on the same day, it would certainly be bankruptcy. In Switzerland, for example, a regional savings bank with a solid reputation, Spar- und Leihkasse Thun, collapsed because in October 1991 too many depositors flocked at once to get their money back. This 'bank run' phenomenon was also fatal for Northern Rock in 2007. The fifth-largest bank in the UK, with 1 million customers, it was nationalised in 2008; the UK injected £1.4 billion into it, then sold it in 2011 for just £747 million to Richard Branson.

The devastating effect of anatocism

Anatocism" (from the Greek ana again and tokos generation) means that interest generates interest again, which in turn generates interest. It is also known as "capitalisation of interest" or "compound interest". The effect is that an amount lent increases exponentially, i.e. not in a straight line, but in an increasingly steep curve.

As the film Debt-money illustrates so well, central banks create money and lend it to governments, either directly or via investment banks. Because of the compound interest owed by borrowers, the national debt grows exponentially. So, in order to pay the interest, people have to work faster and faster: this is the famous "growth", the so-called miracle cure that is supposed to bring prosperity. It's true that technical progress allows the production of goods and services to increase, but this growth is linear rather than exponential. What's more, our planet's resources are finite, whereas the interest curve can take off without limit. As a result, the debt burden is becoming heavier and heavier in relation to gross domestic product.
The growing gap between the growth curve of gross domestic product and the exponential curve of anatocism has been observed since 1945 in the United States, to take just one example. As can be seen from the graph opposite, the gap between output (blue line) and debt (red line) is widening faster and faster, because the weight of compound interest is increasing faster than the fruits of human labour. The difference between output and debt is widening not at a constant rate (linear progression), but at an ever-accelerating rate (exponential progression). It is only a matter of time before the US defaults.

Another country has beaten them to it, Greece. In May 2010, the European Union granted additional loans to this state, so that it could continue to pay the interest on its outstanding loans; in July 2011 new European credits were added; in March 2012 part of the Greek debt was written off, and Europe extended additional credits; now, in October 2013, the Greek prime minister is again asking for a partial write-off of the national debt, plus a new package of credits.
In fact, the so-called "aid to Greece" consists of imposing additional loans, the amounts of which are used exclusively to pay interest to creditors. Why are we so determined to keep the Greek patient in an artificial coma? If Greece ever defaulted, its creditors, mainly French, German and British banks, would be finished - and their savers with them!

The Cypriot example clearly proves this. When Greece wrote off part of its debt, Cypriot banks, which held large amounts of Greek loans, found themselves bankrupt. This is why the Cypriot government temporarily closed them down for several weeks (March 2013), froze depositors' accounts (the freeze is due to be lifted in January 2014) and decided (in July 2013) to levy a 47.5% tax (dry loss) on deposits over €100,000.

Did you know that at the end of June 2012, savers in many parts of France were no longer able to withdraw cash? That their banker was inventing all sorts of pretexts to gain one or two weeks of time? Well, it was only a matter of time before the French banking system collapsed, along with the rest of Europe's banks, in the midst of the 'euro crisis'. A very senior German civil servant, Jörg Asmussen, a member of the management of the European Central Bank (ECB), reveals that in the summer of 2012, "the eurozone, for a brief interval, was facing uncontrolled disintegration. Major companies and banks were beginning to prepare for it" (www.derNewsticker.de, 9 June 2013). To counter this, the ECB announced its intention to buy unlimited amounts of government bonds to refinance nations in difficulty. The eurozone was saved, but only for a few months... We are currently in the nth phase of the European financial crisis. Anatocism is inexorably at work.

Even Germany, which we are always told is a model pupil, is seeing its national debt grow year on year. The Greek grasshopper has nothing left to eat, and even the German ant is finding it increasingly difficult to feed itself. For, as Albert Einstein would have said, compound interest is the greatest force in the universe.

Savers' savings were invested, among other things, in subprime mortgages taken out by poor Americans. When the latter could no longer meet their repayments, the American bank Lehman Brothers went bankrupt (15 September 2008). What is less well known is that the huge Royal Bank of Scotland came within 24 hours of suffering the same fate on 7 October 2008, but was caught out at the last minute. It was saved by state aid, just like other major banks around the world. But the banks were rescued at the expense of middle-class taxpayers (the poor are not taxed and the rich have tax optimisation lawyers). State debt has been considerably increased. Hence the austerity and fiscal tightening, which is hitting the middle classes hardest. As a result of the squeeze on the middle classes, many formerly well-off borrowers will no longer be creditworthy. After the previous subprime crisis, we are now going to see a crisis of premiums. The volume of loans taken out by the middle class is much higher than the volume of mortgages taken out by the lower class. Given this volume, we can assume that the international financial system will not survive.

The derivatives casino

The toxic (subprime) or soon to be toxic (prime) debt held by banks is worrying enough not to entrust your savings to them. But that's not all: bankers have turned their institutions into casinos, where people bet dizzying sums on the future. Will cocoa prices go up or down? The United California Bank lost its bet on cocoa and filed for bankruptcy in 1970. Will the price of silver rise or fall? Switzerland's fourth-largest bank, Schweizerische Volksbank, ruined itself speculating on cocoa in 1980. If the big American bank J.P. Morgan, to take a current example, were wrong in even 1% of its speculative commitments, its own capital would be wiped out.

The tools of speculation are called derivatives. They have a high leverage effect, meaning that with a relatively small stake, the potential gain/loss is high. While it's nice to be able to cash in a lot by speculating skilfully, the downside is that the loser has to pay a large sum, which means there's a serious risk of bankruptcy. And since the banks are all interconnected via the securitisation of loans and the pooling of default risks (credit default swaps, CDSs), the bankruptcy of an institution that has bet on the wrong horse risks triggering a cascade of bankruptcy filings.

Ces leviers contribuent immensément à l’instabilité systémique de la finance mondiale. Le montant total des sommes pariées au « casino global » est estimé à 700 billions de dollars (700'000'000'000'000 $). À comparer avec le produit mondial brut : 70 billions. La somme des dérivés fait dix fois la valeur des biens et services produits par l’humanité en un an !

La spéculation du trader Jérôme Kerviel avec des dérivés a coûté 4,9 milliards d’euros à la Société générale en octobre 2008, mais il est encore plus alarmant que, si la direction n’y avait pas mis fin sous trois jours (21 - 23 janvier 2008), les pertes auraient atteint cinquante milliards (50'000'000'000 €) et ç’aurait été le krach. Même les instituts que l’on pensait conservateurs parient sur des dérivés : la Caisse d’Épargne a ainsi perdu 751 millions mi-octobre 2008. Dernier scandale en date : un trader d’UBS à Londres a flambé 2 milliards.

Making up bank balance sheets

Many banks already have "negative capital", but they hide it from the public. They make up their balance sheets by inventing fanciful values. Here is a non-exhaustive list of the methods used by banks to falsify their balance sheets:

Mark to fantasy: Until the collapse of Lehman Brothers in 2008, banks valued their assets on the basis of their current market value (mark to market). But as toxic assets lost much of their value, and even became unmarketable, the banks, instead of admitting their losses, preferred to change the accounting rules. They now make mark-to-fantasy estimates of what a particular security might be worth if there were a buyer; or they take the initial purchase price as a benchmark, ignoring any depreciation that has occurred in the meantime; or they overestimate the value of a claim because it is expected to be worth more in the future.

Goodwill: When a bank or large company buys another business, it capitalises goodwill. It is not the present value that is taken into account, but the future gains that can be expected. This is the immediate recognition of potential unrealised gains. This expectation of future profits could, of course, turn out to be unrealistic, but in the meantime, it improves the balance sheet.

Gain by loss: Banks themselves issue bonds. If the markets start to worry about a bank's results, or even fear that it may go under, the price of its bonds falls, to take account of the increased risk for the holder of this bank debt security. For example, a loan of 100 million euros will only be quoted at 90 million euros, i.e. a discount of 10%, the risk premium. In theory, therefore, this bank debt is worth less on the market, even though the bank will have to repay it at 100% of its face value in the future. So, as the market value of the debt falls, clever accountants see this as a gain for the debtor bank. The worse it does, the more its credibility deteriorates, the bigger the discount on its bonds, the bigger the accounting gain; logically, the closer we get to bankruptcy, the more fantastic the 'gains' become!

Special purpose vehicle (SPV): A fonds de commun de créances (FCC) whose purpose is to deconsolidate portfolios of bank assets, i.e. place them off the bank's balance sheet. The classic deconsolidation mechanism is securitisation, which consists of removing whole sections of banks' loan portfolios from their balance sheets, especially those that are doubtful or toxic. The rotten securities no longer appear on the bank's balance sheet. In this way, the bank's poor constitution is masked.

Debtor warrant : To take just one example, an Italian bank, instead of letting a company's doubtful debt lapse or sending a bailiff to seize it, decided to ease the credit by reducing the monthly repayments, while having the debtor sign a debtor warrant. This stipulated that the debt would be recovered if the company's health improved. Given the crisis, the recovery of the moribund is pure utopia, but the advantage for the bank is that it does not have to record a loss in its accounts ("Die Suche nach Europas "Zombiebanken" beginnt", www.faz.net, 11 October 2013).

To conceal the true state of their debts, Spanish banks, faced with a catastrophic fall in the property market, prefer not to foreclose on certain building contractors, but to open new credit lines for them, so as not to have to record the default on their balance sheet. For the same reason, they are reducing the monthly repayments of insolvent individuals instead of taking their homes, or they are not necessarily selling all the foreclosed homes so as not to depress property market prices, which would force them to revise their assets downwards and worsen the ratio between the value of the collateral and the amount of the mortgage.

In the same vein of prevarication, the European Union prefers to grant new loans to insolvent and over-indebted Greece, certainly not to "save" this nation, but for the greater profit of the lenders (see the film made by the "arte" television channel, http://future.arte.tv/fr/sujet/le-sauvetage-des-banques-qui-paye). This new money is being used to pay off current loans, and the "troika" (European Commission, ECB and IMF), which is overseeing the operation, is pretending to believe that the Greek economy will be on a sounder footing in the future. It's a kind of debtor warrant, feeding the illusory hope that the budget will gradually enable the national debt to be repaid... on the Greek calendar!

 Conclusion

First of all, we have seen that inflation is higher than the nominal return on savings books. If we didn't want to harm the depositor, it would be normal for inflation not to be higher, but lower than the nominal interest rate, or at least equivalent, so that the saver would retain the same purchasing power. When there was no inflation at all, because money was made of metal (gold, silver, copper), it was fair not to charge interest, and it's easy to understand why the Church prohibited usury, just as Judaism had done before and as Islam still does today. Interest, and especially the capitalization of interest, is a dissolver of the social fabric, driving a wedge between creditors and debtors.

Then we analyzed the more than considerable risks of this investment: the money deposited doesn't stay safely in the bank's vault, but is redispatched to borrowers whose solvency deteriorates from year to year, due to the infernal mechanism of compound interest; it is also used to bet big on risky bets, "derivatives", that (Russian) roulette of the global casino; to which we must add the toxicity of cleverly made-up bank balance sheets and the opacity of off-balance sheet operations. These risks would justify an increase in the interest paid to savers, to compensate for the possibility of a partial or total loss of their claim (because passbooks are a claim). If we wanted to protect depositors, we'd have to award them a hefty risk premium!

Let's take a look at the balance sheet, based on real inflation in the eurozone (at least 8% p.a.) and a risk premium of 4%, so as not to be too greedy, and apply the formula: real interest = nominal interest - inflation - risk premium. 1.25% nominal interest - 8.00% actual inflation - 4.00% risk premium = 10.75% negative real interest.

So every year, you lose 10% of your purchasing power by investing in a savings account. And you'd lose 99% or more a year if hyperinflation hit: in Chile between 1973 and 1979, prices rose a thousand-fold. And you'd lose everything if your savings bank were to remain permanently closed.

Wouldn't it be better to invest your savings in precious metals, which resist any hyper-mega-superinflation, and whose intrinsic value protects you from any "counterparty risk", even if everyone around you were to go bankrupt?

On May 18, 1993, at the Federal Open Market Committee, U.S. central bank chairman Alan Greenspan said that the gold price is the "thermometer" of investor confidence: if it rises, it signals concern, hence the need for the government to sell gold to restore confidence. Some governments deliberately manipulate the price downwards, so that the "thermometer" stops signalling inflationary fever. The price of precious metals has fallen by a third since January 2013. Such abrupt intervention indicates that the situation is abnormal, which is all the more worrying. It's a warning signal. And an opportunity to buy at knock-down prices, before it's too late.

Author : La rédaction d’Euporos SA
Source : www.euporos.ch

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