Waiting for the Avalanche


by Jim Rickards, Daily Reckoning:

I’ve often compared the causes of financial crises to snowflakes that can trigger an avalanche. A massive amount of snow can accumulate before that one final snowflake comes along to start the chain reaction.

The climbers and skiers at risk can never know when an avalanche will start or which snowflake will cause it.

But it helps to know what to look for. Let’s look at three of the most likely snowflakes that could trigger the next financial crisis, all of which are likely in my view. These are by no means farfetched.

Snowflake #1: Credit Crisis in China: China, believe it or not, is in more of a credit bubble than the United States. The United States has got lots and lots of problems. But China is actually much worse — and they don’t have as much experience with this type of credit bubble.

I believe they’re naïve about how bad this can get. They’re over relying on the ability of Communist Party officials to keep a lid on it. I was out in the countryside south of Nanjing not too long ago, visiting some of China’s famous ghost cities.

I was with some Communist Party officials and provincial officials who were behind it all. Everything I saw, construction as far as the eye can see, magnificent in scope, was all empty. I’ve seen it firsthand.

I turned to one of these officials and said, “This is all debt finance. This is all empty, so you have no revenue to pay the debt. So how are you gonna pay the debt?” And he said, “Oh, we can’t. But Beijing’s going to bail us out.” Not we hope Beijing will bail us out — but Beijing will bail us out.

That isn’t an isolated viewpoint. It’s widespread.

But Beijing has its own problems. Whether it’s wealth management products, shadow banking, real estate finance, crony capitalism of the worst kind, flight capital, oligarchs taking all they can and then funneling it out to Vancouver and Australia and Park Avenue, etc., the problems can no longer be papered over.

This has all been happening on a massive scale. It’s going to collapse. But China doesn’t really know how to deal with it.

Snowflake #2: Failure to deliver gold: This is almost definitely coming. So much of the gold market is “paper gold.” This paper gold market is so manipulated, we no longer have to speculate about it. It’s very well documented. But it all rests on a tiny base of physical gold. I describe the market as an inverted period with a little bit of gold at the bottom and a big inverted pyramid of paper gold resting on top.

The [available amount of] physical gold is getting smaller, which surprises many people. The might say, “Gee, there’s 2,000 tons of mining output per year, and the gold that exists doesn’t go anywhere, so why isn’t that little brick getting bigger instead of smaller?”

And the answer is you have to distinguish between the total supply and the “floating supply.” The total supply gets bigger every year by about 2,000 tons. People don’t throw gold to the bottom of the sea. They don’t blow it up with explosives. They hoard it. And so all that gold’s still around, and new gold keeps coming into the system.

Yes, the total supply grows every year, and when they move gold bars from a warehouse in London to the Chinese warehouse in Shanghai, the impact on the total supply is zero. But the floating supply shrinks. Now, what do I mean by the floating supply? The floating supply is the physical gold that is available [to back] paper transactions.

When you take gold from a London warehouse and put it in Shanghai, for example, there’s no impact on the total supply. But you have shrunk the floating supply. I’ve seen this firsthand. I was in Switzerland not long ago, and I met with one of the big four “secure logistics” firms in the world. These are the people that handle the actual physical metal.

They’re building vaults as fast as they can. They’ve been negotiating with the Swiss Army. Over the years, the army’s hollowed out some of these mountains in the Alps to build these extensive warehouses and storage facilities and tunnels that will withstand nuclear attack.

So these vault contractors have been in negotiation to lease the mountains — these nuclear bomb-proof mountains — from the army. My source told me, “We’re building vault space as fast as we can. But we’re running out of capacity.”

I asked, “Where’s the gold coming from?”

He said, “UBS and Deutsche Bank and Credit Suisse, and customers are taking it out of the banks and giving it to us.”

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