When will the Bank Bubble Burst
by Egon von Greyerz
We just had another confirmation that banks are dealing in sums which they don’t understand themselves. A junior employee in Deutsche Bank (DB) paid $6 billion to a hedge fund which was the gross value of a position. He should have paid the net. That in a nutshell shows the uncontrollable exposure of the banking system which will lead to its downfall.
How can a junior employee in a major bank pay the incredible sum of $6B without any controls whatsoever? This is a world gone mad. Governments print trillions, banks issue derivatives in the quadrillions and banks transact in hundreds of billions every week. The zeros no longer mean anything and have no value. This is all routine stuff for the people dealing in these sums and no one has a clue about the risk or the real exposure.
Remember that back in 1995 Barings Bank collapsed in London after a loss of £827 million ($1.3B). The fall of Baring almost brought all the banks down in London. The money printing and the credit creation 20 years later have created a financial system which is out of control, heavily overleveraged and desperately undercapitalised.
Just take Deutsche Bank, their derivatives position is officially $75 trillion. The real figure is probably over $100 trillion but let us accept the $75T. DB’s equity is $83B. This means that just 0.1% loss on the gross derivatives position is enough for DB to go under. It is virtually guaranteed that any loss on their derivatives would exceed 0.1% of gross value. DB is also too big for Germany. DB’s derivatives position is 24 x German GDP and equal to global GDP. Clearly too big to save and too big for the country and the world! But the Bundesbank and the ECB will try and thus create a new hyperinflationary Weimar Republic for Germany.
When the next crisis comes, the derivatives loss could be 100% of the gross exposure. The Great Financial Crisis that started in 2007 was only temporarily patched up. The exposure in the financial system is today a lot bigger than it was in 2007. Banks will of course argue that their net exposure is much smaller. In theory that is correct but when counterparty fails, gross exposure becomes the actual loss.
It is very likely that the total global derivatives exposure of at least $1.5 quadrillion will not just lead to another financial crisis but to The Great Financial Disaster. The bubbles in all asset markets that governments and central banks have created in the last 25 years must implode before real growth in the world can resume again.
But Central Bank will not give up easily. They will print more money than anyone thought possible. But solving a problem by the same method that created it will of course just lead to a bigger bubble and a bigger collapse and to a temporary hyperinflation before a depressionary deflation. Sadly, I consider the likelihood of this scenario being very high. Therefore wealth preservation is critical. Physical gold (and some silver) is the best protection against both hyperinflation and deflation. Remember with a deflationary implosion, no loans will be repaid and the banking system would not survive. Thus gold will be money as it has been for 5,000 years.
Egon von Greyerz
Matterhorn Asset Management AG
For recent action in the gold and silver markets as well as precious metals mining stock please listen to my latest King World News interview. I cover short and longer term price targets for the metals, the Keynesian fallacy and the fate of the dollar among other things.