Tuesday, December 29, 2009

Gold: The Ultimate Wealth Reserve

What is the main difference between a commodity and a currency? Consumption! A currency circulates through the economy as a medium of exchange but is not consumed. A commodity is a useful basic economic good that is produced, traded in common units and prices all over the world, and then consumed by industry or individuals.

Here is a list of commonly traded commodities from Wikipedia:

Rough Rice
Soybean Meal
Soybean Oil
Coffee C
Cotton No.2
Sugar No.11
Sugar No.14

Lean Hogs
Frozen Pork Bellies
Live Cattle
Feeder Cattle

WTI Crude Oil
Brent Crude
Natural Gas
Heating Oil
Gulf Coast Gasoline
RBOB Gasoline (reformulated gasoline blendstock for oxygen blending)

Precious Metals

Industrial Metals
Aluminium alloy
Recycled steel

And what is the difference between a currency and a wealth asset? Time and appreciation! The main difference is the amount of time that each is held. A currency is earned and spent in a short timeframe and wealth assets are accumulated and held for longer timeframes. Here is a list of some common wealth assets:

Endurable Wealth Assets
Real Estate
Fine Art
Other Precious Metals
Rare Classic Cars

Stocks (Equity Ownership)
Bonds (Debt Ownership)
CD's (Currency Time Deposits)

What separates "endurable wealth assets" from the rest of the physical world of consumer goods is their tendency to appreciate against the currency. Take classic cars for example. They usually appreciate versus the dollar while regular every-day cars depreciate as soon as you drive them off the lot! The same goes for Fine Art versus Not-So-Fine Art, and antiques versus their contemporary equivalents.

It all comes down to time... and appreciation over time. This is the difference between Wealth, Currency, and the rest of the real consumer world. The goal of wealth is, and always has been, to retain and/or gain purchasing power during the test of time.

But what is Purchasing Power? In a world where our currency is an ever-depreciating piece of paper such a concept is difficult to measure. I suppose it depends mostly on what you will need and want to purchase in the future when the time comes. And with a world full of things to buy and always new things coming to market, how can one possibly track such purchasing power accurately?

As a whole, we (the human race, the marketplace) are constantly measuring our currency and our wealth against a world full of physical things to buy. You see, there are two sides of this fence. On one side is our money, on the other is the things we buy. And as a group we measure the two sides against each other as time passes to make sure that the present and future division of the real physical world matches up with the currency and wealth scheme we are running parallel to it.

This process of measuring the two sides of the fence against each other is a very complex process, perhaps too complex for even a super-computer. Both sides of the fence experience the push and pull of supply and demand. Currency is in constant demand as men work in order to feed their families and, because currency is only held for a short timeframe, it is also in constant supply. So a very high, almost infinite demand for currency can be quite easily met with a relatively small supply when time is factored in.

Imagine an island of 100 men with a money supply of 1,000 sea shells. That's 10 sea shells for each man. But over the course of a year each man on the island works and earns an annual salary of 100 sea shells. So the total economic power of the island over a year is 10,000 sea shells. We could say that the GDP of the island is 10,000 ss. We could also say that the demand for sea shells is 10,000 over the period of one year and that demand is met by a supply of only 1,000 sea shells.

Now imagine that ownership of a piece of real estate on this island costs about 2 year's salary, and that there are enough pieces of land for each man to either own or rent one. So each piece of property might cost about 200 ss. The entire island's worth of residential real estate would be in the ballpark of 20,000 sea shells, twice the GDP. Yet the money supply still remains at 1,000 sea shells and that limited supply somehow meets demand.

The reason this works is because sea shells are the currency. They circulate and pass from hand to hand over a short timeframe. This is called velocity and it has the exact same effect on the value of a single sea shell as does the size of the money supply. On our island 1,000 sea shells change hands 10 times per year creating an island GDP of 10,000 ss. If they changed hands 20 times a year the GDP would be 20,000 ss. Or if we doubled the money supply to 2,000 sea shells that changed hands 10 times per year it would also yield a 20,000 ss GDP. So velocity and money supply of the currency have exactly the same effect.

This is the main difference between currency and wealth on their side of the fence as we measure their value against the other side of physical things. Currency has a fast velocity of circulation while wealth items have a very slow velocity. We hold a currency unit for maybe a month while we hold wealth items for years and years. So wealth items, as a store of purchasing power measured against the physical world, carry an almost 1 to 1 value ratio across the fence while high-speed currency carries a fractional value.

It is my contention that the denouement of our current state of affairs will carry gold from the commodity zone, across the fence, over to its ancient role as THE wealth reserve par excellence, bypassing completely the velocity-suppressed state of transactional currency. And that this shift will alter all value perceptions in the most astonishing ways one can imagine.

Consider that it is the bankers and central bankers that have gradually compressed the spring that is gold wealth first into velocity-bound circulating currency coins, then into fractionally reserved currency and finally into the mold of a common commodity, all the while protecting their own hoard and calling it a "reserve". What do they know that we don't? It is simple really. They know that eventually the spring must explode.

In the meantime, these same bankers have made a KILLING selling us all on the idea that paper indentures are the real value to be had. That by indenturing each other in perpetual debt servitude we can, as a planet, rise to a new and unlimited level of wealth in a world of limited resources. But the problem is that all this debt has now finally exceeded its own ability to continue existing parallel to a productive world. It can only exist now by Ponzi-cannibalizing itself to its own end. This is where we are today. The spring is held down by only a thread.

To get a handle on the potential energy stored in this "spring", let's take a look at how gold in its commodity mold compares to just one small piece of the rest of the physical world... oil. The total of all "proven" oil reserves in the ground are about 1.2 trillion barrels. Currently oil in the ground is trading at around $15/barrel. So the oil "slice of the pie" is worth around 18 Trillion USD. [1] Meanwhile all the gold ever mined is around 160,000 tonnes or about $5.5 Trillion at today's price. [2]

So confined to its central bank-commissioned commodity prison all the gold in the world is only worth about ONE-THIRD of all the oil in the world! Or said another way, oil could corner the gold market THREE TIMES OVER. This is what Another meant when he said:
Oil is the only commodity in the world that was large enough for gold to hide in.

Here is the full context of his statement:
Date: Sun Oct 05 1997 21:29

Everyone knows where we have been. Let's see where we are going!

It was once said that "gold and oil can never flow in the same direction". If the current price of oil doesn't change soon we will no doubt run out of gold.

This line of thinking is very real in the world today but it is never discussed openly. You see oil flow is the key to gold flow. It is the movement of gold in the hidden background that has kept oil at these low prices. Not military might, not a strong US dollar, not political pressure, no it was real gold. In very large amounts. Oil is the only commodity in the world that was large enough for gold to hide in. No one could make the South African / Asian connection when the question was asked, "how could LBMA do so many gold deals and not impact the price". That's because oil is being partially used to pay for gold!

You see it was oil in the ground that was used to secure gold in the ground through the paper gold market of the 90's. But those "gold in the ground contracts" would ultimately be backed by above-ground gold from the central bank vaults, at least to oil they would, or else oil agreements would be similarly discarded. This was the message Another brought. His insider knowledge that explained not only the volume explosion on the LBMA, but also the low ($300) price of gold happening at the same time as physical was drying up to the point that central banks had to provide supply.
People wondered how the physical gold market could be "cornered" when its currency price wasn't rising and no shortages were showing up? The CBs were becoming the primary suppliers by replacing openly held gold with CB certificates. This action has helped keep gold flowing during a time that trading would have locked up.

In my last post, Gold: The Ultimate Un-Bubble, I made a few predictions about the purchasing power of gold after the restoration of its ancient role. But probably the most important line in that post was this:

The price of gold is completely arbitrary.

Understanding this concept is the key to understanding coming events that will confound almost any observer. So let's expand it:

The value of gold relative to the value of anything and everything on the planet Earth is completely arbitrary.


The value of gold is completely arbitrary.

Gold is neither expensive nor cheap. It is theoretically free. It is a monetary conversion, like buying a Treasury or a money market fund. To the Giants, do you think gold is a game of "how big is my slice of the pie?" Or is it "how much is my slice of the pie worth?" Is it better to have a 15% slice of a commodity pie, or a 5% slice of the wealth pie? Is it more likely that all the gold in the world combined, when used as a wealth reserve, will be worth a large percentage of everything? Or that it is worth only 30% of the known oil reserves?

My friends and I are Physical Gold Advocates. We own physical outright and do so employing the same reasoning mankind used in owning gold throughout most of history. However, there is a major difference between our perceptions of this historic reasoning and the current Western perceptions so many of you are attuned to. Our's is not a mission to unseat the current academic culture concerning money teachings; rather it is to present the historic and present day views of the majority of gold owners around the world. Those of simple thought and not of Western education. Plain people that, in bits and pieces, own and use the majority of above ground gold.

Most contemporary Western thought is centered around gold being money. That is; gold inherently has a money use or money function; built into it as part of the original creation. This thought presents a picture of ancient man grasping a nugget of gold, found on the ground, and understanding immediately that this is a defined "medium of exchange"; money to buy something with. This simple picture and analysis mostly grew in concept during the banking renaissance of the middle ages and is used to bastardize the gold story to this day. Even the term "money", as it is used in modern Bible interpretations, is convoluted to fit our current understandings.

Much in the same way we watch social understandings of music, literature, culture and dress evolve to fit current lifestyles, so too did gold have a money concept applied to it as it underwent its own evolution in the minds of political men. This is indeed the long running, background story of our Gold Trail; an evolution, not of gold itself, but of our own perceptions of this wealth of ages. A evolving message of gold that is destine to change world commerce as it has never changed before.

Onward my friends

In ancient times there was no concept of money as we know it today. Let me emphasize; "as we perceive money today". Back then, anywhere and everywhere, all things known to people were in physical form. All trade and commerce was physical and direct; barter was how all trade was done.

If one brought a cart to market, loaded with 20 bowls and 20 gold nuggets, he used those physical items to trade for other valued goods. The bowls and gold had different tradable value; as did every other thing at the market. Indeed, gold brought more in trade than bowls. Also true; if a barrel of olive oil was in short supply, it might bring even more in trade than all the gold in the market square.

The understanding we reach for here is that nothing at the market place was seen as a defined money value. All goods were seen simply as tradable, barterable items. Gold included. Truly, in time, some items found favor for their unique divisible value, greater worth and ease of transport. Gems, gold, silver and copper among others, all fit this description. These items especially, and more so gold, became the most tradable, barterable goods and began to exclusively fill that function.

But the main question is: was there money in that market place? Sure, but it was not in physical form. Money, back then and today, was a remembered value in the minds of men. Cumbersome it may have been, but even back then primitive man had an awesome brain and could retain the memory values of thousands of trades. In every case, able to recall the approximate per item value of each thing traded. That value, on the brain, was the money concept we use today.

Eventually gold climbed to the top of in the most tradable good category. Was gold a medium of exchange? Yes, but to their own degree, so were the bowls. Was gold a store of value? Yes, but to a degree, so were dinner plates. Was gold divisible into equal lesser parts to define lesser barter units? Yes, but to a degree one could make and trade smaller drinking cups and lesser vessels of oil. Perhaps gold became the most favored tradable good because the shear number of goods for good traded made a better imprint on ones memory; the worth of a chunk of gold in trade became the value money unit stored in the brain.

Seeing all of this in our modern basic applications of "money concept", almost every physical item that naturally existed or was produced then also held, to a lesser degree, gold's value in market barter. But most of us would have a hard time remembering a bowls value and thinking of a bowl as money. The reason this is such a stretch for the modern imagination is because bowls, like physical gold, never contained or were used in our "concept of money". Back then, as also today, all physical items are simple barterable, tradable goods; not of the money concept itself. Their remembered tradable value was the money.

Money, or better said "the money concept", and all physical goods occupy two distinct positions in our universe of commerce and trade. They have an arms length relationship with each other, but reside on different sides of the fence and in different portions of the brain.

For example: say I take a bowl to the mint and place an official government money stamp on the underside. The bowl now is stamped at $1.00. Then I take one tiny piece of gold to the mint; one 290th of an ounce or at today's market a dollar's worth. They stamp that gold as $1.00. Which
physical item would be money? Answer; neither.

Using ancient historic reasoning and the logic of a simple life; the bowl could be taken to the market square and bartered for another good. Perhaps a dinner plate. In that barter trade, we would most likely reach an understanding; that the "bowl for plate trade" imprinted our memory with what a digital, numeric dollar concept is worth. Again, the 1.00 unit was only stamped on the bottom for reference. While the dollar concept is only a rateable unit number to compare value to; like saying a painting is rated from one to ten when judging appearance.

We could do the exact same thing without 1/ 290th ounce piece of gold as with the bowl above. In the process we again would walk away with the knowledge of what a $1.00 unit of money value was worth in trade. The physical gold itself was not the money in trade; the value of the barter itself created the actual money value relationship. Again, the most important aspect for us to grasp here is this:

----- The use of physical gold in trade is not the use of money in trade. We do not spend or trade a money unit, like the dollar, to define the value of gold and goods: we barter both goods and gold to define the worth of that trade as a remembered association to the dollar money unit. That remembered worth, that value, is not an actual physical thing. A dollar bill nor an ounce of legal tender gold represent money in physical form. Money is a remembered value relationship we assign to any usable money unit. The worth of a money unit is an endless mental computation of countless barter trades done around the world. Money is a remembered value, a concept, that we use to judge physical trading value. -----


Naturally, for gold to advance as the leading tradable good it had to have a numerical unit for us to associate tradable value with. We needed a unit function to store our mental money value in. In much the same way we use a simple paper dollar today to represent a remembered value only. Dollars have no value at all except for our associating remembered trading value with them. A barrel of oil is worth $22.00, not because the twenty two bills have value equal to that barrel of oil: rather we remember that a barrel of oil will trade for the same amount of natural gas that also relates to those same 22 units. Money is an associated value in our heads. It's not a physical item.

The first numerical money was not paper. Nor was it gold or silver; it was a relation of tradable value to weight. A one ounce unit that we could associate the trading value to. It was in the middle ages that bankers first started thinking that gold itself was a "fixed" money unit. Just because its weight was fixed.

In reality, a one ounce weight of gold was remembered as tradable for thousands of different value items at the market place. The barter value of gold nor the gold itself was our money, it was the tradable value of a weight unit of gold that we could associate with that barter value. We do the very same thing today with our paper money; how many dollar prices can you remember when you think a minute?

This political process of fixing money value with the singular weight of gold locked gold into a never ending money vs gold value battle that has ruined more economies, governments and societies than anything. This is where the very first "Hard Money Socialist" began. Truly, to this day they think their ideas are the saving grace of the money world. It isn't now and never was then.

When investors today speak of using gold coin as their money during a full blown banking breakdown, what are they really speaking of?

In essence, they would be bartering and trading real goods for real goods. The mention of spending gold money is a complete misconception in Western minds. Many would bring their memories of past buying with them and that is where the trading values would begin. Still, it would take millions of trades before the "market place" could associate a real trading value to the various weight units of gold. It took mankind hundreds of years to balance the circulation of gold against its barterable value. Only then could a unit weight value become a known money concept. In that process, in ancient times, gold had a far higher "lifestyle" value than it has seen in a thousand years. This value, in the hands of private owners, is where gold is going next.

If you are following closely, now, we can begin to see how easy it is for the concepts of modern money to convolute our value and understanding of gold. It is here that the thought of a free market in physical was formed. Using the relationship of a free physical market in gold, we will be able to relate gold values to millions to goods and services that are currency traded the world over. Instead of having governments control gold's value to gauge currency creation; world opinion will be free to associate the values of barter gold against barter currency. In this will be born a free money concept in the minds of men and governments. A better knowledge and understanding of the value of all things.
-FOA (2001)

What does "Gold is Wealth" really mean? It means that gold, all of the gold, is set parallel, on the opposite side of the fence from the rest of the world of consumer goods and endurable wealth assets, as the numéraire of wealth in its role as the one physical holding par excellence for the purpose of preserved purchasing power over long timeframes. That is, denominating global wealth in its physical form only, non-fractionally reserved, non-transactionally diminished through the velocity of exchanges, but in its stationary, one-to-one relationship with the rest of the world's wealth, plus or minus a few lesser competitors.

What's next

Time and volatility are now the greatest threats to the current global fiat regime. As time passes volatility will rise. Volatility means price action in BOTH directions, with only one possible conclusion. For this you must be mentally prepared to not end up a victim of meaningless signals.

The current façade of stability is highly manipulated and controlled, but cracks are opening and we are starting to see through the curtain to the wizard at the controls on the other side. Things are not as they seem. Signals are much more confusing in times like these.

Debt is the very essence of fiat. But as debt fails, the fiat currency can spike sharply in response. Expect the end game to look very different from what you have been told. The dollar as rated by the USDX, a flawed rating system, may rise briefly to something like 150, a level certainly not expected for a currency on the verge of a hyperinflationary collapse! The COMEX gold price, which is really just the price of paper, may drop to $200 or lower before trading is halted.

You can expect this kind of "spiritual experience" price volatility to be heralded as proof that the goldbugs were wrong all along. But don't be fooled. Many a strong hand will turn weak at the worst possible time. Many a bug will be lured by the warm glowing light only to be electrocuted. Don't be one of them.

Remember that ANY volatility is the enemy of the system. Even the price movements that don't go your way are still bringing down a system that has become a complete farce. Hold tight your gold wealth for a brighter day comes. The world of paper debt is, and has been, circling the edge of a lavatory vortex from which there is no escape.

The “PRICE” of short-term paper simply “cannot” be seen to go above PAR …as that in itself rings the death-knell of the System.

Yield in the short-end is essentially determined by how much you pay NOW ..to get back Par over the time period. When you pay $1001 to get back $1000 in 3 months …you're in negative yield. Of itself an oxymoron …and declaring for all the World to see …there IS no monetary Future.

Can ONLY happen in a “Global” Fiat construct FOFOA …the likes of which holds sway at present.

This System is unique in that we've "never" had an arrangement in place before where there was "no escape" monetarily speaking.

In the past, when the economic situation in (say) the UK deteriorated, one simply transferred to a stronger currency ...or Gold ...or Silver ...as they were all monetary functionaries of specie ...or at least "some" of the available currencies were.

We now have the situation where the entire System is stressed beyond coping ...with the $US/Oil configuration back-stopping said System.

It (the REALITY) will permeate ALL facets of "future-derived" valuations FOFOA. Bonds, Stocks, Real-estate ...and even our beloved PM's. (as they are NOW priced with a futures-leaning bias)

The closer you get to the Kernel however (short end of the curve ...<6mo)>DX

...that's why it's SOOO important NOW to dis-associate mentally from the $US pricing of PM's.

We KNOW they're "worth" more ...what we have to realise is ...they're essentially "priceless" under the current regime ...despite what the current market tells us.

What is being priced as Gold ...TODAY ...and what you hold in your hand ...are vastly different. (but you already KNOW that ;-)



Friday, December 25, 2009

Merry Christmas

And for anyone who hasn't seen it yet:
An important read...

Is it all just a Ponzi scheme?
By Eric Sprott & David Franklin

"So to answer the question - who is the Household Sector? They are a PHANTOM. They don’t exist."

Merry Christmas to all!!!


Thursday, December 17, 2009

Wednesday, December 9, 2009

Gold: The Ultimate Un-Bubble


The gold bubble has not popped! ...because gold is not in a bubble. There is no gold bubble. There is no such thing as a gold bubble. Never has been. Never will be. 1980 was not a gold bubble. And anyway, today's situation is entirely different.

In fact, gold is the opposite of bubbles. It is the inverse, the recipient, the beneficiary of "frothy air" that escapes at lightning speeds when bubbles pop. It has already capitalized on the demise two bubbles this decade. And it is now about to absorb the froth spontaneously expelled by two more, the two biggest bubbles the world has ever seen.

For all you technical analysts out there plotting and planning your eventual exit from gold before the blow off phase, I have a new pattern to introduce to you. I call it the Orbital Launch Pattern, or the Inverted Waterfall. In this pattern there is no blow off! It looks something like this...

As you can see, it is the inverse of The Waterfall Effect [1]:

Think about what happens when a rocket shoots for space. Its fuel is consumed in the heat of fire, it sheds its extraneous dead weight which falls back to earth and burns up on reentry, and its underlying asset, a satellite, stays up in perpetual orbit.

What causes bubbles to form?

The answer to this question lies in a simple comparison of a few actual bubbles. Most recently there was "the Housing Bubble" and before that, "the Tech Bubble" or "Dot Com Bubble". In 1929 we had "the Stock Market Bubble". There were the concurrent bubbles in 1720, the British "South Seas Bubble" and the French "Mississippi Company Bubble". And of course there was "the Tulip Bubble" of 1637 in Holland.

In all of these bubbles demand quickly overwhelmed supply in a feedback loop whereby new demand joined the stampeding herd causing the price to rise, causing more new demand to join the stampede and so on. A self-reinforcing feedback loop. Then leverage or credit was added to the rocket-fuel mixture boosting prices to even higher stratospheric levels. With cheap credit even the shoeshine boy could get in on the action!

And with the shoeshine boy in, new and improved Ponzi-paper derivative financial trading products were created allowing the hyper-acceleration of speculative trading. Accelerated paper trading created shortages in the underlying object of desire which in all the above cases was something that could be produced to meet demand. But these temporary shortages blasted the price even higher drawing more lemmings into the stampede.

At this stage euphoria, greed, delusion and mania took over. This was when, in most cases, over-supply had been stockpiled to meet the delusional demand and the true insiders took their profits and got the heck out. Cheap credit was then cut off and the weakest players were forced to sell causing a panic in the herd of lemmings who promptly ran straight off the cliff.

Of course there were subtle differences in each bubble. But the commonality was that the underlying object of desire in each case could either be easily ramped up to meet demand through a little extra human effort [2], or it could at least be valued objectively through common metrics like income, rent, earnings, interest or through careful valuation of its component elements.

The true fair value of the underlying object of desire became obscured by frantic greed-driven trading of, in most cases, its paper equivalent. Then, with leveraged profits driving the paper trade and ramped-up production of the physical object, separation between paper and physical was imminent.

Separation of paper and physical. Sound familiar? Well it's not the same as gold. It is the opposite.

Take the tulip craze. In the early 1600's a rare tulip virus was identified which made tulips bloom in a brilliant mosaic of colors. These rare flowers soon became a status symbol. Then in 1625 an especially rare "mosaic virus"-infected tulip bulb was found which rose in price to around $25,000 in today's dollars. The trading of "paper tulips" went delusional and by 1627 one of these rare bulbs sold for the equivalent of $75K! This price caused speculators to quickly cultivate this rare breed of tulip proliferating its valuable offspring. As the offspring multiplied the rare bulb became much less rare. Then, "one day in Haarlem a buyer failed to show up and pay for his bulb purchase... within days tulip bulbs were worth only a hundredth of their former prices. The tulip bubble had burst." [3] Can you see the difference yet?

In 2000 the Dot Com Bubble ended with a wave of dubious IPO's for tech and Internet companies with little more than a clever idea. The Housing Bubble ended with a rash of ridiculous condo conversions (old apartment buildings flipped into condos) and a giant inventory of new homes that could not clear at even half the price.

To make matters worse, the easy credit that had fueled the Housing Bubble became a drain on the real economy and when it was cut off, the Ponzi financing available to individuals came to an abrupt end.

Pop Goes the Bubble

So as we can see, one of two fundamental things causes bubbles to pop, and sometimes both. In one case, frenetic delusional demand outpaces supply until malinvestment delivers a surplus supply and then the bubble is done. In the other case, frenetic delusional over-valuations outpace rational objective metrics until easy credit must be cut off to save the banks and insiders and then the bubble is done.


Normally bubbles stay popped for a generation or more, at least until the pain of spontaneous impoverishment is forgotten. Of course, once the underlying object of repulsion undershoots a fair valuation the forces of currency inflation resume a gradual ascent. But this phenomenon is anything but bubble re inflation.

In some cases post-pop bubble froth appears to flow directly into new bubbles, as in the case of the Housing Bubble following the Tech Bubble. From this perspective, we are living in a "bubble economy", which is actually true. But these serial bubbles are really just the result of Central Bank inflationary policy meant to dull the pain of newfound poverty like a shot of heroin, and not a flight of real, hard-earned capital.

The flight of hard-earned, highly valued capital always flows down the inverse pyramid directly to the safety of its solid foundation. (Please see: All Paper is STILL a Short Position on Gold)

Golden Receivership

In 1971 we could say that the high value of the US dollar was actually in a bubble. The clearest sign that this bubble was about to pop was Charles de Gaulle's demand of US Treasury gold as France expressed its desire to end the dollar's wealth reserve function. In pure desperation, the gold window was closed and boarded up like a bungalow in the Keys before a hurricane. This display of pure weakness and fright was like a pitchfork impaling the dollar bubble and gold promptly rose 2300%.

In 1929 the Stock Market Bubble burst and even though gold was under strict parity rules, severe pressure had to be released by raising its price 70%. But even this wasn't enough to contain the panicked flight of capital so domestic gold possession had to be outlawed as well.

In 1720 France, John Law's paper currency and "Mississippi Company" bubble popped. The entire capital flow went right into gold and silver. A frantic Law first limited the amount of gold that could be redeemed to stem the flow, then attempted to turn his company stock into actual currency, doubling the money supply and further impaling his bubble. Ultimately he outlawed the ownership of gold in a desperate and feeble attempt to save his dying bubble. But this only made things much worse for him and he was finally forced by the King to flee France for Venice where he died penniless eight years later. [4]

Lastly, from the day the Dot Com Bubble popped until the Housing Bubble popped (7 years later) gold rose 140%. Then, again, from the Housing Bubble implosion until today (a little more than 2 years), gold has risen another 70%.

Two Historic, World-Class Bubbles are About to Pop

Bubble #1: Government Debt (with a nominal value in the tens of TRILLIONS)

Bubble #2: Perceived Wealth, denominated in purely symbolic, un backed, unsustainable-Ponzi-debt-based currency (with a nominal value in the HUNDREDS of trillions)

Darryl Robert Schoon writes:
In the early stages of capitalist systems, interest and principal can be serviced out of the debtor’s cash flow. In the final stage of “mature capitalist systems”, they cannot.

Capitalism’s final stage is what Minsky calls “ponzi-financing”, when debt payments can only be made by additional borrowing. This is what the US, the UK and Japan are doing today, having to borrow against tomorrow in order to pay yesterday’s bills.

For 50 years, not one Dollar of new debt created by the US government to fund the activities it does not wish to tax for has been repaid. The debt has simply been “re-financed” with new debt being sold to retire the existing debt.

At some point, the end finally arrives. Ponzi-financing cannot service debt forever. Investing in unhedged paper assets is the bet that it can. Gold is the bet that it cannot. [5]

Amazingly the mathematical upper limit of Ponzi-finance coincides perfectly with the mathematical limit of the 28-year rise in past-issued bond valuations!

It is the 28-year hyperinflation of the US$-denominated debt asset bubble that is about to pop. When interest rates are falling (like they have been for the past 28 years), the value of past-issued debt assets rise. Anyone who has been playing the bond market since 1981 has made a "gross" killing! (Please see: Bill Gross):

Bill Gross buys $23M mansion in Newport
Friday, August 14, 2009 10:20 PM PDT

Here is the chart of interest rates since 1981:

Flip it over and you will see the chart of Bill Gross' profits during that same time frame:

Of course the inflation of this 28 year mega-bubble was given an assist by the systematic suppression of gold prices beginning with Barrick in 1983 and accelerated by Rubin and Summers in the early 90's with their Gibson's Paradox scheme and Strong Dollar Policy.

But the thing about THIS bubble's rise that is so different from any rise in gold is that the price of past issued debt has a natural upper limit. And the "lowering of interest rates scheme" has a physical floor, an inevitable and unavoidable dead end... call it ZERO.

Yes, we have seen a couple ventures into negative interest rate territory lately. But this is simply anathema to the very concept of money, period. It is the ultimate froth, the last breath of air you can blow in before a bubble pops. It is the sure signal that the end is nigh.

When interest rates hit ZERO, they only have one way to go. And that means that the value of past issued debt, the very kind of TRASH that China is sitting on a land-fill mountain of, only has one way to go... DOWN. This is the very definition of a bubble that is about to pop. As Peter Schiff calls it, this is The Mother of All Bubbles! [6]

There is no such thing as a Gold Bubble, Never was, Never will be

Investment demand, the kind of demand that uses any object of desire as an investment rather than a useful commodity, can obviously flow into almost anything; Tulip bulbs, stocks, bonds, real estate, computer geeks working out of their garage, etc... And as investment demand exceeds utility demand, malinvestment occurs producing the object of desire beyond its commodity demand, creating an inventory surplus.

But changes in the gold price are mostly driven only by investment demand. Industrial supply and demand in gold is very stable relative to investment supply and demand. So any significant rise in the price of gold is a clear indication of growing investment demand and is also a positive confirmation of the premise behind that demand, that gold will rise. This creates a self-affirming feedback loop of positive reinforcement.

And since gold production cannot be ramped up to meet demand like it can in bubblicious items, there is no reason for gold to fall back. Gold mining does not debase gold in the same way that dollars, tulips, homes, Dot Com IPO's or government bonds are debased through production. Mine production is taken from known reserves that are already valued, owned and traded, and all gold on the planet Earth is a fixed amount, the same fixed amount it was a million years ago. All we do is move it around, like poker chips on a table, to those savers that value it the most.

Furthermore, the price of gold is arbitrary. This means that gold can go as high as the people of Earth want to take it without EVER exceeding objective valuations by common metrics like earnings, interest or the sum value of its component elements. Gold IS the element. It cannot be broken down further, except perhaps by the LHC.

One of the most common criticisms of gold's use as an investment is that it cannot be valued the way stocks, bonds and real estate can. They are all commonly valued by their yields, and gold has no yield, therefore it cannot be fairly valued, or so the argument goes. But if we invert this argument then gold can never be OVERvalued either, whilst those other things can, and are... in a bubble!

The price of gold is arbitrary, ergo, there is no such thing as a gold bubble.

And finally, as gold's role in the world evolves from barter item to pure numéraire, to transactional currency, to simple commodity, and ultimately to wealth reserve par excellence, its value relative to the rest of the world can (and has) shifted both up and down by as much as two orders of magnitude. Such phase transitions in the functional value of gold completely invalidate "fair value" methodologies like that used by Paul van Eeden.

1980? This Time is Different!

The only way for a purely symbolic fiat currency to survive the sudden, self-reinforcing and complete coup de grâce (death blow) from its nemesis, gold, is for the central banker to get ahead of spontaneously exploding interest rates without completely demolishing the economy on which it feeds like a mutant parasite.

In 1980 this was possible, but only barely, through a drastic rate increase to 20%, and only because the economy and the national debt load was much different at the time. If the same thing was tried today the economy and the government would come to a standstill, followed by a complete and utter collapse. For this reason it is not only unlikely, it is impossible.

In 1980, the US was a net creditor nation with a balance-of-payments surplus. The financial industry was small and stable. And the US was not subservient to foreign creditors. Today the national debt is over $12 Trillion, the US Treasury Secretary must kowtow to the Chinese, and the financial industry is a brittle behemoth built on derivative quicksand. [7]

Because of these fundamental differences in 1980, Paul Volcker was able to successfully defend the dollar against the same existential threat which WILL take it down this time. That threat is capital flow into the dollar's lifelong nemesis, gold!

You can thank all the players and their activities as identified by GATA for making this time different. You can thank the mining giants that sold forward paper contracts for their future gold. You can thank our Central Bankers who leased half of their gold into the market to squash their foe. You can thank Rubin and Summers for their "Strong Dollar Policy". You can thank Alan Greenspan for the easy green. You can thank them all for making damn sure that this time there is absolutely nothing the Fed will be able to do, nor will it want to!

Interest rates will rise with a vengeance, and soon. And the Fed will have no way to get out in front of them, and no desire to do so either, which would make the Fed look like the entity that single handedly destroyed the economy and the government's golden egg-laying goose. No, the Fed will prefer to let Mr. Market destroy its Ponzi currency scam with the Chairman's remote aspiration of avoiding the hangman's noose-wielding angry mob outside with nothing left to lose.

Unlike 1980, this time gold will go up and stay up! I'm not saying there will not be a temporary overshoot in actual purchasing power. But with the specter of hyperinflation looming, it will not be worth the attempt to capture the overshoot. An exit from gold may just capture YOU in the wrong paper at the most wrong time in all of history!

A Functional Change for Gold

Some people call it the spontaneous re-monetization of gold. [7] They mean that gold will resume one of the three basic monetary functions under the common concept of money. I, on the other hand, call it the complete and final demonetization of gold, meaning gold finally breaks all parity with paper equivalents and trades only in its physical form, trading as the inverse of paper. These re/de-monetization differences are only semantic. We are talking about the same thing. See my three part series titled Gold Is Money for more. [8][9][10]

As gold exchanges its commodity label for that of wealth reserve par excellence, it will mainly replace the debt-asset trade, not the equity or stock trade. But the equity trade will fall by a significant margin as well, in relation to gold, because the frothy debt trade has pushed far too many conservative investors into the risky equity market.

Orbit = Perpetual Levitation

Just as when bubbles pop they stay popped, so too when the ultimate Un-bubble Un-pops it will stay Un-popped!

Probability Distribution

So how much of your perceived wealth have you locked into a real, solid, "good as gold" wealth reserve? I shouldn't have to say this because it is so obvious, but it is clearly better to "cash out" of the paper game and "lock in" your profits BEFORE the two biggest bubbles in history pop. That way you beat the rush, so to speak.

As for the coming rush, by my back of the toilet paper calculation I figure we will soon witness somewhere between $XXT and $XXXT of perceived 2009 dollar "wealth" capital flow into roughly $XT worth of gold on a global scale. For this reason I created my probability distribution curve:

And for those of you that don't yet understand the difference between Freegold and Hyperinflation (which is apparent through statements like "what good is $100K gold if a roll of toilet paper costs me $100?"), I created this second "purchasing power" distribution curve to clarify my position:

A Final Note

For you new readers and those who are reading this post on other websites, I would like to state for the record that my thoughts are not original. My blog now has 90 original articles written by me dating back to August 23, 2008. They are a record of my journey understanding the writings of the enigmatic Another and FOA, and how they relate to our current crisis. It is to these two anonymous messengers that my blog is a humble tribute.


[1] The Waterfall Effect
[2] Gold Price is No Bubble by James West
[3] The Dutch Tulip Bubble of 1637
[4] That's Not How Bubbles Work
[5] 2010 READY OR NOT HERE IT COMES Constant prosperity through credit is no more possible than constant peace through heroin
[6] The Mother of all Bubbles by Peter Schiff 2008
[7] Why the Global Financial System is About to Collapse
by "John Law" 2006
[8] Gold is Money - Part 1
[9] Gold is Money - Part 2
[10] Gold is Money - Part 3

Tuesday, December 1, 2009


Let's spin this globe and take a look at things from a slightly different angle. If we could inventory the entire planet, every real, solid, tradable item we came across would belong to someone. Someone somewhere, or a group of someones would have bragging rights to each and every thing on this planet.

Each one of these items that is the least bit tradable would have some sort of value attached to it. Of course some things are not tradable. For example, a mountain in the United States that has been designated by the collective as public land is not a tradable property. Neither is Antarctica.

But those things to which property ownership rights can be transferred must have a value of some sort. And this value is a numerical representation of their relative usefulness or desirability to humanity when compared to everything else. Of course, less tradable items, like the Kremlin or the White House, need not have a calculable value in any real sense.

Equity versus Debt

Equity is the value of a person's interest in a piece of property in excess of all other claims against that property. If you financed your home you probably pay a little principle and a lot of interest each month on your loan. The principle portion of your payment generally gets added to your equity position in your home.

In the modern world you can obtain bragging rights to a piece of property in a number of ways. But that doesn't necessarily mean you own it. If you purchase something for cash then you have full equity in that item, and no one else has a claim against it. Or you can also obtain bragging rights by borrowing, leasing or financing that same item. This is different than paying cash because it delivers to you the use of that item, but not the full ownership.

Now some items that we find in our planetary inventory are productive equipment items. These are things that if used properly can increase the amount of wealth in the world. A giant crane, for example, can be used to build new structures that can then be valued and traded relative to everything else in the world.

With nearly 7 billion people in the world today, the various tasks of production have been divided to the extreme. For example, you will be hard pressed to find a man operating a crane, who also owns that crane, and also owns the project he is working on as well as the land underneath it. If such a man exists, then it is surely a very small project in his own backyard.

So cranes are generally loaned, leased or financed to those who want to build, by those who want to own (productive capital). And the return to the owner of the crane is a function of the value of the use of the crane. Not the appreciation in the tradable value of the crane itself. Can you see the difference? If someone owns a full equity position in a piece of productive capital, he does so in order to earn a return, a yield based on the value of the USE of that capital. He does not count on the value of the crane increasing in the future so that he can sell it for a profit. There is a big difference! Think about this.

Ponzi Value

Let's imagine I personally paid cash for my home. It was not my best investment as it turns out. But at least I have a full equity position in it. (Let's ignore the separate issue of property taxes to the collective for the sake of this discussion).

My next door neighbor, on the other hand, financed his home. Earlier this year he realized that his equity position had gone very negative and he walked away. Today, 9 months later, his home still sits empty.

But here is my question: Who actually owns that home next door? And what do they actually own? What value (relative to the rest of the real world) do they actually hold? And how does that true value they own compare to the numerical value they believe they own, the one that is printed on their monthly portfolio statement?

The answers to these questions are not as clear as they might seem, at least not the answers I am seeking. We could simply walk down to the county recorder's office and pull the title to that property. It would give us a name, perhaps two names, and a value number. But even the bank's name on that title does not represent a full equity position in the house.

If we were to look at the bank's balance sheet we would see that house (now that my neighbor has left) listed in the asset column and a corresponding number in the liability column (the remainder of the loan my neighbor abandoned). The two numbers will probably cancel each other out. Perhaps it says $400,000 next to the house in the asset column, and -$400,000 in the liability column, for a net position of zero. The problem is that the house can only sell for $250,000 in today's market. This makes the bank's true net position a negative number, -$150,000. And that is only AFTER the bank sells the house. In the meantime, there are costs associated with holding the title, which the bank currently must pay. So who owns the house next door?

For the answer I am looking for we need to play things out the way they should have played out and drill down to who would end up with a full equity position on that house next door. I am also interested in what would be the true relative value of that equity position and how that number compares to this person's or group of people's perception of the value they hold today. Who is it? What do they think they have? And what do they really have?

Drill Down

If the bank was left to its own devices it would have to reconcile its assets and liabilities which would leave that bank insolvent with a negative net worth. So the bank is obviously not the true owner (with bragging rights) of the house next door. What about the bank's managers? Nope, they will be out of a job after liquidation of this insolvent bank. What about the bank's stockholders? These are the real owners of the bank. Nope. As it turns out, they own nothing but a really big negative number. In other words, they own a very real debt that must be paid! Funny how this bank stock traded at hugely positive numbers for the last two years while what was really traded was ownership of a debt!

So in a full liquidation of the bank's assets, who gets them? Well, the way it is supposed to work, the holders of bonds issued by the bank would be the ultimate recipients of the liquidation value of the bank. These are the people that loaned money to the bank. But in the case of commercial banks this seniority ladder is further complicated by an even more senior creditor, the depositor.

Now, in a full liquidation of all insolvent banks we would need to see all homes "owned" by the banks (REO's) go on the market until they were sold. We would see prices fall until they reached a level in which the entire market could be cleared and all debt positions change hands into equity positions.

A rough estimate of this scenario would mean an additional haircut of 50% from current housing price levels. So in the case of my next door neighbor, the empty house of debt would likely be filled with a full equity position (along with all others) at, say, $125,000 (50% of $250,000).

Moving from Debt into Equity Positions

So in the above scenario we have moved all property from a position of debt ownership to a full equity position that can be balanced against the rest of the real world. And in the process we have completely wiped out the original homeowner (who lost all perceived equity in his home), we wiped out the bank (which became insolvent and had to be liquidated), we wiped out all the banks stockholders (debt owners), and we, at best, gave the bondholders a 70% haircut on their savings. At worst (with an insolvent FDIC) we also wiped out all the bondholders and gave the depositors a haircut on their deposits!

Of course this didn't happen because of the FDIC, which is really just a fancy façade in front of a printing press. But if the FDIC was needed to make the depositors whole, then the bondholders were wiped out anyway.

This is the deflationary collapse scenario. This solution for changing debt into equity preserves the sanctity of the senior debt holder (only to the extent of the true value of the physical assets) and the numéraire (denominator) of the debt (the dollar). It keeps the dollar intact and, had it been allowed to play out, would have likely allowed the US Treasury to continue issuing bonds for another whole cycle. But this scenario was never meant to be. It wasn't even an option.

Some people have proposed a different way that debt positions could have been forced and crammed into equity positions had it been done early in the crisis. You see, the difference between debt and equity is that debt is denominated by the numéraire (the dollar), ranging from 0 to infinity, while equity is denominated in percentage terms of ownership, ranging from 0 to 100.

This is why the stock market is known as the equity market, and the bond market is the debt market. When you buy a stock, you are buying a percentage of ownership in that company. But when you buy a bond, you are buying a debt specifying a fixed payment denominated in dollars.

In the stock market you share in the profits or losses of the company, but you are theoretically isolated from the volatility of the numéraire. In the bond market you are theoretically isolated from the performance of the company or public entity, but you are exposed to the risk of total loss through a purely symbolic currency.

The way some say they could have forced debt positions into equity positions would have been to forcefully convert all debt (bonds) into percentage shares of the debtor. Then they would give enough shares to the debtor to match his initial starting capital (down payment). His initial equity position. This keeps the debtor in the game, which keeps the underlying asset valuable to a greater degree than in a massive liquidation of like-kind assets. (This would work similarly for underwater public companies and underwater homeowners alike).

Let's say the ultimate bond holders owned 75% of a $400,000 house upon loan creation and the homeowner put down a 25% down payment. Then the value fell by half. Now the entire asset is worth $200,000 and the debtor is in the hole for $100,000, while the bondholder is still showing a $300,000 "asset" on his books. Choice A; the debtor walks away and the house liquidates for $125,000 and the bond holder gets $125,000. Choice B; the homeowner gets 25% equity in $200,000 and stays... no liquidation! Now the bondholder has a real equity position of $25,000 or 20% more than under choice A! And the system becomes stable and sustainable once again because it is now based on equity, not debt!

There is a precedent for this type of non-usurious system in the Bible and other religious texts. [1] But alas, it would be too logical to do it the easy way. So instead we will do it the hard way. Since we didn't do it by force (forced equity), or allow it to happen within the system's "rules" (deflationary collapse), this highly unstable system will be forced to stabilize itself.

Sustainable Stability, Stable Sustainability

Say that ten times with your eyes closed! :)

Debt is inherently unstable. This is because debt can be destroyed instantly by non-payment, by default. "I'm not going to pay" or "I can't pay" simply destroys debt instruments held as a wealth reserve. In today's marketplace new debt is created extremely easily and casually. A new debt instrument is issued with the ease of a single signature, and then that debt is traded into the marketplace, marked to market as time passes and paper circulates.

Here is a news story that demonstrates the marked to market instability embedded in a fixed debt. Nakheel, the developer of palm tree-shaped islands off the coast of Dubai asked to have marked to market trading of its debt paper halted while it worked out the details of its default because the trading itself could affect the details yet to be worked out. [2]
DUBAI – Dubai's Nakheel asked for three of its listed Islamic bonds worth $5.25 billion to be suspended pending details of restructuring plans at its parent company, a move likely aimed at dampening speculation on the bonds.

The request briefly stalled but did not stop trading in the bonds, which are exchanged over the counter and not on the bourse, where the listing is regarded as a technicality.

The request also added to confusion that has reigned in the markets since the Dubai government last week said it would seek debt standstill agreements from creditors to Nakheel and Dubai World...

"Speculation on the bonds" means the marked to market trading of this "over the counter" debt instrument. Even the anticipation of a debt default can crash a system built on debt! And non-payment is not the only path to default.

If you are the world's largest engine of easy and casual debt creation and also the maker of the paper that denominates it, there is another way to default. And there is another kind of default the market can anticipate. Devaluation!

Another threat of extreme instability in a debt-based system is the chain reaction effect. Almost every entity that issues its own debt also holds the debt instruments of other entities as its reserves. So when one large entity defaults, the falling domino effect can be systemically catastrophic. And to complicate things even more, the methods of stemming systemically catastrophic consequences themselves have an even worse systemically catastrophic outcome; the collapse of the numéraire.

Debt is unstable because it is entered into (created) so lightly, and it is based on the assumption of a fixed future performance by an entity or individual. An assumption that is currently proving to be flawed during an economic contraction.

A system that is built upon equity positions is much more stable as equity agreements are entered into with much more gravity. If both parties share in the risks and rewards of future performance they will take everything more seriously. Also, equity agreements are based on the flexible assumption of variable future performance! A much more realistic assumption.

Finally, equity agreements by their very nature are more tied to the size of the real physical world than are debt agreements which are created at the drop of a hat.

This is why the global equity markets are about half the size of the debt (bond) markets. It is also why a virtual mountain of derivative "insurance policies" has grown around the debt markets like a terminal cancer while no such equivalent monstrosity strangles the equity markets. Credit default swaps and interest rate swaps are all a futile attempt to make an inherently unstable debt-based system stable and sustainable. There is no such need or incentive in an equity-based system.

In an equity-based system, any entity can still issue unlimited paper notes if it wants. Just like the US government does in its crazy debt-financed world. The difference is that the marketplace will price that paper against the real underlying property as it is issued. If a company doubles its issue of stock certificates to raise cash, then the price of each outstanding share will be cut in half. If a sovereign money-printer doubles his currency base to pay his cronies, then the value of each currency unit will be cut in half. But in today's debt world, a company can keep issuing more and more bonds until it ultimately collapses under the weight of its debt service. The same goes for countries.


Instability is the greatest burden the current system places on the real economy. It is what makes it unsustainable. As I read in a recent article:
Business is complicated enough without being inadvertently drawn into the [currency] exchange rate business...

Companies can hedge [this currency risk], to the tune of a notional value of roughly $600-trillion these days. But whereas larger companies, and those in developed countries, can rely on such hedging, companies in all the developing world cannot. [3]

So the instability of this debt-based system grows ever more dangerous as efforts are made to stabilize it. The growing mountain of derivatives is truly a house of cards capable of bringing down the whole system! How's that for stability and sustainability?

The question then becomes how will Mr. Market convert debt into equity and bring the system back to a state of sustainable stability and stable sustainability? Obviously our money masters have refused to go there willingly. Obviously our banks have refused to give up their debt positions. So what is next?


I found this great line in Topaz' Time Currency blog:
The first rule of Faith-based systems is that any and every thing must have a paper equivalent for "valuation" purposes ...in order to compare apples and apples.

This is a great quote on many levels. Today we use these paper equivalents not only for valuation purposes, but also as a way to "save the real thing for future use". The quote also shows the mind set of the system. Paper compares with paper as apples to apples. But can this really be true when comparing equity paper with debt paper and its cancerous tumor of derivatives? With global equity markets at around $35 trillion and global debt markets ($70T) plus their derivatives at more than a quadrillion?

If Mr. Market is going to bring things back in line with reality, how will this be accomplished given the disparity of value between debt and equity?

Remember earlier I said this:
In the stock market... you are theoretically isolated from the volatility of the numéraire. In the bond market you are theoretically isolated from the performance of the company or entity, but you are exposed to the risk of total loss through a purely symbolic currency.

The purely symbolic currency. This is how Mr. Market is going to bring the paper world back into balance... apples to apples. In one fell swoop a foundation for stability and sustainability will emerge through natural morphosis!


If today's deflationists are correct then the numéraire will remain strong or even grow stronger while the world runs from equity ownership of the physical world into the warm embrace of casual debt creation stabilized by its own Ponzi-like exponential growth pattern.

Think it through. We don't just muddle through from here. We either shift toward equity or debt. We are currently not in stasis.

Perhaps at some point the Fed would like to crash the equity markets in order to drive you into its warm (debt) embrace. As someone from London once said, wash, rinse, repeat. Right? Will this be enough to convince Mr. Market to give up on equity positions? Could a stunt like this be enough to convince a world full of realists, producers and savers to hand their claims on real property over to the paper pushers in exchange for a signature?

For those of you who can't already see the obvious answer, as Another once said, "time will prove all things."

What about Gold?

Gold is a little different. Yes, it is the ultimate equity position with assured future global liquidity. Yes it is the ultimate wealth reserve as a known timeless claim on anything you may need in the physical world of your future. But it is also a multi-generationally depressed numéraire of the value of the entire physical planet.

Yes, apples to apples. Paper to paper, physical to physical.

Let's try a simple word replacement in Topaz' quote:

The first rule of [physical equity]-based systems is that any and every thing must have a [physical numéraire] equivalent for "valuation" purposes ...in order to compare apples and apples.

I will leave you to do your own math on where the real value of physical gold will come to rest on the other side of morphosis. I have already presented my calculation in other posts.

The bottom line is that debt (credit) markets appear to work great in a seemingly perpetually-expanding economy, but they are completely unstable, unsustainable and deadly in a severe contraction.

An equity-based system is stable and sustainable and a debt-based system is not. Mr. Market knows this in the same way a million individual ants can find the same piece of meat a mile away. And for the record, I don't buy the idea that an evil cabal can stop the tide from coming in.

I leave you with this little ditty from Bloomberg last Friday...
Nov. 27 (Bloomberg) -- Wall Street’s system for determining payments on derivatives linked to the debt of defaulted companies is showing cracks less than a year after securities firms changed practices to avoid “Draconian” regulation.

Credit-default swaps tied to Thomson SA, the Paris-based owner of film processor Technicolor Inc., paid some holders 30 percent less than those with contracts expiring a day later. In Japan, owners of swaps on Aiful Corp. haven't been compensated, though one of its banks said the consumer lender skipped loan repayments. Dealers can't agree whether to reimburse investors in Mexican cement maker Cemex SAB’s debt swaps.

Disparities are arising in spite of practices adopted in April and July to standardize settlements and curb risk in a market that exacerbated the worst financial crisis since the 1930s by contributing to the downfall of American International Group Inc. Analysts at Bank of America-Merrill Lynch, Barclays Capital and UniCredit SpA say changes are needed as dealers examine how to interpret existing rules to maintain investor confidence.

“The first cracks are being shown in the protocols,” said Edmund Parker, head of derivatives at Chicago-based law firm Mayer Brown LLP in London.

The rules are being tested as the global default rate rises...


[1] History of Usury Prohibition
[2] Nakheel asks for sukuk suspension
[3] As the world floats