To me, Exter’s view makes a lot of sense, because when you stop to think about it, every effort to inflate a currency when that currency is a liability currency rather than an asset currency like silver or gold, brings with it ever more debt. That is true, because in a fiat currency system, debt is the raw material from which money is created. So it’s not exactly as if money is created out of thin air, as most gold bugs like to say. Fiat money is in fact created from debt, and debt is the very thing that is leading to a major credit contraction in the first place!  And so, as more money is created, more debt is also created, thus rendering the system even more insolvent!

That is actually what happened during the Great Depression. Contrary to all that is claimed by the establishment, gargantuan efforts were made during the 1930s to pump money into the banking system. (Read America’s Great Depression, by Murray N. Rothbard.)  The gold standard did not retard efforts to provide liquidity into the banking system. Money was pumped into the banking system with reckless abandon but it could not turn the monetary or economic contraction around, because banks would not lend and borrowers who were creditworthy would not borrow. Does that sound familiar?

What about during the current depression? On the front page of Wednesday’s Wall Street Journal, the above chart was prominently displayed. It shows that, during 2009, outstanding loans at FDIC-insured banks contracted by 7.4%. That is the biggest decline in loans outstanding in 67 years! This contraction has taken place despite the enormous stimulus pumped into the system, which was reportedly 3 times greater, vis-à-vis GDP, than in the 1930s. According to the Wall Street Journal, at the end of 2009, more than 5% of all loans were at least three months past due! That is the highest level recorded in the 26 years the data have been collected.

All of this is happening despite the fact that, unlike the 1930s, we now have FDIC deposit insurance to ensure depositors do not panic and take their money out of banks. In fact, if I remember correctly, FDIC insurance was actually doubled in 2008 to $200,000, to make sure banks remained solvent and thus capable of expanding the monetary system and economy.

During the 1930s, there was a huge run on banks, which meant the lending base of the banks disappeared. But why has bank lending contracted NOW, if the deposit base has been protected by FDIC insurance not to mention the horrendous “stimulus” pumped into our system by the Fed?

The answer is simple. FDIC dulled the senses of bank lending officers by removing the threat of a run on banks. With that threat removed, all constraints on sensible lending practices have been abandoned for the sake of quick quarterly profits and big bonuses to bankers.

But alas, those bonus-grabbing bankers who pumped money out the door with no consideration for its safe return, have run into a brick wall of bank insolvency. With banks quickly going broke not from deposit withdrawal but from downright stupid and inept credit policies, the banking system has reached that point of portfolio pathology when the “pushing on a string” analogy of the 1930s is once again appropriate, even with FDIC insurance. It took insolvency of the banking system before the thick-headed FDIC-protected bankers could understand that lending to people who cannot repay them was a bad idea. But they have apparently finally caught on to that fact. So new loans are not being made as rapidly as old loans are running off the books or being charged off via bankruptcy.

The bank lending chart shown above, which pertains to U.S. banks, is one reason I think we are getting ready for another major decline in equity markets and asset prices in general. You cannot expand let alone sustain a fiat currency system at current levels if loans outstanding are contracting. But on a global basis, I also think the Global U.S. Dollar Liquidity Measure first brought to my attention by Charlie Clough during the Asian Crisis is telling us to look out below! Note the enormous drop in this measure of global liquidity of the world’s reserve currency. It has fallen from over 48% annual growth to about 16% now, which is still large, but not compared to the quantity of monetary barbiturate required to keep the patient alive a few months ago. 

Note also that after this measure of liquidity fell sharply in the past from the two prior peaks (dot-com bubble in 2000 and housing liquidity bubble in 2005), we had a major collapse of asset prices. Logic coupled with good Austrian economic theory suggests the next major implosion is imminent.

“There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.” (Ludwig von Mises) 

Thus, I remain cautious in the near term, regarding equity investments in general, and think it still remains prudent to take some profits from gold share earnings from 2009 to build cash for a great buying opportunity in gold shares if/when they get taken down with the market in general. The baby will no doubt get thrown out with the bathwater, but once market participants realize how great gold mining profits will be, we should witness the buying opportunity of a lifetime. Keep at least some of your powder dry for what I think will be the buying opportunity of a lifetime for gold mining shares.