There is a temptation to compare anything of note in financial markets to the panic of 2008. It is exceedingly easy to do, and considering the scale and scope of everything that went wrong all at the same time it is very likely that Autumn 2008 will remain the benchmark. That does not mean it is the sole measure of comparison for anything that takes place in the intervening months and years.
Primarily, there was so much obvious dysfunction at that time it serves as the model for how we think malfunction should look. Yet, liquidity problems need not look like 2008 at all; there were the problems in 2011, as well as tightening throughout 2007. The former year was notable in its European flavor, but dollar stress was again a prime problem. The latter year, 2007, also offers important lessons for those willing to heed them, namely that liquidity can fester largely unseen by the wider gaze of distracted “markets” full up on Fed faith. Stock prices, for example, ran to new highs while the foundation rot out beneath them.
There was much more than a flavor or whiff of what was to come in 2008 in the air in August 2007 – the eurodollar freeze that month should have been broadly interpreted as a systemic dollar problem, leading to collateral and repo liquidity issues that were never fully resolved. Yet, time after time it was ignored, or if acknowledged at all, it was narrowly interpreted as a segmented curiosity. That was the impulse of the “everything is contained” sentiment.
Collateralized dollar markets turned downright ugly heading into 2008 because they were unprepared to deal with largescale repudiation and wholesale shrinkage of available securities for repo. It got so bad that gold took three very distinct turns as collateral of choice, providing a marginal boost to “dollar” balance sheet access at some very acute and dicey moments. At the end of the third, amidst financial wreckage, forward rates briefly dipped to negative – 3 trading days beginning November 20, 2008, for the 1-month; 2 days for the 2-month. No other negative indications in gold forwards were recorded.
The relation of such obvious backwardation to such massive negative price action is that chain of gold as collateral of last resort. Desperate banks or other financial participants with legal access to stores of gold that are not their own in title, unallocated accounts, can move it in pinch to secure lending arrangements. Eventually, however, that gold must be replaced lest customers get curious as to why gold is unavailable for their own use and withdrawal.
So we see a process of heavy use of gold as collateral, smashing gold prices as this artificial/collateral supply of gold (both physical and paper) is too much to absorb. Then, almost as if a light switch were toggled, prices roar back in the heat of the inevitable physical shortage as banks, now short metal they don’t really own, rush to restock.
The net result is massive volatility in gold prices against the major currencies, but these actions imply or demonstrate little fundamental information about either the gold markets or the currencies themselves. The only “pure” information or analysis to be gleaned here is the state of systemic dollar (or euro, yen, etc.) liquidity in wholesale format. The rising dollar in 2008 said nothing about the state of affairs inside the United States, though some still cling to the silly idea of the “cleanest dirty shirt”.
While it may have been comforting to hold such a view, the rising dollar was simply the massive dollar short coming back to bite the reserve currency as liquidity was pulled out of the system in waves. As the dollar rose, gold went into extreme volatility and repo markets went haywire. That’s not a clean dirty shirt, it is systemic trouble in the reserve currency that was far too over-leveraged globally (particularly through eurodollar conduits).
So now, after having admonished reliance on 2008 as a benchmark, I’m going to do exactly that. While the extremes in volatility in repo markets and the dollar pricing may not be as much as 2008, gold behavior has been moreso. Where there were only a few days of negative forwards, and only briefly to two months, there have been 11 consecutive trading days beginning July 8, 2013, and running out to 3 months. We have also observed two negative days of 6-month forwards as well, meaning such severe shortage was perceived to persist half a year.
These are not “normal” market conditions for gold, or for collateralized liquidity. Something is very much amiss in systemic dollar-land, but it remains, as in 2007, hidden in the opacity of so much OTC framework. The action in repos and gold belies such careless risk-taking and complacency in other higher profile “markets”, another close comparison to the conditions in 2007. And as faith in central banks and their “money stock” measures abounded then, it remains under the umbrella of “unlimited” money “printing” in 2013.
Eventually, however, enough participants will make the “curious” connection between collateral shortage, malfunctioning collateral markets and the impotence of central bankers. If they have created so much “money” that “tail risks” are a thing of the past, why would there be so much stress, persistent at that, in collateralized lending and global dollar markets? The obvious incongruity in the answer to that question makes comparisons to the crisis years unavoidable.
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