Here's what happens when a central bank goes bust

If you are having trouble viewing this email, or you'd like to share this article with your friends, click here July 26, 2013 Kiev, Ukraine Over the past several decades, people around the world have become so brainwashed that few people really give much thought anymore to the safety of their currency. It's not something people really understand... there's apparently some Wizard of Oz type figure at the top of the hill pulling all the levers of the monetary system. And we just trust them to be good guys. This is partially true. Today's financial system is dominated by central bankers who have been awarded nearly dictatorial control of global money supply. In allowing them to set interest rates, they are able to control the 'price' of money, thus controlling the price of... everything. This power rests primarily in the hands of four men who control roughly 75% of the entire world money supply: Zhou Xiaochuan, People's Bank of China Mario Draghi, European Central Bank Haruhiko Kuroda, Bank of Japan Ben Bernanke, US Federal Reserve Four guys. And they control the livelihoods of billions of people around the world. So, how are they doing? We could wax philosophically about the dangers of fiat currency. Or the dangers of the rapid expansion of their balance sheets. Or the profligacy of wanton debasement through quantitative easing. But let's just look at the numbers. In theory, a central bank is like any other bank. It has income and expenses, assets and liabilities. For a central bank, assets are typically securities or commodities which have value in the international marketplace, such as gold or US Treasuries. Central bank liabilities are all the trillions of currency units floating around... dollars, euros, yen, etc. The difference between assets and liabilities is the bank's equity (or capital). And this is an important figure, because the higher the capital, the healthier the bank. Lehman Brothers famously went under in 2008 because they had insufficient capital. They had assets of $691 billion, and equity of just $22 billion... about 3%. This meant that if Lehman's assets lost more than 3% of their value, the company wouldn't have sufficient cushion, and they would go under. This is exactly what happened. Their assets tanked and the company failed. So let's apply the same yardstick to central banks and see how 'safe' they really are: - US Federal Reserve: $54 billion in capital on $3.57 trillion in assets, roughly 1.53%. This is actually less than the 1.875% capital they had in December. So the trend is getting worse. European Central Bank: 3.69% Bank of Japan: 1.92% Bank of England: 0.843% Bank of Canada: 0.532% Each of these major central banks in 'rich' Western countries is essentially at, or below, the level of capital that Lehman Brothers had when they went under. What does this mean? Think about Lehman again. When Lehman's equity was wiped out, it caused a huge crisis. The company's liabilities instantly lost value, and almost everyone who was a counterparty to Lehman Brothers lost a lot of money because the company could no longer pay its debts. Accordingly, if the US Federal Reserve's assets unexpectedly lose more than 1.5% of their value, the Fed's equity would be wiped out. This means that any counterparty holding the Fed's liabilities (i.e. Federal reserve notes) would lose. More specifically, that means everyone holding dollars. Theoretically if a central bank becomes insolvent, it can be bailed out. It happened in Iceland a few years ago. There's just one problem with that thinking. Iceland's government wasn't in debt at the time. So they were able to borrow money in order to bail out their central bank. Today the government is in debt over 100% of GDP, but the central bank is solvent. But governments in the US, Europe, Japan, England, etc. are all too broke to bail out their central banks. These governments are already insolvent. So if the central bank becomes insolvent, there won't be anyone to bail them out. This is one of the strongest indicators of all that the financial system as we know it is finished. When central banks can no longer credibly issue liabilities, and their home government are too broke to bail them out, this paper currency standard can no longer function. Such data really underscores the importance of owning real assets such as productive land and precious metals. Given its nominal roller coaster ride lately, there has certainly been a lot of scrutiny and skepticism about gold. But to paraphrase Tony Deden of Edelweiss Holdings, if you dispute the validity of gold as a hedge against declining fiat currency, that makes you, by default, a paper bug. Can you really afford to be confident in this system? [To be continued on Monday... when I'll give you some even more surprising numbers.]  Simon Black Senior Editor, SovereignMan.com Find out how to invest in the most primal resource there is In last month's issue of Sovereign Man: Confidential our Chief Investment Strategist, Tim Staermose, uncovered 5 junior mining companies in Australia that have plenty of cash in the bank, and whose stocks are selling at a sharp discount to their net balance. Essentially you're paying cents on the dollar for these companies, while their operations and assets are thrown in for free. This month's massive issue of SMC includes: A complete breakdown and step-by-step guidance on how to establish residency in Chile under the 'person of means' immigration program, along with necessary document templates and Simon Black's personal contacts in the country to help you go through it successfully. The requirements are extremely low, but it most likely won't stay that way for a long time. Chile is becoming an increasingly popular place, favored by people from all over the world for its business climate, agriculture potential and a great standard of living. Learn about water as a unique investment opportunity. The fundamentals are clear-- there's a fixed supply of it on Earth, yet demand for it is increasing due to rapid population growth and agricultural needs. There are not many ways of how you can benefit from this trend. Water is highly localized, difficult to transport, and places with clear water rights are rare. Yet we uncover how you can invest in water as well-- this is another SMC exclusive deal, not found anywhere else. Hear from Tim Staermose from the South Pacific where he takes you on a boots on the ground tour of an ultimate tax haven that hardly anyone has ever heard of. We're reviewing banking in Norway as an excellent alternative to keeping your money in undercapitalized banks in bankrupt jurisdictions. Best of all-- you can do it without leaving home. Important updates: Low cost IRA setup; Agricultural fund; Resilient community; Trip to Singapore with Simon with hands on guidance. To get immediate access to the knowledge contained within this month's issue, and all the back issues, click here to get the full details on your invitation to join Sovereign Man: Confidential today. Follow Sovereign Man Facebook Twitter Google+ Neither this email communication nor content posted to the website SovereignMan.com is intended to provide personal financial advice. 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