By Julian D W Phillips

Since August 2007 we have watched the sub prime crisis turn into a credit crunch and from there into a liquidity crisis, writes Julian Phillips of

Like a cancer spreading through the financial system it suddenly struck a vital organ, taking the seemingly benign tumor into an illness that the doctors are fighting to defeat.

Not only has the sight of banks refusing to lend to other banks moved to a new level. Now major banking institutions are tumbling in the face of its onslaught. With the mid March rate cut on direct loans to commercial banks from the Federal Reserve, the drama had a gear shift change. The Fed lopped another quarter point off the discount rate , saying it will allow primary dealers to borrow in exchange for a broad range of investment grade collateral.

The Fed also extended the maximum term of discount window loans from 30 days to 90 days, but it still has not accepted ownership of the assets against payment, so leaving the debt crisis intact.

In the same weekend it saw Bear Sterns Collapse, and gave its hurried blessing to the deal of J.P.Morgan Chase Co. wherein JPM agreed to buy Bear Stearns for $2 a share after, down from the stock market price of one month ago above $30.

Even with JPM now offering $10, it seems the vultures are having a feast. Last week we were all aware of the threats to the money system, but now the tsunami is hitting. Is the Bear Stearns Rescue a sign that the crisis has been conquered?

Not at all! Most now doubt that it has even been contained, with some thinking it has been engineered by the Fed to get worse. The cancer that started to show up last August has now spread to the consumer from the blue collar worker through to executive level, as they are changing from their live now, pay later culture to one of pay now and live as best you can .

The checks eagerly awaited from the stimulus package from President Bush in May are now more likely to fight the fires of debt than to go on more living today . And as inflation begins to point to a higher cost of living and the oil price points to a further doubling to $200 and Gold Prices vault past the $1,000 level an awareness is dawning that the empire of debt on which the last decade of boom has grown is shrinking far faster than thought possible.

Since last August all kinds of tradable debt from dubious mortgage bonds to asset backed commercial paper made up of mortgages, credit card debt, car loans and business loans are finding it harder to stand as collateral for finance. To counter this shrinking credit, the Fed and the European central banks have pumped in billions of dollars worth of Treasury securities in the hope of stemming the atrophy. Interest rates were rapidly lowered, and they continue to drop with last week's 0.75% cut in the hope of easing credit and giving dubious debt more substance.

Meanwhile the disease has spread from collateralized debt obligations to structured investment vehicles and the more senior forms of debt they're built from. So the next step has been to make these debt instruments appear palatable to investors, by accepting them as collateral at the Fed the lender of last resort through Ben Bernanke's new Term Auction Facility .

Mr. Bernanke really climbed aboard his helicopter by distributing $100 billion per month in March, plus infusing another $100 billion into the financial system through its open market operations and created another $200 billion lending program to the big investment banks with mortgage backed securities as collateral.

Certainly unconvinced, the financial world still does not accept that these instruments have been 'saved' by the Fed. Because they remain, for now, only collateral for debt not yet acceptable assets.

This distinction remains a foundation of the financial world right now, a foundation on which the US Dollar's global empire still stands. Once these assets are accepted as assets in payment of debt, however, power will seep from the global banking empire. And meanwhile, the US Dollar's value is descending at an accelerating pace, raising prices in the United States on everything.

The oil price is holding high at never before seen levels, not because of a shortage, but because US and foreign nationals and institutions are fleeing from Dollar instruments into hard assets, sure in the knowledge that their value will rise. Does the Fed have the competence to stop this collapse? Was the 0.75% drop in interest rates and Fannie Mae having another $200 billion to help in the mortgage industry sufficient to turn the US housing crisis around?

No! It will take a concerted action by all of the financial institutions, including the Bush administration and the change of several of their principles, before an effective rescue can be mounted. And they are nowhere near there yet. Indeed they are still reacting to events of around a month ago.

Now Bear Sterns, one of the largest and most aggressive financiers of subprime mortgages has, in effect, collapsed. The task in front of the monetary system, not just the Fed, is to prevent this vital organ of the monetary system from collapsing. The $30 billion credit line to facilitate the takeover of Bear Sterns still does not change the debt into a viable asset. To make the rate for borrowing from its discount window cheaper at 3.25% still won't help. All this has done is to add an air of desperation to the picture.

The Fed's taking over the portfolio of Bear Sterns and controlling all its major decisions is getting close to turning debt into viable assets, but not obviously so. The Fed is now teetering on the brink of credibility as a Lender in a process very close to a nationalization, such as the British government's nationalization of Northern Rock, the failed British mortgage lender.

The final move to date is the most worrying. It is that the Fed will make available unlimited amounts of money to the 20 large primary dealing investment banks in Treasuries that deal directly with the Fed. The credibility of the system itself is now on the line with the value of the Dollar now promised an unlimited level of devaluation. Such is a catastrophic issuance of money.

Meanwhile, the attractiveness of Treasury bonds is waning, as the term of such loans preferred in the market place is shortening dramatically, a sure sign that a dangerous crisis is unfolding. When debt becomes attractive only when it is so short term that it is deemed to be almost cash, then the bank runs really begin. This has been seen in other parts of the world when disaster has struck.

The crisis is as global as the US Dollar itself. The run to Gold is a sprint, despite the 10% pullback last week in a strange, straight line fall drop. Across the world people are realizing that a tsunami of capital is on the move, either disappearing or about to move into new lands, wreaking havoc in selected markets as we are seeing today with most global equity markets sharply down from last summer and with perhaps much more to come as the word 'Depression' is Now Replacing 'Recession' in some quarters.

The words Exchange Controls and Protectionism will be the new dramas to be visited on a hapless world any time now. Under such controls, gold held in Zurich, Switzerland (through BullionVault) would remain physically safe, but the long reach of the authorities could impact your entire portfolio.

After all, the first you will know about any new controls on capital flows will be after they have been imposed. We believe they are not far off now (subscribers please contact us for how to get portfolio protection). Meanwhile the US monetary system is still short of capital and is under pressure to contract.

Who's next? Has the Dollar stopped falling and Gold Prices rising? This is a special article written for Gold News. For our newsletter, please visit

JULIAN PHILLIPS one half of the highly respected team at began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the Dollar Premium . On moving to South Africa, Julian was appointed a macro economist for the Electricity Supply Commission guiding currency decisions on the multi billion foreign Loan Portfolio before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

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