The title of the article may sound like some sort of arcane finance. It’s not, and it matters to all of us who hold gold as a kind of insurance policy against financial collapse. As the article makes clear, make sure you hold physical, and not paper gold. From Charles Hugh Smith and Scott A. Battern, at oftwominds.com:
Claiming to own X quantity of gold is one thing, and reporting how many times the gold has been pledged as collateral is another.
When correspondent Scott A. Batten offered to write an explanation of the rehypothecation of gold and why it matters, I quickly accepted. Like many others, I have breezed over the word rehypothecation with the basic understanding that it means assets pledged by counterparties (such as the infamous copper stored in Chinese warehouses) are reused as collateral/repledged–in effect, the same assets are pledged as collateral multiple times.
But beyond this, I have not had a clear understanding of how the rehypothecation of gold reserves threatens the whole shaky edifice of Infinite Greed, oops, I mean neoliberal capital markets.
Here is Scott’s commentary:When introducing a new concept, it is best to start with the definition of the words to be used. In this case, the discussion of rehypothecation and how it places the world at risk with the fun and games played in the stock market.
Rehypothecation:
Rehypothecation occurs when your broker, to whom you have hypothecated — or pledged — securities as collateral for a margin loan, pledges those same securities to a bank or other lender to secure a loan to cover the firm’s exposure to potential margin account losses.
When you open a margin account, you typically sign a general account agreement with your broker, in which you authorize your broker to rehypothecate.
Now, let’s put this into easy to understand language. Let’s say that you have ten dollars. You take it to the bank to let them “borrow” it, while paying you interest. What you have done, in reality, is given them your money to use as they see fit, while giving you a small percentage of the gains that they will earn. A bank would loan the money to a home buyer or perhaps a small business. At the very least, they can lend all the money in excess of their requirement to hold some cash as reserves–say 10% for ease of math.
They now have nine dollars to invest. Their last resort is to offer it to another bank for that bank to “hold”, because that bank doesn’t have enough money to meet its required reserves. Seems simple enough, right?
Welcome to the games bankers play to make money. Now that this simple format is in place, let’s move to where the serious dangers lie.
To continue reading: The Rehypothecation of Gold, and Why It Matters
