Silver and the precious metal crisis
Steep price rises in silver lead to speculation about failures in derivatives. Mostly, it is ill-informed. This article sets out the true position and addresses the extent of the problem.
Social media commentary from at least one “expert” links the steep rise in silver with the Fed’s injection of $14.75bn into the repo market on Friday, saying it is a bailout of the big US banks’ silver positions which mark-to-market for margin purposes against soaring prices. It is simply not true, particularly when year-end book squaring across all banking activities is in progress. Comments about bank credit are usually made in the belief that bank credit is created on a fractional reserve basis and is therefore finite, which is incorrect.
Instead, banks lend credit into existence, and it is easy for a bank to create it out of thin air to keep its commodity dealing operations solvent. Banks enter into repos and reverse repos to balance their balance sheets, which is an entirely different function from financing positions. The Fed intervenes purely to keep repo and reverse repo rates within the FOMC’s target range.
It is also worth noting that banks are dealers in credit and for preference do not encumber their balance sheets with physical commodities. Instead, they deal in derivatives.
Margins in derivative dealing are slimmer than bank lending, which is why they are only profitable in very large quantities relative to a bank’s capital. Notional derivative obligations are large multiples of a bank’s access to underlying assets, which brings us to commodities and specifically precious metal derivatives where currently there are destabilising liquidity problems.
