Saturday, April 20, 2019

Golden Straws In The Wind

Life in the world of gold bullion is full of mysteries. Each mystery is like a straw in the wind, which individually means little, but tempting us to speculate there’s a greater meaning behind it all. Yes, there is a far greater game in play, taking Kipling’s aphorism to a higher level.

One of those straws is Russia’s continuing accumulation of gold reserves. Financial pundits tell us that this is to avoid being beholden to the US dollar, and undoubtedly there is truth in it. But why gold? Here, the pundits are silent. There is an answer, and that is Russia understands in principal the virtues of sound money relative to possession of another country’s paper promises. Hence, they sell dollars and buy gold.

But Russia is now going a step further. Izvestia reported the Russian Finance Ministry is considering abolition of VAT on private purchases of gold bullion.[i] We read that this could generate private Russian annual demand of between fifty and a hundred tonnes. More importantly, it paves the way for gold to circulate in Russia as money.

We should put ourselves in Russia’s shoes to find out why this may be important. Russia is the largest exporter of energy, including gas, pushing Saudi Arabia into second place. This means she is also the largest acquirer of fiat currency for energy. That’s fine if you like fiat currencies, but if you suspect them, then you either turn them into physical assets, such as infrastructure and military hardware, or gold. Russia does both.

Then there is China. China has started announcing monthly additions to her gold reserves. China is up to her neck in dollars, and the relatively minor monthly additions to her reserves really make little difference. However, the link between the gold exchanges in Moscow and Shanghai strongly suggest Russia and China are coordinating gold dealing activities.

In any event, China now dominates physical bullion markets. Deliveries (withdrawals) from the Shanghai Gold Exchange’s vaults into public hands are running at roughly two-thirds of the world’s annual mine supply. At 426 tonnes in 2017, China is the largest gold mining nation by far, and the state owns all China’s refining capacity, even taking in doré from abroad. No gold leaves this version of Hotel California.

The frequently-expressed reasoning for their gold policies is Russia and China are locked in a financial war with their largest debtor. This is not the underlying reason these nations have chosen gold as an expression of their dislike of America’s weaponization of her monetary policies. They know the difference between unbacked fiat currencies and sound money, which has been chosen by people ever since they began to use a separate commodity to intermediate in transactions.

However, it is true the Americans have weaponised the dollar, bringing an urgency to China’s and Russia’s deployment of gold. US dollars have been the world’s reserve currency for the last forty-eight years, and America, which pays for everything in costless, newly-issued dollars, now says it wants a better trade deal. It obviously assumes the dollar’s supremacy is unchallengeable and in their need for dollars China and other exporters to America will be forced to comply.

Let’s pick this apart. The US Government pays for everything in a currency which it issues at will. New dollars only gain value once they are in circulation, but the cost of production is zero, stealing their circulatory value from previously existing currency. However, the US Government is unable to balance its books without recycling some of these duff dollars into its own IOUs (Treasury stock). Because they are required to be repatriated to balance the US Treasury’s books, the US Treasury borrows them back from foreigners who might otherwise question the dollars true value. So, foreigners get a Treasury IOU eventually paid out in a currency IOU. It really is pig on pork.

So far, the foreigners have been successfully conned, though questions are beginning to be asked.

Logic suggests that the US Government getting something for nothing is as good as it gets. But President Trump thinks this is unfair, not on the Chinese and other foreigners swapping goods for ultimately worthless paper, but on America herself! He holds out for an even better deal. He demands the Chinese and others stop supplying real stuff to his people in return for his costless, dubious paper. In other words, speaking on behalf of the American People, he is now dissuading the Chinese from giving Americans something for what amounts to nothing.

Those on Planet Asia could be forgiven for looking at things rather differently. After Mao’s death and a brief period of accepting the dollar scam on the basis that demand for dollars would always ensure they could be exchanged for value, the Chinese have for a long time smelled a rat. This is why in 1983 they appointed the Peoples Bank to be in charge of liquidating dollars for gold and silver. They have gently played along with the dollar scam ever since, not wanting to be the party that exposes it for what it is.

Now it is Trump himself who has blown the whistle on the dollar. China and Russia have undoubtedly got the message from this new art of the deal. But at the heart of it is a deep, wider malaise in the fiat currency world. Understand that, and we get to the true reason why Russia and China are wary about accumulating the West’s fiat currencies. Until now, they have run with the hare and hunted with the hounds. China in particular uses fiat renminbi to drive expansion. But then if she didn’t, today’s world order would have probably collapsed in the wake of the Lehman crisis as the flaws and weaknesses of fiat currencies would have been exposed...

- Source, Alasdair Macleod via James Turks Goldmoney

Tuesday, April 16, 2019

John Rubino: With QT Ending, What Now For Gold?

John Rubino runs the popular financial website Dollar Collapse. 

He is co-author, with GoldMoney’s James Turk, of The Money Bubble: What To Do Before It Pops, and author of Clean Money: Picking Winners in the Green-Tech Boom (Wiley, 2008), The Collapse of the Dollar (also with James Turk), How to Profit from the Coming Real Estate Bust (Rodale, 2003) and Main Street, Not Wall Street (Morrow, 1998). 

After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a Eurodollar trader, equity analyst and junk bond analyst. 

During the 1990s he was a featured columnist with and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He currently writes for CFA Magazine.

- Source, Seeking Alpha

Saturday, April 6, 2019

The Delusional Psychology of Denying Free Markets

Cycles of human behaviour require a build-up of human prejudice until it becomes unsustainable. One human prejudice which is little examined is why establishments frequently stick to their convictions while denying reasonable debate. As we have seen, much of the answer is that a version of self-serving economic dogma becomes central to the credibility of statist policies. We see it today with our post-Keynesian economic establishment driving economic and monetary policies, while denying the superiority of unfettered markets in these matters. Anyone who challenges the unreason of the establishment’s economics will risk personal vilification and be side-lined.

Create the belief structure and the government can justify any action. Leadership becomes more effective when it is based on prevailing doctrines, with minds firmly closed to all evidence to the contrary. All types of socialism demonstrate opinions insulated from inconvenient contradictions. A socialising government can then appear independent and fair-minded, serving the people when it actually serves itself.

New dogmas become entrenched. The government and also the public, like our hunter-gatherer forebears in their communal caves, huddle round the mutual safety of the new consensus. Concerning the government’s contradictions, comfort is sought by the public from the government itself. It becomes an iterative process that allows the state to drift remorselessly away from free markets, not only with public consent, but public encouragement. It is the basis of groupthink, the enemy of reason.

To the building self-ignorance is added an overestimation of understanding complex issues: an understanding-bias that is reinforced by debate on terms set by society itself, represented by the media. Editors select complex issues which they reduce to simplified choices, that are then discussed by invited participants. The debate always proceeds on the basis of which government intervention or regulation is most likely to achieve a given objective. Spoil the party by insisting that personal freedom is preferable to any government intervention, you damage the media ratings and you will be deemed a maverick, never to be invited back.

Contradiction becomes too difficult to take. A form of naïve realism develops, whereby talking heads promote themselves as supporting the assimilation of a consensus. Furthermore, they believe that those that do not subscribe to the consensus are irrational, biased, uneducated and ignorant. By these means, the benefits of free markets and individualism are increasingly suppressed. Economists are paid to promote policies in favour of the state’s control of money. The universities develop an anti-market bias, and free-market economists are unable to secure paid professorships.

The position these toadying experts occupy was summed up by John Ioannidis, a professor of medicine at Stamford University:

“Scientists in a given field may be prejudiced purely because of their belief in a scientific theory or commitment to their own findings… Prestigious investigators may suppress via the peer review process the appearance and dissemination of findings that refute their findings, thus condemning their field to perpetuate false dogma. Empirical evidence on expert opinion shows it is extremely unreliable.”[ii]

Disappointingly, we all assume scientists are disciplined in their specialisations and unbiased. Not so. In economics, there is the extra problem of human unpredictability, to which is added a total lack of precise definition. Soundly-reasoned theory is swept aside by the introduction of unreliable, and often extraneous statistics as the feedstock for mathematical equations. Reason, freedom and free markets are the casualties.

Instead of reasoning for ourselves and recognising the flaws in debate, we trust an elite to guide our thoughts with their knowledge. Alongside the elite there is a cadre of self-anointing experts consulted by the media. We place value on their independence. We see them as informed insiders, but we forget their privileged access depends solely on supporting the party line. It is a profitable after-life for those who had power, a self-congratulatory basis for the concealed promotion of social policy.

When it gets left behind by progress, the static socialist state eventually becomes the author of its own destruction. Only then might the psychological consensus of denying free markets be broken. If we are lucky, out of the ensuing chaos a new commitment to free markets rapidly emerges. More likely, it becomes the opportunity for extremism, as Germany showed in the aftermath of its inflation collapse of 1923.

Contemporary socialist evolutions

As economic historians, we observe the faults of others usually without recognising them in ourselves, mainly for the psychological reasons noted above. Most economic historians selectively approach the subject with the bias of their culture and generation. The story of Bismarck’s Germany is hardly known in English literature and the lessons are lost in an English-speaking world. The fall of communism in the USSR is fresh in our minds, but the struggles of the state under Yeltsin to replace it with a market-based economy and the ensuing corruption is more topical.

In Britain, many have forgotten the appalling services and products of nationalised monopolies: British Railways, British Telecom, British Leyland, to name just a few. Consequently, the Brits as well as other socialists in the West are never adequately deterred in their antagonism against free markets to change their minds. Bernie Sanders’ desire to run again for President and the Marxism of Jeremy Corbin are testament to the short-mindedness of the voting public. It is a wilful ignorance that defends socialism and never defends free markets.

In America, socialism is being challenged by President Trump. Without us examining his beliefs too closely, he obviously knows that the government establishment has been strangling the US economy. His dislike of the Democrats and their policies under Obama identifies him as an enemy of socialism. But as a free-marketeer, Trump does not defend free markets. Instead, he ends up defending crony-capitalism, military spending and monetary inflation. His trade protectionism, strongly echoing Bismarck’s policies in the late nineteenth century, is similarly socialism under the banner of nationalism. Far from rescinding the socialist tide, Donald Trump is swimming in it.

Trump’s trade policies, as I’ve argued in another article[iii], are driving America and therefore the world into a deep recession. Under current monetary policies the result will be a spectacular increase in monetary inflation, which could lead to the destruction of the dollar. If this happens, Trump almost certainly will be blamed, not socialism. That being the case, the destruction of the American economy and perhaps the dollar with it will not be the end of socialism and the return to free markets. By not properly understanding free markets, President Trump risks condemning his nation and his legacy to a more intense post-crisis socialism similar to that which fuelled fascism in 1920s Germany.

If so, we can only hope the period will be brief. Economists in the free-market tradition can only forecast the likely economic and monetary consequences of current policies. The laissez-faire tradition tells us a failing government should stop intervening and restrict itself to ensuring basic criminal and contract law is enforced. It should stop monetary inflation. As Ludwig Erhard demonstrated in 1948, free markets left alone rapidly restore economic order. But that is not the socialising instinct. As long as there is breath in socialism free markets will continue to be supressed.

The foundation of the European Union echoes the tactical approach of Bismarck: corral a group of nations into a Zollverein customs union, then steer them towards political integration. As the German Historical School was for Bismarck, Marxist-socialism becomes the driving force for the EU, innocuously at first by encouraging free trade within the union. Free trade is then hampered by bureaucratic regulation in the names of common standards, fairness and further integration. Already planned are the imposition of new federal taxes to extend the power of the Brussels government, and the building of a new pan-European military force. Pure Bismarck, and pure Brussels.

Witness the struggle with Brexit, where it turns out the Westminster Parliament is comprised of an overwhelming majority of members who are committed to the EU’s socialising masterplan to the exclusion of democracy. Even a majority of Tory MPs, the party of free enterprise, prefers a federal socialist system to free markets.

It is the stuff of late-stage socialism. The whole world is in its grip, rather than just Germany, just the USSR, just America, just the EU, or just Britain. And these are only some among the traditionally advanced nations. Being cyclical, the bankruptcy of it all in time is for sure. It is set to throw up greater challenges than ever seen before because of its ubiquity. Assuming it does not end in a nuclear destruction of the human race, we will eventually turn our backs on the follies of socialising governments and go back to free markets. Then the cycle of humanity’s socialising madness will start all over again.

- Source, Alasdair Macleod via James Turk Goldmoney

Monday, April 1, 2019

In Defense of Free Markets

Why is it that no one defends free markets, and socialism, despite all the evidence of its failures, comes back again and again? Unsurprisingly, the answer lies in politics, which have always led to a boom-bust cycle of collective behaviour. Furthering our understanding of this phenomenon is timely because the old advanced economies, burdened by a combination of existing and future debt, appear to be on the verge of an unhappily coordinated bust. But that does not automatically return us to the free markets some of us long for.

Cycles of collective behaviour

Throughout history there have been few long-lasting periods of truly free markets. Contemporary exceptions are confined to some small island states, forced to be entrepreneurial by their size and position vis-à-vis the larger nations with which they trade. The governments of these islands know that the state itself is not suited to entrepreneurship. Only by the state guarding the freedom of island markets and the sanctity of property rights can entrepreneurs serve the people in these communities and create wealth for all.

This is not the normal condition for larger nations. Before the Scottish enlightenment which nurtured David Hume and Adam Smith, the benefits of free trade were barely understood. Since then, the wealth created by free trade and sound money has nearly always been the springboard for detrimental change. Sometimes a political strongman, like Mao or Lenin dictates to the people what they can and cannot do. Alternatively, a leader courts popularity by taxing heavily the few for the alleged benefit of the masses. This is the model of welfare states today. Debasement of the means of exchange is an extension of these socialising policies, furthering the transfer of personal wealth to the state.

To understand why free markets are more often than not unpopular, we must put them into a context of human behaviour. In this regard we can stylise a cycle of collective behaviour into three characteristic phases. The first is a lawless condition of no secure ownership of property rights; in the absence of enforceable law the means of possession are necessarily violent and uncertain. It is the natural condition of tribalism and pre-civilisation societies. It is the condition to which humanity returns when the cycle completes.

The second phase is the consolidation of property ownership, with enforceable laws to define and protect it. Out of the chaos that fails to advance the condition of the people comes order, and with it the aggregation of the means of production. Capital in all the forms necessary for production accumulates, and being scarce, is used most efficiently. The backbone of this phase is freedom for the individual to dispose of his or her resources at will. The pace of improvement in the human condition is governed by the level of accumulated wealth and technological innovation.

The third phase is the abandonment of free markets in favour of state control. The state, whose primary function in economic terms is to act as provider and facilitator of the law, increasingly supresses commerce by extracting escalating levels of tax. Taxes are imposed to redistribute wealth from those that earned and conserved it to those that did not. The state takes control of money, issuing its own currency which it can print at will. The damages to the economy are covered up by all the artifices available to the state.

The state regulates. The state confiscates. The state deprives its people of their freedom. The state’s demands become so insatiable, so counterproductive, so impoverishing that the economy collapses back into the first phase of the next cycle.

That is our theoretical cycle of collective behaviour. Out of chaos is created progress. Out of progress lies the course to destruction. The best of these times is the free markets of the second phase. No one defends them.

Empirical evidence of the cycle.

The assembly of German states into a unified nation in 1871 gave credence to a new socialising phenomenon, whereby Bismarck, Germany’s first Chancellor, promoted the state as a socialising entity, superseding free markets. He was the first politician to create a welfare state, introducing accident and old-age insurance and socialised medicine. Shortly after unification, in the mid-1870s Bismarck abandoned free trade and introduced trade protectionism.

His policies echoed the principles of the German Historical School, which drove intellectual thought in the Prussian administration. The Historical School rejected the classical economics of Smith, Ricardo and Mill in favour of a controlling state, backed up by analysis of historical events, hence the name. These lessons were applied to the changing conditions at that time. Workers were moving from the land into new factories, and it was the German establishment’s outdated response to an entirely new social phenomenon.

The creation of a new German socialising state and the denial of economic liberalism inevitably led to the founding of Chartalism, the state theory of money, which stated that only the state has the right to determine the currency used by the people. Georg Knapp published his State Theory of Money in 1905. He handed Bismarck the key to unlock constraints on state spending. The state was then able to consolidate its potential, both in its bureaucracy and military armament. We all know what happened: it fed into to the First World War and in 1923 resulted in the collapse of the currency.

It is worth reflecting that a cycle of events occurred taking ordinary Germans to full state socialism from a freedom to improve their personal circumstances. The start of it was promising, with the introduction of the Zollverein, a customs union between independent German-speaking states. The roots of the Zollverein were in the 1830s, consolidated and formalised in 1861. It preceded the formation of a greater Germany in 1871. It was the gateway to political union, and statist economic management.

It is a doppelganger for the development of the European Union today, but the underlying point for EU-watchers is that it was a cycle of events, taking a nation through the erosion of laissez-faire to full state domination of economic activity and monetary affairs.

In Germany’s case, the political consequences of the First World War and the collapse of the currency were not the end of the story, or the cycle. The rise of extreme fascist socialism finally led to the destruction of the German state in 1945. The return to free markets under Ludwig Erhard’s guidance followed his appointment as Director of the Economic Council for the Occupation Zone and completed the cycle.

Cometh the hour, cometh the man. Soviet-occupied Germany was not so lucky. Erhard had to ignore the instincts and orders of his fellow American and British military committee members, who were stuck in a bureaucratic militaristic frame of mind. In July 1948, without consulting them, Erhard abolished all rationing and price controls. Almost instantly, shops reopened, food became available, the suppressed mood lifted, and people began to rebuild their lives. By way of contrast, victorious socialist Britain continued with rationing until 1954, when meat rationing finally ended.

The evolution in Germany from free markets through increasingly destructive statism and back again to free markets had taken nearly eighty years from unification in 1871. Russia suffered a similar, though initially more dramatic, socialist change from relatively free markets. Instead of a progressive introduction of state control and loss of personal freedom, it was sudden and absolute. After three years of civil war and using a ready-made Marxist template Lenin seized and consolidated control. Both Lenin and Stalin his successor were ruthless in their suppression of freedom. Tens of millions were deemed to be enemies of the state, which included those who merely disagreed or of the wrong race. They were executed or sent to the gulags. That suppression lasted until the soviets had impoverished their people to the point where there was nothing left. In 1989, after seventy-odd years the USSR finally collapsed.

The German and Russian experiences tell us in their own ways that because the beneficiaries of free trade fail to defend it, free trade does not last. Anyone reading about life in Vienna before the First World War would be struck by the widespread prosperity, freedom and artistic flowering of the age, which was destroyed by the war and a subsequent collapse of the currency. It is unfashionable in our socialist times to defend those pre-war years as good times.

I personally grew up with the free-market prosperity of Britain’s African colonies; a prosperity that benefited not just the better-off Europeans but indigenous African and Asian communities as well. That was destroyed by political imperatives, the call for independence from British rule by those who had benefited from the free markets they set out to then destroy. Fully-functioning free-market economies were replaced throughout Africa by corrupt elites that still steal their way to personal prosperity.

It is no accident that post-independence African leaders embraced socialism as the justification for their actions. They argued that the European landowners had seized property which was in the communal ownership of the tribes, and that a newly-independent state had the right to seize it back. But they ignored the fact that before the arrival of Europeans there was no ownership nor property law to define it. Occupation was by force. It is a no more than a common socialist justification for the state to acquire for itself private property.

In only fifty years, free markets had taken the ordinary native in the African heartlands from ignorance of the wheel to the age of jet engines and skyscrapers. Never before have tribal communities witnessed such rapid social change. We forget the appalling conditions and routine cruelty that existed before the introduction of western capitalism. Those conditions are best summed up in a quote from Tacitus, writing about the German tribes in 98AD: “It seems feckless, nay more, even slothful, to acquire something by toil and sweat which you could grab by the shedding of blood.”[i] He could have been describing the cattle raids that still occur today in Kenya’s Northern Frontier District and Laikipia.

Nearly two millennia after Tacitus described tribal Germania, in Africa similar disorder reigned before white settlers developed the land. To escape a subsistence stasis that had seemingly existed for ever, disorder had to be replaced by the white man’s order. Through the introduction of capital and property ownership, free markets allowed the whole population to rapidly improve its condition.

Without these crucial ingredients there can be no progress. Socialism unwittingly returns civilisation to an unenlightened state by encroaching upon, then abolishing, both property ownership and the accumulation of capital. The economy is hindered in its progress, until it withers on the vine. A nation then returns to its pre-capitalist state of lawlessness, corruption, brutality and widespread poverty. Once again, cattle raiding and similar actions become the means of ownership.

But if this repetitive cycle is so obvious, why does humanity fall into the same cyclical trap time and again?

- Source, Alasdair Macleod via James Turk's Goldmoney

Friday, March 22, 2019

Gold Preparing for the Next Move

The global economic outlook is deteriorating. Government borrowing in the deficit countries will therefore escalate. US Treasury TIC data confirms foreigners have already begun to liquidate dollar assets, adding to the US Government’s future funding difficulties. The next wave of monetary inflation, required to fund budget deficits and keep banks solvent, will not prevent financial assets suffering a severe bear market, because the scale of monetary dilution will be so large that the purchasing power of the dollar and other currencies will be undermined. Failing fiat currencies suggest the dollar-based financial order is coming to an end. But with few exceptions, investors own nothing but fiat-currency dependent investments. The only portfolio protection from these potential dangers is to embrace sound money - gold.

The global economy is at a cross-road, with international trade stalling and undermining domestic economies. Some central banks, notably the European Central Bank, the Bank of Japan and the Bank of England were still reflating their economies by supressing interest rates, and the ECB had only stopped quantitative easing in December. The Fed and the Peoples’ Bank of China had been tightening in 2018. The PBOC quickly went into stimulation mode in November, and the Fed has put monetary tightening and interest rates on hold, pending further developments.

It is very likely this new downturn will be substantial. The coincidence of the top of the credit cycle with trade protectionism last occurred in 1929, and the subsequent depression was devastating. The reason we should be worried today is stalling trade disrupts the capital flows that fund budget deficits, particularly in America where savers do not have the free capital to invest in government bonds. Worse still, foreigners are now not only no longer investing in dollars and dollar-denominated debt, but they are suddenly withdrawing funds. According to the most recent US Treasury TIC data, in December and January these outflows totalled $257.2bn.[i] At this rate, not only will the US Treasury need to fund a deficit likely to exceed a trillion dollars in fiscal 2019, but the US markets will need to absorb substantial sales from foreigners as well.

In short, America is going to face a funding crisis. To have this funding problem coinciding with the ending of credit expansion at the top of the credit cycle is a lethal combination, as yet unrecognised as the most important factor behind both American and global economic prospects. The problem is bound to emerge in coming months.

While today’s trade protectionism is less vicious than the Smoot-Hawley Tariff Act, America’s drawn-out trade threats today are similarly destabilising. The top of the credit cycle in 1929 was orthodox; its principal effect had been to fuel a speculative stock market frenzy in 1927-29.

This time, the credit bubble is proportionately far larger, and its implosion threatens to be even more violent. Governments everywhere are up to their necks in debt, as are consumers. Personal savings in America, the UK and in some EU nations are practically non-existent. The potential for a credit, economic and systemic crisis is therefore considerably greater today than it was ninety years ago.

Bearing in mind the Dow fell just under 90% from its 1929 peak, the comparison with these empirical facts suggests we might experience no less than a virtual collapse in financial asset values. However, there is an important difference between then and now: during the Wall Street crash, the dollar was on a gold standard. In other words, the price-effect of the depression was reflected in the rising purchasing power of gold. This time, no fiat currency is gold-backed, so a major credit, economic and systemic crisis will be reflected in a falling purchasing power of fiat currencies.

The finances of any government whose unbacked currency is the national pricing medium are central to determining future general price levels. Just taking the US dollar for example, the government’s debt to GDP ratio is over 100% (in 1929 it was less than 40%). At the peak of the cycle, the government should have a revenue surplus reflecting underlying full employment and the peak of tax revenues. In 1929, the surplus was 0.7% of estimated GDP; today it is a deficit of 5.5% of GDP. In 1929, the government had minimal legislated welfare commitments, the net present value of which was therefore trivial. The deficits that arose in the 1930s were due to falling tax revenues and voluntary government schemes enacted by Presidents Hoover and Roosevelt. Today, the present value of future welfare commitments is staggering, and estimates for the US alone range up to $220 trillion, before adjusting for future currency debasement.[ii]

Other countries are in a potentially worse position, particularly in Europe. A global economic slump on any scale, let alone that approaching the 1930s depression, will have a drastic impact on all national finances. Tax revenues will collapse while welfare obligations escalate. Some governments are more exposed than others, but the US, UK, Japan and EU governments will see their finances spin out of control. Furthermore, their ability to cut spending is limited to that not mandated by law. Even assuming responsible stewardship by politicians, the expansion of budget deficits can only be financed through monetary inflation.

That is the debt trap, and it has already sprung shut on minimal interest rates. For a temporary solution, governments can only turn to central banks to fund runaway government deficits by inflationary means. The inflation of money and credit is the central banker’s cure-all for everything. Inflation is not only used to finance governments but to provide the commercial banks with the wherewithal to stimulate an economy. An acceleration of monetary inflation is therefore guaranteed by a global economic slowdown, so the purchasing power of fiat currencies will take another lurch downwards as the dilution is absorbed. That is the message we must take on board when debating physical gold, which is the only form of money free of all liabilities.

Gold can only give an approximation of the loss of purchasing power in a fiat currency during a slump, because gold’s own purchasing power will be rising at the same time. Between 1930 and 1933 the wholesale price index in America fell 31.6% and consumer prices by 17.8%.[iii] These price changes reflected the increasing purchasing power of gold, because of its fixed convertibility with the dollar at that time.

Therefore, the change in purchasing power of a fiat currency is only part of the story. However, the comparison between purchasing powers for gold and fiat currency is the most practical expression of the change in purchasing power of a fiat currency, because the choice for economic actors for whom gold has a monetary role is to prefer one over the other.

It is an ongoing process, about to accelerate. Chart 1 shows how four major currencies have declined measured in gold over the last fifty years. The yen has lost 92.4%, the dollar 97.42%, sterling 98.5%, and the euro 98.2% (prior to 2001 the euro price is calculated on the basis of its constituents).

The ultimate bankruptcy of currency-issuing governments, likely to be exposed by the forthcoming slump, will be reflected in another lurch downwards in currency purchasing powers.

- Source, Goldmoney

Monday, March 11, 2019

Goldmoney 2019 Roundtable: Roy Sebag, James Turk and Thought Leadership Team

As has become tradition, the Goldmoney leadership team (Roy Sebag, James Turk, Alasdair Macleod, John Butler, Stefan Wieler & Ned Naylor-Leyland) comprised of over a century of practical, diversified financial experience, discuss their outlook for gold and the world economy for 2019 and beyond.

- Source, Goldmoney

Friday, February 22, 2019

Alasdair Macleod: Brexit, Bullion and Bitcoin

​Alasdair Macleod, head of research at in the UK, joins Reluctant Preppers to lay out his vision of 2019, including the impact of Britain's controversial exit from the EU, the trend of nationalism vs. collectivism in 2019, gold and silver's prospects for this year, and whether crypto-currencies will mount a recovery - and if so, when and what extent.

Monday, February 18, 2019

Why Monetary Easing Will Fail

The major economies have slowed suddenly in the last two or three months, prompting a change of tack in the monetary policies of central banks. The same old tired, failing inflationist responses are being lined up, despite the evidence that monetary easing has never stopped a credit crisis developing. This article demonstrates why monetary policy is doomed by citing three reasons. There is the empirical evidence of money and credit continuing to grow regardless of interest rate changes, the evidence of Gibson’s paradox, and widespread ignorance in macroeconomic circles of the role of time preference.

The current state of play

The Fed’s rowing back on monetary tightening has rescued the world economy from the next credit crisis, or at least that’s the bullish message being churned out by brokers’ analysts and the media hacks that feed off them. It brings to mind Dr Johnson’s cynical observation about an acquaintance’s second marriage being the triumph of hope over experience.

The inflationists insist that more inflation is the cure for all economic ills. In this case, mounting concerns over the ending of the growth phase of the credit cycle is the recurring ill being addressed, so repetitive an event that instead of Dr Johnson’s aphorism, it calls for one that encompasses the madness of central bankers repeating the same policies every credit crisis. But if you are given just one tool to solve a nation’s economic problems, in this case the authority to regulate the nation’s money, you probably end up believing in its efficacy to the exclusion of all else.

That is the position in which Jay Powell, the Fed’s chairman finds himself. Quite reasonably, he took the view that the Fed’s marriage with the markets was bound to go through another rough patch, and the Fed should use the good times to prepare itself. Unfortunately, the rough patch materialised before he could organise the Fed’s balance sheet for its next launch of monetary bazookas.

The whole monetary planning process has had to go on hold, and a mini-salvation of the economy engineered. To be fair, this time it is Washington’s tariff fight with China and its alienation of the EU through trade protectionism that has interrupted the Fed’s plans rather than the Fed’s mistakes alone. But by taking early action the hope is the Fed can keep confidence bubbling along for another year or two. It might work, but it will need a far more constructive approach towards global trade from America’s political-security complex to have a sporting chance of succeeding.

However, buying off a crisis by more money-printing does not represent a solution. It is commonly agreed that the problem screaming at us is too much debt. Yet, the inflationists fail to connect growing debt with monetary expansion. The Fed’s objective is to encourage the commercial banks to keep expanding credit. What else is this other than creating more debt?

Powell is surely aware of this and must feel trapped. However, what his feelings are is immaterial; his contractual obligation is to keep the show on the road, targeting self-serving definitions of employment and price inflation. He will be keeping his fingers crossed that some miracle will turn up.

It is too early to forecast whether the Fed will manage to defer for just a little longer the certainty that the monetary imbalances in the economy will implode into a singularity, whereby debtors and creditors resolve their differences into a big fat zero. That is not the purpose of this article, which is to point out why the underlying assumption, that interest rates are the cost of money which can be managed with beneficial results, is plainly wrong. If demand for money and credit can be regulated by interest rates, then there should be a precisely negative correlation between official interest rates and the quantity of money and credit outstanding. It is clear from the following chart that this is not the case.

This chart covers the most violent moves in Fed-directed interest rates ever, following the 1970s price inflation crisis. Despite the Fed increasing the FFR from 4.6% in January 1977 to 19.3% in April 1980, M3 (broad money and bank credit) continued to increase with little variation in its pace. Falls in the FFR designed to stimulate the economy and prevent recession were equally ineffective as M3 continued on its straight-line path after 1980 without significant variation, and it is still doing so today. There is no correlation between changes in interest rates, the quantity of money, and therefore the inflationary consequences.

Gibson’s paradox disproves the efficacy of monetary policy

From the chart above, it is clear that the central tenet of monetary policy, that the quantity of money can be regulated by managing interest rates, is not borne out by the results, and therefore the role of interest rates is not to regulate demand for credit as commonly supposed. This is confirmed by Gibson’s paradox, which demonstrated that a long-run positive correlation existed between wholesale borrowing rates and wholesale prices, the exact opposite of that assumed by modern economists. This is shown in our second chart, covering over two centuries of British statistics.

Economists dismissed the contradiction of Gibson’s paradox because it conflicted with their set view, that interest rates regulate demand for money and therefore prices[i]. Instead, it is ignored, but the evidence is clear. Historically, interest rates have tracked the general price level, not the annual inflation rate. As a means of managing monetary policy, interest rates and therefore borrowing costs are ineffective, as confirmed in our third chart below.

The only apparent correlation between borrowing costs and price inflation occurred in the 1970s, when price inflation took off, and bond and money markets woke up to the collapsing purchasing power of the currency.

The explanation for Gibson’s paradox, which embarrassingly eluded all the great economists who tackled it, is simple. It stands to reason that if the general price level changes, in aggregate businessmen in their calculations will take that into account when it comes to assessing the level of interest they are prepared to pay and still make a profit. If a businessman expects higher prices in the market, he will expect a higher rate of return and therefore be prepared to pay a higher rate of interest. And if prices are lower, he can only afford to pay a correspondingly lower rate. This holds true when capital in the form of savings is limited by the preparedness of people to save, and businesses have to compete for it.

Today, Gibson’s paradox does not appear to apply, partly because capital is no longer scarce (thanks due to central banks) and partly because the abandonment of the Bretton Woods agreement has led to indices of the general price level rising continually. To these factors must now be added wilful misrepresentation of price inflation in official statistics, a deceit that will almost certainly end up destabilising attempts at economic management even further when discovered.

These points notwithstanding, the belief that interest rates are a price which regulates demand for money is disproved. The mistake is to ignore the human dimension of time preference and assume there is no reason for a difference in intertemporal values, the value of something today compared with later. To understand why the degradation of value over time becomes a necessary element of compensation in lending contracts, we must examine in more detail what interest rates actually represent. Only then can we fully understand why they do not correlate with changes in the general level of prices and the growth of credit, which makes up the bulk of M3 in the first chart...

- Source, Alasdair Macleod via Goldmoney

Wednesday, February 13, 2019

Ten Factors To Look For In Gold In 2019

The following is a list of the ten most important factors likely to affect gold in 2019. I have grouped them under two broad headings, economic developments, and factors affecting gold itself.

Possible economic developments to look for

  • It’s late in the credit cycle, and it appears the end of the expansion phase is in sight. This being the case, we can see that government deficits are going to increase, due to lower tax receipts and higher welfare commitments as economic activity contracts. This will be covered by an increase in the rate of monetary inflation, which we are already seeing.
  • International trade flows have slowed sharply, as can be seen from China’s slump in demand. There can be no doubt that US tariff policies are having what could turn out to be a catastrophic effect on international trade.
  • Besides the decline in global trade being a clear signal that the global economy is in trouble, the budget deficit in the US will rise and therefore the trade deficit will tend to rise as well. If not, an increase in the savings rate must occur, which I think we can rule out, or there has to be a contraction in bank credit. In other words, contracting international trade can be expected to propel the US and other domestic economies into a slump. This is bound to provoke the Fed into financing the US government deficit through yet more QE.
  • The main economies in Asia (China, Russia, India and Iran) are all turning their backs on the dollar for trade settlement. This will have a profound effect on central bank reserves not just in Asia, but elsewhere as well, with the dollar being sold. Some countries, notably Russia, are buying gold instead.
  • Foreign ownership of dollar assets and cash exceeds US GDP: $18.412 plus $4.22bn equals $22.6tn. This is the highest rate relative to GDP ever seen. When the dollar and US securities markets begin to fall in earnest measured in declining dollars, there is bound to be massive foreign selling of dollars and dollar assets.

Factors directly affecting gold

  • Geopolitics – Asia, and Russia publicly, have swapped reserve dollars for gold. Given Russia is the world’s largest energy exporter, she will continue to have dollars to sell for gold. Also, Central Europeans, notably Hungary and Poland, are accumulating gold reserves. It is clear which way the Asian wind is blowing, and the Asians know gold is America’s weak point.
  • Price inflation has been badly misrepresented by CPI figures and have been averaging closer to about 8% annually since gold topped in Sept 2011. Since then the purchasing power of the dollar has declined by about 43%, so that in 2011 dollars the gold price is $740. No one seems to have noticed, leaving gold extremely cheap.
  • Monetary inflation post-Lehman crisis has not been fully absorbed. FMQ is still over $5tn above the pre-Lehman long-term expansion trend, and the Fed is unable to bring it down. Rather, they are likely to increase the fiat money quantity to save the government from having to borrow at market rates as the recession bites.
  • These are exactly the conditions faced by the German government between 1918 and 1923, and the likely response by the Fed will be the same. Print money to fund government deficits. Result, wealth transferred from the productive economy to be destroyed in government spending. The only difference is US and other welfare states have a stronger tax base than post-war Germany, so the rate of monetary expansion relative to the size of the economy will be less. Nevertheless, we are on the slippery slope to currency destruction and it will take much more political courage to address the inflation issue than the current political class appear to be capable of.
  • Gold is massively under-owned in the west.

- Source, Goldmoney

Friday, February 8, 2019

Trade Wars: A Catalyst for Economic Crisis

In my last article I used a proven accounting identity to show that the end result of President Trump’s trade tariffs would be to increase the trade deficit, assuming there is no change in the savings rate. The savings rate is important, because if it does not change, then the budget deficit must be financed by any combination of three variables: monetary inflation, the expansion of bank credit, or capital inflows. This is captured in that equation, where the trade balance is the balance of payments, thereby including capital flows as well as goods and services:

(Imports – Exports) = (Investment - Savings) + (Government Spending – Taxes)

It assumes the economy is working normally, and as we shall see, there is no major economic contraction or systemic crisis.

This article explores the implications of the relationship between the twin deficits in the context of the current situation for the United States, which may or may not be on the edge of a significant economic retrenchment. It looks at the detail of how trade tariffs act on the economy at the current stage of its credit cycle and the implications for the economic outlook and for monetary policy. It examines the problem through the lens of sound economic theory, but empirical evidence is invoked as well for confirmation.
The empirical evidence

Looking at history, we find that the effect of tariff increases has depended on the stage of the credit cycle. The best clearest examples are the tariffs introduced after the First World War (the Fordney-McCumber tariffs of 1922) early in the credit cycle, and the Smoot-Hawley Tariff Act of 1930 at the end of it. On the face of it, Fordney-McCumber had little effect, while Smoot-Hawley, it is generally agreed, had a significant effect. Of course, this is in the context of a US-centric viewpoint.

The Fordney-McCumber tariffs were introduced early in the US’s credit cycle. At that time, the US economy still had the legacy of wartime production, whereby imported goods and agricultural products were minimal, having been virtually eliminated by wartime economic planning. The impact of tariffs on the US’s domestic economy was therefore barely relevant to the economic situation. Consequently, unlike the European economies which had been ravaged by war, US agricultural and industrial production were both higher in 1920 than they had been in 1913, the year before the outbreak of war. The effect on Europe was another matter.

European economies found themselves needing dollars to pay reparations (in Germany’s case) and to repay war debt in the case of the Allies. US Tariffs made it extremely difficult for the Europeans to earn those dollars. A number of European economies collapsed into hyperinflation as governments continued the wartime practice of money-printing to finance themselves and service wartime obligations.

Another factor affecting America was the collapse of agricultural prices from inflated wartime levels. By 1921, wheat had collapsed from $2.58 a bushel to 92 cents and hogs from 19 cents per pound to under 7 cents. Tariffs did not help farmers, because at that time, they depended on export markets to a significant degree. And when other countries introduced or increased their tariffs against agricultural products as a response to US tariffs, they proved to be wholly counterproductive for US farmers.

Of course, tariffs were not the sole problem for America’s farmers. Rapid mechanisation increased Canada’s wheat yields, the Argentine was increasing beef production and Cuba exporting large quantities of sugar. Consumers were benefiting from catastrophically lower prices despite tariffs. Other than the pain faced by producers, pain which in free markets is only alleviated by redeploying economic resources away from overcapacity in agriculture, the overall economic effect of the Fordney-McCumber tariffs on America was not significant.

Smoot-Hawley was different. Congress voted in favour of it on 31 October 1929, and the stockmarket clearly saw it coming. The Wall Street Crash commenced on Black Thursday, 24 October, when the market fell 11% that day, before recovering most of the fall. Black Monday followed, when the market fell 13%. By the close on Tuesday 29 October the market had lost over 34% in just fifteen calendar days.

At today’s stock prices, that would be a loss of over 8,000 Dow points. The stockmarket continued its fall to a low on 13 November of 198.7 on the Dow, and after rallying for six months entered a pernicious and continual bear market to a final low of 41.22 on 8 July 1932.

It is always a mistake to attribute a market failure to a single cause: the only certainty was the market fell. However, the importance of the Smoot-Hawley vote to the stockmarket is often missed by economic historians.

The difference between late-1929 and today perhaps, is that Congress voting for it then was a definite event, whereas Trump’s tariffs are progressing as a fluid mixture of bluff and fact. Another key difference was the dollar’s gold exchange standard of $20.67 to the ounce. So long as the exchange rate was defended, a slump would certainly lead more dramatically to widespread bankruptcies. Markets therefore had to discount the enhanced risks from trade protectionism to the economy more immediately compared with today’s fiat currency economy, when it is assumed future investment risk will be ameliorated by monetary expansion.

Pursuing this line of thought is unlikely to lead us to a definite conclusion. A more fruitful approach is to look at the effect of tariffs and trade protectionism in the context of the credit cycle. We have established from our examination of the 1921 Fordney-McCumber tariffs that early in the credit cycle trade protectionism had a limited impact on financial markets and the economy. It stands to reason that an economy floating on a tide of money and credit is in a different position, and more vulnerable to disruption from upsetting events such as the introduction of tariffs.

Adverse changes in trade policy at any time are an upset to market assumptions, and it is clear from both Smoot-Hawley and common sense that Trump’s trade interventions today are a serious spanner in the works of highly valued markets. That is tantamount at the minimum to a claim that Trump has upset the speculators. This is evidently the case, but to understand why Trump’s trade protectionism should be taken more seriously, we need to examine in greater detail the flows implied in the equation at the beginning of this article linking the two deficits.
Why external trade has become central to the whole US economy
Since the oil shocks of the early 1970s, the US has relied on foreign holders of dollars to accumulate US Treasuries issued to finance budget deficits. That recycling of dollars earned by foreigners selling more things to America than America sells to foreigners has through trade imbalances allowed the US Government to run mounting budget deficits.

The Americans have become used to foreigners having no credible alternative to reinvesting their accumulating dollars. However, we can now see that the dollar hegemony behind this proposition is being eroded by China and Russia, acting as the powers which are increasingly directing Asian trade flows. Clearly, as their determination to do away with dollars bears fruit, instead of currently held dollars remaining invested they will be surplus to trade requirements and sold. So far, they have been bought by other foreigners, which is why we see China’s holdings of US Treasuries decline, while those of other foreigners increase, and why Russia’s disposal of cash dollars earned through energy sales has little apparent effect on the exchanges. Meanwhile, the US Government has managed to fund itself without a critical increase in borrowing costs.

This cannot continue ad infinitum, because relative to the volumes of trade concerned and the size of the US economy, there are already large quantities of dollar balances and dollar investments accumulated in foreign hands, which on the last available figures at over $22tn exceed US GDP of around $20tn.

The failure of American trade policy is to not recognise the consequences of upsetting what has become a very delicate balance in capital flows. By imposing aggressively protectionist policies, the Trump presidency has set back cross-border trade significantly, reducing the future availability of dollars from non-domestic sources to fund the budget deficit. Furthermore, US efforts to restrict inward commercial investment by China muddy these waters further.

On these grounds alone, we can see that attempts to restrict Chinese imports are cutting off a vital source of future finance for the US Government. Yet, the accounting identity that explains the twin deficit phenomenon tells us in the absence of an increase in the savings rate the trade deficit will continue. Furthermore, due to tax cuts the budget deficit is still increasing at this late stage of the credit cycle, and an emerging slowdown in the rate of GDP growth tells us it will increase even more rapidly than currently forecast.

Therefore, American protectionist policies risk destabilising the market for US Treasuries, which have increasingly relied on foreign buyers recycling their surplus dollars. The question then arises as to what happens if a contraction in international trade develops out of the current slowdown...
- Source, James Turk's Goldmoney