, James Turk Blog

Friday, July 20, 2018

The Dollar is Oversupplied

In order to assess the effect of a credit crisis on the dollar, we must therefore gauge how extended the dollar appears to be in terms of its international circulation. The most recent numbers from the US Treasury TIC data is for the position in June last year for foreign ownership of US securities, and for end of year 2016 for US ownership of foreign securities. Putting to one side these timing differences, since 2006, dollar-denominated investments owned by foreigners totalled $8.52 trillion more than US ownership of non-dollar foreign investments, up 275% since 2008. This is illustrated in the following chart.

We cannot say for sure this represents something close to Triffin’s tipping point, where the quantity of dollars in foreign hands will undermine the currency. But according to the World Bank, global GDP has only increased by about 20% since 2008, suggesting that there are, indeed, far too many dollars in foreign hands relative to economic activity, compared with ten years ago.

This being the case, the dollar could be set to fall on the foreign exchanges during a credit crisis, when investment liquidation pressures increase, and currency hedges are initiated. Importantly, it could also be the desired outcome for the Fed, which is firmly wedded to the idea that falling prices at the retail level must be avoided at all costs, and a lower currency could be used with zero, or even negative interest rates to help support domestic prices. In these circumstances, gold, and perhaps even cryptocurrencies, will be seen by investors as safe-havens from inflationary monetary policies, whose primary purpose will be to contain debt liquidation and protect the commercial banks.

However, this is not the whole picture with respect to exchange rates.

It is the nature of fiat currencies that their individual values are inherently uncertain, each one reflecting purely subjective values in the foreign exchanges. There can be little doubt that the current equilibrium between, say, the Argentinian peso and the US dollar would be disturbed in a global credit crisis by undermining the peso. We cannot be so certain of the exchange rates between, say, the euro and the dollar. Nor can we be so certain how official Chinese policy towards dollar investments may change, or indeed the position of other sovereign wealth funds. All we can say is the foreign world outside America is overexposed to dollars, just as it was in the late 1960s, when the remedy was to sell them for gold.

- Source, James Turk's Goldmoney

Tuesday, July 17, 2018

Irrational Beliefs Are Ruling Markets

To understand the consequences of the credit cycle, we must dismiss pure opinion, and examine the evidence rationally. This article assesses the fate of the dollar on the next credit crisis, a subject of increasing topicality. It concludes that the late stage of the credit cycle has important similarities with 1927, when the Fed eased monetary policy, following evidence of a mild recession.

Contemporary financial markets are inherently emotional, mainly because they are awash with government-issued currencies. Investors and speculators would never be as careless with sound money as they are with infinitely-elastic fiat. Instead, they are ready to gamble with it, partly because they know that standing still guarantees a loss of purchasing power and partly because rising asset prices, which is actually the reflection of a falling currency, makes selling currency for assets an appealing proposition. Furthermore, credit for speculation is freely available through futures and options.

Financial markets are also irrational due to modern economics, the explanation for it all, having become a belief system. If all central banks pursue economic beliefs, as an investor you will probably do so as well, otherwise you are out of step in a world that follows trends. That works until it doesn’t. Central bankers pursue policies which are a mishmash of neo-Keynesianism and monetarism, the balance between the two setting the fashion of the day, with an overriding assumption that unregulated markets are the source of all our economic and systemic troubles. But there is one element of monetary policy that does not change, and that is a conviction that everything can be cured by monetary inflation.

Is this condemnation of monetary policy over the top? Well, only last week Mark Carney, Governor of the Bank of England, was authorised by the UK Treasury to issue a further £1.2bn of capital, which according to press reports will allow the Bank of England to create further loans totalling more than £750bn.[i] Nice work if you can get it: create some sterling by a few strokes on a keyboard and gear up on it by issuing a further 625 times as much, only backed by the myth that the central bank’s capital is real. What is the purpose? To banish all risk emanating from the private sector, of course.

You can only justify monetary policies of this sort by supposing they are the right thing to do. But it tells us something important: deflation, however you define it, is not the problem.

- Source, James Turk's Goldmoney

Saturday, July 14, 2018

The Goldmoney Story

Goldmoney is the easiest way to invest in physical gold and silver bullion, as well as crypto assets online. We safeguard nearly $2 billion of assets for more than 1.5 million clients in 150 countries.

- Source, Goldmoney

Friday, July 6, 2018

A Massive Trend Change, Russia is Dumping US Treasuries

James say that we’re very, very close to the metals moving higher, silver especially, and with it comes a dropping gold to silver ratio. Here’s why…

In your recent KWN interview you reiterated that central banks would either be forced back onto a gold standard or the system would, in essence, change so much that central banks would willingly move back to a gold standard. Peter Boehringer – the architect of the German repatriation movement stated there were close to 21 countries that were either discussing gold as money, gold repatriation or some form of very high level discussions of gold. Gold has been repatriated by several countries now from U.S. vaults returning to Venezuela, the Netherlands, Germany and most recently Turkey. Is this, in your opinion, countries preparing for a change in the monetary system or is something else at play with these moves?

With Russia recently dumping 50% of their U.S. treasuries – and for the record it wasn’t a real significant volume, however, the gesture was huge – Russia also recently ask their Russian companies to move out of the SWIFT system and into their alternative payment system that is tied directly to the Chinese alternative to the SWIFT system. Would you say Russia is really the canary in the coal mine for some type of change in the global monetary system and is this part of the overall nonstop attacks by western corporate media against Russia?

Tuesday, July 3, 2018

James Turk: I’m Expecting A 30 To 1 Gold To Silver Ratio Down The Road

With Russia recently dumping 50% of their U.S. treasuries - and for the record it wasn't a real significant volume, however, the gesture was huge - Russia also recently ask their Russian companies to move out of the SWIFT system and into their alternative payment system that is tied directly to the Chinese alternative to the SWIFT system. 

Would you say Russia is really the canary in the coal mine for some type of change in the global monetary system and is this part of the overall nonstop attacks by western corporate media against Russia?

Sunday, June 24, 2018

The Relevance Of Hayek’s Triangle Today

Most of us are aware of the inflationary pressures in the major economies, that so far are proving somewhat latent in the non-financial sector. But some central banks are on the alert as well, notably the Federal Reserve Board, which has taken the lead in trying to normalise interest rates. Others, such as the European Central Bank, the Bank of Japan and the Bank of England are yet to be convinced that price inflation is a potential problem.

Virtually no one in the central banks, government treasury departments, or independent analysts see the real inflationary danger. There is a lone exception perhaps in Dr Zhang Weiying, the top economist at Beijing University and formally in charge of China’s economic policy, who quoted Hayek’s business cycle theory to point out the dangers of excessive deficits.[i] Whether he is listened to by his colleagues, we shall doubtless find out in due course. Otherwise, a sudden acceleration of price inflation will come as a complete surprise to our financially sophisticated markets.

This article explains why the danger lies in the structure of production, which in the West at least is seriously out of whack. The follies of post-crisis central bank monetary reflation are likely to drive us rapidly into the next credit crisis as a consequence. To understand why this is so requires us to revisit the 1930s writings of an Austrian-born economist, who was tasked by the London School of Economics with explaining to advanced students the disruption to the production process from changes in consumer demand.

Friedrich von Hayek was famously reported as the economic guru of both Margaret Thatcher and Ronald Reagan. This distinction owes its origin to his market-based approach to economics, which was in stark contrast with the statist approach that was predominant in political circles at that time, and still is today. It was simple shorthand for the media writing for a mass audience.

The distinction is nonetheless correct. Instead of spending his professorial career bending with the socialist and Keynesian winds, he continued to develop and defend free-market economic theory. As a war for hearts and minds, apart from his occasional successes, it was one Hayek lost, and the consequences of the triumphs of Keynes and socialism are reflected today in systemic instability. But that is no reason to abandon the Hayekian tradition.

Hayek made a number of important contributions to economics, including an understanding of the business cycle, which he demonstrated was driven by credit expansion, and the subsequent consequences of that earlier expansion. The root of the problem, as it is today, is the way producers of goods and services adapt to changes in demand for final goods. It is a problem seemingly ignored by policy makers. Instead they believe that monetary expansion can replace savings without negative economic consequences. This is simply not true.

Hayek illustrated the mechanism of production and the effects of capital flows in a capitalistic economy in the form of a triangle, which showed the steps in production from its early stages towards the final product in time sequence. Using this simplistic illustration he explained the effects of fluctuations of consumer demand on production. The following illustration is of Hayek’s triangle.

The triangle’s sides represent an inverted vertical axis of time, and a horizontal axis of output, the output being consumer goods. The dotted lines represent the various stages of production, typically from the gathering of raw materials and the processing of products through intermediate stages of processing, until the final products are ready for sale to consumers. The assumptions are ones of equilibrium, that is to say there is no change from technology, the distribution of stages of production are even, the quantity of money in the economy is fixed, and lastly there are no alterations in consumer choice.

This highly artificial construction is intended to isolate the factors that determine the relationship between production and consumption, a vital subject otherwise concealed from us by the noise from all the other extraneous factors.

At this point, we must dismiss the common assumption behind GDP, that it is only output that matters. The error has a long history, and goes back even to Adam Smith, who wrote,

“The value of goods circulated between the different dealers never can exceed the value of those circulated between dealers and consumers; whatever is bought by the dealer being ultimately destined to be sold to the consumers."[ii]

In the sense of the sum of added values, this is obviously true. But what matters in our context is payments, payments in the production chain and payment for the final product. The payments between the various stages of production can be many multiples of the final payment, a fact which is hidden from us by the GDP statistic. Indeed, it is only partly revealed to us by the business-to-business activities that occur in production as captured by the US Bureau of Economic Analysis’s gross output statistic.[iii]

Hayek took his triangle to the next stage, and that was to consider the relationship of money flows between intermediate processes, compared with payment for the final consumption output. The intermediate steps are given payment values. The working assumption is that they increase at an even rate as they progress towards the final product, which is likely to be the case because if the returns on one intermediate process is out of line with the others, capital flows can be expected to correct the disparity.

- Source, James Turk's Goldmoney

Wednesday, June 20, 2018

A Scheme for Linking Currency to Gold

Comparing the value of bullion held to the narrowest expression of money is likely to prove insufficient upon which to base a future monetary policy. But, given a good base of monetary gold, it is possible to set up arrangements to discourage redemptions of currency for physical gold when a gold exchange standard is fully implemented[vi]. The suggested arrangement that follows is based on the issuance of irredeemable government bonds with a coupon payable in either gold or currency at the owner’s choice (the gold bond). Furthermore, an issue of this sort could be used to improve government finances at the same time.

By issuing the gold bond at a discount to par, early buyers get an enhanced yield. This rewards them for buying a new instrument which has yet to gain its potential market recognition. The market price of the bond will become linked to the yield on physical gold once the conversion rate is set, with an additional margin for issuer risk. And if currency balances invested in such a bond are rewarded with a yield payable in gold, demand for currency redemptions into gold are unlikely to be significant, so long as the public has confidence in the issue and the gold exchange standard. So, a country putting its currency on a gold exchange standard should, with a correctly priced bond, minimise redemptions.

A sinking fund should be established at the same time as the bond is announced to buy physical gold to cover anticipated demand for coupons paid in gold. Some gold from reserves can be allocated for this purpose initially but additional gold should be bought to establish sufficient cover to add conviction to the scheme by winding down existing foreign currency reserves where they are unbacked by gold, immediately.

From here on, we shall assume this scheme to introduce a sound, gold-exchangeable currency is taken up by the Chinese government. Government finances can be expected to improve from the arrangement, to the extent that borrowing costs are reduced. For example, China’s 30-year bond currently yields 4.1% having been as high as 4.4% earlier this year. A gold-linked irredeemable Chinese bond, even allowing for issuer risk would probably yield no more than 3% at the outset, which is slightly less than the current yield on 1-year maturities. If it was issued with, say, a 2.25% coupon, it would be priced at 75.00, giving the attraction of a capital gain to private citizens as the risk premium on Chinese government bonds declines.

This will also lend support to the currency in the foreign exchanges. The gold bond should be listed in Shanghai, Hong Kong, Tokyo, Singapore, Dubai, London and Moscow so that sovereign wealth funds and other conservative long-term investors have ready access to it. New York is not on the list because it is Chinese policy to exclude the American banking system from her monetary affairs as much as possible, and the conflicts that necessarily would arise with the US government. Ultimately, for funds based outside America, the gold bond itself would come to be regarded as a gold substitute for investment purposes, integrating gold into both Chinese-led monetary and investment reforms.

There can be little doubt that if these measures are taken gold convertibility would rapidly promote the yuan to foreigners in Asia and beyond as an acceptable store of value in exchange for trade. In time, all foreign currency held in China’s monetary reserves not backed by gold would have to be disposed for gold or yuan, as being inconsistent with the new monetary policy. As stated above, China’s gold buying using dollars would start immediately and continue until the price of gold has risen to the point where the gold exchange rate is finally established.

Furthermore, with no final redemption on the gold bond, there would be no need to make any repayment provisions. This model is the one that was adopted by the British government for financing the Napoleonic Wars by issuing Consolidated 3% Annuities at a deep discount, so that investors providing war finance not only got an enhanced yield, but also a substantial capital gain when peacetime returned. The fortunes created on the return to peace played an important part in financing the industrial revolution in the early nineteenth century.[vii]

In this sense, there are good parallels between Britain’s war financing two hundred years ago, and China’s current position. In both cases government expenditure exceeded and exceeds respectively tax income by a significant margin, and neither were and are on a gold standard. Britain had temporarily abandoned her gold standard in the 1790s, before reinstating it a few years after Waterloo.

In China’s case, excess government expenditure is due to planned infrastructure spending, which is likely to be ongoing for at least another ten years and extending well beyond her borders. However, Chinese instigated capital expenditure throughout Asia will increasingly be covered by project financing through the Asian Infrastructure Investment Bank, releasing the Chinese government from much of the financing burden.

The British came out of the Napoleonic Wars with an estimated debt to GDP of about 260%. In cash terms it was considerably less, because the debt figure is the total of nominal debt in issue. This was the beauty of irredeemable Consols, because they never need to be repaid, which meant a more accurate debt to GDP figure was 180%. As an historical footnote, it is interesting they were repaid only recently.

China’s government debt is considerably less at just under 50%, but still rising. China is blessed with a savings rate of close to 50% of GDP as well, so further issues of a gold-linked bond into the domestic market should be heavily subscribed. Once the current expansion of infrastructure spending diminishes, the Chinese government will easily return to a budget surplus, paying down its debt more rapidly than the British did in the 1800s.

I would suggest China undertakes the monetarisation of gold in two stages. The first would be to issue the new gold loan outlined above. Proceeds of the new gold bond would be used to finance government expenditure, to purchase existing bonds in the market for cancellation, and to build a sinking fund to provide cover for future coupon demands in gold. The price relationship between coupons paid in gold and yuan will be fixed at a later date and will be the rate for the gold exchange standard once it is set. It cannot be set at the outset, because it is clear that for gold to be rehabilitated into China’s monetary system, and consequently the likelihood it will be elsewhere, will require a far higher gold price than at present. In price theory, it is the introduction of a new use that will set a higher marginal price. That will be the second step, which is announced in advance when the new gold bond is first issued but at a rate yet to be decided.

- Source, James Turks Goldmoney

Sunday, June 17, 2018

Gold’s Monetary Rehabilitation

There is a quiet revolution taking place in the monetary vacuum that’s developing on the back of the erosion of the dollar’s hegemony. It is perhaps too early to call what’s happening to the dollar the beginning of its demise as the world’s reserve currency, but there is certainly a move away from it in Asia. And every time the Americans deploy their control over global trade settlement as a weapon against the regimes they dislike, nations who are neutral observers take note and consider how to protect themselves, “just in case.”

Vide Europe over the Iran issue. And Turkey. These are rifts in NATO. Countries in Africa, and elsewhere are now taking China’s money. And to please the Chinese, Gambia, Burkina Faso, Panama and the Dominican Republic have all recently severed diplomatic relations with Taiwan. Small fry perhaps, but a weathervane showing which way the wind is blowing.

We’ve seen Russia set up an alternative to SWIFT in order to be free from American monetary interference in pan-Asian trade. We’ve seen China take major steps to exclude the dollar from her trade as much as possible and to enhance the role of her own currency. And now we have a schism over Iran between America and the Europe it set up after WW2 through the mechanism of the CIA-controlled American Committee for United Europe in 1948.

It is unprecedented, and today America obviously cares less for her relationship with European allies than she hates Iran. There can be little doubt that America’s undeclared war against the land of Omar Khayyam is intended to undermine its economy and create the conditions for internal revolution. The Iranian rial has continued its collapse, and the theocratic government has played into US hands by shutting down “unauthorised” money-changers, with Grand Ayatollah Nasser Makarem Shirazi calling for the execution of money changers to help end the currency crisis. The black-market rate for rials has rocketed as a result, and according to Professor Steve Hanke whose department at John Hopkins University makes a study of these things, the true rate of price inflation has jumped to 74.8%.

For the ordinary Iranian, gold has always been the ultimate money, while their government’s rials are to be rapidly passed on to someone else. America’s sanctions and the government’s actions merely reinforce that message. Time will tell whether America’s attempt to undermine Iran’s theocracy succeeds, but history suggests it is unlikely. And at a national level, Iran is driven by American actions into accepting anything but dollars in payment for her oil exports. She would like euros, and given the EU is still trying to sell her capital goods, that makes sense. But no commercial bank dares facilitate payment in any currency under the threat of US sanctions and penalties.

That leaves only three possibilities beyond America’s influence: Chinese yuan, Russian roubles, and gold, all independent from the West’s banking system. It is no wonder the new yuan for oil contract in Shanghai, perhaps with a little help from China’s state-owned banks, has got off to a roaring start. We can all understand the desire to lock in oil prices for future delivery, in this case it is in return for yuan issued by the People’s Bank of China. However, in the future Iran will be able to spend the bulk of her yuan on other raw materials, using a range of yuan futures contracts as a bridge to them from her oil.

Essentially, US sanctions are forcing Iran onto a yuan standard for her foreign trade. Furthermore, China is there to pick up the pieces the West abandons because of American sanctions, driving Iran into an increasing dependency on China. The new Silk Road, the Chinese-built 200kph railway between Tehran and the eastern city of Mashad, as well as other Chinese-led rail projects are opening up Iran in a purely Eurasian context, marginalising American power. Iran’s problem with this, if there is one, is international yuan markets are not yet developed enough to make full use of hedging instruments. But Iran’s demand for sophisticated financial tools, as well as from other nations in Asia turning their backs on America, is bound to hasten their development.

I have written several times in the past about the importance of yuan-denominated deliverable gold futures in this context, and the evidence that the two markets offering these contracts, Hong Kong and Dubai, are cooperating in establishing additional vaulting facilities in China, roping in other gold centres in South-east Asia as well. In the case of gold, where physical delivery measured in tonnes is tight, the Chinese are ensuring as far as possible that deliverable liquidity will be there.

Additionally, last week the London Metal Exchange, owned by the Hong Kong Exchange and Clearing (HKEX), admitted it is considering introducing yuan contracts for base metals as well. We can safely assume that while the HKEX is an independent commercial entity, its strategic objectives are closely aligned with and encouraged by the Chinese government. Not only do the Chinese dominate gold markets in Asia, but last year HKEX successfully introduced regulated precious metal contracts in London. There can be little doubt that HKEX will be an important platform for expanding international markets for the Chinese currency. And at some time in the future, a state like Iran will be able to use not only yuan contracts to sell commodities in order to buy other commodities, but to use them as a stepping-stone to mobilise state-owned gold for payments as well.

Our topic is now moving on to gold being actively used as money instead of fiat currencies. While this point is not yet being considered by Western commentators, we can be sure it is by the forward planners in Asian governments. It’s not for nothing India is trying everything to get hold of its citizens gold. To an extent, gold is already used as money by governments, which is why they are still included in monetary reserves. But they are there as a backstop, the money of last resort, no one’s liability. What we could be seeing with the development of international yuan currency markets is a platform that links the use of gold to trade settlement.

This insight means we must look at both the Chinese and Russian policies on gold in a new light. Assumptions in the markets seem to be that China and Russia only see gold as a dollar hedge, or alternatively their accumulation of gold is either to balance the US’s holding of 8,133 tonnes, or alternatively (if you believe the American’s are lying about their reserves) Chinese and Russian gold is there to be used like a sword of Damocles held over the dollar. It would be wrong to dismiss these theories out of hand, but surely, they miss the point. You don’t carefully plan to become a dominant world power, edging out the Americans and their dollars, without careful forward planning of monetary affairs.

There is irrefutable evidence that China has been planning for a post-dollar world since shortly after her leadership threw in the towel on communism and embraced free markets. The regulations appointing the People’s Bank with sole responsibility for gold and silver date all the way back to 1983, since when we can confidently assume the PBOC has quietly accumulated gold on behalf of the state at prices that varied between $250-500 over a nineteen-year period. We know this, because in 2002 the PBOC then permitted private ownership, setting up the Shanghai Gold Exchange to facilitate physical acquisition. This would only have happened after the state had had a clear run at accumulating sufficient physical gold for its future purposes. And, as the largest gold mining nation for many years by far, with state monopolies in refining domestic production, recycling scrap and refining imported doré, there should be no doubt over her policy towards her accumulation of gold bullion.[ii]

Since 2002, the Chinese government has actively encouraged its nationals to accumulate physical gold and judging by net withdrawals from the Shanghai Gold Exchange vaults, the public possesses roughly 18,000 tonnes from more or less a standing start.[iii] My estimate for state ownership of bullion, based on contemporary prices, an analysis of capital inflows in the 1980s, followed by trade surpluses in the 1990s and before the public were permitted to buy in 2002, is approximately 20,000 tonnes. Even so, that may be not be enough gold bullion owned by the state at current prices to operate a simple gold exchange standard, being the equivalent value of ¥5.22 trillion, compared with currency in circulation of ¥7.15 trillion.[iv] For comparison, when President Roosevelt devalued the dollar to $35 in January 1934, the US Treasury held gold worth $7.44bn at the new price against currency in circulation of $5.72bn. Therefore, if the Chinese government has 20,000 tonnes, and if it is to have the same currency cover as America had on 31 January 1934, at current exchange rates gold would have to be priced at $2,317.

Russia began accumulating gold only more recently and is now aggressively building her official reserves. Whether she has accumulated bullion “off balance sheet” is not known but should not be dismissed. Based on her official reserves at 1,910 tonnes worth RUB5.0 trillion, it does not cover M0 yet (RUB8.44 trillion)[v] but a rise in the gold price to $2,200 will do so, and a gold price of $2,860 would be required to match the Americans in 1934. In fact, for both Russia and China if gold is to have a monetary role it would have to be at a far higher price than it is today.

Thursday, June 14, 2018

EU Banks are Insolvent, Disaster is Coming

The disruption of an Italian withdrawal from the euro would be fatal for the EU’s banking system on at least four levels.

The support from the ECB for the Italian banks would be withdrawn, which would have the potential to allow a cascade of bank failures in Italy to develop, either as a result of bad debts crystallising within the system, or due to balance sheet deterioration from falling Italian government bond prices.

Problems for banks will arise when past loans remain denominated in euros, while their balance sheets are transitioned into a new, weakening currency. The Italian banks lack the margins to weather lop-sided balance sheets, whose assets are denominated in a declining currency relative to the currency of their liabilities.

There will be a rush for residents in other Eurozone countries to reduce and eliminate their Italian commitments, amounting to a banking run against the whole country. The only political solution would be to impose draconian capital controls between Italy and the rest of the world, including other EU member states.

Lastly, there is the threat to the ECB and the euro-system itself.

These require little elaboration, expect perhaps for the threat to the ECB and the euro-system. The ECB has been buying large quantities of Italian bonds, effectively financing the Italian government’s excess spending, at yields that are ridiculously low. In effect, the ECB has put itself in an impossible position, and as the Italian situation worsens, the debate over the fate of TARGET2 imbalances is bound to intensify. These are shown in the chart below, which is of balances at end-March.

So long as the euro-system holds together, we are reassured that these imbalances do not matter. However, with the Italian central bank in debt to the system to the tune of a net €447bn, how these imbalances would be dealt with on an Italian exit from the euro without a collapse of the system is an interesting question. And it is worth noting that Spain’s central bank is also in the hole for €390bn, just in case the Spanish electorate, or even the Catalans or Basques get ideas of leaving as well.

The Bundesbank is owed a net €896bn and will be extremely nervous about Italy. The ECB itself also owes a net €235bn to all the national central banks. When the ECB buys Italian government debt, the Banca d’Italia acts on its behalf. The Italian bonds are held at the Banca d’Italia, and the money is owed to it. To the extent the ECB has bought Italian bonds, the overall negative balance at the Banca d’Italia is reduced, so its deficits with the other national banks in the system are actually greater than the €447bn shown, by the amount owed to it by the ECB.

In short, it is hard to see how Italy can leave the euro without the ECB having to formally guarantee all TARGET2 deficits. It is not impossible and the guarantee is already implied, but the ECB won’t want anyone questioning its own solvency, so we can safely assume an exit will not be permitted, for one simple reason: the system and the banks in it are only solvent so long as the system is unchallenged.

The question over Italy’s euro membership may not arise anyway, because the new coalition does not yet know what it wants. The Italians must also be dissuaded from their desire for debt forgiveness, for the same reasons the Greeks were similarly deterred. And as the Greeks found, trying to negotiate with the EU and the ECB was like talking to a brick wall. The Italians will experience the same difficulties. We can dismiss any idea that because Italy is a far bigger problem, they have negotiating clout. A brick wall remains a brick wall.

So far as Brussels and Frankfurt (the home of the ECB) are concerned, they are always in the right. The European project and the euro are more important than the individual member nations, and their electorates have no say in the matter. We often take this to be arrogance, which is a mistake. It is worse: like Marxists, the eurocrats have unarguable conviction on their side. Across the table will sit the Italians, with no political beliefs worth mentioning, and all too readily frightened by the consequences of their own actions.

This is the way the EU works. Inevitably, in a faceless statist system such as this there are always problems at the national level to deal with. Then there are localised difficulties, such as Deutsche Bank, whose share price tells us it is failing. But in that event, it will doubtless be rescued because of its enormous derivative exposure, the containment of eurozone systemic risk, and German pride. The ECB has shown great skill at bluffing its way through these ands other problems and is likely to continue to succeed in doing so, except for one particular circumstance, which is the crisis stage of the credit cycle.

- Source, James Turk Goldmoney

Monday, June 11, 2018

The Gently Rotting Debt Ridden EU

The EU as a political construction is in a state of terminal decay. We know this for one reason and one reason alone: its core principle is the state is superior to its people. A system of government can only work over the longer term if it recognises that it is the servant of the people, not its master. It matters not what electoral system is in place, so long as this principle is adhered to.

The EU executive in Brussels does not accept electoral primacy. It shares with Marxist communism a belief in statist primacy instead. The only difference between the two creeds is Marx planned to rule the world, while Brussels is on the way to ruling Europe.

The methods of satisfying their objectives differ. Marx advocated civil war on a global scale to destroy capitalism and the bourgeoisie, while Brussels has progressively taken on powers that marginalise national parliaments. Both creeds share a belief in an all-powerful executive. The comparison with Marxism does not flatter the EU, and suggests it has a limited life and that we may be on the verge of seeing the EU beginning to disintegrate. Despite economic evolution in the rest of the world, like Marxian communists Brussels is stuck with a failing economic and political creed.

It has no mechanism for compromise or adaptation. A rebellion from Greece was put down, the British voted for Brexit, which is proving impossible to negotiate, and now Italy thinks it can partially escape from this statist version of Hotel California. The Italians are making huge mistakes. The rebel parties forming a coalition government want to stay in the EU but are looking to exit from the euro. Putting aside the impossibility of change for a moment, they have it the wrong way around. If they are to achieve anything, they should be exiting the EU and staying in the euro. Let me explain, starting with the politics, before considering the economics.

As stated above, the EU is quasi-Marxist, placing the state above the people. The Italian government has collaborated with Brussels to enslave its own people as vassals of the EU super-state. If there is a revolt in Italy, this is what the electorate is rebelling against. Faceless eurocrats tell the Italian people what to do and what to think. The people are discontent with both the super-state and their own weak governments.

The two parties forming the latest coalition are too frightened to blame the EU, and instead propose to beg for debt forgiveness and say they are considering leaving the euro. But without a clear vision, and understanding why the Italian electorate is discontent, this coalition will turn out, in one of Boris Johnson’s memorable phrases, to be comprised of little more than supine protoplasmic invertebrate jellies. Greece is the precedent. This makes it easy for the EU to deal with the Italians. They will get nothing.

The economic argument, that Italy would be better with her own currency, is insane. With a history of weak irresponsible governments, it is far better for the currency to be beyond Italy’s control. However, Keynesian commentators are sympathetic to the weak currency argument, believing that the euro was constructed for the benefit of Germany. Italy, along with the other Mediterranean members, is said to be paying the price. This, they allege, is the fatal flaw in the one-size-fits-all euro. This interpretation of the monetary situation is baloney. It ignores the fact that Italy’s debt rocketed after the formation of the euro, because the cost of borrowing for Italy fell towards Germany’s borrowing rates, thanks to the guarantee of eventual unification. The difference was Germany borrowed to invest in production, while the Italian government borrowed to spend. The problem today is the profligacy of the past has caught up with Italy, and its government must stop borrowing.

Setting up a lira alternative, or the mooted mini-BOTs, is an ill thought out concept that only makes matters worse. The mini-BOT proposal appears to be for an issue of certificates backed by future tax revenues to be used to pay the government’s creditors. They would then circulate like bills drawn on the state, but at a discount to reflect both their time value and the fact they are not euros. It seems to not occur to the promoters of schemes like this that the state’s creditors will insist on payment in euros.

Promoters of schemes like mini-BOTs are monetary cranks, incentivised by a desire to avoid reality. The Italian government has been using this sort of hocus-pocus for years, mostly with securitisation of future income streams, such as the national lottery. Mini-BOTs appear to be a proposal for just one more throw of the dice.

It’s hardly surprising that the Italian people are fed up with their establishment and feel they can only collectively undermine it by voting against it at election time. But it is too late, because the state, and therefore the banks, are already irretrievably bust, a fact barely concealed by the ECB’s funding of the Italian government at near-zero interest rates through the purchase of government bonds. Not only is the ECB in denial over Italy’s financial situation, but also Italy is firmly imprisoned.

- Source, James Turks Goldmoney

Monday, May 28, 2018

It’s not stagflation, but inflationary impoverishment

It is a matter of personal interest that it was my uncle, Iain Macleod, who invented the term stagflation shortly before he was appointed shadow chancellor in 1965i. It is no longer used in its original context. From Hansard (the official record of parliamentary debates) 17 November that year:

We now have the worst of both worlds —not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of "stagflation" situation and history in modern terms is indeed being made.ii

The inflation that Iain was referring to was of wages, which were averaging an increase of 6.2%, and rising, and stagnation in production, which had declined from an index of 134 to 131. It was this divergence that gave him the opportunity to invent this portmanteau word. It has now passed into more common use to describe an economy that fails to respond to the stimulus of monetary inflation.

Its use in this context is therefore different from the original. The idea that stagflation exists as an economic phenomenon is only really true for neo-Keynesians, who view inflation as economically stimulative, and its failure to stimulate perplexing. In this sense it is frequently applied to conditions today, where massive monetary stimulus does not appear, so far at least, to have brought about the economic growth that might have been expected from it.

The explanation why monetary stimulus has not worked as intended is not difficult to understand, but for neo-Keynesians it is unpalatable. This article takes its cue from the misapplication of the stagflation term to explain why Keynesian stimulation of the economy is bound to fail, and symptoms commonly but incorrectly referred to today as stagflationary are simply a reflection of the costs of monetary policy imposed on ordinary people.

It involves the reinstatement of Say’s law to its rightful place, not as Keynes misleadingly described it, that supply creates its own demand. It requires an understanding of why inflation destroys wealth, the opposite of the creation of wealth that a stimulus implies. And it necessitates an appreciation that GDP is no more than a misleading accounting identity covering only a minor part of the economy. I shall explain the relevance of these topics in turn, and why stagflation is an inappropriate description of some sort of intermediate condition between inflation and deflation...

- Source, James Turks Gold Money, Read More Here