, James Turk Blog

Sunday, January 13, 2019

Gold: A Perfect Storm For 2019

For gold bulls, 2018 was disappointing. From 11 December 2017, when gold made a significant bottom against the dollar at $1243, it has ended virtually unchanged today, after being 4.2% up. Gold had to struggle against a rising dollar, whose trade-weighted index rose a net 3.7% over the same period, and as much as 9.4% from its mid-February low.

Dollar strength has been driven less by trade imbalances and more by interest rate differentials. A speculating bank for its own book or for a hedge fund client can borrow 3-month Euro Libor at minus0.354% and invest it in 3-month US Treasury bills at 2.36%, for a round trip of over 2.7%. Gear this up ten times or more, either on a bank’s capital, or through reverse repos for annualised returns of over 27%. To this can be added the currency gain, which at times has added enough to overall returns for an unhedged geared position to double the investment.

Not that these forex returns have been guaranteed, but you get the picture. The ECB and the Bank of Japan have been frozen into inactivity, reluctant to raise rates to correct this imbalance, and the punters have known it.

Financial commentators have routinely misunderstood the fundamental reason for the dollar’s strength, attributing it to foreigners’ desperate need for dollars. In fact, non-US holders of dollars hold it in record amounts, with over $4 trillion in deposits in correspondent bank accounts alone, and a further $930 billion in short-term debt.[i] This $5 trillion of total liquidity was the last reported position, as at end-June 2017. Speculative dollar demand since then, driven by interest rate differentials, will have added significantly to these figures. The continuing US trade deficit, currently running at close to a trillion dollars annually, is both an associated and additional source of dollar accumulation in foreign hands.

Meanwhile, the same US Government data source reveals that US residents’ holdings of foreign securities was $6.75 trillion less than the foreign ownership of US securities, and the US Treasury reports that major US market participants (i.e. the US banks and financial entities operating in the spot, forwards and futures contracts) sold a net €2.447 trillion in the first nine months of 2018. Assuming these sales were not absorbed by official intervention on the foreign exchanges or by contracting bank credit, they can only have added to foreign-owned dollar liquidity.[ii]

To summarise the point; far from there being a dollar shortage, as market participants believe, the world is awash with dollars to an extraordinary degree.

The great dollar unwind is now overhanging markets, which will remove the principal depressant on the gold price. And when it begins, as a source of supply these hot-money dollars will be seen as the continuation of escalating supply, with the prospect of future US trade and budget deficits to be discounted. These dynamics are a duplication of those that led to the failure of the London gold pool in the late-sixties, which led to the abandonment of the Bretton Woods gold-dollar relationship in 1971. And as I argue later in this article, the supply of physical liquidity in bullion markets to satisfy demand arising from dollar liquidation is extremely tight.
Geopolitics and gold in 2018
It is likely that at a future date we will look back on 2018 as a pivotal year for both geopolitics and gold. Russia has moved to a position whereby it has substantially replaced its dollar reserves with physical gold. It is now able, if it should care to, to do away with the dollar entirely for its energy exports payments. It is even possible for it to link the rouble to gold.

China took the seemingly innocuous step of launching an oil contract denominated in yuan. It had prevaricated since at least 2014 before making this move, presumably conscious that it was an in-your-face threat to the monopoly of the dollar in pricing energy.

There was expectation that the oil-yuan futures contract would be a segway into a yuan-gold futures contract either in Hong Kong or Dubai, allowing countries such as Iran to avoid receiving dollars entirely. And indeed, a number of gold exchanges and interests in Asia have banded together to open a 1500-tonne vault in Qianhai to facilitate gold storage resulting from pan-Asian trade flows.

These include the China Gold and Silver Exchange Society, the Hong Kong Gold Exchange, and gold market interests in Singapore, Myanmar and Dubai. The objective is to give Hong Kong the opportunity to coordinate Asian gold markets and develop a “gold corridor” for the countries along China’s Belt and Road initiative. Therefore, both private and public sectors will be able to accumulate the oldest form of money as a backstop to local currencies, as an alternative to accumulating those of their trading partners.

Geopolitics evolved from fighting proxy wars in the Middle East and Ukraine, which were effectively won by Russia, to the less obvious war of trade tariffs. President Trump has styled himself as “A Tariff Man”. We have presumed that he is ignorant of economics, but that is no longer the point. Tariffs have evolved from a policy to make America great again to bankrupting China. China is seen as the greatest economic threat to America, and in this duel, tariffs are Trump’s weapon of choice.

The objective is to impede China’s technological development. It was tolerated when China, to steal a line from Masefield’s Cargoes, was the world’s supplier “…of firewood, iron-ware and cheap tin trays”. But China is moving on, creating a sophisticated economy with a technological capability that is arguably overtaking that of America. The battle for technological supremacy came out into the open with the detention on 1 December in Vancouver of Meng Wanzhou, the CFO of Huawei. Huawei is China’s leading developer of 5G mobile technology, installing sophisticated equipment around the world. 5G’s capability will make internet broadband redundant and will become widely available from next year.

Ms Meng’s arrest represents such an escalation of deteriorating relations between China and America that many assume it was ordered by rogue elements in America’s deep state. Maybe. But these things are difficult to reverse: does America tell the Canadian authorities to just let her go? It would uncharacteristic for America to admit a mistake, and it would probably need President Trump to personally intervene. This is difficult for him because application of the law is not in his hands.

If Ms Meng is not released, we will enter 2019 with the Chinese publicly insulted. They will realise, if they haven’t already, that ultimately there can be no accommodation with America. Fighting tariffs with more tariffs is a policy that will achieve nothing and damage China’s own economy.

It therefore becomes a matter of time when, and not if, China deploys financial weapons of its own. These will be targeted at the US’s obvious weaknesses, including her dependency on China for maintaining and increasing holdings in US Government debt. The increasingly compelling use of physical gold to both protect the yuan from attack in the foreign exchanges and limit the rise of yuan interest rates would serve to insulate China from the fall-out of a collapsing dollar.

The economic outlook, and the effect on the dollar

For market historians, the economic situation rhymes strongly with 1929, when the Smoot-Hawley Tariff Act was being debated. Eighty-nine years ago, the first round of votes in Congress was passed on 30 October, and Wall Street fell heavily that month in anticipation of the result. Following the G20 meeting two weeks ago, where it was vainly hoped there would be progress in the tariff negotiations between the US and China, markets fell heavily, reminding market historians of the 1929 precedent.

When President Hoover stated his intention to sign Smoot-Hawley into law on 16 June 1930, Wall Street crashed again. The lesson for today is that equity markets are likely to crash again if Trump continues with his tariff policies. Smoot-Hawley raised import tariffs on over 20,000 imported raw materials and goods, increasing the average tariff rate from 38% to over 60%. The difference today is that instead of tariffs being used only for protectionism, they are being targeted specifically against China.

There will be two likely consequences. The first is the the undermining of financial markets, which in the 1930s led to the virtual collapse of the US banking system and the global depression. And secondly, there is the escalation of a wider financial war raging between China and the US. These two factors are potentially very serious, with stock markets already on shaky ground.

This is not the uppermost reason for market weakness in investors’ minds, who worry about the economic outlook more generally. The conventional credit cycle features rising interest rates as a consequence of earlier monetary expansion, and the exposure of malinvestments. Markets discount the phases of the credit cycle when they become apparent to far-sighted investors, and only indirectly contribute to the collapse itself. But when valuations have become wildly optimistic, the fall in markets becomes a crisis on its own, contributing to the collapse in business that follows. This was the point taken up by Irving Fisher in the wake of the 1929-32 bear market.

In any event, the global economy appears to be at or close to the end of its expansionary phase, and is heading for recession, or worse. As well as the potential impact from an unanchored reserve currency, price inflation in the US will be boosted by Trump’s tariffs, which amount to additional consumer taxes. Price inflation pressures will then call for further rises in interest rates, while economic prospects will point to easing monetary conditions.

We have yet to see how this will be resolved. A further problem is that an economic downturn will increase government welfare commitments and therefore borrowing requirements. Bond yields will tend to rise and therefore borrowing costs, driving spendthrift governments into a debt-trap, just when price inflation is likely to demand higher interest rates. The most likely outcome will be further losses of fiat currencies’ purchasing power.

The 1930s depression saw a rising purchasing power for the dollar, with all commodity and consumer prices declining. The dollar was on a gold standard, and prices were effectively measured in gold, the dollar acting as a gold substitute. This is no longer true, and the purchasing power of the dollar, along with all other fiat currencies will at best remain stable measured against consumer products, or more likely will decline. In other words, a severe recession which looks increasingly likely on cyclical grounds, will lead to higher gold prices, irrespective of fiat currency interest rates...

- Source, James Turk's Goldmoney, read more here

Wednesday, January 9, 2019

The Arrival Of The Credit Crisis

Those of us who closely follow the credit cycle should not be surprised by the current slide in equity markets. It was going to happen anyway. The timing had recently become apparent as well, and in early August I was able to write the following:

“The timing for the onset of the credit crisis looks like being any time from during the last quarter of 2018, only a few months away, to no later than mid-2019.”

The crisis is arriving on cue and can be expected to evolve into something far nastier in the coming months. Corporate bond markets have seized up, giving us a signal it has indeed arrived. It is now time to consider how the credit crisis is likely to develop. It involves some guesswork, so we cannot do this with precision, but we can extrapolate from known basics to support some important conclusions.

If it was only down to America without further feed-back loops, we can now suggest the following developments are likely for the US economy. Warnings about an economic slowdown are persuading the Fed to soften monetary policy, a process recently set in motion and foreshadowed by US Treasury yields backing off. However, price inflation, which is being temporarily suppressed by falling oil prices, will probably begin to increase from Q2 in 2019. This is due to a combination of the legacy of earlier monetary expansion, and the consequences of President Trump’s tariffs on consumer prices.

After a brief pause, induced mainly by the threat of an unstoppable collapse in equity prices, the Fed will be forced to continue to raise interest rates to counter price inflation pressures, which will take the rise in the heavily suppressed CPI towards and then through 4%, probably by mid-year. The recent seizure in commercial bond markets and the withdrawal of bank lending for working capital purposes sets in motion a classic unwinding of malinvestments. Unemployment begins to rise sharply, and consumer confidence goes into reverse.

Equity prices continue to fall, as liquidity is drained from financial markets by worried investors, but price inflation remains stubbornly high. Consequently, bond prices continue to weaken under a lethal combination of foreign-owned dollars being sold, increasing budget deficits, and falling investor confidence in the future purchasing power of the dollar.

The US enters a severe recession, which is similar in character to the 1930-33 period. The notable difference is in an unbacked pure fiat dollar, which being comprised of swollen deposits[ii] (currently 67% of GDP versus 36% in 2007), triggers an attempted reversal of deposit accumulation. The purchasing power of the dollar declines, not least because over $4 trillion of these deposits are owned by foreigners through correspondent banks.

One bit of good news is the US banking system is better capitalised than during the last crisis and is unlikely to be taken by surprise as much it was by the Lehman crisis. Consequently, US banks are likely act more promptly and decisively to protect their capital, driving the non-financial economy into a slump more rapidly by calling in loans. Price inflation will not subside, because that requires sufficient contraction of credit to offset the declining preference for holding money relative to goods. Any credit contraction will be discouraged by the Fed, seeking to avert a deepening slump by following established monetary remedies.

The Fed’s room for manoeuvre will be severely restricted by rising price inflation, which it can only combat with higher interest rates. Higher interest rates will become a debt trap springing tightly shut on government finances, forcing the Fed to buy US Treasuries under cover of monetary stimulation. The true reason for QE will be that with a rapidly escalating budget deficit exceeding $1.5 trillion and more, the Fed will want to suppress borrowing costs compared with what the market will demand. Economic conditions will be diagnosed as a severe case of stagflation. In reality, the US will be ensnared in a debt trap from which the line of least resistance will be accelerating monetary inflation.

It will prove difficult for neo-Keynesian central bankers to understand the seeming contradiction that an economy can suffer a slump and escalating price inflation at the same time. It is, however, the condition of all monetary inflations and hyperinflations suffered by economies with unbacked fiat currencies. The choice will be to rewrite the textbooks, discarding current groupthink, or to soldier on. We can be certain the neo-Keynesians will soldier on, because they are intellectually unable to reform existing monetary policy in a manner acceptable to them.

That would be the likely outcome of the developing credit crisis if it wasn’t for external factors. There is precedent for it, and we can expect it from a purely theoretical analysis. It would be a rolling crisis, becoming progressively worse, taking six months to a year to unfold, followed by a period of economic recovery. But there is a major snag with this analysis for the US economy, and that is US monetary policy has long been coordinated with the monetary policies of other major central banks through forums such as the Bank for International settlements, G20 and G7 meetings.

The surprise election of President Trump upset this apple-cart with his untimely budget stimulus and the havoc he is wreaking on international trade. The result is the Fed is no longer on the same page as the other major central banks, particularly the Bank of Japan and the European Central Bank. Therefore, unlike crisis phases of previous credit cycles, the Eurozone enters it with negative interest rates, as does Japan, which are creating enormous currency and banking tensions. We will put Japan to one side in our search for knock-on systemic and economic effects triggered by the Fed’s increase in interest rates, and instead focus on the Eurozone, the heart of the European Union.

- Source, Alasdair MacLeod via James Turk's Goldmoney

Thursday, January 3, 2019

Pop Goes The Money Bubble with James Turk

What To Do Before It Pops is the latest book by James Turk and John Rubino. In their first book The Coming Collapse of the Dollar and How To Profit From It: Make a Fortune by Investing in Gold and Other Hard Assets, the authors questioned the housing bubble and advised the public to buy gold. The Money Bubble goes one step further: rather than addressing discrete asset classes, it deals with the world's major currencies -- and the bubble they represent.

Thursday, December 27, 2018

James Turk: The Start Of Something Big In Silver

"Are price trends the only thing to rely on? No, when it comes to markets there is no perfect formula. It is possible that silver may remain in the trading range marked by the two horizontal lines. It is even possible the price may drift lower. But today may be the start of something big, and if so, spotting trends can help.

Silver Finally Turning Higher

Who could have predicted that crude oil would collapse from $70 to $50 during October and November? A lot of money was made there by the shorts. As the saying goes, “the trend is your friend.” So if following the trend is helpful, so is watching for any clues that a trend reversal may be at hand. And right now this break of the downtrend line could be saying that the trend in silver is finally turning higher. If so, maybe a lot of money is about to be made by the longs in the precious metals.”

- Source, King World News, Read More Here

Sunday, December 23, 2018

James Turk: The Start Of Something Big In Silver, Plus the Collapse In Gold Open Interest

Everyone who understands the precious metals, Eric, knows that they are undervalued. So they also intuitively know that the downtrend in the price of the precious metals over the past several months will eventually turn higher…

Do This And You Won’t Have To Worry About A 2008 Scenario

Of course no one can predict when that turn will come, so I continue to recommend the same strategy that precious metals should continue to be accumulated for the simple fact that you are buying undervalued assets. View these purchases as saving money that is outside the banking system, and therefore immune to those types of risks that we saw in 2007 and 2008.

The same logic applies to the shares of mining companies. If you are prepared to invest in them and accept the risks, accumulate those you have concluded are good value. The good ones will turn higher when the precious metals themselves turn higher.

Collapse In Gold Open Interest

While we wait for the precious metals to reverse their downtrend and turn higher, I’ve been watching for clues that might indicate the turning point is near. And there have been a couple of important ones recently. One of those clues was the collapse in Comex gold and silver open interest over the past several days as the December contract approached first notice day. I didn’t check the historical records, but the collapse in open interest is the largest I can ever recall. I take it as an indication that the market is sold out, which itself might be saying that a turn is at hand.

Another clue is today’s action, which I see as very important. Is it telling us something we need to know? You bet it does, particularly given how undervalued the precious metals are at the moment. One thing I have learned from my five decades of experience in trading and investing is to let the market tell its story, and then listen to what it is saying. I do this by watching price trends, so take a look at this chart of the spot silver price, Eric.

Silver Breaks Out Of Downtrend!

Today the price of silver closed in both London and New York above a long downtrend line that goes back all the way to June. This event over time may prove to be a big deal.

- Source, King World News, Read More Here

Tuesday, December 18, 2018

Brexit: Where to From Here?

The deal has been agreed, subject to Parliament. Mrs May now has the uphill task of selling the deal to MPs. The overwhelming majority who have expressed an opinion including both Remainers and Brexiteers have condemned it. As has President Trump. She will be praying for no further asides from him at the G20 in Buenos Aires.

The vote is scheduled for 11 December, after a five-day debate. The Government’s tactic is to rely on Mrs May’s deal being the only one on offer, the alternative being the supposed abyss of a no-deal. The risk to this strategy is that Brexiteers expose the choice as being false and that Mrs May should go back to Brussels and renegotiate. The EU stands ready to reaffirm they will not accept any other deal to cut off this option.

The Treasury and the Bank of England have cranked up their economic and financial models again to forecast maximum disruption in the event Parliament fails to support Mrs May’s deal. However, in the Commons, the Treasury backed off from its responsibility for its post-Brexit forecasts, saying it was based on analysis involving a wide range of government departments. One is left wondering why the Treasury Secretary felt unable to give it his wholehearted support.

The Bank of England has been less delicate in its approach, by claiming we are all doomed. The result after only one day of airing its forecast is a loss of public credibility for the Bank and particularly for Mark Carney, its Governor.

The frighteners extend to a hodgepodge of claims of many things vital to life and employment, put together by government quangos[i]. Shortages of medicines, transport disruption, chemicals for water purification and many more are all documented in eighty different official papers. The deceit is to assume these supplies are provided at an inter-governmental level, and not by profit-seeking businesses, which would surely do everything in their power to secure continuing sales. The Port of Calais is expected to cut off its nose despite its face and turn away traffic.

This line of propaganda seems to be an irresistible line of attack for the Government, accustomed to frightening the populous into a preferred course of action. This is despite the failure of this tactic ahead of the Brexit referendum, when the public decided it was a stinking rat.

What is the deal, and why the fuss?

Britain leaves the EU on 29 March next year and under Mrs May’s plan enters an implementation period when there is no change in current trade arrangements, until at least 1 January 2020. After that, if the trade agreement is not in place (highly unlikely – it takes years to get the EU to agree to trade deals), Britain can either extend the implementation period for a time, or the backstop on the Irish border will be implemented.

The backstop ensures the Irish border would remain open to EU trade, as it is today, until a trade agreement is finally agreed and implemented. Until then, either the whole of the UK continues to be in the customs union, or Northern Ireland alone remains in it, effectively putting a border down the Irish Sea. The backstop, if it is implemented, can only be turned off “when we have fulfilled our commitments on the Irish Border.”[ii]

The agreement states that both the EU and the UK will use best endeavours to reach a trade agreement. But given it can be blocked by EU member countries which are not a party to the agreement, this reassurance must be worthless. Even before the ink was dry, Spain forced concessions on Gibraltar, and President Macron of France made it clear France would withhold its consent to a trade agreement if French fishing vessels were denied fishing rights in British waters.

The problem with the agreement is that by not agreeing, EU member states can ensure, in the words of Boris Johnson, Britain remains a vassal state. Worse than that, with this agreement it is a zombie state, a walking-dead captive of the customs union.

Even the Remainers don’t like it, because it is as plain as a pikestaff that Britain is in a far worse position with this agreement than it would be remaining in the EU. It is chained to the customs union with no influence over the regulations imposed upon it. Accordingly, Remainers of all parties are united in the call for a second referendum, which they hope will reverse the first, allowing Britain to remain as a full member of the EU. But to concede a second referendum would be unprecedented, and also an admission of failure by the government. Furthermore, it would take months to go through Parliament, time which it does not have. With no practical alternative, many prominent Remainers are expected to vote against the agreement.

For the Brexiteers, it is already an admission of failure, particularly since the Prime Minister always refused to consider a Plan B. Britain has agreed unconditionally to pay the EU £39bn as the divorce settlement and will continue to pay into Brussels the annual tribute of roughly £9bn until the new trade terms are agreed and implemented (which could be never). While the agreement generally limits the European Court of Justice’s powers to adjudicate on trade and related matters, it means Britain does not have control over future trade arrangements during implementation and backstop periods, and it will be impossible for Britain to strike her own trade deals until that time has passed. Hence President Trump’s remarks.

We have confirmation it is Hotel California: you can check out but never leave. The deal is so unpopular that already the media are saying it will never get through Parliament. The Daily Telegraphhas aggregated various sources of information to estimate 221 MPs will vote for it and 418 against.[iii]But much can change in a short fortnight.

Let us look at it from Downing Street’s point of view, to try to understand the Government’s strategy. 96 Conservative MPs have said they will vote against, out of a parliamentary party of 314 (excluding Speaker Bercow). The Democratic Unionist Party, with ten MPs who provide the Conservatives with their slim Commons majority, have also vowed to vote against it. The Labour Party with 257 MPs have said they will vote against it, but there are perhaps 60 Labour rebels. The Scottish National Party has 35 MPs, who will also vote against it. Liberal Democrats, with 12 are probably against it, but may not be united on the threat of no deal.

That leaves 216 Conservatives likely to support the Government (including 94 Ministers), perhaps 240 after the whips have done their work. 74 MPs from the other parties are then required, at least 60 of which must be Labour MPs. It is worth recalling that 64 Labour MPs defied the Labour whip over an amendment tabled to remain in the customs union last December, close to the number of Labour MPs required to rebel this time for Mrs May to win the vote. And that’s assuming Labour isn’t persuaded to abstain, which would guarantee Mrs May gets it passed by a comfortable margin.

Clearly, the key to success is Labour’s intentions, which is why Downing Street is wooing their MPs. However, two weeks ahead of the vote, talk of a heavy defeat for the government looks, on Downing Street’s likely assessment, wide of the mark.

All this assumes Labour will resist the temptation to topple Mrs May and create havoc for the Tories. That is a big assumption, because it is definitely in Labour’s interest to defeat the government to see what opportunities might arise. Consequently, while the Downing Street assessment may turn out to be too optimistic, the Brexit camp cannot afford to be complacent.
Brexiteer tactics

The Brexiteers will concentrate on mustering as much support as possible to reject the proposed agreement. They already have the ten DUP members on side, and 96 Conservatives who have said they will vote against. They need to work on the other 218 Conservative MPs, of which 94 are ministers, leaving a pool of 124 possible votes.

It would help their case enormously if more Brexit-supporting ministers resigned from the government ahead of the vote, so they are likely to be privately encouraged to do so. This would benefit the Brexit cause by fatally undermining the Government’s claim that the agreement is in the spirit of Brexit.

Brexiteers will also have to build cross-party alliances. Above all, they must come up with an alternative strategy acceptable to both Brexiteers and Remainers to force the Government to return to Brussels for better terms, despite Brussels saying the only alternative is no deal.

To achieve the necessary parliamentary support, Brexiteers are likely to focus on the least contentious issue, being the failure to achieve total parliamentary sovereignty in the draft agreement. Even Jeremy Corbin and others on the far left of the Labour Party can agree on this, because they want to be free from all Brussels regulations so that they can nationalise and subsidise unionised industries.

Sovereignty is the one issue the Government cannot argue convincingly, which is why it deflects the issue into one of taking control of immigration. The economic effects, which are a transitional problem, are less important to the bigger picture, but are more immediate to the electorate. For these reasons the Government is focusing on the economic effects, promoting hypothetical problems that grab the headlines and divert attention from the sovereignty issue.

The scope for half-truths and downright deception is enormous and is being exploited by both the Government and allegedly independent analysts. In the last few days, we have been told that stockpiling food has left Amazon short of warehouse space. This follows earlier assertions from Barclays Bank research that extra tariffs on food and drink imports could cost £9.3bn per annum, leading to higher food prices.[iv]

This must assume the Chancellor imposes, Trump-like, yet higher import tariffs on food than the ones being dropped on a no-deal Brexit. It might assume sterling will crash (we’ve heard that one before) but ignores the possibility the euro will fall even more. These scare stories are easy to counter and should be given no credence, but the media is always more likely to take as gospel truth the information spoon-fed to it by background government briefings, while questioning reasoned argument from Brexiteers with relative scepticism.
Mrs May’s future

Press reports suggest that Downing Street believes that if the vote is not passed, Mrs May could probably survive if it is rejected by less than a hundred votes. Any more than that, and she is toast.

This is probably too simplistic, and ignores the fact that David Cameron immediately resigned when he lost the Brexit referendum, irrespective of margins. It also relies on the ten DUP MPs continuing to give her a majority, which they have already withdrawn. If she relies on Labour votes, having failed to get sufficient support from her own party (which Downing Street is already doing), she will be ejected whatever the outcome. For the moment, everyone is being very polite, saying she has admirable qualities of perseverance and determination against all odds. And don’t we all love a fighter. This can rapidly elide into being pig-headed, domineering and deliberately misleading.

Act too early, and MPs who wish to ditch her will be accused of disloyalty and naked ambition. Furthermore, Brexiteers do not have control of the agenda. For these reasons, rival candidates for the leadership remain in the shadows. But they will be watching for that change of emphasis, which is likely to come in the wake of the Commons vote, if not before.

The only way Mrs May can save herself and the integrity of the Conservative Party is to cancel the debate and tell Brussels it simply won’t wash. She must remind them of the consequences of their rejection of David Cameron’s demands, and tell them they will have to come up with better terms, otherwise it is no deal.

Will she do it? We shall see. She has some leverage, if she can understand it. Brussels is bust and needs money urgently. The knock-on effects of a no deal might be unpredictable for the UK, but, and this is the point few have taken on board, it would be catastrophic for the EU.

- Source, Alasdair Macleod via James Turk's Goldmoney

Tuesday, December 11, 2018

Why Interest Rates Are Rising Long Term

Since 1981, interest rates have been in a secular decline, falling from 20% to zero in US dollars. They are now on the rise, but the general assumption is the current low interest rate environment will broadly continue. This view is complacent and likely to be expensively wrong, being founded on the erroneous view that significant levels of price inflation have been banished.

For the last forty years or so, monetary expansion has taken over from savings as the means of funding business expansion. This accords with the wish expressed by Keynes in his General Theoryfor the euthanasia of the rentier (or saver) and for entrepreneurial capital to be provided through the agency of the state.[i] Not only have declining interest rates deterred personal savings and encouraged the proliferation of consumer debt, but pension funds, seen as a personal savings backstop, have been undermined by the reduction of compounding interest. Therefore, we can say that during the time of our headline chart, the state has taken over the role from free markets of setting interest rates and distributing capital.

The chart above of the 10-year US Treasury bond tells us that there is now a break in this trend (shown by the dotted line). It appears there is a significant reversal of falling bond yields, threatening the state’s control of interest rates and capital allocation. Lines on charts are notoriously misleading at times, but they also indicate a very low interest rate level is enough to create a credit crisis. That is one issue, another is the general assumption that interest rates can remain permanently low.

The origin of the hope that interest rates will remain low is in large part psychological. For millennia, high interest rates have been seen as usury, or unfair charges imposed by greedy money-lenders on defenceless borrowers. This was certainly Keynes’s view, and it persists with his followers today.[ii]Instead, low interest rates are seen as both an inducement to spend rather than save, and to favour the entrepreneur investing in production over the saver.

Keynes’s view appeared to be that savers, or rentiers as he called them, were the idle rich, not employed but living off usury. To him it was morally wrong that “functionless investors” should benefit from the scarcity of capital, hence his desire for the euthanasia of the rentier. To take this line of argument, he had to navigate round the sheet-anchor of classical economics, Say’s law. He did this by describing it in such a way that it was open to question. These were his words:

“Thus, Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output is the equivalent to the proposition that there is no obstacle to full employment.”[iii]

That is nearly all he had to say on the principle which previously had been the greatest obstacle in economic theory to government intervention. He does not define it, but interprets Say’s law sympathetically to his intentions, and misdirects the reader by alleging that Say’s law was a denial of the high levels of unemployment that persisted in the decade when he wrote these words. And if the greatest living English economist at the time implies that the evidence of mass unemployment shows Say’s law cannot be true, it from that moment dies like Monty Python’s parrot, becoming an ex-law.

Say did not write down a precise definition of what subsequently was associated with him as an iron rule, but he set out very clearly his understanding of how human exchange operated. He demonstrated that we work in order buy the things we need, and our savings are the source of finance for production. This means that all consumer demand is the consequence of and follows the production of supply. Says was describing the division of labour, which is the way humanity maximises relevant output and improves its lot. Say also made it clear that the role of money is only temporary to facilitate the process.

It is a system born from the market, where people freely negotiate their business. It particularly benefited Britain during the industrial revolution, improving the lives of ordinary people, creating wealth and economic progress. There was never any need to replace savers with the state as the provider of capital as Keynes described. Nor for that matter, to replace the peoples’ money, which was gold and silver, with the state’s money. If there was disruption of production, it always came from the government and its licenced banks, which created credit out of thin air through fractional reserve banking. Diluting money by expanding both it and associated credit is a fraud on existing owners of money.

This is Keynes’s inflationary financing, relying on the fact that no one can tell the difference between existing currency and the introduction into circulation of yet more. Obviously, if you expand the quantity of money, other things being equal you have more money chasing the same quantity of goods, so prices will rise. That is the message from Say. The Keynesians answer to this is the demonstrably false proposition, that higher prices encourage consumer demand. However, there is one circumstance where this is true, and that is when the average person shifts his ownership preferences away from money towards goods and services. But this is playing with fire, because such a move can undermine a currency’s purchasing power with surprising rapidity, building into an unstoppable momentum.

There are therefore two variables that alter a currency’s purchasing power: the quantity in circulation and the public’s judgement of its future value. Central banks tend to pay attention to the quantity. The qualitative element cannot be calculated by a mathematical approach, so is generally ignored. Furthermore, mathematical economists tend to overlook sectoral shifts, whereby currency and credit flow between financial and non-financial applications. It is the non-financial economy, the part that produces goods and services that they monitor, assuming financial activities and the asset inflation they stimulate are merely a by-product.

There is a further dimension we cannot ignore. Since the interest rate spike in the early-1980s, savings have migrated from earning interest to seeking equity participation. The simplistic economic model of consumers saving and businesses borrowing has disintegrated, with consumers increasingly taking entrepreneurial risk and funding their personal consumption with credit. Companies with low credit ratings have been happy to print equity rather than go to the bond markets, encouraged further by the freedom from having to pay any dividends.

The result of these changes has been to skew the economy in favour of asset inflation, which has replaced interest on bank deposits and bonds held to redemption as wealth-creator for the ordinary saver. Asset inflation is excluded from inflation statistics, which means it can be increased at will. But asset inflation reflects the passage of expanded money and credit into the financial sector, from whence it always leaks into the real world of production.
The CPI badly underestimates price inflation

The expansion of credit taken up by consumers should have an immediate effect on consumer prices. Yet, if official CPI statistics are to be believed, there has been little price impact from the expansion of consumer credit since the Lehman crisis. And here Say’s law partly explains why.

We specialise in our production to buy the goods and services we do not provide for ourselves. Therefore, when new unearned money is put in our pockets to spend, we bid up prices, reducing the purchasing power of the currency. Alternatively, we can buy goods and services from abroad because they are available at the old prices. This is why the expansion of credit leads to trade deficits. Our ability to import to spend reduces the immediate price impact of extra money and credit, and is a temporary safety-valve for the CPI.

When monetary inflation leads to a trade deficit, the adjustment to the currency’s purchasing power takes place in the foreign exchanges. However, in the case of the dollar, this is often delayed by demand for it as a reserve currency, allowing US price inflation to remain at a lower rate than otherwise. Inevitably, this contribution to price inflation will reverse at some point in the future, probably leading to a substantial adjustment.

There can be no doubt that lower import prices is one reason price inflation has been subdued. But there is another factor at play, phony statistics. You can talk of the general price level, but that doesn’t mean you can measure it. My experience of price inflation is not the same as yours, and yours is not the same as your neighbour’s. A concept is not the same as a statistic.

The CPI statistic is therefore inherently meaningless, which allows statisticians to take views on its composition. Bearing in mind that inflation-linking means a range of welfare payments becomes more expensive to the government if the CPI is rising, you can appreciate that adjustments in this slippery concept will incrementally favour its suppression.

By comparison, the Chapwood index[iv] makes this point by coming up with far higher rates of price inflation than official statistics. Chapwood is comprised of a fixed basket of 500 goods and services, typically bought by the average middle-class American in 50 major cities. It is calculated twice a year with these 2,500 inputs, and for the last five years the average annual price increase of these inputs has been 9.8% That means a dollar today has a buying power of only 62.8 2013 cents. But the government’s version of price inflation says it has averaged 1.53%, and that the dollar buys 92.7 2013 cents. It is an enormous difference.

The CPI’s constituents are continually updated and adjusted, with assumptions made about product substitution replacing rising prices, effectively deflating the index. Parts of the CPI index are adjusted for hedonics, which deflates prices for product improvements. Each adjustment may be small, but they add up. The Chapwood index is simply a fixed basket, with no adjustments at all, and therefore indicates the degree of corruption in the CPI.

Whichever way you cut it, the CPI dramatically understates price inflation. Incredibly, financial analysts think the CPI is not only authoritative, but they even get agitated by CPI calculations that differ from their forecasts by as little as 0.1%. Perhaps it’s the threat of rising price inflation to the long-term trend of asset inflation that subconsciously motivates their wilful blindness. Perhaps it is the unquestioned acceptance of government statistics. Perhaps it’s the inability of analysts to think independently (we certainly see a herd instinct when it comes to forecasting). The three wise monkeys’ syndrome is a combination of all three probabilities.

It amounts to intellectual complacency. Complacency thrives on trends, and so long as there is no disruption to them, there is no pressure for a rethink. But when the trend changes, then even the most supine analyst can no longer ignore reality. That is the worrying thing about the chart of the 10-year US Treasury bond. Not only have we the evidence that the post-1980s trend of lower interest rates may be over, but we can begin to see the inflation dynamics that are already wreaking havoc with consumer prices.

It is not just the US Government’s statisticians in the Bureau of Labor Statistics. CPI calculations are harmonised worldwide and must be producing similarly supressed results. It is obviously wrong to believe in a statistic that is used to manage public expectations and reduce government costs everywhere in the hope that inflation will not be noticed.

When the established order is threatened by a break in trend, doubts over official estimates of price inflation commence with anecdotal evidence. More people will begin to think Chapwood has a point. But has the purchasing power of the dollar really fallen to 62.8 cents in only five years? What does that mean for the GDP deflator: have we been assuming the presence of economic growth, when a properly defined deflator tells us the economy has been in recession ever since Lehman? Does that mean interest rates will have to rise far more than we earlier thought to control the inflation monster?

These questions are not yet being asked. Instead, markets are assuming the Fed is raising interest rates before there is firm evidence of price inflation. Indeed, anticipation is the Fed’s stated policy. The Fed is not even looking at the message from Chapwood. Instead, it sees President Trump’s budget deficit accelerating growth late in the cycle, expecting inflationary consequences. It may also be anticipating the price impact of new and future trade tariffs, which will drive up consumer prices on imported goods, and therefore on goods domestically produced as well.

These are inflation pressures, yet to develop, which are in addition to the existing price erosion hidden from us by the CPI.
The market effects

It is obvious that mainstream economists and analysts are wilfully ignorant of the extent of current price inflation, and only recognise the future pressures on prices that guide monetary policy. They have noticed that rising interest rates have a habit of tripping up the economy, sending it into recession, and that the Fed has a track record of not being able to judge interest rate neutrality. This next chart is what particularly worries them.

The rise in the Fed Funds Rate has taken it through a danger zone (between the two pecked lines), which in previous credit cycles triggered an asset deflation, followed by recession, financial crisis or both. The view gaining ground is that an economic downturn is becoming more likely, as well as the possibility of a systemic event, such as a banking crisis in the Eurozone.

For these reasons, a fall in equity markets is causing a shift of investment funds within the financial sector from equities to bonds, from high-risk to lower-risk, while the narrative is moving from growth to risk of recession. Wall Street is jumping to conclusions about Main Street, when the cause of financial markets instability is, so far, mostly bottled up in Wall Street itself.

The common view is that if a recession comes to pass, inflationary pressures will ease. This expectation is incorrect, as all past inflation episodes involving fiat money have proved. Inflation of fiat currencies continues in a recession because central banks are always ready to compensate for any contraction of bank credit. Stabilisation of consumer prices is only ever temporary, usually imagined rather than real. Instead, monetary inflation only conceals declining economic activity, particularly when the deflator is under-recorded. The simplistic view that price inflation only increases with expanding activity will almost certainly turn out to be a costly mistake for investors fleeing equity risk into bonds.

And here we are, entering the next credit crisis with the inflationary excesses of the previous one unresolved. From August 2008, the month Lehman went under, the total of checking accounts, cash and bank deposits, collectively the public’s dollar exposure, increased from $5.4 trillion to $12.9 trillion today. While this dollar exposure has increased by 140%, the increase in GDP has been only 37%. Clearly, the US economy is still awash with underemployed surplus dollars. Unless higher interest rates begin to properly compensate deposit holders for loss of purchasing power, their relative preferences in favour of holding deposit money will almost certainly begin to decline.

A central bank faced with that prospect risks losing control over interest rates and therefore over the cost of its government’s borrowing. The forthcoming credit crisis is unlikely to replicate Lehman, when a potential collapse of the entire financial system led to a temporary increased preference for holding deposit money in systemically important banks, and a corresponding decrease in preference for goods. That led to a short-term slump in some prices (such as for autos), which quickly passed following the introduction of zero interest rates and money-printing. Zero interest rates will not apply this time, because the problem will be accelerating price inflation that already exceeds interest rates by a substantial margin, coupled with an exceptionally high level of bank deposits relative to the size of the economy.

When financial markets wake up to these inflationary dangers and the consequences for interest rates, there is bound to be a sizeable reappraisal of investment values. At the time in the cycle when Keynesians expect fiscal and monetary policies to soften the recession, they will be forced in the opposite direction. The US Government, as well as other spendthrifts, will find rising borrowing costs have pushed it firmly into a debt trap.

The choice will be stark. Either the US Government and the Fed will have to abandon Keynesian policies and allow a cathartic slump to take hold, or they will have to sacrifice the currency. They lack the collective intellectual capacity to understand the starkness of the choice, so will probably fudge it, leading to the destruction of the currency anyway.
The only solution

For all governments, there is an escape route from this increasingly certain mess. It requires a government to do two things: call a halt to all inflationary financing, and switch from a welfare-driven to a wealth-creation model of fiscal and economic policy. The welfare-driven economies have consistently rejected this direction of travel and will find it especially difficult to change tack, given the totality of vested interests. The two nations that can do it are Russia and China. Russia is aggressively building her gold reserves so as to be independent from the influence and decline of fiat currencies. China will have to modify her economic policy, having supped at the table of bank credit, but her government finances are sound enough to contemplate it.

Historians will look back to current times and note the credit crisis of 2018-2019 marked the end of an era that started with monetary cooperation between two central banks, the Fed and the Bank of England following the First World War. It evolved from there. It took the free world progressively into inflationism and the destruction of the wealth upon which economic progress previously depended. The final credit crisis fuelled by fiat currencies was the end of the Anglo-Saxon empire that had dominated world affairs.

Asia under communism had been a sleeping giant who awoke when socialism collapsed under its contradictions. Without the West’s accumulation of costly welfare systems, the Asian continent with nearly half the global population broadly escaped the calamity of the ending of fiat money by embracing sound money – gold. With it, China and Russia turned their backs on a Western currency collapse and built their own industrial revolution, embracing the whole continent.

For America, the Europeans and Japan, the end of the fiat money era was swift. The end of government policies of intervention allowed their peoples to take control over their own lives again, by embracing what for millennia had been central to Say’s law: their own choice of money to facilitate peaceful coexistence under free markets.

We can only hope the last bit turns out to be true. The rest appears increasingly certain.

- Source, Alasdair Macleod via James Turk's Goldmoney

Tuesday, December 4, 2018

G20 and the Financial War

President Trump initiated the trade war with China. There is a widespread assumption he is pursuing his “art of the deal”, coming into negotiations aggressively to get a satisfactory compromise. Therefore, the script goes, China will be forced to climb down on its restrictive practices, technology and patent theft, and modify its Made in China 2025 (MiC2025) initiative to open it to American corporations. Trade negotiators from both sides have been working in the background to achieve some sort of progress before Presidents Trump and Xi meet at the G20 this weekend, which buoys up hopes of a positive outcome.

If so, it will be the start of a more public process, perhaps with threatened trade tariffs deferred. Meanwhile, the rhetoric on tariffs has escalated in recent weeks, as is often the case in negotiations when President Trump is involved, and particularly when deadlines loom. But there are concerns the situation is more serious than this optimistic version of events would have us believe.

This article briefs readers about the bigger picture behind this trade spat, which is just one battle in an ongoing financial conflict between China and America. Worryingly, it takes place against a deteriorating economic outlook for the world’s largest trading bloc, the EU.

The trade tariff position

American sources have been upping the rhetoric against China’s trade ahead of the G20 both generally and specifically. For example, the US has accused China’s Huawei of planting spyware in electronic equipment. Huawei is a major global telecoms manufacturer and a leader in the development of 5G mobile technology, set to become more important to data transfer technology than broadband, and the Americans obviously want to shut them out of this market.

It was widely believed the Trump administration pursued a tough stance against China’s unfair trade practices to maximise the Republican’s success in the mid-term elections. If so, it was a policy that failed, with the Democrats gaining 38 seats in Congress. In any event, the mid-terms are no longer relevant to American trade policy, if they ever were.

The wider trade concerns expressed by America are over access to China’s markets for American corporations, the protection of intellectual property, and exclusion from MiC2025. But with MiC2025, it is a case of the American pot calling the Chinese kettle black, because America is also increasingly protectionist. However, there are small adjustments China can make to seek a trade resolution, for example modifying or dropping clauses limiting foreign involvement in key industries. Furthermore, there are pressures on the American side to seek an accommodation with China from both American-based multinationals with cost-effective supply chains in China, and from financial markets which have nose-dived in recent weeks. Add to that the soya farmers in the US, and resolving trade disputes should be a no-brainer.

Assuming a positive outcome, we can then expect that China’s economy, which has become a material driver for global economic growth, will have significant negative pressures lifted from it. The yuan will then rally, and with it a decent recovery in US stockmarkets will surely follow. US stockmarkets are important to Trump, having hitched his wagon to them. Surely, he would like to see higher stock prices. China would also welcome a trade deal. In China, the uncertainty is affecting the availability of bank finance for private sector manufacturers and undermining consumer sentiment.

With MiC2025, China wants to catch up with the West when it comes to manufacturing technologically-advanced products. Its objective is reasonable. MiC2025 has singled out ten sectors for government support, from robotics to transport, to new-generation IT, to bio-pharma. By encouraging development in industrial sectors, China is doing what all other governments do, including the US, and the US surely knows it.

Therefore, if trade is the genuine concern, all reason suggests a positive outcome from this weekend’s G20 will occur, the yuan will rally as will Wall Street. And President Trump will be praised by American industry and financial markets for his successful negotiating strategy.

There is a deep problem with this analysis, which was exposed at the Asia-Pacific Economic Cooperation summit in Port Moresby, capital of Papua New Guinea two weeks ago. For the first time ever, APEC broke up without a joint communiqué. It was also reported that the police were called after Chinese diplomats tried to force their way into PNG’s foreign ministry.[i] Geopolitics overshadowed trade issues with tensions boiling to the surface. US Vice-President Mike Pence accused China of debt diplomacy, whereby China was creating debt slaves of the smaller nations.

It was in short, a diplomatic disaster. It was also a timely reminder that there is a bigger picture, with America determined to limit Chinese expansion. The politics included criticism of China’s annexation of reefs in the South China Sea as well as the “debt slave” issue. The US, in conjunction with Australia, promised to develop a naval base at Lombrum on Manus Island, about 350 km north of PNG. Furthermore, the US has agreed with Australia and Japan to spend some $2bn improving PNG’s infrastructure, including electricity.

Doubtless, the US feels it has now bought PNG’s cooperation in its cold war against China and prevented China’s exploitation of PNG’s resource potential. It hopes to have called a halt to China’s economic expansion into the South Pacific. Australia will also have greater security from her largest customer, if it is needed in future.

Another delicate issue is Taiwan, with America sending two warships through the Taiwan Strait in a move seemingly designed to provoke China. So those hoping for a positive outcome from the G20 might like to note that it is at odds with the way America is moving on the Pacific chessboard.
The world is changing

In any attempt to divine the economic future, it is a mistake to think only in terms of China and America. The largest economic bloc by GDP is the EU, and it has also been cast into a trade and political never-never land by President Trump. The EU is losing its security blanket, which has always been provided by the US through NATO. It is now planning its own army, which will almost certainly take over from NATO in the longer term. Trade differences with the US have been put on ice but are still there.

The EU’s approach to trade is deeply protectionist, having imposed over 12,500 tariffs on imports into the EU. Additionally, Brussels regulates to the micro level what products can be sold within the EU. So, in the case of Huawei’s 5G technology referred to above, the battle in Europe is less about security issues (though they are always there) but more about influencing or responding to the regulatory regime, which is effectively controlled by its European competitors based in the EU.

In this context, Britain losing all her power to restrain protectionist instincts in the EU is crucial. The UK has been the driving force in supporting liberal trade policies against protectionist France and Germany, and following Brexit that is now no longer the case. The EU is bound to become increasingly inward-looking as a consequence of Brexit, increasing both tariffs and regulations. Add to this a developing euro crisis, with interest rates stuck below the zero bound, and it is hard to see how the EU will not resort to increasing state control of both money and trade.

From China’s point of view, the time when her export business drove her economy must be in its sunset phase. Even if a trade agreement with the US is achieved in the coming months, there’s no guarantee Trump will not renege on a deal. China’s leadership had planned for this some time ago, with a state-induced shift of economic emphasis away from export dependency. Instead, there is a strategic move towards a more service-oriented economy, with better infrastructure and improved living standards for a rapidly growing middle class. But the pace of this strategic change is being swiftly overtaken by events. Therefore, China’s leadership needs to accelerate its plans in the light of both President Trump’s trade and security policies, and the knock-on effects of Brexit on EU trade policy.

The implications for global growth are undoubtedly negative, even dire. If China accelerates her plans towards a service and technologically driven economy, it is bound to lead to a temporary rise in unemployment from its redundant export industries before labour is transitioned to the new. The social consequences could become destabilising.

In the US, the problem is a potentially stagnating economy coupled with rising prices, fuelled in part by tariffs on imported goods. Only this week, Trump made it clear not only is he prepared to increase tariffs from 10% to 25% on $200bn of Chinese imports from 1 January but is prepared to extend tariffs to all Chinese imports. The walking shadows of Smoot and Hawley once more strut and fret upon the global stage.

It may be the art of the deal, and President Trump displays the bravado of someone who has his opponent on the run. If so, he risks the enjoyment of the chase while ignoring the collateral damage. But the threat of tariff-inflated prices cannot be ignored by the Fed. If President Trump refuses to find a means whereby China can save face, which is rapidly becoming the single most important issue this coming weekend, the prospects for not only China’s economy, but that of the US and the EU as well, will rapidly deteriorate.

- Source, via James Turk's Goldmoney

Saturday, November 24, 2018

Prices When Gold Is Money

We are getting ahead of ourselves here. Gold does not circulate as money – yet. It might never do so. Perhaps the end of government currency, fiat money imposed on us by government laws, may never be replaced by what for millennia has been the people’s money, gold. Do we even wish it? Given what we have to do to get there, probably not.

It is hard to think of a life without Nanny State giving us her money-tokens to buy our sweets, telling us what to eat and what medicine to take. But Nanny State is getting long in the tooth. When she was younger, she was less controlling. Her constant refusal to allow us, the ordinary people, to do what we want is an increasing source of friction.

Growing numbers of us can see Nanny State should pack her bags. But Nanny State’s favourites are frightened at the prospect of no nanny. Those of us who want a life without Nanny State can’t agree what it should be, and don’t know what happens when she goes.

Above all, there’s a feeling our secure, controlled world is coming to an end. Increasing financial instability and economic uncertainty are our common destination. Nanny State has frittered away all our pocket money, and it turns out the cupboard is now bare.

We can see the state is irretrievably bust. But governments don’t go bust, economists tell us, because they just issue more money to pay the bills. This is wrong: it is going bust by other means, and those of us who don’t see it are driven by wishful thinking. Ultimately, government-issued money will reflect its issuer’s complete bankruptcy. And there’s no point in following up the collapse of one fiat currency with another. The Zimbabwe dollar is followed by the bond note, and Venezuela’s bolivar is being followed by the bolivar soberano. Bust is bust is bust. It is the logical outcome for all national currencies issued by spendthrift governments.

In the entire scope of human history, government money is always ephemeral. It dances above the water for a relative day or two before it is spent and dies. One day in the future, we will turn back to gold, as we always have in the past. Governments, as demonstrated by the Mnangagwa and Maduro regimes, will resist it to the bitter end. Like children robbed of all their pocket-money, the ordinary citizen will be left with nothing. The only exchangeable value will be gold, and probably silver as well.

Those who have gold will escape the poverty of those that don’t. In time it will begin to circulate as the gold haves buy things from the have-nots, and gradually with the wider distribution of gold a sense of normality will return. It matters not if we price things in gold-grammes, or whether a slimmed-down government gives it a name. Sovereigns, eagles, krugerrands. It matters not if we use them electronically, so long as the bullion is readily there, and all credit is repaid in physical gold.

This article explains how prices work in a world that trades using gold as money. It assumes all forms of cash and electronic money is gold in another guise. We assume there is no issuer risk, because there is no fiat money. To explain pricing in gold we must contrive an ideal. It is this ideal we will assume.
The basic role of money

Money’s basic function is to facilitate the exchange of goods and services, its role always being temporary. Both parties in a transaction must have faith that the money is readily accepted by everyone with whom they transact, and that means all those counterparties must have faith that their counterparties will accept it as well. This has always been gold’s strength. It is a considerable disadvantage of fiat money, whose acceptance is confined by national boundaries.

We exchange goods and services because it is infinitely more efficient to buy from others what we cannot provide for ourselves, or that to do so would waste our time unnecessarily. Instead, we specialise in our own production, selling it for money so we can buy all those other things. It means we must keep a small store of money, or at least a facility to access it, in order to satisfy our daily needs and wants. And who sets that amount? Well, we do as transacting individuals.

When we have a temporary surplus of money, such as from the sale of an asset, we reinvest it. Either we buy another asset, or we lend it to someone else (usually through an intermediary) for interest. It matters not whether it is fiat money or gold.

The general level of prices is set by the purchasing power of the money in which it is measured. The two most important variables are the quantity of money in circulation, and the relative average preferences that people have for holding money relative to goods. Of the two, changes in relative preferences have the greatest immediate impact on prices.

If people decide as a whole to reduce their preference for money, then the general level of prices will rise. Indeed, hyperinflation, described as a catastrophic rise in prices, is the visible symptom of a widespread flight out of money. In other words, preferences are to not hold any money at all and to get rid of it as quickly as possible.

Alternatively, if there is an increased preference for holding money, prices will fall. This additional preference for money can be expressed in two ways. It can be held as physical cash, or more commonly people increase their savings. An increase in savings generates a shift in production methods to compensate for the lower prices of consumer goods. The greater supply of capital for investment tends to reduce interest rates and alter the businessman’s calculations in connection with his production.

These are the considerations behind the deployment of money in a community, whether it is fiat money or gold. It is the way economic actors make best use of the money available, and in free markets, which have proved to be the most consistently progressive of systems, production does not need the stimulus of additional money to that already in circulation. That is a neo-Keynesian myth.

Trading with gold as money

People in a community, town, city or even a nation set their own monetary requirements. Let us assume that in doing so, the general price level, that is to say the balance of preferences for or against gold relative to goods, differs from that of a neighbouring population. In that case, an arbitrage will take place, whereby gold will flow to the community with the lower prices to pay for current consumption, so that the purchasing power of the gold in the two communities will tend to equate.

Additionally, gold savings will seek out the higher returns between the two centres and flow the other way from gold seeking lower prices. However, the quantities of gold held as savings are always significantly less than the quantities spent in consumption. In fact, the arbitrage takes place both through the trade of goods and also by the deployment of capital exploiting interest rates differentials, so that a balance in prices and interest rates is achieved.

It is therefore easy to see that in a commercial world with effective transport and communications, whatever the local preferences are for holding money relative to goods, multi-centre arbitrage tends to produce a common price level and a common level for interest rates. These adjustment factors are conducive to trade, not only between communities but between nations. And trade priced and settled in gold is, all else being equal, far more effective than when individual fiat currencies are involved, because with gold as the common money national boundaries are not a barrier and trade is truly global.

Given gold’s ubiquity as money, the effect of localised changes in general preferences for holding gold relative to goods can be regarded as minimal. An additional consideration is an underlying inflation of above-ground stocks of gold through mine supply, but this is broadly offset by population growth.

Technological innovation and improvement in production methods as well as competition all tend in the long run to reduce the general price level of goods and services. So, while there is little change in the general level of prices from the money side, there can be a significant reduction in prices over long periods of time from the goods side. The effect is to enhance the purchasing power of savings, leading to stable, low interest rates and the accumulation of private wealth.

- Source, James Turk's Goldmoney

Tuesday, November 20, 2018

The Psychology of Systemic Consensus

We are all too familiar with established views rejecting change. It has nothing to do with the facts. Officialdom’s mind is often firmly closed to all reason on the big issues. To appreciate why we must understand the crowd psychology behind the systemic consensus. It is the distant engine that drives the generator that provides the electricity that drives us into repetitive disasters despite prior evidence they are avoidable, and even fuels the madness of political correctness.

Forget the argument, look at the psychology

A human prejudice which is little examined is why establishments frequently stick to conviction while denying reasonable debate. Anyone who addresses the unreason of the establishment risks their motives being personally vilified and attacked. There are many fields of government where this is demonstrably true.

Leadership is too often based on prevailing beliefs, with minds firmly closed to any evidence they might be wrong. Even Galileo was forced by the Inquisition in 1633 to recant his scientific evidence that the earth revolved around the sun – a thoroughly reasonable and logical though novel proposition to the independent mind. But it wasn’t until 1992 that the religious establishment at the Vatican forgave him for being right.

That was 359 years later and long after it mattered to Galileo. Fortunately, when the establishment view departs from the facts it rarely survives as long. Socialism, economics, climate change and Brexit show the same static opinions insulated from inconvenient contradictions. This is not to say the establishment need be judgemental. Democratic government at its best tries to remain neutral and reflect a balance of opinion. But there are times when it loses sight of firm ground and becomes subverted by the psychology of its own established but unfounded beliefs.

The debate over Brexit is a classic illustration of psychology over reason, where few Remainers or Brexiteers have changed their views since the referendum in 2016. Influential Remainers are, by and large, those who have worked in government during the forty-five years of Britain’s increasing transfer of political power to Brussels. There are others who vehemently believe that being part of a larger economic unit is more secure than exposure to free markets. There are also those who believe Brexit will directly affect their lives and fear the uncertainty. Whatever their reasoning, their subconscious instinct is to seek protection in a guardian establishment rather than risk a commercially-based proposition.

The purpose of this article is not to debate Brexit, or any other government policy, but to explain the psychology of systemic consensus. Brexit is only an example of a wider phenomenon and serves as a topical example. This article expands the scope of the work of Pierre Desrochers and Joanna Szurmak, both of Toronto University, who examined the longstanding link between theories of overpopulation and climate change.[i] I argue that their thesis is also applicable to other instances of human debate, where psychological factors inhibit reason. Brexit will be our case study, being topical, but I shall refer to other examples as appropriate.
Brexit’s propositions

There are two main propositions upon which Brexiteers base their argument. The first is the loss of British sovereignty, by which they mean the right of the British electorate to determine its collective future. Traditionally, this has been the preserve of Britain’s parliamentary democracy, with an elected Parliament enacting all legislation which is then administered by the courts through criminal and civil law. These established democratic rights have been increasingly abrogated to an unelected executive in Brussels. True, there is a European Parliament to which the British electorate sends representatives, but it cannot initiate legislation, nor can it to all practical extent exercise control over the executive. The remote Brussels executive is also superior to national parliaments and imposes regulations which have to be adopted in national laws. The European Court of Justice is the supreme court, overruling national legal systems.

Being in the EU means the loss of democratic accountability for the British electorate. The Brexiteers say it is a simple matter of fact. Being out of the EU and reverting to full parliamentary accountability would be a return to long-standing democracy, which nearly everyone agrees is the best form of government.

The second major issue is arguably the lesser of the two, and that is whether Britain’s economic prospects are better in the European Union customs area, or independent from it. The empirical evidence is Britain did spectacularly well in the nineteenth century by removing all trade barriers and tariffs and having no trade agreements, owing its pre-WW1 global status almost entirely to unrestricted trade. The Brexiteers claim the economics supports the empirical, with EU trade in goods accounting for only 8% of Britain’s GDP, and declining relative to trade in goods with the rest of the world.

It is interesting to note that the Government’s economists and their supporters do not fully engage on the economic issue, with only the Brexit-supporting European Research Group (ERG) making the economic case seriously. This does not appear to be because of media focus. Rather, the economic establishment lost credibility at street-level by forecasting an economic slump in the event of Brexit. It was clear that the UK Treasury, the Bank of England, and the IMF set the inputs to their economic models in such a way that a Brexit outcome from the referendum would be dire. Instead, inward investment has increased, defying predictions that European and foreign corporations would sell up. The UK economy is now booming, despite the uncertainty over the Brexit negotiations.

In contrast with the ERG’s positive critique, the Remainers have continually resorted to scare tactics, such as claiming Calais will be shut to Dover’s shipping (denied by the Calais port authorities). They claim all flights from the UK to the EU and flights crossing EU territory will be threatened (ridiculous, being against international aviation law, and Britain’s Air Traffic Control controls transatlantic flights into Europe anyway). They claim that drugs for the NHS will be withheld (really?). And so on. All the establishment Remainers have done is resort to using fear as a substitute for debate.

Remainers have never adequately addressed the issue of democratic accountability either, presumably because they know they cannot win that debate. Instead they skirt round the issue. Logically, given the attestable facts on democracy and economics and having had two years to consider the democratic and economic issues, one would think increasing numbers of Remainers would accept their original position was untenable and revise their stance. Not so. They remain firm as ever, rather like the Vatican and its long-standing denial of Galileo’s discovery.

- Source, James Turk's Goldmoney

Wednesday, November 14, 2018

James Turk: Why Gold is Money and Will Always be Money

GoldMoney founder and bestseller author James Turk explains his view on the current global economy and gold market.

He explains why gold is and always will be money.