The Path for Oil

Last week oil finally broke out of its narrow trading range of USD45-55/bbl (Brent) it has been trading in since mid-2016. The final push over USD55/bbl last week was driven mainly by concerns over Turkey President Erdogan threatening to shut down an oil pipeline bringing crude from the Kurdish controlled region in Iraq, should the Kurds vote for independence.

However, the rally was short lived and oil prices moved sharply lower again as it became clear that, despite the rhetoric, the oil kept flowing, at least for now. This pushed prices back to USD55/bbl at the time of writing, the same levels as at the beginning of the year. However, what the market seems to be missing is that the oil balance is fundamentally different from the beginning of the year. More specifically, over the past few months we have witnessed a global oil market shifting from years of surplus into deficit.

Global petroleum inventories have been building since 2014 on the back of relentless growth in US crude oil production. Initially OPEC decided to let things play out. They were reluctant to cut back output to accommodate US production growth, knowing that over the long run that would be a losing strategy as it would simply cost OPEC market share while the pressure on prices would remain. As a result, prices collapsed in the second half of 2014 and inventories began to build rapidly. The price decline eventually led to sharp cuts in CAPEX among US producers and US oil output began to contract in 2015. From that point global Inventories no longer built at the same speed, yet the market remained in a slight surplus. OECD inventories stopped building altogether but stocks remained at elevated levels. In order to speed up the inventory normalization process, OPEC decided in late 2016 to curtail production nevertheless. While initially this led to some price recovery, oil prices soon began to decline again as the market believed that the OPEC cuts were insufficient to bring down inventories meaningfully.

However, the more data we receive, the more obvious it becomes that inventories, particularly in the West, have been in a seasonal deficit for months now. While in the first quarter of 2017, the global oil market was still in surplus and global inventories were building (faster than the seasonal trend), this seasonal surplus shifted to a seasonally balanced market in 2Q17 and by 3Q17 we were in a seasonal deficit (see Figure 1).

More importantly, even as global inventories were building earlier this year, most of this occurred in non-OECD countries (Chinas SPR absorbed a lot of the surplus) while inventories in the OECD countries have been in a seasonally adjusted deficit for many months now (see Figure 2). In the US, the draws in total petroleum stocks was particularly impressive as we have been writing for some weeks.

The market so far has largely ignored this trend as it seems to be more focused on growing US production. The weekly petroleum status report published by the US Department of Energy (DOE) every Wednesday suggests that US production growth went from negative year-over-year at the beginning of this year to over 1mb/d as of now. This would, so the argument goes, soon put an end to the inventory normalization.

However, as we have pointed out before, the weekly DOE petroleum report has been overstating US production growth for months. This is mainly due to two reasons. First, there is a base effect. Production growth looks so impressive because the DOE had reported a sharp decline in US production in summer 2016 in the weekly data. However, the more accurate monthly data (according to the DOE the monthly data is not a revision of the weekly, it is simply a different and more accurate dataset) shows that this decline was heavily overstated (leading to an understated production figure). Understating production in one year will lead to an overstated year-over-year production growth figure for the same period the following year (see Figure 3) which is what we are seeing now.

Second, similar to how the weekly data understated production last year, it is overstating production this year. More specifically, in the weekly production data, US output rose to 9.4mb/d by July 2017. However, the monthly data shows that production only reached 9.2mb/d. Putting all these numbers together, year-over-year production growth in 2Q2017 was only 303kb/d and not 527kb/d as reported in the weekly data, a delta of 224kb/d. This divergence grew to a whopping 377kb/d in July (monthly production growth of 556kb/d vs weekly 993kb/d).

This poses some severe doubts over the 1mb/d year-over-year production growth figures for August and September as reported in the weekly data. We believe that the weekly data for August and September will be revised down sharply once the monthly data comes out. If the revisions of the past three months are any indication, true output was likely flat over the past two months (up 600kb/d year-over-year). But if the revisions are as large as the one for July, production has actually declined over the past two months. In a nutshell, contrary to what the market currently seems to believe, US shale production is unlikely to grow at 1mb/d year-over year in a USD50/bbl price environment.

- Source, James Turk's Gold Money

Oil for Gold: The Real Story

The mechanism of introducing an oil for yuan contract could hardly be clearer, yet the rumour mill went overtime into Chinese whispers. Some analysts appeared to think China was authorising a new oil for gold contract of some sort, or that China would be supplying the gold, both of which are untrue.

The purpose of this article is to put the proposed oil for yuan contract, which has been planned for some time, into its proper context. It requires knowledge of the history of how China’s policy of internationalising the yuan has been developed, and will be brought up to date with an analysis of how the partnership of China and Russia is taking over as the dominant power over the Eurasian land-mass, a story that is now extending to the Middle East.

This fulfils the prophecy of the founder of geopolitics, Sir Halford Mackinder, made over a century ago. He described the conjoined continents of Eurasia and Africa as the World Island, and that he who controls the Heartland, which lies between the Volga and the Yangtze, and the Himalayas and the Artic, controls the World Island.ii The Chinese-Russian partnership is well on its way to controlling the World Island, including sub-Saharan Africa. We know that successive Soviet and Russian leaders have been guided by Mackinder’s concept.

Events of recent months have accelerated the pace of the Heartland’s growing dominance over the World Island, and become pivotal to the balance of global power shifting in favour of the Heartland. Even political commentators in the mainstream media are hardly aware this is happening, let alone future implications. Financial commentators and economists are even less informed, despite the monetary consequences being of overriding importance for the impact on the wealth of nations and their peoples.

This is the backdrop to China’s internationalisation of her currency. To enhance our understanding of the implications of the introduction of yuan futures contracts, we must begin with the relevant monetary developments.

The Hong Kong – London axis

For a considerable time, China has followed a policy of replacing the dollar as its settlement currency for the purposes of trade. After all, China dominates international trade, and on a purchasing power parity basis, her economy rivals that of the US, and if it hasn’t done so already will soon overtake it. From China’s point of view, being forced by her trading partners to accept and pay in dollars is an irritating anachronism, a hangover from American imperialism.

Furthermore, China’s strategic military analysis has convinced her that America uses the dollar as an economic weapon, wielding it to sustain global hegemony and to support her own economy at the expense of others. Therefore, there are clear strategic reasons for China to do away with the dollar for as much of her international and trans-Asian trade as possible.iii

For America’s part, she has strongly resisted moves to have the dollar replaced as the world’s dominant trade currency. America has a tough grip on all commodities, because international physical and derivative markets are priced almost exclusively in dollars. Furthermore, nearly all currency hedging has the dollar on one side of the transaction. This allows the Americans to exercise enormous control over international markets, and even to artificially inflate commodity supplies through the creation of futures contracts, keeping prices lower than they would otherwise be. By these means, America has suppressed the relationship between monetary and price inflation, increasing the apparent stability of the dollar. This is central to the illusion of American monetary hegemony. Therefore, China’s policy of doing away with the dollar is, from the American standpoint, a fundamental challenge to her post-war global domination, and amounts to a declaration of financial war.

China’s problem in displacing the dollar is the lack of an international market for the yuan. Furthermore, with strict exchange controls limiting the ability of Chinese citizens and businesses to trade on the foreign exchanges, it was always going to be an uphill struggle to provide the necessary liquidity in the yuan to make it acceptable to foreign counterparties. China had to come up with a plan, and it made sense to use the existing financial links between Hong Kong and London to develop international markets for her own currency.

We can date public awareness of China’s strategy to June 2012, when Hong Kong Exchanges and Clearing made a successful offer for the London Metal Exchange. While noting that Hong Kong is an autonomous region, and that, officially at least, China does not meddle in Hong Kong’s affairs, China has a direct interest in important acquisitions of this sort. China is the world’s largest importer of base metals, and London is the global metal pricing centre for warehouse stocks and physical delivery.

The LME earlier this year decided to offer a series of precious metal futures contracts, priced in dollars, centred on gold. The gold contract has been a great success, something guaranteed when you bear in mind that the Industrial and Commercial Bank of China, owned by the Chinese state, is a lead sponsor of these precious metals contracts. By this action, China is parking its tanks on the London Bullion Market Association’s lawn. At some stage in the future, the LME will almost certainly offer deliverable futures contracts priced in yuan, not just for precious metals but for base metals as well.

In October 2013, fifteen months after the acquisition of the LME, Boris Johnson as Mayor of London led a trade mission to Beijing. British trade missions are a major feature of Foreign Office duties, the way Britain develops bilateral trade relationships. These trade missions, being planned through diplomatic channels, are prearranged and coordinated well in advance. Therefore, it was unusual to find that George Osborne, the Chancellor of the Exchequer, at very short notice got up a second trade mission, and met Johnson in China.

The reasons for this turn of events were never properly explained; however, we can work them out. In May 2012, David Cameron had met the Dalai Lama in London, which caused a diplomatic furore with China. Despite this earlier public spat and the point having been made, Osbourne was sent to China. While it is likely his trade mission was a cover for UK Government efforts to smooth things over, subsequent events suggest financial cooperation between Hong Kong and London was discussed, and Chinese plans to use Hong Kong and London to enhance the yuan’s international liquidity were agreed in principal. Following Osborne’s visit, David Cameron himself went to Beijing for discussions with President Xi the following month, confirming the importance to Britain of bilateral financial relations with China.

The following year, the UK took the unusual step of issuing a 3bn yuan bond, both as an indication of intent, and to help kick-start the offshore yuan market in London. This was followed by Britain being the first non-Asian nation to join the Asia Infrastructure Investment Bank as a founder member in March 2015 (announced by none other than George Osborne). The AIIB, which was set up by China and headquartered in Beijing, is the first supra-national organisation independent of the Bretton Woods institutions, which are all controlled by the US. These institutions, led by the World Bank and the IMF, as well as several regional development banks, were how the US, using the dollar, dominates the world’s finances. The establishment of the AIIB was an unwelcome development for America, and the US expressed acute disappointment that Britain had decided to join.

And lastly, after six or seven years of lobbying the IMF, the yuan was finally included in the SDR basket from 1 October last year, further promoting it as a trade settlement currency to be included in foreign countries’ reserves.

There can be no clearer evidence of China’s intention to replace the dollar with her own currency, than the sequence of events outlined above. She identified that Britain’s interests were aligned with her own, enabling her to cut out America from future developments. She has obtained arms-length control over London’s physical metal exchange. She had set up a non-dollar rival to the World Bank and IMF, ensuring future Asian development financing is under her control. And, with more than 80 member countries eventually joining the AIIB, she has successfully picked off America’s allies. The inclusion of the yuan in the SDR basket can be taken as an acknowledgement of China’s importance on the world stage.

The eventual intention is to price in yuan everything imported into and exported from China. Much trans-Asian business is already settled in yuan, and even remote Angola settles her oil sales to China in yuan. It will in time involve developing yuan futures contracts for all the tradeable commodities the state deems significant. The most important of these is a standard oil contract. But before we cover the genesis of the oil contract, we should remind ourselves about China’s gold strategy.

Cornering the physical gold market

It is only relatively recently that Western capital markets have become aware that Chinese demand for physical gold absorbs large quantities of annual mine production, and that the country is now the largest mining nation by far, extracting it at a rate of over 450 tonnes per annum. Knowledge of China’s overall demand is restricted to deliveries out of the Shanghai Gold Exchange’s vault into public hands, running at about 2,000 tonnes per annum, which with India’s public demand accounts for nearly all global mine extraction of about 3,000 tonnes.

The SGE was established in 2002, yet China began to embrace capitalism in 1980, when the first Special Economic Zone was established. China at that time showed reserves of 395 tonnes, a figure that was unchanged until 2001, when it was increased to 500 tonnes, and the following year to 600 tonnes, which it remained until 2009. Over this time, the Chinese economy enjoyed enormous capital inflows from 1980 until the early 1990s, when Western companies set up manufacturing facilities. These were followed by growing export surpluses thereafter. The Peoples Bank of China (PBOC), the state-owned central bank, was managing the currency, neutralising these flows by buying mostly dollars.

It also made sense for the Chinese to diversify the foreign exchange portfolio gained through intervention. The need to increase gold holdings would have been obvious to communist-trained economists at the heart of government. They had had the Marxist belief drummed into them that capitalism would eventually destroy itself, and the capitalists’ paper currencies with it. Rather like Germany in the 1950s and the Arabs in the 1970s, they felt it was prudent to put a significant part of their foreign exchange into gold.

Consequently, new regulations appointing the PBOC to “guarantee the state’s requirements for gold and silver” came into force on June 15, 1983.iv Private ownership of gold and silver remained banned.

It should be noted that state-owned gold declared as official reserves bear little relation to the total accumulated. Anecdotal evidence informs us that bullion is dispersed into accounts in the possession of the Peoples Liberation Army and the Communist Party. Therefore, we cannot know China’s true holdings. All one can do is make a reasonable assessment of how much gold the PBOC is likely to have accumulated since 1983 and before 2002, when private citizens were allowed for the first time to buy physical gold and silver. During this period gold had suffered the greatest bear market in the history of fiat currencies. The scale of redistribution from weak hands into stronger long-term hands was enormous, bearing in mind that Indians, the other great national buyers today, only began to buy gold in significant quantities in the early-nineties, after the repeal of the 1968 Gold Control Act in 1990. It is also known that in 1990-2000, many Middle Eastern portfolios sold gold in favour of equity investment, as did many other private investors with Swiss private bank accounts. Furthermore, central banks were leasing gold in large quantities, artificially inflating physical supply.

Taking all these factors into account, plus mine production totalling 42,460 tonnes over the period, it was easily possible for the Chinese state to secretly amass over 20,000 tonnes by 2002, through a process of gradual accumulation. As to whether they did so, we must look at the evidence from China’s gold strategy.

- Source, James Turk's Gold Money

Common Commodity Misconceptions

Commodities are the most basic economic goods, providing essential inputs into progressively more complex goods at advanced stages of production. Yet the economic mainstream generally fails to understand commodities, treating them as distinct from the processes whereby they are created and the processes they subsequently enable, when in fact they are an integral part of a dynamic, complex, adaptive economic system. A correct understanding of commodities is essential if we are to understand what their price signals are telling us about supply, demand, and economic activity generally. In this report, I offer some thoughts on longer-term commodity price trends, including the so-called ‘supercycle’. Is it over? Or has it further to run? The truth, in fact, is neither: There never was a ‘supercycle’ in the rst place! I conclude with some thoughts on commodities investing and trading strategy, in particular how to take advantage of ‘overshooting’.

Thomas Malthus and the 'Myth' of Scarcity

Common sense is a good place to start when thinking about the role that commodities play in an economy. As with all goods, they are limited in supply: there is not enough available to satisfy the potentially in nite needs and wants of consumers. Sure, some are more plentiful than others, but even those once thought essentially unlimited, say fresh water (or even fresh air!), might not be as unlimited as they once were.

Goldmoney Macro Views and Research Highlights

The Reverend Thomas Malthus (1766-1834), a prominent classical economist, explored this concept of scarcity in some detail, in particular with respect to food production and consumption. He noted that farm production tended to grow linearly over time, yet populations tended to grow non-linearly. Eventually this would lead to demand outstripping supply, rising real food prices, and the impoverishment of the masses. A similar phenomenon is observed when bacteria are isolated inside a test tube with a limited food source: The bacteria grow exponentially until the food source becomes limited and access becomes restricted, at which time there will begin a precipitous decline and, in the end, a complete wipe-out of the entire population as the food source is depleted.

Malthus was entirely correct in his view, given his assumptions, as the test-tube example above demonstrates. In practice, however, his assumptions have been completely wrong. Indeed, the technological advances of the industrial revolution were already in full swing during his lifetime, but he failed to understand the role of technology and the associated division of labor and capital that was enabling, already during his own lifetime, a multifold increase in agricultural productivity.

Modern, neo-Malthusians sometimes retort that global population growth has now caught up with agricultural productivity to the point where food scarcity is again becoming an issue. There is some evidence for this claim. Food price in ation has been positive overall, if low, in recent years. But is this really due to scarcity? Or is it due to something else entirely?

Understanding Commodity Price Inflation

When thinking about commodity price in ation, we naturally tend to think of this
in terms of the dominant medium of exchange. In the US, this would be US dollars, although dollars are used around much of the world. In Japan, people think in yen terms; in the euro-area, in euro terms, etc. But while this is certainly conventional and convenient, when considering whether scarcity might be causing food price in ation, it can be horribly misleading. For example, food price in ation in the UK has risen sharply over the past year. But is this due to scarcity? Or to the sharp devaluation of sterling that began in 2015 and accelerated in 2016? Back in 2010-11, UK food price in ation was also unusually high. But was this due to scarcity, or to the sharp devaluation of sterling in 2008-9?

It should be obvious that currencies that experience sharp swings in their purchasing power serve as poor measures for benchmarking food price in ation, or any form of price in ation for that matter, and thus obscure its true cause. So which currency should we use?

The answer is... wait for it... None! NO currency can serve as a perfect measure of price in ation because all currencies are subject to swings in their purchasing power. These swings occur naturally, as currency supply and demand uctuate, although most central banks purport to keep such swings to a minimum. (As we know, central banks in fact fail miserably to keep such swings to a minimum, but that is a topic for another day.)

My commodities investment philosophy and the associated investment processes I have derived through the years are based on the idea that the best way to understand commodity prices is to think of them in relative terms, that is, relative to each other, rather than to denominate their prices in currency terms. So if we want to nd an answer to the question of what is behind food price in ation we should rst get a sense of to what extent there has been relative food price in ation vis-à-vis other commodities.

Let’s start by comparing the price of food to that of one of the key inputs in production: crude oil. Mechanized agriculture is powered primarily by petroleum products. Have food prices (in dollars) been rising relative to crude? Not really, no. How about metals? No. In fact, food prices have been lagging the general price rise in commodities since the early 2000s...

- Source, James Turk's Gold Money

James Turk: Actually it's time to buy Gold and Silver now

James Turk: Gold and Silver Solutions to Monetary Madness

Over the past several months it has become quiet clear that we had best be seeking solutions for this ongoing monetary madness that will safe guard our our individual needs and future wealth preservation. This is not a great mystery nor is it some "theory" dreamt up by basement dwelling lunatic. All one needs to do is read the headlines around the world and the picture is as clear as bright sunny day.

- Source, The Daily Coin

After The Two Week Takedown In Gold And Silver, Here Is The Big Surprise

BIS Surprises Gold Market Participants

Eric King: “James, I wanted to talk about the BIS (Bank for International Settlements) mobilizing all of that gold. As you know, the bullion banks, who act as agents for Western governments, were heavily shorting the gold market. And you were saying there were large backwardations in gold and silver, Maguire was talking about how they were getting overrun in the physical market. And then all the sudden the BIS mobilized all of that gold and the smash in the gold and silver markets began. Can you talk about that?”

James Turk: “Yes, we’ve seen this so many times, Eric, that you almost have to expect it. When there is panic behind the scenes by the bullion banks and the governments that are trying to cap the gold price, they go to the vault and they pull out some bars that haven’t seen the light of day for probably decades and then ship them over to Asia. And this just happened again…

James Turk continues: “In fact, what the BIS mobilized was a record amount of physical gold (for the BIS). And that’s an indication of what we are seeing. The physical demand for gold and also for silver has just been huge. It (physical gold and silver) is getting vacuumed up by entities who are moving out of dollars, the stock market, and other assets, into something safe.”

Eric King: “James, when you see a lot of the people who have been around these markets for 20, 30, 40 years, they are having such a hard time after that 5 1/2 year bear market. Their minds are messed up and they are waiting for the next shoe to drop (in the gold market). And even though this is a normal correction, they seem to be having a hard time dealing with it. What would you say to those people?”

James Turk: “You know it’s really hard this time around, Eric, because everything is so crazy today. We are really living in a whacko world with…Everyone around the world needs to listen to this remarkable interview with James Turk because it covers so much important ground as Turk let’s listeners know what surprises to expect next.

- Source, King World News, Read More Here

The Importance of Gold and Reasons for its Suppression

The post-war Bretton Woods Agreement confirmed the US dollar to be fixed to gold at $35 per ounce. All other national currencies were linked to gold through the dollar at the central bank level. Ordinary civilians, businesses and commercial banks were not permitted to exchange their currencies for gold through central banks, so this was simply a high-level arrangement designed to maintain control of gold priced in dollars.

A few years after Bretton Woods, in 1949 and when the newly-fledged IMF began to collate statistics on national gold reserves, the US Treasury was recorded owning 21,828.25 tonnes of gold, 74.5% of all central bank reserves, and 43.6% of estimated above-ground gold stocks. However, over the years the proportions changed, and by 1960, US gold reserves had declined to 15,821.9 tonnes, 47% of central bank reserves, and 24.9% of above ground stocks.

Clearly, American control of gold had weakened considerably in the two decades following Bretton Woods. This weakening continued until the failure of the London gold pool, the arrangement dating from 1961 whereby the major American and European central banks collaborated to defend the $35 peg. The Americans had abused the gold discipline by financing foreign ventures, notably the Korean and Vietnam wars, not out of taxation, but by printing dollars for export, and it began to put pressure on the dollar. The London gold pool effectively spread the cost of maintaining the dollar peg among the Europeans. Unsurprisingly, France withdrew from the gold pool in June 1967, and the pool collapsed. By the end of that year, the US Treasury was down to 10,721.6 tonnes, 30% of total central bank gold reserves, and 15% of above-ground stocks.

Inevitably the decline continued, and by the time of the Nixon shock (August 1971 – the abandonment of the gold exchange commitment) it was clear the US Government had lost control of the market. She had only 9,069.7 tonnes left, representing 28.3% of central bank gold, and 11.9% of above ground stocks. Monetary policy switched from the fixed parity arrangements centred on gold through the medium of the dollar, to a propaganda effort aimed at removing gold from the monetary system altogether, replacing it with an unbacked dollar as the international reserve standard.

The result was the purchasing power of the dollar and the other major currencies measured in gold has all but collapsed, as shown in the chart below.

Between 1969 and today, the dollar’s purchasing power relative to gold declined by 97.3% (the blue line). By banning gold from having any monetary role, the US removed price stability from the dollar. More recently, since the great financial crisis the quantity of fiat money in the global currency system has expanded dramatically relative to the long-term average growth rate of money and bank credit. This is illustrated in our second chart, which records the growth in the total amount of fiat dollars in the US banking system.

The fiat money quantity is the sum of true money supply and commercial bank reserves held at the central bank (the Fed). It is the measure of all deposits, including those of the commercial banks. Monetary inflation has expanded dramatically since the great financial crisis, illustrated by its acceleration above the long-term trend. The consequences for the dollar’s purchasing power in time will be to accelerate the dollar’s decline even more.

The monetary expansion of the dollar has been echoed in the other major currencies, with negative consequences for global price inflation in the coming years. Meanwhile, gold’s inflation, at roughly 3,200 tonnes annually, is about 1.9% of above-ground stocks. The different rates of increase between above-ground gold stocks and the fiat money quantities of unbacked state-issued currencies is what ultimately drives the price of gold measured in those unbacked currencies. It is easy to see why a higher gold price, reaffirming gold’s role as sound money at a time of excessive fiat currency inflation, is viewed by the major monetary authorities as a potential threat to their currencies’ credibility.

There can be little doubt that without the propaganda war against gold led by the US monetary authorities, without the expansion of unbacked paper gold constituting artificial gold supply in the futures and forwards markets, and without the secret interventions of the US’s Exchange Stabilisation Fund, the gold price would be considerably higher, expressed in dollars.i

However, gold remains centre-stage as a global hedge against the decline in purchasing power of fiat currencies. Besides rescuing the financial system from collapse nine years ago, the expansion of bank credit is inherently cyclical.ii The credit-cycle for China’s yuan appears to be moving into a new expansionary phase, reflected in a rising trend for nominal GDP. This will be put into context later in this article, but it is noticeable that on the back of China’s GDP growth, Japan, the EU and the UK are also enjoying export-led revivals.

The US does not share these benefits, partly because China and Russia, the founders of the Shanghai Cooperation Organisation (SCO), are deliberately freezing America and her money out, and partly because of America’s own tendency towards trade isolationism.iii It is therefore less certain that America is close to moving from the recovery stage of the dollar’s credit cycle into expansion. In the absence of other factors, the difference in interest rate outlooks this implies should be reflected in a declining dollar exchange rate against the other major currencies, a trend that has been under way since last January.

Despite the massive expansion of fiat money over the last nine years, it is possible for governments to stabilise the future purchasing power for their currencies. It will require their fiat currencies to be tied convincingly to the characteristics of gold. It depends on the government concerned accepting that gold is superior money to its own currency, owning sufficient physical gold reserves to convince the markets, and the gold price being at a level where the arrangement sticks. There is no doubt that China, Russia, as well as the other SCO member states and their populations regard gold as a superior money to fiat currencies, partly because their fiat currencies do not have well-established records of objective exchange value.

In the US, Japan, the UK and through much of Europe, the populations have experienced a longer, generally more stable objective exchange value for their currencies. Under pressure from their governments to use only state-issued currency, they have lost the habit of regarding gold as money. The monetary authorities of these countries, with a few exceptions, also do not regard gold as having any monetary role at all, beyond paying lip-service to a vague concept it has value as an asset which is no one else’s liability.

Therefore, understanding the role of gold and the protection it can offer fiat currencies is split into two geographic camps: the governments of Asia which are actively accumulating, or would like to accumulate additional reserves of monetary gold, and the governments of North America and Western Europe which see the gold price as irrelevant from the monetary point of view.

- Source, Alasdair Macleod of James Turk's Gold Money

How the 2008 Financial Crisis Will Eventually Destroy the US Reserve Currency Standard

While World War I and the financial crisis of 2008–2009 are hard to compare in many respects, such as the devastation they wrought or their political consequences, they have certain things in common. Both had a huge impact on the health of economies, including that of the country providing the global reserve currency. Both led to economic policy decisions at the national level that were clearly not in the interest of other nations. As such, both destabilized the Nash equilibrium required to maintain a reserve currency standard.

It is not yet generally understood, however, the extent to which the 2008–2009 financial crisis and global economic policy responses to it have already fatally undermined the fiat-dollar standard equilibrium. This is due primarily to a misconception within the economics profession that for most, if not all, of the key players involved, the costs of moving away from the fiat-dollar standard still far exceed the benefits.

This view has been the conventional wisdom for some years. In late 2003, three prominent economists, David Folkerts-Landau, Michael Dooley, and Peter Garber, published a paper making the case that the so-called Bretton Woods II arrangement of fixed or generally managed emerging market exchange rates vis-à-vis the dollar—a system that had been more or less in place following the various Asian currency crises of 1997–1998—was a stable equilibrium for a variety of reasons. The most important reason given was that the emerging markets were undergoing a long-term structural investment boom that could be properly financed only through export-led growth, much as had been the case under the original Bretton Woods arrangements in the 1950s and 1960s, when Western Europe and Japan exported their way to renewed postwar prosperity. As such, notwithstanding a declining share of global economic output and rising fiscal and current account deficits, the fiat dollar was likely to remain the world’s preeminent reserve currency for the foreseeable future, indeed, for decades to come.

Here is the abstract to the paper on the NBER website, which originally appeared in the International Journal of Finance and Economics:

The economic emergence of a fixed exchange rate periphery in Asia has reestablished the United States as the center country in the Bretton Woods international monetary system. We argue that the normal evolution of the international monetary system involves the emergence of a periphery for which the development strategy is export-led growth supported by undervalued exchange rates, capital controls and official capital outflows in the form of accumulation of reserve asset claims on the center country. The success of this strategy in fostering economic growth allows the periphery to graduate to the center. Financial liberalization, in turn, requires floating exchange rates among the center countries. But there is a line of countries waiting to follow the Europe of the 1950s/60s and Asia today sufficient to keep the system intact for the foreseeable future.

I was not alone at the time in being somewhat skeptical that this was indeed a stable equilibrium. As a result of maintaining fixed or managed exchange rates with the United States, not only were the emerging markets growing much faster than the United States but also accumulating vast dollar reserves that were then reinvested in US assets, thereby pushing down dollar interest rates and pushing up asset valuations, including, of course, house prices, to levels inconsistent with US household income growth . But with consumer price inflation low as a result of cheap manufactured goods from abroad and low rents at home—the flip side of the increasing rate of home ownership, courtesy of low interest rates—the US Federal Reserve saw no need to raise interest rates in response to the domestic credit, housing, and consumption boom, which ultimately originated from the Bretton-Woods II regime.

It is now generally accepted by the economic mainstream that the Fed’s decision to hold interest rates low for a sustained period in 2003–2005 was the key contributing cause of the growth of the US housing bubble that burst in 2007, thereby triggering the subsequent global financial crisis. As the bubble was inflating, Fed officials repeatedly claimed that not only was the rise in house prices not a bubble but also that low interest rates had little if anything to do with it. In 2005, Ben Bernanke, who had only recently assumed the Fed chairmanship, claimed that low US borrowing costs were the result of a “global savings glut,” in particular in rapidly growing Asian countries, rather than a function of Fed monetary policy. But the global savings glut and Fed policy should never have been separated in this way. The latter directly enabled the former.

By focusing on consumer price inflation only, rather than money and credit growth generally, the Fed completely missed the connection between US interest rates, global savings, investment, and asset prices. It therefore failed to see that its policies were the ultimate cause of the housing bubble and that the global savings glut was just one link in a long money-and-credit chain that had become unanchored. The late great Austrian economist Kurt Richebächer recognized clearly that this was the case. As he wrote in April 2005:

In earlier studies published by the International Monetary Fund about asset bubbles in general, and Japan’s bubble economy in particular, the authors repeatedly asked why policymakers failed to recognize the rising prices in the asset markets as asset inflation. Their general answer was that the absence of conventional inflation in consumer and producer prices confused most people, traditionally accustomed to taking rises in the CPI as the decisive token for inflation.

It seems to us that today this very same confusion is blinding policymakers and citizens in the United States and other bubble economies, like England and Australia, to the unmistakable circumstance of existing rampant housing bubbles in their countries.

Thinking about inflation, it is necessary to separate its cause and its effects or symptoms. There is always one and the same cause, and that is credit creation in excess of current saving leading to demand growth in excess of output. But this common cause may produce an extremely different pattern of effects in the economy and its financial system. This pattern of effects is entirely contingent upon the use of the credit excess— whether it primarily finances consumption, investment, imports or asset purchases.

A credit expansion in the United States of close to $10 trillion—in relation to nominal GDP growth of barely $2 trillion over the last four years since 2000— definitely represents more than the usual dose of inflationary credit excess. This is really hyperinflation in terms of credit creation. In other words, there is tremendous inflationary pressure at work, but it has impacted the economy and the price system very unevenly. The credit deluge has three obvious main outlets: imports, housing and the carry trade in bonds. On the other hand, the absence of strong consumer price inflation is taken as evidence that inflationary pressures are generally absent. Everybody feels comfortable with this (mis)judgment.3

The mistake made by Folkerts-Landau, Dooley, and Garber was that they failed to see back in 2003 that the Fed’s easy money policy was fueling rampant money and credit growth that, in time, would lead to a colossal global credit crisis. To be fair, the entire economic mainstream missed it too. But this just begs the question of why. The best explanation is that the modern economics profession focuses primarily on consumer price inflation as a potential source of economic instability, rather than money and credit growth generally. Austrian School economists, such as Richebächer, know better. He was hardly the only Austrian economist to predict the crisis.

- Source, John Butler via James Turk's Gold Money