James Turk: The Path Towards Fiat Money Destruction

In this interview with James Turk I ask him about Gold as Money and why gold is not an investment. 

The distinction between money and currencies. 

The path of fiat money destruction and the loss of its purchasing power. 

Why the currency and the financial system are flawed. 

What is payment risk? Governments printing money and its consequences. 

Silver versus gold and James views on both Mene a new product from Gold Money. 

What is it and why you need to know. Physical gold and counter party risk.

- Source

Why a Bear |Market will Lead to a Dollar Collapse

The cumulative effect of central bank intervention has led to bond prices that have come badly adrift from reality. Taking a more realistic estimate of the dollar’s purchasing power than that implied in goal-sought CPI numbers, plus an estimated amount for the time preference involved, ten-year US Treasuries should yield closer to 10% to maturity, not the 1.31% implied today. If a ten-year bond has a coupon such that it is currently priced at par, the price should halve.

Those who put our monetary misfortunes down to the coronavirus have missed the point. Yes, it will be fatal, both economically and unfortunately for some of us as individuals as well. It is early days in what is definitely becoming a pandemic, that is to say an epidemic that is not restricted to national boundaries. Not only China, but other nations as well are going into a state of lock-down. Hopes that things will return to normal in the second half of this year are obviously based on a belief that there is nothing else wrong in the global economy.

This is where those who actually understand money and the credit cycle part from the economic establishment, which continuously demonstrates its cluelessness. Note these indisputable facts:

1. Economic destabilisation arises from a cycle of bank credit expansion always followed by a credit crisis. It does not arise from business, but from time to time the willingness of banks to expand credit out of thin air, creating a temporary period of economic optimism which does not last.

2. The expansion of the global money quantity since 2008 has been unprecedented, not only numerically, but in proportion to the size of underlying economies. If nothing else, logic suggests the bust that follows will be proportionately destructive.

3. While their relative magnitudes to each other were different ninety years ago, a combination of trade tariffs and the top of the credit cycle mirrors the conditions that led to the Wall Street crash between 1929 and 1932. That should be warning enough that even without a coronavirus pandemic the world is on the edge of not just a recession, but a vicious slump.

The most important difference between the Wall Street crash and the depression that followed is found in the money. In those days, both the US and UK currencies were on a gold standard, which meant that collapsing commodity prices through the dollar and sterling were effectively being measured against gold. Other factors, such as the rapid mechanisation of farming and the productivity that followed exacerbated the situation for farmers worldwide, until the UK abandoned gold in 1932 and the dollar was devalued the in 1934. In short, the link with gold meant that leading currencies were not undermined by the depression.

Nevertheless, economists in the 1930s blamed the depression on gold, and governments have sought to remove it from the monetary system. Since 1971 there has been no residual link between gold and the dollar and therefore all other state-issued currencies. The quantity of money in circulation has been free to be expanded by central banks, the only limit being the consequential limitation of price inflation. That has now been conquered by statistical method.

From their actions following the Lehman crisis it is clear central banks now feel no constraint on the expansion of the money quantity as a policy tool. The Fed, the ECB and the Bank of Japan are already expanding base money before the crisis stage of the credit cycle has materialised, which should alert us to the catastrophic failure of monetary policy. Keynes’s concept of reviving animal spirits with a kick-start of inflation has morphed into a continual and accelerating monetary inflation over the whole cycle.

Collectively, in the post-war years we all bought into monetary inflation by shifting investment allocation progressively from bonds into equities to protect long term savings. But since the interest rate spike in the early 1980s, bond yields have generally declined to the point where in dollars, euros and yen they yield less than their values of time preference. In the two latter cases investors are now even paying for the privilege of lending money to their governments.

The abolition of meaningful yields has been achieved through a combination of statistical suppression of price inflation and monetary expansion. But this is just the start of it. Imagine for a moment a collapse today akin to the 1929-32 Wall Street crash, followed by an economic slump on a 1930s scale. Freed from apparent restrictions on the expansion of money and having a mandate to do whatever it takes, combined with demands for the financing of soaring government budget deficits the expansion of money will go into hyperdrive – everywhere at the same time.

Not only do we have that problem, but we now have a viral pandemic that has all but shut down the largest manufacturing economy in the world, disrupting the overwhelming majority of supply chains elsewhere. And that assumes the coronavirus is contained to China and that early signs of it turning into a global pandemic turn out to be false. But the signs are that it is becoming a pandemic on the eve of Wall Street crash Mark II, bringing forward and amplifying the economic destruction that always follows a period of credit expansion. The effect of the virus threatens to turn an economic slump, perhaps a once in a century event, into an outright production and consumption collapse.

What lies before us will be radically different from the past. Understanding money and the effects of changes in it as a circulating medium have rarely been more important. This article outlines the effects of what lies ahead, likely to commence in a collapse of financial asset values and the purchasing power of currencies.

- Source, Goldmoney

The Euro: Can it Survive?

A dusty concept called the regression theorem suggests the most fragile of the major currencies is the euro. This states that in the users’ collective mind its validity as money is derived through experience. The fact it was money yesterday, and in the days, weeks, months and years in the past confirms its status: the longer the better. For the fiat currencies with the longest history, their status as money was derived from their role as a gold substitute, linking their credibility to sound money in the distant past.

In the euro’s case, it derived its original status from the fiat currencies it replaced and is only twenty-one years old. In a generally stable economic and monetary situation the lack of a longer history of regression may not matter, but it could be more easily destabilised than a more established currency at a time of crisis. Despite the Lehman catastrophe, the subsequent banking crisis in Europe and negative interest rates, the euro has so far survived intact.

The fact it has done so is in large measure due to the lack of any alternative for the 340 million eurozone residents. Perhaps its survivability has been enhanced by the convenience of non-cash transactions. In any event, a population mandated to use a state issued currency finds it is in its interests to accept its validity as a circulating medium and only abandons it as a last resort. It is when approaching that point that the regression theorem will matter.

That is a consideration for domestic users of the euro. Meanwhile, foreigners have voted with their feet, driving the rate down in recent years from $1.60 in 2008 to $1.05 in 2016, and from $1.24 in 2018 to $108 recently. It has been the principal counterpart to a rising dollar expressed in the latter’s trade weighted index. Behind these moves there is the net effect of trade balances and speculative flows.

In 2019 the Eurozone’s balance of trade was a positive $175bn, while the US trade deficit was $667bn. The sharp difference between the two economies represented a strong headwind in favour of the euro and against the dollar, but since 2018 it was more than overcome by the pull of interest rate differences. While the ECB maintained a negative deposit rate, US-based hedge funds through the fx swap market shorted the euro and bought dollars to benefit from interest rate differentials.

Since April 2018, when it became clear that President Trump’s tax policies would stimulate the US economy the fx swap trade was on. There can be no knowing the true size of it, but it was significant enough to force the Fed to intervene in the repo market to provide extra liquidity from last September to this day.

The Fed has now reduced its funds rate by fifty basis points to 1.0-1.5% and the 13-week T-bill is leading the way to yet lower yields by yielding only 0.675%. Given that prime brokers fund their inventory at the fed funds rate, they are still losing money, so the Fed will be forced to lower the FFR again to 0.5%-0.75% to avoid disrupting the T-bill market. Even that assumes no further fall in T-bill discounts, but it does mean that interest differentials between dollars and euros will fall again, with consequences.

The declining profitability of fx swaps out of both euros and Japanese yen and into dollars plus increasing liquidity and counterparty risks means hedge funds should be aggressively unwinding their positions. Already, in recent days we have seen the yen rise from 112 to the dollar to 106.9 (note that a decline in the rate signals a stronger yen). And the euro against the dollar has gone from under 1.08 to 1.1175. The effect on the dollar’s trade weighted index has been dramatic, as shown in Figure 1 below.

The start of the fx swap trade for hedge funds is highlighted by the solid arrow, when in April 2018 it became clear that President Trump’s fiscal policies would lead to higher dollar rates and bond yields relative to both those of the euro and the yen, but particularly against the euro due to the index’s weighting in favour of it. While the bull market persisted, for most of the time it has been in the form of a weak broadening top delineated by the pecked lines. It is in this context we can see the impact of the coronavirus on dollar exchange rates, with the TWI suddenly falling by about 2½%. If it breaches 96.5, we will have technical confirmation the dollar is due to fall significantly, possibly quickly, against the euro.

In the short term, the unwinding of fx swaps combined with the relative trade imbalances with the dollar are the reason their closure could drive the exchange rate for the euro higher, likely to provoke the ECB into attempts to offset it. Policymakers enamoured of the Taylor rule will argue for deeper negative rates, a move that favours spendthrift governments but does nothing for the real economies in the EU. Worse, it comes at a time when overleveraged eurozone banks will be reducing outstanding bank credit, as loans reflecting dollar swaps positions taken out by both hedge funds and commercial entities are being wound down. And they will also be trying to reduce their loan exposure to businesses whose cashflows are being undermined by the coronavirus. In short, bank credit faces an imploding pull.

- Source, James Turk's Goldmoney

Will Brexit and Coronavirus End the EU?

Brexit came as a shock to the political bureaucracy that comprises the European Union. They had, and still have an ostrich-like stance with their heads in the sand and their rear ends exposed to passing dangers. Their economic incompetence has been exposed for all to see as well as their political ineptitude.

Professional politicians with any semblance of a democratic mandate do not work in Brussels but run the nation states that comprise the union. We can criticise national politicians for their ignorance on what makes their electorates wealthier and happier. They are elected by the ignorant for their own ignorance, but soon learn the political ropes that keep them in power. Or they fail and are rapidly ejected, often ending up in Brussels.

The EU is divorced from the need for realistic political representation. It is the collective dustbin for the power-seekers who have either been ejected by their own national electorates, or who are simply unelectable. It is heaven for power wannabes unwilling to face the consequences of their actions. And as the body of these dangerously inept individuals has grown, they have ensured a bureaucratic cancer has spread into national administrations. You can’t do this minister, because Brussels over-rules it. A bureaucratic statis has spread throughout the administrations of member states.

This was what Brexit challenged and exposed. The establishments in Whitehall and Westminster have become full-on eurocrats, dismissive of Britain’s own parliamentary democracy and remain fully committed to the European project.

Our dictionaries tell us that a moral statis is a condition where things do not change, move or adapt, which is definitely true of the EU’s economic policies. Other than the one change, which is its relentless acquisition of power to intervene and distort, this describes Brussels to a tee. The Eurocrats despise free markets, the source of external change, and seek to control them through mountains of suffocating regulations. As arch-protectionists they find it impossible to permit free trade except under duress. The overwhelming majority of the EU’s free trade agreements are with small insignificant states which are immaterial to the bigger picture. As an entrepôt, Britain’s escape will show by comparison just how much the EU has become a socialising command economy. It has too much in common with the old, centralising USSR and its satellites, a lighter touch perhaps and without the gulags.

However, change is a fundamental part of the human condition, and it is coming from a wholly unexpected direction. The spread of the coronavirus is shutting down the European economy. In increasing numbers people are no longer travelling. The spread of the virus, whether through fear or fact, is sharply reducing both production and demand. Indebted businesses will not have the cashflow to pay debt interest and supply chains will be riddled with payment failures. Previously acceptable debt is becoming junk. Banks will need to be rescued from defaulting customers and the euro’s future will be increasingly questioned.

For the moment, eurocrats might be able to get tables in their favoured restaurants more easily while national governments take it on the chin. But this is a temporary situation, which could easily evolve into a threat against the union, serious enough to either end or emasculate it when diametrically opposed interests are enhanced by the course of events and become unreconcilable.

Following Britain’s exit, the squabbling will now begin. Germany, with some commonality with the Netherlands, Austria and Finland has suffered the pain of unsound money to see its citizens’ savings taxed by negative interest rates and having them recycled into supporting bad debtors in the Mediterranean states. The Mediterranean states will demand even more money, taking their debt-to-GDP ratios into the stratosphere. The new boys in the East, Poland, Hungary, the Czechs, Slovaks, Bulgarians, and Romanians, who still think they can change Brussels will realise that as the subsidies from Brussels dry up, they have been sold a pup.

The eurocrats in Brussels lunching on their langoustines will conclude nothing need change and the ECB can deal with it.

If only it was so simple.

- Source, Goldmoney

Oil Markets Predicting Risk of a Global Recession

Oil prices have sold off sharply over the past month. Despite a series of bullish events – the US airstrike targetting Qasem Soleimani, Iran’s retaliation attack on US troops in Iraq, the shutdown of almost the entire Libyan production and the US’ tightening the screws on Venezuela by sanctioning Rosneft and potentially refusing to renew waivers to US companies stating in April - oil prices are now substantially lower than before these events. Brent front month prices peaked at $72/bbl in early January and are now at below $50/bbl (See Exhibit 1).

Moreover, by mid-January, the geopolitical tensions and supply losses had pushed the Brent curve into severe backwardation. June-December 2020 time-spreads for example traded as high as $4.50/bbl just one month ago, reflecting prolonged physical tightness. Those time-spreads are now in contango (see Exhibit 2).

This massive change in sentiment happened as the Coronavirus situation in China unfolded. Importantly, while we do expect a significant impact on Chinese oil demand from the massive travel restrictions in China, that alone would not warrant such a move in the curve in our view. Instead, we think the recent moves in oil prices is reflecting expectations for a significant slowdown in global economic growth. In fact, we think the oil price move is now pricing in a significant probability for a global recession in 2020.

Commodity markets are the only markets which currently reflecting this view. Equity markets, despite the recent sell-off, do not. Importantly, we believe commodity markets are still underpricing the risks to aggregate demand. The question is not longer whether the economic impact from the Coronavirus outbreak will be short-lived or whether it will be more pronounced. The question is whether the economic impact will be pronounced or catastrophic. In our view, energy markets are currently pricing in a pronounced impact with substantial fiscal and monetary stimulus down the road. There is substantial downside risk if that view turns out to be too optimistic.

That said, in either case we expect central banks to return to the 2008 playbook soon. Nominal interest rates will only decline from here and we are likely going to see a reacceleration in quantitative easing. However, in the catastrophic scenario, we believe central banks will quickly realize that the tools they have been using since 2008 will not get them very far this time. Hence, we would expect central banks to become more creative, by deploying something like “helicopter money”. This is not far-fetched. Hong Kong announced a few days ago that it would give every adult citizen HK$10’000, around $1300, in order to combat the economic fallout Coronavirus-crisis. We believe this would push gold prices sharply higher medium term.

- Source, Goldmoney

Goldmoney 2020 Outlook Roundtable

As it has become tradition, Goldmoney’s leadership team – Roy Sebag, James Turk, Alasdair Macleod and Stefan Wieler – were joined by a special guest, former Member of the European Parliament Godfrey Bloom, to discuss the state of global economy, financial and systemic risks, the developing threat of the coronavirus, and outlook for gold and financial markets.

- Source, Goldmoney

The Great Coronavirus Awakening

If our thesis is correct, that being bound together the purchasing power of the dollar and values of financial assets will probably collapse at the same time, we will see a different outcome from that which might otherwise be expected. Today, anyone discussing the consequences of monetary inflation would suggest the currency’s purchasing power will decline over a period of several years at an accelerating rate, giving those who recognise what’s happening time to protect themselves. This was the experience in Germany and some other European nations in the wake of the first World War. Instead, if it happens as described herein, the collapse will be extremely rapid, with bonds, equities and unbacked state currencies collapsing together in the space of less than a year. All that’s required is for the private sector to stop buying government bonds.

It has happened once before, exactly three hundred years ago. Like the central banks of today dealing with their governments’ debt, John Law in Paris had used the inflation of his own banknotes to ramp up the price of the Mississippi Company shares. By December 1719 Law’s scheme had begun to hit headwinds: the flood of his printed money into Mississippi shares fuelled profit taking. Law’s unbacked livres entered general circulation and led to a rise in price inflation.

The factor that finally undermined his scheme was the young King selling out the royal holding of 100,000 shares at 9,000 livres on 28 February for staged payments. It was a combination of a signal and too much supply for the market to bear, and both the shares and Law’s paper livres began to collapse. By the following September, while Mississippi shares still had a notional value of a few thousand livres, the livres were worthless.

The collapse of the currency preceded that of the shares by just a few months. Today, a similar tiredness around currencies prevails, whose purchasing power governments wittingly or unwittingly conceal. In recent years, price inflation in the United States has been running at about 10% in most major cities, based on evidence from independent analysts, not the goal-sought 2% of official figures.[ii] Given the standardisation of CPI method, we can assume price inflation in other jurisdictions is similarly understated. But we have yet to see the purchasing powers of unbacked fiat currencies begin to accelerate in their decline, as appeared to be the case in late-1719.

No matter. Instead, we should assess likely changes in monetary policy in the coming months. This time, we have the additional damage done to human interaction by the coronavirus. China’s economy, where production is ceasing and food prices are rocketing, could be evolving into a John Law-like collapse, in which case the currency will be next. Commentators are saying that once the virus passes, everything will return to normal. It won’t because the lies and hype that go with paper money will almost certainly have been exposed, as John Law found to his cost.

We can see that, rather like King Louis cashing out of John Law’s scheme in February 1720, in China the bullish spell is being challenged by the coronavirus. And China matters, being the world’s largest producer of consumer and intermediate production goods in the world. The Chinese government are expanding the money quantity rapidly to support the stock market and will also do so through state-owned banks in a vain attempt to support the wider economy. Just like John Law in those final three months.

The signal that it’s all going wrong for the yuan is likely to be reflected in demand for bitcoin, which can be bought online through peer-to-peer marketplaces, even by punters under quarantine (Chinese bitcoin exchanges were shut down by the government in 2017). At the time of writing, they were trading at a small premium to the dollar price. If that premium increases, or the number of bids suddenly jumps, it will be an indication that Chinese residents are beginning to lose faith in their currency. If the authorities try to ban peer-to-peer bitcoin sites, it will send a similar signal.[[iii]Even without the coronavirus spreading to other nations and undermining their economies directly, those who believe in the efficacy of their central bank’s monetary policy will begin to have doubts as not even negative interest rates have succeeded in stopping an economic decline. The error came from unswerving beliefs in the inflationary policies of John Law and John Maynard Keynes.

- Source, James Turks Goldmoney

Coronavirus and credit, a perfect storm

“Ring-a-ring o' roses / A pocket full of posies / A-tishoo! A-tishoo! / We all fall down.”

Some folk attribute this old nursery rhyme to the plague in England of 1665. But it seems singularly appropriate for coronavirus or COVID-19, about which, as yet, we know little. Its origin is, allegedly, a mutation of a virus from a snake, bat or pangolin. Alternatively, one school of thought believes it escaped from a biological warfare laboratory in Hunan. At the time of writing, officially, the ratio of reported deaths to reported recovered is about 23%, which has been declining as time progresses.[i] While the fatality rate is expected by Western analysts to level out at about 3.5-4% of those infected, its spread is probably much more serious than admitted, with the Chinese being accused of playing the crisis down. To be fair, it will have been hard for the authorities to keep up with its rapid spread. Coming during the Chinese New Year holiday when most factories have closed anyway, there is some confusion about the economic impact. Officially, the public holiday ended on 30 January, but nearly all factories were still closed a week later, and their reopening will be gradual at best.

Not only do Chinese factories supply the world with consumer goods, but they are integral to global supply chains. Hyundai in South Korea has already been forced to close all its factories due to lack of Chinese components and other car makers around the world have expressed similar difficulties. For all intents and purposes, China is shut, and therefore its economy is not functioning. And the longer this goes on it is increasingly difficult to see when, if ever, past normality will return.

China’s experience threatens to be repeated elsewhere, in which case the world, with closed factories and people severely restricted in their human interactions, faces the deepest global economic slump since medieval times, when the plague ravished Europe. Ring-a-ring o' roses indeed. Meanwhile, financial assets stand close to all-time highs. This is undoubtedly due to money and credit being pumped into financial markets at a quickening pace, and while bond yields are suppressed by freely available money, it seems economic actors prefer not to hold bank deposits relative to the risk of holding equities.

Just when this viral epidemic materialised, the financial system was already on life support and at its weakest. The credit cycle is due to turn down, and the dynamics behind it suggest it could be worse than the Lehman crisis, which was broadly contained to financial entities and residential property prices. This time the banks have accumulated worrying levels of junk debt directly and indirectly through collateralised loan obligations. Money markets are badly stretched with liquidity having miraculously disappeared. Central banks are flooding them with new money even before the periodic banking and systemic crisis has occurred. But all this extra central bank money achieves is to drive financial asset values even higher.

It will be a mistake to blame the financial and economic events that follow on the coronavirus, but inevitably this is what those who have relied on a failing monetary system will do. As to the course of the coronavirus epidemic, only time will tell. With financial markets already teetering on the edge of a systemic and economic crisis, the timing of its emergence could pull the trigger on a global financial and economic collapse.

The credit cycle and asset inflation

We should remind ourselves that the credit cycle, which is the manifestation of banking psychology in changes in the availability of credit, is on the turn. There are three distinct classifications of credit demand affected: the non-financial economy, speculators (particularly large hedge funds) and governments.

Commentary by financial pundits almost exclusively concerns the non-financial economy, with monetary policy officially targeting consumer prices and employment. The encouragement of banks to lend is part of it. By creating an artificial boom, banks are further persuaded to increase their lending at suppressed rates, leading to a misallocation of capital resources. Prices of consumer goods then begin to rise, and interest rates with them, undermining the basis of business calculation. Sensing increased loan risk, the banks begin to restrict the expansion of bank credit, which only increases credit risk even more. Banks begin to panic, withdraw revolving credit facilities and consequently they drive the economy into a slump.

That is a brief summary of the classic credit cycle, but it bears little relation to that of today. Instead of bank credit being predominantly deployed for production, it is increasingly taken up by financial intermediaries lending to consumers. Furthermore, consumers have reduced their deferred consumption in the form of savings, which in former times were integral to the workings of the credit cycle. And despite central bank propaganda about being primarily interested in the non-financial economy, this sector has become progressively demoted relative to the funding needs for financial speculation in order to maintain asset values and sustain government borrowing.

Today, in the US, UK and many other developed economies, with the exception of pension and insurance funds, savings as an economic force have virtually disappeared. The majority of consumers are now living pay-day to pay-day and continually in debt with respect to their current spending. Predominantly at the expense of ordinary people, wealth and real income have been increasingly transferred from productive individuals to governments, the banks and their favoured borrowers through monetary debasement. The effects of monetary debasement have been concealed by statistical method, leaving consumers considerably worse off than slavish followers of government statistics are generally aware.

Every credit cycle impoverishes consumers even more, as their earnings and diminishing savings are continually eroded by ever accelerating monetary debasement. Having tamed the statistics, governments such as the US, the UK and some members of the EU now think they can abandon all fiscal probity. They think they can finance budget deficits, public investment projects and even sustainable energy projects with only limited consequences for the currency’s purchasing power, all by inflationary means. It is, of course, all delusion, consistent with end of cycle psychology.

The reality is government spending is out of control. The net present values of future welfare commitments are materialising in the form of current liabilities. Governments are funded by the expansion of their central banks’ balance sheets. The only thing keeping this illusion going is the activities of speculating hedge funds leading directly and indirectly to continually rising financial asset values.

But there is a crunch coming. It appears to have started to arrive last September, when the US repo market suddenly seized when the overnight rate spiked up to ten per cent. Such are the accelerating demands of government funding that they cannot be accommodated as well as the interest arbitrage activities of the speculators active in repos and foreign exchange (fx) swaps.

The speculators, particularly the big relative value hedge funds, turned bullish on the dollar in April 2018, three months after President Trump took office. It was clear, to the speculators at least, that his proposed tax cuts would stimulate the economy, drive up government borrowing rates, and therefore foreign demand for dollars to invest in US debt at a time when euro and yen interest rates were trapped under the zero bound. That point is marked by the up-arrow in Figure 1 below, when a clear breakout in the dollar’s Trade-Weighted Index took place.

The dollar’s trade-weighted index is heavily weighted in favour of the euro. Since the ECB had pegged its interest rates below the zero bound, it gave rise to an immensely profitable trade. A speculator could borrow euros at close to zero interest rates to buy US Treasury bills and even coupon-paying bonds for a yield pick up of over 1.5% in April 2018, rising to 2.39% for T-Bills a year later as the Fed tried to reduce its balance sheet. Much of this trade is conducted through fx swaps, which lock in interest rate differentials for as long as a year (sometimes more) and whose 10% deposit for the forward leg allows a speculator to gear the trade up ten times. The basic mechanism is shown in the schematic illustration below (courtesy of The Bank for International Settlements).

Putting counterparty risk aside, this is seen by hedge funds as a riskless trade, with the leg at maturity fixed at the outset. Therefore, it operates much like a repo. But it should be noted that when the trade is unwound, changes in the value of the collateral and the exchange rate have to be absorbed directly or indirectly by the swap provider.

Rising bond yields and a fall in the dollar exchange rate will have significant consequences for swap availability. Meanwhile, according to The Bank for International Settlements, FX forwards and swaps outstanding grew from $53.9 trillion to $59.4 trillion in the first half of 2019, the vast majority involving dollars. Given the increasing popularity of this trade it is likely to have grown further into the year-end. It is now straining the resources of the banking system to lend dollars as part of swap arrangements at the same time as the primary dealer subsidiaries of the G-SIBs have to hold increasing quantities of inventory of US Treasury bills and bonds.

We must also consider the currency effect. Because the trade requires the FX swap counterparty directly or indirectly to short euros or yen for dollars and to invest them in T-bills and short maturity US Treasuries, the effect has been to depress the euro and the yen while increasing demand for dollars. So much so, that the trade imbalances that favour the euro and yen and strongly disfavour the dollar have not been uppermost in currency pricing. Normal trade related supply and demand has been swamped by speculative demand for the dollar.

But as the chart in Figure 1 suggests, the dollar’s bullish momentum is now stalling. The strains on the banks, particularly the global systemically important banks (G-SIBs) who under Basel III rules have to demonstrate sufficient liquidity to cover all forward liabilities thirty days in advance, are now capacity constrained. The signal for this liquidity crisis occurred on the same day as Deutsche Bank sold its prime brokerage to BNP, suggesting there may be other risk elements in the mix. For the dollar, the consequence is that unless demand for fx swaps continues to be supplied, it will begin to decline.

The Fed had no alternative but to step in and through repos provide extra liquidity to the G-SIBs, which it has been doing since September at a wildly fluctuating daily amount, recently averaging about $50bn. To the extent the G-SIBs are now reliant on the Fed’s repos, they act as a pass-through to the speculating hedge funds. In effect, the Fed is directly supporting the speculating hedge funds in their activities and is now the primary agent behind the inflation of financial asset prices.

Whether it is by default or intent, the Fed has effectively welded the dollar’s purchasing power to the values of financial assets. They are both rising together and will almost certainly fall together. The only question is which will take the lead.

The Fed’s policy of inflating financial assets has taken them into severely overvalued territory. The reality being ignored is that governments, particularly the US Government which with its reserve currency sets the valuation basis for all markets, have only short-term solvency available by debauching their currencies. Raising taxes instead would be ruinous for the underlying economy, and cutting spending goes against the expressed wishes of central banks looking for fiscal stimulus.

The rating of the US Government’s debt is wholly incompatible with the facts. Worse, when markets begin to reflect on this contradiction, they will realise that the higher the cost of funding goes, the higher it will then go. The US Government is firmly ensnared in an inescapable debt trap. And as time passes, the only alternative to government spending grinding to a halt will be to continually accelerate currency debasement.

Meanwhile, the tranquillity of financial markets everywhere belies their biggest challenge yet. The impact of the coronavirus on China’s economy, and therefore the global economy should not be lightly dismissed. Even if it does not become a pandemic, defined as an epidemic across national borders, it comes at a time when the global economy is entering the crisis stage of the latest credit cycle. The fact that these two events have also coincided with a collapse of cross-border trade, brought about by President Trump’s tariffs against China, gives an added viciousness to the situation. Even without the virus, the similarities with 1929 leading to the Wall Street crash and the subsequent economic depression, should give thinking investors considerable pause for thought.

- Source, James Turk's Goldmoney

Alasdair Macleod With QE Infinity, Is Deflation Possible

Alasdair Macleod of James Turks Goldmoney explains why mild deflation is no longer possible but instead we face prospects of rising consumer inflation as well as continued asset inflation.

- Source, Jay Taylor Media

How to Return to Sound Money

There has been very little commentary in recent years about the benefits of sound money, being limited almost entirely to followers of the Austrian school of economics. Even less has been written about how to back out of inflation-ism, end unsound money and return to a monetary arrangement which cannot be corrupted by governments and the banking system.

The most notable attempt was by Ludwig von Mises who appended a chapter on the subject in his updated 1952 version of The Theory of Money and Credit[i] The circumstances were very different from that of today. At that time, the US had corrupted its gold exchange standard to progressively exclude the ability of individuals to demand gold for paper dollars. And both Keynesianism and socialism, in the West at least, were in their earlier days. Today, we face more of an end game where considerable damage has been done since to the status of circulating money, and we face the prospect not of reform but of a collapse of the entire fiat money system.

It is a situation which, if nothing had been done in the 1950s, von Mises predicted in his writings would eventually happen. We are now witnessing not just the failure of state currencies, but also the economic damage wrought. That the root of the problem is a combination of progressive inflationism fuelling a credit crisis is gradually becoming obvious to a small but growing number of critics.

Recent events, which are germane to all our economic prospects in 2020 and beyond, are now unmasking a deterioration in demand for manufactured output and declining credit quality consistent with the ending of the expansionary phase of the credit cycle. The increase of American trade protectionism at this point in the credit cycle has worrying echoes of 1929, when the Smoot-Hawley Tariff Act was passed by Congress and signed into law by President Hoover in 1930.

The opening months of 2020 should see yet more statistical confirmation that the world’s production is declining, only concealed by renewed monetary inflation. Recession and its consequences are the central banks’ worse fear and they are already in accelerated printing mode in yet another attempt to forestall it.

The immediate future of fiat currencies is centred on the dollar’s prospects as the reserve currency. Dollar-centric markets remain in denial, believing the dollar will always be supported by a flight to safety if things cut up rough. In the short-term, it might be a self-fulfilling prophecy. But after an initial Pavlovian reflex, the dollar’s future measured in other state currencies depends on the relative needs of economic actors on a national basis and the actual ownership position.

Here, the dollar fares badly, with dollar assets and cash in foreign hands totalling about $24 trillion, and US ownership of non-dollar assets less than half that at $11.297 trillion (end-2018). US ownership of foreign short-term debt securities was $502bn at that date, of which only $92bn was in foreign currencies the rest being in dollars, according to TIC data from the US Treasury. Other than foreign listed securities, which are small in total compared with foreign ownership of US securities, that $92bn is all the foreign currency American residents have to sell in a financial meltdown.

Of their $24 trillion total, foreigners owned $19.4 trillion of dollar assets, of which more than $8 trillion is in equities, and includes short-term debt securities of $980bn. Additionally, dollar deposits held through correspondent banks totalled $3.6 trillion last October. Dollar liquidity in foreign hands is therefore nearly $13 trillion, before one considers foreign investment in US Treasuries, which is mostly held by foreign governments and official organisations. Clearly, when foreign balances adjust to a world of contracting trade, dollars will be sold heavily, destroying its value and disrupting US capital markets with very little in the way of flows the other way to offset it.

In these circumstances it will be impossible for the US Government to fund its budget deficits through capital inflows as it is wont to do. And given the absence of domestic savings accumulation, which would detract from final consumption and therefore undermine the GDP statistic anyway, trillion-plus deficits will have to be financed almost entirely by monetary and bank credit inflation.

Sooner or later this is bound to lead to a severe crisis for the dollar and therefore all the fiat currencies that regard it as King Rat. The crisis will be further fueled by a mixture of escalating government debt, falling purchasing power for the dollar, and increasing interest rates, the last being driven by the market response to a declining currency in terms of its purchasing power. It is a debt trap which will be reflected at the very least in a substantial decline of the full faith and credit in the US Government.

Eventually, possibly in a matter of only a few years, the dollar could become worthless. The few commentators aware of this danger have for some time been arguing for a currency reset without much idea how it can be implemented. It is almost certain that central banks will convene to cook up a new monetary plan as the dangers to the current system increase. But given the statist culture behind the problem, the basis of any state-initiated plan will surely include an attempt to secure the state’s monetary role and to extend its powers over markets. With the same underlying characteristics, any new currency arrangement based on a modification of the state-issued currency system is guaranteed to fail. History tells us that when the fiat route is pursued a second time, the public is already aware of government trickery and the second failure is swift (cf. France 1789-97 – assignats followed by mandates territoriaux which hardly lasted six months).

From an economic standpoint, the introduction of sound money will yield immediate benefits for the population compared with a failing currency regime. The problems obstructing it are a lack of understanding of catalytic theory by professorial economists and the establishment’s relentless grip on bureaucratic and political power.

To illustrate the required scale of the whole socio-economic and monetary reform involved, a solution which works must be proposed. Such a proposal must have sound incorruptible money at its heart, because no other arrangement will survive over time. It requires the termination of the central banking model. That central banks will be required to make their policy roles redundant virtually guarantees that the destruction of the fiat currency system, and its immediate replacement on a reset, are bound to occur before a sound money system of money and credit can be contemplated.

We should proceed with this assumption. Our sound money will be a phoenix rising from the ashes of monetary and economic destruction.

This article provides a template for how a new monetary system based on sound incorruptible money can be implemented. It addresses the following topics: the reintroduction of gold as circulating money handing all monetary power to its users, dealing with existing government debt, reforming the banking system, and resetting economic theory to where it was before Keynes worked up fallacious roles for the state. Properly addressed and planned, its implementation should be less difficult than it at first appears, and any nation following the courses of action in this article is likely to see substantial economic benefits in less than a year.

Sound money – it can only be physical gold

For the avoidance of doubt, a gold substitute is a currency in all its forms fully backed by and convertible into gold on demand by all of its users. A gold exchange standard permits the expansion of unbacked bank credit and does not prevent governments inflating total money supply.

Before critics jump to the conclusion that I am promoting a role for gold, it should be clear that my primary interest is sound money, which happens to be gold. So, yes, I am promoting gold but only as sound money; the order is sound money first, gold second. This is why I (and my colleagues at Goldmoney) insist the proper role of physical gold is as money, and it is not to be regarded as an investment, though related media, such as ETFs, derivatives and mining shares are properly classified as gold-related investments.

There should be no need to reiterate why gold emerged as the money of people’s choice, ever since the division of labour progressed beyond the exchange of goods through barter. But it is worth making the point that the difference between today’s money of the state and gold is that the state uses the debasement of its currency as a means of wealth transfer from the people to itself and those in its favour. It is an instrument of funding additional to taxation.

With sound money monetary debasement is strictly limited. The quantity of gold required as money in the global economy is only part of above-ground stocks and its quantity and distribution is decided by economic actors, not the state. The obvious source of global supply is mining, which runs at about 2% of above-ground stocks, in line with long-term population growth. The other source of deployment is scrap, recycling gold to and from other uses. This is why prices measured in gold are inherently stable.

As a common form of trusted money, gold also facilitates trade across borders, and when trade is settled in gold or gold substitutes which a government or bank cannot magically create out of thin air, there are no trade imbalances other than temporary shifts in the ratio of gold to goods that align price levels across jurisdictions.

Clearly, the reintroduction of sound money requires a radical change of socio-political and economic culture. Constrained by a sound money regime, the inability of a government to run continual deficits will remove considerable power from the state. Sound money also forces governments to abandon socialising legislation and makes ordinary people more responsible for their own actions.

Since the abandonment of the Bretton Woods agreement, the degree of monetary inflation has been substantial. The rise in the price of gold from the pre-war peg of $35 has to an unknown degree corrected earlier monetary inflation when the dollar was first put on a gold exchange standard, following the Gold Standard Act of 1900. It has continued to reflect monetary inflation thereafter, particularly following the suspension of all convertibility in 1971. The adjustment to date has not compensated for all of the increase in the quantity of fiat dollars in existence, but that matters less than a conversion price which can be maintained for all time, because if it is to succeed the new dollar must be a proper gold substitute.

The setting of the conversion price is the most important decision to be exercised by the issuer of new dollars. But as we have seen, an arm of the government is always ill-equipped to take monetary decisions, so the sensible policy would be to announce the decision to return to gold as the primary form of money and allow the market a period of time to approximately settle the pricing of gold relative to that of the new state currency. At the same time, consolidation terms for exchanging old dollars for the new should be announced, which will stop the old currency sliding into worthlessness, if it hasn’t already, and ensure the new currency is widely distributed at the outset.

During the period between announcing the scheme and its implementation, the central bank or Treasury department (in the case of the US) should cause an independent metal audit of its gold stocks to be conducted, having established an oversight committee drawn from neutral observers to oversee the process.

It is vital to ensure markets trust the existence of gold reserves from the outset. In the case of the US Treasury, with a stated 8,134 tonnes in possession a proper metal audit may take too long. A metal audit has to confirm the existence, identity, weight and purity of every bar and coin held in or allocated to the reserve backing the currency. In any event, there may be more gold in the Treasury’s possession than needed to back the new currency at the outset.

As soon as sufficient progress in the metal audit has been made for the auditor to indicate the degree of discrepancies (if any) then the approximate rate will have been set by markets in the knowledge there is sufficient gold to allow the new currency to circulate as a substitute. The remaining gold stocks (if any) can be held in abeyance.

Once the ratio between the new currency and a weight of gold is fixed, decisions can then be taken over matters such as the form of coinage. A dollar/gold rate would have been defined. For example one gram of gold might be represented by 10 new dollars. A new dollar therefore would be ten centigrams of gold. And every new dollar issued electronically, in paper or coinage form would only exist if it is 100% backed by gold held at the central bank.

All restrictions on gold ownership must cease. In order to ensure the state does not surreptitiously elide from a currency substitute system towards a gold exchange standard, it is vital to have gold circulating alongside its substitutes. This is easily facilitated by issuing high-value gold coins, the basis of the British sovereign, which ties a face value to a weight of fine gold. Depositors withdrawing funds from a bank must have the facility to withdraw them either in gold coin or paper substitutes.

Coins for small amounts would circulate as token money, instead of gold itself. This would permit the monetary authorities to issue practical, hard-wearing alloy coins for circulation, being fully backed by gold. The issuance of these tokens will also replace small-denomination banknotes to downplay the role of bank notes generally, thereby enhancing the role of gold as the true circulating medium. With the elimination of unbacked bank credit (see below) cheques and electronic transfers will also be fully backed by gold and be recognized as gold substitutes...

- Source, James Turk's Goldmoney

Why is Bank Credit so Destructive?

At the outset it should be understood that a cycle of bank credit leads to alternate booms and slumps and much debate has occurred over the years as to how to deal with it. This topic is becoming important again, since there are growing signs that the expansion of bank credit is faltering, a tendency for it to contract will follow and a business recession, or even worse, is now increasingly certain.

For many neo-Keynesians, the issue comes down to unpredictable private sector bank credit behaviour compared with more certain central banking control over base money. Some, such as the supporters of the 1935 Chicago plan, have argued that the way to deal with it is to introduce 100% reserve banking and to hand a monopoly of monetary creation to the central banks, targeting price stability, or simply managing a steady growth rate for money supply.

The Chicago plan was cooked up during the great depression, which was blamed by the inflationists on the gold standard. In the context of the controversy in the nineteenth century between the currency and banking schools the Chicago Plan was something of a hybrid, leaning towards the currency school but without the discipline of gold upon which the currency school based its proposition. Anyway, banking interests ensured the plan lay dead in the water.

It was also naïve, assuming that the relationship between the quantity of money and the general level of prices was simply mathematical, when we should know through empirical evidence and reasoned economic theory that it is not. There is enormous subjectivity in the general level of prices, reflected in relative preferences between the public’s desire for consumption relative to holding money. Furthermore, following the great depression, in debating these issues there was, and still remains, an unquestioned assumption that leaving any form of money at the mercy of free markets is dangerous and that it should be under the control of the state.

Aide-memoire: How bank credit is created

When a bank takes deposits onto its own balance sheet, it acquires possession of them and owes a debt to its depositors. Its balance sheet liabilities consist of the bank’s capital and what is owed to depositors and other creditors. Matching these liabilities are the bank’s total assets. The ratio between the bank’s own capital and its depositor liabilities is easily varied by the bank’s management. Technically, this can be done in one of two ways. Either a loan account with a matching deposit are created for a customer, so that the loan is offset by the deposit. Alternatively, a loan facility is made available, creating deposits as it is drawn down. Any imbalances at an individual bank are made up by deposits drawn from payments by other banks, or by borrowing from other banks through wholesale money markets.

Therefore, a bank can use possession of customer deposits to extend credit of its own creation. By expanding its balance sheet in this way, the gross income arising from the difference between loan charges and interest paid on deposits increases the ratio of earnings to the bank’s capital.

Equally, borrowers and depositors can cause the bank’s balance sheet to contract by the simple expedient of paying down their obligations, reducing their deposits. If a bank is to maintain an expanded balance sheet, it must repetitively find new business. Consequently, there is an inbuilt bias in favour of continual expansion of bank balance sheets and therefore of bank credit. But the expansion of credit distorts the price structure in the economy, lowering the cost of borrowing and discouraging savers from saving by reducing the time preference value of money.

Over time, an economy driven by bank credit expansion will move from being savings-driven, where investment capital for the wider economy is funded out of past profits and earnings retained as savings, to being driven by the creation of debt and matching deposits.

Putting aside the wishful thinking that bank credit can continue to expand on an even course in perpetuity, we should note that once an expansionary course is under way demand for bank credit starts off being less than the banks are prepared to finance. Spurred on by increasing banker confidence and growing bank competition for loan business, rates are then reduced to below where they would otherwise be in a savings-driven economy. This leads to an artificial boom that eventually generates more demand for credit than the banks are willing to provide, or are restricted from doing so by bank regulation.

When the banks call a halt to further credit expansion, borrowers can no longer fund their incomplete plans, and banks will want to protect themselves from the fallout by reducing loans and deposits to protect their own capital. The urgency of this change of course is due to the catastrophic impact on a bank’s own capital of an oversized balance sheet when bank credit expansion slows, stops and threatens to contract.

The consequence is a repetitive cycle of boom and sudden bust. (See here for a video further explaining the phenomenon).

The only way this can be prevented is to disallow the creation of bank credit in the first place, a solution so alien to today’s bankers and inflationist economists alike, that it is readily dismissed. The progression of successive cycles in Britain since the Napoleonic Wars, adopted increasingly by other jurisdictions has, for modern times, led to an end point in bank credit creation, where consumers have little or no savings left and the majority live on tick between salary payments. Having abandoned all forms of sound money in favour of fiat currency inflation, the creation of base money is now being accelerated in a final attempt by central banks to buy off the consequences of not just the current cycle of bank credit inflation, but all those leading up to it.

Nothing goes on for ever, so sooner or later the system that has flourished on the possession of depositors’ bank balances will end. A new system of banking will then be devised, and its success will require a return to sound money, money that cannot be created out of thin air on the whim of a commercial or central banker.

In the wider context of history, the current debate about the role and behaviour of banks has occurred in a moral and legal vacuum, ignoring issues which have been debated since ancient history. And it was the Romans who resolved it in the third century AD, differently from our modern assumptions...

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

Where, Why and How to Hold Gold and Silver For The Coming Collapse