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After two decades, the euro’s minders look set to drive the Eurozone into deep trouble. December was the last month of the ECB’s monthly purchases of government debt. A softening global economy will increase government deficits unexpectedly. The consequence will be a new cycle of sharply rising bond yields for the weakest Eurozone members, and systemically destabilising losses in the bond portfolios owned by Eurozone banks

The blame-game

It’s the twentieth anniversary of the euro’s existence, and far from being celebrated it is being blamed for many, if not all of the Eurozone’s ills.

However, the euro cannot be blamed for the monetary and policy failures of the ECB, national central banks and politicians. It is just a fiat currency, like all the others, only with a different provenance. All fiat currencies owe their function as a medium of exchange from the faith its users have in it. But unlike other currencies in their respective jurisdictions, the euro has become a talisman for monetary and economic failures in the European Union.

Recognise that, and we have a chance of understanding why the Eurozone has its troubles and why there are mounting risks of a new Eurozone systemic crisis. These troubles will not be resolved by replacing the euro with one of its founding components, or, indeed, a whole new fiat-money construct. It is here to stay, because it is not in the users’ interest to ditch it.

As is so often the case, the motivation for blaming the euro for some or all the Eurozone’s troubles is to shift responsibility from the real culprits, which are the institutions that created and manage it. This article briefly summarises the key points in the history of the euro project and notes how the mistakes of the past are being repeated without the safety-net of the ECB’s asset purchases.

…click on the above link to read the rest of the article…

The Eurozone Is in a Danger Zone

January 7, 2019

The Eurozone Is in a Danger Zone

It is easy to conclude the EU, and the Eurozone in particular, is a financial and systemic time-bomb waiting to happen. Most commentary has focused on problems that are routinely patched over, such as Greece, Italy, or the impending rescue of Deutsche Bank. This is a mistake. The European Central Bank and the EU machine are adept in dealing with issues of this sort, mostly by brazening them out, while buying everything off. As Mario Draghi famously said, “whatever it takes.”

There is a precondition for this legerdemain to work. Money must continue to flow into the financial system faster than the demand for it expands, because the maintenance of asset values is the key. And the ECB has done just that, with negative deposit rates and its €2.5 trillion asset purchase program. But that program ends this month, making it the likely turning point, whereby it all starts to go wrong.

Most of the ECB’s money has been spent on government bonds for a secondary reason, and that is to ensure Eurozone governments remain in the euro system. Profligate politicians in the Mediterranean nations are soon disabused of their desires to return to their old currencies. Just imagine the interest rates the Italians would have to pay in lira on their €2.85 trillion of government debt, given a private sector GDP tax base of only €840 billion, just one third of that government debt.

It never takes newly-elected Italian politicians long to understand why they must remain in the euro system, and that the ECB will guarantee to keep interest rates significantly lower than they would otherwise be. Yet the ECB is now giving up its asset purchases, so won’t be buying Italian debt or any other for that matter. The rigging of the Eurozone’s sovereign debt market is at a turning point.

…click on the above link to read the rest of the article…

The Arrival Of The Credit Crisis

December 29, 2018

The Arrival Of The Credit Crisis

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

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

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

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

After a brief pause, induced mainly by the threat of an unstoppable collapse in equity prices, the Fed will be forced to continue to raise interest rates to counter price inflation pressures, which will take the rise in the heavily suppressed CPI towards and then through 4%, probably by mid-year.

…click on the above link to read the rest of the article…

Gold – A Perfect Storm For 2019

December 13, 2018

Gold – A Perfect Storm For 2019

This article is an overview of the principal factors likely to drive the gold price in 2019. It looks at the global factors that have developed in 2018 for both gold and the dollar, how geopolitics are likely to evolve, the economic outlook and how it is worsened for the dollar by President Trump’s tariff war against China, the availability and likely demand for bullion, and the technical position in paper markets. Taken together, the outlook is bullish for gold.

2018 reprise

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

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

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

…click on the above link to read the rest of the article…

G20 and the financial war

December 1, 2018

G20 and the financial war

This weekend, the G20 nations meet at Buenos Aires. The most important issue will be America’s use of trade policy, ostensibly to bring an end to China’s unfair trade practices. Rather, it could mark a significant milestone in the cold war against China and drive the global economy into a slump.

Introduction

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

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

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

The trade tariff position

…click on the above link to read the rest of the article…

Does China Have Enough Gold to Move Toward Hard Currency?

November 20, 2018

Does China Have Enough Gold to Move Toward Hard Currency?

Are the Chinese Keynesian?

We can be reasonably certain that Chinese government officials approaching middle age have been heavily westernised through their education. Nowhere is this likely to matter more than in the fields of finance and economics. In these disciplines there is perhaps a division between them and the old guard, exemplified and fronted by President Xi. The grey-beards who guide the National Peoples Congress are aging, and the brightest and best of their successors understand economic analysis differently, having been tutored in Western universities.

It has not yet been a noticeable problem in the current, relatively stable economic and financial environment. Quiet evolution is rarely disruptive of the status quo, and so long as it reflects the changes in society generally, the machinery of government will chug on. But when (it is never “if”) the next global credit crisis develops, China’s ability to handle it could be badly compromised.

This article thinks through the next credit crisis from China’s point of view. Given early signals from the state of the credit cycle in America and from growing instability in global financial markets, the timing could be suddenly relevant. China must embrace sound money as her escape route from a disintegrating global fiat-money system, but to do so she will have to discard the neo-Keynesian economics of the West, which she has adopted as the mainspring of her own economic advancement.

With Western-educated economists imbedded in China’s administration, has China retained the collective nous to understand the flaws, limitations and dangers of the West’s fiat money system? Can she build on the benefits of the sound-money approach which led her to accumulate gold, and to encourage her citizens to do so as well?

…click on the above link to read the rest of the article…

The biggest of big pictures

October 27, 2018

The biggest of big pictures

I have had a request from Mrs Macleod to write down in simple terms what on earth is going on in the world, and why is it that I think gold is so important in this context. She-who-must-be-obeyed does not fully share my interest in the subject. An explanation of the big picture is also likely to be useful to many of my readers and their spouses, who do not share an enduring interest in geopolitics either.

That is the purpose of this article. It can be bewildering when a casual observer tries to follow global events, something made more difficult by editorial policies at news outlets, and the commentary from most analysts, who are, frankly, ill-informed. Accordingly, this article addresses the topic that dominates our future. The most important players in the great game of geopolitics are America and China. But before launching into an update, I shall lay down the disciplines required for an informed analysis.

Do try to look at issues from all sides in order to understand both strategic considerations and prospective outcomes. Understand that characteristics which may apply to one side do not necessarily apply to the other. For example, financial analysis that applies to the US economy does not necessarily apply to China’s. Do try to remain neutral and objective, analytical and unbiased. Remember the old stockbroker’s adage: where there’s a tip, there’s a tap, meaning that the dissemination of information is usually designed to promote vested interests.

The list of don’ts is somewhat longer. Don’t believe what governments say, because they will tell you what they want you to believe. Don’t believe anything coming out of intelligence services: if the information is good it is highly unlikely to come your way, and if good information does come your way, it will be indistinguishable from conspiracy theories.

…click on the above link to read the rest of the article…

How Gibson’s paradox has been buried

October 20, 2018

How Gibson’s paradox has been buried

Until the 1970s, all recorded history showed that bond yields were tied to the general price level, not the rate of price inflation as commonly believed. However, since then, the statistics say this is no longer the case, and bond yields are increasingly influenced by the rate of price inflation. This article explains why this has happened, and why it is important today.

This paper is a follow-up on my white paper of October 2015.^[i] In that paper I explained why, based on over two-hundred years of statistics, long-term interest rates correlated with the general price level, and not with the rate of inflation. I now take the analysis further, explaining why the paradox appears to no longer apply.

The two charts which illustrate the pre-seventies position are Chart 1 and Chart 2 reproduced below.

The charts take the yield on the UK Government’s undated Consolidated Loan Stock (Consols) as proxy for the long-term interest rate, and the price index and its rate of change (the rate of price inflation) as recorded in the UK. The reasons for using UK statistics are that Consols and the loan stocks that were originally consolidated into it are the longest running price series on any form of term debt, and during these years Britain emerged to be the world’s leading commercial nation. Furthermore, for the bulk of the period covered by Gibson’s paradox, London was the world’s financial centre, and sterling the reserve basis for the majority of non-independent foreign currencies.

The evidence from the charts is clear. Gibson’s paradox showed that the general price level correlated with long-term interest rates, which equate to the borrowing costs faced by entrepreneurial businessmen.

…click on the above link to read the rest of the article…

The Credit Cycle is on the Turn

October 16, 2018

THE CREDIT CYCLE IS ON THE TURN

We are on the verge of moving into an era of high interest rates, so markets will behave differently from any time since the early-1980s. There are enough similarities with the post-Bretton Woods era of the 1970s to give us some guidance as to how markets are likely to evolve in the foreseeable future.

The chart above says much. Last week, the yield on the 10-year US Treasury bond broke new high ground for this credit cycle. The evolution of key moving averages in bullish sequence (for higher yields, but sharply lower bond prices) is a model example out of the chartist’s textbook. The underlying momentum looks so powerful that a quick rise to 3.5% and beyond appears to be a racing certainty. The credit cycle, transiting from a period of cheap finance into higher borrowing costs is clearly on the turn.

In the fiat-money world, everything takes its valuation cue from US Treasury bonds. For equities it is theoretically the long bond, which is also racing towards higher yields. Having ignored rising yields for the long bond so far, the S&P500 only recently hit new highs. It has been a fantasy-land for equities from which a rude awakening appears increasingly certain. It is likely that the current downturn in equity prices is the start of a new downtrend in all financial assets that have been badly caught on the hop by the ending of cheap credit.

At some stage, and this is why the bond-yield break-out is important, we will face a disruption in valuations that undermines the relationship between assets and debt. This has been a periodic event, with central banks taking whatever action was needed to rescue the commercial banks. When the crisis happens, they reduce interest rates to support asset valuations, propping up government bond markets and ultimately equities.

…click on the above link to read the rest of the article…

We Should Ditch GDP as a Measure of Economic Activity

October 9, 2018

WE SHOULD DITCH GDP AS A MEASURE OF ECONOMIC ACTIVITY

This article exposes the false economic concepts behind GDP, which is only the visible tip of a large iceberg of economic deceit. Describing an increase in GDP as economic growth owes its meagre validity to imprecise definition. An economy does not grow, only the quantity of fiat currency deployed grows. A successful economy progresses our condition, our wealth, our standards of living. The evolution of misleading statistics such as GDP to their current condition is only governed by their usefulness to governments, not as an objective development of sound theory by seekers of truth.

There are perhaps two plausible reasons for producing the GDP statistic, other than employing statisticians, and both have nothing to do with economics. By compiling the figures, a government keeps track of its tax base, and it can enter into the game of my-country-is-bigger-than-yours.

In international comparisons of economic performance, gross domestic product adjusted for price inflation is the most common metric used. Countries are ranked by size, and success is measured by the rate of growth in GDP. This is important to the political class.

About two years ago, I was told that the Indonesian central bank had a plan to do away with cash entirely, because it would bring unrecorded transactions into Indonesia’s GDP, promoting it from sixteenth to perhaps the thirteenth largest nation measured by GDP. I have no idea if this was true, but allegedly, this was important to the Indonesian government.

We should not be surprised if going cashless is partly motivated to give the illusion of GDP growth, in the same way that in 2014 the EU decided to add in estimated contributions from prostitution and drug dealing. These are examples of why and how GDP is manipulated to produce a goal-sought answer.

…click on the above link to read the rest of the article…

John Law and the Mississippi Bubble – 300 Years Later

September 9, 2018

John Law and the Mississippi Bubble – 300 Years Later

Most people are aware that historically there have been speculative bubbles. Some of them can even name a few – the South Sea bubble, tulips, and more recently dot-coms. Some historians can go even further, quoting the famous account by Charles Mackay of the South Sea bubble, the tulip mania and the Mississippi bubble, published in the mid-nineteenth century.

The most valuable bubble empirically for the purpose of our elucidation has to be the Mississippi bubble, whose central figure was John Law. Law, a Scotsman whose father’s profession was as a goldsmith and banker in Edinburgh, set up an inflation scheme in 1716 to rescue France’s finances. He proposed to the Regent for the infant Louis XIV a scheme that would be based on a new paper currency.

Law was a somewhat louche character, who in his Continental travels had spent his mornings studying finance and the principles of trade, and the evenings in the gaming-houses of Europe. He was a successful gambler, because of his ability to calculate odds.

Some similarities with the personality of Keynes two hundred years later are striking. Keynes was a mathematician first, and an economist second. Their approach was also similar: see a problem and try to find a solution, instead of seeing a problem and trying to understand why it existed before solving it. Both Law and Keynes felt that sound money was too restrictive for the enhancement of an economy.

Consequently, much of what Law proposed and then enacted in France rhymes with our neo-Keynesian world today. The difference, perhaps, is that when given the opportunity, Law seized it, and had ultimate financial and monetary power. He harnessed the roles of a central bank, monopolist in international trade, stock promoter and finance minister.

…click on the above link to read the rest of the article…

Apocalypse, Or Not?

September 7, 2018

Apocalypse, Or Not?

Members of the American libertarian movement, particularly extremist preppers, are often associated with a belief that a complete breakdown in society is the only outcome from government economic policies and will lead to complete social disintegration. At the centre of their concerns is monetary destruction, with other issues, such as the erosion of personal freedom and the right to bear arms, important but peripheral. They cite history, particularly the hyperinflationary collapses, from Rome to Zimbabwe, and now Venezuela. They draw on Austrian economic theory, which fans their dislike of government and their expectation of total chaos.

Properly reasoned economic theory certainly reduces the science to one of black and white conclusions, which suits conclusion-jumpers. But the whole point of it is to explain society’s errors, so that they may be corrected. It is only by understanding the errors of state intervention and socialism, both communistic and fascist, that solutions can be found. Solutions then need to be applied, not taken into a mountain or forest retreat never to be implemented.

The real world does not work on black and white economic theories. It progresses along a muddled course, torn between statist mistakes and society’s unending patience with government intervention. Governments are the source of all wars and wealth destruction, but societies tolerate them. Philosophers have argued over this from Plato versus Aristotle onwards, and we are still here, two and a half millennia later, chewing over the same bones.

History records our philosophical chewing, and Man’s continuing conflict with and tolerances of the state. It records the rise and fall of kings, emperors, dictators and governments. Hermits and other preppers come and go, either unrecorded or, like Saint Simeon Stylites, noted as little more than historical footnotes. To future generations, prepping will almost certainly be a bygone curiosity, and humanity will continue despite government suppression.

…click on the above link to read the rest of the article…

Turkey’s Crisis and the Dollar’s Future

August 26, 2018

Turkey’s Crisis and the Dollar’s Future

Last week’s collapse of the Turkish lira has dominated the headlines, and it is widely reported that this and other emerging market currencies are in trouble because of the withdrawal of dollar liquidity. There are huge quantities of footloose dollars betting against these weak currencies, as well as commodities and gold, on the basis the long-expected squeeze on dollar liquidity is finally upon us.

Doubtless Triffin’s dilemma is dominating these speculators’ thoughts, telling them demand for the dollar as the reserve currency is infinite. This article points out that foreign financial entities as a whole already possess most of the excess liquidity created by monetary expansion of the dollar since the Lehman crisis. Admittedly, ownership of dollars is unlikely to be evenly distributed across correspondent banks representing all foreign nations. But this is no reason to say dollars are not under-owned by foreign users, and we must not forget dollars are also available in the foreign exchanges, as always, for credible buyers. Nor must we forget that the reason for the enormous quantity of currency derivatives ($75 trillion in US dollars alone1) is that future demand for dollars is already significantly hedged.

No, the reason certain EM currencies are losing purchasing power is the fault of individual governments and their central banks, who do not seem to realize that their unbacked fiat currencies are valued purely on trust, both that of their own people and on the foreign exchanges. And as we should know, trust is not something to be toyed with.

Furthermore, comments that China is in trouble from trade tariffs and being undermined by a strong dollar are wide of the mark. Geopolitics dominates here. America’s occasional successes in attacking the rouble and yuan are no more that transient pyrrhic victories.

…click on the above link to read the rest of the article…

Macroeconomics Has Lost Its Way

August 9, 2018

MACROECONOMICS HAS LOST ITS WAY

The father of modern macroeconomics was Keynes. Before Keynes there were macro considerations, which were firmly grounded in human action, the personal preferences and choices exercised by individuals in the context of their own earnings and profits. In order to give a role to the state, Keynes had to get away from human action and devise a positive management role for central planners. This was the unstated purpose behind his General Theory of Employment, Interest and Money.

To this day, his followers argue that macroeconomics is different from individual actions, and the factors that determine the behaviour of individuals are not the same as those that determine the wider economy. This article explains why it cannot be true, why modern macroeconomic beliefs are fundamentally flawed, and why interventionism has not only failed to produce overall benefits for the wider public, but has been at an unnecessary economic cost.

The basic fallacy

Last week, Martin Wolf (the FT’s chief associate editor and chief economic commentator) presented a programme entitled Economics 101 on BBC Radio 4, in which he raised the question as to whether a democracy can function when voters have little idea of how the economy works and why there has been so little effort to teach economics in schools.^[i] The independent economists interviewed, Larry Summers and Joseph Stiglitz, and Wolf himself are strongly pro-Keynesian, and the programme made no mention of the fact that there are different schools of economic thought. The question as to what information should be given to the public and crammed into the minds of schoolchildren was never addressed, and it was clearly to be the Keynesian view.

…click on the above link to read the rest of the article…

Macroeconomics Has Lost Its Way

August 4, 2018

Macroeconomics Has Lost Its Way

The basic fallacy

…click on the above link to read the rest of the article…

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