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The Eurozone’s financial disintegration

The Eurozone’s financial disintegration

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Introduction

The Euro Crisis Monitor (above) shows the increasing imbalances in the TARGET2 settlement system between all its members: the ECB (itself with a €145bn deficit) and the national central banks in the Eurozone. Other than minor differences reflecting net cross-border trade not matched by investment flows going the other way, these imbalances should not exist. But following the Lehman crisis and as the Eurozone developed its own series of crises, imbalances arose. Commentators have grown used to them, so have more or less given up pointing them out. But in the last few months, the apparent flight into the Bundesbank (€995,083m surplus) has gathered pace, as have the deficits for Italy (€536,722m) and Spain (€451,798m). It is time to take these rising imbalances seriously again.

Target2 — the ECB’s flexible friend

Target2 is the settlement system for transfers between the national central banks. The way it works, in theory, is as follows. A German manufacturer sells goods to an Italian business. The Italian business pays by bank transfer drawn on its Italian bank via the Italian central bank through the Target2 system, crediting the German manufacturer’s German bank through Germany’s central bank.

But since the Lehman crisis, and more noticeably the last eurozone crisis, capital flows appear to have gravitated from Portugal, Italy, Greece and Spain (the PIGS — remember them?) to principally Germany, Luxembourg, Netherlands and Finland in that order. Before 2008, the balance was maintained by trade deficits in Greece, for example, being offset by capital inflows as residents elsewhere in the eurozone bought Greek bonds, other investments in Greece and the tourist trade collected net cash revenues.

In this sense, it would be wrong to suggest that trade imbalances have led to Target2 imbalances. But part of the problem must be put down to the failure of private sector investment flows to recycle.

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Explaining the Credit Cycle

EXPLAINING THE CREDIT CYCLE

This article summarises why the credit cycle leads to alternate booms and slumps. It is only with this in mind that they can be properly understood as current economic conditions evolve.

The reader is taken through three monetary models: a fixed money economy, one governed by changes in bank credit, and finally the consequences of central bank intervention.

Classical economics provided the basis for an understanding of the effects of bank credit expansion. The theory, embodied in the division of labour, eluded Keynes, who was determined to justify an interventionist role in the economy for the state.

 Neo-Keynesian policies have been responsible for growing monetary intervention. This article serves as a reminder of the distortions introduced by the credit cycle and why central bank monetary policies are fundamentally destructive of the settled economic order that exists without monetary expansion.

Defining the problem

The credit cycle drives the business, or trade cycle. It should be obvious that changes in the quantity of money, mostly in the form of bank credit, has an effect on business conditions. Indeed, that is why central banks implement a monetary policy. By increasing the quantity of money in circulation and by encouraging the banks to lend, a central bank aims to achieve full employment. Other than quantitative easing, the principal policy tool is management of interest rates on the assumption that they represent the “price” of money.

But there is also a cyclical effect of boom and bust, linked to changes in the availability of bank credit, and so modern central banks have tried to foster the boom and avoid the slump.

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

Explaining the credit cycle

Explaining the credit cycle

This article summarises why the credit cycle leads to alternate booms and slumps. It is only with this in mind that they can be properly understood as current economic conditions evolve.

The reader is taken through three monetary models: a fixed money economy, one governed by changes in bank credit, and finally the consequences of central bank intervention.

Classical economics provided the basis for an understanding of the effects of bank credit expansion. The theory, embodied in the division of labour, eluded Keynes, who was determined to justify an interventionist role in the economy for the state.

 Neo-Keynesian policies have been responsible for growing monetary intervention. This article serves as a reminder of the distortions introduced by the credit cycle and why central bank monetary policies are fundamentally destructive of the settled economic order that exists without monetary expansion.

Defining the problem

The credit cycle drives the business, or trade cycle. It should be obvious that changes in the quantity of money, mostly in the form of bank credit, has an effect on business conditions. Indeed, that is why central banks implement a monetary policy. By increasing the quantity of money in circulation and by encouraging the banks to lend, a central bank aims to achieve full employment. Other than quantitative easing, the principal policy tool is management of interest rates on the assumption that they represent the “price” of money.

But there is also a cyclical effect of boom and bust, linked to changes in the availability of bank credit, and so modern central banks have tried to foster the boom and avoid the slump.

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

The new deal is a bad old deal

The new deal is a bad old deal

So far, the current economic situation, together with the response by major governments, compares with the run-in to the depression of the 1930s. Yet to come in the repetitious credit cycle is the collapse in financial asset values and a banking crisis.

When the scale of the banking crisis is known the scale of monetary inflation involved will become more obvious. But in the politics of it, Trump is being set up as the equivalent of Herbert Hoover, and presumably Joe Biden, if he is well advised, will soon campaign as a latter-day Roosevelt. In Britain, Boris Johnson has already called for a modern “new deal”, and in his “Hundred Days” his Chancellor is delivering it.

In the thirties, prices fell, only offset by the dollar’s devaluation in January 1934. This time, monetary inflation knows no limit. The wealth destruction through monetary inflation will be an added burden to contend with compared with the situation ninety years ago.

Introduction

Boris Johnson recently compared his reconstruction plan with Franklin D Roosevelt’s New Deal. Such is the myth of FDR and his new deal that even libertarian Boris now invokes them. Unless he is just being political, he shows he knows little about the economic situation that led to the depression.

It would not be unusual, even for a libertarian politician. FDR is immensely popular with the inflationists who overwhelmingly wrote the economic history of the depression era. In fact, FDR was not the first “something must be done” American president, a policy which started with his predecessor, Herbert Hoover. But the story told is that FDR took over from heartless Hoover who had failed to step in and rescue the economy from a free-market catastrophe, by standing back and letting events take their course instead.

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

The path to monetary collapse

The path to monetary collapse

Few mainstream commentators understand the seriousness of the economic and monetary situation. from a V-shaped rapid return to normality towards a more prolonged recovery phase.

The fact that a liquidity crisis developed in US money markets five months before the virus hit America has been forgotten. Only a rising gold price stands testament to a deeper crisis, comprised of contracting bank credit while central banks are trying to rescue the economy, fund government deficits and keep the market bubble inflated.

The next problem is a crisis in the banks, wholly unexpected by investors and depositors. At a time when lending risk is soaring off the charts, their financial condition is more fragile than before the Lehman crisis. Failures in European G-SIBs in the next month or two are almost impossible to avoid, leading to a full-blown monetary and credit crisis which promises to undermine asset values, government financing and fiat currencies themselves.

We can now discern the path leading to the destruction of fiat currencies and take reasonably guesses as to timing.

How central banks view the current situation.

The financial world is bemused: what is it to make of the economic effects of the coronavirus? The official answer, it seems, is on the lines of don’t panic. The earliest fears of millions of deaths have subsided and in the light of experience, a more rational approach of easing lockdown rules is now being implemented in a number of badly hit jurisdictions. Whether this evolving policy is right will be proved in due course. But the motivation is moving from saving lives to restricting the economic damage.

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

Time to learn about money

Time to learn about money

An unexpected destruction of fiat currency has been advanced by the monetary and fiscal response to the coronavirus. Financial markets have yet to discount the possibility of such an outcome, but in the coming months they are likely to awaken to this danger.

The question arises as to what will replace fiat currencies. In the past the answer has always been gold but today there are cryptocurrencies as well, whose enthusiasts are more aware than most of fiat money’s failings.

This article describes the basics about money, what it is and the role it plays in order to understand what will be required by the eventual replacement for fiat. It concludes that gold will return as the world’s medium of exchange, and secure cryptocurrencies, unable to provide the scalability and stability of value required of a medium of exchange will be priced in gold after the demise of fiat. But then the rationale for them will be gone, and with it their function as a store of value.

The destruction of fiat money

These are strange times. Circumstances are forcing governments to destroy their money by debasing it to pay for their obligations, real and imagined. If central bankers had a grasp of what money really is, they wouldn’t have got into a position where they are forced to use their seigniorage to destroy it. They are so ignorant about catallactics, the fundamentals behind economics, that they cannot see they are destroying the means of exchange they have imposed upon their citizens with far worse consequences than the abandonment of the evils they are trying to defray.[i]

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Anatomy of a fiat currency collapse

Anatomy of a fiat currency collapse

This article asserts that infinite money-printing is set to destroy fiat currencies far quicker than might be generally thought. This final act of monetary destruction follows a 98% loss of purchasing power for dollars since the London gold pool failed. And now the Fed and other major central banks are committing to an accelerated, infinite monetary debasement to underwrite their entire private sectors and their governments’ spending, to prop up bond markets and therefore all financial asset prices.

It repeats the mistakes of John Law in France three hundred years ago almost to the letter, but this time on a global scale. History, economic theory and even common sense tell us governments and their central banks will rapidly destroy their currencies. So that we can see how to protect ourselves from this monetary madness, we dig into history for guidance to see who benefited from the Austrian and German hyperinflations of 1922-23, and how fortunes were made and lost.

Introduction

The way inflation is commonly presented by modern economists, as a rise in the general level of prices, is incorrect. The classical, pre-Keynesian definition is that inflation is an increase in the quantity of money which can be expected to be reflected in higher prices. For consistency and to understand the theory of money and credit we must adhere strictly to the proper definition. The effect on prices is one of a number of consequences, and is not inflation.

The effect of an increase in the quantity of money and credit in circulation on prices is dependent on the aggregate human response. In a nation of savers, an increase in the money quantity is likely to add to savers’ bank balances instead of it all being spent, in which case the route to circulation favours lending for the purpose of industrial investment.

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

The destructive force of bank credit

The destructive force of bank credit 

Commentators routinely confuse the deflationary effects of a contraction of bank credit with the inflationary effects of central bank policies designed to offset it. Central banks always ensure their stimulus is greater, so inflation, not deflation, is always the outcome.

In order to understand bank credit, we must enter the mind of a banker and understand how it is created, why it is expanded and why expansion is always followed by a sharp contraction. 

But we have now moved on from a simplistic credit cycle model, given the global economy was already facing a tendency for bank credit to contract before the coronavirus drove supply chains into the greatest global payment crisis in history. The problem is now so large that to maintain both economic stability and price levels for financial assets the central banks, led by the Fed, will have to issue so much base currency that fiat currencies will become almost worthless.

In these conditions the banks that survive the next several months will then begin to expand bank credit anew to buy up physical assets instead of their normal financial fare, sealing the fate of fiat currencies with a final expansion of bank credit as the banks themselves dump worthless currencies for real assets.  

Introduction

Never has it been more important to understand the psychology and motivation behind changes in the level of bank credit at a time when governments and central banks are relying on commercial banks to transmit Keynesian stimuli to distressed borrowers. And never has it been more important for analysts to differentiate between deflationary forces that come entirely from the contraction of bank credit and inflationary forces that arise from central banks’ monetary policy.

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

The looming derivative crisis

The looming derivative crisis 

The powerful forces of bank credit contraction are at the heart of a rapidly evolving financial crisis in global derivatives, whose gross value is over $600 trillion; an unimaginable sum. Central banks are on course to destroy their currencies through unlimited monetary expansion, lethal for bullion banks with fractionally reserved unallocated gold accounts, while being dramatically short of Comex futures.

This article explains the dynamics behind the current crisis in precious metal derivatives, and why it is the observable part of a wider derivative catastrophe that is caught in the tension between contracting bank credit and infinite monetary inflation.

Introduction

One of the scares at the time of the Lehman crisis was that insolvent counterparties risked collapsing the whole over-the-counter derivative complex. It was for this reason that AIG, a non-bank originator of many derivative contracts, had to be bailed out by the Fed. By a mixture of good judgement and fortune a derivative crisis was averted, and by consolidating some of the outstanding positions, the gross value of OTC derivatives was subsequently reduced.

According to the Bank for International Settlements, in mid-June last year all global OTC contracts outstanding were still unimaginably large at $640 trillion, a massive sum in anyone’s book. It is unlikely to have changed much by today. But in bank balance sheets only a net figure is usually shown, and you have to search the notes to financial statements to find evidence of gross exposure. It is the gross that matters, because each contract bears counterparty risk, sometimes involving several parties, and derivative payment failures could make the payment failures now evident in disrupted industrial supply chains look like small beer.

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

A primer for gold newbies

A primer for gold newbies 

The purpose of this article is purely educational. Increasingly, the wider public is turning to gold in a spontaneous reaction to financial and economic problems that have become suddenly apparent, hastened by the spread of the coronavirus. For everyone now thinking of buying gold it is a leap into the unknown, so they should know why.

It is not just the financially inexperienced, but investment managers and financial advisors are equally unaware of what is happening to money and capital markets. We are in the early stages of a radical debasement of state-issued currencies which is on course to collapse the entire financial system.

I explain the two phases of this destruction of fiat money, the one experienced so far and the one we are about to suffer. I explain why sound money has always been physical gold and silver, returned to by the people after government and banks have collectively destroyed state-originated unsound money.

Introduction

Suddenly, there is increasing public interest in gold. The financially aware will be scratching their heads over what’s going on in financial markets in the broadest sense and might have heard some unintelligible chatter about what is going on in gold. They are asking, why does gold matter? Isn’t gold just an old-fashioned hedge against risk and the true safe haven investment today is US Treasuries? Then there’s the mass of financially unknowledgeable investors who are used to leaving investment matters to their financial advisers, and until recently have viewed the rise in the gold price as an opportunity to sell unwanted jewellery for scrap.

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

Why a bear market will lead to a dollar collapse

Why a bear market will lead to a dollar collapse 

Falling equity markets this week are likely to signal the onset of a bear market, responding to a combination of the coronavirus spreading beyond China and persistent indications of a developing recession.

This has provoked a flight into US Treasuries, with the ten-year yield falling to an all-time low of 1.31%. This will prove to be a mistake, given US price inflation which on independent estimates is running close to ten per cent, exposing US Treasuries as badly overpriced.

After this short-term response, much higher US Treasury yields are inevitable. Foreigners, who possess more dollars and dollar investments than the entire US GDP will almost certainly sell, driving bond yields up and the dollar down, leaving the Fed the only real buyer of US Treasuries.

This article goes through the sequence of events likely to destroy value in US financial assets and the dollar as well. And what goes for the US goes for all other fiat-currencies and their financial markets.

Introduction

In my last article I pointed out that 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.

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Coronavirus and credit – a perfect storm

Coronavirus and credit – a perfect storm 

This article posits that the spread of the coronavirus coincides with the downturn in the global credit cycle, with potentially catastrophic results. At the time of writing, analysts are still trying to get to grips with the virus’s economic impact and they commonly express the hope that after a month or two everything will return to normal. This seems too optimistic.

The credit crisis was already likely to be severe, given the combination of the end of a prolonged expansionary phase of the credit cycle and trade protectionism. These were the conditions that led to the Wall Street crash of 1929-32. Given similar credit cycle and trade dynamics today, the question to be resolved is how an overvaluation of bonds and equities coupled with escalating monetary inflation will play out.

This article sees worrying parallels with the collapse of John Law’s Mississippi scheme exactly 300 years ago. By tying in the purchasing power of his livres to the value of his Mississippi venture, Law ensured they both collapsed together in the space of only six months.

The similarities with our Keynesian experiment are too great to ignore. Could a simultaneous collapse of fiat currencies and financial assets happen again? If so both the money bubble and financial asset bubble could be fully deflated into worthlessness by this year’s end.

The epidemic

“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.

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The Cannibalization Of The Financial System Will Force Investors Into Silver

The Cannibalization Of The Financial System Will Force Investors Into Silver

Day in and day out, the global financial system continues to cannibalize itself.  Clear evidence of this points to the massive “Artificial” liquidity and asset purchase policy instituted by the Federal Reserve.  While financial analysts provided several theories why the Fed was forced to inject liquidity via the Repo Market and also purchase $60 billion a month in U.S. Treasuries, the real reason has to do with the falling quality of oil and its impact on the value of assets and collateral.

It’s really that simple.  However, there is no mention of it (energy) by any of the leading financial or precious metals analysts.  For example, in Alasdair Macleod’s recent Goldmoney.com article titled, How To Return To Sound Money, he states the following:

This article provides a template for an enduring sound money solution that will deliver economic progress while eliminating destructive credit cycles. It posits that a properly constructed gold and gold substitute monetary system, which also includes the removal of bank credit inflation as a means of providing investment capital, is the only way that lasting stability and prosperity can be achieved.

Alasdair Macleod, who I have a great deal of respect, doesn’t mention “Energy” once in his entire article suggesting that returning to sound money, through gold, is the only way for lasting stability and prosperity can be achieved. The majority of economic prosperity has come from the burning of oil, natural gas, and coal, not from gold or silver. The precious metals act as money, a store of value, or economic energy, but are not the ENERGY SOURCES themselves.  While this is self-evident, it is very important to understand.

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

Gold’s outlook for 2020

Gold’s outlook for 2020 

This article is an overview of the economic conditions that will drive the gold price in 2020 and beyond. The turn of the credit cycle, the effect on government deficits and how they are to be financed are addressed.

In the absence of foreign demand for new US Treasuries and of a rise in the savings rate the US budget deficit can only be financed by monetary inflation. This is bound to lead to higher bond yields as the dollar’s falling purchasing power accelerates due to the sheer quantity of new dollars entering circulation. The relationship between rising bond yields and the gold price is also discussed.

It may turn out that the recent extraordinary events on Comex, with the expansion of open interest failing to suppress the gold price, are an early recognition in some quarters of the US Government’s debt trap. 

The strains leading to a crisis for fiat currencies are emerging into plain sight.

rum 1

Introduction

In 2019, priced in dollars gold rose 18.3% and silver by 15.1%. Or rather, and this is the more relevant way of putting it, priced in gold the dollar fell 15.5% and in silver 13%. This is because the story of 2019, as it will be in 2020, was of the re-emergence of fiat currency debasement. Particularly in the last quarter, the Fed began aggressively injecting new money into a surprisingly illiquid banking system through repurchase agreements, whereby banks’ reserves at the Fed are credited with cash loaned in return for T-bills and coupon-bearing Treasuries as collateral. Furthermore, the ECB restarted quantitative easing in November, and the Bank of Japan stands ready to ease policy further “if the momentum towards its 2% inflation target comes under threat” (Kuroda – 26 December). 

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

A History of Inflationary Money: From 1844 to Nixon

A History of Inflationary Money: From 1844 to Nixon

So that we can understand the financial and banking challenges ahead of us, this article provides an historical and technical background. But we must first get an important definition right, and that is the cause of the periodic cycle of boom and bust. The cycle of economic activity is not a trade or business cycle, but a credit cycle. It is caused by fractional reserve banking and by banks loaning money into existence. The effect on business is then observed but is not the underlying cause.

Modern banking has its roots in England’s Bank Charter Act of 1844, which led to the practice of loaning money into existence, commonly described as fractional reserve banking. Fractional reserve banking is defined as making loans and taking in customer deposits in quantities that are multiples of the bank’s own capital. Case law in the wake of the 1844 act, having more regard for the status quo as established precedent than for the fundamentals of property law, ruled that irregular deposits (deposits for safekeeping) were no different from a loan. Judge Lord Cottenham’s ruling in Foley v. Hill (1848) 2 HLC 28 is a judicial decision relating to the fundamental nature of a bank which held in effect that

The money placed in the custody of the banker is to all intents and purposes, the money of the banker, to do with it as he pleases. He is guilty of no breach of trust in employing it. He is not answerable to the principal if he puts it into jeopardy, if he engages in haphazardous speculation.

This was undoubtedly the most important ruling of the last two centuries on money. Today, we know of nothing else other than legally confirmed fractional reserve banking. However, sound or honest banking, with banks acting as custodians, had existed in the centuries before the 1844 act and any corruption of the custody status was regarded as fraudulent.

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Olduvai IV: Courage
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Olduvai II: Exodus
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