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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.

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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.

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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.

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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.

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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.

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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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Fiat’s failings, gold and blockchains

Fiat’s failings, gold and blockchains 

The world stands on the edge of a cyclical downturn, exacerbated by trade tariffs initiated by America. We know what will happen: the major central banks will attempt to inflate their way out of the consequences. And those of us with an elementary grasp of economics should know why the policy will fail.

In addition to the monetary and debt inflation since the Lehman crisis, it is highly likely the major international currencies will suffer a catastrophic loss of purchasing power from a new round of monetary expansion, calling for a replacement of today’s fiat currency system with something more stable. The ultimate solution, unlikely to be adopted, is to reinstate gold as circulating money, and how gold works as money is outlined in this article.

Instead, central banks will struggle for fiat-based solutions, which are bound to face a similar fate with or without the blockchain technology being actively considered. The Asian and BRICS blocs have an opportunity to do something with gold. But will they take it?

Introduction

Central banks around the world are praying that there won’t be a recession, and if there is that a further monetary stimulus will ensure economic recovery. Their problem is Keynesian theory says it will work, but last time it didn’t. In fact, it has never worked beyond a temporary basis. The big surprise this time was the lack of officially recorded price inflation. But this is due to the system gaming the numbers, making it appear there has been some moderate growth when a proper deflator would confirm most Western economies have been contracting in real terms for the last ten years. 

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America’s trade policy will end up destroying the dollar

America’s trade policy will end up destroying the dollar 

America’s tariffs against China are already showing signs of undermining the global economy and will create a funding crisis for the Federal Government when it leads to foreigners no longer buying US Treasury debt and selling down their existing dollar holdings. A subversive attempt by America to divert global portfolio investment from China by destabilising Hong Kong will force China into a Plan B to fund its infrastructure plans, which could involve actively selling down her dollar reserves and hastening the introduction of a new crypto-based trade settlement currency.

The US budget deficit will then be financed entirely by monetary inflation. Furthermore, the turn of the credit cycle, made more destructive by trade tariffs, is driving the global and US economy into a slump, further accelerating all indebted governments’ dependency on inflationary financing. The end result is America’s trade policies have been instrumental in hastening the end of the dollar as the world’s reserve currency, ultimately leading to its destruction.

Introduction

For almost two years President Trump has imposed various tariffs on imported Chinese goods. He advertised his tactics as hardball from a tough president who knows the art of the deal, taking his business acumen and applying it to foreign affairs. He even proudly described himself as a tariff man.

His opening gambit was to impose tariffs on some goods to get leverage over the Chinese, with the threat that if they didn’t cooperate, then further tariffs would be introduced. The Chinese declined to be cowed by threats, introducing tariffs themselves on US imports, particularly agricultural products, to bring pressure to bear in turn on President Trump. 

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The monetary lessons from Germany

The monetary lessons from Germany 

Germany suffered two currency collapses in the last century, in 1920-23 and1945-48. The architect of the recovery from the former, Hjalmar Schacht, chose to cooperate with the Nazi successors to the Weimar Republic, and failed. In that of the second, Ludwig Erhard remained true to his free market credentials and succeeded. While they were in different circumstances, comparisons between the two events might give some guidance to politicians faced with similar destructions of their state currencies, which is a growing possibility.

Introduction

Let us assume the next credit crisis is on its way. Given enhanced levels of government debt, it is likely to be more serious than the last one in 2008. Let us also note that it is happening despite the supposed stimulus of low and negative interest rates, when we would expect them to be at their maximum in the credit cycle, and that some $17 trillion of bonds are negative yielding, an unnatural distortion of markets. Let us further assume that McKinsey in their annual banking survey of 2019 are correct when they effectively say that 60% of the world’s banks are consuming their capital before a credit crisis. Add to this a developing recession in Germany that will almost certainly lead to both Deutsche Bank and Commerzbank having to be rescued by the German government. And note the IMF recently warned that $19 trillion in corporate debt is a systemic timebomb, and that collateralised loan obligations and direct exposure to junk held by the US commercial banks is approximately equal to the sum of their equity.

Then we can say with some confidence that a major credit crisis is developing, and that it will almost certainly be far greater than Lehman.

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Precious metals round-up

Precious metals round-up 

 By October 24, 2019 

Growing evidence of an economic downturn despite unprecedented monetary inflation since Lehman means a new credit and systemic crisis is becoming increasingly certain. In an attempt to prevent a new crisis developing, this time the scale of monetary inflation by the authorities will have to be even greater. The rise in the price of gold since December 2015 and its break-out from a three-year consolidation period earlier this year confirms that the risks of a credit and systemic crisis undermining fiat currencies have been increasing for some time. 

It is now likely that in future portfolio managers will increase their investment allocations in favour of gold and actively consider investing in silver and platinum as well. It is in this context that this article looks at the price relationships between the three precious metals and their relevant monetary and investment characteristics.

Introduction

Markets are playing a dangerous game of chicken with economic reality, which every passing day tells us that trade is slowing, and credit everywhere is maxed out. Key economies are beginning to reflect this in statistics, having for much of this year screamed the message at us through business surveys. Central banks know their monetary policies have failed. The ECB has already announced deeper negative deposit rates and is reviving its asset purchase programme (printing) from next month. The Fed is injecting liquidity (more printing) through repos in far larger quantities into its monetary system which, mysteriously, is short of money despite commercial banks having combined reserves of $1.44 trillion at the Fed.

We should not be surprised at its inability to join the dots between cause and effect, but warnings from the IMF about a $19 trillion corporate debt timebomb, coming from an organisation that is the deep-state of the economic system and has been consistently advocating monetary inflation, is tantamount to an official admission of global monetary failure. Where to now? Print, and print again. 

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Monetary failure is becoming inevitable

Monetary failure is becoming inevitable 

This article posits that there is an unpleasant conjunction of events beginning to undermine government finances in advanced nations. They combine the arrival of a long-term trend of rising welfare commitments with an increasing certainty of a global-scale credit crisis, in turn the outcome of a combination of the peak of the credit cycle and increasing trade protectionism. We see the latter already undermining the global economy, catching both governments and investors unexpectedly.

Few observers seem aware that an economic and systemic crisis will occur at a time when government finances are already precarious. However, the consequences are unthinkable for the authorities, and for this reason it is certain such a downturn will lead to a substantial increase in monetary inflation. The scale of the problem needs to be grasped in order to assess how destructive it will be for government finances and ultimately state-issued currencies.

Introduction

Water graph

Listening to recent commentaries about the repo failures in New York leads one to suppose there is insufficient money in the system. This is not the real issue, as the chart below of the fiat money quantity for the dollar clearly shows. 

The fiat money quantity is the amount of fiat money (in this case US dollars) both in circulation and held in reserve on the central bank’s balance sheet. Before the Lehman crisis, it grew at a fairly constant compound growth rate of 5.86%. Since the Lehman crisis, it has grown at an average of 9.45%, even after the slowdown in its rate of growth that started in January 2017. FMQ is still $5 trillion above where it would have been today if the massive monetary expansion in the wake of the Lehman crisis had not happened. If there is a shortage of money, it is because the process of debt creation to fund current expenditure is spiralling out of control.

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An Inflationary Depression

An Inflationary Depression 

Financial markets are ignoring bearish developments in international trade, which coincide with the end of a long expansionary phase for credit. Both empirical evidence from the one occasion these conditions existed in the past and reasoned theory suggest the consequences of this collective folly will be enormous, undermining both financial asset values and fiat currencies.

The last time this coincidence occurred was 1929-32, leading into the great depression, when prices for commodities and output prices for consumer goods fell heavily. With unsound money and a central banking determination to maintain prices, depression conditions will be concealed by monetary expansion, but still exist, nonetheless.

Introduction

The unfortunate souls who are beholden to macroeconomics will read this article’s headline as a contradiction, because they regard inflation as a stimulant and a depression as the consequence of deflation, the opposite of inflation. 

An economic depression does not require deflation, if by that term is meant a contraction of the money in circulation. More correctly, it is the collective impoverishment of the people, which is most easily achieved by debasement of the currency: in other words, monetary inflation. Fundamental to the myth that an inflation of the money supply is the path to economic recovery are the forecasts by the economic establishment that the world, or its smaller national units, will suffer no more than a mild recession before economic growth resumes. It is not only complacent central bank and government economists that say this, but their followers in the private sector as well. 

It is for this reason that the S&P 500 Index is still only a few per cent below its all-time high. If there was the slightest hint that Corporate America risks being destabilised by a depression, this would not be the case.

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The Ghost of Failed Banks Returns

The Ghost of Failed Banks Returns 

Last week’s failure in the US repo market might have had something to do with Deutsche Bank’s disposal of its prime brokerage to BNP, bringing an unwelcome spotlight to the troubled bank and other foreign banks with prime brokerages in America. There are also worrying similarities between Germany’s Deutsche Bank today and Austria’s Credit-Anstalt in 1931, only the scale is far larger and additionally includes derivatives with a gross value of $50 trillion. 

If the repo problem spreads, it could also raise questions over the synthetic ETF industry, whose cash and deposits may face escalating counterparty risks in some of the large banks and their prime brokerages. Managers of synthetic ETFs should be urgently re-evaluating their contractual relationships.

Whoever the repo failure involved, it is likely to prove a watershed moment, causing US bankers to more widely consider their exposure to counterparty risk and risky loans, particularly leveraged loans and their collateralised form in CLOs. The deterioration in global trade prospects, as well as the US economic outlook and the likelihood that reducing dollar interest rates to the zero bound will prove insufficient to reverse a decline, will take on a new relevance to their decisions.

Problems under the surface

Last week, something unusual happened: instead of the more normal reverse repurchase agreements, the Fed escalated its repurchase agreements (repos). For the avoidance of doubt, a reverse repo by the Fed involves the Fed borrowing money from commercial banks, secured by collateral held on its balance sheet, typically US Treasury bills. Reverse repos withdraw liquidity from the banking system. With a repo, the opposite happens: the Fed takes in collateral from the banking system and lends money against the collateral, injecting liquidity into the system. The use of reverse repos can be regarded as the Fed’s principal liquidity management tool when the banks have substantial reserves parked with the Fed, which is the case today.

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Olduvai IV: Courage
In progress...

Olduvai II: Exodus
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