Here Is The Setup As We Kickoff 2022

January 1 (KWN) – Alasdair Macleod: Following the Lehman crisis, it became fashionable to cite the Triffin dilemma (named after Robert Triffin – 1911 to 1993) as justification for inflationary US policies and why they would not undermine the US dollar in the foreign exchanges.

But far from being simply a justification for continual dollar trade deficits, Triffin correctly described a situation which was bound to lead to problems for a reserve currency. This article describes how his analysis was borne out by events during the Bretton Woods Agreement, and the lessons that can be learned from it with respect to the current situation facing the US dollar.

Introduction
In the years following the Lehman crisis, it became popular to refer to the Triffin dilemma. Commentators usually invoked it as an explanation of a strong dollar despite a worsening trade deficit and even for the encouragement of more dollar inflation to satisfy foreign demand. According to Triffin, being the reserve currency and the medium for pricing commodities and international trade, foreigners always needed dollars. Therefore, the US could continue to run a trade deficit without damaging the exchange rate.

At that time, the world was recovering from what many economists have since named as the great financial crisis. It originated in the US residential property market which had boomed on the back of unfettered bank credit expansion and a growing alphabet soup of collateralisations. Central banks, who were meant to be the ringmasters controlling the expansion of banking activities were caught unexpectedly and disgracefully unaware of the expansion of off-balance sheet bank lending. And their understanding of the dangers of securitisations of securitisations of liar loans upon which the marginal pricing of residential property depended was sadly lacking.

When the music stopped, a new dollar number came into common parlance — the trillion. Until then we looked at the emergence of billions in the financial lexicon in the early noughties (early years of the Century) with some awe. Now the Fed was writing open cheques, potentially in the trillions just so that the inflated financial system, the counterpart of credit loaned to people who could not afford to buy the property assets securitising the whole kaboodle, would not collapse. The Fed printing dollars without limitation meant that Lehman was the only significant American bank to go under.

Other central banks were less fortunate in their policy outcomes. Eurozone member states had given up their monetary seigniorage to the ECB (European Central Bank), so whole countries had to be bailed out — Ireland, Cyprus, Greece, Italy, Spain, and Portugal. BAFIN, Germany’s banking regulator turned a blind eye to the true condition of its banks, and the large private banks (Deutsche and Commerzbank) are still struggling today.

In the years following the crisis, Triffin was like a comfort blanket for those of us who turned a blind eye to all the currency expansion in the wake of it. It justified the Fed’s extraordinary new measures, such as quantitative easing, without having to worry about the consequences. The Fed therefore could and should expand its balance sheet to unprecedented levels, because foreigners needed the dollars to grow their economies out of crisis. But we were ignoring the second part of Triffin’s dilemma: those consequences

What is The Triffin Dilemma?
Let us get it from the horse’s mouth. The following is extracted from the IMF’s (International Monetary Fund) website:

“Testifying before the US Congress in 1960, economist Robert Triffin exposed a fundamental problem in the international monetary system.

If the Untied States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.

If U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits (dollar glut) would erode confidence in the value of the U.S. dollar. Without confidence in the dollar, it would no longer be accepted as the world’s reserve currency. The fixed exchange rate system could break down, leading to instability.”

In other words, for the dollar to function as the world’s reserve currency and to be used as the currency for international trade, the US Fed and Treasury must run their monetary policies and the economy in such a way as to create dollars for export to foreign ownership. A continual US deficit on the balance of trade, which in the absence of an increase in the savings rate requires a continual increase in the budget deficit, is the principal means of production of those dollars. These policies are obviously inflationary at the monetary level, any negative effect hidden from producer and consumer prices by the demand for dollars leading to the maintenance of their purchasing power.

But it is a balancing act. Too much currency inflation created by a deliberate increase in the trade deficit risks eroding confidence in the currency, leading to its purchasing power being undermined. That is one side of the coin. The other, not mentioned by Triffin, comes from the dollar’s foreign users. Unless the American authorities have the means and the will to balance the quantities of dollars exported with accurately forecast foreign demand for them, a policy of supplying dollars for international purposes would be bound to fail at the first global economic downturn.

For example, if foreign demand for dollars was to fall, then the US should reduce the quantity of dollars exported by raising domestic taxes to reduce the budget deficit and therefore the trade deficit. Alternatively, saving by US consumers would have to be encouraged to reduce immediate demand for foreign goods, either by encouraging saving through tax breaks or by raising interest rates on deposit accounts to discourage spending.

Immediately we can see problems with these solutions. If the level of foreign demand for dollars falls, it is likely due to the onset of a global recession, and policy advice would almost certainly be to stimulate demand to prevent a global recession impacting on the US economy. Reducing the dollars in circulation to maintain its purchasing power would be seen to be counterproductive to the Keynesians (current Washington theory) who would argue that monetary stimulus should be increased instead to counter a recession.

As for tax breaks for savers or the supposed benefits to them of higher interest rates on their bank deposits, these are no-go areas for economic and monetary policies as well, again for Keynesian reasons. Triffin’s recommended solution was as follows:

“Triffin proposed the creation of new reserve units. These units would not depend on gold or currencies but would add to the world’s total liquidity. Creating such a new reserve would allow the United States to reduce its balance of payments deficits, while still allowing for global economic expansion.”

In other words, he proposed something along the lines of Keynes’s bancor which was rejected in favour of the dollar by the Bretton Woods Agreement. In fact, Triffin’s underlying approach was as inflationary as anything Keynes proposed in the 1940s, and his assumption that the world could not do without an expanding reserve currency, a situation thought to lead to economic and price stability, was similarly questionable. But Triffin’s prediction that the fixed exchange rate system backed by the dollar as reserve currency could break down was obviously correct and borne out by events…

The Dollar’s Failure in The 1960s
Following his US Congress testimony, Triffin’s forecast was confirmed by events later in the decade by the failure of the London gold pool. The background that led up to it was excess inflation of the dollar and a trend of bank credit expansion financing US corporate growth abroad in the post-war years. 

Economic and monetary stability were particularly undermined by the Vietnam war. The productive economy became heavily slanted towards military production and away from the goods and services genuinely demanded by the American consumer. The war in Vietnam particularly led to the export of cash dollars in large quantities. From 1954 onwards, America became increasingly bogged down in Vietnam, so by the mid-1960s, there had been over ten years of increasing dollar cash exports due to that war alone.

The Vietnam war was fought in what previously had been French Indochina, so it was natural for legacy French interests to end up with unwanted dollars. And it was France under President de Gaulle, advised by Jacques Rueff, which led the repatriation of these dollars in exchange for US gold in accordance with the terms of the Bretton Woods Agreement. 

After the US’s gold reserves had fallen from 21,828 tonnes in 1949 to 15,060 tonnes in 1961, the London gold pool was set up to defend the $35 per ounce exchange rate. Seven European nations joined the US in keeping the gold price at $35, but still gold was lost to the markets. By 1968, when the arrangement failed, the US’s gold reserves had fallen to 9,679 tonnes, while the other participants had increased their gold reserves by 3,346 tonnes. The only central bank which supported the policy by its actions was the Bank of England, which under the agreement sold 868 tonnes. The others all went behind the US’s back to increase their gold reserves.

There is more honour among thieves than there appears to have been between the central banks which were members of the gold pool. It was hardly surprising that the arrangement failed, and that subsequently President Nixon suspended the Bretton Woods Agreement in 1971. It was the darker side of the Triffin dilemma: the pursuit of bad economic and monetary policies to ensure that there were enough dollars to satisfy global reserve requirements in the post-war years caused the dollar to devalue against gold from $35 to over $800 some nine years later. 1971 was also the first of the post-war years that the US suffered a deficit on the balance of payments, turning around a surplus of $2.331bn the previous year into a deficit of $1.433bn.

Triffin After Bretton Woods
Since the mid-seventies, the US balance of payments has deteriorated at an increased pace, ensuring the world has already become awash with dollars. The latest US Treasury TIC figures show foreign holdings of long-term securities now totals a record $26.865 trillion, to which can be added short-term securities and bank balances of $6.752 trillion for a combined total of $33.617 trillion.

Looking at these numbers in the context of Triffin tells us that with foreign cash and investments in US dollars now at about 150% of US GDP, there are probably too many dollars in foreign hands and a repeat of the conditions that led to the failure of the London gold pool in 1968 is now in place. 

Following on from our analysis of the 1968 failure of the London gold pool, global demand for these dollars is likely to subside as the global economy stops growing, of which there is mounting evidence. The engine pulling the other foreign economies along has been China, which has been slowing in recent years and is now beset with a developing property crisis of its own, Evergrande (Chinese Property Company) potentially being a walking shadow of Lehman. And nearly all other governments in advanced nations are still prioritising Covid lockdowns over production, with supply chain issues continuing to disrupt trade.

At the same time, the Biden administration is increasing US government spending on the premise that it will be financed by taxes gained from soaking the rich and by stimulating economic recovery. Biden’s wish-list doubles down on neo-Keynesian fallacies of the past and will ensure that the production of dollars to end up in foreign hands will continue apace. Instead of reducing the supply of dollars to balance a fall in demand for them, the combination of a developing global recession and increasing US Government budget deficits is set to undermine the dollar’s exchange rate and/or its purchasing power. Due to economic stagnation, the flow of excess dollars out of foreign ownership is now set to replicate the crisis of 1968, but in an entirely fiat currency context.

And now there is another spectre haunting us from the Keynesian past: increasing price inflation. There must be no doubt that stubbornly rising consumer prices will lead to interest rates in 2022 rising significantly from the lowest levels in the history of fiat currencies, ever…

The Consequences of The Developing Triffin Crisis
Measured by the price of gold, that is to say real money and not currency, the dollar has already seen its purchasing power fall by over 98% (i.e. $35/$1800). The dollar’s fate has been broadly shared by all the other currencies which became purely fiat when the Bretton Woods Agreement was abandoned in 1971. But only now, the dark side of Triffin’s dilemma is about to hit the dollar and the other fiat currencies already badly undermined over the last fifty years. Furthermore, through the suppression of dollar interest rates at the zero bound, market values have become horribly distorted. Clearly, a rise in interest rates will result in a destabilising value shock in financial markets.

The ensuing bear market in US dollar investments will remove any reason for foreign holders to maintain investments in bonds, whose capital values are bound to fall, and in equities, where the motivation for excessive investment of some $14 trillion’s worth is essentially opportunistic. For foreigners, the only justifiable dollar holdings become strictly trade-related and for offshore insurance funds in Cayman and elsewhere maintaining reserves against potential onshore liabilities. The potential for selling of dollars by foreigners therefore appears to be substantial, leading to a potentially self-feeding collapse of financial asset valuations, irrespective of the actions of domestic American investors.

Therefore, the set-up for a significant bear market triggered by rising interest rates is almost certainly a set-up for a dollar collapse as well. But sellers of dollars are faced with the problem that their currencies are loosely tied to the dollar, and domestic conditions for foreigners make their currencies unattractive as well. Consequently, a dollar crisis is unlikely to be confined to the reserve currency, potentially undermining all other fiat currencies.

The best escape route from a currency crisis appears to be to reduce exposure to all currencies in favor of goods and of true money — that is physical gold and silver.

The move out of currencies has already begun, as illustrated by the chart below.

Measured by this tracker fund, commodity prices have more than doubled since the Fed reduced its fund rate to the zero bound and instituted an inflationary QE, which has added over $2 trillion to the dollar’s circulating quantity. Rises in the general level of commodity prices has not been because of extra economic demand.

After significant increases in the prices of gold and silver between March and August 2020, since then gold and silver have broadly consolidated those gains. Consequently, over this year they have underperformed a basket of non-monetary commodities, consistent with a lack of contemporary understanding of the differences between money, currency, and bank credit…

As the current fiat money crisis evolves, this underperformance is likely to be corrected. The situation could lead to a new attempt by leading central banks at a new gold suppression policy. In the face of failure, will they simply continue to insist that their fiat currencies are modern money and that gold and silver have no contemporary role in the monetary system? Or will they club together to suppress the evidence of gold’s superiority over fiat currency?

If they attempt the latter, the Americans and the British (who, incidentally, sold most of their gold at under $300, under Gordon Brown more than 20 years ago), might find, yet again, that the major European national central banks use any such agreement to top up their reserves by buying gold from the Anglo-Saxons, just as they did in the 1960s.



Gold prices moving higher after U.S. CPI rises 6.8%, biggest jump since 1982

Neils ChristensenFriday December 10, 2021

Gold prices are pushing higher, following a stronger-than-expected rise in U.S. consumer prices.

Friday, the U.S. Labor Department said its U.S. Consumer Price Index rose 0.8%

in November, after a 0.9% rise in October. The data beat consensus forecasts as economists were forecasting a 0.7% rise.

For the year, the report said that headline inflation rose 6.8%. The report said this is the “largest 12-month increase since the period ending June 1982.”

Annual inflation rose in line with expectations. Some economists were bracing for inflation to rise above 7%.

Meanwhile, core CPI, which strips out food and energy costs, increased 0.5% last month, up from a 0.6% increase in October. The data was in line with expectations. For the year, core CPI is up 4.9%.

The gold market moved into positive territory in an initial reaction to the firm headline number. February gold futures last traded at $1,779.50 an ounce, up 0.18% on the day.

Looking at some of the components of the report, consumers continue to feel the pinch of rising energy prices. The report said that the gasoline index increased 6.1% last month, pushing the energy index up 3.5%. For the year, energy prices are up 33.3%.

Food prices also increased, rising 0.7%. For the year, the food index is up 6.1%.

The report said that the rise in food and energy prices is the most in 13 years.

Katherine Judge, senior economist at CIBC, said that with inflation hitting another multi-decade high, the Federal Reserve could be on track to raise interest rates by June 2022.

“While December will see some relief from lower energy prices on omicron, causing total inflation to decelerate, there is scope for supply chain issues to prop up core goods prices again as omicron spreads globally and disrupts production,” she said. With inflation at a lofty pace, the Fed is set to accelerate its QE tapering timeline at the December meeting, to finish in the early spring, and to allow for a rate hike in Q2 2022, when the winter wave of Covid could be behind us.”

Neils Christensen




Russians go on a gold buying spree

Rajan Dhall Monday December 13, 2021

Russian nationals have bought a record amount of gold since 2014, the Russian media has reported (Sputnik). They bought four tonnes of gold bullion and coins in the past nine months, which is around 8% more when compared to the previous year, the reports specified.

Traditional gold investments have become very popular in other countries as well, with Americans having purchased 91.3 tonnes of the yellow metal in the past nine months (+79%), while in China and India gold buying has surged by 54% and 24% respectively.

The large difference between the amount of purchased gold can be put down to a 20% value-added tax (VAT) rate on gold bullion in Russia, which is the highest in the world. The Russian authorities have been considering a bill to cancel VAT on gold investments recently as part of a broader program to support domestic gold demand. According to the latest reports, they will go ahead with this plan starting 2022. Yet, some experts and officials have been sounding alarms regarding potential budget losses for Russia once this bill is approved, and about the risks of the country running out of gold.

Gold is currently stuck in a very heavy consolidation pattern. The price is 0.30% higher on the session but has been hovering around $1787/oz for around 14 sessions. There are some key central bank events that could get the markets moving this week. The market is looking to gather information about how the new omicron COVID-19 variant could hinder plans. The Fed has been aggressive in comparison to the ECB, some Fed members are looking for a further reduction in QE, and even interest rate rises by the summer of next year (2022). This week could give us some more information about the trajectory of this plan. The next FOMC meeting will be on Wednesday 15th

By Rajan Dhall


SocGen sees gold prices at $1,900 in Q2, no rate hikes until second half of 2022

Neils Christensen Thursday December 09, 2021

The first quarter of 2022 could represent the high water mark for gold prices next year, according to commodity analysts at Société Générale.

In a report published Thursday, the analysts said they see gold prices trading around $1,900 an ounce by the second quarter. Last month the French bank said that they see gold prices pushing to $1,945 in the first quarter of 2022.

The bank reiterated that although gold prices have struggled through 2021, it remains optimistic on the precious metal as low real interest rates will continue to support prices.

“Despite Powell’s renomination and his hawkish stance, our rates strategists do not expect interest rates hikes before 2Q22. This, combined with our economists’ above-consensus inflation forecast, points to negative real rates; a perfect mix of for gold,” the analysts said.

The analysts also said that the critical element for higher gold prices remains investors’ demand for gold-backed exchange-traded products. They noted limited scope for investment demand to push prices higher than $1,900 an ounce.

“ETF holdings are only 11.6% below their recent record, and still much higher than the average for the past decade. This indicates that investors have limited dry powder to allocate large amounts to gold,” the analysts said.

Looking past the first half of 2022, SocGen said it sees growing headwinds for gold as inflation is likely to have peaked and the Federal Reserve starts to raise interest rates.

“We expect rising real rates to become a strong headwind for gold only in 2H22,” the bank said.

One saving grace for the gold market could be further central bank diversification. The bank said that central bank gold purchases should help support prices next year.

“As the economic world becomes more multipolar, it is less important for central banks to hold USD. Central banks, especially in EM countries such as China and India, keep a low share of reserves in gold compared to western economies, and a partial catch-up would greatly support demand for the precious metal,” the analysts said.

While $1,900 an ounce is SocGen’s base-case scenario, the analysts said they see a 25% chance of prices falling to $1,700 an ounce or rising to $2,100 an ounce. They said that these two outlooks depend on the growth trajectory for the global economy that continues to be impacted by the COVID-19 pandemic.

“Our upside economic scenario would be bearish for gold as it assumes new COVID strains are effectively combatted via high vaccination rates and drug treatments. This would reduce risk-off sentiment, which is detrimental for gold, but more importantly would lead to easing of restrictions and thus higher services consumption,” the analysts said. “Our downside economic scenario would be bullish for gold as central banks around the world would have to keep monetary policies highly accommodative for their economies to cope with renewed COVID restrictions.”

By Neils Christensen




The Great Dollar Paradox

Jim Rickards – 9-3-2021

Dear Reader,    The greatest paradox in foreign exchange markets today is the U.S. dollar (USD).  

U.S. fiscal responsibility is in ruins. In the past two years, the U.S. has authorized $11.5 trillion of new deficit spending and increased its base money supply by over $4 trillion. The U.S. debt-to-GDP ratio now stands at 130%, comparable to Lebanon, Italy and Greece, among the most profligate countries in the world.

Meanwhile, U.S. growth is slowing rapidly.


The Atlanta Fed GDP Now forecasting tool showed projected annualized growth slowing from 13% in April to 11% in May to 7.5% in June. The actual GDP growth figure for the second quarter of 2021 was 6.5%.

Third-quarter growth is now projected at 5.1%.

Actual growth will come in even lower because those projections do not take into account the full extent of new lockdowns, mask mandates and vaccine mandates, which are damaging travel, entertainment, resorts, restaurants and retail sales. Consumer confidence just recorded the steepest one-month drop in the history of that data.

So the U.S. is experiencing soaring debt, reckless money printing, slowing growth and a new wave of COVID. That sounds like a recipe for full-scale flight from the U.S. dollar.

But that’s not happening.

The dollar has been getting progressively stronger. The U.S. dollar index (DXY) has rallied from 89.64 on May 25, 2021, to 93.57 as recently as Aug. 19. Other dollar indexes show comparable gains.

How does the dollar soar in the face of fiscal and monetary failure and slowing growth?

The Dollar Isn’t Just a National Currency

The answer is that the U.S. dollar is more than just a national currency. It is the global reserve currency. It is used worldwide for trade, investment and payments, and it is created outside the U.S. in the form of eurodollars by U.S. and foreign banks operating in London, Frankfurt and Tokyo, among other money centers.   

The eurodollar market relies on dollar-denominated securities such as U.S. Treasury bills and notes for collateral in leveraged transactions.

In short, the dollar has a life of its own independent of the Federal Reserve, the White House and the U.S. Congress. It’s the lifeblood of the international monetary system regardless of whether U.S. policymakers are reckless in fiscal and monetary policy or not.

Banks need dollars to buy Treasury bills to pledge as collateral and keep the system afloat whether U.S. domestic policies are sound or not.

How will the paradox of profligate fiscal and monetary policy by the U.S. and increased demand for U.S. dollars by international banks be resolved?

In the short run, the paradox will not be resolved.

I expect continued record deficits from the U.S. Congress and continued demand for dollars by highly leveraged international banks.

Still, that condition is non-sustainable. Possible remedies include a new dose of fiscal responsibility in Congress (unlikely before 2023 if ever), direct Treasury intervention in foreign exchange markets to weaken the dollar (unlikely until it’s too late) or a global financial crisis that leads to major reforms in the international monetary system, possibly including a new Bretton Woods-style agreement.

That kind of collapse followed by reform is the most likely outcome. It’ll happen because policymakers will have no other choice.

Long Overdue for a New Monetary System

My research has led me to one conclusion — we’re going to see the collapse of the international monetary system. When I say that, I specifically mean a collapse in confidence in paper currencies around the world. It’s not just the death of the dollar or the demise of the euro. It’s a collapse in confidence of all paper currencies.   

Over the past century, monetary systems have changed about every 30–40 years on average. The existing monetary system is 50 years old, so the world is long overdue for a new monetary system.

When confidence is lost, central banks may have to revert to gold either as a benchmark or an actual gold standard to restore confidence. That wouldn’t be by choice. No central banker would ever willingly choose to go back on a gold standard.


But in a scenario where there’s a total loss of confidence, they’ll likely have to go back to some form of a gold standard.

Few remember that Nixon explicitly said that the suspension of gold convertibility by trading partners was being done “temporarily.”

I spoke to two members of the Nixon administration, Paul Volcker and Kenneth Dam, who were with the president at Camp David the weekend the suspension was announced. They both confirmed to me that the intention was for the suspension to be temporary.

The plan was to convene a new international monetary conference, devalue the dollar against gold and other currencies, primarily the Deutsche mark, Swiss franc and the Japanese yen and then return to the gold standard at the new exchange rates.

The first part did happen. There was an international monetary conference in Washington, D.C., in December 1971. The dollar was devalued against gold (from $35.00 per ounce to $42.22 per ounce in stages) and other major currencies by about 10–17%, depending on the currency.

Yet the second part never happened. There was never a return to a gold standard. While countries were negotiating the new official exchange rates, they also moved to floating exchange rates on international currency markets.

The cat was out of the bag.    

Why Do Central Banks Cling to a “Barbarous Relic”?

We’ve been living with floating exchange rates ever since. The creation of the euro in 1999 was a way to end currency wars among the European nations, but the EUR/USD currency wars continue.

The temporary closing of the gold window by Nixon has become permanent, though it was only intended to be temporary…

Still, gold is always lurking in the background. I consider gold a form of money rather than a commodity.

 Central banks and finance ministries around the world still hold 35,000 metric tonnes of gold in their vaults, about 17.5% of all the aboveground gold in the world.

Why would they hold onto all that gold if gold was just a barbarous relic?

Looking at the price of gold in any major currency tells you as much about the strength or weakness of that currency as any cross-rate. Gold still has a powerful role to play in the international monetary system with or without a gold standard.

The timing of any financial crisis is always uncertain, but the probability of an eventual crisis is high. New signs of liquidity stress are emerging every day.


No investor should be surprised if the crisis happens sooner rather than later.

Regards,  
Jim Rickards  

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