The last month of the summer is looking “terrific” for gold and “tough” for the S&P 500, said CNBC’s Jim Cramer.
“The charts, as interpreted by the legendary Larry Williams, suggest that August could be a tough month for the S&P 500, but a terrific month for gold,” Cramer said Monday. “Given the big picture backdrop right now, that wouldn’t surprise me one bit.”
And it is the seasonality which makes all the difference, the ‘Mad Money’ host explained.
“Williams is long gold for precisely the same reason he’s worried about the S&P: The seasonal pattern,” Cramer said.
One thing Cramer pointed to is the build-up of the debt ceiling worries that come after the two-year suspension of the debt ceiling expired at the end of July. “Remember, during the original debt ceiling debacle a decade ago, the stock market broke down and … gold did great,” Cramer noted.
The technical setup is also working in gold’s favor, especially when looking at the Commodity Futures Trading Commission (CFTC) data that show commercial hedgers stepping up their gold buying. Cramer added that this increased activity usually leads to “a nice rally.”
On top of that, gold is currently undervalued in comparison to Treasury bonds. “Not only does the precious metal have a powerful seasonal trend on its side … but it’s extremely undervalued versus the bonds,” Cramer said, citing Williams’ analysis.
For the S&P 500, the situation looks very different from both the seasonality and the technical perspectives.
“Just since the beginning of the summer, [Williams] can point to three moments when the S&P rallied to higher highs, but the Advance/Decline line failed to make a higher reading, meaning the market went up on not-so-hot breadth,” Cramer said. “For Williams, that suggests lots of big money managers must be selling many of their positions. He says he’s seen this pattern before, and it’s not healthy. Normally when stocks rally, the Advance/Decline line should be making new highs. But that’s not happening, and it means this move could have feet of clay.”
Also, the on-balance volume, which is the momentum indicator, is flashing bearish signals, Cramer said as he once again pointed to Williams’ research.
“The S&P makes new highs, but the On Balance Volume stays flat. That’s another negative. Remember, for technicians, volume is like a lie detector. When it’s weak, that means a move is deceptive. One more reason Williams is worried about the rest of this seasonally challenging month,” Cramer said.
Cramer’s comments come as the gold market is suffering from a lack of conviction while traders wait for the key macro data of the week — the July nonfarm payrolls, scheduled to be released on Friday in the U.S.
On Tuesday, gold was trading above $1,800 an ounce but was unable to break out significantly higher. They were last at $1,813.80, down 0.46% on the day.
July 30 (KWN) – Alasdair Macleod: Following the demise of gold’s active August contract, gold and silver had a better week. In European morning trade, gold was at $1829, up $28 from last Friday, while silver rallied to $25.60, up 45 cents.
As always at the month-end, the bullion banks had an interest in seeing prices lower, so that call options expired worthless and in the hope that short-term speculators would trade these factors, giving added downward impetus to prices.
Following a pause on Wednesday, the change came yesterday when gold rose over $20 and silver by 56 cents. Until then, positive sentiment had deteriorated, probably the lowest seen for some time, lower even than at the end of June when gold tested the $1750 level. And in silver, the unwinding of small investor interest in SLV, which momentarily drove silver to touch $30 on 1 February, has brought back some liquidity into the market — enough to encourage bullion banks to shake some more silver out of loose hands.
This left the gold/silver ratio to 71.5 this morning, which is our next chart.
Gold/Silver Ratio Preparing To Break Below 60
Having nearly halved from the 20 March 2020 peak, the upper sixties proved to be resistance to further falls. While there is no knowing when that resistance might be overcome, we can conclude that when it is the bullish move for silver relative to gold is likely to be significant. And the lesson from yesterday’s trading, when silver was up 3% at one point tells us that futures traders are short enough to be badly squeezed.
But with some physical liquidity being recovered in London, the direction will probably come from gold, and it has been noticeable in the market how gold held up relative to silver, perhaps confirming relative liquidities. That said, excess silver liquidity tends to dry up in a flash.
On fundamentals, this week saw the release of the Fed’s FOMC July minutes, another factor that nailed the timing of precious metal price recoveries to late this week. Ahead of it, buyers held off, amid rumours that the Fed might say something about tapering, given the sudden rise in official price inflation figures. Instead, the FOMC remained firmly in denial of these factors, maintaining the funds rate at 0-0.25%. It was an exercise in justifying no change.
For bond markets it was all one big yawn. But the dollar’s trade-weighted index slipped noticeably, helping to underwrite gold and silver, along with some key commodities such as copper. The dollar’s TWI is next.
US Dollar May See Major Breakdown Below 90
Having briefly touched 93 and failed to properly test the high established in late March, the TWI appears to have some downside in it. It will need close watching, because a combination of further rises in commodity prices and a weakening TWI would be a threat to the Fed’s interest rate policies. Equities, and even bond markets would then begin to take note.
But other than these factors, the outlook for gold and silver next week looks positive based on technical factors. The sellers have sold, and bullion banks are wary of increasing their shorts…
A reminder why they always will be sound money and why bitcoin cannot fill that role
With bitcoin’s price still rising and expected to rise even more, there has been a growing belief in cryptocurrency circles that it will replace unbacked government currencies when they eventually fail.
The assumptions behind this conclusion are naïve, exposing hardly any knowledge in what qualities are needed for sound money. This article agrees that current events are accelerating the path towards fiat destruction, and that historical precedents point to their eventual replacement with a sounder form of money. But what that money will be is decided when governments lose control over their fiat; and the public, its users, through free markets will set the monetary agenda.
Only then will the general public determine the qualities required, and in the past, it has always opted for metallic money. And because government treasury departments and their central banks coincidently possess only gold in their non-fiat reserves, its monetisation is the only option for governments to survive the collapse of their fiat currencies. That is what will eventually happen, with silver perhaps fulfilling a subsidiary monetary role to gold.
Introduction
While increasing numbers of the fiat investment community understand that the quantities of government money are being expanded without any sign of limitation, they have also concluded that bitcoin, not gold, is the pure investment play because over the next few years bitcoin will approach its final quantity.
It is almost certain that like the majority of gold and silver bulls hodlers expect to sell bitcoin for profit measured in their governments’ currencies, creating for themselves relative wealth in dollars, euros, yen — whatever their governments impose on their citizens as money. But it is an investor’s, or speculator’s approach, which is accompanied by feverish examination of charts, confirmation bias from “experts” and only a half-understood concept of what is driving the price. So sudden and wonderful has been the unbanked wealth creation in leading cryptocurrencies, that investors commonly proclaim that gold and silver are yesterday’s story and that we oldies should move with the times…
These investors claim that five thousand years of empirical evidence is about to be overturned. But they are investors. All bulls and no bears. Other than banking fabulous profits in fiat at a future date, this has nothing to do with money per se. The point about sound money is you acquire it by spending fiat, so that when fiat goes you will have it to spend. It is not an investment decision, but more like an insurance policy taken out for which a risk assessment has to be made. If it is decided the risk is that fiat currencies will not fail in one’s lifetime, then the insurance premium, which is an individual’s decision, need only be small or not even taken out. But if it is decided that the risk is there and growing, then the allocation into physical sound money should be increased accordingly. Lack of physical ownership, be it bitcoin gold or silver is not an option.
There is no doubt that economic and monetary instability are increasing. After all, this is fuelling the investment rationale for bitcoin, understood by those whose reasons for buying it are to benefit from its slow rate of quantity expansion compared with that of fiat. But the investment rationale is that all the subjective price performance is in bitcoin, and the national currency is the unchanging objective value. Otherwise, why value bitcoin in your fiat currency, and why would you ever sell it? And do you ever adjust your other investment returns for the debasement of the currency? No one does this.
The objective view of currency is so powerful that very few people can get away from it. But the decision to insure against the death of fiat currencies is about advance possession of their likely successor, not measuring gains. It requires an understanding of what money represents, its function, and the what and the why that is happening to fiat currencies. It involves an understanding that fiat money is being debased, and what that really means for the sound money of tomorrow. And it requires individuals to comprehend what is happening to fiat money’s objective value, evidenced by rising commodity prices, stock markets, house prices, bitcoin as well as gold and silver — all measured in fiat.
Today, very few owners of precious metals or of bitcoin understand that investment is fine and dandy, but the ultimate reason for possessing them is against the possibility that fiat money will fail. They are yet to make an informed choice about what that replacement will be. And talk of bitcoin going to a million dollars or gold going to five thousand misses the point entirely.
Characteristics of sound money
Figure 1 gives us a basis for assessing the credentials of the principal contenders to replace fiat money when it dies. It should be noted that throughout the history of money, money mandated by governments with nothing to back it other than its legal status has always failed and been replaced with money which is essentially chosen by individuals through their personal exchanges with each other. With the invention of cryptocurrencies, there is offered a new technological form of money which claims to be sound, competing with the established metallic monies of the past for attention. We can ignore centralised central bank cryptocurrencies on the basis that is just rearranging the deck chairs on the fiat Titanic.
In estimating the suitability of each form of money, they have to survive the tests in Figured 1. Clearly, gold satisfies all categories, but some explanation is needed why this is so, and why bitcoin and silver do not.
Public acceptability
Both gold and silver have acted as money for millennia and are widely distributed. They are generally associated with a monetary value, that is to say suitable to be a medium of exchange. Indeed, silver was the basis of the pound sterling from as early as 775 AD and was the monetary standard until the adoption of the gold standard in 1816, though Sir Isaac Newton introduced a secondary standard for gold in 1717. That’s over a thousand years of monetary silver. Silver was still the currency standard in many jurisdictions on the European continent until the Franco-Prussian War, when Germany exacted tribute from France in gold, allowing it to change its monetary standard from silver to gold.
Both metals have a long history of being used as money throughout Europe and Asia. And when Columbus discovered the Americas, it was found that these metals were also valued by their civilisations — principally the Aztecs and Incas — which had had no prior trading connection with Europeans and Asians. Deep in the human psyche there has always been an appreciation of their constancy and their suitability as mediums of exchange.
The same cannot be said of bitcoin, which is held out as the leading and most sound cryptocurrency. But its distributed ledger cannot be corrupted by anyone, including governments. So long as electricity flows through our economic veins and our computers and mobile phones remain interconnected there will be bitcoin and its blockchain. But as a replacement for fiat, it suffers many disadvantages, some of which will doubtless be overcome. But the one thing it cannot do is act as the medium of exchange for those unwilling or unable to use it. The hodlers’ enthusiasm for bitcoin as money does not stretch much beyond educated millennials — less than a hundred million perhaps out of a transacting population of seven billion. It falls at this fence because it is not hodlers who ultimately decide what to use as money, but the wider public.
But bitcoins are already accepted in some outlets, and even Elon Musk is said to accept them in exchange for his Teslas. Maybe; but if someone thinks bitcoin is going to rise in price, then they would likely accept it as payment. It would be a way of acquiring bitcoin, so that they can be sold for a greater profit at a later date. This is not bitcoin being used as money.
Public acceptability
For a medium of exchange to be effective, it must be accepted by everyone in a community of people who divide their labour, and if one community is to benefit from trading with other communities, it must be accepted more widely for the exchange for goods. But we know that confining transactions to coins or metallic money by weight is an inefficient form of money. This is why fiat currencies started out as gold or silver substitutes in the forms of both cash and bank deposits, exchangeable into physical metal on demand at a fixed rate.
The convenience of being able to pay in sound money substitutes cannot be underestimated. A national currency fully fungible with gold or silver was central to the economics of the industrial revolution and is the basis of the currencies of the great nations of today. Markets in them developed, such as discounted bills, loans, bonds, stocks, and trade finance. Gold and silver substitutes were trusted. Businesses developed internationally, exchanging their money substitutes for commodities, importation of consumer goods and goods of a higher order. While Country A’s money did not circulate in Country B it was accepted and could be redeemed for its money at a cross rate fixed by their gold standards, or alternatively exchanged for physical gold. This was the basis of global trade before the First World War.
The monetary system based on the free exchange of gold and silver substitutes was so successful that it brought the nations that benefited from the arrangement out of feudal subsistence living into the greatest economic advancement for mankind since the ending of barter. It set the basis for modern economies and their technological advancement. Money could be trusted. You could save it, making it accessible for entrepreneurs to finance their production, knowing that gold or silver backed money would retain their purchasing power over time. It was fundamental to the evolution from medieval societies into free markets.
Through their money substitutes it was governments and their central banks which cheated on metallic money. Starting with the suspension of gold standards to finance the First World War, European nations failed to return to them and some currencies collapsed. Britain eventually introduced a gold bullion standard in 1925, replacing its gold specie standard at the pre-war rate. By only permitting the exchange of pounds for 400-ounce bars and removing the pre-war commitment to swap paper pounds for sovereigns, the general public effectively lost the gold substitute facility. The UK’s bullion standard only lasted until September 1931, when it was “temporarily” abandoned, never to be reintroduced.
The flaw in the system was not the fault of gold, or in earlier times, silver. The fundamental problem was that banks were free to expand the quantity of money in the form of credit, which when drawn down and spent was indistinguishable from gold substitutes. Following the Bank Charter Act of 1844 which permitted the existence of unbacked bank credit, the cycle of bank credit expansion was broadly self-liquidating through periodic bank crises. That changed when the Bank of England adopted the role of lender of last resort, subsequently copied by the Fed.
The credit tail had begun to wag the monetary dog, and led to the situation today, where money originating from bank credit makes up the bulk of money in circulation. Without a reform of the banking system to restrict the role of bank credit, the reintroduction of gold and silver substitutes is corrupted and cannot work for long. This must be addressed when fiat dies, otherwise the cycle of bank credit will destabilise the new monetary system.
If bitcoin is to be the money of the future, it will need enormous degrees of persuasion for the public to accept it as sound money compared with gold or silver. That persuasion is unlikely to come from markets, which are the sum total of people’s transactions, so it can only come from the state. An establishment agency of some kind, a revolutionary government in agreement with other revolutionary governments would have to successfully impose a cryptocurrency, over which no state has distributive control, on the general public whose traditional concept of money is very different. Not only is this proposition illogical, but it is logically the consequence of assuming the state decides what is money and not the people.
Official sanction of the new money
The last thing any government or central bank would wish is to lose control over money. These agencies will continue with fiat until the last possible moment and will then want to determine its replacement. Intellectually, they are not suited to the task, believing that the state must retain control of its national money at all times in order to manage economic outcomes. It sees free markets as the enemy of state-imposed order.
The collapse of fiat currencies will demolish the state theory of money, and not for the first time. Irrespective of how long it takes, the rapid loss of fiat currencies’ purchasing power means that governments will no longer be able to finance their obligations. There will, therefore, come a point where fiat money must be abandoned in the search for monetary stability. The demise of fiat is the demise of state money and the function of its replacement will be to restore public trust.
It is theoretically possible for trust to be restored without abandoning fiat, but that would be to act in anticipation of a monetary crisis. Cutting government spending to an economically sustainable level, balancing budgets, reforming the banking system and abandoning regulatory and other interventions in favour of free markets would have to be a deliberate policy. But it is unlikely that the necessary reforms would be possible politically ahead of a major economic and monetary crisis. Therefore, the crisis comes first, and then the state responds with an electorate fully aware of the consequences of failure…
At some stage in the collapse of a fiat money’s purchasing power it will have to be halted. In November 1923, Germany’s paper mark was finally exchanged for a new mark notionally tied to the gold mark at the rate of one trillion to one. The reasoning behind the conversion rate was it enabled the new Reichsmark to enter circulation. Today, the replacement of fiat currencies with the new money will almost certainly follow a similar procedure.
The replacement money can only be based on something in governments’ possession. And either in their treasury departments or central banks, other than each other’s fiat they only possess gold in their monetary reserves. It may take a few debilitating attempts by states to avoid it, but we can be certain that the only replacement for fiat money will be to back them with gold. It is necessary to stabilise everyone’s money. The other actions, reducing the scope of government and freeing markets from intervention will also have to be addressed. But following the increasingly obvious prospect of a total monetary collapse, stabilising the currency by turning it into gold substitutes exchangeable for gold coin should then become a politically viable solution.
It is not the intention to make light of the difficulties involved, nor to dismiss the political consequences. Based on the German experience following the collapse of its paper mark, Hayek’s The Road to Serfdom is instructive reading. The demise of the dollar raises geopolitical questions, because China has effectively cornered physical gold markets and there is evidence that she has accumulated very large quantities of non-monetary gold. Gold as circulating money would enhance her power relative to that of the United States. Russia’s central bank has also built her gold reserves at the expense of the dollar and can be assumed to have accumulated significant amounts of physical gold not otherwise declared.
The time taken for a fiat monetary collapse is another important factor not addressed in this article but will have significant consequences. If it is as much as a year from now, governments might introduce price controls and attempt to confiscate gold — these are traditionally resorted to in the past, going back as far as Roman times. The introduction of central bank digital currencies might just be advanced, hurried along by a falling purchasing power for traditional fiat. And the impoverishment of the middle classes through monetary inflation must not be ignored.
But eventually, a movement towards gold substitutes is bound to occur, and silver can then become supporting coinage. But one thing is clear, and that is a publicly distributed ledger cryptocurrency not in possession of the state cannot be adopted as a substitute for its fiat currency, because states do not have the means to introduce it.
Monetary flexibility
It is a mistake to think that a sound money is one that doesn’t vary in its quantity. The point behind sound money is that it is the users, the general public and businesses, who decide the quantity required and not the state. It was Georg Knapp’s State Theory of Money, published in 1905 that led to Germany’s inflationary financing that ended with the paper mark collapsing in 1923. It was Knapp’s theory and his Chartalist fellow travellers that permitted Germany to arm itself ahead of the First World war and then to prosecute it at no visible cost to the taxpayer. It is not a strict limitation on the quantity of money that is the problem, it is who determines its quantity.
We are told that above ground stocks of gold total some 200,000 tonnes, and that its extra supply is about 3,300 tonnes of annual extraction. Growing at about 1.5% annually, that is wrongly taken to be gold’s money supply. Monetary gold is just one function of the metal, and only 35,220 tonnes are officially monetary gold. In addition to official holdings, there are vaulted bars on behalf of governments and their agencies not officially designated as money, as well as hoarded bars owned by the general public. And with an estimated 60% in the form of jewellery and other uses, that leaves a global gold money supply of about 80,000 tonnes.
This gives gold enormous scope for increasing its monetary use. If gold is used as backing to turn fiat currencies into credible gold substitutes, its purchasing power becomes the determinant of the quantities of scrap acting as an arbitrage between uses. Free markets will decide how much gold is needed, and the supply is available if required.
With its predominantly industrial uses, silver acting as money is a more complex issue. Increasing values relative to gold will diminish industrial demand until the time monetary stability eventually returns, leaving the majority of an estimated 840 million ounces annual mine supply then feeding into the quantity of monetary silver. But unlike gold, above ground silver stocks are minimal, and furthermore, ownership of monetary silver by government agencies is virtually non-existent. And having been generally abandoned as monetary backing for note issues in European states as long ago as the early 1870s, silver is likely to have a future monetary role only secondary to gold. But its reintroduction as coinage would serve as a public affirmation, along with higher value gold coins, that currency reform is soundly based.
Unlike metallic-backed money, for its hodlers the virtue of bitcoin is the strict limit on its quantity, meaning that so long as governments expand their fiat money quantity, its price is bound to rise. But if the general public is to determine the future of money through free markets, they will need a form of money whose quantity is not dictated by government and the banks. Under a bitcoin standard one country can only expand the quantity of its bitcoin in circulation by obtaining them from another country. The economic mechanism is for the country to have lower prices of goods and services than the others, so that it obtains bitcoin in payment for net exports. Assuming no change in the proportion of savings relative to immediate consumption, this would require the government to increase its surplus of revenues relative to spending in an attempt to supress demand in its own economy and thereby lower prices.
Consequently, a bitcoin standard requires government intervention to operate, with governments setting marginal demand. But they cannot act in concert. And if one country contrives to increase its quantity of circulating bitcoin, it causes more accute deflation in the others. The lack of any monetary flexibility is bitcoin’s Achille’s heel…
Financial flexibility
Following the ending of the post-war Bretton Woods agreement, over the last fifty years financial markets have developed on the back of an unprecedented expansion of the quantity of money. In the US alone, since August 1971 broad M3 money supply has increased from $685bn to $19.4 trillion, a multiple of twenty-eight times. And the major US banks have increasingly diverted credit expansion from financing production to financial activities. These include purchases of government and other debt, rising from $160bn to $4.92 trillion over the same timescale. The expansion of regulated futures markets and the far larger over-the-counter markets have been explosive, with the Bank for International Settlements estimating the notional amounts outstanding of OTC contracts at $609 trillion in June 2020.
While much of these increases are the consequences of monetary inflation, there can be little doubt that having the ability to hedge risk, which is what derivatives are all about, is demanded by economic actors in any monetary system. In fact, futures, forwards and options existed long before the current fiat regime. We must therefore assume that financial markets will continue to find these services demanded, but perhaps in lower quantities.
A replacement monetary regime must therefore allow for derivatives and other financial activities, such as trade finance and the provision of credit to the non-financial sector to continue. The fact that derivatives have a longer history than fiat money is proof that metallic monies are no obstacle to them. Similarly, bond markets existed alongside bank credit, which are necessary to facilitate production and therefore consumption.
With prices generally stable, the purchasing power of metallic money increases over time as a result of competition driving manufacturing innovation along with the development and application of new technologies. Consumers can save in the knowledge that they are safeguarded from monetary debasement by the state, and that their standards of living will improve over time along with the purchasing power of their savings.
None of this would be possible with a form of inflexible money strictly limited in its quantity. Instead of the current situation of wealth being transferred from depositors to borrowers through currency debasement, wealth would tend to flow strongly the other way, only offset by contracting economic activity to act as a counter-pressure on a tendency for a rise in the purchasing power of a fixed-quantity form of money. The world as a whole would find itself in a permanent depression led by a decline in production.
Banks would be unable to fund themselves beyond sight deposits, with negative interest rates likely to offset the fixed money supply leading to its increasing purchasing power. Bond markets would be driven by negative yields increasing along the yield curve. In this upside-down world no entrepreneur would consider financing production from initial investment to final product sales, because prices for final products in that fixed currency would almost certainly fall substantially over time. And the wisest choice a consumer might make would be to spend nothing except on the barest essentials in order to hoard as much of this fixed quantity money as possible. These would be the basic conditions under a bitcoin currency regime.
Conclusion
This article has made the simple assumption that the demise of fiat currencies will be succeeded by sound money. It has glossed over the likely political and economic turbulence such a change would cause, which is assumed herein to be a temporary phase. Nonetheless, there are other institutional changes that need to be made for the introduction of a sound money regime to stick. These include governments reducing both their financial commitments and economic involvement to a bare minimum, maintaining balanced budgets, not discouraging savings by taxing them and ensuring they never take actions which discourage free markets. It must be admitted that the prospect of a smooth transition to sound money is close to zero, but transition there will eventually be.
This article has also played down the role of banks, whose credit creation is by far the greatest factor in the expansion of money. The misunderstanding of the importance of the factors behind the cycle of bank credit expansion and its sudden episodes of contraction led to interventionist policies with fatal long-run consequences. It is not generally understood that banks create money, with the financial establishment believing they simply have an intermediary role: it is not for the first time we see the high priests of central banking being utterly deluded about the business of commercial banking.
In a monetary revolution there can be no place for this type of loose thinking, so with it will have to be a process of rapid re-education for politicians and planners alike — probably in the real world of experience. Bank reform will have to be aimed at dampening the bank credit cycle. Purists of the Austrian School have suggested that banking must be realigned into deposit takers, who operate as off-balance sheet custodians, and financial arrangers for savers investing in productive enterprises. Then there should be no doubt in anyone’s mind about the status of their money, and unbacked bank credit would be eliminated.
While this approach is an ideal, it might be more practical to simply remove limited liability from banks. This would allow them to continue with existing banking practices and accounting. But the risks arising from balance sheet leverage would be significantly reduced because the homes and other assets of shareholders and directors would be on the line. This simple measure would likely be enough to drive banks towards the Austrian solution.
Aside from the institutional changes, the eventual replacements for fiat currencies that will initially be required will be driven by the establishment attempting to save itself from only having a worthless currency as its means of finance. Inevitably, it will require governments to use the only means at their disposal, and that is to monetise gold reserves because they are the only money they possess in non-fiat form. On this basis alone, cryptocurrencies, including planned central bank cryptocurrencies which are merely another unbacked form of fiat, don’t even get to the starting gate.
If that were not enough, we have established that a future sound money must be flexible enough to not only finance production, but to act as the mainspring for markets. Bitcoin enthusiasts have failed to grasp the importance of a degree of flexibility in the quantity of money, driven by free markets and not imposed by the state, for it to act as a medium of exchange. For now, bitcoin as money is merely poorly informed speculation. And when the world has returned to metallic money for all the reasons outlined in this article, bitcoin’s legacy will be the invention of a blockchain and all that follows it, and not its price in fiat currencies, which will be of no consequence.
What a way to kickoff trading in the month of February as the silver market surged over $30 at one point during trading. Look at who just predicted we will see $2,500-$4,000 gold and $57-$130 silver.
Sterling Silver
February 1 (KWN) – Top Citi analyst Tom Fitzpatrick: The surge in Silver overnight has taken us back to the prior trend high just below $30 which we are trading close to this morning.
What now?
IF Silver can sustain above $30 on a weekly close basis it would open up the way for extended gains towards good horizontal resistance and the 76.4% pullback level just above $35…
On To $50
Above here and a return to the all-time double highs of $49.45 (1980) and $49.80 (2011) would look likely.
3rd Time’s A Charm As $50 Will Be Broken
We have mentioned before that IF we were to test this huge level near $50 a 3rd time our bias would be “3rd time a charm” and we would suspect that it could give way.
At present levels Gold is over 100% higher than the peak seen in 1980 so that leaves Silver with plenty of catch up potential.
In that respect it is worth looking at the Gold/Silver ratio.
If Silver Closes The Week Above $30, Look For Extended Upside Gains
This ratio looks like it can go significantly lower with a minimum target of 43.5 and possibly as far as 30.5. (We are not even focusing at this point on the low of 14 posted in 1980).
All of these lows in that ratio have been associated with an up move in Silver and also normally a rally in Gold.
1996-1998 was an exception to this when Gold actually fell during what was an extended bear market culminating in the Bank Of England (1999-2001) and the Swiss national Bank (2000-2008) selling off a significant portion of their Gold reserves.
Silver To Outperform
In General a move lower towards these lower levels in the Gold Silver ratio is more likely to be Silver outperforming (Poor man’s Gold catching up) in a bull market.
$2,500-$4,000 Gold
Our bias has been that this bull market in Gold could take us to $2,500 (possibly even this year) and on a multi-year basis towards $4000.
IF (and it is a big if) we look at those numbers in conjunction with the Gold Silver ratio targets what do we get?
The most conservative dynamic is that Gold only goes to $2,500 and the Gold Silver ration only goes to 43.5. In that instance we would be looking at a potential Silver price of $57+
The middle scenario would be Gold only going to $2,500 and the ratio going to 30.5. That would put Silver close to $81
The most aggressive scenario would be for Gold to go to $4,000 and the Gold Silver ratio at 30.5. That would put Silver at $131+
Silver To Significantly Exceed 2011 High Of $50
Time will tell if any of these numbers materialize but right now there seems a very credible argument for Silver over time to not only get back to but likely significantly exceed the all-time high levels posted close to $50 in 1980 and 2011.
It is beginning to be obvious that global economic woes extend beyond covid lockdowns and that monetary inflation for the dollar, as the common foundation for other fiat currencies whose issuers face similar problems, will continue to accelerate.
Fiat currencies have only survived this long due to increased financialisation of the dollar and the US economy. Since the 1980s Wall Street has gradually dominated the US economy at the expense of Main Street. It has done so through monetary inflation, creating the conditions for the ultimate monetary collapse.
This article describes how the dollar’s collapse is likely to progress. There are two distinct aspects. The first is foreign selling, which is already becoming apparent in the weakening trade weighted index. The second is the realisation of domestic Americans that the purchasing power of their dollars will not remain stable, as the CPI suggests, but continue to decline, and that they should dispose of them sooner rather than later. There is evidence from prices of financial assets in a financialised economy that this is already beginning to happen.
Introduction
It is dawning on officials and commentators alike that the covid-19 crisis will not just go away and normality return when populations are vaccinated. The disease will be subdued, but the economic wreckage is immensely serious and long lasting. Talk of V-shaped or W-shaped recessions is increasingly being dismissed as little more than attempts to bolster consumer confidence or just wishful thinking. The damage to hospitality and retail industries is extremely serious, with bankruptcies extending to their suppliers and their supply chains as well. And it doesn’t stop with those sectors.
The global economy was already fragile, with nothing fixed by policies of extend and pretend since the Lehman crisis twelve years ago. In the advanced economies, monetary inflation has resulted in further accumulations of unproductive debt. And the greater the debt mountain, the greater the problem: modern economies have become prey to a fatal combination of profligate governments and zombie corporations managed by crony capitalists. It is a situation bound for failure, and the longer failure is put off the worse it will be…
Central to it all is an accelerating issuance of money by central banks. But the wise heads in commercial banks know they cannot be part of the solution, having already over-extended their balance sheets and are now suffering mounting bad debts. We blame the bad debts on the virus, but before the virus the global economy was already tipping into a credit-induced slump.
Have we forgotten the repo crisis, which, if nothing else, indicated that after eleven years of bank credit expansion, the banking system had run out of balance sheet capacity? Have we forgotten the trade war between the world’s two largest economies, and how that ground cross-border trade to a halt, driving exporting nations, such as Germany, into recession? And only then came the virus to deflect our attention from an already deteriorating situation.
To anyone relying on macroeconomic statistics, causes for alarm look overblown. But as Lord Canning remarked two hundred years ago, long before the modern reliance upon them, that you can prove anything with statistics — except the truth. The reality of Canning’s aphorism is set to surprise those who think GDP actually means something, and that changes in the CPI are an acceptable estimate of changes in the purchasing power of state-issued currencies.
This is the background to an acceleration of monetary inflation, which was with us long before the virus and its lockdowns. The virus merely made a deteriorating outlook even worse. As the second wave of covid-19 hits us, the full horror of the economic consequences is only now just dawning upon us. And our governments’ response can only be one: issue money without limit to stop zombie corporations from going bankrupt and to fund government deficits. Our economies are on the crumbling edge of a chasm, which without the support of increasing state intervention will fall into it. This imperative tells us that state-issued currencies are being sacrificed in a vain attempt to save us all.
Central to this sacrifice is the US dollar. As the world’s premier currency, it is the representative for all the others. If the dollar fails, the others fail. But the world’s insatiable desire for more dollars, vital for its credibility, is fading. That is the consequence of American trade protectionism and bank credit contraction replacing the previous vision of continual economic growth. All that is now history, and multinational corporations are beginning to realise it. Their need for yet more dollars is now diminishing with falling global trade prospects as America and China continue to pursue policies destructive to free trade.
International demand for dollars is reversing
In a number of recent articles, I have drawn a distinction between changes of a currency’s purchasing power emanating from the foreign exchanges and from purely domestic considerations. The motivations and reasonings of these two categories are different, and domestic users of the currency will be addressed later in this article. In the main, foreign users of the dollar are comprised of manufacturers exporting to another country including the US, businesses which will always require an element of treasury and currency management. This includes the maintenance of liquidity and the anticipation of foreign currency payments. The treasury department of a multinational corporation itself becomes a profit centre, dealing in the currencies of every country in which the corporation conducts business. And if the corporation manages its own employees’ pension fund, payment for foreign portfolio investment will usually be routed through the treasury department…
Billionaire Eric Sprott Buying
An organisation run on these lines does not take strategic positions, unlike foreign central banks and sovereign wealth funds, where politics can play a role. But it would be hard to refute the charge that as well as running a balanced position, corporate treasurers are tempted to speculate with their currency positions in order to generate extra profits. These speculations are normally in the more liquid currency and derivative markets. Nowhere is this speculation greater than in dollar exposure, where, according to the latest available figures from the US Treasury TIC system (for August) foreigners own an estimated $28.6 trillion, $22 trillion of which is invested in US long-term securities, an increase of $3.1 trillion since March. The balance is in cash and short-term Treasury and commercial bills.
Of that increase, $2.4 trillion was due to private sector foreign investors increasing their exposure to equities and equity funds, with a further $363 billion held by foreign official sources such as the Swiss National Bank and sovereign wealth funds. But adjusted for the performance of US equities, either private sector foreign-owned equities significantly underperformed the S&P500 index — up only 37% compared with 50% for the index and more for NASDAQ — or they have been net sellers.
Private sector foreigners have also reduced their holdings of Treasury stock and Agency debt by £254bn, which is hardly surprising, given ultra-low yields and the weakness of the dollar. But they have increased holdings of corporate debt, one assumes because of the attraction of higher yields, or just as likely, by investing in loans with an equity entitlement attached.
In addition to long-term financial investments, by August foreigners owned $6.6 trillion of dollar bank deposits and short-term bills, which together with the long-term investments described above totalled $28.6 trillion. This remarkable figure is about 140% of current US GDP and is easily the largest numerical displacement from national currencies into a foreign currency ever recorded.
The behavior of these foreign private sector investors is likely to determine the near-term course of financial asset prices as well as the future exchange rate for the dollar, so it is essential to look at the dollar’s prospects from their perspective.
Future trade prospects
It will shortly be dawning on foreign corporations that the counterpart to the massive increase in US budget deficits will be a broadly matching increase in the trade deficit — unless, of course, there is a substantial change in US consumer savings habits. But that is discouraged by the Keynesians in charge of economic policy, because it is only by maintaining current spending that a consumer recession can be avoided. This leaves enormous potential for foreign manufacturers to increase sales into US markets.
The other side to this benefit is a predicted increase in dollar balances in the hands of the treasury departments of non-US multinationals, already overexposed to dollars. And with interest rates close to zero, the penalty cost of selling those anticipated extra dollars for forward settlement is unusually low. It will become increasingly clear to those looking at international trade opportunities in a post-pandemic trading environment that international markets will be flooded with more dollars, and that the wise course would be to sell them for forward settlement ahead of the event.
The dollar is already hitting three-year lows, as Figure 1 shows. And if there is a glut of anything in the foreign exchanges, it is of dollars.
State actors view the situation differently, and most of them are pro-dollar, maintaining them as the core of their foreign currency reserves. The exceptions are found in Asia, with China pushing for her yuan to be more accepted for international trade settlement. But having had little alternative China itself has maintained large dollar reserves. Russia, which earns dollars through energy exports has been pursuing a policy of adding to its gold reserves at the expense of dollars. Iran has been frozen out of dollars. With the exception of India — which is fence-sitting with not enough gold at the state level and with a history of strongly pro-Keynesian economic policies — the Shanghai Cooperation Organisation, its associate and observer members, are firmly in China’s camp with a growing preference for gold and yuan for their foreign reserves.
While the dollar still dominates international trade settlement, the Asian tide is turning against it. The big dollar earners, and therefore funders of US Government debt, are based in the region. In particular, China has changed her approach from exporting to America to placing a greater emphasis on encouraging her consumers to consume. In doing so, she has changed her currency intervention policy, allowing the yuan to rise against the dollar. At the same time, she has sold dollars for stockpiles of raw and industrial metals, sending a clear signal where her preferences lie, and that she is a further seller of dollars and dollar bonds.
China is emerging as the new key player in an American hegemonic world, deserting the dollar and dollar denominated debt while the rest of the world is awash with dollars. Couple this with the prospect of an accelerating dollar supply as the trade deficit grows, being twin to the US budget deficit, and a dollar crisis is in the making.
In certain respects, the dollar is in the same position as the Icelandic kroner in 2008. Two years before, Iceland’s trade deficit had shot up to 20% of GDP, and led by Fitch, rating agencies began to change their ratings to negative. Previously available financing became more expensive. And when the Lehman crisis hit, global economic confidence in Iceland evaporated and banks, attempting to preserve their own balances sheets and liquidity, suddenly attempted to withdraw their exposure to Iceland.
Iceland’s three major banks were massively overextended, having balance sheet assets about ten times Iceland’s GDP. Even though their balance sheets were denominated in króna, their funding was predominantly in foreign currencies, and it was the withdrawal of this funding that collapsed the banks and the króna. Today, US funding is denominated in dollars, but since America began to rely on the maintenance of its balance of payments (i.e. trade deficits covered by inward foreign investment), like Iceland before the Lehman crisis funding it has become dependent on foreign investment.
As well as this underlying fragility for the dollar, there can be little doubt that current economic conditions are adding to the problems of foreign and domestic banks operating in dollar markets, and that a periodic crisis from a contraction of bank credit is overdue. If liquidity injections by the Fed into the repo market in September 2019 had not rescued banks from an impending liquidity crisis, a banking crisis would almost certainly be upon us by now. But since then, the situation has worsened considerably, requiring the Fed to dramatically expand its balance sheet to create extra bank reserves.
Just as Fitch rang the bell on Iceland’s crisis, one wonders at what point rating agencies will realise that the US trade deficit is now rapidly expanding and downgrade the US economic outlook. The figures are stark: the budget deficit for 2020 was estimated at $3.3 trillion — about 17% of GDP. Given there is a timing lag between the inflationary funding of a budget deficit and its re-emergence as a trade deficit, the trend emerging in the St Louis. FRED chart below is only a start.
It will shortly become clear that official estimates that the US Government’s funding deficit will stabilise later in the current fiscal year are wide of the mark. The Congressional Budget Office estimated the current 2021 fiscal deficit will be $1.81 trillion before the second coronavirus wave. That will almost certainly be a considerable underestimate. It must be admitted that other major currencies face similar problems from rapidly escalating budget deficits, but it is with dollars that the greatest imbalances lie.
To the current estimates of foreign ownership of dollars must be added the bulk of trade deficits yet to percolate through from last year’s fiscal deficit and all of the current fiscal year. The danger is that corporate treasurers in non-US multinationals will wake up to this overload of dollars at the same time and act accordingly — just as the international banks did following the Lehman Crisis with Iceland. (The krona crashed from the official peg, at 131 to the euro on 7 October 2008, to 340 in about a month.)
For now, it is inconceivable to forex traders that the dollar could suffer such a fall. Yet, the dynamics are there for them to wake up one morning and turn from complacency to panic. Whether a panic will happen out of the blue or triggered by systemic failures in payment or production chains, we shall only know in due course. For now, we can only know that a cliff edge exists.
The domestic outlook
As noted above, domestic consumers’ motivations are very different from those of actors in the foreign exchanges. After putting aside savings — today almost entirely comprised of mandated contributions into pensions schemes and insurance policies — they maintain a balance between liquidity available for spending and the purchase of goods. Changes in this balance by the population as a whole have a profound impact on prices.
Since 23 March, when the Fed’s monetary expansion was reset into hyperdrive, the sum of cash, checking and savings accounts at the banks held by domestic residents increased by just under 20% to $17.4 trillion at end-September. These balances are split between corporates and individuals, financial and non-financials, residents and foreigners. While the amounts that ended up in domestic consumers’ hands and their bank accounts cannot be known, the fact that the first stimulus included a direct cash injection into every adult’s bank account of $1200 adds to their cash balances relative to their purchases of goods. But this is only one aspect of the $2.2 trillion CARES Act, which aims to help individuals and businesses cope with the pandemic’s financial consequences.
While some people will use government sourced money to pay down debt or add to their liquidity balances, this is not typical behaviour. When economic conditions worsen, of which there can now be no doubt, not only will the bulk of the inducement to consumers to spend be spent as intended, but they will also tend to reduce their liquidity balances in favour of goods. This is because deteriorating economic conditions inevitably lead to lower cash balances being maintained. If these conditions persist, further reductions in the ratio of dollar liquidity to goods commonly purchased will simply undermine the purchasing power of the dollar to the point where it is no longer used as a medium of exchange.
These conditions are set to persist and develop with no prospect of an offsetting and sustained demand for dollars from foreign sources. Even before all the CARES Act funds have been spent, a further package is expected, to be paid for again by monetary inflation. It is quite possible that a further contribution to consumers’ bank balances will end up accelerating the disposal of money for goods, not only undermining the dollar’s purchasing power at a greater pace than the monetary expansion would suggest is reasonable, but it will intensify the feedback loops which make the inflationary degeneration almost impossible to stop.
In a modern financial economy, the first evidence of the adjustment to lower personal cash balances is seen in the increased prices of financial assets, with the exception of fixed interest bonds. Cryptocurrencies, equity markets, monetary metals, commodities and raw materials are all rising in price, a condition that can only occur as the result of monetary debasement. It is evidence that those that can are already dumping dollars for financial assets, which raises the question as to the effect on the dollar’s purchasing power of the next dose of monetary inflation…
Interest rates
When economic actors realise that monetary debasement is not a lone episode and will continue, a lender will take into account his estimation of the future depreciation of the money’s purchasing power up to when it is due to be repaid. This is the basis of time preference. Equally, a borrower will understand that when a loan matures its value expressed in goods will be somewhat lower, yielding a benefit to him. An understanding of this condition, whereby a fall in the currency’s purchasing power favours borrowers at the expense of savers needs no further explanation.
The conditions today add some complexity to this basic proposition. Thinking they are stimulating economic activity, central banks intervene to suppress interest rates, increasing the transfer of wealth from lenders to borrowers. The trick requires government statisticians to supress the evidence of increases in the general level of prices to allow capital to circulate between lenders and borrowers at suppressed interest rates.
Central banks have been pursuing policies of suppressing interest rates since the 1980s, when led by the Fed and the Bank of England, the US and UK economies began to be moved from a production to a financial basis. The financialisation of economic activity has had the effect of increasing the control of central banks over their economies, a power that has not been used wisely.
With that power has come a belief that monetary planning is the solution to everything. And as each policy step has failed in its objective, the suppression of interest rates has even taken them into negative nominal territory. Far from economic stimulation it has turned into a policy cul-de-sac; a brick wall beyond which no policy maker can travel. Because of financialisation, which has now made Wall Street considerably more important than Main Street, in economic terms the global interest rate structure has become so distorted that the rates at which savers will lend to borrowers no longer appear to matter. But with interest rate policies unable to suppress rates any further, they are finally beginning to rise. This is shown in Figure 2, of the benchmark US Treasury 10-year bond yield.
Rising yields for the benchmark 10-year UST is an early sign that the Fed is losing control over interest rates at the short end of the yield curve. Already, other than mandated pension and insurance funds, the only significant buyer of US Treasuries at these suppressed yields is the Fed.
The Fed is making the mistake of believing that having lowered its funds rate to zero and therefore the cost of borrowing they will stimulate economic activity. In fact, they stifle it, because no one in their right minds will lend money on terms where they are bound to lose. As this message becomes more widely understood and both domestic and foreign holders of dollars dispose of them instead of lending them, interest rates will rise irrespective of the Fed’s interest rate policies. They will need to rise to the level where economic actors feel they will be compensated for dollar debasement.
And here is the trap: raise the interest rate and government finances become completely undermined. The true cost of interest rate policies which support zombie corporations will also become apparent when they rise. Not only will inflationary funding become more expensive for all governments, not only will bad debts in the banking system suddenly emerge like a monster from the deep, but the increasing pace of transfers of wealth between the productive economy to the government and from saver to borrower will reveal how monetary inflation has hollowed out all aspects of the economy.
Faced with this prospect, the Fed will almost certainly refuse to raise rates sufficiently, and the dollar will continue to sink. But perhaps the decision will be taken from them: collapsing government bond prices will signal the game is up and the dollar, the reflection of full faith and credit in the US Government, will be on the way to extinction.
