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Blinded By The Money Illusion

Author, Editor, Founder, and Executive Director @
July 5, 2017

Contrarians Heading For The Woods After Yellen's "Not In Our Lifetimes" Comment

"Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we're much safer and I hope that it will not be in our lifetimes and I don't believe it will be." – Fed chair Janet Yellen

With those words, Janet Yellen put investors around the world on notice, though probably not in the way she intended. In the past, such smug assurances have been enough to send contrarian villagers heading for the safety of the near-by woods. The informed student of financial history knows that panics, manias, crashes and collapses are as common to investment markets as thunderstorms are to placid summer afternoons. To think that suddenly we have banished their recurrence for "our lifetimes" smacks of the kind of misguided hubris that contributed directly to the 2008 meltdown and subsequent untold financial hardship. Just about the time most everyone came to the conclusion nothing could go wrong, everything went wrong…and in a hurry.

So why now? Why the sudden and unexpected reassurances about market stability from America's central bank? Is something brewing behind the scenes that required an investor pep talk?

Central Bank Balance Sheet Liquidations: A Little-Understood Threat To Market Stability

One specter haunting central bankers, not just in the United States but around the world, is what to do with all the assets that have built up on central bank balance sheets in recent years through various quantitative easing programs. Reminiscent of the taper tantrum that shook the U.S. financial scene in 2013, markets were sent reeling in Europe recently when the ECB's Mario Draghi and BoE's Mark Carney mentioned that something will need to be done to trim central bank balance sheets.

A recent Financial Times article ("End of cheap money leaves central bankers lost for words") adds some insight to the dilemma facing central bankers:

"For seasoned hands such as Peter Praet, the ECB’s chief economist, the experience highlights his warnings earlier this year that central bankers should not say too much too soon about the details of its exit strategy. The chief economist cautioned that markets had become 'particularly sensitive to any perceived change in the future course of monetary policy'.

Mr Praet and others fear that revealing too much detail would undo much of the support QE has provided to the eurozone economy and send borrowing costs for governments and businesses soaring. Those fears are based in large part on the dramatic sell-off in markets that accompanied the US’s Federal Reserve’s musing about plans to end its QE programme in 2013."

The Federal Reserve has gone to great lengths to emphasize that any liquidation of its assets would be gradual and conducted with a keen sense of how such operations might affect the stock and bond markets. Still, no one knows for certain how the markets will be affected once the process actually begins.

In a piece of analysis that makes a great deal of sense, Lee Adler, editor of the widely-followed newsletter, The Wall Street Examiner, concludes that the effects will be strictly deflationary:

"Measures of speculative financial lending for the purposes of financial engineering have signaled that the game is over. But they have not yet signaled that collapse is imminent. We should start to see those signs once the Fed actually begins the process of shedding assets. That will force the Treasury to sell additional debt to the public to pay off the Fed for the bonds it is redeeming. That supply will pressure the market.

As that occurs, money will begin to be extinguished. Money supply growth will slow or even shrink. Bank lending for financial speculation will all but disappear. There will be downward pressure on bond prices with the mirror image rise in bond yields and short term interest rates. Likewise, stocks will also come under increasing liquidation pressure."

Perhaps it is unsettling scenarios like Adler's that pre-occupy the Fed chair's thinking and prompted the soothsaying. As long as central bank balance sheet liquidations hang like a sword of Damocles over the marketplace, instability will be woven into the market context, even if it is not reflected in the vaunted, but probably flawed, volatility index. Few understand the forces roiling below the seemingly placid surface and the potential consequences once the central bank balance sheet volcano springs to life.

Why Were So Many Blinded By The Money Illusion?

Gold ownership is traditionally a form of battening down the hatches against these recurring financial storms and, for the minority who adhere to it, is an effective and ever-ready defense. Nialls Ferguson, the economic philosopher, summed up what a good many were thinking in the wake of the 2008 meltdown when he said: "Those few goldbugs who always doubted the soundness of fiat money – paper currency without a metal anchor – have in large measure been vindicated. But why were the rest of us so blinded by money illusion?"

Why indeed…and why, pray tell, are so many blinded by it now?


"You say: 'I did not think it would happen.' Do you think there is anything that will not happen, when you know that it is possible to happen, when you see that it has already happened?" – Seneca

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A chronology of panics, manias, crashes and collapses
(377 BC to present)

Sovereign Default of 400 BC (Syracuse, Greece) - Dionysius confiscated gold and silver money, re-minted it keeping the weight the same but changed the denomination from one to two drachmae -- the first known official devaluation at the expense of the general population. A virulent inflation ensues.

Sovereign Default of 377 BC (Ephesus, Greece) - Gold and silver jewelry confiscated to pay budgetary deficit and avoid a collapse of the city-state, no compensation is paid to owners (reported by Aristotle).

Punic Wars Inflation of 241-146 BC (Rome) - Continuous debasement of gold and silver coinage to pay for wars against Carthage. Wealthy classes of savers, who saved in the form of metal, suffered the greatest losses; heavily indebted masses did not object.

Sovereign Default of circa 200 BC (Miletus, Greece) - Economic depression, first instance of forced public bond subscription by citizens to pay the debts of the bankrupt city-state.

Inflation Crisis of 64 AD (Rome) - Emperor Nero debased gold, silver and copper coinage as an indirect tax on Roman savers. Policy ignited inflation and caused general impoverishment of the lower classes. This same devaluation tactic was used repeatedly by emperors during Rome's decline and fall.

Inflation Crisis of 301 (Rome) - Emperor Diocletian minted an overvalued silver denarius and touched off a rapid and devastating price inflation, then speculative frenzy and social chaos.

Inflation Crisis of 1020 (China) - One of the first paper money-printing schemes (S'ung Dynasty) to buy off potential invaders that led to rapid inflation.

(Note: China's Cai Lun invented paper in 105 AD, so it is fitting that China would introduce the first paper banknotes in 806 AD. Upon Marco Polo's return from China, he described its use as money: "All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver; and on every piece a variety of officials, whose duty it is, have to write their names, and to put their seals. And when all is duly prepared, the chief officer deputed by the Khan smears the Seal entrusted to him with vermilion, and impresses it on the paper, so that the form of the Seal remains printed upon it in red; the Money is then authentic. Anyone forging it would be punished with death." It would follow too that the first abuses in the printing of paper money would occur where it was first issued.)

Hyperinflationary Crisis of 1166 (China) - Money printing scheme (Chin Dynasty) based on government monopoly of tea and salt to pay for war against Mongols led to hyperinflationary breakdown.

Inflation Crisis of 1296, 1309, 1350 and 1374 (China) -- Series of inflationary crises related to debased currency issuance by various dynasties, explosive credit and subsequent economic breakdowns.

Inflation Crisis of 1455 (China) - Excess issuance of paper money caused inflation to soar, paper currency eliminated as the means of payment for several hundred years.

Medici Bank Collapse of 1494 (Florence, Italy) - Corruption, faulty investment, political intrigue and incompetent management brought down the famed Florentine bank -- millions lost resulting in tyrannical taxes imposed on citizenry.

Inflation of 1520-1640 (Spain, Europe) - Gold and silver from the New World drove down the value of money leading to Europe-wide hyperinflation. Spain defaulted on its sovereign debts in 1557, 1560, 1575 and 1596.

Tipper and See-Saw Debt Crisis of 1621 (Holy Roman Empire) - States in Europe minted debased coinage that touched off an inflationary nightmare resulting in widespread riots, political instability and crippled economies.

Tulipmania of 1637 (Netherlands) - Speculative frenzy in tulip bulbs ruined thousands when the bubble burst.

South Sea Bubble of 1720 (Great Britain) – Collapse of inflated shares in the South Sea Company ruined investors; value depended on individuals willing to pay ever higher prices for shares, not company- generated profit.

Mississippi Bubble of 1720 (France) – Financial crisis and paper money scheme perpetrated by John Law based on exaggerated wealth and trade opportunities in Louisiana. French economy collapsed when the bubble burst.

Crisis of 1772 (Great Britain) - Triggered by the collapse of a major London banking house.

Continental Currency Failure of 1779 (United States) - America's first currency collapsed, George Washington complained that a "wagon load of money will scarcely purchase a wagon load of goods". Spanish silver dollar purchased 1.25 Continentals in 1777 and 500 Continentals in 1781.

Fiat Money Inflation of 1789 (France) – Over-issuance of paper money plunged nation into decade-long inflationary crisis leading ultimately to the French Revolution.

Panic of 1792 (United States) - Brought on by credit expansion of newly formed Bank of the United States and rampant speculation by prominent bankers.

Panic of 1796 (United States, Great Britain) - Precipitated by collapse of inflated land prices.

Debt Panic of 1813 (Denmark) – Early sovereign default created internal financial crisis.

Panic of 1819 (United States) – End to first American boom-bust economic cycle fueled by unrestrained issuance of paper money through the Second Bank of the United States; encouraged speculation resulted in financial disaster.

Panic of 1825 (Great Britain) – Stock market crashed due to widespread failure of British banks, near collapse of the Bank of England.

Panic of 1837 (United States)– Deflationary breakdown in the United States caused 25% unemployment rate, bank collapses, business failures.

Panic of 1847 (Great Britain) – Financial markets collapsed following 1840s railroad boom with similar effects to the Panic of 1837. Specie standard reinstituted as a result.

Panic of 1857 (Global) – First pervasive international economic breakdown. New York financial sector did not recover until after the Civil War Panic of 1866.

Panic of 1873 (United States, Europe) – So-called "Long Depression" lasting twenty years started with financial failures in Vienna and spread to rest of Europe and finally the U.S., resulting in widespread bank failures and railroad bankruptcies.

Panic of 1884 (United States) – Caused by tight credit following depletion of gold reserves in Europe and the failure of two New York City banks with ripple effect to other banks.

Panic of 1890 (Great Britain) – Crisis triggered when Barings Bank nearly went bankrupt due to poor investments in Argentina. Bank of France bailed out British central bank.

Panic of 1893 (United States)– Gilded Age collapse and stock market collapse similar to 1873 triggered by shaky railroad investments and a coup in Argentina. Also caused a run on gold at the U.S. Treasury.

Panic of 1896 (United States)– Commodity price deflation and a drop in U.S. silver reserves caused stock market collapse and minor economic depression.

Panic of 1901 (United States) – First crash on the New York Stock Exchange precipitated once again by speculation in railroad stocks.

Panic of 1907 (United States) – Major banking panic, run on deposits, stock market collapse (many feel that this panic led ultimately to the creation of the Federal Reserve System). JP Morgan organized bank bailout to keep financial failure contained.

Panic of 1910–1911 – The after-effects of the Sherman Anti-Trust Act, the break-up of Standard Oil caused slight depression.

Nightmare Hyperinflation of 1923 (Germany) - Inflation rate hit 3,250,000% per month at its peak, many blamed World War I reparations as the cause of the money printing binge that brought on the crisis. (Note: Similar hyperinflationary crises, though not as severe, occurred during the 1920s in Hungary, Poland, Austria and the Soviet Union.)

Wall Street Crash of 1929 (United States, Global) – The most devastating stock market crash in U.S. history launched the Great Depression of the 1930s.

Nightmare Hyperinflation of 1944 (Greece) - Started with the German occupation and reached its peak after liberation. Citizens refused to accept the Drachma in commerce; the country became impoverished.

Nightmare Hyperinflation of 1946 (Hungary) - Worst inflation ever recorded; prices doubled every fifteen hours wiping out savings.

Stagflation Crisis of  1973 (United States, Global) – Global double-digit inflation rates and high unemployment caused by decoupling gold from the dollar and two associated dollar devaluations (1971, 1973).

Debt Crisis of 1982 (Latin America) – Excessive external debt triggered most serious capital crisis in Latin American histor. Currency devaluations and sovereign debt defaults followed.

Stock Market Crash of 1987 (Global) - Began in Hong Kong, spread to Europe and then the United States, the largest one-day percentage decline in history of Dow Jones Industrial Average (called Black Monday).

S&L Crisis of 1989-1991 (United States) – Nearly one-fourth of U.S. savings and loan associations failed as the result of bad real estate loans and brought on a mirror real estate crash and disinflationary economic environment.

Asset Bubble of 1990 (Japan) – Stock and real estate prices crashed launching Japan’s Lost Decade, deflationary/disinflationary crisis largely confined to Japan.

Scandinavian Banking Crisis of 1990 (Sweden, Finland) –  Currency and financial institution breakdown, real estate bust.

Pound Sterling Crisis of 1992–93 (Great Britain) – Speculative attack on British pound forced UK’s withdrawal from European Exchange Rate Mechanism and caused recession.

“Tequila Crisis” of 1994 (Mexico) – Sudden devaluation of peso touched off high inflation,  asset destruction, bank runs and  controversial bailout by the United States government.

Financial Crisis of 1997 (Asia) – Financial contagion affected several Asian nations, including stock market collapses, high inflation and unemployment, real estate busts and a general financial panic.

Monetary Crisis of 1998 (Russia) – Russia devalued ruble, defaulted on its debts with knock-on effects globally, including an 11.5% drop in the Dow Jones Industrial Average in three trading sessions and the collapse of Long Term Capital Management.

Economic Collapse of 1999 (Argentina) – Government defaulted on sovereign debts causing bank runs, riots, capital flight. Overnight, the government froze all bank accounts for 12 months. The economy ground to a virtual halt.

Dot-com Bubble Bust of 2001 (United States) – Internet stock speculative frenzy ended in tech stock market collapse and general market malaise that lasted for over a decade. Helped launch gold’s secular bull market.

Bank Crisis of 2008 (Iceland) - Banks’ collapse caused depositor run, sharp drop in value of Icelandic kronor.

Nightmare Hyperinflation of 2008 (Zimbabwe) - The worst 21st century hyperinflation thus far, a 79.6 billion per cent annual inflation rate at its peak in 2008.

Financial Crisis of 2008 (United States, Global) – Near collapse of global financial system caused extensive, widespread government bailouts and strong international safe-haven gold demand among private investors, institutions and central banks.

Sovereign Debt Crisis of 2010 (European Union) – Began in Greece and spread through most of Europe. Ongoing crisis precipitated fear among global investors about stability of Europe’s banking system and the Euro currency bloc.


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A little USAGOLD history. . . .Pictured are News & Views hard copies from 1999 just before gold began its secular bull market. News & Views first made its appearance at a time when gold-based publications were few and far between. The "Big Breakout" headlined in the November, 1999 issue refers to a price jump from $260 to $330 per ounce. Your editor sees a good many similarities between that period and now.

Michael J. Kosares is the founder of USAGOLD and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold." He has over forty years of experience in the physical gold business. He is also the editor of News & Views, the firm's newsletter which is offered free of charge and specializes in issues and opinion of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.

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Michael J. Kosares has over 40 years’ experience in the gold business. He is the founder and executive director of USAGOLD (both the website and gold brokerage service), the author of three books on the gold market, and the editor of "News, Commentary & Analysis," the firm's client letter. He has written numerous magazine and internet essays and is well-known for his ongoing commentary on the gold market and its economic, political and financial underpinnings. 

China is the world’s biggest gold producer with more than 355 tons annually. Australia is second.
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