first majestic silver

Broken Markets And Fragile Currencies

Author & Head of Research @ Goldmoney
July 5, 2019

There are growing signs that the global economic slowdown is for real. As was the case in 1929, the combination of the peak of the credit cycle coupled with trade protectionism in the Smoot-Hawley Tariff Act are similar conditions to those of today and potentially pose a serious economic challenge to the post-Bretton Woods fiat currency system. Therefore, we must consider the consequences if monetary policy fails to contain the developing recession and it turns into a full-blown slump. Complacency over broken markets is no longer an option, with rising prices for gold and bitcoin signalling the prospect of a new round of currency debasement to avoid market distortions unwinding. This article shows why this outcome could undermine fiat currencies entirely and looks at the alternatives of bitcoin and gold in this context.


Never in all recorded history have financial markets been so distorted everywhere. In our lifetimes we have seen the USSR and also China under Mao attempt to do without markets altogether and fail, having starved and slaughtered millions of their citizens in the process. The Romans started a long period of currency debasement, lasting from Nero to Diocletian, who wrote prices in stone (the origin of the phrase) in a vain attempt to control them. While the Roman Empire was the known world at the time, it was essentially restricted to the Mediterranean and Europe. Subsequently, there have been over fifty instances recorded of complete monetary collapse, the vast majority in the last hundred years, which have led to the breakdown of every society involved. And now we could be facing a global totality, the grand-daddy of them all.

We have become inured to cycles of credit expansion, driven by fractional reserve banking at least since the Bank Charter Act of 1844, which legalised fractional reserve banking. Extra impetus was given by central banks from the 1920s onwards. We have become so used to it that we now expect central banks to issue and control our money and only get really worried when we think they might lose control. In their efforts to satisfy the mandate they have assumed for themselves central banks intervene more and more with every credit cycle.

Our complacency extends to prices, especially regarding the exchange and valuation of capital assets. There are now about $13 trillion of bonds in issue with negative yields. We rarely think in any depth about this strangeness, but negative yields are never the consequence of market pricing free from monopolistic distortions. The ECB, the Bank of Japan and the Swiss National Bank all impose negative interest rates, as well as Sweden’s Riksbank and Denmark’s Nationalbank. The ECB commands the currency and finances of the largest economic area in the world and the BoJ the third largest national economy. In Denmark, mortgage lenders are even offering negative-yield mortgages: in other words, Danes are being paid to take out loans with negative interest rates. Ten-year government bonds issued by Germany, Japan, Sweden and even by France have negative yields. All Danish government bonds have negative yields.

Negative yields stand time-preference on its head. Time-preference refers to the fact that we prefer current possession to future possession, for obvious reasons. So, when we part with our money we always do so at a discount to expected repayment, which is reflected in a positive rate of interest. The idea that anyone parts with money to get less back at a future date is simply nuts.

It gets even more bizarre. The French government has debts roughly equal to France’s GDP and by any analysis is not a very good credit risk, but it is now being paid by lenders to borrow. Only forty per cent of her economy is the productive tax base for a spendthrift, business-emasculating government. An independent observer evaluating French government debt would be hard put to classify it as investment grade in the proper meaning of the term. But not according to bond markets, and not according to the rating agencies which today’s investors slavishly follow.

There are a number of explanations for this madness. Besides complacency and misplaced investor psychology, the most obvious distortion is regulation. Investors, particularly pension funds and insurance companies are forced by their regulators to invest nearly all their funds in regulated investments. Their compliance officers, who are effectively state-sponsored bureaucrats, control the investment decision process. Portfolio managers have become patsies, managing capital with little option but to comply.

Additionally, with their highly-geared balance sheets state-licenced banks complying with Basel II and III are also corralled into “riskless” assets, which according to the regulators are government debt. The rating agencies play along with the fiction. For example, Moody’s rates France as Aa2, high quality and subject to very low credit risk. This is for a country without its own currency to inflate to repay debt. Low enough for negative yields? Low enough to be paid to borrow?

In Japan, the country’s government debt to GDP ratio is now over 250%. The Bank of Japan maintains a target rate of minus 0.1%, and the 10-year government bond yield is minus 0.16%, making the yield curve negative even in negative territory. It doesn’t stop there, with the Bank of Japan having bought 5.6 trillion yen ($52bn) of equity ETFs last year. This takes its total equity investment to 29 trillion yen ($271bn), representing 5% of the Tokyo Stock Exchange’s First Section. Last year’s purchases absorbed all foreign selling of Japanese equities, so they were clearly aimed at rigging the equity market, rather than some sort of monetary manoeuvre.

It’s not only the Bank of Japan, but the National Bank of Switzerland has been at it as well. According to its Annual Report and Accounts, at end-2018 it held CHF156bn in equities worldwide ($159bn), being 21% of its foreign reserves. We can see the direction central bank reserve policy is now heading and should not be surprised to see equity purchases become a wide-spread means of rigging stockmarkets and expanding base money.

Sovereign wealth funds, which are government funds that owe their origin to monetary inflation through the foreign exchanges, have invested a cumulative total of nearly $2 trillion dollars in listed equities. While this is only 2.5% of total market capitalisation of listed securities world-wide, they are a significant element in marginal pricing, more so in some markets than others.

Between them, central banks and sovereign wealth funds that are buying equities in increasing quantities further the scope of quantitative easing. The precedent is now there. Economists in the central banking community now have a basis for drafting erudite neo-Keynesian papers on the subject, giving cover for policy makers to take even more radical steps to pursue their interventions.

By all these methods, state control of regulated public and private sector funds coupled with the expansion of bank credit has cheapened government borrowing, and it would appear that governments are now enabled to issue limitless quantities of zero or negative-yielding debt. So long as enough money and credit is fed into one end of the sausage machine, it emerges as costless finance from the other. Never mind the destruction wreaked on key private sector investors, such as pension funds, whose actuarial deficits are already in crisis: that is a problem for later. Never mind the destruction of insurance fund finances, where premiums are normally supplemented by healthy bond portfolio returns. Just blame the insurance companies for charging higher premiums.

This is now the key question: are we entering a new phase of low-inflation managed capitalism, or are we tipping into a mega-crisis, possibly systemically destructive?

If the latter, there’s a lot to go horribly wrong. The Bank for International Settlements, the central banks’ central bank, is certainly worried. Only this week, it released its annual economic report, in which it said, “monetary policy can no longer be the main engine for economic growth.” Clearly whistling to keep our spirits up, it calls for structural reforms to boost government spending on infrastructure. Translated, the BIS is saying little more can be achieved by easing monetary policy, so Presidents and Prime Ministers, it’s over to you. You can create savings by making government more efficient and you can spend more on infrastructure.

While the BIS washes it hands of the problem, history and reason tell us increased state involvement in economic outcomes will only make things worse. It is in the nature of government bureaucracy to be economically wasteful, because its primary purpose is not the efficient use of capital resources. And while the outcome, be it a new high-speed railway or a bridge to nowhere may be a visible result, it fails to account for the true cost to the economy of diverting economic resources from what is actually demanded.

Heed the message from the credit cycle

Bullish investors should note that we are already far down the path of our economic decline, which gives a fundamental falsity to financial valuations. Following the Lehman crisis, the expansion of money and credit fed into asset inflation, creating an illusion of improving business prospects. The suppression of interest rates was the come-on to businesses to invest in production. The government’s budget deficit created extra spending as a further encouragement. The government’s economists say it’s all down to reviving those animal spirits. But they have been encouraging businesses to chase a mirage, which as they progress towards it always seems that little bit further away, until it finally disappears altogether. Businesses that relied on the state’s mirage now find it is just an illusion.

For those of us struggling to preserve our savings the effect of monetary inflation on financial prices is the reality that matters. The purchasing power of the currency in which we measure our savings is a commonly neglected consideration, an issue of added importance at times of high monetary inflation. Unfortunately, it is an effect that cannot be measured, but it doesn’t stop statisticians from persuading us that they can. Even though they are accepted by financial analysts without any reservation, government statistics on price inflation have underplayed the progressive impoverishment of productive consumers by monetary debasement. Since this dishonourable manipulation of statistics was adopted, governments have been faced with a stark choice: either they confess to the deceit and protect the currency from further debasement, or like every Roman Emperor who followed Nero, continue to debauch the currency so long as there are suckers to believe in it.

The growing dishonesty of statistical manipulation over time is an additional factor to take into account when observing successive credit cycles. They are part of a policy of concealing the fact that they are getting worse, when the official line is otherwise: policy-makers claim to be improving their control over the excesses of the markets by supressing evidence to the contrary.

Credit cycles have been generally worsening, at least since the inflationary crisis of the 1970s, which followed the abandonment of the Bretton Woods Agreement in 1971. Central banks have debauched their currencies increasingly over successive credit cycles, building up to an inevitable apocalyptic crash. The approaching one could be our global totality, the grand-daddy of them all.

Those of us not wrapped up in the illusion of modern monetary theory and Keynesian and monetarist claptrap have always know it will happen one day. The collapse of the Bretton Woods Agreement was an event in a larger cycle of government intervention and failure. Von Mises knew it would happen, and he explained why in his The Theory of Money and Credit, first published in German over one hundred years ago. Ten years before it happened, he predicted the collapse of the mark and other European currencies in the early 1920s. Since then, we have proved that collectively we have learned little.

It’s like living on the slopes of a volcano, knowing it is certain to erupt one day. The optimists are betting that the growing mountain of negative-yielding debt is not the apocalypse’s calling-card.

Trade protection and the credit cycle

So far, I have described the worrying imbalances in financial markets, evidenced in this credit cycle by growing quantities of negative-yielding debt. But last year, an additional problem arose through American trade tariffs, which now combine with the top of the credit cycle.

I have written about this before, so will only summarise the main point here. In 1929, the Smoot-Hawley Tariff Act was legislated at the end of the 1920s credit expansion, and it was the combination of the two that changed the similarly benign conditions of the 1920s to those of today into the 1929 crash and the depression that followed. Undoubtedly, there were other factors that made the situation worse than it otherwise would have been, principally President Hoover’s disastrous attempts to intervene in the economy. Today, government intervention is far more pervasive, and has the potential to make things even worse.

It must not be assumed that today’s stock markets will fall by nine-tenths, as was the case between 1929-32. Through the medium of dollar, in those days prices were effectively measured in gold at the fixed rate of $20.67 to the ounce. Today, currencies are totally fiat, and the price of any financial asset will reflect changes in value from the money side as well as from the asset itself. However, stocks are still likely to be liquidated in a serious downturn. Added to this today is a potential ETF problem, where investors’ only attachment is to bullish stockmarkets and not individual investments. As soon as the public wake up to changed market conditions we can expect them to liquidate index-tracking ETFs.

By all appearances, in its early days the ending of a prolonged period of credit expansion is turning out for investors to be no worse than a normal downturn – nothing monetary policy can’t fix. It is certainly possible the can will be kicked down the road just one more time. If that fails, a second phase of investor psychology will anticipate a deepening of the global recession and a realisation that monetary policy is failing to stop it. Equity markets should then begin to fall in earnest. Property prices can be expected to follow, perhaps declining heavily given the leverage of mortgage debt. So far, so conventional.

If it happens, almost certainly there will be a financial abyss into which we will all stare. We have seen it before: in January 1975 in the UK, it was after the stockmarket had fallen 73% from its 1972 peak. There was a similar moment in America in 2002, when Alan Greenspan turned it round. And during the great financial crisis, there was another moment, still fresh in our minds. Always, the solution was for the establishment, comprising the government, its central bank, the commercial banks and the pension and insurance funds to act together behind the scenes to restore confidence. We can be sure that government coercion to achieve the same revival of confidence will be tried again if the situation arises.

If an attempt to fully restore confidence fails to do more than provide a short-term fix, government finances will deteriorate further, and monetary inflation will be tried in even greater quantities than we have seen heretofore. Flooded with fiat money, most economies will then experience rising price inflation that can no longer be camouflaged by government statistics. To protect the currencies and reflect the markets’ increasing time-preference, higher interest rates will then surely follow.

In such an environment, the world’s banking system will be under enormous strain, and the risk of systemic failure will escalate. While it is never too late to look for alternatives to deposits in the banking system, it is far better to seek them before a crisis can be seen on the horizon. In the event that global fiat-money finances do deteriorate into a systemic crisis, the majority of people will be caught by surprise, having relied on the state to regulate greedy bankers and crony capitalists of all stripes.

Unfortunately, complacency and ignorance are no defence in the courts of human experience. The two alternative stores of value, whereby money can be taken out of a bank without queueing for physical cash, are through the purchase of secure cryptocurrencies such as bitcoin and metallic money - gold and silver. Their prices are already rising, perhaps reflecting shortening odds of the cataclysmic events described herein taking place.

For this reason, the merits and limitations of both should hold our interest.

Bitcoin, King of the cryptos

The more prescient individuals amongst us will have already taken out some insurance against the inevitable calamity von Mises described over a hundred years ago. Traditionally, this has meant portfolio exposure to precious metals. But in the last few years, we have observed an interesting development. The decentralisation of information through the internet has undermined government control of the media, particularly with respect to money.

The growing numbers of millennials now seeking the truth about money is a new phenomenon. They seek alternatives to state-issued currency, and are the driving force behind cryptocurrencies. The invention of a digital rival, bitcoin, along with other cryptocurrencies has profound implications for the hitherto unquestioning public acceptance of fiat currency.

Keynes wrote that:

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces on the side of destruction and does it in a manner which not one man in a million is able to diagnose.” (The Economic Consequences of the Peace, 1919).

With the new millennials, the ignorance of the masses upon which currency-issuing governments depend is being unexpectedly eroded. Through their interest in cryptocurrencies they have learned about the drawbacks of fiat currencies, and while their unconditional support for bitcoin and the like may be challenged, they realise that governments debauch currencies at their expense. For this reason, cryptocurrencies, particularly bitcoin, are a significant threat to state currencies.

The consequence may be to speed up the collapse of fiat currencies. Faith in fiat currencies is already being tested, which can be deduced from the performance of bitcoin’s price. Furthermore, if commercial banks become systemically threatened, we can expect to see rapidly increasing amounts of fiat deposits being exchanged by millennials for diminishing quantities of bitcoin.

The mistake observers of bitcoin often make is to disqualify it as money because it is volatile. What matters is not its use as a medium for transactions, but its ability to store value wholly protected from government intervention by virtue of its distributed ledger. Through their continual debasement and their tightening control over the use of fiat currencies, governments have created and fuelled the demand for bitcoin. And when it comes to security, bitcoin and its blockchain has survived all attempts to break them. It is in various service providers that the weaknesses lie, not in bitcoin and its blockchain.

Though they have shown interest in the blockchain, financial institutions are only now beginning to take notice of bitcoin itself, and pressure is mounting for it to be accepted as an investment asset. Regulated bitcoin futures contracts are being traded on Comex, and when other asset classes yield inadequate returns, pressure for financial institutions to invest in bitcoin should continue to increase.

While no one can predict how bitcoin prices will actually evolve, it is already becoming clear that its story has much left to tell. Interestingly, bitcoin’s recent dramatic price move has come at a time when the risk of a deepening and global economic recession appears to be increasing. It is not yet tangible evidence that bitcoin could accelerate the transfer of value away from fiat money, thereby undermining it, but it is food for thought.

Gold, the only money that survives all

In all history, its rarity, desirability and chemical stability tell us that gold is the most secure form of money. It is only in the advanced economies in the West, where we have fallen for decades of government propaganda that gold no longer has a monetary role, that people have forgotten its proven qualities as the ultimate money.

It stands to reason that as the purchasing-power of state-issued currencies is increasingly threatened by over-issuance, the west’s collective amnesia will be replaced by a reassessment of gold as the proven protection from collapsing fiat currencies. Despite the excitement generated by secure cryptocurrencies such as bitcoin, gold remains the refuge of choice for those concerned about an emerging post-fiat world, a world where even the internet and mobile communications risk being disrupted, rendering cryptocurrencies temporarily useless as transaction money.

Ahead of a collapse in fiat currencies, the most powerful argument in favour of both bitcoin and gold is their ability to store value. This is not the same as their role as currency, which becomes more important afterwards, when bitcoin cannot compete with gold. The transfer of bitcoin ownership is restricted to a daily rate of about 500,000 and is already running close to this capacity. For this reason, it can never replace conventional forms of instant exchange, unlike a gold coin. Only gold (and additionally silver) will offer both the store of value and cash-transaction functions demanded in a post-fiat world. The physical supply of gold will become central to its price relationship with failing fiat currencies, so a proper assessment of the stock of gold available as currency in a post-fiat world is essential.

Gold as money can be regarded as being in two categories. There are the reserves, held by central banks, which will be required to back note issues and electronic money when the fiat-money component of reserves become worthless. Additionally, there are gold bars and coins distributed in public ownership. The two quantities appear to be similar, as the following analysis demonstrates.

Of a total above-ground stock of physical gold, which at Goldmoney we estimate to be about 176,000 tonnes, perhaps 60% is used for jewellery and industrial purposes, leaving 70,400 tonnes, of which 34,024 tonnes are recorded as official reserves. However, it is almost certainly the case that nations, such as China, hold gold which is undeclared, and at the same time, not all official reserves are bullion, but bullion swapped and leased so are double-counted. Let us simplistically assume that these two quantities cancel each other out. That leaves an estimated 36,376 tonnes owned by the public as bar and coin, which together with official reserves we can regard as the gold money supply.

Strictly speaking, it is a mistake to include jewellery in Asia (where the bulk of it is held) as part of gold’s money supply. While it can easily be encashed close to melt value, in practice it is not held for this purpose. The flow of gold into jewellery tends to be a one-way phenomenon, where it is more likely to be used as collateral at Asian pawnshops for the purpose of bridge financing and capital spending, with the intention of being redeemed for fiat cash. Therefore, except in the case of a post-apocalyptic economic catastrophe, gold jewellery is not part of gold’s monetary flow. Significantly higher gold prices may change this, but for now gold jewellery should be regarded as its owners see it: a dependable asset to be held and passed on to successive generations.

The reason for belabouring the point is analysts mistakenly use estimates of total above-ground stock as gold’s money supply. It confuses a store of value with money available for transactions, the same confusion that leads advocates of cryptocurrencies to regard bitcoin as a circulating currency. Bitcoin can only circulate within the constraints of a distributed ledger, so its theoretical status is more akin to a form of digital jewellery, hoarded and not intended to be spent.

We can now compare the value of gold that will circulate as currency with the total of cash and bank deposits in fiat currencies held round the world. Internet searches tell us the world’s fiat money totals about $80 trillion, while the quantity of monetary gold as redefined above at current prices is worth $3.2 trillion, a ratio of 25 times. And that’s before any further expansion of fiat money is issued in an effort to stem a developing credit crisis.


It is very likely the recent strength in both gold and bitcoin is linked to changing perceptions of risk to the global economy. It has become increasingly clear in recent weeks that the coincidence of the end of the expansionary phase of the credit cycle coinciding with trade protectionism has damaged global trade very severely, and the effects are now extending into domestic economies. This being the case, we can expect a renewed acceleration of monetary inflation. While supporting government finances through new bouts of quantitative easing, the wealth-transfer effect of monetary inflation will increasingly undermine the productive economy.

That is why gold and bitcoin prices could turn out to be an early warning of an acceleration in the rate at which fiat currencies will lose purchasing-power. If leading nations through their central banks fail to protect their currencies, then these two alternatives to fiat currencies will have only just started to rise.

Alasdair Macleod


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Alasdair became a stockbroker in 1970 and a Member of the London Stock Exchange in 1974. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy. After 27 years in the City, Alasdair moved to Guernsey. He worked as a consultant at many offshore institutions and was an Executive Director at an offshore bank in Guernsey and Jersey.

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