We live in a world where all currencies are “fiat”, none backed by gold,
silver, oil or anything else. Yes of course the dollar, otherwise known
as the “petrodollar” has functioned and survived (so far) based on oil
revenues being recycled back into U.S. Treasury bonds, but this has been
changing over recent years. The change has accelerated greatly
over the last five years. This era of “fiat” everywhere and real money
nowhere is now 44 years long in the tooth and the very first time in human
history there was no alternative currency with a real foundation.
Before you tell me “the U.S. is the most powerful military nation in the
world, we don’t need no stinkin’ backing”, think this through. Though
for a time, this “arrangement” worked and no one could stand up to the U.S.,
is this still true? Can we impose our will with everyone and everywhere
on the planet? Or has our military technology been leapfrogged as
evidenced by the USS Donald Cook last year? Can’t countries just decide
to do business with each other …at the exclusion of the U.S. and use their
own currencies to settle? Isn’t this what has begun to happen with
China and other nations doing individual trade deals? Countries’ trade
moving away from the U.S. and away from using dollars is as simple as grade
school kids gravitating away from the schoolyard bully and deciding to play
in harmony amongst themselves.
This 44 year old experiment has always needed “confidence” to exist. At
first it worked because the U.S. was not over indebted and had plenty of room
to lever up or “reflate” if you will. We still had plenty of untapped
or unencumbered collateral left to borrow against, this is no longer so.
Once the 2nd Great Depression kicked off in 2007, the Treasury started to run
trillion dollar deficits and have now doubled our indebtedness. The
Federal Reserve has more than quadrupled their balance sheet to well over $4
trillion that sits on the head of an equity needle of less than $70 billion,
they are THE largest and most leveraged hedge fund in the world! The
monetary lunacy by no means is confined to the U.S., it spans the globe and
is practiced everywhere. Europe and Japan’s central banks have done the
same, so has China to some extent but with a couple of large caveats.
In order to have monetary confidence, there are two prime necessities,
collateral and credibility. In other words, who wants to do business
with a bankrupt or someone who cheats or lies? Any business partner or
someone you will do business with must be both solvent and
truthful, neither of these conditions still exist in the
big three monetary nations of the West. Each and every year since 2011
we have been told the Federal Reserve would end QE, begin to tighten and thus
normalize interest rates. As I have written several times before, the
Fed cannot ever raise interest rates again, this would destroy
derivatives, the economy, the Fed’s own balance sheet and create a situation
where tax revenues would not be enough to pay the interest on federal
debt. Raising rates is not an option. Unfortunately, it is the
same situation in both Europe and Japan, they have no options left
either. Japan began a very outsized QE operation last year
while the ECB began theirs just two months ago.
Both of these central banks are running into the same problem the Fed did,
namely they are and have already taken too much collateral out of the
system. “Collateral” is what underlies the shadow banking system’s
ability to lend, without it credit dries up. It is so bad in Japan that
the BOJ is buying more treasuries than are even issued. Not only are
they at 100% monetization, they are beyond this. In Europe, the
situation is so bad that market participants don’t expect a tightening until
2020, (we’ll never get there). This is the reason for the euro’s recent
marked weakness, the realization of how poor business really is and the lack
of any options available.
My point for writing this very basic (maybe even boring) piece is to
remind those who have been distracted by the propaganda. The bottom
line is this, the collateral necessary for the “grand plan” of reflation does
not exist. The available collateral has already been encumbered and
used in previous efforts. The answer, which has always been “reflation”
is now an impossibility.
I mentioned “China with a couple of large caveats” above and needs
explaining before we finish. First, China sits in the exact same
position the U.S. did in 1929, they have the world’s largest manufacturing
capacity in a world where demand for this capacity is and will continue to
wane. They have attracted huge amounts of capital just as the U.S.
did. The second large caveat is China has been importing massive
amounts of gold and certainly amassed more than 10,000 tons. The
argument can be made they now have 20,000 tons or more.
In my opinion, whether the number is 10,000, 20,000 or even 100,000 tons,
it really does not matter. It does not matter because a large part of
whatever they have purchased has been delivered FROM Western vaults and
highly likely including the FRBNY’s custodial holdings for other
sovereigns. You see, if the West is left with little to no gold
because of clandestine back door sales or even theft, the difference between
China having 10,000 tons and 20,000 or more tons is almost meaningless.
It is meaningless because China will have the ability to mark the price up in
Western currencies and make it all but impossible to ever “catch up”.
The only way to accumulate gold would be the old fashioned way, “mine
it”. But this is a very slow and arduous process that takes real work
…something of a rarity in today’s Western world and will never happen at
current prices.
With any announcement of how much gold China has hoarded will come
the above realization of what comes next, the price of gold will
explode! With an announcement of gold holdings will come credibility
that they have collateral followed by the “natural” confidence the U.S. once
had …a fairly simple concept if you stand back to look at it.
Regards, Bill Holter
