This being LME Dinner Week, I have been quite occupied. Richard Horswill has kindly stepped in to write this article (the first half of a two-parter, the second half of which will appear in the near future). As ever with guest writers, the views expressed are strictly his own.
Ever since the financial crash of 2008, central banks, politicians and private banking elites have struggled to contain the after effects of the crisis. Even though media propaganda tells an unsuspecting public that all is okay, it’s probably more accurate to say that absolutely nothing has been done structurally to the financial system to protect against future events and the possibility of a similar occurrence. However, the outcome of such a similar event could be even more devastating as the system is now even bigger with more debt and derivative exposure than ever before. Debt servicing costs have been maintained by zero interest rate policy, allowing failed institutions to be saved and their massive debt has been dumped on the taxpayer via the public balance sheet. Financial repression slowly eats away at the debt and the lifestyles of the majority, QE maintains asset prices avoiding uncomfortable bank liquidity issues, bankers keep their jobs and the status quo is maintained. But for how long and what could possibly tip us over the edge into the abyss?
Fear of Deflation
Central banks are absolutely terrified of deflation so to avoid a contraction of money supply leading to asset price collapse and generalised bankruptcy, the policy of quantitative easing has been predominant. By refloating the banking system with freshly printed cash in exchange for illiquid assets banks are recapitalised so they are once again able to provide lending to the economy. Those assets (gilts in the UK) are placed on the balance sheet of the central bank and are considered neutral (sterilised) balance sheet entries. If the asset/debt were to be cancelled by the central bank direct debt monetisation would occur expanding the amount of currency in circulation and directly devaluing the currency. Providing the debts aren’t cancelled they could in principal be sold off at a later date thus debt monetisation would not occur. As it stands, most indebted economies that have their own central bank end up resorting to this policy to keep the wheels turning. The public at large are generally ignorant of these policies, particularly debt monetisation. Who would really notice a little stealth inflation? Just another tax! (Incidentally, the interest on the QE debt that the BofE currently holds has been paid directly back to the treasury to help reduce the current UK debt levels. This is debt monetisation lite; however it has been mooted that Mark Carney may well decide to cancel/monetise the entire £375 billion).
Hang on a moment though. The Federal Reserve has been running a policy of QE on and off since 2008 (mainly on), but it is now potentially stopping the program for good. Is it too much of a step to suggest that deflation may result from the money taps closing? It is questionable whether the US economy - and for that matter the global economy - will be able to cope with zero stimulus. (Also, how will the US fund its war on terror, its war(?) with Russia, its war with Syria, its war with Iran, etc?) Could QE 4 be around the corner? If it is, problems could result.
Surplus countries that hold significant dollar reserves may not be too happy about all the currency devaluation taking place. Confidence in the reserve currency is essential if it is to be held by their central banks. While expansion of the Fed’s balance sheet has been seemingly tolerated up to now, further stimulus may be the final straw that breaks the camel’s back. So what can countries like China and Russia do that hold billions or even trillions in US dollars? This is where the role of gold becomes increasingly important.
Currency or Precious Metals?
Even though the paper price of gold has dropped significantly since 2011 physical demand has been as healthy as ever. Vast quantities of gold have been finding their way to refineries in Switzerland where it is remelted into higher quality kilo bars, making it into good delivery for the Shanghai exchange. Russia has also been seen to be a strong buyer of gold whilst selling US treasury debt. How else would one hedge one's dollar risk other than buying the oldest form of money (which incidentally has a scarcity value unlike the “almighty” but infinite US dollar)? Another thing to note is that US dollar money supply (M2) and gold are generally positively correlated; however, since 2011 they have diverged, creating a real opportunity for surplus countries to buy cheap gold. It is almost as if it were planned that way. Who wouldn’t want to hold the real stuff instead of a manipulated representation of money? The price of gold will only start rising again once physical supplies in New York and London run out, which may be quite soon based on actual demand and supply figures. Western central bank holdings seem to have been the key to holding down the price. Could it be that a potential default in the gold (or silver) complex could be a trigger for the next step in the ongoing financial crisis begun in 2008?
Standing on the Edge?
It would appear that the global financial authorities (FED, BofE,BoJ,ECB) have an agenda to control at best the confidence levels of the financial markets and of course the public at large. By hook or by crook they will try as they might to fool all of the people all of the time but as history has shown, you can’t! Let us hope that the abyss is further away than it would appear; otherwise be prepared for the ride of your life.