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Category: Soap Box

Soapbox: Going for broke!

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‘Voodoo economics’ is dead but won’t lie down.

The UK’s Chancellor, Kwasi Kwarteng, scythed a field of taxes last Friday, pushing the Pound Sterling almost to parity with the US Dollar, its lowest since 1971. That’s good and bad news – Britain’s exports have thereby become more competitive but its imports have got pricier; bad news for inflation, already nearly 10%.

The Sterling slump was the judgement of the financial markets – they think that Kwarteng’s tax cuts – the most sweeping since 1972 – in an effort to kick-start economic growth, will very soon run into a brick wall.

The last time the country saw such tax cuts was in 1972, when a pint of beer cost 14 pence (in London today the price is around £7) and the average house price was £5,158 (as opposed to today’s average of £292,000). As Kwarteng spoke, the gold price (in Pound terms) immediately shot up by more than 1%, from around £1,496 to almost £1,517/ounce. In early trading on Monday this week the gold price (in Pound Sterling terms) was around £1,534/ounce – up by 2.5% from the day when Kwarteng made his announcement.

Back in 1972, Anthony Barber was the (Conservative Party) chancellor. He slashed taxes in what became known as a ‘dash for growth’. Economic growth was indeed stimulated but inflation rose, many workers went on strike, the country was put onto a ‘three-day week’, the economy fell into stagflation, and the Conservative Party lost the general election in 1974. Not an example Kwarteng wants to follow.

Kwarteng’s tax cuts will be funded by borrowing – the Institute for Fiscal Studies, a British think-tank, estimates that the UK’s borrowing will rise to £190 billion this year, the third-highest peak since the Second World War. Prime Minister Liz Truss reckons the tax cuts will stimulate economic growth of 2.5% a year over the medium term, confident that the money not snaffled up by the government will ‘trickle down’ into the wider economy.

It’s essentially the same plan adopted by the 40th President of the US, Ronald Reagan. Its roots go even further back, to the 1890s, when it was called ‘Horse & Sparrow economics’, the idea being that if you stuffed your horse with more oats than it could digest then its manure would contain undigested oats, which sparrows could pick at. The 29th US President, Warren Harding, used Horse & Sparrow Economics to tempt voters in 1920, promising to cut the then 91% tax bracket to 25%; he won the election, the ‘Roaring 20s’ resulted. Reagan reinvented Horse & Sparrow economics and called it trickle-down economics. Very little is new under the sun.

Reagan’s supply-side policies involved very favourable tax cuts for the richest Americans in the belief/hope it would promote economic growth as society overall became richer. A subsequent President, H. W. Bush, sceptically called Reagan’s policies “voodoo economics”. Prime Minister Liz Truss and her Chancellor are now trying voodoo economics all over again. “Lower taxes lead to economic growth, there is no doubt in my mind about that”, said Truss. She’s out of step with US President Joe Biden, who has said he is “sick and tired” of trickle-down economics and that “it has never worked”.

Biden shares the almost universal scepticism that the extensive tax cuts Kwarteng announced will bring about 2.5% economic growth. The UK has had more than a decade of sluggish growth; between early 2008 and early 2022, trend growth of output per UK worker was 0.5%/year. Reversing that trend will be difficult and take much longer than the two years the Truss government may have before it faces a fresh general election.

Moreover, this massive fiscal stimulation is being criticised for other reasons: it’s seen by trade unions and special interest groups as extremely unfair. Those earning £1 million a year will have £54,400 ($60,700) extra in their pockets while those earning £25,000 ($27,900) will benefit to the tune of about £280 ($312). The government has also removed the cap on bonuses for bankers, who many believe escaped serious punishment for their role in the Great Financial Crash of 2008.

Social divisions will be fuelled; the UK is already racked with inequality, and is the fourth most unequal state in Europe according to the Organisation for Economic Cooperation and Development (OECD). Making the wealthy even wealthier is ‘unfair’ but by definition the poorer in society spend a proportionately higher amount of liberated money on immediate consumption; the hope is that the richer will do more investing with their much more ample extra cash.

But the biggest contradiction inherent in this latter-day Horse and Sparrow economics is that it flies in the face of the Bank of England’s mission to foster price stability. With inflation in the UK currently almost 10% – five times higher than its target – the Bank is already struggling. The Bank has just raised its base interest rate to 2.25%, making mortgage, credit card, and other debts more expensive – and squeezing many people already anxious about how they can pay their bills. Cutting taxes at any level is bound to throw some fuel on the inflation fire.

Whether it’s dressed up as ‘supply-side’ economics, ‘trickle-down economics’, ‘voodoo economics’, or ‘Horse and Sparrow economics’, the bottom line is that the Truss government is going for broke. Martin Weale, the academic economist who served at the BoE from 2010 to 2016, said it will “end in tears” and a run on the pound – which has already started.

Totally nuts

Willem Buiter, a former Bank of England rate-setter and Citi’s chief global economist until 2018, said Kwarteng’s plans to ramp up borrowing were “totally, totally nuts”.

“I think the UK is behaving a bit like an emerging market turning itself into a submerging market… I think Britain will be remembered for having pursuing the worst macroeconomic policies of any major country in a long time”. That’s the view of Larry Summers, former US Treasury Secretary. He called the Truss policies “naïve” and “wishful thinking”. He could be wrong. Let’s hope so.

The instant judgements that journalism specialises in have been harshly negative about Kwarteng’s economic plan, arguing that trickle-down economics fail to improve economic growth and merely enrich the already wealthy. Special interest groups will inevitably protest about this social engineering. However, it may be argued that inequality is at the heart of our society and Kwarteng’s moves simply reinforces what we already live with. Taxation per se can be seen as rank unfairness, legitimised theft by the government to pay for services we deem socially necessary.

Yet the highly educated Kwarteng (Eton, Cambridge and Harvard universities) seems unaware of academic research that also condemns voodoo economics. In the Socio-Economic Review of April this year, a study of 18 countries between 1965 and 2015 belonging to the OECD found that tax cuts for the rich “do not have any significant effect on economic growth or unemployment. Our results therefore provide strong evidence against the influential political–economic idea that tax cuts for the rich ‘trickle down’ to boost the wider economy”.

A much more serious worry is that this gamble, experiment, whatever you want to call it, will fail. The sugar rush of these massive tax cuts are likely to push up the costs of government borrowing, will give a fresh boost to inflation, and drive the BoE to put rates even higher. Ruth Gregory, senior UK economist at Capital Economics, spoke for many economists: unless the gamble to boost the underlying growth rate works, “today’s fiscal package just means more inflation, higher interest rates and a higher debt ratio in the future”.

In such a context of government gambles, the likelihood of even higher inflation and a further sinking of the value of the Pound, the options for self-defence are few. Gold has lost value in Dollar terms this year, as the Dollar and Dollar-denominated assets have been relatively strong while all else has weakened. But in Pound Sterling terms the gold price has risen more than 8%. Since Anthony Barber tried his ‘trickle-down’ experiment the Pound has lost more than 90% of its purchasing power; this year alone it will have lost some 10% thanks to inflation. The pounding of the Pound will do UK plc no good; but it has already benefitted the gold price when measured in Pounds.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: Out of the frying pan, into a fire?

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It’s a momentous week, not just because the UK has said a final farewell to its longest-ever serving monarch. Tomorrow (Thursday) the Bank of England (BoE) is expected to announce what one newspaper calls “the biggest rise in borrowing costs for at least 25 years” in an effort to reduce inflation from its current 8.6%. Next day, the Chancellor of the Exchequer, Kwasi Kwarteng, is expected to give details of the new Conservative administration’s relaxed attitude toward government spending of money it will need to borrow. This borrowing could be as much as £200 billion ($230 billion), rivalling the more than £300 billion that government handed out during the Covid-19 pandemic.

This will push up the already high UK budget deficit; gross UK government debt is more than £2.3 trillion, very close to 100% of gross domestic product (GDP). Hopes of closing the deficit look slim, as the new Prime Minister, Liz Truss, has in her campaign to win the leadership of the governing Conservative Party pledged there will be “no new taxes”; indeed she also promised around £30 billion of tax cuts. Increasing spending and cutting revenues is a gamble “on a huge scale” which one leading commentator calls “frightening”.

On the other side of the Atlantic the Federal Reserve is widely expected today (Wednesday) to announce a third successive 0.75% interest rate increase, or perhaps even a full percentage point. Previous rate rises this year have done little to calm US inflation, which in August was an annualized 8.3%, against 8.5% the previous month. So-called ‘core’ inflation (inflation minus the contributions of food and energy costs, which are regarded as volatile) rose by 0.6% over the previous month.

US energy bills: source employamerica

Tighter monetary policy – pushing up interest rates, making borrowing more expensive – is the orthodox economic policy in the face of high inflation. Central bankers and governments however worry that too much ‘tightening’ could shift the balance too much in the opposite direction – and create conditions for a recession. The World Bank is only one institution to be alarmed about this.

From getting inflationary signals wrong in 2020 and 2021 (it wasn’t ‘transitory’ after all), central bankers may again be taking a wrong turning according to the World Bank and people such as Maurice Obstfeld, former chief economist at the International Monetary Fund (IMF). “Just as central banks, especially those of the richer countries, misread the factors driving inflation when it was rising in 2021, they may also be underestimating the speed with which inflation could fall as their economies slow”, he has said.

Central bankers, playing ‘catch-up’, may get out of the frying pan and jump straight into a fire.

Cheap money and zombies

In the UK, the government has signalled its readiness to borrow inordinate amounts to fend off supposedly unacceptable energy costs. Britain has had some 15 years of ultra-low interest rates and almost £1 trillion of quantitative easing since the Great Financial Crash of 2008. This ‘easy money’ has done very little for economic growth, which the Truss government says it will boost to 2.5%/year; it will be miraculous if that’s achieved given that annual average growth rates have roughly halved since the 1960s and productivity has hardly increased at all since 2008.

To be sure, low interest rates have helped many ‘zombie’ firms to survive. Zombie firms are businesses unable to cover their debt servicing costs from current profits. But although that has prevented many from becoming unemployed, it’s unhealthy for the economy as a whole, suggests the Bank for International Settlements (BiS). It says that “zombies weigh on economic performance because they are less productive and because their presence lowers investment in and employment at more productive firms” and that the numbers of zombies globally has grown “since the late 1980s”. In the US, as many as 20% of the largest 3,000 public companies are zombies, with debts of some $900 billion (£791 billion) according to one estimate; the figure is even higher in the European Union (EU).

As rates have started to move higher, firms exposed to unsustainable debt levels have started to feel the squeeze; in August, there were 35,355 bankruptcy filings in the US, 10% higher year-on-year according to the American Bankruptcy Institute (ABI). Amy Quackenboss, the ABI’s boss, says that debt problems are not just for firms but also financially “distressed households” who are “experiencing expanding debt loads amid rising interest rates, inflation and supply chain concerns”. 56% of Americans now say that price increases are causing financial hardship for their household according to a Gallup poll.

In the UK, household debt peaked in early 2008 at more than 150% of disposable income and in early 2022 was above 131%. According to one estimate average personal debt in the UK “equates to around 107% of average earnings per adult”.

Debt jubilees?

The levels of personal and national debt in the UK and the US will rise in the coming years. Rising and possibly unsustainable debt is becoming a social concern on both sides of the Atlantic. Total consumer debt in the US rose by $23.8 billion in July to a record $4.64 trillion, according to the Federal Reserve. The US national debt is almost $31 trillion (above £27 trillion) and rising fast.

At what point does this indebtedness become unsustainable? Might a ‘debt jubilee'(a round of forgiveness of debts) be proposed by governments? There’s already been an example of this in the US, where President Joe Biden has announced plans to forgive up to $20,000 in student loans for individuals earning less than $125,000. Credit card debt in the US is getting out of hand; inflation is exceeding wage gains so more households have relied on revolving debt. Consumers in their 20s and 30s and those in the lowest income brackets are more likely to carry a balance to cover daily expenses such as groceries, child care or utilities than older generations. According to one survey, 60% of credit-card debtors are now carrying debt for a year or more. Loading up the credit card will become more expensive as rates rise.

Central bankers pride themselves as being guardians of price stability but the only tool they have to combat inflation higher than they desire is putting interest rates up, to try to take the steam out of an economy. The Federal Reserve and the BoE ‘target’ inflation at an annual 2% – meaning they want inflation of 2% a year. 2% doesn’t sound much but after five years of 2% inflation the loss of purchasing power of fiat money is 9%; after 10 years that loss is 18%. If the current high inflation rate sticks around for a decade then the loss of purchasing power of the Dollar or Pound Sterling will be close to 60%.

Yet while this pushing up interest rates may work in the US, where inflation is largely a factor of a rapid (Covid-19-induced) contraction followed by a swift expansion, it may be less successful in the UK or EU, where on top of the exit from Covid-19 consumers face high energy prices as a result of the Russo-Ukraine war. Being more self-reliant in energy the US is less subject to international energy price rises.

Central bankers face a difficult dilemma. If they push up interest rates only mildly this will fail to stifle inflation. If they move aggressively that could kick off a recession, stock market collapses, and a shrinking economy. They are also facing (as always) a changing macro-economic environment, in which food prices, which have been rising fast due to a variety of factors (including record fertilizer prices) appear to be cooling: the UN’s Food and Agriculture Organization’s price index, which tracks the most globally traded food commodities, fell in August for the fifth successive month, although was still almost 8% higher year-on-year.

A year ago, this newsletter said a major worry was the possibility that the world might drift into stagflation – a combination of a stagnating economy and high price rises. So far this year around 90 central banks have raised their interest rates, and about half by at least 0.75%, the broadest tightening of monetary policy for 15 years. 2008 ushered in an era of cheap money, cheap credit; 2022 will be remembered for laying the ground for global stagflation. The irony is that as US interest rates rise, the Dollar strengthens, other currencies weakens, and thus imported inflation increases for those countries whose currencies have slid against the Dollar. It begins to feel like a vicious spiral, in which everyone needs to put up interest rates as a defensive measure – and debt interest payments go up for all.

Soapbox: Constancy and Change

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Soapbox China Russia

As Britain comes to terms with the death of Queen Elizabeth II after 70 years on the throne, the BBC’s radio and TV channels have been packed with predictably reverential homages and something more unexpected – fulsome coverage of Charles III and assertions of his rightful ascendancy to the throne, with many ceremonies asserting Charles as king. It’s almost as if the nation might have doubted – challenged even – his claim to be the new monarch. But Britain doesn’t do revolutions, at least it hasn’t for centuries – Charles is the new king. Revolutions are for elsewhere, other sectors.

The Russia-Ukraine war started with gunfire but swiftly turned economic, as the US used the only weapon it felt able to deploy – its currency. This is bringing about a revolution in the global energy trade, albeit one that will happen across years rather than days or weeks. This war of tanks and missiles has spilled into heating and cooking, and will further spill over into what the world regards as and uses as a reserve currency. For now, the US Dollar is top dog, close to its highest in two decades against a basket of other currencies . As the Financial Times says, “the currency still has an outsized influence on the global economy given its dominant role in global trade and finance”.

We have a sovereign debt burden that is a catastrophe waiting to happen; emerging markets are burdened by huge Dollar-denominated debts which are just getting bigger as the US pushes interest rates higher to stifle inflation. The International Monetary Fund says that some 20 countries have debt that is trading at distressed levels. Heavily-indebted Sri Lanka has already gone bust amid considerable social mayhem; Pakistan is looking vulnerable.

Another developing chaos concerns Europe’s energy supply as it enters the northern hemisphere’s winter. From a dependency on Russia for 40% of its gas needs, Europe will need to revolutionise its energy sources if it is to achieve its declared aim of cutting gas imports from Russia by two-thirds within a year. How will it do that? By a combination of (it hopes) in the short-term finding new suppliers of liquefied natural gas (LNG), while over the longer term it will return to some fossil fuel use from its own resources (coal especially), more nuclear, and building more renewable sources (wind and solar). Meanwhile heads of European States are wrangling about imposing a price ‘cap’ on Russian gas exports, which would be difficult to police, and to which President Putin has said he would then halt all energy supplies to the European Union (EU). Despite sanctions, EU member states have spent more than €91 billion ($92 billion) on Russian fossil fuels since the war started on 24 February.

The smooth transition of the monarch in the UK implies constancy, but change is more familiar in today’s world.

Putin’s Pyrrhic Victory?

Despite excitable Western media reports of Ukraine’s retaking about 3,000 square kilometres of territory seized by Russia, the military odds remain stacked in Russia’s favour. At the start of the conflict Russia had four times Ukraine’s standing military personnel, more than six times the armoured vehicles and nine times the aircraft. The determination and willingness to fight seems to favour Ukraine, but we only see pro-Ukrainian sources; any Russian deserter or captive is readily displayed on Western media. We do not know what President Putin’s war aims are, but he has staked everything on being able to declare some kind of victory. Equally, Ukraine’s President Zelenskyy has vowed that only a full restitution of all territory taken by Russia (including Crimea, annexed in 2014) would be enough to gain a ceasefire. This war will drag on through 2023, with both sides gaining and losing territory in a messy slugging match.

But even if he succeeds on the battlefield, President Putin’s larger ambition – toppling US global economic hegemony – will remain unfulfilled. For him, Ukraine is not enough. President Putin is gambling – not only for domination of Ukraine, but that he can pivot his country’s most valuable resources away from the West and towards the East. Russia might secure a short-term victory but it could turn out to be pyrrhic – won at too great a cost to be worth it – over the long term. According to Elina Ribakova, deputy chief economist at the Institute for International Finance, “Russia’s authorities might be laughing now, but they will become excessively dependent on China and India for energy exports as Europe pivots away from Russian gas in the coming one to two years. This is why Russia is using its leverage now, as it knows soon it will no longer be as effective in the energy wars”.

Cuddling up to China

It’s conceivable that Ukraine is not the real target for President Putin. His ambition is much bigger – the true enemy is the Dollar. For that, tanks and missiles will not be enough. He needs allies, more diplomatic muscle.

Who better than someone who shares his ultimate ambition?

President Putin has spent much of what spare time he has in recent months forging closer relations with China, discussing the formation of an alternative international reserve currency with other members of the BRICS group, and proposing to launch Russia’s own version of the London Bullion Market Association’s ‘good delivery’ gold bar. Such challenges to the West have nothing to do with Ukraine but they are just as deliberate, just as strategically threatening as if Russia had attacked a NATO member.

So we should pay attention to what little news we get from Uzbekistan later this week. Chinese President Xi Jinping and Russian President Vladimir Putin are expected to meet in Samarkand, Uzbekistan, at the Shanghai Cooperation Organisation (SCO) summit taking place September 15-16. Undoubtedly Ukraine (and progress towards the Dollar’s demise) will be on the agenda.

Russia and China declared a “no limits” friendship before the start of this year’s Winter Olympics; what that means is being proved. Russia’s energy giant Gazprom has just signed an agreement with China to settle payments for its gas exports in Yuan and Roubles instead of US Dollars. This is a remarkable event; crude oil has been priced in Dollar terms since 1973, when the US agreed to offer armed protection to Saudi Arabia. India too is buying lots of heavily discounted Russian oil; its imports of Russian fossil fuels have risen by more than €64 million a day since March. Only the US, Australia and Canada currently have a complete embargo on Russian fossil fuels – but then, they have plentiful supplies of their own. Bloomberg’s Javier Blas has written that for “now, at least, energy sanctions aren’t working”. On several fronts Russia seems to be winning the battle for strategic partners, whether or not its troops are suffering a (probably only temporary) setback.

Keeping the lights on

On 3 August 1914, one day before Britain declared war on Germany, the British foreign minister, Sir Edward Grey, said the “lamps are going out all over Europe, we shall not see them lit again in our lifetime”. In Berlin, the lamps are already darkening; at least 200 monuments and public buildings are no longer illuminated at night. As the temperatures drop the fragile unity of the West’s opposition to Russia and its allies (more than a dozen of whom have joined this week’s Russia-led Vostok military exercises in the Far East) will be tested to the extreme. Europeans can live with dark streets; cold homes will be trickier.

Russia’ s war against Ukraine is offensive to Western liberal values of toleration, self-determination, negotiation rather than conflict. But there is no end in sight that might satisfy those values. Rather it is merely the precursor to a much bigger battle – with the US Dollar the central target.

Soapbox: CBDCs get another ally

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Soapbox CBDC

The International Monetary Fund (IMF) says it aims to “promote financial stability and monetary cooperation”. It has “three critical missions: furthering international monetary cooperation, encouraging the expansion of trade and economic growth, and discouraging policies that would harm prosperity”. Given that it has such a broad remit, it’s perhaps inevitable that sooner or later it would turn its attention to the thorny question of Central Bank Digital Currencies (CBDCs). The Bank of International Settlements (BiS), the central bankers’ bank, has already thrown its weight behind CBDCs and now the global lender of last resort, the IMF, appears to have done the same. The technology supporting the development of CBDCs and cryptocurrencies has rapidly advanced in the past couple of years; but their thrust and motivation are completely opposed. Cryptocurrencies aim to decentralize the control of money, enable anonymity, remove control over money from governments that have lost trust; CBDCs centralize the infrastructure of a digital currency and enable greater control, inspection, and a reinforcement of state supervision. The battle lines are not just over what money will be; they are between growth in state power and the right of the individual to use money anonymously. Cryptocurrencies are regarded by central banks and governments as dangerous, uncontrollable buccaneers. They may have to live with them, but they hope to police them out of existence. No better way to do that than to steal the ocean they sail in. CBDCs have got another powerful ally in the form of the IMF; but that doesn’t mean they should be welcomed.

The spread of CBDCs

We are accelerating towards a cashless world. The development of digital forms of money and greater use of credit and debit cards have led to a decline in the use of cash, which has fallen by some 15% a year since 2017. CBDCs have come a long way since 1993, when the Bank of Finland (BoF) launched what is considered the first, the Avant smart card, an electronic form of cash. According to 2020 analysis by the BoF, Avant “didn’t gain enough traction to survive… debit cards gained wider acceptance”. Currently just two CBDCs have launched – the e-naira in Nigeria and the Bahamian Sand Dollar. China’s CBDC, the e-yuan, has been operational in selected cities. As of today there are an estimated 97 CBDCs under research or development.

A CBDC is a digital version of a country’s currency created by the central bank, and which is available for households and businesses to use for payments or storing value – to use as fiat money. CBDCs are backed by the government and pegged to the value of the national currency – unlike cryptocurrencies, which are backed by no asset or institution. Like cryptocurrencies, CBDCs use Distributed Ledger Technology (DLT) to facilitate supply of money and transaction monitoring. Also, central banks may integrate permit payment services with the ledger to facilitate easier transactions. Yet CBDCs share with cryptocurrencies and all forms of money one critical thing –trust from their users that this money will keep its value, or at least not lose much.

CBDCs have gained in popularity with central banks for several reasons: they can simplify and speed payments (and reduce costs) for individuals and businesses. In 2020, there were around $23.5 trillion cross-border transactions, costing $120 billion in fees and taking an average two to three days to complete. That would be cheaper and faster with a CBDC, so long as it was recognised and accepted across borders. They’d also promote financial inclusion by allowing unbanked individuals to conduct transactions more easily. CBDC supporters say they can also help governments implement monetary policies by, for example, allowing the destruction of currency ‘tokens’ in circulation, thus reducing money supply and tackling inflation. Increased surveillance of money flows in an economy, such as would be possible with a CBDC, could help prevent tax evasion, reduce corruption, and disrupt the funding of illicit activities, like drug trade or terrorism.

“Coined liberty”

The novelist Fyodor Dostoevsky wrote that money – cash in his day – was “coined liberty”. Cryptocurrency was invented to reinforce that claim. And all the advantages of CBDCs need to be set against the some drawbacks – which can be boiled down to giving greater power to ‘Big Brother’. Governments which can centrally monitor currency – which would be one implication of a CBDC – would mean every single payment could be subject to government oversight and possible disruption if a transaction annoyed government. While no-one wishes to facilitate illegal activities by permitting anonymous financial exchange, as a society we accept the possibility of such exchanges for the sake of mass privacy.

And while a CBDC would enable cuts to the money supply by the simple means of destroying an amount of the CBDC ‘token’, the reverse is also obviously true. Any government that felt itself strapped for cash would be able simply to issue new ‘tokens’ to any desired amount. Rather than promoting “financial stability” the IMF’s embrace of CBDCs might usher in greater instability.

Then there are other worries about CBDCs – unlike cryptocurrencies, which run on public blockchains that are decentralized, CBDCs will be fully centralized and hosted on private or permissioned blockchains; malicious hackers need only to breach a few servers and they might be able to control a nation’s whole money supply. The implication for the expanded role of Big Tech is concerning; CBDCs will probably need to expand to already existing digital payment systems such as Apple Pay, giving those systems the power to gather and potentially misuse personal data and enable hackers to steal your money.

To be fair to the IMF, in the latest edition of Finance and Development, the IMF’s magazine, the academic Eswar Prasad writes (in a personal capacity) that a CBDC “has disadvantages…Societies will struggle to check the power of governments as individual liberties face even greater risk”.

In the US, there has been much speculation about the ‘digi-Dollar’, a CBDC from the Federal Reserve. That now looks less likely to see the light of day – all the talk now is of FedNow, a “modern and reliable instant payment system” that will be launched between May and July 2023, according to Lael Brainard, the Fed’s vice chair. The Fed hopes that FedNow achieves a couple of things – making available for all its users cheap, reliable and irreversible payment settlements within seconds, and simultaneously killing off some of the attractions of cryptocurrency. FedNow promises to enable the processing and settlement of “individual payments within seconds, 24 hours a day, 7 days a week, 365 days a year”. It apparently will use a blockchain developed by a company called Cypherium. Cypherium is of course secure – until it isn’t. Both individuals and businesses will be able to use FedNow, with an initial transaction limit of $25,000, although that limit is forecast to grow. It promises to adhere to ISO 20022, which is an open global standard for electronic data exchange between financial institutions. Faster payments should make it harder for fraudsters to intercept payments.

The Fed describes FedNow as a modernization of the national payment system; if it’s widely adopted it will spell the end of the Automated Clearing House framework which currently settles interbank transactions. A modernization it may be; it’s possibly also groundwork preparation for a full-on CBDC. But even if the US decides it doesn’t need a CBDC, the movement towards CBDC adoption by the rest of the world may force its hand, especially if it wants to retain the financial hegemony of the Dollar.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: Helicopter Money Taking Off

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A former Conservative Party British Prime Minister, Theresa May, took a lot of flak in 2017 for telling a nurse who complained on TV that her salary had not risen since 2009 that “there isn’t a magic money tree that we can shake that suddenly provides for everything that people want”.

Five years later, that assertion is about to be tested like never before.

Sky-high energy bills are about to arrive for British consumers, and the clamour for the state to help out and cover some (if not all) of the 80% rise in gas and electricity prices are coming fast and furious. The repercussions of zooming energy prices are starting to make themselves felt across all parts of the British (and European) economy. Britain’s 48,000 corner shops, places to buy milk at midnight, have an association representing 70% of them, the Association of Convenience Stores or ACS. ACS has asked the Chancellor for a £575 million “assistance package” or risk losing many of these small stores. As energy prices soar, many small businesses will go under and households will struggle; with inflation yet to peak at up to 20%, a severe recession is inevitable. Government will come up with various ‘support’ packages such as a cut in VAT or direct payments, at a time when tax revenues will plunge. Helicopter money – money dropped from above – is about to return to the UK.

Britain only has a few more days before it learns who its new Prime Minister will be. The previous one, Boris Johnson, supposedly stepped down in July although he has stayed in post as a ‘caretaker. Despite promising that major policy changes should await his successor, Johnson has recently said that whoever succeeds him will announce “another huge package of financial support… to help people through the crisis”. This seems to tie his successor’s hands – or risk angering the electorate. According to one commentator, neither of the two front-runners to replace Johnson has “the first idea of what to do about the UK’s deep-seated economic problems”.

With inflation likely to be around 13% by the end of this year, and energy prices forcing half of UK households into fuel poverty , there’s no doubt that many families are finding their disposable income is shrinking. Johnson’s competitors to become his successor are promising tax cuts or more money give-aways, either of which is just a different form of helicopter money.

 

No free lunch

The first welfare state was Germany, where Chancellor Otto von Bismarck in the 1880s introduced social benefit schemes designed to weld together the different classes of the fledgling German state. His motives were not philanthropic but political – he wanted to pull the rug from under the Social Democrat Party, which he regarded as dangerously revolutionary.

Almost 150 years later, we have morphed from welfare being a piece of generosity by a grateful state to it being seen as a right. The European version of the welfare state has apparently crossed the Atlantic. In 1996, then-Senator Joe Biden said “the culture of welfare must be replaced with the culture of work”, he said on the floor of the Senate…The culture of dependence must be replaced with the culture of self-sufficiency and personal responsibility”. We have moved from a culture in which the infirm, the unemployable, the poor, the elderly, are left to struggle – and our society is all the better for that humanising change. But as our population ages, or ‘black swan’ events such as wars disrupt our economies, our ability to fund that welfare comes into question. Triage will increasingly need to be employed; can we cover the cost of this? Can we afford that? What will have to be sacrificed if we want that?

In January this year, the Institute for Fiscal Studies, which specialises in UK public policy, said that welfare payments must rise “by twice as much as planned this year if the poorest households in Britain are to be supported through the cost of living crisis”. That would have cost an extra £3 billion/year. Since then energy prices have shot up and inflation has far exceeded estimates.

In the US, the state spent an additional $1.9 trillion on social support payments, the ‘American Rescue Plan’ Act of 2021. That put total US federal, state and city spending in 2021 at almost $10 trillion, or around half of national gross domestic product. As Larry Summers, former US Treasury Secretary, warned in February 2021, “there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability”.

The Congressional Budget Office estimated that the US federal government ran a deficit of $212 billion in July 2022, $90 billion less than July 2021. The country’s national debt is fast approaching $31 trillion and 124% of gross domestic product (GDP), against some 57% just two decades ago.

All must have prizes

The demands increasingly placed on the state sound rather like the Dodo in Alice in Wonderland, who after a race announces that “everybody has won, and all must have prizes”.

But in the context of lingering high inflation and an increasing likelihood of a global recession, it’s questionable as to whether states will be able to afford their growing welfare bills. Fewer and smaller prizes will be available in future.

At their Jackson Hole junket last weekend central bankers seemed united in a determination to stamp out inflation whatever the cost. The battle is not just to kill rising prices but to defend their own reputation. Isabel Schnabel, a board member of the European Central Bank, said “regaining and preserving trust requires us to bring inflation back to target quickly… [the] longer inflation stays high, the greater the risk that the public will lose confidence in our determination and ability to preserve purchasing power”. Another Jackson Hole guest, Agustin Carstens, head of the Bank for International Settlements (BiS) issued a grim warning: “The global economy seems to be on the cusp of a historic change as many of the aggregate supply tailwinds that have kept a lid on inflation look set to turn into headwinds”.

There has been one prize winner however – the US Dollar, which is now stronger than it has been in 20 years, thanks to rising US interest rates and the generalised sense that central banks will fight inflation to the death. The Dollar looks like a giant on clay legs. The US owes the world a net $18 trillion, or 73% of its GDP. For now, the Dollar is the cleanest shirt in a bundle of grubby washing. Since the 15th century, points out one commentator, “the last five global empires have issued the world’s reserve currency… for 94 years on average. The dollar has held reserve status for more than 100 years, so its reign is already older than most… the dollar share of foreign exchange reserves is currently at 59% – the lowest since 1995”.

The Dollar’s strength has helped depress the gold price, which in Dollar terms has slid almost 5% since the start of the year, although the weakness of the Pound Sterling means that in Pound Sterling terms the gold price has risen by 10% since the start of 2022. As the world inches closer towards stagflation, the importance of gold not just as a means of saving but, thanks to Glint, as real, everyday money, will become increasingly apparent. While fiat currency can be created galore, gold cannot. When voters feel financially squeezed, the temptation for governments is not to address long-term and difficult problems such as how to increase productivity, but to quell disquiet by creating more paper money. With inflation approaching 20%/year, fiat money in the UK is annually losing around 20% of its purchasing power.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: Moving on – maybe

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Soapbox US Inflation

On Friday this week, the chairman of the US Federal Reserve, Jerome Powell, will address his peers and would-be peers at this year’s economic symposium at Jackson Hole in Wyoming. Rarely have a central banker’s words been more eagerly awaited; rarely will they prove to be more disappointing. Powell needs to decide whether high inflation is ebbing away of its own accord, whether it needs ‘taming’ by higher interest rates – or whether it is now being caused by factors far beyond his or anyone’s control.

If Powell says US interest rates must go higher to combat inflation, now at an annualized 8.5%, the risk is that this makes a recession more odds-on. It is unthinkable that he will act with the determination of a predecessor, Paul Volcker, who got double-digit inflation in the 1980s “under control through the economic equivalent of chemotherapy: he engineered two massive, but brief, recessions, to slash spending and force inflation down. By the end of the 1980s, inflation was ebbing and the economy was booming”. Powell will be hyper-aware that the man who re-affirmed him in his job, President Biden, does not need a recession.

If Powell speaks mildly about inflation then the risk is that everyone relaxes and that wages and prices begin to chase each other, rather like a snake swallowing its tail, and inflation becomes firmly embedded.

At the back of Powell’s mind – of everyone’s mind – is the rapidly approaching date of the US mid-term elections. On Tuesday 8 November, all 435 seats in the House of Representatives and 35 of the 100 seats in the Senate are up for grabs. President Biden currently is disapproved of by more than 54% of the electorate. If Biden and his Democratic Party are to avoid becoming ‘lame ducks’ they need Powell to come up with some good news for the electorate – and fast.

Biden/the Democrats will not face a fresh Presidential election until the end of 2024, but if the Democrats lose their slim Congressional majority in November they will be unable to pass legislation – and Biden’s dream of being a second F.D. Roosevelt will burst.

In the UK, around 160,000 people – all the members of the governing Conservative Party – are about to choose the country’s next Prime Minister, following the resignation of Boris Johnson in early July. Whoever that person might be, they will lead the country for perhaps more than two years – the next general election is scheduled to be hold no later than 24 February 2025. These two years could be the most testing in decades, as a horrible level of inflation stimulates public sector worker pay demands that the government won’t be able to finance out of revenues.

Surging prices, and the success or failure to control them, will likely determine voter choices in both countries within two years. With inflation in both countries at a 40-year high, political leaders and their central bankers face huge difficulties. They desperately want to move on – if circumstances allow.

Adjusting the inflation target?

At Jackson Hole last year, Powell said that inflation was “likely to prove temporary”. At the time some of us gasped in shock – how could the policy of quantitative easing (which saw the central banks of the Eurozone, Japan, the UK and the US collectively expand their balance sheets by more than $11 trillion since the start of 2020) and the massive cash give-aways to keep economies on the road during Covid-19 translate into transitory price rises? “The stimulus payments which helped employers keep staff on also allowed consumers to shore up their savings”. US households on average have twice as much cash ready to hand as they did at the end of 2019; that’s playing its part in the inflation gallop. Powell and his peers either ignored or forgot Milton Freidman’s dictum that “inflation is always and everywhere a monetary phenomenon”, the result of governments expanding the money supply too enthusiastically.

We should remind ourselves of something that today looks absurd – the UK, the US, and the European Central Bank all aim to get inflation of around 2% a year. The Bank of England (BoE) now forecasts that inflation will peak above 13% in the final quarter of 2022, and still be above 9% in the third quarter of 2023. Little wonder that UK workers in all kinds of fields are now taking sporadic strike action. They watch their declining real (inflation-adjusted) wages rapidly decline while simultaneously noting that the likely cost of bailing-out the (failed) energy retailer Bulb may cost them more than £4 billion ($4.71 billion).

Independent analysts are forecasting still higher inflation for the UK – Citi has this week projected inflation will hit 18.6% in January 2023, the highest in almost 50 years. This could be worse – in Argentina expectations are that inflation will be higher than 90% over the course of this year, while in Turkey it is already 80%/year.

Powell is no Volcker: he will not raise US interest rates above the inflation level, there is too much at stake to risk a deeper recession. Rather he may well move the goalposts: instead of trying to pin annual inflation to around 2% we may have to get used to a fresh ‘target’, around 4%. Hitting that higher target would be easier.

Powell also must struggle to make sense of apparently contradictory information about US consumer behaviour. On one hand Americans are clearly anxious about the economy; “consumers are more gloomy now than they were during the worst of the Covid-19 pandemic, the global financial crisis or any other moment since…1952”. Yet while they are getting less for their Dollars “they are still spending them”. Halting high inflation will become more painful the longer it endures – and it’s going to last through 2023 for Brits.

Shocks ahead

Larry Summers, a former US Treasury Secretary, has said that “we need five years of unemployment above 5% to contain inflation… or one year of 10% unemployment”. Wages have recovered in the US since their calamitous Covid-19 drop. Unemployment levels are the lowest since 1969 in the US.

US real hourly wages by industry: % change since January 2020

 

Summers’ prescription to get inflation under control is harsh, but perhaps inflation’s appearance of slowing in the US (if not the UK or the European Union) is deceptive.

Europe is particularly vulnerable, with 40% of its natural gas and 25% of its crude oil coming from Russia last year. The International Energy Agency (IEA) said in July that the squeeze on energy supplies may have only just started and this is “affecting the entire world”. Russia has just ruled out any possibility of a diplomatic solution in its war with Ukraine; “the world has changed” Gennady Gatilov, Russia’s permanent representative to the United Nations in Geneva, told the Financial Times.

The management consultants McKinsey called their latest research into US consumer behaviour “The Great Uncertainty”. Powell faces his own ‘great uncertainty’ at Jackson Hole; British consumers are shortly going to face a great certainty, the certainty of energy bills rising even more. The US Dollar and Pound Sterling have lost around 80% of their purchasing power in the years since the last energy crisis, brought about by the oil export embargo of 1973, when gold then fetched around $106/ounce. Since then gold has risen by more than 1,500%. Gold is security; Glint its key.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: We need the middle class

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“The middle class champions political stability and good governance. It prevents political polarization and promotes greater compromise within government”. So says a 2019 report by the Organization for Economic Cooperation and Development. So we should perhaps take more care to nurture our middle classes, and not let its members drop into the ‘precariat’.

What is the precariat?

In 2013, Guy Standing, professor of development studies at the School of Oriental and African Studies, informed the Financial Times that the ‘precariat’, is a new class which faces “chronic uncertainty” and has “grown sharply since 2008… the old Beveridge and Bismarckian variants of the welfare state have been dismantled” to be replaced by “a mish-mash of means-tested, behaviour-tested social assistance, with a growing tendency to force young unemployed into workfare schemes, which are helping to depress real wages”. The Precariat is what happens when people lose hope, a new class that needs to be re-embraced for the good of us all.

According to the Pew Research Center, the American middle class has shrunk from being 61% of the population in 1971 to 50% in 2021. As the middle-class strata shrank, the upper-and-lower income segments have steadily expanded – respectively from 14% to 21% and from 25% to 29% over the same 50 years.

It’s similar to the position in the UK. “The lifestyle that the average earner had half a century ago – reasonably sized house, dependable healthcare, a decent education for the children and a reliable pension – is becoming the reserve of the rich. Middle-class pensioners look on amazed at how their children, now into adulthood, seem to have a far harder time” wrote one British commentator in 2013.

‘Precariat’ derives from the word ‘precarious’. According to Standing, the precariat feels itself to be (and objectively is) poorer, both materially and spiritually, where hope of a materially better future has been replaced by “a combination of anxiety, anomie, alienation and anger”. Conditions of unstable labour, a loss of non-wage benefits (such as pensions or medical coverage), living on the edge of unsustainable debt and chronic economic uncertainty – all these characterise the precariat.

During those same 50 years, the US Dollar has depreciated six-fold, falling by 86%. For the Pound Sterling, the decline is even worse – 94% of its value has been lost in the last 50 years. Over the same period the gold price has moved from some $45/ounce to about $1,800/ounce currently – an increase of around 3,900%. Impossible to identify a causal connection, but the correlation is compelling. As the money supply became easier, the Precariat has formed and grown.

As fiat currency has lost purchasing power, more people have dropped out of the US middle class and turned to state welfare for support. Yet we need the middle class, to provide that social stability.

Failing State Welfare

The precariat overlaps that segment of society which depends on the state for support. One of the growing concerns of our age is that the state, overwhelmed by demands from different directions, is running out of capacity to keep up with welfare demands.

In the UK, the combined debt servicing costs and welfare payments are likely to rise by “more than” £50 billion in the next financial year. UK welfare support is at its lowest in 50 years according to the Joseph Rowntree Foundation, a charity. The bills go up, tax revenues may go down, and government is becoming more squeezed.

UK domestic energy bills could rise to above £4,000 a year in early 2023 which, given that an average annual salary is around £31,000 (before tax), will create hardship for many households and lead many people to seek some welfare support. A campaign – “Don’t Pay” – has started up, with the aim of gathering support to reduce energy bills to an “affordable level”; if not, and if the campaign gets one million pledges by 1 October, its signatories pledge to cancel their direct debit payments to energy suppliers. This kind of inchoate direct action protest is erupting alongside more conventional protests – strikes or threatened strikes by rail workers, junior barristers, mail workers, and nurses. Even a general strike has been talked of. More than five million people work in the UK’s public sector; the wage bill is almost £200 billion a year, equivalent to 25% of all UK tax receipts. For every 1% pay rise the government needs to find an extra £2 billion. So far this year public sector pay deals have been around 5% – still far below the rate of inflation, which Goldman Sachs estimates will peak at 14.4% in early 2023.

In the UK, fuel poverty is conventionally defined as when energy costs exceed 10% of a household’s income. In the financial year 2019-20, almost 20% of UK households were in that category, but the rise in costs means that will rise to 50% by the start of 2023 according to research published by the Child Poverty Action Group. Local councils around the country are now planning to offer people ‘heat banks’ for this winter, where they can gather to stay warm, rather like food banks, where people can get food parcels.

The Trussell Trust, the UK’s largest national food bank charity, says there was a 5,146% increase in emergency food parcels distributed between 2008 and 2018. One journalist has observed that “this is a genuine national crisis…social unrest is surely a distinct possibility… The unavoidable truth is that the United Kingdom is in such a fragile, frayed state that it can no longer keep its people warm or adequately feed them”.

The Global Gig

The precariat is a contemporary version of Karl Marx’s proletariat: “a new class of alienated, insecure workers who are ripe for radicalization and mobilization…. This class is growing once again…” At the same time as demands on state welfare have increased, public confidence in the state’s funding ability is diminishing. In 2015, the Brussels-based think tank Bruegel published a survey stimulated by a report into ageing by the European Commission, which found that the European Union will move from four working-age people per person over 65 today, to about two working-age people in 2040. This means less revenue because of the shrinking working-age population, and more spending because of higher costs for pensions, health and long-term care. An average of almost 60% of those surveyed thought that by 2050 the state would be unable to cover the pension bill.

Source: Bruegel

What results from this growing disenchanted class? As home prices have soared, wages stagnated, job conditions become more insecure, the ‘freedoms’ of the gig economy have soured, and the ‘advantages’ of globalization and the deflation that has resulted from shipping jobs to countries with cheaper labour costs, have turned to ashes. Younger people – Millennials – are losing sight of and hope in the long-term. One developing trend is “quitting quietly” – doing one’s job, but no more than that. China has spawned its own version, thanks to a social media protest titled “lying flat is justice” which went viral in 2021. It was a “manifesto of renunciation… The extraordinary stresses of contemporary life were unnecessary”. Young Chinese flocked to the post, which rejected ambition and openly despised effort. Last year huge numbers of US workers quit their jobs, including 4.5 million in November alone. On the internet forum Reddit the r/antiwork movement thread, which became a very attractive forum for disenchanted employees during the Covid-19 pandemic, went from 180,000 members in October 2020 to 1.6 million in January this year, although it has since gone private.


Doreen Ford, a moderator of the r/antiwork site, told the Financial Times in January this year: “Most of us are just normal people… We have jobs that we don’t like, which is the whole point of why we’re in the movement to begin with”.

What’s true of the UK and the EU may also hold for the US. The US has one advantage – it continues to be a honeypot for immigrants and can thus able to replenish and refresh its workforce, although the overall immigrant population (new arrivals and established immigrants) is “aging rapidly”.

American society overall is getting older – fewer employed people will be paying the taxes needed to keep welfare programmes afloat. In 2022, around $1.3 trillion (about £1.1 trillion) is likely to be spent on various programmes and account for more than a fifth of the federal budget. While there were 3.7 workers per Social Security beneficiary in 1970, projections are that will fall to just 2.1 by 2040.

The inescapable conclusion is that several pinch points or ‘crunch times’ are headed this way. The Covid-19 pandemic saw the extremely rich get richer. Americans for Tax Fairness, a non-profit organisation, claims that US billionaires have increased their wealth by 57% ($1.7 trillion) since the start of the Covid-19 emergency. The wealthiest 10% now own 84% of all stocks, with the bottom 75% owning none at all. Little wonder that many Millennials used their Covid-19 state handouts to gamble with cryptocurrencies, which tempted by social media tales of people gaining swift riches.

States are facing a squeeze on their finances, which will not be helped by the looming recessions. Rather than disappoint and/or anger voters by failing to meet welfare pledges, they will be tempted to ‘create’ money. The ‘magic money tree’ will, sooner or later, come to pass and further devaluations of fiat currency will result.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: Two tribes at war

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According to Timothy Garton Ash, professor of European Studies at Oxford University, writing in The Guardian newspaper, “we are at war”. Garton Ash writes that Russia’s President Putin is embarked on a “campaign” to “defeat not only Ukraine but also the west”.

There’s now too much evidence amassed to doubt this assertion. President Putin wanted to join NATO, according to the NATO head between 1999 and 2003. But he didn’t want Russia to have to stand in line “with a lot of countries that don’t matter”. A missed opportunity.

When he was told that Russia would need to apply rather than be invited to join, President Putin saw it as a snub. Disenchantment set in and grew until it exploded in February this year. The result is that the west is now engaged in a proxy war with Russia, which is busily gathering sympathisers – not only China but even European Union leaders such as Viktor Orbán, who has said recently that “Hungary needs to make a new agreement with Russia”. Images of destroyed Ukrainian cities, credible reports of violations of civilians, the horror of the war are undeniable – but if it is a proxy war with the west, it must be somewhat uncomfortable to realise that Ukraine is scarcely less tainted a country than Russia, occupying as they do positions 122 and 136 respectively on Transparency International’s Corruption Perceptions Index of 180 countries. Criminal smuggling of weapons supplied by the west to Ukraine has become a concern.

But a bigger concern is also a more hidden one – if we are at war, does the west have the will and the money to sustain it? The real test is just a short time away; European resolve might crumble when cold weather arrives and gas prices soar or rationing spreads as a consequence of shortfalls in Russian supply. In the UK, the former Prime Minister Gordon Brown has warned that a “financial timebomb” will explode in October as fresh fuel price rises push “millions over the edge”.

Astronomical costs

At the start of July this year the Kiel Institute for the World Economy’s Ukraine Support Tracker said that it had recorded total support commitments to Ukraine since the start of the war of €80.7 billion ($82.25 billion), although there is a “large gap between pledged and delivered support”, and the momentum of support is “slowing”. The cost of the war doesn’t even begin to consider how much it might cost to rebuild Ukraine (around $1 trillion has been estimated), to assist millions of refugees, and Ukraine’s plea for several billion Dollars per month in support. Where’s the money coming from?

The US last had a federal budget surplus – an excess of revenues over spending – in 2001. The US has only been debt-free in 1835-1837. In 2021, the US federal government ran a deficit of $2.8 trillion in the last full fiscal year, which always starts in October. The deficit for the first nine months of the 2022 fiscal year is running at 23% lower year-on-year – but it’s still a deficit.

US federal deficits/surpluses since 2001

Wars are not only expensive, they also stoke inflation. According to one study, US prices rose by about 120% between 1913 and 1920 during the First World War and its aftermath, and by 200% in the UK and 400% in France. The “hyperinflation which reduced the value of money in Germany to zero from 1919 to 1923 would have been inconceivable without World War I and its aftermath… Wars and revolutions without taxation to cover the cost have been the principal causes of hyperinflation in industrial countries in the last two centuries”.

The key words there are “without taxation“. In other words, if a country decides to go to war and wants to avoid inflation, it would be advised to ensure it can pay the costs from the revenue it takes in. Otherwise, it simply builds up debts for its children and their children. Currently, the US national debt is fast approaching $31 trillion (£25.6 trillion), which means the US debt to gross domestic product (the monetary measure of all goods and services produced by the US) is around 124%. As a share of the economy, the US debt was a mere 2.7% in 1916.
The huge debt is sustainable for as long as the US’s creditors continue to think the country’s economy is sound; the World Bank says that an additional percentage point of debt costs 0.017% of annual real growth when the debt-to-GDP ratio is above 77%.

It’s alarming to be told that we are “at war”. It’s twice as scary to think that we might lose it, not militarily, but financially.

Even if sustainable, the debt acts as a huge drag on the American economy. The US resembles an elderly boxer slugging it out with an opponent while tethered to a ball-and-chain, clamped on during previous wars. And it’s only round three in a ten-round bout in this one.

Russia’s ‘Rocky’

But maybe President Putin has bitten off more than he can chew. He may not be a Russian ‘Rocky’ after all.

According to a paper published by Yale School of Management towards the end of July, “business retreats and sanctions [against Russia] are catastrophically crippling the Russian economy”. Its authors state that Russia faces “economic oblivion… as long as the allied countries remain unified in maintaining and increasing sanctions pressure against Russia”.

The two main boxers in this fight are Russia and the US – without the support and encouragement of the US Ukraine would have crumbled by now, for all its soldiers’ bravado.

As the west inches closer to a recession – technically already in place in the US, with a 15-month-long one for the UK forecast by the Bank of England (BoE), and consumers in the Eurozone now the “gloomiest on record” – it’s not in a good position for a lengthy fight.

Neither is Russia, perhaps.

The future might be one in which a pair of bloodied, bruised, battered opponents, stagger around the ring, clinging to one another to avoid falling over. Meanwhile, the global economy shrivels, set back decades – restoring it, restoring trust, will be tough, and it is conceivable that we may never return to globalisation. From the ashes will slowly emerge a new political – and monetary – hegemony.

Soapbox: Beware the bear

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The final week of July saw the US stock markets notch up their best results in more than two years – the S&P 500 rose by almost 9% in July, the Nasdaq 12% and the Dow Jones Industrial Average 6%, its biggest monthly gain since March 2021. Investors seem to be accustoming themselves to the war in Ukraine, 40-year-high inflation combined with central bank dithering, signs that economic growth is faltering, and taking comfort from a better than expected earnings’ season by big US companies. The broad market, as assessed by the Morningstar US Market Index, ended July almost 12% higher than its 52-week low on 16 June.

It seems to be a case of ‘happy days are here again!’ so fill your boots with shares.

But maybe this is a classic bear market ‘trap’? Do we think that recession/stagflation fears are over?

A bear market is one where there are prolonged price declines, generally in the order of 20%; the S&P 500 index dropped into bear market conditions towards the end of May this year. Bear market rallies can suck in the gullible and punish them mightily.

Bear markets are fairly regular – since the Second World war there have been nine declines of 20%-40%, and three of more than 40% in the S&P 500, with the last bear market being in February and March 2020, when the S&P fell 34%, only to rebound by mid-August.

What happens to gold in a bear market? Historically when stocks overall are falling, the gold price tends to move higher. It’s probably too soon to be sure which way we are headed – but all the circumstances that typically accompany a bear market seem to be in place.

Is this going to be 2008 all over again?

Few of those who were alive and aware at the time will forget the real fear that gripped the world during the Great Financial Crash of 2008. The catalysts for that were a collapse in US house prices and a concomitant rise in the numbers of mortgage holders unable to repay their loans.

Opinions are sharply divided as to whether conditions this year resemble those of 2008. Some have dubbed this as the ‘New Great Recession’; the chief investment officer of Morgan Stanley has said the “chances of a recession ticked higher last week, driven by the Federal Reserve’s latest rate hike and hawkish forward guidance” although added that the 2008 crash was fundamentally brought on by unsustainable debt rather than the problem today, which is “excess liquidity” – “extreme levels of COVID-related fiscal and monetary stimulus pumped money into households and investment markets, contributing to inflation and driving speculation in financial assets”.

Elon Musk, Tesla’s CEO, said at the start of June he had a “super bad feeling” about the economy and wanted to cut around 10% of salaried staff. Mind you, Musk evidently makes mistakes – in February last year, he said Tesla had bought $1.5 billion of Bitcoin, when the month’s closing Bitcoin price was $45,068.05, 36.5% up for the month. He said at the time that “Tesla will not be selling any Bitcoin”, only to sell 75% of Tesla’s Bitcoin holdings in July this year , when the price was close to $23,000.

According to the US Commerce Department, US gross domestic product (GDP) fell by an annualized rate of 0.9% in the second quarter of this year. That means the US is technically already in a recession as the first quarter saw GDP slump by 1.6%.

How do you feel?

Chat about bear markets is far removed from many peoples’ concerns. It’s how far money stretches that worries people at the moment – and that stretch is much less than this time last year.

The chart above shows that people living in the majority of US states feel pretty miserable, thanks to record-busting inflation of more than 9%, and above 10% in eight cities. US President Joe Biden urged Americans to ‘stay calm’ and said that his team was tackling the problem, by passing an ‘Inflation Reduction Act’, which will probably not “have any impact on inflation” according to an academic study. As the certainty grows that the slowdown will turn into a recession President Biden is running out of time to turn the economy around before November’s critical mid-term elections; according to the National Bureau of Economic Research (NBER) since 1945 the average recession has lasted about 10 months.

Misery is getting a grip on households both sides of the Atlantic. Across the 19 countries within the Eurozone inflation rose to 8.9% in July; in the UK it hit 9.4% in June. By October the UK will have a new Conservative Prime Minister, with the two candidates vying to outdo one another on unfounded promises to their party’s electorate, who will choose the winner. The European summer will soon be over and colder days are ahead. The Russo-Ukraine war drags on, with Russia’s gas supply to Europe now a useful weapon for the Kremlin. Energy bills for an average consumer in the UK could reach almost £4,000 by next January and some sources suggest that gas storage facilities across the European Union could run out entirely by March 2023 unless savings of 11% (compared with previous years) are made; 22% in Germany.

The Ukraine war has already seen some unexpected consequences. Uniper, which supplies around 60% of Germany’s natural gas, has been bailed out by the government (at a cost of €15 billion or $15.40 billion) to save it from bankruptcy – German customers of Uniper will have to pay an extra €1,000 a year for the period October-April. As David Frum has said in The Atlantic magazine, one of the “world’s largest energy producers is using its oil and gas as a weapon against its formerly best customers. World markets are disrupted as a result”.

Since 1980, the US Dollar has lost 72% of its value, the Pound Sterling 79%. This year’s record inflation rates exacerbate those declines in fiat currency values. Until the war in Ukraine ends – preferably amicably – the world can only hope for no more inflationary shocks. Central banks have not just lost control of inflation; even monetary policy may no longer be in their hands.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Soapbox: Taming the ‘Wild West’

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Soapbox Crypto

“Today we put order in the Wild West of crypto assets and set clear rules for a harmonised market… The recent fall in the value of digital currencies shows us how highly risky and speculative they are and that it is fundamental to act”, said Stefan Berger, a German centre-right lawmaker. Just a few days later the Financial Stability Board (FSB), established in 2009 by the G20 group of economies, to try to prevent the kind of financial black hole that threatened in 2008 to suck into itself the world’s banking system from happening again, said it will draw up “robust” global rules in October for cryptocurrencies. Russia is still represented at the FSB, and the Russian financial monitoring agency, Rosfinmonitoring, is now using software to track cryptocurrency transactions. The blockchain technology, on which cryptocurrencies are based, records transactions, but not the identity of wallet-owners. Anatoly Aksakov, head of the financial committee in Russia’s lower house of parliament, has said draft legislation on regulating cryptocurrencies would be considered in the fall. “Obviously there will be strict regulation”, Aksakov said, comparing what he called “cryptomania” to gambling addiction. Apart from periodic collapses in the value of various cryptocurrencies, governments are alarmed that cryptocurrencies facilitate the eluding of scrutiny and evasion of sanctions; the world’s biggest cryptocurrency exchange, Binance, has been used by traders evading sanctions re-imposed on Iran by the US. Binance dominates the $950 billion crypto industry, offering its 120 million users a wide range of digital coins, derivatives and non-fungible tokens, processing trades worth hundreds of billions of dollars a month.

The meltdown in the value of cryptocurrencies – the so-called “crypto winter” – has seen around 70% wiped off the value of the most dominant, Bitcoin, and it has also seen the collapse in value of some of the biggest cryptocurrency exchanges, such as the US-based Coinbase, whose share price has lost more than 84%. Some people who ploughed all their investments into cryptocurrency have lost everything, tempted in by the adrenalin-fuelled rise in prices only to see it all tumble. Various exchanges – including CoinLoan, an Estonian-based exchange, and the Singapore-based Vauld – have started to restrict transactions and limit withdrawals. Jason Stones, a former employee of another platform, Celsius, is now suing Celsius; among his allegations is that the company was running a Ponzi scheme.

The mathematical statistician Nicholas Taleb, a long-standing sceptic of cryptocurrencies, told The Guardian newspaper recently “this is the first time we’ve seen a financial bubble coupled with religious, cult‑like behaviour and an investment strategy not seen before in history… I would tell people who are still holding Bitcoin: ask your grandmother if the idea makes sense. And if it doesn’t make sense to her, it doesn’t make sense… if you buy gold and store it in your basement or wear it on your neck, there is no chance of that gold turning to lead over any foreseeable horizon… Metals don’t need maintenance. Bitcoin requires continuous maintenance”.

What about the US?

The US has many different, overlapping regulations at the federal level; and many states have their own practices. Federally, probably the most important watchdog is the Financial Crimes Enforcement Network (FinCen). FinCEN’s task “is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities”. FinCEN, the Inland Revenue Service does not consider cryptocurrencies to be legal tender but accept that they can substitute for money. Cryptocurrency exchanges fall under the Bank Secrecy Act, administered by FinCEN and designed to prevent money-laundering and terrorist financing. Money laundering activities carried out by HSBC bank saw it pay a record $1.9 billion in settlement in 2012, under the Act.

In December, 2020 FinCEN proposed new cryptocurrency regulations that will impose data collection requirements on cryptocurrency exchanges and wallets. By the fall of this year, if the proposal has no hold-ups, exchanges will be required to submit suspicious activity reports for transactions over $10,000 and require wallet owners to identify themselves when sending more than $3,000 in a single transaction.

In March this year, President Biden signed an Executive Order – meaning Congressional approval was not necessary – on ‘ensuring responsible development of digital assets’, a very broad document that talks about the need to protect consumers, businesses and investors, and mitigate the risks of illicit finance, and calls for various agencies to get their acts together, but which swiftly pivoted to the contentious topic of Central Bank Digital Currencies, linking it to “sovereign money”, i.e. money under the control of the government – which is precisely what cryptocurrencies are designed to avoid, and partly explains their rapid growth. Cryptocurrency’s creators have taken note of the decline of fiat money (the Dollar has lost more than 80% of its value since 1970, while Pound Sterling has been even worse, down by 94% over the same time), and built something that they hope will not be a plaything of the markets or governments, but whose value will be stable. The wild west has yet to be tamed – cryptocurrencies’ wild volatility has not only ruined the hopes of many small investors, it may also lay to rest the idea that digital tokens – at least, those invented by private hands – might one day become ‘money’. They should be re-named and referred to as ‘crypto-assets’. One of the inherent characteristics of money is stability, not stasis but small movements in purchasing power, such as with gold. There’s too much illegality, too much at risk to society for crypto-assets to claim the status of money. No-one is safe – the British Army’s Twitter and YouTube accounts were taken over a few days ago, the fake Twitter feed used to promote crypto schemes and non-fungible tokens, while the YouTube account aired clips of Elon Musk and directed users to crypto scam websites. This truly is a wild west, and it will be tamed by governments. As Sir Jon Cunliffe, deputy governor of the Bank of England with responsibility for financial stability, said in a recent speech- “people don’t fly for long in unsafe aeroplanes”.

Here come CBDCs!

In classic Western movies, the Marshal may be lonely and slow to gun down the bandits; but eventually he gathers supporters and the bandits are destroyed. This scenario is being played out in cryptocurrencies – order will slowly, but surely, be imposed on the Wild West. It doesn’t mean that cryptocurrencies will die out – there are always fresh bandits challenging the Marshal but their apparent power will be circumscribed. But the Marshal has learned a few valuable lessons from the bandits – cryptocurrencies’ underlying technology (the blockchain) is being adopted and utilised as this is written by 105 countries, representing 95% of global gross domestic product.

CBDCs give governments the chance to issue “programmable money” relying on “smart contracts”, programs stored on a blockchain that run when pre-determined conditions are met. This has advantages of speed and cost, but it could leave an individual CBDC vulnerable to attack. There are some very serious and important questions around ‘Big Brother’ style intrusions into individual privacy or the exclusion of people who either don’t have or don’t want the kind of digital connectivity required, let’s face it, the issue of data security is an enormous and untested issue. Nevertheless, like it or not – and there are many who rightly have some serious concerns… the Marshal, armed with his CBDC, is coming to town.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.