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Soapbox: Borrowing to survive

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“Neither a lender nor a borrower be”. So Polonius tells his son Laertes in Shakespeare’s Hamlet. Wise advice. But it appears to have been utterly forgotten by governments. The world has been embarked on a massive borrowing spree, borrowing to survive. Governments have argued, perhaps with some justification, that it has been important to get through the Covid-19 crisis first, and sort out the bill later.

It’s a big bill. Global debt is now $296 trillion (£215 trillion) according to the Global Debt Monitor, which monitors 61 countries, of the Institute of International Finance (IIF). That’s $36 trillion (£26 trillion) higher than prior to the Covid-19 pandemic.

Does this matter? Mrs Thatcher, the tough-minded British Prime Minister and staunch opponent of debt, would certainly have thought so. She said in 1980 “it is neither moral nor responsible for a government to spend beyond the nation’s means”. Thatcher thought it was not good policy and also unethical to run up debts. Maybe that was simply a reflection of her upbringing as the daughter of a frugal grocer. No borrowing to survive for her – just tighten your belt.

Modern Monetary Theorists (MMters), who seem to be in the saddle these days, pooh-pooh Thatcher’s parsimoniousness. For them, sovereign countries such as the US, who control their own money supply, don’t have to rely on taxes or borrowing for spending because they can print as much money as they want or need. They can’t ever default on their debts or go bankrupt. Borrow as much as you like – or create money. Or so the argument goes.

Borrowing To SurviveThis debate is vitally important right now. The global economy needs to return to growth, but there are many signs that this growth is elusive. Could this drowning in debt be a drag on economic growth?

The risk to growth

How does one know whether growth is at risk from high debt? In answering this most international financial institutions refer to the ratio between debt and gross domestic product or GDP.

GDP is the total monetary value of all the finished goods and services produced by a country in a given time, typically a year. As a measure of how well an economy is doing, GDP has its critics (it doesn’t take account of the informal economy, nor of domestic work in the home for instance) but it’s about the most comprehensive measure we have.

According to the IIF, debt as a share of GDP – the debt/GDP ratio – fell in the second quarter of this year, from its (record) high of 362% in the first three months of 2021 to 353%. That’s still a staggering figure. The average debt/GDP ratio for emerging market economies in the late 1980s and early 1990s was around 100%; in 2010 advanced economies had a debt/GDP ratio just above 90%.

Some economists argue that high levels of debt, this borrowing to survive, have a big negative effect on GDP growth: “On average across individual countries, debt/GDP levels above 90% are associated with an average annual growth rate 1.2% lower than in periods with debt below 90% percent debt”.

Borrowing To Survive Graph 2

There is a tremendous irony here. Governments have pumped trillions into the monetary system to support jobs and businesses. Yet all this may have done is to push up global debt to levels that drastically slow economic growth.

It also seems to imply there is a ‘safe’ debt/GDP ratio but there isn’t. There is only a ‘safe’ ratio between a country’s debt and its ability to pay off that debt. If a country has strong growth, stable expenditures, a coherent tax system, and solid expectations of future budget surpluses, it can borrow heavily. Are there any countries which can point to those today?

Total debt

In 2008, the global debt/GDP ratio was 280%. Since that year’s Great Financial Crisis – which fundamentally was brought about by crazy lending and borrowing levels – global borrowing has risen by more than a third. It’s an astonishing example of amnesia.

In the US, the national debt is now rapidly approaching $29 trillion (£21 trillion), around 125% of GDP. That debt load would be much higher if off-balance sheet commitments such as Social Security (pensions) and Medicare (health provisions) were counted. These are future expenditures the government is obliged to pay by law. If the present value of these off-balance sheet items for the next 75 years were included the debt would be more like $147 trillion (£107 trillion) according to the non-partisan group Truth in Accounting. In the UK, the government debt is more than £2.2 trillion ($3 trillion).

These debts will never be repaid. That doesn’t matter, say MMTers: a government that can issue its own currency can simply create the money it needs. Provided there’s no inflation, a government deficit doesn’t matter. There is no need to worry about the government defaulting on its debt; the government can just create new money, new bonds, to pay its creditors or roll over the debt.

Life’s a gas

Voters and investors tend to be distracted by short-term issues happening in their own backyards. We have become accustomed to rock-bottom interest rates; the cost of borrowing money has rarely been cheaper. Deflation, not inflation, has long been uppermost in the minds of central bankers in the US, UK and the European Union.

But inflation is returning. Wholesale gas prices in the UK have risen by more than 400% since a year ago and in other European countries energy bills are also soaring. Natural gas prices in the US have doubled in the past six months. Such is the inter-connectedness of our economies today that the higher gas costs in the UK have forced two large fertiliser plants to shut down, which has caused supply shortages of the by-product CO2, which in turn is causing problems in food supply – CO2 is used to stun animals before slaughter and to keep some packaged foods fresh. Poultry prices will be going up, too.

Maybe it’s all a matter of confidence. So long as investors feel confident that countries can continue servicing their debts, they will continue buying the bonds attached to rolled-over debt. They will however run out of patience once it becomes apparent that higher inflation levels can only be stamped out by a rise in interest rates. Governments don’t want to raise interest rates as that would push up the cost of servicing their debt. Higher interest rates would also make credit more expensive.

But higher inflation also causes the value of currencies to decline; inflation lets debtors pay lenders back with money that is worth less than when they originally borrowed it. Inflation is a mixed blessing – good for borrowers and owners of physical assets, bad for those on fixed incomes, lenders, those who hold fiat money.

Sovereign debt defaults are not something one expects to see in such stable countries as the US or the UK. But they might happen to poorer, massively over-leveraged countries. In the private sector there are already growing risks from defaults, and risks of a global ripple effect are rising.

In China, the massive conglomerate Evergrande, which borrowed more than $300 billion (£217 billion) and which owes money to some 171 domestic banks and 121 other financial firms, is in deep trouble; it can’t pay its debts. Evergrande’s debt swamp has already knocked stock markets around the world. The authorities may choose to punish Evergrande and let it collapse; but the fall-out from that might be felt not just in China’s economy but Wall Street too. Could Evergrande trigger a series of defaults and another financial crisis, similar to 2008?

And what of gold amid all this? Generally the price of gold has an inverted relationship with the Dollar; if the Dollar loses value, then the gold price tends to rise. Higher US interest rates would strengthen the Dollar. For much of this year the US Federal Reserve has been flirting with an end to its quantitative easing policies; as inflation starts to stick around it looks like interest rates will need to rise sooner rather than later. Understandably gold has spent much of this year, like the rest of us, nervously watching the Fed, the Dollar.

At Glint, we try to achieve a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power. We strongly believe that gold is the fairest and most reliable currency on the planet, but 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.

The dominos have not yet started tumbling, but warning signs are arriving thick and fast; rocketing gas prices, Evergrande’s woes, the continuing computer chip shortage…’black swan’ events are coming at an accelerating pace. The German-American economist Rüdiger Dornbusch famously said “the crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought”. Inflation has been riding a three-legged pony but now looks like switching to a Porsche 911. The Fed wants a bit of inflation to come back. But how much? And will it be able to control it once it’s here?

Soapbox: Fiat currencies headed for the trash can?

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“Cash is trash” said Ray Dalio, founder of the US-based investment firm Bridgewater Associates, which manages around $160 billion, in January last year. His sceptical view of fiat currencies came at 2020’s global cocktail party for the great and the good, the World Economic Forum in Davos, Switzerland. “You have to have balance… I think you have to have a certain amount of gold in your portfolio” said the billionaire. Can’t disagree with that.

Rapper Dan (Dan Sur), a Mexican musician, has used his head to load up with gold. Dan has told his 1.9 million TikTok followers that he has become the first rapper (will there be more?) to implant gold chain hooks into his scalp. “This is my hair. Golden hair,” he said.

You don’t need to follow Rapper Dan’s lead. But Dalio has a point. Fiat currencies are simply bits of paper that a government declares has value. Something becomes ‘trash’ if there’s so much of it around that no-one values it any more. That’s why people fling confetti at weddings; it’s only purpose is to throw it away. The US Dollar supply has grown fantastically in the last few months; is it becoming confetti?

By the end of 2020, one in five Dollars had been newly created by the US Federal Reserve. This massive creation of fiat money was part of the Fed’s ‘quantitative easing’, or QE for short. Cash can be created on a whim.

The Fed first used QE between December 2008 and October 2014; the Covid-19 pandemic and the worldwide government shutdowns saw the Fed re-start QE. Since June 2020, it has been buying $120 billion of assets a month.

QE has become the main tool of central bankers – not just at the Fed – who are alarmed at slow or zero economic growth. This newly-created money is meant to dribble through the economy, like coffee dripping through a filter, until it reaches and refreshes us all. It fails.

Source: katusaresearch.com

The Fed is not alone – the Bank of England (BoE), the European Central Bank, and others have all created more fiat currencies at a similar rate. The BoE by the end of this year will own £895 billion ($1.24 trillion) of government and corporate bonds, thanks to its own QE. That £895 billion is about 40% of the UK’s gross domestic product. The European Central Bank has its own version of QE, the pandemic emergency programme or PEPP, which will total some €1.85 trillion ($2.19 trillion).

Does QE work? Apparently not – all it seems to do is make the rich richer. The money created through QE buys government bonds from the financial markets; so it goes directly into the financial markets, boosting bond and stock prices.

The BoE estimates that its first bout of QE boosted those prices by around 20%. In the UK, 40% of the stock market is owned by the wealthiest 5% of the population, so while most families saw no benefit from QE post-2008, the richest 5% of households were each up to £128,000 ($177,313) better off.

The BoE estimates that it takes £375 billion ($519 billion) of new money just to create £23-28 billion ($32-$39 billion) of extra spending in the real economy. It’s a very ineffective tool; it relies on boosting the wealth of the already-wealthy and hoping that they increase their spending.

But instead they tend to the extra fiat currencies on investments or savings – further boosting already inflated asset prices. In the past 50 years, the personal savings rate in the US averaged about 8%. In 2020, it soared to 34%. A lot of the Fed’s newly created cash went into equities. A record $120 trillion (£87 trillion) was traded on US stock exchanges in 2020, 50% higher than in 2019.

In a report on QE published in July this year, the UK House of Lords Economic Affairs Committee said QE is “an imperfect policy tool” which helped prevent a recurrence of the Great Depression in 2009 but has “exacerbated wealth inequalities”. The upper house of the British parliament was talking about the UK’s QE, but what it said stands for QE everywhere. The BoE, said the report, was “addicted” to QE. The Fed, the ECB, and other central bankers are all addicts to QE. Like all addictions, giving up – tapering – will be hard.

Inflation turns cash to trash

Many people in the US Federal Reserve will be back-slapping this week. The annualised headline inflation rate rose in August by 5.3%, dropping by a whole 0.1% from June and July. Hurrah! Crisis averted. We can carry on producing more new dollars and keep markets happy. In the UK, consumer price inflation in August rose to 3.2% on an annualised basis, 1% more than the Bank of England’s target.

But your Dollar in 2022 will buy you 5% less than this year. Your Pound will get you 3.2% less than in 2021? Even if the official line, that inflation is ‘transitory’, is correct, it may be stickier than we would like. Prices are several per cent higher than they were; and they are not coming down.

‘Sticky’ inflation is just one headache. There are many problems facing central bankers who would like to turn off their QE spigots, and start tapering.

A shortage of workers is just one – a survey of nearly 45,000 employers across 43 countries showed 69% of employers reported difficulty filling roles, a 15-year high. The US economy has five million fewer people employed than before Covid-19 but still there are record job openings.

And then there are the higher costs necessary to hire and keep workers. Amazon, now the second-biggest US private employer, has just announced a 6% pay rise. In some locations, Amazon is paying $3,000 ‘signing-on’ checks as it struggles to find workers.

There’s also the Delta variant, which keeps popping up and prompting fresh lockdowns and creating further supply-chain blockages. The Chinese city of Xiamen, an electronics manufacturing and exporting hub and home to 4.5 million people in the province of Fujian, has just been placed into a tight lockdown as the authorities pursue their zero-Covid policy.

China’s economy is sluggish – retail sales rose by 2.5% in August year-on-year, the slowest increase in 12 months and far below forecasts. Evergrande, the massive Hong Kong-based property developer, is drowning in more than $300 billion of debt and is close to collapse. Its share price has lost 80% so far this year. Millions of people have given the company deposits for new homes that have yet to be built. Real estate accounts for around 30% of China’s economic output. The authorities won’t let Evergrande go bust, but the cost of saving it will be huge – and will be financed by cash creation from the People’s Bank of China (PBOC).

The Amazon wage hike may be deserved but it sets a benchmark. All US workers will now be looking for a minimum $18 an hour. At the start of this year, President Biden was pushing for a national minimum wage of $15 an hour. The benchmark is now 20% higher than he sought. Psychologically, people are adjusting inflation. This changes their behaviour, their expectations.

In several European countries, energy prices are ‘skyrocketing’ and are expected to go up by 20% for domestic consumers, according to Citigroup. China’s producer price inflation rose by 9.5% in August. The spot price of a 40-foot shipping container between Europe and Asia is now more than 500% higher than a year ago. The full impact of inflationary pressure has probably not yet been felt in consumer inflation data.

Bust before boom?

The danger right now is that we are facing a stagnating global economy before the post-pandemic boom has properly got started.

According to Neil Shearing, chief economist at the UK-based economic research consultancy Capital Economics, there is “a whiff of stagflation” in the air. “It’s now clear that recoveries in the US, UK, Eurozone and China have lost steam in recent months”, he says.

During the last stint of QE, in the years following the Great Crisis of 2008, people feared that all the freshly-created money would lead to a much higher rate of inflation. It didn’t, because the money being injected into the system was largely retained by the financial sector to shore up balance sheets and regain profitability.

The macro-economic picture is very different this time around. Banks are well-capitalised; the newly created fiat currencies, like mercury, finds its own channels – going into physical assets like houses, financial assets like stocks and cryptocurrencies, and commodities, the prices for all of which have soared.

While fiat currencies may not exactly be trash, Dalio is right in one sense. Never before has so much new money been created. And never before has it made so little sense to not put that cash – if you have some – to work, by holding physical assets. Including gold, and especially gold that can be used as money, as with Glint.

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

Cash is fast becoming trash; alarmingly, stagflation looks like setting in. Holding cash, fiat currencies in that environment would be like conserving confetti – a wasted opportunity.

Soapbox: CBDCs & crypto – a two-speed digital world

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cbdcs & crypto

Not heard about ‘Project Dunbar’? You’re not alone – the ‘project’, which is all about CBDCs (central bank digital currencies) was only announced by the Bank for International Settlements (BiS) on 2 September. CBDCs & cryto have become hot topics in the financial world.

Dunbar is the latest step on the path towards wider development of CBDCs. It’s perhaps another nail in cash’s coffin. The BiS says that Dunbar is an alliance of the “Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank with the Bank for International Settlements Innovation Hub to test the use of central bank digital currencies (CBDCs) for international settlements.”

In other words, the plan is to develop a way of linking together national CBDCs to make cross-border settlements – instantly and cheaply – in one digitised currency.

Dunbar is not alone. There is the catchily-named project mCBDC being collaboratively tested by the Hong Kong Monetary Authority, the Bank of Thailand, the central bank of the United Arab Emirates and the ‘Digital Currency Institute’ of the People’s Bank of China (PBoC). It’s odd that the PBoC is part of mCBDC. China is already busily deploying its own CBDC, the so-called ‘e-yuan’. China Construction Bank, a state-owned but publicly listed enterprise, has already opened more than eight million digital wallets for individuals and companies.

As of June this year, the China Construction Bank reported more than 28 million e-Yuan transactions with a total value of Yuan 18.9 billion (about $3 billion). Total e-Yuan transactions by all Chinese banks are now more than $5 billion. At Beijing’s winter Olympics in February 2022 foreign visitors will find themselves ‘encouraged’ to use the e-Yuan for all their spending. In order to do so they will have to provide the PBoC with their passport information.

Remember that in 2013 China’s President-for-life Xi Jinping said “whoever controls data has the upper hand.”

The US has its own CBDC project being tested by boffins at the Massachusetts Institute of Technology (MIT). The American CBDC in-waiting has already been dubbed the ‘Fedcoin’; the Fed is expected to issue a report this month on digital Dollars. The European Central Bank aims to introduce a CBDC by 2025.

CBDCs are not going away. But how fast will they be rolled out? Can they stop the onward march of private cryptocurrencies?

China’s CBDC – digital Leninism?

China clearly has ‘first-mover advantage’. But China’s e-Yuan, a CBDC, also undermines one of the main ambitions of private cryptocurrency proponents – the anonymity that comes from using them. The e-Yuan is designed so that all transactions using it are traceable in real time, “providing a state surveillance capability that does not exist with the current mixture of cash and digital payments operated by private platforms such as WeChat Pay and Alipay.” Some are calling it digital Leninism or techo-authoritarianism.

While there has been a rush to develop and promote private cryptocurrencies (currently there are around 6,000 different ones) the central banking world outside China is moving slowly but steadily. CBDCs carry a multiplicity of risks, both for governments and individuals. At the heart of these risks is one word – power. The power of the state, the power of the individual.

Power is control over money – who issues ‘legal tender’ can best stake a claim to be the legitimate government. A CBDC, no matter how it’s issued, will still depend on how much faith one has in a central bank. Whether it’s a fedcoin, an e-yuan, or an e-euro, a CBDC will only be a new form of the fiat Dollar, Yuan or Euro.

The Wild West of CBDC crypto

The rapid growth of crypto and fintech firms, have changed the way we make payments, deposits and loans – the whole infrastructure of commercial banking – into a plethora of unsupervised and barely regulated networks.

It’s a kind of Wild West right now, with central banks the isolated marshal (think Henry Fonda clutching a CBDC) desperately trying to chuck the drunks (armed with their cryptocurrencies) out of the saloon. The newcomers on the block are disrupting commercial banking’s previously stable deposit base, and cutting profits.

Commercial bank bosses are worried that the development of a retail CBDC (such as China’s e-Yuan) will disintermediate them – cut them out of the financial supply chain.

Collapse of faith in the banking system?

But conventional commercial banks have been their own worst enemy. Expensive, cumbersome and slow payment systems gave birth first to credit cards, then payment platforms, and now decentralised blockchain-based solutions. Cash has meanwhile steadily lost ground.

Without the near-meltdown of the global banking system in 2008, when banks benefited hugely from tax-payer funded bail-outs, confidence in the reliability of commercial banks might still be high. The surge of interest in cryptocurrencies outside the conventional banking system is partly down to consumers’ collapsed faith in commercial banks and fiat money. Lots of people say that buyers of cryptocurrencies are just trying to make a quick buck; but I suspect many are simply trying to protect what money they have.

Regulators continue to make speeches about how it’s “difficult for regulators around the world to stand by and watch people, sometimes very vulnerable people, putting their financial futures in jeopardy, based on disinformation and fear of missing out” (as Charles Randell, chairman of the UK’s Financial Conduct Authority, said this week). It may be a headache for regulators; for those of us wondering what money might be today and tomorrow, it’s a nightmare.

CBDC and crypto stability

As central bankers deliberate, some countries have already decided what form of alternative currency they are going for. We have seen China’s plans. Others are taking a private route.

El Salvador has become the first country to make Bitcoin legal tender. President Nayib Bukele says use of Bitcoin will be optional, although the law that opened the way for the Chivo says Bitcoins must be accepted if offered, and that salaries and pensions will continue to be paid in US Dollars, which replaced the Salvadoran Colon as legal tender in 2001.

Salvadorans are being offered $30 in Bitcoin slivers via a state-provided digital wallet called “Chivo” (slang for ‘cool’) but opinion polls suggest most Salvadorans are against the idea.

On the other hand, some crypto supporters point to the massive stimulus programme being implemented by the US and speculate this will inevitably lead to a debasement in the Dollar’s value. Given that some 20% of El Salvador’s gross domestic product (GDP) is accounted for by remittances in US Dollars sent home from abroad, having an alternative that might keep its value makes sense.

El Salvador’s gamble hit the buffers on its first day – the price of Bitcoin crashed from $52,000 to less than $43,000 at one point. The International Monetary Fund (IMF) doesn’t like countries using cryptocurrencies as legal tender. It says cryptocurrencies threaten “monetary stability”.

And the Salvadoran experiment will mean that the intergovernmental Financial Action Task Force (FATF) “will be all over El Salvadoran banks, businesses, and other financial institutions like a wet blanket.” That may be true; but cryptocurrencies like Bitcoin only make the game more complex for anti-corruption agencies such as FATF – they don’t change the game entirely. In emerging economies, where financial instability, high inflation and weak national currencies are a fact of life, cryptocurrencies have gained a firm foothold.

Money needs to be publicly acceptable

According to one commentator: “states exist to provide essential public goods. Money is a public good par excellence. That is why dispensing with the role of governments in money is a fantasy.”

But what if money is somehow taken out of the hands of governments, which is what private cryptocurrency users shout about? Or what if governments change what is considered money, without consulting the people who vote for them?

In China the latter question is not really a concern; the politburo decides and enforces that decision as law. The e-Yuan is clearly going to be a winner in China.

Western-style democracies give their citizens greater freedom of choice, and many millions have chosen cryptocurrencies over fiat money. That may be an unwise choice, not simply because the barriers to entry for creating cryptocurrencies is so low but also because they are so volatile; “the volatility of Bitcoin prices is extreme and almost 10 times higher than the volatility of major exchange rates (US dollar against the euro and the yen).”

This may upset El Salvador’s monetary experiment; if people there pay their taxes in Bitcoin while government spending remains primarily in US Dollars this would put heavy pressure on the exchange market and on the country’s international reserves, which in any case are tiny, just over $3 trillion.

Gold, crypto, value and exchange

As we have said in previous editions of Soapbox, since President Richard Nixon finally killed the gold standard 50 years ago money has been de-anchored from anything but our collective trust that governments and their tools, central banks, will behave responsibly. That trust was fatally injured during the 2008 financial crisis. Shortly after, technology facilitated the creation of cryptocurrencies – badly named because they aren’t currencies but a “very speculative asset” according to Steve Hanke, an economics professor at Johns Hopkins University.

Money on the other hand should be a store of value, a unit of account and a medium of exchange. A really sound currency is durable, portable, divisible, uniform, limited in supply and acceptable. Cryptocurrencies are neither a store of value (they can go up and down like a yo-yo) nor a good unit of account.

Glint is a part of the digital payment Revolution without being part of any blockchain. Yet it’s independent of nationally controlled fiat currencies. If ever a world of private money was to dawn, we believe that nothing else but gold would have the trust that is essential in any money that is universally accepted. 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: The gold-buying season

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As the northern hemisphere daylight hours shorten we’re approaching the season when gold-buying historically picks up, according to some academic research. Gold demand conventionally increases towards the end of the year, driven largely by purchases from Indians who give and exchange gold items around the festival of Diwali, which falls on 4th November this year.

This research holds that there is a recurring pattern of a seasonal rise in the gold price between May and the following January, with an increase observed “in 20 of 30 years, resulting in an average profit of +19.2%. But there were also 10 years, where the price of gold fell during this period of the year. The average loss then was -12.3%. The overall rise during all 30 years was +7.6% p.a.”

Fat years and lean years. So far 2021 seems to be shaping up to be a ‘lean’ year – the gold price has fallen by about 6.5% in the past 12 months.

Yet, last December it seemed to one source that gold “momentum and dollar weakness suggest that 2021 is going to be a very bullish year”. Since commodities are priced in US Dollars, weakness in the Dollar generally results in stronger commodity, including gold, prices. And if you pay attention to Goldman Sachs, the Dollar is due to decline, like some ancient warrior now past his peak: “We forecast broad Dollar depreciation over time on our expectation that the global economic recovery will continue and that slowing domestic growth and lower inflation will allow the Fed to remain on hold until Q3 2023”. But the decline, adds the bank, will be slow and bumpy.

Perhaps 2021 is even stranger than last year. 2020 started with a global panic over the coronavirus but ended with euphoria as vaccines were developed and started to be rolled out. 2021 was going to be the year when life returned to normal and economies began their recovery. But by September we have a white noise background – all audible frequencies are playing at once, making it impossible to pluck out any single dominant sound.

To continue the metaphor, let’s take just a few of the stronger ‘notes’. What’s happening to inflation? How fast might the central banks start to unwind their massive stimulus programmes? When will the US Federal Reserve start to raise interest rates – and how high? Will recurrences of coronavirus variants continue to impede economic growth? Could China succeed in toppling the Dollar as the international reserve currency? Is the massive global debt – nudging $300 trillion (more than £217 trillion) – sustainable? The US is planning a multi-trillion Dollar spend on infrastructure, which will push its fiscal deficit (so far this year more than $2.5 trillion, more than £1.8 trillion) even higher. This will simply add to the US federal debt, now almost $29 trillion (£21 trillion). In the US Social Security benefits are likely to run out earlier than expected; the annual Social Security trustees report now forecasts retirees and the disabled will only be able to receive full benefits on a timely basis until 2034. After that, the programme would have enough income to pay only about 78% of scheduled benefits unless Congress steps in to shore it up – by, presumably, sanctioning an increase in the money supply.

Who’d be a central banker?

As for inflation, that’s showing signs of far from being “transitory”, as central bankers persist in arguing. On the other hand countries are emerging from the global economic recession patchily. Central bankers are desperately trying to ascertain whether the world economy is properly on the road to recovery or if it’s stalling. It’s crystal ball time.

Jerome Powell, chairman of the US Federal Reserve, which sets America’s interest rates, seems more worried about deflation – when the general level of prices fall – than inflation. At last week’s Jackson Hole gathering of central bankers he said: “The pattern of low inflation likely reflects sustained disinflationary forces, including technology, globalization, and perhaps demographic factors, as well as a stronger and more successful commitment by central banks to maintain price stability. While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. It seems more likely that they will continue to weigh on inflation as the pandemic passes into history”.

In the 19 countries of the Eurozone consumer prices in August rose by an annualised 3%, following 2.2% in July and well above the ECB’s 2% target, and the fastest surge in overall consumer price growth in a decade. In Germany – the Eurozone’s biggest economy – inflation is likely to approach 5% in the coming months. Thomas Nuernberger, managing director of EBM Papst, which makes industrial fans in Germany, told Bloomberg: “In my career we haven’t had a situation with so many commodities being scarce at the same time, and I’ve been dealing with the same materials since 1996”. House prices in the US are scorching – up by almost 20% in June compared to the same month in 2020. The US consumer price index (CPI), which rose by 5.4% during the last 12 months, conveniently does not include the cost of housing units. Other major economies are facing bursts of inflation – take Brazil for instance, where the annualised inflation rate in July was 8.99%.

The dilemma for central bankers is becoming daily clearer. Face up to growing inflation and start to end their quantitative easing programmes, and begin raising interest rates. But that will damage economies that are struggling to emerge from the coronavirus lockdowns.

Covid-19 variants keep popping up and forcing fresh lockdowns; in Vietnam’s Ho Chi Minh city, for example, residents have just been told not to leave their homes, which is causing delays to Vietnam’s exports and has already pushed up wholesale Robusta coffee prices. Even China, the workshop of the world, may be facing a slowing economy. The Caixin manufacturing purchasing managers’ index, an important independent survey of factory activity, was 49.2 in August, dropping below the 50-mark that separates monthly expansion from contraction, for the first time since April 2020.

No crystal ball necessary

We come full circle. Will 2021 see a seasonal uplift in the gold price towards the end of the year, on strong demand from India around Diwali? Or might this year be one of those outliers – a lean year, in which the gold price ends lower than where it started?

According to The Golden Constant, the seminal book by Roy Jastram published in 1977 , in Pound Sterling terms over the past four centuries gold lost purchasing power in every period of inflation; by anything from 21% (in both 1675-1695 and 1752-1776) to 67% (1897-1920). The story is similar for four periods out of five in the US, from 6% (1861-1864) to 70% (1897-1920). In each of the four deflationary periods since the 17th century gold has increased its purchasing power in Pounds Sterling, by between 42% (1658-1669) and 251% (1920-1933). In the US during the deflationary periods of 1814-1830 and 1929-1933 gold’s purchasing power rose by between 44% and 100%.

But that’s the past. And as every financial adviser will tell you, ‘the past is not a reliable guide to the future’. That’s as true of gold as any other financial asset, including stocks, cryptocurrencies, bonds, and even houses. But one has to ask oneself why one buys gold in the first place. Is it just a ‘safe haven’ when all else seems to be chaotic?

One thing is true: you will never find ‘the best’ time to buy gold. You will never find the ideal buying point. That shouldn’t bother you, because with Glint your allocated gold performs a dual function. It’s a means of saving when times are uncertain – and times have rarely been this uncertain – and hedging your bets against the erosion of the purchasing power of fiat currencies. And it can be used as money, at the grocery checkout, when booking a car rental, buying dinner at a restaurant – in fact, wherever the Mastercard®is accepted.

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

Soapbox: In a hole

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Jackson Hole, in the state of Wyoming, has the only US airport sitting entirely inside a national park. It was the first state in the country to allow women the right to vote, serve on juries, and hold public office – which is why Wyoming is also known as the ‘Equality State’.

But Jackson Hole is today probably better known for hosting an annual symposium of economists and central bankers, who normally deliver speeches and papers on such things as ‘Maintaining Stability in a Changing Financial System’ (in 2008), or this year on ‘Macroeconomic Policy in an Uneven Economy’. ‘Uneven economy’; a huge understatement today.

Few central bankers will be jetting into Jackson Hole airport for this year’s meeting, scheduled for Friday and Saturday this week, however. An uptick in US Covid-19 cases means that the event will now be virtual, says the symposium’s sponsor, the Federal Reserve Bank of Kansas City. The big dog of the proceedings is always the chairman of the US Federal Reserve, currently Jerome Powell. What he has to say on 27 August will be closely watched by financial markets around the globe.

Powell is sitting in a hole from which there is no easy escape. Rock-bottom interest rates in the US and quantitative easing by the US Fed (to the tune of $120 billion a month) and the vast stimulus programmes from US President Biden has meant there are trillions of extra Dollars sloshing around, which has helped push up prices of all kinds of assets – stocks, houses, cryptocurrencies… even Beanie Babies.

We all know why the Fed supervised the biggest explosion in money supply since at least the Second World War. It’s because it tries to steer between the Scylla and Charybdis of the economy – between ensuring ‘full employment’ and price stability.

Forty-four years after that dual-track policy was mandated by the US Congress it’s starting to look like trying to have your cake and eat it.

Too much cake

Too many contradictory cakes are causing Powell a touch of dyspepsia.
On the one hand he is confronting that fact that job vacancies in the US are not being filled; vacancies rose to more than 10 million in June, well above expectations. And while the unemployment rate fell in July by 0.5%, to 5.4%, 8.7 million people remain unemployed, far more than the pre-pandemic 5.7 million in February 2020. In the first quarter of 2021, the US economy bounced back faster than expected; but the 2nd quarter’s annualised rate of 6.5% growth was some 2% less than expected. For a variety of reasons, people are not flowing back to work as expected – or desired. Complicating matters are the various COVID variants, which is making a return to economic ‘normality’ very bumpy.

And prices are hardly stable. The US consumer price index (CPI) was at a 13-year high in July, the same as in June. US whole price inflation in July rose sharply for the sixth successive month to 7.8%. Maybe these will slow in coming months – and maybe they won’t. Jeremy Siegel, professor of finance at the Wharton School of Pennsylvania, said in May this year that he expects “over the next two, three years we could easily have 20% inflation” thanks to the expansion of money supply rising by almost 30% since the start of this year. “That money is going to find its way into spending and higher prices…The unprecedented monetary expansion, the unprecedented fiscal support… was first going to flow into the financial markets, into the stock market, and then once we’re reopening, and we’re right at that cusp, it was going to explode into inflation”.

But for every Siegel you can find a Powell, telling us the inflation is ‘transitory’.

Tapering in the spotlight

The US Fed has bought trillions of Dollar assets during the pandemic, equivalent to 18% of US Gross Domestic Product (GDP). Its total balance sheet is now more than $8 trillion.

This Quantitative Easing (QE) certainly helped the US economy weather the pandemic storm but has also distorted all markets; easier financial conditions have led to higher asset prices, booming stock prices (often disconnected to companies’ underlying positions), and less credit discipline. ‘Zombie’ companies – those with low earnings and high debts – have survived thanks to QE and subsequent low interest rates. The number of ultra-high net worth individuals (defined as those with investable assets worth more than $30 million) rose by 24% in 2020, the fastest rate of increase since 2003.

At Jackson Hole, Jerome Powell will be unable to be frank. He will shrug off the threats of inflation; he won’t be able to talk about the threat of a balance sheet recession; he will avoid talking about (except in very guarded terms) the most serious problem of all – how and when to bring to an end the massive QE programme.

But markets will turn sour whenever he signals that the Fed will start “tapering” its QE; volatility would rise as investors desperately shed risky assets and hunt for yield. Tapering QE and starting to raise interest rates would kill off what Ben Bernanke, a predecessor of Powell as Fed chairman, memorably called in 1996 the “irrational exuberance” of the markets. The US Dollar would strengthen, making US exports less competitive (and probably causing the Dollar/gold price to weaken) and would risk pushing the US into recession.

As the Financial Time’s John Plender has written: “The difficulty is that central banks cannot take away the punch bowl and raise [interest] rates without undermining weak balance sheets and taking a wrecking ball to the economy.

The temptation for policymakers is to muddle on and perpetuate the boom, bust and bailout cycle. That way ultimately lies the balance sheet recession — a downturn caused by debt burdens — to end all recessions”.

I expect Powell to do exactly what Plender suggests – muddle on and hope that things improve, that more Americans get vaccinated and start returning to work, and that the US economy starts growing again more solidly. He is likely to go down in history as “Mr Muddle On”. The merry-go-round must end – or spin off out of control.

Soapbox: Afghanistan matters but not why you think

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In February this year, US President Joe Biden said: “the message I want the world to hear today: America is back. America is back”. Maybe he should have said ‘American troops are back’. This week’s ghastly pictures from Kabul, showing hapless Afghanis clinging to (and falling from) the side of monster US jets taxiing down the runway of Hamid Karzai International Airport as they try to flee the Taliban, are reminders of the ignominious US retreat from Saigon in April 1975. US military power and the vigour of its foreign policy have progressively diminished since its failure to defeat the Vietcong almost 50 years ago. The deposing of the Shah of Iran, Iraq, Libya, and now Afghanistan… all expensive foreign ventures that America has started and walked away from.

The prime beneficiary of this latest humiliation of the US – apart from the Taliban – is China. Those Afghans opposed to the Taliban feel they have been ‘betrayed’ by the US and, by extension, the West. China says it will respect the ‘choices’ of the Afghan people. China’s state-backed tabloid newspaper mouthpiece the Global Times quickly commented that: “The US’ desperate withdrawal plan shows the unreliability of US commitments to its allies: when its interests require it to abandon allies, Washington will not hesitate to find every excuse to do so”. Commentators closer to home have already started to write about the “post-American world”. The cost to the US is not merely in prestige; wrapped up in all this is the fate of the US Dollar.

Control of money is power

For some, the US has been on a steady decline since President Nixon ended the gold standard and ushered in the era of fiat money. What started 50 years ago was a new monetary order which ultimately will spell the end of the Dollar’s international dominance. The 18th century French philosopher Voltaire said “paper money eventually returns to its intrinsic value – zero.” Perhaps we are closer to that zero than we imagine. The Dollar has already lost around 90% of its purchasing power since 1933 and even at a fairly low rate of around 3% inflation it will have lost another half of its purchasing power by 2022.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power. While we strongly believe that gold is the fairest and most reliable currency on the planet, 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.

The Dollar effectively replaced gold as the international currency standard in 1973. The US quadrupled its grain export prices shortly after the Nixon finally killed the gold standard in 1971. In response oil-exporting countries quadrupled their oil prices. Then US diplomats led by Henry Kissinger, Secretary of State did a deal with Saudi Arabia under which the US agreed to supply military hardware to and defend Saudi Arabia in return for all oil trade being denominated in US Dollars. The ‘petrodollar’ was born.

By 1975, all members of OPEC (the Organization of Petroleum Exporting Countries) were trading their oil in US Dollars, creating a voluminous demand for the US Dollar and US government bonds. On the back of that the US fuelled its decades-long instant gratification splurge, able to finance a vast array of government-funded schemes and an explosion in consumer demand through this petrodollar ‘recycling’. The US could literally print money to buy oil, and then have the oil producers hold the debt that was created by the printing presses in the first place. Neat.

What is coming?

Upheaval.

That’s according to Stephen Leeb, a US economist and author.

Last December, he published China’s Rise and the New Age of Gold which is avowedly bullish on the future gold price because he sees the direct link between money and power: “China’s rise is spearheading a historic shift in economic power from West to East that is leading to a foundational change in global relationships. It’s a change that points inexorably to higher gold prices. And the United States will be powerless to hold back the tide”, he writes.

Key to his message is what he sees as China’s long view, which he contrasts with America’s short-termism: “China – in contrast to the United States – does know where it’s going…understanding that China plays the long game is one of the most important insights you can have about what lies ahead”.

In this respect, Leeb highlights China’s ‘Belt and Road Initiative’ (BRI) as providing major long-term support for a wide range of basic commodities such as concrete and steel. This requires him to digress into important side-bars, such as China’s Ultra-High-Voltage Grid, its rail network expansion and its ‘ghost cities’, megalopolises which were built before anyone moved in. Western commentators initially mocked empty cities, but they have now started to fill and thrive. The US has built no new rail track since 1950, claims Leeb, and less than 1% of its total rail network is electrified; China meanwhile has leapt forward in providing its citizens with high-speed electric rail connections. Leeb dismisses America’s fracking ‘revolution’, once touted as freeing the US from its dependency on oil imports, as “mostly a chimera”.

A new international currency

If control over money is power, then the reverse is also true – power is control over money. This power is mutating at a rapid rate. It’s not just that the US has lost an immense amount of prestige over its hasty but well-flagged retreat from Afghanistan. Part of the enormous power of the US has been, still is, the possession of the global international currency, the Dollar.

But America’s power – that control over money – is being undermined from many directions: the blockchain and the thousands of cryptocurrencies it has given rise to; the challenges to the SWIFT international payments’ system by fintechs such as Glint; the relentless drive by China to roll out and compel the use of its own digital money, the e-Yuan; all of these (plus the multitude of internal divisions within the US itself) signal a profound fragmentation in what has been the steady-state system we have lived under since Nixon ended the gold standard.

China, Russia, and other states are bridling against the Dollar’s hegemony. They see the Dollar’s primacy as granting the US privileges it no longer merits. They are bristling against what they regard as the US being able to browbeat other nations, by imposing sanctions on them it when wants and using the Dollar as a big stick. It irritates China by forcing other developing nations – a growing number of which are part of the BRI – to trade with China using Dollars, rather than their own currencies. From China’s perspective, the Dollar stands in the way of the trade it wants. And, remote though it seems, the ignominious failure of the American mission in Afghanistan is yet another indication of waning US power, and the dying of the Dollar.

 

So presumably China’s ambition is to see its currency, the Yuan, replace the Dollar as the international currency? Not according to Leeb: “While internationalising the yuan is an important initial step, China isn’t looking to simply replace the dollar with the yuan. Rather, its ultimate vision is a basket of currencies that includes the yuan in a prominent role alongside the dollar and selected other currencies and, crucially, that is linked with gold… Because in the eyes of China’s leaders, a monetary reserve system based on any single sovereign currency is inherently flawed. A basket of currencies, backed by gold, would address those flaws, in China’s eyes better serving not just China’s interests but the world’s”. Leeb quotes part of a 2014 speech by Song Xin, then president of the China Gold Association:

“For China, gold’s strategic mission is to support the internationalisation of the renminbi [yuan] and be a strong support for China’s goals of becoming an economic power and realising the ‘Chinese Dream’.

Gold is the only product that holds properties of a commodity and currency; it’s the most trusty asset on which modern fiat currency can be based… [gold has] a glorious and holy role to play during the revitalisation of the greatness of the Chinese people…”

In such a tightly controlled, top-down state as China, it may safely be assumed that Song’s words had Beijing’s endorsement.

How much gold China has in its reserves is a tightly-controlled secret. Currently, it officially has almost 2,000 tonnes, sixth in the world’s rankings. But many believe it has much more. In Leeb’s view, “gold will back a new reserve currency, pushing gold prices far higher. Of that much I’m certain”. But “the new gold standard will be a whole new animal: a gold-backed currency that lets gold rise to accommodate expanding economic activity, especially growing international trade”.

Thus does China’s willingness to deal with the Taliban make sense, even though it is obviously worried about a fundamentalist Islamic state so close to its own large minority Muslim population, the Uighurs. It’s not simply that Afghanistan is, according to the US Department of Defense, “the Saudi Arabia of lithium”, a critical component for electric vehicles and renewable energy batteries. It’s that China’s ultimate mission is to topple the Dollar – and in this it’s making progress. How fast, how benign this transition will be, is a matter of speculation. But that it’s happening is not.

Soapbox: The 50 year-old shock

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Fifty years ago today, on 13 August 1971, US President Richard Nixon delivered a shock to the US and the world. He effectively brought to an end the Bretton Woods agreement, established in 1944 and designed to provide a new international monetary system for the post-war world. Some of Bretton Woods’ legacies are still with us, such as the International Monetary Fund (IMF) and the World Bank. But the international financial stability promised by Bretton Woods, through fixed exchange rates, is today in tatters.

Bretton Woods was to prevent problems arising from protectionism, beggar-thy-neighbour devaluations, hot money flows and unstable exchange rates. The core feature was the mandatory convertibility of any currency to another; central banks were required to intervene in currency markets to maintain their exchange rate within 1% of a set “par” value. Those par values were held in place by the guaranteed convertibility of the Dollar to gold at a set price. Because the US held the majority of the world’s monetary gold, the US became the centre of the international monetary system. The Bretton Woods system therefore came to function as a de facto Dollar standard.

Two days later Nixon addressed the nation via television, in which he promised in an 18-minute speech “prosperity with full employment during peacetime” and to stifle inflation, which he correctly said “robs every one of you… in the four war years between 1965 and 1969 your wage increases were completely eaten up by price increases. Your pay checks were higher, but you were no better off”.

He continued: “We must protect the position of the American Dollar as a pillar of monetary stability around the world… the strength of a nation’s currency is based on the strength of that nation’s economy… I have directed the Secretary of the Treasury to take the action necessary to defend the Dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the Dollar into gold or other reserve assets… the effect of this action will be to stabilise the Dollar… Our best days lie ahead”.

What “best days”?

That “temporarily” turned into “permanently”. The so-called ‘gold window’ wasn’t just shut; later administrations have painted over it.

President F. D. Roosevelt started the process in June 1933. In April that year he decreed that all gold coins and gold certificates in denominations of more than $100 were turned in to the Federal Reserve by 1 May for the set price of $20.67 per ounce. By 10 May 1933 the government had taken in $300 million of gold coin and $470 million of gold certificates. In 1934, the government price of gold was increased to $35 per ounce, effectively increasing the gold on the Federal Reserve’s balance sheets by 69%. This increase in assets allowed the Federal Reserve to further inflate the money supply.

President Nixon in 1971 was facing a serious threat to his re-election. Unemployment had risen to 6%, where it stubbornly stayed. In June 1971, the New York Times had published the Pentagon Papers, showing the US administration had repeatedly and secretly increased American involvement in the Vietnam War. Nixon was feeling vulnerable on many fronts. Moreover, the “gold pool”, a consortium of central banks organised in 1961 to carry out purchases and sales of gold to peg the market to the official price, had fallen apart.

Nixon believed that easy monetary policy would reduce unemployment. So he closed the gold window; permitted the Dollar to float; imposed a temporary freeze on prices and wages to “combat inflation”; and put a temporary 10% tariff on imports to “improve balance of payments”.

Today President Nixon’s promises ring hollow. There are strong parallels between 1971 and 2021. In 1971 the US was disengaging from Vietnam, a war that cost the US an estimated $843.63 billion (£608 billion); the US is now pulling out of Afghanistan, which has cost an estimated $910.47 billion (£656 billion). The US consumer price index (the official inflation rate) for 1971 averaged 4.38%; today it’s about 5%. In 1971 the Cold War between the US and the USSR was raging; today a new Cold War – between the US and China – is on the cards. So much has changed in 50 years; Nixon could not have foreseen the internet, Covid-19, electric cars, private space travel, climate change anxieties, cryptocurrencies, the 2008 financial crash, and much else besides.

In the 50 years since President Nixon’s TV address to the nation, the purchasing power of the US Dollar has plunged, thanks to inflation over the five decades totalling more than 554%. To buy the same amount of stuff you could get for $100 (£72) in 1971 you would need around $654 (£472) today. Wages have progressively fallen behind inflation.

Source: AFL-CIO

 

Some standard is needed

Operating a gold standard – pegging a currency to the amount of gold held by a government – imposes a discipline (opponents argue too harsh a discipline) on government actions. Under a gold standard the creation of more currency – creating more Dollars, for example – requires obtaining more gold, which raises the market price of gold, and stimulates more gold mining to produce backing for that newly-minted currency. The US was on some form of gold or metallic standard for 179 years, between 1792 and 1971; during that time the US economy grew an average 3.9% a year. Since 1971 under a fiat money regime economic growth has averaged 2.8% a year, i.e. an economy that is about $8 trillion smaller than it would otherwise have been.

In a gold standard system gold provides a standard of value, a standard that everyone can share. But a gold standard ties the hand of governments. In a regime of floating exchange rates such as we have today there is no independent, objective entity that can counteract the temptation for central bankers to increase (and thus devalue) fiat money supply. Central bankers and their government backers want the freedom to construct economic policy according to current events. So, in a period of severe crisis (such as with Covid-19) they argue it is vital to be able to “splash the cash” to bring the economy back to life – or prevent its collapse. With the Covid-19 pandemic unfunded government spending – racking up huge debts – no doubt prevented many people from economic hardship. But we are left wondering how those debts will be repaid – will they be inflated away? Will they ever be repaid? Will more debts be incurred to repay the original debt?

Ultimately, what President Nixon did was to throw the fate of gold into the hands of private individuals. This ‘privatisation’ of gold swept certainty away from exchange rates, which now float in a kind of untethered ever-changing chaos, from which foreign currency traders make a killing. But departing from gold as a standard against which fiat currencies are measured has dramatically failed to provide price or employment stability. And the US federal debt is rapidly moving to $30 trillion; it was $398 billion in 1971. Fifty years ago the US debt-to gross domestic product ratio was 34%; today it’s almost 130%.

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. We have seen since last Friday how gold reacts to wider market conditions. Gold prices dropped when the Federal Reserve announced in 2014 it was wrapping up its controversial stimulus program after the financial crisis of 2008, the first “taper tantrum”. Last week all the financial markets talked about was a similar end to the current round of Fed quantitative easing. That’s what brought gold down – but it is important to realise that we have seen this before; and gold moved higher after markets had their “tantrum” and settled down after 2014. The gold price started rising again from 2018; maybe a similar pattern is once again building?

There are sensible arguments both for and against a gold standard, but the idea that we could return to one now is probably dead. 50 years on from the death of the gold standard, people argue that gold could never again be considered money, a means of exchange in daily life. That was true until the development of Glint, which has embraced this privatisation of gold and is positioning gold as an alternative everyday currency. With Glint it is possible to buy, sell and spend in gold, which has again become a viable form of money. President Nixon got re-elected, so finally killing the gold standard achieved his main goal. The gold “standard” meanwhile has simply shifted from government control into private hands.

Soapbox: A tale of two countries

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Outside Russia and central bank circles Elvira Nabiullina is not a familiar name. Educated in both Russia and the US, Nabiullina has been governor of the Russian central bank since 2013. She has lived through a period of extreme inflation, in 2014. Euromoney magazine named the 57-year-old as their central bank governor of the year in 2015.

Last week she said that inflation could become a long-term problem in Russia. According to some sources, Russians expect inflation to exceed 13% this year. The Russian central bank pushed its main lending rate to 6.5% after the official inflation rate came in at 6.5% in June – the highest since August 2016. The previous peak was 17%, in December 2014, when Nabiullina crushed inflation which had been running at more than 10%.

 

 

Russia’s inflation

“Inflation… is a tax on poverty. The poor are the ones who suffer the most”, said Nabiullina. Poverty in Russia is a reality for about 20 million Russians. Real household incomes in Russia have fallen for 5 of the past 7 years. It’s claimed that the Russian standard of living has fallen by 11% in the last 7 years. The central bank stated after the interest rate rise: “Inflation is developing above the Bank of Russia’s forecast… This largely reflects the fact that steady growth in domestic demand exceeds production expansion capacity in a wide range of sectors. In this context, businesses find it easier to transfer higher costs to prices”. It said that it would consider making further interest hikes if needed. Russia has struggled to boost its economic sovereignty and to achieve a fiscal surplus. Its COVID-19 pandemic support programme has been carefully tailored and – by the standards of other countries – relatively constrained.

Russia is not alone in pushing up interest rates. Other emerging markets have too. Brazil, where consumer price inflation is running at an official 8.59%, has  just raised the Selic rate – its benchmark rate – to 5.25%. Mexico added 0.25% to its benchmark rate in late June, putting it at 4.25%. Armenia, the Czech Republic and Hungary pushed up their rates, the latter two the first European Union countries to raise their rates in recent years.

Meanwhile, central bankers of the US, UK, and the European Central Bank (ECB) are betting that economic growth is returning to its pre-pandemic levels, that evidence of surging inflation rates is “transitory”, and higher outputs will soon arrive. They don’t want to raise interest rates too soon or too high for fear that the ‘recovery’ will be weak or illusory.

Christine Lagarde, president of the ECB, has said that the ‘Delta’ variant of the coronavirus presents “a growing source of uncertainty” and has pledged that the ECB will tolerate more inflation. The ECB has tweaked its inflation target to allow overshooting of its previous 2% a year target “over the medium term”, a handily undefined date.

In the US, the producer price index (formerly called the wholesale price index until 1978) in June was 7.3% higher, year-on-year, suggesting that consumers face price hikes down the line. America’s consumer prices rose to 5.4% in the 12 months to June, the largest monthly gain since June 2008. Both the chairman of America’s central bank, the Federal Reserve, Jerome Powell, and the Treasury Secretary, Janet Yellen, are also relaxed about inflation, seeing it as sector-specific, all to do with supply-chain bottlenecks, and temporary. Yet Disney has recently put up the price of its subscription video-streaming service ESPN+ by 17%. What’s that got to do with supply chains?

 

Whiplash economics

The US economic recovery appears to be regaining strength – growth in the first half of 2021 averaged 6.4% on an annualised basis. But maybe all that this means is that the US is returning to the status quo ante-Covid? The moratorium on evictions in the US introduced during the worst of the pandemic has been extended; around 15 million people owe as much as $20 billion to their landlords. Only some Americans have benefited enormously from the state handouts. Yet the US is living through a record peacetime budget stimulus of about 13% of gross domestic product (GDP) and a drawdown of an estimated $2 trillion in savings (about 8% of GDP) accumulated during the pandemic lockdown. The ‘helicopter money’ from the federal government has drifted down patchily.

In the Eurozone, the input price index (an index of industrial goods’ prices) hit 89.2, its highest reading since the survey began in June 1997. At the back of Lagarde’s mind is that even though growth has been surging – GDP up by an astonishing 13.7% in the second quarter of 2021 – the Eurozone economy remains around 3% smaller than it was at the end of 2019. Lagarde and Yellen are nervous that their economies could face a whiplash – swing dramatically from inflation to a recession.

The central bank of Russia tries to maintain inflation (‘targets’ inflation) at around 4% per year; the US Federal Reserve at around 2%, the same as the ECB and the Bank of England. Currently none of them are hitting their target. In the US and the Eurozone the policymakers are not asking if they are doing something wrong; they have simply loosened those targets.

Who is right, Nabiullina or Yellen & Lagarde? Or maybe both are? Central banks prefer inflation to deflation but inflation at any level is destructive of the purchasing power of fiat currencies, whether it’s Rubles, Dollars, or Pounds. Inflation also destroys wages and the living standards of people on fixed incomes. It provokes social unrest, and demands for salaries to increase in line with or above inflation, thus fuelling further inflation.

Alternatives

Like a tiger burst from its cage, inflation now seems to be stalking the world. As this ravenous tiger strolls down the high street, people are running amok, looking for an escape route. Some will turn down a blind alley; some will burst into a safe house; some go into buildings that look safe but where the tiger can get into; some will get eaten.

Maybe private cryptocurrencies provide some inflation protection? The total crypto market now has a purported value of some $1.6 trillion but do all the tokens available offer a reliable medium of exchange, or is the crypto landscape more of a “Wild West” in the words of Gary Gensler, chairman of the US Securities and Exchange Commission? “This asset class is rife with frauds, scams and abuse in certain applications”, said Gensler, who has taught classes in crytptocurrency at the Massachusetts Institute of Technology. “These products are subject to the securities laws and must work within our securities regime”, he said.

Cryptocurrencies were initially seen as giving people the chance to opt-out of government-controlled fiat currency. Instead the technology in which cryptocurrencies depend – the blockchain – is being captured by national governments to develop their own e-currency. Having effectively killed Bitcoin mining within its borders, China will field its digital, government-authorised Renminbi at the 2022 Winter Olympics in Beijing. A bi-partisan group in the US Congress has said the digital Renminbi is a challenge to the global dominance of the US Dollar and might pose a threat to national security. Lael Brainard, who is on the board of the US Federal Reserve and is seen by some as a contender to replace Jerome Powell if he is not re-appointed in 2022, has said she can’t “wrap my head around” the fact that the US doesn’t have a digi-Dollar in the offing.

Gold is an alternative to fiat money that has more of a history than cryptocurrencies and, because it’s in so many hands, would more strongly resist any attempt by government to corral it. The gold price has lost around 10% since its peak price last summer. Surely that’s a reason to take a dim view of what I am arguing for? It all depends on how you see the future; none of us has a crystal ball; and it depends too on timing. Had you bought gold three summers ago, when it was trading around $1,175 (£942) an ounce, you would be more than 54% up on the deal.

Some argue that gold is set for a fresh break upwards. Loose monetary policy will push the gold price to $3,000-$5,000 an ounce in the next 3-5 years, according to Diego Parrilla, managing partner of the asset manager Quadriga Igneo fund and formerly of Goldman Sachs and Bank of America Merrill Lynch. Parrilla has traded precious metals for 25 years. In his view, low interest rates have created asset bubbles that are too big to burst and which will make it very difficult for central banks to normalise rates without risking collapse. “Central bank money printing isn’t really solving problems, it’s delaying the problem… Gold will benefit purely from being a physical asset that you cannot print”, in Parrilla’s view. Look and you will find others taking the completely opposite view to Parrilla.

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

Moreover, with Glint you have allocated gold – which means you own it – and gold that can be easily used in payment for goods and services. With Glint gold you have a form of money that is technologically as astute as any cryptocurrency, and you have certainty that you are not participating in, or being subject to, any fraud or scam. In the coming world of central bank digi-currencies, which will actually be a cloaked form of fiat money, standing outside government-issued money will become more difficult. We don’t give advice. But if you are fleeing a hungry tiger – even if it turns out to be toothless – it only makes sense to avoid a blind alley.

Soapbox: The instability of Stablecoins

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“If you look at cryptocurrencies as a whole, it is a pure trading instrument. There is no inherent worth in it whatsoever. It is a tulip bulb”. Thus said Luke Ellis, chief executive of the world’s biggest listed hedge fund, Man Group, this week. So we don’t think it’s worth anything, but we’ll still trade it because we can make money; cryptocurrencies according to Ellis are one of “probably 800 markets we trade today on top of 15,000 stocks and thousands of credits”. You have to admire the man’s cynical honesty. He added: “I think we stay in a world of very low rates until central banks lose control and when they lose control, it’s not going to be fun… for some of the strategies we trade, we might do very well. But that doesn’t mean it’s a good thing”.

Are ‘stablecoins’ a good thing? At the last count there were around 200 ‘stablecoins’ in existence, forms of digitised ‘money’ that, unlike pure cryptocurrencies, claim to be pegged or tied to other assets, including traditional fiat currencies (such as the US Dollar) or other digital assets. There are even some that claim to be backed by gold. It’s not clear to me why you would want to be invested in asset A which is tied to asset B; why not just own asset B? But it’s a strange world these days.

Part of the DeFi (decentralised finance) movement which has grown rapidly since the 2008 financial crash, stablecoins’ have their supporters. Proponents like to assert that, because they are pegged to some more solid underlying asset, the volatility (the price swings) of stablecoins is less extreme than other forms of cryptocurrency, precisely because they are pegged to something.

Defy the world

DeFi supporters come in many shapes and sizes but the word DeFi/defy gives a clue; DeFi is all about wresting control over what constitutes money from governments and central banks and placing that power in the hands of ‘the people’. Anonymity of ownership is prized. This opacity of ownership and trading is intrinsic to cryptocurrencies but it enables criminals and scammers in their work; it’s estimated that investors have lost more than $16 billion since 2012 in cryptocurrency fraud.

Undaunted, DeFi continues growing – Bullish Global, a cryptocurrency project backed by several billionaires, started this week a seven-week private pilot of its trading platform, which is scheduled to launch fully later this year. And Goldman Sachs has applied to the US regulator, the Securities and Exchange Commission, to launch an exchange-traded fund (ETF) focusing on digital assets and blockchain technology, tracking the profits of companies active in the market.

Tethered

One of the main issuers of stablecoins is Tether. Tether is controlled by Bitfinex, a Hong Kong-based cryptocurrency exchange owned and operated by iFinex, which also has its headquarters in Hong Kong and is registered in the British Virgin Islands or BVI. The advantages of registering a company in the BVI are that it can be done quickly, with minimal financial reporting requirements and there are no restrictions where a BVI company can carry out its business. Also of significance is that the BVI has no income tax, corporation tax, capital gains tax, wealth tax or similar fiscal laws. Neither the register of directors nor the register of shareholders of a BVI company are publicly available. If you want to avoid too much public scrutiny of your company, BVI registration is about as good as it gets.

On Tuesday this week, Bloomberg reported that the US Department of Justice is stepping up its investigation (started in 2018) into allegations of fraud at Tether. Tether responded by implicitly suggesting that Bloomberg is indulging in ‘clickbait’ and that “the continued efforts to discredit Tether will not change our determination to remain leaders in the community. Tether routinely has open dialogue with law enforcement agencies, including the US Department of Justice, as part of our commitment to cooperation, transparency, and accountability”.

In February this year, Tether and Bitfinex settled a long-running legal dispute with New York’s attorney-general over allegations that the firms tried to cover up $850 million in losses. They paid an $18.5 million fine but without acknowledging any wrongdoing. Letitia James, the attorney general, said that “Tether’s claims that its virtual currency was fully backed by US dollars at all times was a lie… These companies obscured the true risk investors faced and were operated by unlicensed and unregulated individuals and entities dealing in the darkest corners of the financial system”. Around half of all Bitcoin trades are transacted via Tether.

Regulatory uncertainty

Perhaps the most famous example of a would-be stablecoin was the Facebook-backed Libra, which Facebook announced in 2019. It said Libra – which initially was to be backed by a basket of fiat currencies – would revolutionise the global payments system. Libra swiftly faced pushback from regulatory authorities, was scaled back, and renamed Diem and is to be backed one-for-one by the US Dollar.

Like much of the cryptocurrency world, stablecoins currently exist in a kind of regulatory patchwork. As one commentator says: “A major regulatory challenge relating to global stablecoins is international coordination of regulatory efforts across diverse economies, jurisdictions, legal systems, and different levels of economic development and needs. Calls for the harmonization of legal and regulatory frameworks include areas such as governing data use and sharing, competition policy, consumer protection, digital identity and other important policy issues. Regulatory difficulties are compounded by a remarkable diversity in structure, economic function, technological design and governance models of stablecoins”.

In the US Janet Yellen, the Treasury Secretary, has called for quick action to put in place a regulatory framework for stablecoins. A good academic paper published this month says “stablecoins will grow and evolve. The main question is how policymakers will adjust our regulatory framework to handle their growth and evolution in the coming years”. One of its conclusions is that stablecoins could present a threat to financial stability: “If policymakers wait a decade, stablecoin issuers will become the money market funds of the 21st century — too big to fail — and the government will have to step in with a rescue package whenever there’s a financial panic”.

Apart from all the obvious risks – such as possible criminal activity, privacy issues, regulatory ire and more – the ‘too big to fail’ risk (which last surfaced in the 2008 financial crash, as taxpayers were required to bail-out banks collapsing like dominos) – is becoming more alarming: “privately produced money is vulnerable to runs”.

When it launched in 2014 Tether said its tokens were fully backed by US Dollars in bank accounts. Then in 2019 it said its reserves included commercial paper, with cash making just about 3% of its backing. Tether’s market capitalisation, currently some $62 billion, has increased more than 13 times since February 2020. It says its tokens are directly backed and redeemable by the US Dollar. But what if all the holders of its tokens demanded they were redeemed for Dollars right now, i.e. if there was a run on Tether?

Gold not paper

The risks seem to me starkly obvious. We have seen what can happen in the UK if a regulatory body cracks the whip over a cryptoasset business. The Financial Conduct Authority said in June this year that Binance, registered in the Cayman Islands, was not authorised to operate as a crypto business in the UK; clients found it difficult to withdraw their money.

All this touches on some very profound issues: what is money? What is privately-issued money? How stable is the conventional banking system? How stable is the kind of ‘shadow banking’ operated by marketers of stablecoins such as Tether? How quickly can central banks react by issuing their own digital currencies?

The digitisation of fiat money by governments is rapidly approaching. I understand the desire of people to avoid fiat money if possible; even low inflation eats away at fiat money’s purchasing power, like a caterpillar nibbling a leaf – pretty soon no leaves are left, and you haven’t even noticed them going.

I believe that gold can help minimise risks, even though the gold price has its own fluctuations and thus its purchasing power can also be eroded. But Glint clients know that their holdings in gold, Dollars, Euros or Pounds are secure and exist – and are not backed by paper, commercial or otherwise. If stability is your desire, then Glint has a good claim to be able to achieve that, perhaps better than any stablecoin – which may turn out to be not that stable after all.

Soapbox: Inflation’s here – how bad will it get?

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Are you chill about inflation, now that the US consumer price index (CPI) jumped to 5.4% in June, a 13 year high, and following a 5% rise the previous month? The word ‘inflation’ was mentioned on 87% of the earnings conference calls tracked by Bloomberg in July, compared with 33% a year ago. Clearly inflation is on investors’ minds.

Maybe it’s not the CPI we should be worried about, but wholesale prices – the producer price index in the US went up by 7.3% last month, the biggest annualised gain since 2010. That suggests prices in the shops are going higher in the coming months.

In the UK, The Guardian newspaper ran a provocative – or maybe rhetorical – headline on 18 July, directly addressing the Bank of England governor, Andrew Bailey: “Inflation isn’t out of control yet, governor, but can you reassure us it won’t be?” The UK’s official figure for consumer price inflation (CPI) in June was 2.5%. The Guardian added that “forecasters agree 3% is a nailed-on certainty this year, with a few saying 4% will be seen”.

The UK’s CPI doesn’t take account of the rise in house prices, which went up by 10.7% in May compared to the same month last year. In the US, the S&P Case-Shiller national home price index rose by 14.6% in April, year-on-year, after it went up by 13.3% in March.

 

Jamie Dimon, CEO of JP Morgan Chase bank, told a conference call in July that inflation may be worse than the Fed anticipates but “it won’t make any difference” if jobs are plentiful and growth remains strong. Maybe Dimon is tossing his hat into the ring as a candidate for the position of chairman of the US Federal Reserve in 2022, when Jerome Powell’s tenure expires. Powell looks like a shoo-in for re-nomination in charge of the Fed. A survey in April of 34 fund strategists and economists showed 74% of them thought that President Joe Biden would re-select Powell. In any case, Dimon has a comfortable $1.8 billion cushion against rising prices.

As for the Eurozone, the “harmonised index of consumer prices” was at an annual rate of just 1.9% in June, down from 2% in May. The European Central Bank (ECB) is due to meet on Thursday this week. The expectation is that it will continue staying ultra-dovish; 2% inflation remains its target. Average annual inflation in the Eurozone has been just 0.9% since 2013, compared with 1.9% in the US. The Eurozone contracted by almost 7% in 2020. It will recover much of that lost ground this year – but real growth still eludes it, despite all the European Central Bank’s efforts.

Keep an eye on it

Jerome Powell’s job hangs on how he steers the US economy through the troubled waters of the next 12 months. He seems pretty relaxed about inflation. He said recently: “if people believe that prices will be pretty stable, then they will be — because they won’t ask for very high wage increases and people who sell things won’t be asking for high price increases… Once that psychology sets in, it tends to perpetuate itself”. That’s either a thunderbolt of profundity or breathtakingly naïve. The US Treasury Secretary, Janet Yellen, is singing the same song. She said last week “we will have several more months of rapid inflation… I think over the medium term, we’ll see inflation decline back toward normal levels. But, of course, we have to keep a careful eye on it”.

Yellen is almost 75; Powell is 68. Both of them therefore can clearly remember the 1970s, when the US was in the grip of double-digit inflation. Americans then took to wearing badges reading ‘whip inflation now’. It might be time to get those old badges down from the attic.

That inflation was broken only by very painful, recession-causing action by a former chairman of the Federal Reserve, Paul Volcker. Volcker pushed interest rates to 20% to kill inflation. “At some point this dam is going to break and the psychology is going to change”, said Volcker. Almost four million jobs were lost in the recessions that followed as people learned some Volcker-psychology.

Today, no-one knows which direction inflation is headed, nor even what its real level is. Official CPI stats, based on a basket of goods which has changed over time, are questioned by some people. John Williams, founder of ShadowStats in the US argues that, if the methodology once used by the US government, with an unchanged basket of goods was applied today, then inflation would be revealed as much higher, around 13.5%. It “will get quite a bit worse” in his words.

There are as many learned economists telling us to relax, nothing to see here, move along quietly, as there are equally expert pundits telling us we are going to hell in a handcart. The former chief economist of the IMF (International Monetary Fund) and now Professor of economics at Harvard, Kenneth Rogoff, said last week “mildly elevated inflation more likely signals that things are going well than that we are doomed. There is no reason for the Fed to squash it too quickly… US inflation today is much more like good news than bad”.

On the other hand, another esteemed academic, Professor Steve Hanke, who teaches applied economics at Johns Hopkins University, warned in May that: “more – perhaps much more – inflation will enter the system”. Who should we believe?

Psychology – what people expect will happen and how much that influences what they do – is only half of it. It’s also a matter of how much money is sloshing around. It’s unfashionable to link inflation to increased money supply – modern monetary theory, which de facto seems to have taken hold of central bank thinking, asserts that running deficits and creating more fiat currency doesn’t matter, so long as an economy keeps growing. So central banks create more fiat money: almost one in five Dollars in existence was created in 2020.

All these extra trillions of Dollars, Pounds and other fiat currencies have been injected into the system. Not all will be stashed under the mattress. Some of it has been or will be spent – on cars, holidays, houses, whatever. According to the New York Federal Reserve bank roughly a third of all stimulus payments received by Americans has been used to pay down debt, while 25% has been spent on consumption. As Steve Hanke said in May this year, “money growth will lead in the first nine months to asset‐​price inflation”. We’ve seen that, in houses and equity valuations. “Then, a second stage will set in. Over the 18 months after a monetary injection, economic activity will pick up”. That’s what central bankers are hoping. “Ultimately, the prices of goods and services will increase. That usually takes between one and two years after the injection”.

We may be in for a nasty surprise – not inflation but stagflation: stagnant economic growth combined with inflation. The Eurozone has been trying to get its economy to return to growth, with little success, for years. We have had a demand shock – strong demand for just about everything from basic agricommodities to semiconductors – as economies re-open. The stimulus from the Fed (and the central banks of other countries) has been fuelled by running up ever greater debts. The official figure for US national debt is close to $29 trillion, but another source, taking into account unfunded Social Security and Medicare pledges, puts it at more than $133 trillion.

A Minsky moment

Hyman Minsky, who died in 1996, lived a fairly obscure life as an American academic economist. His name became familiar during the 2008 financial disaster. Minsky posited that economies are inherently unstable. During periods of bullish speculation they shift from financial stability to fragility and then into crisis, thanks to speculative bubbles in asset prices. 2008 was a classic Minsky ‘moment’.

At the moment everything in the garden looks rosy. But maybe we are headed for a fresh Minsky ‘moment’? The euphoria following the pandemic, and the continuing loose monetary policies to prevent outright collapse are building bubbles on several fronts. Economies are rebounding, admittedly at different speeds, and we are in danger of being carried away by headlines that shout about strong growth. But maybe this is a house of cards? Is real underlying productivity rising so strongly?

In this febrile moment, poised as the world is between signs of economic recovery from COVID-19 and alarms about fresh variants, the Fed is between a rock and a hard place – push up interest rates to choke off inflation and risk stifling economic recovery and killing off many ‘zombie’ companies, or leave interest rates at their rock-bottom level and watch inflation steadily climb higher. As Nouriel Roubini, another eminent economist brain, wrote at the end of June: “years of ultra-loose fiscal and monetary policies have put the global economy on track for a slow-motion train wreck in the coming years. When the crash comes, the stagflation of the 1970s will be combined with the spiralling debt crises of the post-2008 era, leaving major central banks in an impossible position… this slow-motion train wreck looks unavoidable”.

Roubini envisages our future to be stagflation – low or no economic growth, combined with rising prices. What to do to protect oneself in such turbulent times? The purchasing power of fiat money continues to slide; asset bubbles are everywhere. While gold has had its ups and downs, when down can obviously have a negative effect on purchasing power, the overall trajectory for the past 50 years at least has been up, while fiat currencies have relentlessly been down. Our mantra is that gold is security and Glint its key; but Boy Scouts have an equally sound motto: “Be prepared”.