Alasdair Macleod – 09 December 2013 In the jigsaw that is the Great Game of Asia pieces which heretofore made little sense on their own are beginning to slot in to give us an idea of the final picture. These disparate pieces are as varied as China’s claim of territorial rights over Japan’s Senkaku Islands,
Alasdair Macleod – 10 December 2012 I thought I had a good idea what disasters we might face in 2013, and then I saw the most recent US Commodity Futures Trading Commission’s Bank Participation Report for gold and silver. On the basis of recent BPRs these markets are heading for a crisis, which is generally
Alasdair Macleod – 10th January 2014 In reviewing this excellent book I should first declare and deal with vested interests. James Turk with his son founded GoldMoney, and as GoldMoney’s Head of Research he and I are co-writers with similar views. Those who think we have a vested interest in promoting gold would be right,
Alasdair Macleod – 05 September 2014
In a radio interview recently* I was asked a question to which I could not easily give a satisfactory reply: if the gold market is rigged, why does it matter?
I have no problem delivering a comprehensive answer based on a sound aprioristic analysis of how rigging markets distorts the basis of economic calculation and why a properly functioning gold market is central to all other financial prices. The difficulty is in answering the question in terms the listeners understand, bearing in mind I was told to assume they have very little comprehension of finance or economics.
I did not as they say, want to go there. But it behoves those of us who argue the economics of sound money to try to make the answer as intelligible as possible without sounding like a committed capitalist and a conspiracy theorist to boot, so here goes.
Manipulating the price of gold ultimately destabilises the financial system because it is the highest form of money. This is why nearly all central banks retain a holding. The fact we don’t use it as money in our daily business does not invalidate its status. Rather, gold is subject to Gresham’s Law, which famously states bad money drives out the good. We would rather pay for things in government-issue paper currency and hang on to gold for a rainy day.
As money, it is on the other side of all asset prices. In other words stocks, bonds and property prices can be expected to rise measured in gold when the gold price falls and vice-versa. This relationship is often muddled by other factors, the most obvious one being changing levels of confidence in paper currencies against which gold is normally priced. However, with bond yields today at record lows and equities at record highs this relationship is apparent today.
Another way to describe this relationship is in terms of risk. Banks which dominate asset markets become complacent about risk because they are greedy for profit. This leads to banks competing with one another until they end up ignoring risk entirely. It happened very obviously with the American banking crisis six years ago until house prices suddenly collapsed, threatening to take the whole financial system down. In common with all financial bubbles everyone ignored risk. History provides many other examples.
Therefore, gold is unlike other assets because a rising gold price reflects an increasing perception of general financial risk, ensuring downward pressure on other financial asset prices. So while the big banks are making easy money ignoring risks in equity and bond markets, they will not want their party spoiled by warning signs from a rising gold price.
This is a long way from proof that the gold market is manipulated. But the big banks, and we must include central banks which are obviously keen to maintain financial confidence, have the motive and the means. And if they have these they can be expected to take the opportunity.
So why does it matter if the gold price is rigged? A freely-determined gold price is central to ensuring that reality and not financial bubbles guides us in our financial and economic activities. Suppressing the gold price is rather like turning off a fire alarm because you can’t stand the noise.
*File on 4: BBC Radio4 due to be broadcast on 23 September at 8.00pm UK-time and repeated on 28 September at 5.00pm.
The Matterhorn London Interviews – Aug 2014
In this 2nd of a series of London interviews that Lars Schall conducted for Matterhorn Asset Management this summer, Lars has a City of London streetside conversation with Alasdair Macleod right outside the Dutch reform Church in Austin Friars near the Bank of England. Together they talked about, inter alia: the challenges for The London Bullion Market Association (LBMA); China’s appetite for gold; the Shanghai Cooperation Organization as THE future player in the gold market; and the problems related to Germany’s gold at the New York Fed.
Watch the full interview here.
Alasdair Macleod – 29 August 2014
In recent months talking heads, disappointed with the lack of economic recovery, have turned their attention to wages. If only wages could grow, they say, there would be more demand for goods and services: without wage growth, economies will continue to stagnate.
It amounts to a non-specific call to stimulate aggregate demand by continuing with or even accelerating the expansion of money supply. The thinking is the same as that behind Bernanke’s monetary distribution by helicopter. Unfortunately for these wishful-thinkers the disciplines of the markets cannot be bypassed. If you give everyone more money without a balancing increase in the supply of goods, there is no surer way of stimulating price inflation, collapsing a currency’s purchasing power and losing all control of interest rates.
The underlying error is to fail to understand that economising individuals make things in order to be able to buy things. That is the order of events, earn it first and spend it second. No amount of monetary shenanigans can change this basic fact. Instead, expanding the quantity of money will always end up devaluing the wealth and earning-power of ordinary people, the same people that are being encouraged to spend, and destroying genuine economic activity in the process.
This is the reason monetary stimulation never works, except for a short period if and when the public are fooled by the process. Businesses – owned and managed by ordinary people – are not fooled by it any more: they are buying in their equity instead of investing in new production because they know that investing in production doesn’t earn a return. This is the logical response by businesses to the destruction of their customers’ wealth through currency debasement.
Let me sum up currency debasement with an aphorism:
“You print some money to rob the wealth of ordinary people
to give to the banks to lend to business
to make their products
for customers to buy with money devalued by printing.”
It is as ridiculous a circular proposition as perpetual motion, yet central banks never seem to question it. Monetary stimulus fails with every credit cycle when the destruction of wealth is exposed by rising prices. But in this credit cycle the deception was so obvious to the general public that it failed from the outset.
The last five years have seen all beliefs in the manageability of aggregate demand comprehensively demolished by experience. The unfortunate result of this failure is that central bankers now see no alternative to maintaining things as they are, because the financial system has become horribly over-geared and probably wouldn’t survive the rise in interest rates a genuine economic recovery entails anyway. Price inflation would almost certainly rise well above the 2% target forcing central banks to raise interest rates, throwing bonds and stocks into a severe bear market, and imperilling government finances. The financial system is simply too highly geared to survive a credit-driven recovery.
Japan, which has accelerated monetary debasement of the yen at an unprecedented rate, finds itself in this trap. If anything, the pace of its economic deterioration is increasing. The explanation is simple and confirms the obvious: monetary debasement impoverishes ordinary people. Far from boosting the economy it is rapidly driving us into a global slump.
The solution is not higher wages.
22 August 2014
Being interviewed on the FinancialSurvivorNetwork website, Alasdair MacLeod discussed the new and improved Silver Fix. It seems the new fix is no more transparent than the old one. Administered by the CME Group and Reuters, Alasdair is finding it quite unhelpful. He states that the precious metals business is expanding throughout the globe and that London will lose its once cherished position as the center of the trade to China.
Listen to the full interview at FinancialSurvivorNetwork.com
21 August 2014
Besides what the Fed is doing by printing money, there is another big threat to the dollar, said Alasdair. Countries in Asia are banding together in order to rid themselves of using the dollar in international trade.
Read the full interview at Sprott Global
Alasdair Macleod – 22 August 2014
There will be a defining geopolitical event next month when India, Pakistan, Iran and Mongolia become full members of the Shanghai Cooperation Organisation (SCO). This will increase the population of SCO members to an estimated 3.05 billion. We should care about this because it is the intention of the SCO to do away with the US dollar for trade settlement.
The nations joining in September are currently designated as Observer States and the only one left will be Afghanistan, which will presumably join when it can untie itself from NATO. Dialog Partners, defined as states which share the goals and principals of the SCO and wish to develop mutually beneficial relations, include Belarus Sri Lanka and Turkey. Turkey is of special interest because it has been a long-standing NATO member. It had hoped to join the EU but it became clear that this was never going to happen. Instead under the leadership of Recep Erdoğan Turkey is moving towards the SCO.
Erdoğan was re-elected earlier this month by a comfortable majority and it will be interesting to see how quickly Turkey’s new alignment evolves. Erdoğan must be aware that Asia is on the up while the EU declines, in which case Turkey as a front-line state is better off joining the SCO.
The SCO’s influence extends beyond its boundaries, with China and India’s diasporas populating much of the rest of south-east Asia. SCO members, particularly China and India, are also the largest consumers of Middle Eastern energy. And because they write the biggest cheques they have primacy over the west; so the swing away from the petro-dollar towards Asia is in the making. China also has sub-Saharan Africa sewn up, securing vital minerals such as copper from Zambia.
We must also consider why Russia is aggressively driving the pace of the SCO’s development, and it’s not just to escape the west’s economic sanctions as many observers think. Fundamentally the SCO is about resources and the production of goods: Russia controls Asia’s resources and China turns them into goods.
One of the first persons to identify the geopolitical importance of Russia’s resources was Halford Mackinder in a paper for the Royal Geographical Society in 1904. He later developed it into his Heartland Theory. Mackinder argued that control of the Heartland, which stretched from the Volga to the Yangtze, would control the “World-Island”, which was his term for Europe, Asia and Africa. Over a century later, Mackinder’s theory resonates with the SCO.
The underlying point is that North and South America, Britain, Japan and Australasia in the final analysis are less important than Mackinder’s World-Island. There was a time when British and then American primacy outweighed its importance, but this is no longer true. If Mackinder’s theory is right about the overriding importance of undeveloped resources, Russia with the backing of the SCO’s members is positioned to become the most powerful nation on earth.
The SCO is the greatest challenge yet mounted to American economic power, and Russia and China are clearly determined to ditch the dollar. We don’t yet know what will replace it. However, the fact that the Central Bank of Russia and nearly all the other central banks and governments in the SCO have been increasing their gold reserves could be an important clue as to how the representatives of 3 billion Euro-Asians see the future of trans-Asian money.
Alasdair Macleod – 15 August 2014
All commodities and near-commodities are priced internationally in dollars, and the dollar is used for over 80% of cross-border trade settlements. Consequently the dollar is the base currency for all countries’ foreign reserves, giving it its reserve status. However, there are now challenges to the dollar’s hegemony, with Russia, China as well as the other members, dialog-partners and associates of the Shanghai Cooperation Organisation (SCO), taking deliberate steps towards doing away with the dollar entirely for pan-Asian trade. Recent developments setting up a rival to the IMF by the BRICS nations is part of this challenge.
If you follow the geopolitics, you might reasonably conclude that the dollar’s dominance has peaked and is now declining. The SCO appears to believe there can be a transition away from the dollar, an idea that could turn out to be dangerously wrong at a time of great but generally unrecognised currency fragility. At the heart of the issue there is a worrying lack of distinction between the dollar’s reserve function and its function as the monetary standard from when it replaced gold in 1971. To fully appreciate the importance of the dollar as the standard for all other currencies, we must review the monetary history behind how and why the dollar replaced gold, and the implications for today.
The US dollar progressively broke its relationship with the gold standard from 1933 onwards, when gold ownership by US citizens was unexpectedly banned. The Bretton Woods Agreement after 1944 then defined the gold-based monetary order until the Nixon Shock in 1971. President Nixon ended Bretton Woods and all rights to dollar conversion into gold. By default, all other national currencies went on a US dollar standard, albeit a floating one. Crucially, the confidence in the purchasing power of all fiat currencies became vested in an underlying confidence in the purchasing power of the US dollar. This is a separate monetary function from the dollar’s reserve status, though the two functions are intertwined and may be difficult to separate in practice.
There are obviously differences in the way the gold standard operated compared with the dollar standard of today, but the function is the same. Before the Nixon Shock, the relationship between the gold standard and the US dollar was illustrated famously by John Exter, who showed gold at the apex of an inverse pyramid, supporting ever-increasing categories and quantities of dollars and dollar liabilities. Between 1932 and 1971 the quantity of money and bank credit expanded, and this is shown in the graphic below, based on Exter’s illustration, but with a pure monetary emphasis.
In 1932 when gold officially exchanged at $20.67 per ounce the relationship with the monetary base was by today’s standards very conservative. However, the fractional-reserve credit expansion at an additional 9.3 times (note that M3 includes the monetary base) was a threat to the entire US banking system when the banks were facing escalating bad debts because of the economic depression. And since the dollar was technically a money-substitute (with gold being the freely-exchangable underlying money), the dollar risked being exposed as over-issued and therefore valueless. For this reason, President Roosevelt’s Executive Order forcing American residents to surrender their gold and rescinding all rights to exchange their dollars for gold, was the only feasible option open to his government, the alternative being the collapse of the banking system. In January 1934 he revalued gold to $35 per ounce, making the Exter pyramid relationships more sustainable.
In 1944, the Bretton Woods Agreement formalised arrangements for central banks to fix their currencies to the dollar and for them to continue to have the right to exchange dollars at the Fed for gold at $35 per ounce. So central banks while originating their own currencies were still on a gold standard, through the US dollar. By 1971, when President Nixon ended this limited gold convertibility, the Fed’s monetary base and broad M3 money had become exceedingly stretched at nearly seven times and 72 times respectively.
The alternative would have been to revalue gold from $35 to a level where the US would suffer no more outflows, taking a leaf out of President Roosevelt’s book. Revaluation of gold was ruled out and rigorous attempts were made to discredit gold instead. The dollar therefore replaced gold as the de facto standard for all currencies. Freed from the discipline of gold, the Fed was able to continue to expand its monetary base and US banks their bank credit, while growing foreign demand for dollars to purchase energy, other commodities and for trade-finance, underwrote its purchasing power. And because the demise of Bretton Woods led to the end of fixed exchange rates, the expansion of US dollar quantities was mirrored by the expansion of cash and credit in other currencies as well, as non-US central banks managed their currency rates vis-à-vis the dollar base.
The next pyramid shows the relationship not only between US dollar quantities but also includes an estimate of the dollar equivalent of global broad money supply, and a new feature that did not noticeably exist in 1971: shadow banking. This quantifies the relationship between dollar money and the quantity of money in other currencies, with the dollar as the new currency standard.
In 2013 the relationship of US bank deposits relative to the Fed’s monetary base was only 2.4 times. This was due to the rapid expansion of the Fed’s balance sheet since mid-2008, having increased to 4.7 times the Pre-Lehman Monetary Base. The world’s broad money at $168.5 trillion is geared nearly 40 times, including the Financial Stability Board’s estimate of off-balance sheet shadow banking. To put it mildly, even after the rapid expansion of the Fed’s Monetary Base, which dramatically lowered the broader money ratios from what they would otherwise have been, the international monetary situation is still dangerously geared.
The risk of a new currency crisis has been dramatically increased by the major central banks acting to maintain financial asset values, particularly in bond and stock markets. This transfers risk from investment assets into the currencies themselves, something that is certain to become evident in the event of a rise in interest rates. For example a 10% fall in over-valued sovereign bond prices could easily threaten the survival of some systemically important banks, triggering a new financial crisis. Obviously, this cannot be allowed to occur and there can be little doubt that the central bank response will be to flood the financial system with yet more money.
Alternatively, the global banking system is too highly geared to survive an economic slump, which is an increasing risk in both the Eurozone and Japan and may well spread elsewhere. Remember that the dollar M3-to-gold ratio of 11 times in 1933 was enough to force a system reset; today the global ratio is nearly 40 times, on an admittedly flexible dollar. Again, the solution will be to flood the financial system with yet more money.
So either way, recovery or slump, price inflation or deflation, the current currency equilibrium with its dangerously high monetary gearing is unlikely to continue for long. And as if this is not enough the major emerging and Asian economies are proposing a monetary schism, breaking half the world’s population away from the dollar. The yuan, rouble, rupee and all the other Asian and emerging-economy currencies involved may be able to trade between themselves without the dollar, but they will be unable to ditch it as a back-up monetary standard. They will still remain on a dollar standard.
This is why despite determined efforts to do without the dollar nobody in Asia has come close to proposing a realistic alternative. Let us hope the powers-that-be in the Shanghai Cooperation Organisation understand the important difference between a reserve currency used for trade settlement and a currency standard; otherwise by bringing into the open the fundamental question about the dollar’s suitability as a monetary standard, they could end up undermining the dollar and with it an extremely fragile global monetary system.
Alasdair Macleod – 04 August 2014
Watch the interview here.
Alasdair Macleod – 08 August 2014
At the end of July global equity bull markets had a moment of doubt, falling three or four per cent. In the seven trading days up to 1st August the S&P500 fell 3.8%, and we are not out of the woods yet. At the same time the Russell 2000, an index of small-cap US companies fell an exceptional 9%, and more worryingly it looks like it has lost bullish momentum as shown in the chart below. This indicates a possible double-top formation in the making.
Meanwhile yield-spreads on junk bonds widened significantly, sending a signal that markets were reconsidering appropriate yields on risky bonds.
This is conventional analysis and the common backbone of most brokers’ reports. Put simply, investment is now all about the trend and little else. You never have to value anything properly any more: just measure confidence. This approach to investing resonates with post-Keynesian economics and government planning. The expectations of the crowd, or its animal spirits, are now there to be managed. No longer is there the seemingly irrational behaviour of unfettered markets dominated by independent thinkers. Forward guidance is just the latest manifestation of this policy. It represents the triumph of economic management over the markets.
Central banks have for a long time subscribed to management of expectations. Initially it was setting interest rates to accelerate the growth of money and credit. Investors and market traders soon learned that interest rate policy is the most important factor in pricing everything. Out of credit cycles technical analysis evolved, which sought to identify trends and turning points for investment purposes.
Today this control goes much further because of two precedents: in 2001-02 the Fed under Alan Greenspan’s chairmanship cut interest rates specifically to rescue the stock market out of its slump, and secondly the Fed’s rescue of the banking system in the wake of the Lehman crisis extended direct intervention into all financial markets.
Both of these actions succeeded in their objectives. Ubiquitous intervention continues to this day, and is copied elsewhere. It is no accident that Spanish bond yields for example are priced as if Spain’s sovereign debt is amongst the safest on the planet; and as if France’s bond yields reflect a credible plan to repay its debt.
We have known for years that through intervention central banks have managed to control the prices of currencies, precious metals and government bonds; but there is increasing evidence of direct buying of other financial assets, including equities. The means for continual price management are there: there are central banks, exchange stabilisation funds, sovereign wealth funds and government-controlled pension funds, which between them have limitless buying-power.
Doubtless there is a growing band of central bankers who believe that with this control they have finally discovered Keynes’s Holy Grail: the euthanasia of the rentier and his replacement by the state as the primary source of business capital. This being the case, last month’s dip in the markets will turn out to be just that, because intervention will simply continue and if necessary be ramped up.
But in the process, all market risk is being transferred from bonds, equities and all other financial assets into currencies themselves; and it is the outcome of their purchasing power that will prove to be the final judgement in the debate of markets versus economic planning.
June’s FMQ components have now been released by the St Louis Fed, and it stands at a record $13.132 trillion. As can be seen in the chart above, it is $5.48 trillion more than an extension of the pre-Lehman crisis exponential growth trend. At this point readers not familiar with the construction of FMQ and its purpose may wish to refer to the original paper, here.
It should be borne in mind that there may be seasonal factors at play, with dips in the growth rate discernable at this time of year in the past. So the slower growth rate of FMQ, up $44bn between April and June when it might have risen $150-200bn, is not necessarily due to tapering of QE3. If tapering was responsible for slowing growth in FMQ, we could expect to see some tightening in short-term interest rates. But as the chart of 3-month T-bill rates shows they have been in a declining trend since last November.
The chart confirms that tapering seems to be having little or no effect on money markets and therefore the growth rate of fiat currency.
Weakness in interest rates is also consistent with poor economic demand. This week the first estimate of Q2 GDP was released which came in at an annualised 4%, substantially above market estimates of 3.1%. This outturn conflicts sharply with the lack of any meaningful demand for money, until one looks at the underlying estimates.
Of this 4% increase, the change in real private inventories added 1.66%. In other words GDP based on goods and services actually sold was only 2.34%. That changes in unsold goods, which is what inventories represent, should be part of final consumption is a dubious proposition, but need not concern us here. According to the technical note accompanying the release, figures for inventories and durable goods (which showed an incredible rise of 14%) are estimated and not hard data, so are subject to future revision. On this basis, the surprise GDP figure is little more than a government econometrician’s guess until the real data is available. Suspicions that these guesses err on the optimistic side are confirmed by the experience of the Q1 GDP figure, which was revised sharply downwards from first estimates when hard data eventually became available.
Whichever way we look at FMQ, it continues to expand at a frightening pace irrespective of the GDP outturn and its flaws. Furthermore, a look at the most recent Fed balance sheet confirms this view, showing that the 1st August figure will be considerably higher, unless there is an offsetting contraction of bank credit.
There is little sign of any such contraction. We can conclude from short-term market interest rates that the US economy is going nowhere fast, contrary to this week’s GDP estimate, and that demand for credit continues to come from essentially financial activities. But given that GDP estimates turn out to be far too optimistic, what if the US economy stalls or even slumps? Won’t that lead to a reversal of FMQ’s growth trend?
This is essentially the argument of the deflationists. In a slump they expect a dash from credit into cash as asset prices tumble. The counterpart of credit is deposits, the major components of FMQ. And without Fed intervention FMQ would rapidly contract. But in the event of a slump the Fed cannot be expected to stand idly by without taking extraordinary measures: in the words of Mario Draghi at the ECB, whatever it takes.