FOOLS´ GOLD AND GOLD / MACLEOD FINANCE

Fools’ gold and gold

Credit is beginning to implode, starting with equities. Investors are wavering, not knowing where to go for safety. Bitcoin? It corelates with tech stocks. The public have been fooled.

ALASDAIR MACLEOD

Introduction

Last weekend, I put out a note to my Substack paying subscribers detailing the differences in valuation between bonds and equities, and that by this measure, equities are more overvalued than they ever have been before. 

The timing of my article was prompted by developments in Japan, leading to a substantial recovery in the yen, imposing huge losses on Japan’s institutional investments in US and other equities, which in response to the Bank of Japan’s negative interest rate policy had led them to seek better returns abroad.

A sharp recovery in the yen was the set-up for a massive bear squeeze on the carry trade, which had become an important element in financing the US Government’s borrowing requirement, principally through the buying of short-term debt in the form of Treasury bills. 

It was to be the trigger for beginning the unwinding of the valuation disparity between bonds and equities.

When that trigger was pulled, equities came tumbling down. 

If they continue to fall, there is likely to be an emergency meeting at the Fed to reduce interest rates in an attempt to save the stock market from total meltdown. 

It is this possibility which has driven US Treasury bond yields lower — still not enough to close the valuation gap.

The Fed’s actions are set to repeat its interventions of late-1929. 

The New York Fed purchased government securities on the open market and lowered the discount rate. 

It supplied the extra reserves to keep commercial banks open and to satisfy demand for deposits, while keeping short-term interest rates from rising due to credit shortages.

To repeat those actions today, the Fed will set up an aggressive programme of quantitative easing while reducing interest rates. 

In the absence of a gold standard, it is not expected to do much else in order to stabilise the stock market. 

In its own historical record upon which the above paragraph was based, the Fed’s analysts stated that “…when stock market crashes occur, their damage can be contained by following the playbook developed by the Federal Reserve Bank of New York in the fall of 1929”.

Those actions stabilised the market, which recovered almost half its losses from the previous September before a far more pernicious and continual slide in stock prices set in, taking the Dow down for an eventual loss of nearly 90% by mid-1932.

For now, the stock market panic appears to be in its early stages. 

For desperate investors the sources of funds to cover losses are by selling previously high-flying stocks and cryptocurrencies led by bitcoin and ether. 

These two asset classes appear to corelate closely, as the chart below illustrates.

 

We can draw two conclusions from the relationship. 

The first is that far from behaving like a new form of money as bitcoin enthusiasts claim, bitcoin is behaving like a volatile technology stock. 

And the second is that technology stock and bitcoin prices are being set by the same cohort of investors. 

Therefore, given the price increases of the last two years, both NASDAQ stocks and cryptocurrencies will be sources of funds to cover other losses in a developing bear market.

In the context of a widening credit meltdown, this relationship has important implications for bitcoin’s supposed status as the future counterparty-free role as money. 

Does it replace gold, or is it just the fool’s version?

Bitcoin’s dénouement

Ownership of cryptocurrencies, led by bitcoin, has become more widespread than one would think. 

According to the Financial Conduct Authority, 9% of UK adults owned crypto-assets as of August 2022, a proportion which has probably increased since then. 

That these are simply speculators is consistent with widespread ignorance about money: as Keynes put it, not one man in a million understands how money is debauched. 

Therefore, 9% of the UK’s population cannot be informed hedgers of fiat currency risk.

Widespread ownership of cryptos is by no means confined to the UK. 

It is a global bubble fuelled by wild talk of bitcoin rising to millions of dollars, seemingly confirmed by it already going from mere cents to tens of thousands. 

But there are good reasons to reject what can only be a fraud perpetuated on the ignorant by the promoters:

• Legally, bitcoin is not money. 

In common law, that role is reserved for physical gold, silver and copper, firmly established through juristic rulings following Rome’s twelve tables and consolidated into Justinian’s Pandects a millennium later, and confirmed in the Basilica in 892 AD. 

These findings defined money, credit and their different characteristics and are the basis of common law in all the Roman Empire’s successor nations, which colonised the world, including America. 

Giving bitcoin the same legal status is not a simple matter. 

Hodlers seem to think that a fiat collapse will sweep away these considerations. 

It would require the ultimate anarchy, and even then bitcoin’s future role would be uncertain.

• There is a crucial difference in law between fungible goods (i.e. coin, banknotes and credit generally) and the possession of more permanent property with respect to recourse in cases of theft. 

The former cannot be recovered once entered into general circulation, while the latter right of possession is unchanged and recoverable without compensation. 

The blockchain identifies every fragment of bitcoin, which makes it property recoverable without compensation if stolen from any previous owner, or demonstrated, or even suspected, to have been the proceeds of crime. 

If the courts back this ruling (as they seem to be bound to do) then it renders the possession of bitcoin as property highly uncertain, given its widespread use for criminal activities.

• It must be admitted by enthusiasts that the global population prepared to use bitcoin as money is miniscule compared with those that still hoard gold and silver for monetary purposes. 

Gold remains the money of choice for central banks, even though they issue fiat currencies.

• There is a common misunderstanding that legal money circulates. 

It only does so as a last resort. 

It is credit which circulates, and it is hard to see how bitcoin-based credit can function, when what is demanded by businesses is price stability as the basis for economic calculation. 

This would appear impractical with tightening bitcoin supply over time and a hard limit on its quantity. 

If bitcoin was to become the monetary standard, the absence of credit would almost certainly plunge the entire world into the economic conditions that existed before the Industrial Revolution.

Bubbles are simply fuelled by excess credit. 

It is no accident that recent years of heavily suppressed interest rates and currency expansion have coincided with the bitcoin phenomenon. 

The destruction of the value of credit, and of credit itself will remove the fuel powering the cryptocurrency phenomenon.

Gold

In contrast with the fool’s gold of bitcoin and other cryptocurrencies, gold has enjoyed the legal position of money without counterparty risk since Rome’s first legal charter, the Twelve Tables (or tablets) in 448 BCE. 

That’s 2,500 years, and gold, silver, and copper have endured in this role because Roman law defined what the users of money naturally accepted.

The principal attribute is stability. 

It is often said that a Roman toga cost about the same as a decent suit today. 

Certainly, comparing prices in Diocletion’s edict of maximum prices with similar items today, we see that priced in gold many prices are similarly valued over a span of 1,700 years. 

I put together some examples for a Goldmoney article two years ago, which is shown below.

Gold’s value in US dollars has increased by 40% since the table was constructed, but that doesn’t undermine the evidence. 

In fact, it reduces the difference in prices for foodstuffs (wheat, olive oil, chicken etc.) making them virtually unchanged over seventeen centuries.

We also see the low-price volatility of commodities priced in gold in the comparison between energy priced in dollars more recently:

With respect to crude oil, the purchasing power of the fiat dollar has declined to less than one thirtieth of its 1950 value, while oil valued in gold has declined by about 40% with considerably less volatility. 

Clearly, it’s the fiat dollar detached from gold which is the problem.

As the major reserve currency and the pricing medium for commodities and international trade settlement, the dollar is regarded as the highest form of credit. 

Yet its jurisdiction of origin in unarguably in a debt trap, whereby the rate of interest being rolled up in the government’s debt is at a faster rate than the growth of tax revenue. 

Therefore, the US Government is already in a debt crisis which without radical remedial action can only lead to its default — a default recognised by a collapse in the dollar’s value, in which all subordinate debts are denominated.

In recent days there has been a definite trend to what economists lazily term recession — evidence of disappointing demand. 

It is apparent that the US jobs market is deteriorating with the unemployment rate rising. 

The Sahm Rule, which has proved to be a reliable jobs-based recession indicator has just been triggered. 

And with recession comes falling tax receipts and rising welfare costs which will drive the Federal budget deficit currently estimated at 6.2% of GDP towards my expectation of 9%+ in the next fiscal year. 

That debt trap is intensifying…

Credit is in trouble and all the values that reflect it are downstream from the dollar itself. 

The least secure form of credit is the supposed investor ownership of equities. 

Far from possessing part of a corporation, investors rely on vague promises of future value, wrapped up in a system where share ownership has even been replaced by entitlements. 

It is all a chimera of possession, against a background of record value disparity against bonds. 

I repeat a chart previously shown to my Substack subscribers to illustrate this disparity.

Portfolios of regulated investments are comprised of a mix of bonds and equities. 

The relative risk-based allocations are set by their respective values. 

With the value disparity at all-time records in favour of bonds, there is a strong argument that no equities should be held at all, and ignoring cash and hedging instruments the allocation should be entirely in bonds, the duration of which is a separate issue. 

It is the most compelling argument for getting out of equities, particularly ahead of an economic downturn.

The total market capitalisation of all US stocks is about $50 trillion, making up about half of world-wide equity values. 

They form a major element of the collateral securing bank loans. 

Therefore, a severe bear market risks destabilising the entire credit structure, from the mountain of derivatives, commercial banks, central banks, to fiat currencies themselves.

The few who truly understand the implications are getting out of credit into physical gold. 

The decline of bitcoin along with overvalued technology stocks will expose bitcoin’s true colours as not a new money at all, but just a fool’s version of gold.