THE DEATH OF FIAT / MACLEOD FINANCE

The death of fiat

The end of the 54-year fiat currency era is imminent — that is gold’s message. Increasing credit risk means higher interest rates, which will burst credit bubbles.

ALASDAIR MACLEOD

The yield on the long bond is ready to break out on the upside over 5%, giving a technical target above 9%. 

Implications for all financial markets are dire.

Introduction

That central banks are ditching dollars for gold and have been for at least the last four years is an important message for us all. 

Geopolitics and even US politics are involved: but the fact that this widespread rebalancing of reserves is taking place is the clearest indication that the ultimate insiders to the currency game know that the dollar’s gig is nearly up.

Critics of the 54-year old anti-gold propaganda spreading out of the US and being repeated ad nauseum by its Keynesian epigones in the G7 are no longer dismissed as conspiracy theorists. 

Increasingly, the middle classes in these nations see the threat from rapacious governments taking their earnings and savings. 

And these defenceless victims of social democracy are only just beginning to understand that there is an additional theft of their wealth through the debasement of their currencies.

Initially, their wake-up call came from the bitcoin concept. 

The legal relationship between corporeal gold and incorporeal credit remains a mystery to them — but not to the insiders at central banks.

Reasoned economic and monetary theories, confirmed by historical evidence, tell us that currencies must return to gold standards to secure their values, circulating as trusted gold substitutes. 

Only then, can general economic progress resume. 

Getting there is going to be extremely difficult but is not the focus of this article. 

Instead, we must all focus on how to protect our personal wealth from the death throes of the dollar-based fiat currency system.

The debt-cum-credit bubble

One of today’s most common errors is to believe that the cost of debt is always controlled by central banks. 

When debt is not excessive, a central bank can manipulate interest rates and bond yields to some extent. 

But when debt is excessive and rising exponentially, it is creditors who have the final say.

These are the conditions emerging today. 

The authorities won’t admit it, but the US economy is sliding into recession, which with its government debt to GDP ratio at about 120% means that buyers of accelerating dollar debt issuance will see increasing risk of a debt trap. 

Bond yields will reflect that risk, and will rise accordingly.

Ever-higher bond yields are the consequence of a debt trap, which deters all buying of bonds. 

As yields rise and commercial banks attempt to avoid lending risk, the Fed will end up underwriting the entire credit system. 

Inevitably, the dollar’s purchasing power will be further undermined as currency and reserves flood the system, requiring yet higher interest compensation for holders of both short and long-term debt.

It is the engine that drives hyperinflation.

This outcome is supported by experience. 

In the UK, a sterling crisis in 1975 ended with the IMF being sent in to impose fiscal and spending discipline on the government of the day. 

In those times, gilt funding required coupons of over 15% and consumer price inflation hit 25%.

This external discipline is not available to the US, so it will be imposed by markets. 

There is no foreseeable limit on how low the dollar can go and how high bond yields and interest rates will rise. 

Already, the US Treasury is resorting to short-term finance because of poor demand for long-dated bonds at current yields.

Essentially, the US Treasury relies increasingly on pay-day loans on a national scale, as the Fed holds short-term rates above those of the yen and euro. 

But we know what eventually happens to the rates on pay-day loans. 

And as the mighty US Treasury loses credibility, rates rocket or the dollar sinks — most likely both. 

That is what gold is telling us: it’s not that gold is rising, but the dollar is sinking. 

And since all fiat currencies operate on a loose dollar standard, they are going down with the dollar as well.

However, the dollar is even declining against other fiat currencies, reflected in its trade-weighted index which has lost 10.6% since mid-January:

The US government with its dollar are not the only highly indebted government and fiat combination. 

Other G7 economies are also struggling, declining even when their budget deficits are subtracted from GDP. 

Debt and matching credit bubbles are evident everywhere, from Japan to France, from Spain to the UK.

Most investors are myopic about the role of credit. 

But for every debt there is a credit, and increasingly that credit has fed into stocks. 

Margin finance is now over $1 trillion, and rising steeply:

However, towards the end of an equity bull market, bond yields begin to rise. 

This stretches valuation differences to the point where eventually the equity bubble bursts. 

Today, the valuation difference is already the highest on record, illustrated in the next chart:

By way of explanation, the chart has been constructed to show the close negative correlation between the long bond yield and the S&P Index over time by inverting the long bond yield and indexing both metrics to 100 in January 1985.

The principal aberrations in this correlation were the dot-com bubble, the Lehman crisis when bond yields and equities both fell, covid when the long bond yield was suppressed to one per cent, and today when the long bond yield has risen to 4.9% while the S&P continues to rise.

The correlation always reverts to its mean for obvious reasons. 

But relative to the long bond, equities are the most overvalued for forty years, and probably for all time.

Clearly, this is an extremely dangerous situation. 

Even without the long bond yield rising further, the correlation returning to its mean would see the S&P losing 75% to test the previous 2000 and 2007 highs. 

But bond yields are certain to rise from current levels. 

When, not if, the 30-year UST bond rises through 5% it will crash the equity market.

Meanwhile, credit continues to fuel asset values. 

M2 money supply has expanded by about $500 billion over the last two years, matching the increase in margin debt in the penultimate chart above. 

But riding the equity bubble is like living in the shadow of a volcano: all is fine and dandy until suddenly without warning it isn’t.

Other than equities and bonds, activities whose very existence will be challenged when the bubble pops include:

· Cryptocurrencies, which have no standing as legal tender and whose performance correlates closely with the more speculative technology stocks in NASDAQ, and which will just as surely be doomed by the credit bubble bursting.

· Without secure and trusted payments, the collapse in economic activity will almost certainly be far greater than that of the 1930s slump, creating additional problems for all credit.

· Financial collateral will be sold to cover loans or become worthless in bankruptcy.

· Debt finance availability will collapse, and over-indebted businesses will fail to refinance at rates they can afford. 

Even conservatively leveraged commercial operations will be threatened by higher bond yields and the absence of available bank credit to supplement cash flows.

· Residential property prices depend on mortgage finance, so will decline. 

Excess capacity in commercial real estate is already being revealed with much more to come.

· Key commodity derivatives are already facing physical liquidity constraints. 

The risk inherent in all OTC derivatives due to the risk of counterparty failure will outweigh their use for risk protection.

· Global trade will contract sharply, initially because of tariff disruption and then because settlement in failing fiat is undesired. 

Bartering goods one for another will become common.

This list is of just some examples of where the dangers to our wealth lie and is far from exhaustive. 

But there is only one solution for those seeking to protect their wealth and their families: get out of credit as much as you can and into real corporeal money without counterparty risk. 

And that is only gold, with silver as a subsidiary metal.