GOLD SIGNALS THE END OF FIAT CURRENCIES / MACLEOD FINANCE

Gold signals the end of fiat currencies

There is increasing evidence that the fiat currency era is drawing to a close. Like the canary in a coal mine, this is what a developing crisis in gold and silver derivatives indicates.

ALASDAIR MACLEOD

Derivative dislocation is just the start…

With the ultimate insiders from central banks and governments downwards cleaning out bullion supplies and market liquidity, lease rates are soaring and backwardations are now common, notably in silver. 

The entire basis of paper contracts in precious metals is now undermined by the absence of physical liquidity, leaving delivery obligations at a growing risk of failure.

Disruption to these vital derivatives appears to be intensifying as prices rise. 

And there is little doubt that they will spike higher — probably much higher as the entire foundation of precious metal derivatives disintegrates. 

Given our repeated reasoning that the fiat currency system is coming to an end, it should be little surprise to regular readers to this Substack column that it is now being telegraphed by a developing crisis in precious metals.

This is not a repeat of the nickel crisis which hit the London Metal Exchange in March, 2022 resolved by the cancelation of contracts. 

That was one major short failing to deliver metal in the required configuration. 

Gold and silver involve the entire market: declare force majeure and prices will spiral even higher.

To innocent bystanders, gold is in a bull market and silver too. 

For them it raises the question as to whether they should buy, or if they are lucky enough to have bought lower down to take some profits. 

It is entirely natural to think this way, but it would be a mistake.

Over long periods, gold’s purchasing power is relatively stable — the statistics are there to prove it. 

It is modern fiat currencies which decline in their purchasing power, so the right way to look at gold is to conclude that the currency is declining rather than gold rising.

For proof we only have to look at the evidence. 

54 years ago, the fixed exchange rate with the dollar at $35 to the ounce, which was the basis for nearly all currency values was abandoned. 

With the gold price today at over $3800 the dollar has sunk to less than 1% of its 1971 value, measured in gold. 

Until 1971, under the Bretton Woods gold standard commodity and wholesale prices in dollars were remarkably steady. 

It is only since then that inflation, the common description for rising prices has been a problem.

The before-and-after of 1971 is illustrated in the chart of WTI oil, with the pecked line marking the point that August when America ended the $35 gold peg.

The pressure for higher oil prices started soon after, leading the Americans to give in to the Saudis and OPEC on control of oil prices, in exchange for a commitment to price and sell oil exclusively in dollars. 

Crude oil then rose from $3.56 per barrel ultimately to $140 in June 2008, with much volatility to this day. 

Meanwhile, the relative stability of oil priced in gold stands out.

It is a matter of fact that price volatility commenced when the dollar floated against gold and continues to this day. 

And it’s not confined to oil — all prices have risen multiple times, which can only reflect a decline in the dollar’s value, while that of gold remains relatively constant. 

But recently, the decline in the dollar against gold has begun to accelerate, with economists seemingly unaware of the implications. 

This is reflected in the widening gap between commodities valued in gold compared with the dollar:

There is no doubt that covid lockdowns had a major impact on currency values, which are still evolving. 

The expansion of government debt and the attendant suppression of interest rates led to an average doubling of commodity values between April 2020 and June 2022. 

This weakness in the dollar and other currencies relative to commodities was not initially reflected in gold, whose price in dollars rose broadly in line with commodities, outpacing the average only slightly. 

But as commodity prices stabilised in dollars, they declined significantly in gold between June 2022 and today to levels only seen at the height of the pandemic.

With its long-term price stability, gold is a proxy for the general level of commodities, which is why the relationship has persisted for as long as records exist. 

It is confirmed by the fiat dollar’s purchasing power declining since 1971, compared with that of gold being broadly maintained. 

The Invesco DB Commodity Index priced in gold is now at a substantial discount to its gold value, suggesting that the general level of commodity values even priced in gold should rise appreciably to close the gap.

Put more conventionally, valued in dollars whose purchasing power continues to decline, we should expect dollar commodity prices to rise significantly over the next two years. 

Therefore, the outlook for commodity-driven price inflation is being severely underestimated. 

And it will be the basis for a host of problems set to undermine faith in all fiat currency values in the coming years.

Meanwhile, the Fed and other G7 central banks have fuelled expectations that inflation is “transient”, allowing them to reduce interest rates into next year. 

And it is this expectation which is driving the credit bubble and asset values to new extremes.

Clearly, there is a shock in store. 

All credit bubbles come to a bad end, usually with higher bond yields which are driven ultimately by risk assessment in the markets, and not by central bank policy committees.

The 1918—2023 German experience compares

Following the First World War, the reichsmark weakened for two years before it stabilised and a credit boom fuelled the stock market. 

That lasted a further two years to December 1921 when the market crashed. 

It was followed by a collapse in the reichsmark’s purchasing power which took less than two more years, recalled by economic historians as the great inflation. 

There is a worrying symmetry with our contemporary post-covid years as the table below illustrates.

We can now speculate how the fiat currency dollar-based system might evolve over the next year or two:

· An inflation shock begins, when currency purchasing powers measured in commodities, foodstuffs, and raw materials begin to decline unexpectedly.

· Bond yields rise, reflecting compensation demanded by market participants for the falling purchasing power of fiat currencies. G7 Government finances deteriorate sharply as the doom-loops of debt traps are sprung, and zombie corporations cannot afford to refinance unproductive debt undermining lenders’ balance sheets.

· Simultaneously, the credit bubble bursts, leading to rapidly declining asset values, bankruptcies and soaring counterparty risks in financial markets. 

Foreign holders of dollar assets sell down stocks, bonds, and dollars in a panic.

· Currencies’ purchasing powers decline at an accelerating rate, as the market’s faith in them is undermined by the effective bankruptcy of governments unable to fund their soaring welfare commitments as economies slump. 

Central banks have no alternative but to resort to rapid credit expansion through quantitative easing and near-cash funding. 

Welcome to the world as faced by the Reichsbank in 1922—1923.

Unless a government is prepared to let a deep slump to run its course without intervening, to drastically reduce its own spending, and to take any other action necessary to end its fiat currency regime by binding its purchasing power to that of gold, its currency will decline at an accelerating rate without stopping. 

Indeed, so long as markets see that a government is powerless to stop the slide, the loss of faith in its currency will spread to its users who will want rid of it.

The timing to activate these events appears to be close. 

The bursting of the credit bubble will probably be triggered by the US long bond breaking above the 5% yield level. 

And as the chart below illustrates, the flag pattern preceding the next strong move to higher yields is close to completion.

Gold and silver are the principal refuges from this impending chaos.