THE END OF FIAT -- WHAT IT MEANS / MACLEOD FINANCE

The end of fiat — what it means

We can now recognise a path of financial and economic developments leading to the end of fiat currencies. We address what will happen unless and until a sound replacement is found.

ALASDAIR MACLEOD

Summary

The big surprise will be high inflation in 2026—2027, threatening to get out of control entirely. 

Almost no one today expects it. 

Government and central bank economists will misdiagnose it as usual, not appreciating that it reflects the consequences of a combination of accelerating QE and loss of faith in the value of the dollar by its foreign holders and its domestic users. 

Instead, the usual bogeymen will be blamed: greedy businessmen, foreign enemies, and domestic hoarders of consumable goods. 

Price controls will be implemented.

Instead, we will be witnessing the dollar-based financial credit bubble imploding from massive overvaluations while bond yields soar. 

Unless the US government finds a politically creditable way of stopping the slide, dollars and associated fiat currencies will descend into worthlessness.

The recent rise in gold prices is only just beginning to discount this outcome. It is a warning not to be ignored!

Introduction

Soaring gold prices tell us that the fiat currency system is in deep trouble. 

The days when politicians buy votes by borrowing are running out. 

Stock prices have been inflated by a credit bubble, despite persistently high bond yields. 

G7 government debt to GDPs are typically 100%, or more. 

Nevertheless, politicians continue their spendthrift ways.

The most dangerous of the lot is President Trump, an ex-property mogul for whom interest rates and borrowing costs should be minimal. 

He’s about to appoint someone to chair the Fed who will undoubtedly share his view. 

Trump is doubly dangerous because the US dollar is the one currency to which all others defer: the fiat dollar goes, and so do the rest.

Big cracks in the financial system are beginning to appear. 

The Fed is abandoning quantitative tightening in favour of injecting liquidity into markets. 

The methods used are suppression of interest rates and the return of quantitative easing. 

The inflation target is being abandoned while CPI inflation is still 150% of the Fed’s 2% target.

Gold, silver, and a raft of commodities are starting to rise in value in a way which reflects declining confidence in the value of the Fed’s dollar. 

It’s purchasing power is under attack, yet the consensus among economists and the financial community is that the outlook is stable enough to justify further cuts in interest rates. 

But without radical changes, the purchasing power of the dollar is bound to continue its decline, which is why bond yields remain persistently high and are set to go higher.

The principal factor driving bond yields higher is the growing threat of a debt trap. 

Broadly, the sustainability of debt depends on the borrower ultimately having the means to service it. 

International and domestic creditors will assess whether the tax base is growing sufficiently to do so. 

With mounting evidence of a stagnating economy being telegraphed by the Fed abandoning its inflation mandate to support it, the tax base is threatening to decline.

When a debt trap is triggered, it drives bond yields higher. 

It becomes a doom-loop whereby higher rates make the debt even less attractive, until a debtor government grasps the nettle of higher taxes, lower spending and a budget surplus to pay down debt instead of increasing it.

Until then, we know that the entire fiat currency system based on the US dollar is ending in a sea of debt which cannot be serviced let alone repaid. 

The yield on US government debt remains persistently high, having broken the long-term downtrend which was in place for the last forty years. 

It is now set to go significantly higher, as the chart below illustrates. 

It is all about loss of confidence in the currency in which the debt is denominated.

At over $38 trillion outstanding, US government debt is becoming unsustainable and economically unserviceable, which will be reflected in significantly higher bond yields to compensate for debasement risk. 

Indeed, already other G7 government bond markets are reflecting this trend, notably Japan:

With its government debt to GDP of 235% and the Bank of Japan owning over half of it, the sins of excessive debt are catching up. 

Markets are clearly reassessing lending risk. 

Furthermore, the super-low bond yields of the past means that Japan’s pension funds and insurance companies invested heavily in US Treasuries. 

The yield differential is now closing, which with currency risk is likely to lead these institutions to sell US treasuries in favour of their own government debt.

The near certainty of two further rate increases by the JGB while the Fed reduces its funds rate will make this almost certain and also kill the carry trade, whereby US domestic and offshore hedge funds initiate long positions in US Treasuries by borrowing cheap yen and euros.

With respect to the ending of the financial credit bubble, this is the first point to be made about the prospects for US Treasury yields: they are going to go higher along the yield curve.

The second point is the consequences for equity markets. 

The other side of the US dollar’s debt bubble is credit, large amounts of which are applied to the purchase of non-bond financial assets. 

Consequently, equity valuations relative to bonds have become disproportionately expensive.

The valuation disparity is already at an historic extreme, indicated by the double-arrow on the right. 

This is an equity bubble like no other, and when it becomes apparent that bond yields are due to rise again, the bubble is bound to burst.

The pathway to decline

As noted above, the dollar is the most important of the fiat currencies, and its future determines that of the others. 

Furthermore, the US stock market is mostly driven by the credit bubble. 

Not only has it become highly leveraged through margin lending by brokers, not only have hedge funds and other institutions leveraged their positions by going directly to the banks, but in addition foreign investors have an unprecedented $44.09 trillion invested in dollars and underlying financial investments (September UST TIC figures). 

Of that total, $21.26 trillion is in US equities and $7.83 is in US Treasuries with over one year to maturity.

Clearly, when bond yields rise and the equity bubble bursts, there will be massive selling of US treasuries, equities, and the US dollar by foreign investors. 

The extent to which it is offset by US selling of foreign investments in their currencies is minor, because foreign equities are priced in US$ ADRs, and lending to foreign creditors is nearly always in dollars.

The increasing risk of this outcome and its growing proximity is what gold is telling us. 

Not only will the nominal values of bonds and equities face sharp declines, but so will the international purchasing power of unwanted dollars. 

It will come as an unexpected shock in 2026 in the form of rising consumer prices driven by higher dollar-prices for commodities and imported goods. 

But before that becomes obvious, the speed of the asset valuation collapse is set to deliver a collateral crisis as stock leverage is unwound and banks attempt to reduce their asset exposure to protect their own capital.

The lack or even contraction of bank credit coupled with foreign liquidation of financial assets will drive up bond yields. 

Zombie corporations will face insolvency, and the US government with its agencies will be faced with the task of reflating sufficiently to save the entire financial system and the economy.

This will be done through a new round of quantitative easing, for which the groundwork is already in place. 

The inflationary expansion of the currency and bank reserves will reflect the Fed’s purchases of not just US treasuries, but agency debt to soften the blow on mortgage rates. 

It will also be extended to corporate debt to protect those unwise enough to have indulged in financial leverage. 

These are the conditions which will rapidly undermine the dollar’s credibility and value as a currency.

A worrying precedent

A similar situation happened in Germany in 1921. 

Following the initial post-war debasement of the reichsmark, in February 1920 the currency stabilised. 

Between that date and November 1921, the stock market boomed, rising some 300%. 

But from July that year, the gold price in reichsmarks began to rise, the pace accelerating from RM4,000 in July 1921 to over RM14,000 in November.

Today’s bull market has been running longer, but the current boom in equities commenced after a selloff last March, having risen nearly 40% since. 

But from August gold began to rise sharply, appearing to front-run an impending credit bubble collapse in the same manner as it anticipated Germany’s stock market crisis in late-1921.

While Rudolf Havenstein as the Reichsbank’s president was blamed by modern commentators for Germany’s hyperinflation, they have yet to appreciate the similarity of political pressures facing the Fed and US Treasury today. 

They have no mandate other than to support financial asset values, the entire banking system, and to ensure that derivatives do not lead to counterparty risk spreading out of control. 

They are staffed with economists whose comprehension of credit is certainly no better than that of Havenstein and his colleagues a century ago: the formers’ understanding of inflation is restricted to the effects on prices.

It was Karl Helfferich as finance minister who was identified by Jens Parsson[i] as “the chief architect of Germany’s economic disaster”. 

Yet, as Parsson went on to say,

“Helfferich was neither a fool nor a political hack. 

To the contrary he was a brilliant monetary theorist whose stature was compared with some validity to that of Lord Keynes. 

His ponderous treatise on money, Das Geld, translated, was still in print in the United states as late as 1973, and a reading of his book is convincing proof of Helfferich’s intellectual capabilities. 

Ironically enough, after contributing the most to the destruction of the mark Helfferich also made the principle theoretical contributions to the formation of the miraculous Rentenmark plan which ended the inflation. 

As his book demonstrates, Helfferich knew perfectly well the relationship between money creation and price inflation; but, he said in substance, under the circumstances in Germany nothing could be done about it.”[ii]

From this history we can not only deduce that irrespective of the combined economic talents of a finance minister and the head of the central bank, politics determine outcomes. 

But also, after 54 years of a fiat currency environment today compared with the nine-year lifespan of the reichsmark, there is a far higher level of economic ignorance today when it comes to preventing a fiat dollar collapse.

Conclusion

Germany’s monetary collapse took the reichsmark from 90 to the gold ounce before 1914 to 90 trillion in November 1923. 

The collapse in its purchasing power accelerated tenfold from July 1922 by the following November, and two-hundredfold by June 1923, eventually quadrupling each week. 

A similar outcome for today’s dollar might be inconceivable but is not impossible. 

And it is becoming increasingly difficult to see how it can be avoided.

For the sake of everyone, not just those who use dollars but those depending upon the value in all fiat currencies, we must hope that unlike the politicians in 1920s’ Germany today’s politicians succeed in preventing a total collapse of today’s fiat currencies. 

But there is no evidence that this will be the case.

Until the collapse is stopped and in case it is not, one’s working assumption should be that the dollar faces a similar fate to that of the reichsmark. 

How long it will take cannot be known until it is well underway. 

But the starting point will be the crisis set off by a combination of rising bond yields and the bursting of the stock market bubble. 

It will then not be too late for those who have been unwise enough not to get out of credit already, which includes fiat currencies, and to get into gold. 

But by then, much personal wealth will already have been destroyed.

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[i] Dying of Money: Lessons of the Great German and American Inflations: Wellspring Press 1974, Boston

[ii] ibid