CREDIT CRISIS IMMINENT / MACLEOD FINANCE

Credit crisis imminent

Following the US government’s determination to destroy Iran’s theocracy, a rapid collapse of the entire financial system is now virtually guaranteed, driven by higher bond yields. 

ALASDAIR MACLEOD

Introduction and summary

This article is timed ahead of an increasingly turbulent few weeks for financial markets with bond yields rising, triggered by growing inflation concerns. 

Debt traps for G7 governments will be triggered, and funding crises will inevitably follow.

In these circumstances, never have gold and silver become so cheap, because with other commodities they will reflect accelerating currency debasement. 

It is inevitable, partly because of inflation triggered by the war against Iran, but mainly because of the prospect of massive QE by governments attempting to prevent both a crisis hitting financial markets and business slumps in non-financial sectors.

As a consequence for fiat currency values, we now stand on the edge of the largest wealth transfer in history, from creditors to debtors as the latters’ obligations to the former are wiped out in a worldwide fiat currency collapse.

While this outlook is poorly understood in western capital markets, Asians led by China are sucking the physical lifeblood out of gold and silver paper markets. 

Chinese banks are rationing gold, which is sold out immediately, such is investor demand. 

Silver flies from western vaults to Asia and despite being marked down in paper markets is still in backwardation.

We cannot say for certain that the selloff in gold and silver derivatives is over, but it presents a bonus opportunity to accumulate both metals in physical form to be stored outside the banking system in a secure location — if you can get it.

Goodbye to lower interest rates, hello to higher bond yields

Already, even with recent promises of lower interest rates we have seen private credit and private equity unable to afford current financing costs. 

Now that the promise of lower interest rates is withdrawn, higher bond yields will bring on an existential financial crisis. 

Not only will it saddle banking systems with bad debts, but it will lead to an economic slump which brings forward the collapse of fiat currencies.

This is just one aspect of a developing crisis, initially reflected in rising bond yields. 

The implications of the Iran war for price inflation over the course of this year are only just sinking in. 

It’s not only oil and LNG, but fertilisers locked in the Persian Gulf at the beginning of the food growing season will lead to acute global shortages and higher food prices in the summer. 

It will be made worse as other major fertiliser exporters, such as China, restrict their exports to conserve their own stocks.

Even pharmaceuticals rely heavily on petrochemicals, as do all other consumer items directly or indirectly. 

All consumer items, including services, are set to rise in price, accelerated by the Gulf conflict. 

A better way of describing this outcome is that the purchasing power, or the value of currencies, are set to decline significantly measured in commodities, raw materials, and wholesale and consumer prices. 

Creditors of these currencies will demand compensation through higher interest rates and bond yields.

Therefore, bond yields are set to go higher, much higher, with four of the G7 nations already seeing them soar into post-covid new high ground. 

The others, the US, Italy, and Canada will follow. 

The chart below shows where this is going for US treasuries:

The 10-year US treasury note yield is now on its way towards 10% — probably rapidly and maybe even higher. 

Just think what a breakout above 5% yield will do to equities, already in massive credit bubble territory as the next chart illustrates:

This chart reveals that relative to bonds, the S&P is over twice as expensive as it was during the peak of the dotcom bubble (shown by the two sets of arrows). 

It is the culmination of the era of financialisation which started in the mid-eighties. 

Unfettered by the fiat currency regime, this credit-driven financial bubble is almost certainly larger than anything seen before, including the roaring twenties which resulted in the Wall Street crash of 1929.

Ever since the financial crisis of 2008—2009, MacleodFinance has been expecting this eventual outcome as central banks suppressed interest rates and government budget deficits rose. 

That crisis 18 years ago was the last in a progression of increasingly large credit bubbles, whose consequences were simply kicked down the road until they could be no longer.

The timescale has been foreshortened by covid, which accelerated the debt creation process for both governments and private sector debt zombies. 

Before the oil crisis in the Persian Gulf, the financial situation was becoming increasingly precarious. 

Now the bursting of the mother of all credit bubbles is upon us.

The sequence of events has clarified

Last year, we laid out the developments we expected to lead to the end of the fiat currency system. 

They bear repeating:

· Increasing credit risk from debt traps would lead to higher bond yields, triggering a debt finance crisis for governments and zombie corporations. 

To this we can now add the prospect of soaring inflation.

· The rise in bond yields will crash financial markets inflated by the largest credit bubble in history.

· Falling share prices will trigger collateral liquidation, driving equity indices into a self-feeding downward spiral.

· The crisis spreads to banks, shadow banks, and derivatives in a systemic meltdown.

· The Fed intervenes in an attempt to steady markets, worried that loss of confidence in financial markets will lead to a thirties-style slump. 

Initially, it freezes interest rates while accelerating QE by purchasing T-bills and short-term Treasuries. 

Bond yields along the curve continue to rise despite the Fed’s attempts to control interest rates.

· The US treasury expands its support and subsidies across the entire economy. 

Together with the collapse of tax revenues and increasing welfare commitments, its budget deficit soars.

· This is hyperinflation, the ultimate destruction of a fiat currency. 

It will be a fate shared with the other G7 national currencies as their governments respond to the crisis in a similar manner.

The value of credit can be extinguished two ways: either through defaults or debasement. 

Political imperatives will lead to the latter. The end of the fiat currency system looms and there is nothing that can now be done to stop it.

Gold, silver, and commodities

Investors trying to protect their capital have been hit hard by the initial effect of the Iran crisis, last week seeing gold and silver prices falling sharply. 

It is this volatility which makes trading so dangerous for professional fund managers and members of the public alike. 

If the basic premise is that gold and silver are the ultimate protection, it is widely assumed that their values should rise without meaningful setbacks.

This assumption ignores the position of bullion bank traders and market makers short of paper gold and silver. 

Like investors, some of them see heightened uncertainty eventually raising gold and silver prices, in which case they will want to force speculators to sell so that they can close their short positions and go long. 

Others see the short-term threat of higher interest rates which makes it more expensive to hold gold, so they expect it to fall.

When this has happened in the past, the initial effect has been to drive gold and silver prices sharply lower before a recovery takes them significantly higher. 

This was the case in 2008—2009, when gold was marked down from $1000 to $680, before tripling to its subsequent high of $1920 in September 2011.

And silver was marked down sharply from $18.90 in February 2020 to $11.67 on 17th March before rising to nearly $30 the following August. 

Last week’s markdown, which may or may not be over, appears to be following the same pattern.

Obviously, it is a bad mistake to fall for these selloffs, because they only serve to give renewed momentum to significantly higher prices. 

And the ultimate bull case for gold and silver, which is that the fiat currency system of 55 years is coming to an end, is now more certain than ever.