In our last article (A Minsky Moment is coming for gold) we presented the “Minsky Moment”, referring to a point in time when a period of bullish speculation leads to a spectacular market crash.
Named after economist Hyman Minsky, the theory centers around the inherent instability of stock markets, especially bull markets such as the current one that has been in place for over a decade.
“Minsky held that, over a prolonged period of prosperity, investors take on more and more risk, until lending exceeds what borrowers can pay off from their incoming revenues. When over-indebted investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash — an event that has come to be known as a ‘Minsky moment.”- The Levy Economics Institute of Bard College
In our article we asked, “Is the current US stock market, and global economy, approaching a Minsky Moment?” If so, precious metals gold and silver will surely go ballistic in the aftermath of the collapse.
The intellectual challenge is identifying the metaphorical pin that pops the bubble, which investors, banks and governments have been happily inflating.
Our Minsky Moment piece pinpointed some catalysts that could lead the global economy down a road of economic ruin. They include the coronavirus; a related collapse in ocean freight shipping rates; “fake” good news that is masking serious problems in the US economy, like a lack of business investment; record share buybacks that enrich management not companies nor their shareholders; plus any number of “white swan” geopolitical risks - hotspots that could at any time boil over into a conflagration that destabilizes the fragile global economy.
The truth of the matter though, is these are all symptoms of a bigger, much more insidious disease, and that is paper money - more specifically, piles and piles of consumer, business and government debt that has been allowed to accumulate, without consequences, under our fiat/ paper monetary system.
Gold’s Minsky Moment will come when everyone realizes that the paper monetary system, and its reserve currency the US dollar, has no intrinsic value, and therefore can no longer be trusted - when money is worth nothing but the paper it’s printed on, and previously rejected gold and silver re-emerge as currency backstops.
The making of the Fed
The US Federal Reserve operates as a central bank, controlling fiscal and monetary policy. Its three goals are to promote maximum employment, keep prices stable (ie. control inflation) and to moderate long-term interest rates. The Fed is “independent” in that it is not a part of the US government. While the US President appoints its seven-member board of governors, including its chair (appointments must be approved by the Senate), he has no direct control over its policies - though he’d certainly like to. (witness President Trump’s attempts to bully current Fed Chair Jerome Powell into dropping interest rates in order to keep the US dollar low - needed for Trump’s MAGA credo of reviving the US manufacturing sector)
How did the US come to have a central bank that is independent from the government? It all goes back to November 22, 1910, when a delegation of the nation’s leading financiers, led by Senator Nelson Aldrich, left New Jersey for a secret 10-day meeting on Jekyll Island, Georgia. Among the attendees are some now-familiar American family banking names:
- Frank Vanderlip, president of the National City Bank of New York, associated with the Rockefellers
- Henry P. Davison, senior partner of J.P. Morgan Company, regarded as Morgan’s personal emissary
- Charles D. Norton, president of the Morgan-dominated First National Bank of New York
- Col. Edward House, who would later become President Woodrow Wilson's closest adviser and founder of the Council on Foreign Relations
- Benjamin Strong, a lieutenant of J.P. Morgan
- Paul Warburg, a recent immigrant from Germany who had joined the banking house of Kuhn, Loeb and Company, New York directed the proceedings and wrote the primary features of what would be called the Aldrich Plan.
Read the surprising history of the Fed in Voluntary Servitude Begins With A Debt
The whole point of creating the Federal Reserve System was to give the new central bank (the Fed) control over the money supply - having been spooked by the crisis of 1907. Here a bit of history is useful, courtesy of former US Senator Ron Paul and Lewis Lehrman’s ‘The Case for Gold’ - written back in 1983.
In their seminal work of economic history, Paul and Lehrman go right back to the beginning of what they call “The Present Monetary Crisis” when in 1784, Thomas Jefferson said, “If we determine that a dollar shall be our unit, we must then say with precision what a dollar is.”
The founding fathers followed his advice and in 1792 defined one dollar as 371 grains of silver. From then until 1971, the dollar was defined by a weight of either silver or gold, but since 1971, when President Nixon abandoned the gold standard, the dollar remains undefined by a physical value. The greenback is really nothing more than a piece of paper printed with government ink and imbued with the subjective value that a $1 bill is in fact worth the 100 cents the government says it is worth.
In 1900 the governing Republicans officially announced the gold standard. All paper money was to be redeemable in gold, and silver continued as a subsidiary metal. The problem was that between 1897 and 1914, an increase in gold production pushed the gold supply up by 7.5%. However the amount of cash deposits during the same period overwhelmed the amount of gold in bank vaults - total bank deposits increased 317.5% to gold’s 7.5% rise. In 1907 the Treasury was called upon to bail out the banks that ran short on cash, resulting in an agreed need for some form of central banking.
Hence the 1910 meeting at Jekyll lsland, Georgia and the creation of the US Federal Reserve.
An instrument of inflation
Paul and Lehrman explain how by creating the US Federal Reserve System, the government invited persistent inflation:
By establishing the Federal Reserve System, the federal government changed the base of the banking pyramid to the Federal Reserve Banks. Only the Federal Reserve could now print cash, and all member banks could now multiply their deposits on top of Federal Reserve deposits. All national banks were required to join the Federal Reserve, and their gold and other lawful money reserves had to be transferred to the Federal Reserve. The Federal Reserve, in turn, could pyramid its deposits by three-to-one on top of gold. This centralization created an enormous potential for inflationary expansion of bank deposits. Not only that, reserve requirements for the nation's banks were deliberately cut in half in the course of establishing the Federal Reserve System, thereby inviting the rapid doubling of the money supply. Average reserve requirements for all banks prior to the Federal Reserve Act is estimated to be 21 percent. In the original Act of 1913, these were cut to 11.6 percent and three years later to 9.8 percent. It is clear then that the Federal Reserve was designed from the very beginning to be an instrument for a uniform and coordinated inflation of bank money.
Indeed, total bank deposits were $14.0 billion at the beginning of the Federal Reserve System in January 1914; after six years, in January 1920, total bank deposits had reached $29.4 billion, an enormous increase of 110 percent or 18.3 percent per year. The creation of the Federal Reserve had made that expansion possible.
Yet it was nothing compared to what would come after 1971, when President Nixon announced that no more gold would be given in exchange for dollars. “There were now absolutely no checks on the availability of the United States to inflate,” states the Paul and Lehrman report.
In a clear reference to the inflationary 1980s, the authors conclude that There has never, in peacetime American history, been any sustained rate of inflation to match the inflation since 1941. The same, in fact, is true of wartime, which at least has never lasted more than a few years. And it is not an accident that the highest, most accelerated rate of inflation has taken place since 1971, when the United States went off the international aspects of the gold standard and went over completely to fiat paper.
And in the forward to the report:
[All] the effort and planning imaginable cannot make paper money work. There is no way paper can be "improved" as money. Whenever governments are granted power to purchase their own debt, they never fail to do so, eventually destroying the value of the currency. Political money always fails because free people eventually reject it. For short periods individual countries can tell their citizens to use paper, but only at the sacrifice of personal and economic liberty.
The Fed’s ability to print money on a whim, to “purchase their own debt” in the words of Ron Paul and Lewis Lehrman, is best exemplified by the “quantitative easing” programs that followed the 2008 financial crisis, which in retrospect was another debt-fueled “Minsky Moment,” in that case the popping of the US housing market bubble, elevated out of control via easy credit and toxic bank loans.
QE was used to maximum effect to counter-act the effects of the crisis that brought down Lehman Brothers and Bear Stearns, among other large banks.
Between 2008 and 2015 the Fed bought trillions of dollars worth of T-bills and mortgage-backed securities, keeping interest rates near zero percent, but making the US debt balloon from $900 billion to $4.5 trillion.
Debt crisis
Five years later the US debt stands at $23 trillion and counting. In January the World Bank warned of the risks of a new global debt crisis - pointing to the latest of four waves of debt accumulation over the past 150 years.
The current wave which the Washington, DC-based group says started in 2010, is thought to be “the largest, fastest and most broad-based increase” in global borrowing since the 1970s, CNN reports.
In the first quarter of 2019, world debt hit $246.5 trillion, reversing a trend that started in the beginning of 2018, of reducing debt burdens, when global debt reached its highest on record, $248 trillion.
We’ve written extensively about the dangers of the mounting US debt load.
The country is accumulating about the same amount of debt as its annual economic output. Each year another trillion dollars gets added to the national debt.
According to its latest projections, the Congressional Budget Office says debt-to-GDP will reach 150% by 2047, well past the point where financial crises typically occur. The budget deficit is also likely to rise, nearly tripling from 2.9% of GDP to 9.8% in 2047.
De-dollarization
It’s not a stretch to envision a scenario whereby the world’s reserve currency, the US dollar, collapses under the weight of unmanageable debt, triggered say, by a mass offloading of US Treasuries by foreign countries, that own about $6 trillion of US debt. This would cause the dollar to crash, and interest rates would go through the roof, choking consumer and business borrowing. Import prices would skyrocket too, the result of a low dollar, hitting consumers in the pocket-book for everything not made in the USA. Business confidence would plummet, mass layoffs would occur, growth would stop, and the US would enter a recession.
All the countries that sold their Treasuries would then face a major slump in demand for their products from American consumers, their largest market. Eventually companies in these countries would begin to suffer, plus all other nations that trade with the US, like Canada and Mexico. Before long the recession in the US would spread like a cancer, to the rest of the world.
This isn’t some tin foil-hat-wearing conspiracy theorist’s idea. “De-dollarization” has already begun, as America’s adversaries punt the dollar in favor of other currencies and gold bullion. (in 2019 Russia grew its gold reserves by 158.1 tonnes and Chinese gold reserves increased by 95.8 tonnes over the first nine months, according to the World Gold Council)
In 2018 Russia sold off 84% of its US debt holdings between March and May, leaving just $14.9 billion in its US reserve account. That compares to $102 billion in December 2017. The sell-off corresponded with tough US sanctions imposed on Russian President Putin’s closest associates and Rusal, which produces 7% of the world’s aluminum.
The dumping of US Treasuries by Russia caused barely a ripple, since the country only holds about 1/10 of the T-bills owned by China, which has the most of any country, $1.2 trillion. But it begs the question, what would happen if China started selling US Treasuries? Think it would never happen?
Consider: the trade war with China isn’t over - the coronavirus has thrown a spanner into the Phase 1 trade agreement signed on Jan. 15. China’s promise to purchase an additional $200 billion worth of US goods including agricultural products is now in considerable doubt. Beijing is reportedly being urged to invoke “force majeure” - a clause allowing the two parties to consult one another if a natural disaster or force beyond its control delays either party from meeting its obligations under the agreement.
The possibility of moving forward on a Phase 2 agreement seems unlikely, in light of all the supply chain interruptions caused by the pandemic.
China is warming to Russia through energy deals and is buying Iranian oil despite US sanctions. Its One Belt, One Road initiative is key to its plan to exert Chinese hegemony and create a trading bloc without the need to trade with its former enemies: the US and Europe. Eventually China could stop buying US Treasuries altogether.
How would that affect the US dollar? And more significantly, how would the US finance its $23 trillion debt if the anti-T-bill movement spread to other countries and the market for them dried up?
The current arms buildup between the US, China and Russia, precipitated by the US pulling out of the 1987 INF Treaty due to Russia breaking its terms, could easily trigger a war especially if China is pushed into a corner due to economic weakness and is looking for a scapegoat. Taiwan, Hong Kong, Vietnam and US naval positions in the East and South China Seas are all potential hot spots that could lead to a military confrontation.
That, combined with persistent trade barriers that are keeping the Chinese economy weak, could result in China dumping US Treasuries.
We’ve lived under US dollar rule since 1944 but history shows us that all currencies have a shelf life. As we wrote in The Later United States Empire, history is marked by empire after empire that has over-extended itself, militarily; the US is no different.
The Roman and British empires were underpinned by strong militaries that both expanded territories and defended them. The same can be said for other empires throughout history - the Akkadians, Vikings, Greeks, Gauls, Spanish, Portuguese and Soviets, to name a few, all seized power by conquering or seizing other lands.
The United States since World War Two has been the street cop on the global block – occasionally challenged but never (yet) surpassed in economic nor military power.
World domination however comes at a heavy price to the national budget. Military spending is the main reason for the spiraling debt over the past few years; as a line item, it is second only to Social Security. If Special Forces, nuclear weapons and the VA budgets were added to the military budget, military spending would dwarf all other spending programs.
The US under the Trump administration has been punching above its weight. The country no longer walks softly and carries a big stick. If anything it's the other way round. Hence the testing of decades-old alliances, picking fights with adversaries, inciting racism at home, stacking the Supreme Court, sowing division amongst Republicans, all amid allegations that Trump interfered with an investigation into whether Russia helped get him elected, and pressured the Ukrainian leader to investigate Joe Biden – the subject of an impeachment trial at which he was later acquitted.
But as America fights against those who threaten her hegemony and wealth – North Korea, China, Mexico, the EU, Iran, etc. - and tries to borrow and spend its way out of the financial quagmire it finds itself in, through low interest rates and monetary stimulus – others see a country that is no longer operating an economy responsibly enough for its currency to rule the world.
What could bring the US down? We believe the answer lies in a relatively arcane, and under-reported, change to US trade policy.
Currency Rule
The Trump administration is going down a very dangerous road with its new Currency Rule that imbues the US Commerce Department with incredibly strong powers to invoke across-the-board trade protectionism from countries all the way down to individual companies. The way we see it this could be the beginning of an all-encompassing trade war and a truly global round of highly competitive currency devaluations, wherein the winner is the biggest loser.
Some industries, and us at AOTH, believe this aggressively protectionist stance will lead to currency wars and turn the $6 trillion per day global currency market into a new battleground for Trump’s trade wars.
Goods benefiting from weaker currencies then the US dollar, representing each and every one of America’s trading partners, could be recipients of duties or countervailing duties, equal to the difference between the weaker currency and the US dollar - in other words, eliminating that country’s currency advantage.
While China is the obvious target of US tariffs, and rule changes strengthening the Commerce Department’s hand in dealing with currency complaints, there are many other countries, and individual businesses Commerce has in its sights.
Last year the Treasury Department came out with a report that recommended 21 trading partners should face scrutiny over their currencies - they include China, Germany, Japan, South Korea, Ireland, Italy, Malaysia, Vietnam and Singapore.
These trading nations, and even their individual businesses that import goods into the US, are now vulnerable to being tariffed on targeted imports - an amount that will make imports sell for more than their US counterpart.
Minsky Moment
Taken to its logical solution, if the US starts slapping tariffs on all the products its domestic industries can’t compete against, we are looking at the complete collapse of global trade as we know it.
Imagine you want to, hell you need to sell your products to the US because of the enormity of the US market - consumer spending makes up 70% of US GDP! To be a successful international company, you need to be selling into the US.
But your American competitors don’t like how cheaply you’re able to sell your goods in their own backyard. They complain to the Commerce Department and, bang! Your US imports are immediately hit with a 25% tariff. Guess what just happened to your US market?
Any country in the world that manufactures goods that are priced higher than ones made in the US, or any country/ company that manufactures goods the Commerce Department thinks can be made cheaper domestically, can be subjected to punishing duties. Those duties aren’t picked up by the so-called currency manipulators, they are added to the prices paid by US consumers and go directly into US government coffers. And because a lot of goods previously made in America, no longer are because of globalization, American consumers end up paying billions of dollars worth of duties which are effectively an import “tax” on consumers.
Having treated its former trading partners with such disdain, they begin looking elsewhere to replace the increasingly closed-off US market. In-country supply chains spring up. Regional trading blocks with countries friendly enough to not engage in a race-to-the-bottom devaluation battle, start to emerge - including the countries that are part of China’s Belt and Road Initiative.
The problem though is everything is priced in US dollars. Companies don’t have to sell into the US but they do have to buy raw materials which invariably are priced in USD. Soon discussions at higher levels, like the IMF and the WTO, point to alternatives beyond the USD.
The US has been in danger of losing its "exorbitant privilege" as the reserve currency but now, its adversarial trade stance pushes the major powers into adopting a new global currency, possibly backed by gold.
Once this happens the US dollar plunges in value. Hardly anyone can afford to trade with the US because of its radical protectionism.
In this environment of fear and isolationism, the metals that prosper are gold and silver - traditional safe havens that hold their value and can be relied upon as tangible currencies in the event of a fiat money breakdown.
Conclusion
This is gold's true Minsky Moment. Many things can happen to cause instability in the global economy, including a worsening coronavirus, a slowdown in shipping, a denting of the largest economies – the US, China, Germany, Japan – and in the worst of cases, a war (though that would be good for the military-industrial complex) or another global recession.
But these are just reactions, symptoms of the disease…paper money, a global fiat currency system. The uncontrolled printing of paper money has caused consumer debt, business debt and government debt to reach out-of-control proportions and the country in the worst debt shape is the United States which also happens to have the world's reserve currency.
“All the effort and planning imaginable cannot make paper money work. There is no way paper can be "improved" as money. Whenever governments are granted power to purchase their own debt, they never fail to do so, eventually destroying the value of the currency. Political money always fails because free people eventually reject it. For short periods individual countries can tell their citizens to use paper, but only at the sacrifice of personal and economic liberty.”
We know that the US stock market is a bubble and all bubbles pop. It's only a matter of when. We also know that much has been done by the Trump administration to fray existing alliances and to inflame tensions with trading partners-turned-adversaries, namely China, the European Union and even its two NAFTA “amigos”, Canada and Mexico. China, Russia, Turkey and others, are already moving away from pricing trade in US dollars and buying US debt through treasury purchases. Central Banks have been stocking up on gold.
Will the rest of the world follow and punt the US$ as the world’s reserve currency? We at AOTH think so and we await gold's coming Minsky Moment.
Richard (Rick) Mills
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