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Category Archives: Money

Infographic: The Salary You Need to Buy a Home in 50 U.S. Cities

See large image . . . . . .

Source : Visual Capitalist

Welcome to 1984

Jim Rickards wrote . . . . . . . . .

I’ve been addressing the war on cash lately, and for good reason. While everyone’s attention is focused on the war in Ukraine, inflation and the Supreme Court, government plans to eliminate cash are accelerating.

For example, central bank digital currencies (CBDCs) are coming even faster than many anticipated. The digital yuan is already here; it was introduced in China last February during the Winter Olympics.

Visitors to the Olympics were required to pay for meals, hotels, transportation, etc., using QR codes on their mobile phones that linked to digital yuan accounts. Nine other countries have already launched CBDCs. Europe is not far behind and is testing the digital euro under the auspices of the European Central Bank.

The U.S. was lagging, but is catching up fast.

The Federal Reserve was studying a possible Fed CBDC at a research facility at MIT. Now the idea has moved from the research stage to preliminary development.

Fed Chair Jay Powell said, “A U.S. CBDC could… potentially help maintain the dollar’s international standing.”

But this has little to do with technology or monetary policy and everything to do with herding you into digital cattle chutes where you can be slaughtered with account freezes, seizures, etc.

NOT Crypto

First off, CBDCs are not cryptocurrencies. The CBDCs are digital in form, are recorded on a ledger (maintained by a central bank or finance ministry and the message traffic is encrypted. Still, the resemblance to cryptos ends there.

The CBDC ledgers do not use blockchain, and CBDCs definitely do not embrace the decentralized issuance model hailed by the crypto crowd. CBDCs will be highly centralized and tightly controlled by central banks.

The CBDC ledger can be maintained in encrypted form by the central bank itself without the need for bank accounts or money market funds. Payments can be done with an iPhone or other device, with no need for credit cards or costly wire transfers.

Who needs bank accounts, checks, account statements, deposit slips and the other clunky features of a banking relationship when you can go completely digital with the Fed?

CBDCs are a technological advance, but they do not replace existing reserve currencies.

Not a New Currency

It’s important to understand that a CBDC is not a new currency. It’s just a new payment channel. A digital dollar is still a dollar. A digital euro is still a euro. It’s just that the currency never exists in physical form. It is always digital, and ownership is recorded on a ledger maintained by the central bank.

You will have an account showing how many digital dollars you own. They are transferred by an app on a smartphone or a desktop computer.

Of course, in many ways, dollar transactions are already digital. Most people receive money by wire transfer, go shopping with credit cards and pay bills online. All of those transactions are digital and encrypted. The difference with CBDCs is that you don’t need banks or credit card companies or even PayPal.

Again, everything can be done through the Fed with a single account for payment and receipt. CBDCs could disintermediate the entire banking and credit card sectors to a great extent.

Welcome to 1984

The other big difference is that it will give the government control of your money and the ability to put you under constant surveillance. In a world of CBDCs, the government will know every purchase you make, every transaction you conduct and even your physical whereabouts at the point of purchase.

It’s a short step from there to negative interest rates, account freezes, tax withholding from your account and even putting you under FBI investigation if you vote for the wrong candidate or give donations to the wrong political party.

If that sounds like a stretch, it’s not.

China is already using its CBDC to deny travel and educational opportunities to political dissidents. Canada seized the bank accounts and crypto accounts of nonviolent trucker protesters last winter.

These kinds of “social credit scores” and political suppression will be even easier to conduct when CBDCs are completely rolled out.

How does this relate to what is sometimes called the Great Reset? This would be the movement toward a single global reserve currency.

CBDCs and the Great Reset

Displacing the dollar would involve a meeting and agreement similar to the original Bretton Woods agreement of 1944. The agreement could take many forms. Still, the process would conform to what many call the Great Reset.

Still, things don’t happen that quickly in elite circles. Even Bretton Woods took over two years to design and another five years to implement even under the duress of World War II. The transition from sterling to the U.S. dollar as the leading reserve currency took 30 years from 1914 to 1944.

As they say, it’s complicated. Still, there are some huge changes that could emerge from the Great Reset.

For example, a new global currency regime would be an opportunity to devalue all major currencies in order to steal wealth from savers.

All currencies cannot devalue against all other currencies at the same time; that’s a mathematical impossibility. Yet all currencies could devalue simultaneously against gold. This could easily drive gold prices to $5,000 per ounce or much higher to increase the “inflation tax” (I’m sure you agree that you’re paying more than enough already!).

The Surveillance State on Steroids

Another change would be that CBDCs make it much easier to impose negative interest rates, confiscations and account freezes on some or all account holders.

This can be used for simple policy purposes or as a tool of the total surveillance state. Surveillance of incorrect behavior as defined by the Communist Party is the real driver of the digital yuan more than any aspirations to a yuan reserve currency role.

All of these shifts are now underway. The U.S. won’t adopt its own CBDC overnight, but it’s coming sooner or later.

The endgame for CBDCs would closely resemble George Orwell’s dystopian novel Nineteen Eighty-Four. It would be a world of negative interest rates, forced tax collection, government confiscation, account freezes and constant surveillance.

You might not be able to fight back easily in the world of CBDCs, but there is one nondigital, nonhackable, nontraceable form of money you can still use.

It’s called gold.


Source : Daily Reckoning

US$5 Gas in the U.S.: AAA Says Nationwide Average Hits New High

David Koenig and Julie Walker wrote . . . . . . . . .

The nationwide average price for a gallon of gasoline has hit $5 for the first time ever.

Auto club AAA said the average price on Saturday was a fraction of a penny over $5.00. Motorists in some parts of the country, especially California, are paying far above that.

The national average price has jumped 19 cents in just the past week, and it is up $1.93 from this time last year.

The high cost is taking a toll on people who need their vehicles to earn a living.

It was bad enough for cab driver Joseph Pierre when it cost $25 to fill his tank. Now he shells out $40 or $45.

“I’m losing money because some passengers I pick up, they don’t care about that, they don’t tip you,” Pierre said Saturday as he pumped gas at a BP station in Brooklyn.

Katisha Thompson, who paid $79 for 13 gallons of premium at the same station, said the price is “becoming overbearing.”

“It’s a lot, especially when you are trying to feed a family,” she said. “And it’s not just gas. It’s groceries, everything is going up.”

Americans are still burning less gasoline than they did before the pandemic, with many people still working from home instead of commuting. But there are early signs that higher prices might be affecting drivers’ habits, too.

The amount of fuel consumed last week was down 3% from the previous week and 6% from this time last year, according to preliminary figures from the Oil Price Information Service.

There are several reasons for the surge in gasoline prices.

Americans typically drive more starting around Memorial Day, so demand is up. Global oil prices are rising, compounded by sanctions against Russia, a leading oil producer, because of its war against Ukraine. And there are limits on refining capacity in the United States because some refineries shut down during the pandemic.

Add it all up, and the cost of filling up is draining money from Americans who are facing the highest rate of inflation in 40 years.

California has the highest average price, at $6.43, according to AAA. The lowest average is Mississippi, at $4.52.

While this is the first time breaking the $5 barrier, it’s still not a record when inflation is taken into account. Gas peaked at $4.11 a gallon in July 2008, which would be equal to about $5.40 a gallon today.


Source : AP

Average Cost of Filling Up Car in UK Hits Record 100 Pounds

Sylvia Hui wrote . . . . . . . . .

The average cost of filling up a typical family car has exceeded 100 pounds (US$125) for the first time in Britain, as Russia’s war in Ukraine drives gasoline prices higher.

Figures from data firm Experian Catalist showed that the average price of a liter of gas at U.K. pumps hit a record 182.3 pence ($2.3) on Wednesday, taking the average cost of filling a 55-liter (14.5-U.S. gallon) family car to 100.27 pounds. The prices are the equivalent of about $8.8 per gallon.

Motoring association AA said the price hikes have been a “huge shock” for drivers and urged the government to intervene.

“Enough is enough. The government must act urgently to reduce the record fuel prices which are crippling the lives of those on lower incomes, rural areas and businesses,” AA President Edmund King said.

“The 100-pound tank is not sustainable with the general cost-of-living crisis, so the underlying issues need to be addressed urgently,” King said.

Russia’s invasion of Ukraine led to concern about oil and gas supplies and worsened soaring energy prices, trickling down to customers filling up at the pump. High gasoline prices have hit people across Europe and in the United States, prompting governments to pass measures to try to ease the pain.

The British government in March announced a fuel tax cut of 5 pence per liter to help drivers after record jumps in pump prices.

Many motorists argue the tax cut reduced the cost of filling up a car by only a tiny amount. There are also growing concerns that fuel retailers are not passing on the tax cut to customers.

Prime Minister Boris Johnson’s government is facing heavy pressure to do more to help Britons struggling with fuel and food prices and domestic energy bills amid a severe cost-of-living crisis.

Johnson’s spokesman said Wednesday that soaring fuel prices were “hugely concerning,” and the government wants to make sure companies are passing the tax cut on to consumers.

“It is important the public understand what actions each of the fuel retailers are taking, and so we are considering what further options we can take in this area,” he said.


Source : AP

Chart: The Countries Committing the Most of Their GDP to Ukraine Aid

Source : Statista

The Failure of Fiat Currencies and the Implications for Gold and Silver

Alasdair Macleod wrote . . . . . . . . .

What is money?

To understand why all fiat currency systems fail, we must start by understanding what money is, and how it differs from other forms of currency and credit. These are long-standing relationships which transcend our times and have their origin in Roman law and the practice of medieval merchants who evolved a lex mercatoria, which extended money’s legal status to instruments that evolved out of money, such as bills of exchange, cheques, and other securities for money. And while as circulating media, historically currencies have been almost indistinguishable from money proper, in the last century issuers of currencies split them off from money so that they have become pure fiat.

At the end of the day, what constitutes money has always been determined by its users as the means of exchanging their production for consumption in an economy based on the division of labour. Money is the bridge between the two, and while over the millennia different media of exchange have come and gone, only metallic money has survived to be trusted. These are principally gold, silver, and copper. Today the term usually refers to gold, which is still in government reserves, as the only asset with no counterparty risk. Silver, which as a monetary asset declined in importance as money after Germany moved to a gold standard following the Franco-Prussian war, remains a monetary metal, though with a gold to silver ratio currently over 70 times, it is not priced as such.

For historical reasons, the world’s monetary system evolved based on English law. Britain, or more accurately England and Wales, still respects Roman, or natural law with respect to money. To this day, gold sovereign coins are legal tender. Strictly speaking, metallic gold and silver are themselves credit, representing yet-to-be-spent production. But uniquely, they are no one’s liability, unlike banknotes and bank deposits. Metallic money therefore has this exceptional status, and that fact alone means that it tends not to circulate, in accordance with Gresham’s Law, so long as lesser forms of credit are available.

Money shares with its currency and credit substitutes a unique position in criminal law. If a thief steals money, he can be apprehended and charged with theft along with any accomplices. But if he passes the money on to another party who receives it in good faith and is not aware that it is stolen, the original owner has no recourse against the innocent receiver, or against anyone else who subsequently comes into possession of the money. It is quite unlike any other form of property, which despite passing into innocent hands, remains the property of the original owner.

In law, cryptocurrencies and the mooted central bank digital currencies are not money, money-substitutes, or currencies. Given that a previous owner of stolen bitcoin sold on to a buyer unaware it was criminally obtained can subsequently claim it, there is no clear title without full provenance. In accordance with property law, the United States has ruled that cryptocurrencies are property, reclaimable as stolen items, differentiating cryptocurrencies from money and currency proper. And we can expect similar rulings in other jurisdictions to exclude cryptocurrencies from the legal status as money, whereas the position of CBDCs in this regard has yet to be clarified. We can therefore nail to the floor any claims that bitcoin or any other cryptocurrency can possibly have the legal status required of money.

Under a proper gold standard, currency in the form of banknotes in public circulation was freely exchangeable for gold coin. So long as they were freely exchangeable, banknotes took on the exchange value of gold, allowing for the credit standing of the issuer. One of the issues Sir Isaac Newton considered as Master of the Royal Mint was to what degree of backing a currency required to retain credibility as a gold substitute. He concluded that that level should be 40%, though Ludwig von Mises, the Austrian economist who was as sound a sound money economist as it was possible to be appeared to be less prescriptive on the subject.

The effect of a working gold standard is to ensure that money of the people’s choice is properly represented in the monetary system. Both currency and credit become bound to its virtues. The general level of prices will fluctuate influenced by changes in the quantity of currency and credit in circulation, but the discipline of the limits of credit and currency creation brings prices back to a norm.

This discipline is disliked by governments who believe that money is the responsibility of a government acting in the interests of the people, and not of the people themselves. This was expressed in Georg Knapp’s State Theory of Money, published in 1905 and became Germany’s justification for paying for armaments by inflationary means ahead of the First World War, and continuing to use currency debasement as the principal means of government finance until the paper mark collapsed in 1923.

Through an evolutionary process, modern governments first eroded then took away from the public for itself the determination of what constitutes money. The removal of all discipline of the gold standard has allowed governments to inflate the quantities of currency and credit as a means of transferring the public wealth to itself. As a broad representation of this dilution, Figure 1 shows the growth of broad dollar currency since the last vestige of a gold standard under the Bretton Woods Agreement was suspended by President Nixon in August 1971.

From that date, currency and bank credit have increased from $685 billion to $21.84 trillion, that is thirty-two times. And this excludes an unknown increase in the quantity of dollars not in the US financial system, commonly referred to as Eurodollars, which perhaps account for several trillion more. Gold priced in fiat dollars has risen from $35 when Bretton Woods was suspended, to $1970 currently. A better way of expressing this debasement of the dollar is to say that priced in gold, the dollar has lost 98.3% of its purchasing power (see Figure 4 later in this article).

While it is a mistake to think of the relationship between the quantity of currency and credit in circulation and the purchasing power of the dollar as linear (as monetarists claim), not only has the rate of debasement accelerated in recent years, but it has become impossible for the destruction of purchasing power to be stopped. That would require governments reneging on mandated welfare commitments and for them to stand back from economic intervention. It would require them to accept that the economy is not the government’s business, but that of those who produce goods and services for the benefit of others. The state’s economic role would have to be minimised.

This is not just a capitalistic plea. It has been confirmed as true countless times through history. Capitalistic nations always do better at creating personal wealth than socialistic ones. This is why the Berlin Wall was demolished by angry crowds, finally driven to do so by the failure of communism relative to capitalism just a stone’s throw away. The relative performance of Hong Kong compared with China when Mao Zedong was starving his masses on some sort of revolutionary whim, also showed how the same ethnicity performed under socialism compared with free markets.

The relationship between fiat currency and its purchasing power

One can see from the increase in the quantity of US dollar M3 currency and credit and the fall in the purchasing power measured against gold that the government’s monetary statistic does not square with the market. Part of the reason is that government statistics do not capture all the credit in an economy (only bank credit issued by licenced banks is recorded), dollars created outside the system such as Eurodollars are additional, and market prices fluctuate.

Monetarists make little or no allowance for these factors, claiming that the purchasing power of a currency is inversely proportional to its quantity. While there is much truth in this statement, it is only suited for a proper gold-backed currency, when one community’s relative valuations between currency and goods are brought into line with the those of its neighbours through arbitrage, neutralising any subjectivity of valuation.

The classical representation of the monetary theory of prices does not apply in conditions whereby faith in an unbacked currency is paramount in deciding its utility. A population which loses faith in its government’s currency can reject it entirely despite changes in its circulating quantity. This is what wipes out all fiat currencies eventually, ensuring that if a currency is to survive it must eventually return to a credible gold exchange standard.

The weakness of a fiat currency was famously demonstrated in Europe in the 1920s when the Austrian crown and German paper mark were destroyed. Following the Second World War, the Japanese military yen suffered the same fate in Hong Kong, and Germany’s mark for a second time in the mid 1940s. More recently, the Zimbabwean dollar and Venezuelan bolivar have sunk to their value as wastepaper — and they are not the only ones.

Ultimately it is the public which always determines the use value of a circulating medium. Figure 2 below, of the oil price measured in goldgrams, dollars, pounds, and euros shows that between 1950 and 1974 a gold standard even in the incomplete form that existed under the Bretton Woods Agreement coincided with price stability.

It took just a few years from the ending of Bretton Woods for the consequences of the loss of a gold anchor to materialise. Until then, oil suppliers, principally Saudi Arabia and other OPEC members, had faith in the dollar and other currencies. It was only when they realised the implications of being paid in pure fiat that they insisted on compensation for currency debasement. That they were free to raise oil prices was the condition upon which the Saudis and the rest of OPEC accepted payment solely in US dollars.

In the post-war years between 1950 and 1970, US broad money grew by 167%, yet the dollar price of oil was unchanged for all that time. Similar price stability was shown in other commodities, clearly demonstrating that the quantity of currency and credit in circulation was not the sole determinant of the dollar’s purchasing power.

The role of bank credit

While the relationship between bank credit and the sum of the quantity of currency and bank reserves varies, the larger quantity by far is the quantity of bank credit. The behaviour of the banking cohort therefore has the largest impact on the overall quantity of credit in the economy.

Under the British gold standard of the nineteenth century, the fluctuations in the willingness of banks to lend resulted in periodic booms and slumps, so it is worthwhile examining this phenomenon, which has become the excuse for state intervention in financial markets and ultimately the abandonment of gold standards entirely.

Banks are dealers in credit, lending at a higher rate of interest than they pay to depositors. They do not deploy their own money, except in a general balance sheet sense. A bank’s own capital is the basis upon which a bank can expand its credit.

The process of credit creation is widely misunderstood but is essentially simple. If a bank agrees to lend money to a borrowing customer, the loan appears as an asset on the bank’s balance sheet. Through the process of double entry bookkeeping, this loan must immediately have a balancing entry, crediting the borrower’s current account. The customer is informed that the loan is agreed, and he can draw down the funds credited to his current account from that moment.

No other bank, nor any other source of funding is involved. With merely two ledger entries the bank’s balance sheet has expanded by the amount of the loan. For a banker, the ability to create bank credit in this way is, so long as the lending is prudent, an extremely profitable business. The amount of credit outstanding can be many multiples of the bank’s own capital. So, if a bank’s ratio of balance sheet assets to equity is eight times, and the gross margin between lending and deposits is 3%, then that becomes a gross return of 24% on the bank’s own equity.

The restriction on a bank’s balance sheet leverage comes from two considerations. There is lending risk itself, which will vary with economic conditions, and depositor risk, which is the depositors’ collective faith in the bank’s financial condition. Depositor risk, which can lead to depositors withdrawing their credit in the bank in favour of currency or a deposit with another bank, can in turn originate from a bank offering an interest rate below that of other banks, or alternatively depositors concerned about the soundness of the bank itself. It is the combination of lending and depositor risk that determines a banker’s view on the maximum level of profits that can be safely earned by dealing in credit.

An expansion in the quantity of credit in an economy stimulates economic activity because businesses are tricked into thinking that the extra money available is due to improved trading conditions. Furthermore, the apparent improvement in trading conditions encourages bankers to increase lending even further. A virtuous cycle of lending and apparent economic improvement gets under way as the banking cohort takes its average balance sheet assets to equity ratio from, say, five to eight times, to perhaps ten or twelve. Competition for credit business then persuades banks to cut their margins to attract new business customers. Customers end up borrowing for borrowing’s sake, initiating investment projects which would not normally be profitable.

Even under a gold standard lending exuberance begins to drive up prices. Businesses find that their costs begin to rise, eating into their profits. Keeping a close eye on lending risk, bankers are acutely aware of deteriorating profit prospects for their borrowers and therefore of an increasing lending risk. They then try to reduce their asset to equity ratios. As a cohort whose members are driven by the same considerations, banks begin to withdraw credit from the economy, reversing the earlier stimulus and the economy enters a slump.

This is a simplistic description of a regular cycle of fluctuating bank credit, which historically varied approximately every ten years or so, but could fluctuate between seven and twelve. Figure 3 illustrates how these fluctuations were reflected in the inflation rate in nineteenth century Britain following the introduction of the sovereign gold coin until just before the First World War.

Besides illustrating the regularity of the consequences of a cycle of bank credit expansion and contraction marked by the inflationary consequences, Figure 3 shows there is no correlation between the rate of price inflation and wholesale borrowing costs. In other words, modern central bank monetary policies which use interest rates to control inflation are misconstrued. The effect was known and named Gibson’s paradox by Keynes. But because there was no explanation for it in Keynesian economics, it has been ignored ever since. Believing that Gibson’s paradox could be ignored is central to central bank policies aimed at taming the cycle of price inflation.

The interests of central banks

Notionally, central banks’ primary interest is to intervene in the economy to promote maximum employment consistent with moderate price inflation, targeted at 2% measured by the consumer price index. It is a policy aimed at stimulating the economy but not overstimulating it. We shall return to the fallacies involved in a moment.

In the second half of the nineteenth century, central bank intervention started with the Bank of England assuming for itself the role of lender of last resort in the interests of ensuring economically destabilising bank crises were prevented. Intervention in the form of buying commercial bank credit stopped there, with no further interest rate manipulation or economic intervention.

The last true slump in America was in 1920-21. As it had always done in the past the government ignored it in the sense that no intervention or economic stimulus were provided, and the recovery was rapid. It was following that slump that the problems started in the form of a new federal banking system led by Benjamin Strong who firmly believed in monetary stimulation. The Roaring Twenties followed on a sea of expanding credit, which led to a stock market boom — a financial bubble. But it was little more than an exaggerated cycle of bank credit expansion, which when it ended collapsed Wall Street with stock prices falling 89% measured by the Dow Jones Industrial Index. Coupled with the boom in agricultural production exaggerated by mechanisation, the depression that followed was particularly hard on the large agricultural sector, undermining agriculture prices worldwide until the Second World War.

It is a fact ignored by inflationists that first President Herbert Hoover, and then Franklin Roosevelt extended the depression to the longest on record by trying to stop it. They supported prices, which meant products went unsold. And at the very beginning, by enacting the Smoot Hawley Tariff Act they collapsed not only domestic demand but all domestic production that relied on imported raw materials and semi-manufactured products.

These disastrous policies were supported by a new breed of economist epitomised by Keynes, who believed that capitalism was flawed and required government intervention. But proto-Keynesian attempts to stimulate the American economy out of the depression continually failed. As late as 1940, eleven years after the Wall Street Crash, US unemployment was still as high as 15%. What the economists in the Keynesian camp ignored was the true cause of the Wall Street crash and the subsequent depression, rooted in the credit inflation which drove the Roaring Twenties. As we saw in Figure 3, it was no more than the turning of the long-established repeating cycle of bank credit, this time fuelled additionally by Benjamin Strong’s inflationary credit expansion as Chairman of the new Fed. The cause of the depression was not private enterprise, but government intervention.

It is still misread by the establishment to this day, with universities pushing Keynesianism to the exclusion of classic economics and common sense. Additionally, the statistics which have become a religion for policymakers and everyone else are corrupted by state interests. Soon after wages and pensions were indexed in 1980, government statisticians at the Bureau of Labor Statistics began working on how to reduce the impact on consumer prices. An independent estimate of US consumer inflation put it at well over 15% recently, when the official rate was 8%.[i]

Particularly egregious is the state’s insistence that a target of 2% inflation for consumer prices stimulates demand, when the transfer of wealth suffered by savers, the low paid and pensioners deprived of their inflation compensation at the hands of the BLS is glossed over. So is the benefit to the government, the banks, and their favoured borrowers from this wealth transfer.

The problem we now face in this fiat money environment is not only that monetary policy has become corrupted by the state’s self-interest, but that no one in charge of it appears to understand money and credit. Technically, they may be very well qualified. But it is now over fifty years since money was suspended from the monetary system. Not only have policymakers ignored indicators such as Gibson’s paradox. Not only do they believe their own statistics. And not only do they think that debasing the currency is a good thing, but we find that monetary policy committees would have us believe that money has nothing to do with rising prices.

All this is facilitated by presenting inflation as rising prices, when in fact it is declining purchasing power. Figure 4 shows how purchasing power of currencies should be read.

Only now, it seems, we are aware that inflation of prices is not transient. Referring to Figure 1, the M3 broad money supply measure has almost tripled since Lehman failed, so there’s plenty of fuel driving a lower purchasing power for the dollar yet. And as discussed above, it is not just quantities of currency and credit we should be watching, but changes in consumer behaviour and whether consumers tend to dispose of currency liquidity in favour of goods.

The indications are that this is likely to happen, accelerated by sanctions against Russia, and the threat that they will bring in a new currency era, undermining the dollar’s global status. Alerted to higher prices in the coming months, there is no doubt that there is an increased level of consumer stockpiling, which put another way is the disposal of personal liquidity before it buys less.

So far, the phases of currency evolution have been marked by the end of the Bretton Woods Agreement in 1971. The start of the petrodollar era in 1973 led to a second phase, the financialisation of the global economy. And finally, from now the return to a commodity standard brought about by sanctions against Russia is driving prices in the Western alliance’s currencies higher, which means their purchasing power is falling anew.

The faux pas over Russia

With respect to the evolution of money and credit, this brings us up to date with current events. Before Russia invaded Ukraine and the Western alliance imposed sanctions on Russia, we were already seeing prices soaring, fuelled by the expansion of currency and credit in recent years. Monetary planners blamed supply chain problems and covid dislocations, both of which they believed would right themselves over time. But the extent of these price rises had already exceeded their expectations, and the sanctions against Russia have made the situation even worse.

While America might feel some comfort that the security of its energy supplies is unaffected, that is not the case for Europe. In recent years Europe has been closing its fossil fuel production and Germany’s zeal to go green has even extended to decommissioning nuclear plants. It seems that going fossil-free is only within national borders, increasing reliance on imported oil, gas, and coal. In Europe’s case, the largest source of these imports by far is Russia.

Russia has responded by the Russian central bank announcing that it is prepared to buy gold from domestic credit institutions, first at a fixed price or 5,000 roubles per gramme, and then when the rouble unexpectedly strengthened at a price to be agreed on a case-by-case basis. The signal is clear: the Russian central bank understands that gold plays an important role in price stability. At the same time, the Kremlin announced that it would only sell oil and gas to unfriendly nations (i.e. those imposing sanctions) in return for payments in roubles.

The latter announcement was targeted primarily at EU nations and amounts to an offer at reasonable prices in roubles, or for them to bid up for supplies in euros or dollars from elsewhere. While the price of oil shot up and has since retreated by a third, natural gas prices are still close to their all-time highs. Despite the northern hemisphere emerging from spring the cost of energy seems set to continue to rise. The effect on the Eurozone economies is little short of catastrophic.

While the rouble has now recovered all the fall following the sanctions announcement, the euro is becoming a disaster. The ECB still has a negative deposit rate and enormous losses on its extensive bond portfolio from rapidly rising yields. The national central banks, which are its shareholders also have losses which in nearly all cases wipes out their equity (balance sheet equity being defined as the difference between a bank’s assets and its liabilities — a difference which should always be positive). Furthermore, these central banks as the NCB’s shareholders make a recapitalisation of the whole euro system a complex event, likely to question faith in the euro system.

As if that was not enough, the large commercial banks are extremely highly leveraged, averaging over 20 times with Credit Agricole about 30 times. The whole system is riddled with bad and doubtful debts, many of which are concealed within the TARGET2 cross-border settlement system. We cannot believe any banking statistics. Unlike the US, Eurozone banks have used the repo markets as a source of zero cost liquidity, driving the market size to over €10 trillion. The sheer size of this market, plus the reliance on bond investment for a significant proportion of commercial bank assets means that an increase in interest rates into positive territory risks destabilising the whole system.

The ECB is sitting on interest rates to stop them rising and stands ready to buy yet more members’ government bonds to stop yields rising even more. But even Germany, which is the most conservative of the member states, faces enormous price pressures, with producer prices of industrial products officially increasing by 25.9% in the year to March, 68% for energy, and 21% for intermediate goods.

There can be no doubt that markets will apply increasing pressure for substantial rises in Eurozone bond yields, made significantly worse by US sanctions policies against Russia. As an importer of commodities and raw materials Japan is similarly afflicted. Both currencies are illustrated in Figure 5.

The yen appears to be in the most immediate danger with its collapse accelerating in recent weeks, but as both the Bank of Japan and the ECB continue to resist rising bond yields, their currencies will suffer even more. The Bank of Japan has been indulging in quantitative easing since 2000 and has accumulated substantial quantities of government and corporate bonds and even equities in ETFs. Already, the BOJ is in negative equity due to falling bond prices. To prevent its balance sheet from deteriorating even further, it has drawn a line in the sand: the yield on the 10-year JGB will not be permitted to rise above 0.25%. With commodity and energy prices soaring, it appears to be only a matter of time before the BOJ is forced to give way, triggering a banking crisis in its highly leveraged commercial banking sector which like the Eurozone has asset to equity ratios exceeding 20 times.

It would appear therefore that the emerging order of events with respect to currency crises is the yen collapses followed in short order by the euro. The shock to the US banking system must be obvious. That the US banks are considerably less geared than their Japanese and euro system counterparts will not save them from global systemic risk contamination.

Furthermore, with its large holdings of US Treasuries and agency debt, current plans to run them off simply exposes the Fed to losses, which will almost certainly require its recapitalisation. The yield on the US 10-year Treasury Bond is soaring and given the consequences of sanctions on global commodity prices, it has much further to go.

The end of the financial regime for currencies

From London’s big bang in the mid-eighties, the major currencies, particularly the US dollar and sterling became increasingly financialised. It occurred at a time when production of consumer goods migrated to Asia, particularly China. The entire focus of bank lending and loan collateral moved towards financial assets and away from production. And as interest rates declined, in general terms these assets improved in value, offering greater security to lenders, and reinforcing the trend.

This is now changing, with interest rates set to rise significantly, bursting a financial bubble which has been inflating for decades. While bond yields have started to rise, there is further for them to go, undermining not just the collateral position, but government finances as well. And further rises in bond yields will turn equity markets into bear markets, potentially rivalling the 1929-1932 performance of the Dow Jones Industrial Index.

That being the case, the collapse already underway in the yen and the euro will begin to undermine the dollar, not on the foreign exchanges, but in terms of its purchasing power. We can be reasonably certain that the Fed’s mandate will give preference to supporting asset prices over stabilising the currency, until it is too late.

China and Russia appear to be deliberately isolating themselves from this fate for their own currencies by increasing the importance of commodities. It was noticeable how China began to aggressively accumulate commodities, including grain stocks, almost immediately after the Fed cut its funds rate to zero and instituted QE at $120 billion per month in March 2020. This sent a signal that the Chinese leadership were and still are fully aware of the inflationary implications of US monetary policy. Today China has stockpiled well over half the world’s maize, rice, wheat and soybean stocks, securing basics foodstuffs for 20% of the world’s population. As a subsequent development, the war in Ukraine has ensured that global grain supplies this year will be short, and sanctions against Russia have effectively cut off her exports from the unfriendly nations. Together with fertiliser shortages for the same reasons, not only will the world’s crop yields fall below last year’s, but grain prices are sure to be bid up against the poorer nations.

Russia has effectively tied the rouble to energy prices by insisting roubles are used for payment, principally by the EU. Russia’s other two large markets are China and India, from which she is accepting yuan and rupees respectively. Putting sales to India to one side, Russia is not only commoditising the rouble, but her largest trading partner not just for energy but for all her other commodity exports is China. And China is following similar monetary policies.

There are good reasons for it. The Western alliance is undermining their own currencies, of that there can be no question. Financial asset values will collapse as interest rates rise. Contrastingly, not only is Russia’s trade surplus increasing, but the central bank has begun to ease interest rates and exchange controls and will continue to liberate her economy against a background of a strong currency. The era of the commodity backed currency is arriving to replace the financialised.

And lastly, we should refer to Figure 2, of the price of oil in goldgrams. The link to commodity prices is gold. It is time to abandon financial assets for their supposed investment returns and take a stake in the new commoditised currencies. Gold is the link. Business of all sorts, not just mining enterprises which accumulate cash surpluses, would be well advised to question whether they should retain deposits in the banks, or alternatively, gain the protection of possessing some gold bullion vaulted independently from the banking system.


Source : Gold Money

Explainer: U.S. Yield Curve Inversion – What Is It Telling Us?

David Randall, Davide Barbuscia and Saqib Iqbal Ahmed wrote . . . . . . . . .

The U.S. Treasury yield curve inverted on Tuesday for the first time since 2019, as investors priced in an aggressive rate-hiking plan by the Federal Reserve as it attempts to bring inflation down from 40-year highs.

Here is a quick primer explaining what a steep, flat or inverted yield curve means and how it has in the past predicted recession, and what it might be signaling now.

WHAT SHOULD THE CURVE LOOK LIKE?

The U.S. Treasury finances federal government budget obligations by issuing various forms of debt. The $23 trillion Treasury market includes Treasury bills with maturities from one month out to one year, notes from two years to 10 years, as well as 20- and 30-year bonds.

The yield curve plots the yield of all Treasury securities.

Typically, the curve slopes upwards because investors expect more compensation for taking on the risk that rising inflation will lower the expected return from owning longer-dated bonds. That means a 10-year note typically yields more than a two-year note because it has a longer duration. Yields move inversely to prices.

A steepening curve typically signals expectations of stronger economic activity, higher inflation, and higher interest rates. A flattening curve can mean the opposite: investors expect rate hikes in the near term and have lost confidence in the economy’s growth outlook.

WHAT DOES AN INVERTED CURVE MEAN?

Investors watch parts of the yield curve as recession indicators, primarily the spread between the yield on three-month Treasury bills and 10-year notes and the U.S. two-year to 10-year (2/10) curve .

On Tuesday, the 2/10 part of the curve inverted, meaning yields on the 2-year Treasury were actually higher than the 10-year Treasury. That is a warning light to investors that a recession could follow.

The U.S. curve has inverted before each recession since 1955, with a recession following between six and 24 months, according to a 2018 report by researchers at the Federal Reserve Bank of San Francisco. It offered a false signal just once in that time.

According to Anu Gaggar, Global Investment Strategist for Commonwealth Financial Network, who looked at the 2/10 part of the curve, there have been 28 instances since 1900 where the yield curve has inverted; in 22 of these episodes, a recession has followed. The lag between curve inversion and the start of a recession has averaged about 22 months but has ranged from 6 to 36 months for the last six recessions, she wrote.

The last time the 2/10 part of the yield curve inverted was in 2019. The following year, the United States entered a recession – albeit one caused by the global pandemic.

WHY IS THE YIELD CURVE INVERTING NOW?

Yields of short-term U.S. government debt have been rising quickly this year, reflecting expectations of a series of rate hikes by the U.S. Federal Reserve, while longer-dated government bond yields have moved at a slower pace amid concerns policy tightening may hurt the economy.

As a result, the shape of the Treasury yield curve has been generally flattening and in some cases inverting.

Other parts of the yield curve have also inverted, including the spread between five- and 30-year U.S. Treasury yields , which this week moved below zero for the first time since February 2006, according to Refinitiv data.

ARE WE GETTING MIXED SIGNALS?

Still, another closely monitored part of the curve has been giving off a different signal: The spread between the yield on three-month Treasury bills and 10-year notes this month has been widening , causing some to doubt a recession is imminent.

Meanwhile, the two-year/10-year yield curve has technical issues, and not everyone is convinced the flattening curve is telling the true story. They say the Fed’s bond buying program of the last two years has resulted in an undervalued U.S. 10-year yield that will rise when the central bank starts shrinking its balance sheet, steepening the curve. read more

Researchers at the Fed, meanwhile, put out a paper on March 25 that suggested the predictive power of the spreads between 2 and 10-year Treasuries to signal a coming recession is “probably spurious,” and suggested a better herald of a coming economic slowdown is the spread of Treasuries with maturities of less than 2 years.

WHAT DOES THIS MEAN FOR THE REAL WORLD?

While rate increases can be a weapon against inflation, they can also slow economic growth by increasing the cost of borrowing for everything from mortgages to car loans.

Aside from signals it may flash on the economy, the shape of the yield curve has ramifications for consumers and business.

When short-term rates increase, U.S. banks tend to raise their benchmark rates for a wide range of consumer and commercial loans, including small business loans and credit cards, making borrowing more expensive for consumers. Mortgage rates also rise.

When the yield curve steepens, banks are able to borrow money at lower interest rates and lend at higher interest rates. Conversely, when the curve is flatter they find their margins squeezed, which may deter lending.


Source : Reuters

Opinion: The End of Fiat Hoving into View . . . . .

Alasdair Macleod wrote . . . . . . . . .

Tragic though the situation in Ukraine has become, the real war which started out as financial in character some time ago has now become both financial and about commodities. Putin made a huge mistake invading Ukraine but the West’s reaction by seeking to isolate Russia and its commodity exports from the global marketplace is an even greater one.

Furthermore, with Ukraine being Europe’s breadbasket and a major exporter of fertiliser, this summer will bring acute food shortages, worsened by China having already accumulated the bulk of the world’s grains for its own population. Inflation measured by consumer prices has only just commenced an accelerated rise.

Because they discount falling purchasing power for currencies, rising interest rates, and collapsing bond prices are now inevitable. Being loaded up with bonds and financial assets as collateral, the consequences for the global banking system are so significant that it is virtually impossible to see how it can survive. And if the banking system faces collapse, being unbacked by anything other than rapidly disappearing faith in them fiat currencies will fail as well.

Unforeseen financial and economic consequences

Back in the 1960s, Harold Wilson as an embattled British Prime Minister declared that a week is a long time in politics. Today, we can also comment it is a long time in commodity markets, stock markets, geopolitics, and almost anything else we care to think of. The rapidity of change may not be captured in just seven calendar days, but in recent weeks we have seen the initial pricking of the fiat currency bubble and all that floats with it.

This is turning out to be an extreme financial event. The background to it is unwinding of economic distortions. Through a combination of currency and credit expansion and market suppression, the difference between state-controlled pricing and market reality has never been greater. Zero and negative interest rates, deeply negative real bond yields, and a deliberate policy of artificial wealth creation by fostering a financial asset bubble to divert attention from a deepening economic crisis in recent years have all contributed to the gap between bullish expectations and market reality.

Today, almost no one thinks that our blessèd central banks and their governments can fail, let alone lose control over markets. And if you walk like a Keynesian, talk like a Keynesian you are a Keynesian. Everyone does — even the gait of mathematical monetarists is indistinguishable from them in their support of inflationism. And Keynesians believe in the state theory of everything, despising markets and now fearing their reality.

This week sees growing concerns that American-led attempts to kick Putin’s ass comes with consequences. Put to one side the destruction wreaked on the Ukrainian people as the two major military nations wage yet another proxy war. This one is in Europe’s breadbasket, driving wheat prices over 50% higher so far this year. Having laid waste over successive Arab nations since Saddam Hussein invaded Kuwait in 1990, the people who have survived American-led wars in the Middle East and North Africa and not emigrated as refugees are now going to face starvation.

Fuelled by the expansion of currency and credit, it is not just wheat prices which are soaring. Other foodstuffs are as well. And we learn through various sources that the Chinese have been prescient enough to stockpile enormous quantities of grains and other comestible materials to protect their citizens from a summer food crisis. Twenty per cent of the world’s population has secured more than half the globe’s maize and other grains (Nikkei Asia, 23 December – see Figure 1). And that was two months before Putin ordered the invasion of Ukraine, which has made the position over global food supplies even worse. And China’s dominant position in maize will hit sub-Saharan Africa especially hard, while global shortages of rice will hit Southern and East Asian nations.

All we need now is crop failures. Speaking of which, fertiliser shortages, exacerbated by the Ukraine war and high gas prices, are bound to affect global food production adversely for this year’s harvest. And well done to our elected Leaders for imposing sanctions on Russian exports of fertiliser, which added to China’s conservation of its supplies will ensure our poor, and everyone else’s poor, face soaring food prices and even starvation in 2022.

Yet, few seem aware of this developing crisis. While Ukraine is an obvious factor driving up food and energy prices, the root cause has been and will continue to be monetary policies driving the leading currencies. History is littered with examples of currency debasement leading to a food crisis and civil unrest: the Emperor Diocletian’s edict controlling prices in 301AD; coin debasement leading to soaring food prices in 1124AD at the time of England’s Henry I; the collapse of John Law’s livre in 1720 France, to name but a few.

From the dollar as the reserve currency, to euros, yen, pounds, and the rest, all of them have been debased in what used to be called the civilised world. And an understanding of money and the empirical evidence both point to a consequential food crisis this summer.

How will we pay for the higher prices? Well, no one need go without, because it will be a Keynesian designated slump. And the authorities will be onto it. Your central bank will simply issue more currency and you might even get some helicoptered to you. Price controls will prove irresistible to our leaders, and just as Diocletian penalised butchers and bakers who raised their prices under pain of death, today’s providers of life’s essentials will be accused of profiteering and taxed accordingly.

And how do we ensure our lifestyles will be not undermined? We can borrow more to pay for cars and holidays. And how do we ensure we preserve our wealth? Your central bank will suppress interest rates to keep stock markets bubbling.

It is, in essence, a trick played on us all by using fiat currency masquerading as traditional money. The risk is that the investing public, and then the public on Main Street, will twig it. First the financial asset bubble pops and then we will be unable to feed ourselves. Those who vaguely see the danger by projecting known factors think that decline is a gradual process. The mistake they make is a human element, which results in unforeseen consequences in the form of a sudden financial and economic crisis.

This article is about the approaching financial and banking crises, which we can now say will likely overwhelm us sooner rather than later. We start with a reality check on the current state of the commodity, financial and economic war. That is raging now, and it will almost certainly destabilise the current world order. And the consequences for interest rates will require the entire global financial system to be recapitalised, starting with the central banks.

The developing commodity and financial crisis

If Putin had stuck to his original objective of driving a wedge between Europe and America, he would have been able to push up natural gas prices in Western Europe without resorting to any other economic weapons. Events have dictated otherwise. And now America in kick-ass mode has united its NATO European members to drive up energy prices beyond Europe and food prices globally by proscribing all financial payments with Russia. The wider economic concern is that soaring commodity, energy, and food prices will lead to a worldwide slump.

Driven by an initial flight by investment funds away from risk towards safety, bond yields were initially driven lower from recent highs. Figure 2 shows how bond yields for the 10-year bonds in America, Germany, and Japan had declined from recent peaks earlier this week.

Though yields have risen slightly since, these declines were something of a lifeline for the Fed, ECB, and BOJ, and it would be convenient for them if they were to stabilise at current levels. It fits their preferred narrative, which is that inflation, by which they mean rising consumer prices, is fuelled by temporary factors which will diminish in time. And when Putin is forced to give up his aggression against Ukraine, prices will normalise.

Western policy planners see signs that their economies are being undermined by these developments and expect the outlook will change from inflation to recession. Therefore, central bankers and economists are beginning to think that to raise interest rates would prove to be an error of policy which could drive a mild recession into a possible slump.

Currencies are also affected by the flight to safety. The conventional view is that the safest currency is the dollar, and that has rallied sharply, as shown in Figure 3.

But it should be noted that foreign ownership is already heavily skewed into US dollars and US dollar assets. According to the latest US Treasury TIC figures, Long-term and short-term securities and bank deposits owned by foreigners totalled $34 trillion last December. This represents about 150% of US GDP and has almost certainly risen further since.

By any measure, the US dollar is over-owned by foreigners.

The current wave of foreign currency deposits fleeing into dollars is storing up trouble for the dollar in future, because they either represent inefficiently deployed liquidity for foreigners accounting in other currencies or they are invested in over-valued financial assets. But for now, not only is the dollar the king of currencies, but the proximity of the Eurozone to Ukraine and the commercial links to Eastern Europe in the wider sense undermines confidence in the euro. The euro is the largest component of the dollar’s trade-weighted index in Figure 3 above.

But the flight to safety in currencies and bonds is a temporary step driven by investors in thrall to Keynesian macroeconomics. Having been educated exclusively in Keynesianism they lack an understanding of gold and its monetary role. When freely exchangeable for gold coin, only then does a currency take on gold’s monetary qualities. It has been eighty-nine years since the dollar enjoyed this status, and for the last fifty-one years it has been totally fiat, taking all other currencies off gold with it. In fact, the temporary suspension of the Bretton Woods agreement has been replaced with American anti-gold propaganda in to secure dollar hegemony.

The few people who both understood money as opposed to fiat currencies and manage financial assets have long since retired. All currencies are now state-issued fiat, vulnerable to a schism between their purchasing power and that of gold. The escape from these unsound characteristics will undoubtedly be into metallic money, that is gold and silver, when public confidence in fiat finally disappears. That is not yet the current situation.

Russia’s central bank will be considering its position

The position in Russia is contrastingly different. Over the last two years its M2 money supply has increased by 27% compared with 41% for the dollar. The rouble has not been driven down so much by inflationary policies but by an external threat to it. This has led to cash withdrawals from their bank accounts by middle-class Russians, reflecting an erosion of domestic confidence in the commercial banks. On the foreign exchanges, the rouble has almost halved against the dollar. The Russian Central Bank will be considering its reserves policy, beyond its initial response of raising interest rates to 20% and imposing restrictive foreign exchange controls.

Of the RCB’s total foreign reserves, about $500bn equivalent is in foreign currencies and $130bn is in gold. Sanctions against it have rendered the foreign currency element valueless, at least so long as sanctions are enforced. The difference between fiat currency and gold has been clearly demonstrated. Only physical gold reserves, which have no counterparty risk, has any value to the Russian state. The question now faced by the RCB is how to stabilise the currency and return public confidence in it.

It has some high-value cards in its hand. The run on the banks is likely to diminish in time and the rouble should stabilise after the initial fall on the foreign exchanges. A period of currency stability will take the pressure off the banking system as the panic recedes. The increase in global commodity prices will go a long way towards stabilising Russia’s finances, despite Western sanctions. Russia will adapt to sanctions and find ways to export energy and raw materials. Whenever sanctions have been imposed, such as against South Africa in the apartheid years, after an initial shock the nation emerges stronger. And in the near term, labour costs have been halved relative to commodity outputs.

Meanwhile, a consequence of the failure to take Ukraine will increase the likelihood that Putin will escalate the energy and commodity crisis as a means of destabilising Russia’s Western enemies. He has been forced into a corner in this respect, and we have not yet seen his response. The intriguing question is what Russia will do about gold.

Clearly, with the bulk of its currency reserves sanctioned by the West, gold has become the stand-out asset. And if the RCB feels the need to stabilise the rouble in the longer term, then its gold reserves could be deployed to stabilise the currency and insure it against future hostilities. To advance a gold policy, the RCB might want to drive the dollar gold price higher before fixing a rate for the rouble, which would also have the effect of increasing the value of its gold reserves relative to roubles in circulation. It could do this through Asian markets, particularly the Shanghai Gold Exchange, deploying its yuan reserves.

For the moment, any such action is merely conjecture. But the consequences for the West and its dollar-based currency system would likely be to see confidence in its fiat money system undermined, making it an interesting option for Putin. Together with rising commodity and energy prices rising gold prices would draw attention to the counterparty risks faced by holders of currencies in the foreign exchanges. The West’s response is likely to be hampered by the mindset of fifty-one years of American anti-gold propaganda. And the lack of physical bullion in the US Treasury’s possession to sell into the markets could become widely suspected — this was exposed by the difficulties Germany had in getting the Federal Bank of New York to return a minor portion of its earmarked gold back in 2013.

If gold became an issue, doubtless America would apply pressure on the Europeans to supply some of their gold into bullion markets to drive the price down. But this would probably play into Putin’s hands because the European central banks, facing their own difficulties (more on this below) are unlikely to cooperate. That would drive the wedge between America and Europe, which before his mistaken invasion of Ukraine was Putin’s real objective.

Despite what might happen on gold, if interest rates in Western currencies are not permitted to rise, their purchasing power will be undermined at an increasing pace. Let it be explained for our Keynesian friends: interest rates are not the price of money, but compensation demanded by markets for expectations of a currency’s loss of purchasing power. Withhold that compensation and your currency is toast.

Recapitalising the West’s global banking system

The flight into government bonds and the dollar shown above in Figures 2 and 3 respectively is merely an initial market response seeking safety and to preserve fiat liquidity. And bond yields remaining low are consistent with unrealistic expectations that the outlook will become less inflationary and more recessionary over time. This appears to reflect hope that Putin will fail in his attack on Ukraine, and the crisis will soon be over.

A proper understanding of the crisis in prices is that they are fuelled not by war itself, but by currency debasement. Following both the Lehman failure and covid lockdowns global currency debasement in the Western partnership has been both substantial and universal, and the fallout from Putin’s war can only increase it further. Therefore, measures of inflation will not decline back towards the 2% target but increase substantially. Following the initial commodity and financial crisis, driven by market expectations interest rates are bound to rise significantly despite central bank suppression.

The effect of higher interest rates on the banking system will be materially different from past cycles. US commercial banks have not increased their lending to Main Street materially in recent years, focusing on credit creation for the financial sector and the Federal Government. According to the Fed’s H.8 Table, since 11 March 2020 (before the Fed reduced its funds rate to zero and instituted QE of $120bn per month) the expansion of bank credit in favour of securities in bank credit has increased by 32%. The increase in favour of loans and leases has been only 6%. We can assume that the cycle of bank credit in its contraction phase will be driven more by rising bond yields and collapsing stock markets than by conventional business credit contraction.

Central banks have become similarly vulnerable themselves. They have taken on the role of investors in government and agency debt, and the Bank of Japan has also accumulated equities through exchange traded funds. So not only will commercial banks suffer losses that threaten to wipe out their equity, but the major central banks face the same problem when rising interest rates getting beyond their control undermine the value of their investments. Rising interest rates mean that the entire Western banking system will need to be bailed out by a recapitalisation.

It may surprise those unfamiliar with the differences between money, currency, and credit, that new capital for a bank is always financed from its own balance sheet. In effect, temporary credit is turned into permanent capital. This is because either a deposit from an existing customer is re-allocated, or one is paid in from another bank creating a new deposit. Alternatively, and this is usually the case today, an agent is appointed to arrange subscriptions for the new capital, be it in the form of a rights issue or placing. On completion, the agent transfers subscribers’ deposits to a deposit account created for the purpose at the recapitalising bank. The deposit is then exchanged for the extra capital promised to the depositors under the terms of subscription.

Understanding the process is important. Most people would think that money or currency is involved when it never is. Bank capital is always provided out of bank credit.

A central bank raises capital by the same means but has the additional facility of creating and then redeeming its own bank notes, swapping them across its books for permanent capital. For this reason, a note issuing bank or central bank is never stuck for permanent capital. Furthermore, when you read that a bank has permanent capital of a billion dollars, most people think it is paid up in hard money. But it is an illusion funded entirely by bank credit — credit created by the bank itself.

To explain the mechanics, we can refer to how the Bank of England’s capital was increased in 1697. The Bank was founded in 1694 to act as banker to the government with an original capital of £1,200,000.

In the second half of 1696 the Bank had stopped payment due to a depositor’s run on its stocks of silver, brought about by a shortage of new coin following the Recoinage Act of January that year, and its circulating notes fell to a discount of 20% to their face value. To restore public credit in the Bank, Parliament in 1697 determined to increase the capital of the bank by £1 million (the actual figure in the Bank’s records was £1,001,171 10s[i]) but no part of the increased capital was actually paid up in money, which was silver (England was on a silver standard at that time). In pursuance of the Act £800,000 were paid in Exchequer tallies (effectively a loan issued to the Treasury by the Bank to allow the Treasury to subscribe for stock) and £200,000 in the bank’s own depreciated notes which were taken at the full value in cash. Thus, at the first increase of capital from the original £1,200,000, £200,000 of the capital consisted of its own depreciated bank notes. And the Bank was then authorised to issue its own banknotes to the amount of this portion of the increase in capital, so that the quantity of circulating banknotes remained the same.

Such are the methods by which the capital of a bank which issues notes may be increased. But the capital of a bank which does not issue notes may be increased by similar means. The essence of banking is to make advances by creating credits or deposits, and they can be used to increase its capital. The method was proved in the case of the Bank of Scotland when it increased its capital in 1727.

Suppose that a bank wishes to increase its capital and its customers wish to subscribe. In theory, they may pay in currency (that is bank notes) but today that never happens. But they can give the bank a check drawn on their account. This is the same thing as paying the bank in its own debt to subscribe for capital. It is the release of a debt owed by the bank to its customer, and that debt released then becomes a matching increase of capital. The recently agreed procedures for bank bail-ins, whereby a failing bank is recapitalised by exchanging bond obligations and large deposits for equity stock, accords entirely with these principals and is the way in which the capital of all commercial banks is increased.

Having clarified the procedures, we can now understand how the global banking system can be recapitalised and the potential difficulties.

The consequences of a mass bank recapitalisation

The recapitalisation of commercial banks which are not irretrievably bankrupt has been not uncommon in the past. For the first time, we are likely to see additional losses on central bank bond investments at all the major central banks (excepting China and Russia) which on a mark-to-market basis will wipe out their notional equity, leaving balance sheet liabilities exceeding their assets. And because this will occur as interest rates rise and bond prices fall, it is likely to occur when commercial banks need rescuing from the same effects of rising interest rates on loan collateral and their bond investments, along with the complications of the usual cyclical contraction of commercial bank credit.

In 1697 the recapitalisation of the Bank of England was to stop the run on silver coin. No specie was involved in the recapitalisation. The outward appearance of the bank’s stability was enhanced which removed the embarrassing discount on its bank notes, making them acceptable as a substitute for silver coin. Today, the objective of a mass central bank recapitalisation will be so that their credit as issuers of fiat currencies can be maintained.

The obvious concern becomes how such an exercise will affect confidence in their currencies. With the Fed, the ECB, the BOJ, and the BOE all technically bust and with no money backing them (that is physical gold), the fiat currencies they issue rely on confidence in the issuer and its currency. The losses on their bond investments from rising interest rates and the need for their recapitalisation will be synchronised by circumstances. How this plays out in terms of public confidence in financial markets and currencies for now is a matter of speculation. But we should bear in mind that while the other central banks can perform a modern version of the Bank of England’s 1697 recapitalisation, the ECB has no government treasury ministry to act as the principal counterparty.

Its shareholders are the nineteen national central banks in the euro system. Nearly all the national central banks have liabilities in excess of their assets as well or will have on just a small increase in euro-denominated bond yields. There is the further complication that through the TARGET2 settlement system some NCBs are creditors of the ECB already, and most of them owe euro credits to Germany’s Bundesbank, that of Luxembourg, Finland, and a few others.

A further concern will be about the survival of commercial banks in a higher interest rate environment. Of the expansion of commercial bank credit in the US since March 2020, the overwhelming majority has been into government and agency debt. The average balance sheet leverage of the US’s global systemically important banks (the G-SIBs) is about eleven times, so a rise in interest rates sufficient to discount the falling purchasing power of the dollar will wipe out the capital in all of these banks, even before other negative effects of a collapse of financial collateral values are accounted for.

The commercial banking networks with the highest leverage are in the Eurozone with its G-SIBs asset to equity ratios averaging over 21 times, with some considerably higher. The Japanese banks are also at about 21 times. Both the ECB and the BOJ have imposed negative interest rates, so the rise in global interest rates are bound to wipe out commercial bank capital in these jurisdictions first.

These problems are only defrayed for as long as the Keynesian establishment, including the investment community, is unaware of the consequences of currency inflation past, present, and future. When it has become clear that whatever happens in Ukraine only aggravates a situation over food, energy, and other prices with their knock-on effects we will have seen bond prices already collapsing, taking down the whole banking system from top to bottom.

Full faith and credit in fiat currencies is bound to evaporate, repeating on a global scale what happened in John Law’s France in 1720.


Source : Gold Money

Chart: China’s Fiscal Deficit Back Below 3%

Source : Caixin

What is China’s SWIFT Equivalent and Could It Help Beijing Reduce Reliance on the US Dollar?

Frank Tang wrote . . . . . . . . .

The United States, European Union, Canada and Britain have decided to exclude selected Russian banks from the Swift financial messaging system, the so-called nuclear option for sanctions.

While the list of banks is yet to be released, China is watching developments closely, especially how the Russian equivalent to Swift works and to what extent it can contain damage to the Russian economy.

The move to ban Russian financial institutions is likely to accelerate expansion of Beijing’s own cross-border payment and settlement system, which has gained more prominence amid US threats to decouple its economy from China’s in 2019. Below are key facts about the Chinese system.

What is CIPS?

The Cross-Border Interbank Payment System, or CIPS, was launched in October 2015 to provide an independent international yuan payment and clearing system connecting both onshore and offshore clearing markets and participating banks.

Based in the financial hub of Shanghai, it employs more than 100 people and has registered capital worth 2.38 billion yuan (US$376.9 million). The important financial infrastructure is overseen by the People’s Bank of China.

The China National Clearing Centre, an affiliate of the central bank, is the largest shareholder, with a stake of 15.7 per cent. The National Association of Financial Market Institutional Investors, the Shanghai Gold Exchange, China Banknote Printing and Minting Corporation and China Union Pay each own a 7.85 per cent share, according to business registration information published by Tianyancha.com.

Foreign banks also have shares in CIPS, including a 3.92 per cent stake owned by HSBC Holdings, 2.36 per cent by Standard Chartered, and 1.18 per cent by the Bank of East Asia.

What is the origin of CIPS?

The system was created to boost international use of China’s currency, a mission started in 2009 with an initial focus on trade settlement. It became more important after Beijing initiated the ambitious Belt and Road Initiative that involves hundreds of billions of yuan worth of Chinese investment overseas.

Use of the yuan increased after its inclusion in the International Monetary Fund’s Special Drawing Rights basket in 2015. However, its share is not in proportion with its status as the world’s second largest economy, accounting for 18 per cent of global gross domestic product.

Swift data showed that the Chinese yuan accounted for 3.2 per cent of global payments in January, far below the US dollar, which accounted for 39.92 per cent of settlements, the euro on 36.56 per cent and the British pound at 6.3 per cent.

CIPS reported 2.68 million transactions in the first 11 months of last year, an increase of 58 per cent from a year earlier. The transaction value jumped 83 per cent to 64 trillion yuan, the Shanghai Securities News reported, citing data from the system operator.

Do overseas banks use CIPS?

After CIPS launched in 2015, 19 banks signed on to phase one of the project, including 11 Chinese banks and eight locally registered entities of overseas banks – Standard Chartered, Deutsche Bank, HSBC, Citi Bank, DBS Bank, Bank of East Asia, BNP Paribas and ANZ.

In January this year, the system had 1,280 users across 103 countries, including 75 directly participating banks and 1,205 indirect participants. The operator said last year overseas indirect participants account for 54.5 per cent of the total.

The involvement of large international banks sets it apart from Russia’s System for Transfer of Financial Messages (SPFS), which has around 400 users but only a dozen foreign banks from countries such as China, Cuba, Belarus, Tajikistan and Kazakhstan.

Standard Chartered led overseas banks in terms of CIPS transactions last year, according to a statement from the bank in mid-February.

How does CIPS compare to Swift?

CIPS is viewed as a possible alternative to the US-controlled global settlement system, which includes Belgium-based Swift and the New York-based Clearing House Interbank Payments System.

However, it is much smaller than Swift, which is used by 11,000 financial institutions across 200 countries or regions, including nearly 600 Chinese banks.

Currently, there is more cooperation than competition between the two systems. Swift set up a wholly-owned subsidiary in Beijing in 2019, while it also formed a joint venture with several affiliates of the Chinese central bank in early 2021, including CIPS.

What is the future of CIPS?

Chinese analysts believe sanctions on Russian banks will be a wake-up call for Beijing.

“As seen from Russia’s Swift exclusion and the China-US trade friction in recent years, it is necessary to reduce reliance on Swift to ensure financial security,” Dongguan Securities analysts Chen Weiguang, Luo Weibin and Liu Menglin wrote on Monday.

Tianfeng Securities analyst Miao Xinjun said on Monday the connection between international financial institutions and CIPS could receive a boost.

Swift sanctions on Iran and Russia – both important oil producing nations – could accelerate the decline of the petrodollar system and facilitate yuan internationalisation, Miao said in a note.

CIPS president Xu Zaiyue said in an interview with Shanghai Securities News last December the organisation aims to increase the number of directly participating banks.

“We hope to provide services all around the globe one day, and especially to facilitate services to overseas participants,” he said. “There will be CIPS services wherever there is yuan.”


Source : SCMP