The Coming Global Monetary Crisis (Peter Tran)

The Coming Global Monetary Crisis

by:  Peter Tran (3/29/2015)


 In order to predict any coming financial crisis with accuracy, one must first correctly identify what type of crisis is lurking on the horizon. I am going to make a final attempt to explain why the coming Global Monetary Crisis (current Dollar Standard Monetary System) is inevitable. In past analyses, I examined different parts of the puzzle in detail. In this piece, I will focus on linking key concepts, so the forest can be unveiled from the cover of the thickness of the trees.

  • Although the financial tsunami is still lurking underneath the surface, it is moving closer to its striking zone as the current cyclical bull cycle has now entered its top (final) phase. Once the cycle turns down, the odds of the financial tsunami manifesting increase with the passage of time.
  • It’s quite understandable why there are many skeptics out there: (1) one camp believes that the U.S. comes from another planetary system, completely immune from the gravitational laws of economics and can escape from the weight of heavy indebtedness; (2) the other camp believes the Fed can continue to extend the current system decades into the future. If these two camps were not able to predict the Global Financial Crisis in 2008 and still do not fully understand it even in hindsight after 6 years, what are the odds that they will see the coming Global Monetary Crisis?

Key Summary

A) Why the global monetary tsunami will emerge?

  • Due to structural design flaws, it’s inevitable that the system will eventually fail and has to be reset. For centuries, monetary history has been littered with cases of failure caused by the same structural flaws, even though the triggering catalysts were different. Unlike the cyclical business cycle, secular monetary cycles have much longer durations, and while their inflection points occur less frequently, they still always arrive without exception.
  • The flaws are: (1) the system requires perpetual debt accumulation to function as money is debt, which ultimately leads to a breaking point; (2) currently, most wealth is saved in the form of debt; (c) fractional banking practices and an inherent leveraged structure with the boom-and-bust self-reinforcing processes.

B) The Fed (central banks in general) will be ineffective (hitting limit) in dealing with the monetary crisis.

  • Cannot solve the problem of too much debt.
  • Cannot force over-indebted borrowers to get more into debt and banks to create credit money.
  • Can create unlimited amount of currency, but cannot print value of currency at the same time.

C) In the aftermath of the global monetary tsunami, what will be the next global monetary standard?

  • Whatever the final structure formalized by the world powers is will involve the “golden” solution and a revaluation of the gold price much higher. Why?
  • Gold will (a) provide an optimal solution to both creditor and debtor nations and (b) solve both monetary and economic problems.

Understanding the Mechanics of How The Monetary System Works

In order to understand the coming Global Monetary Crisis as an inevitable event and anticipate its likely remedy, we must first grasp the fundamental building blocks. In the case of the economy and investment, we start with the monetary system itself, which is the fundamental building block (DNA) of our modern economics and investment ecosystem. We must have a clear understanding of the fundamental mechanics of how the monetary system works and its evolution.

A) The Function of Money

In the realm of the monetary system, money generally means both medium of exchange (national currency) and store of value (all forms of wealth reserves = financial and hard assets) as the unit of account function of money will follow naturally. Within the domestic tier of an economy, people and institutions trade with each other mainly with credit denominated in national currency as the legal medium of exchange. Any imbalances within the domestic market will then be settled (cleared) in the national currency itself. Any entities with surpluses can store (save) them in financial/hard assets.

B) Domestic Tier

Monetary reserves are the fundamental basis on which the monetary system builds upon.

  1. At the central bank level, money begins with the monetization of central bank reserves (gold/government debt). The process starts with the government borrowing money into existence from the central bank (CB). Mechanically, the central bank creates base money (printing currency = physical cash or reserves = electronic cash “out of thin air”) and exchanges it for interest-paying government debt.
  2. At the banking system level, commercial banks use the central bank base money as their reserves, which serve as the backing for banks to create credit money (loans).
  3. At this juncture, we now have a fully reserved monetary system for a domestic economy.
  4. Along with the fractional reserve banking system and the need to support economic growth (rising demand for bank credit money), banks can now expand their balance sheets. However, as credit money grows, the asset side will be balanced with new assets instead of reserves. In other words, through fractional reserve banking, the banking regulation allows banks to legally lend the same money to several people or institutions at the same time and collect interest.
  5. All new money is loaned into existence (money is debt). Bank loans can then serve as collateral for additional lending and borrowing. Basically, lending always expands the money supply.
  6. In terms of the clearing process, the entire banking system (economy) is dependent on the trust that banks will have the physical cash available (as well the confidence in a stable currency) for final transactions settlement (clearing) on demand since deposits (liabilities) cannot be redeemed or cleared (settled) with assets.
    • When banks extend new money credits (loans) out-of-thin air balanced with new assets (balance sheet money), they simultaneously create a liabilities (deposits) upon themselves. It actually means that banks owe physical currency (dollars) on the new money credits they just create from thin air, which are not fully balanced with reserves. Since banks do not have the legal authority to print currency (only the central bank has the authority), they ultimately must earn or find the physical cash (dollars) they owe.
    • To obtain physical cash, banks can: attract new deposits, sell assets, call in loans, and/or borrow temporarily using assets as collateral (interbank borrowing).
  7. In summary, the central bank creates base money out-of- thin air backed by government debt with interest. In turn, banks use central bank base money as reserves to create credit money (loans with interest). Reserves are the foundation of the basic money supply of banks, while assets represent the banks’ extension of credit (credit money growth). Money supply (credit money) expansion (through debt expansion) is the engine for economic growth and a functioning economy, yet the central bank base money is not directly linked.


C) Foreign Tier

At the international level, different nations trade with each other having different national currencies. Since trades are not perfectly matched, international trade imbalances accumulate, and they need to be settled (cleared) with official foreign exchange reserves (currently dollars / US government bonds) between central banks. On the asset side of balance sheet, central banks have foreign exchange reserves and assets. Foreign exchange reserves are either claims against non-residents denominated in a foreign currency (official FX reserve) or gold. Assets cannot be used to settle international trade imbalances because they are claims against domestic residents denominated in national currency.

To summarize, the domestic legal tender law specifies the national currency as the medium of exchange to settle (clear) all domestic economic imbalances through its banking system. Essentially, the bank reserves are used for clearing, redemption, and credit expansion in the domestic market, but only central bank reserves can be used at the international level. At this level, the global monetary standard governs the protocol of official foreign exchange reserves to clear (settle) international trade imbalances between countries through respective central banks. Clearly, both the domestic and official international reserves are the foundation of the monetary system. The reserves are based on debt. When debt fails to perform, the monetary foundation will crumble.  The section below will trace the evolution of the global monetary standard. To visualize the monetary structure, a simplified diagram is shown below.

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D) Global Monetary Standard

Before WWI, the world monetary system was under the Gold Standard in which gold was the agreed foreign exchange reserve for international trade settlement.

  • After WWI, the global monetary system was altered to the Gold-Exchange Standard. Along with gold, the new system incorporated the US dollar and British pound into international official reserves. Specifically, the US dollar was backed gold, while the British pound was backed by US dollar and gold. Essentially, they created “paper gold” reserves in form of US dollars and pounds.
  • After WWII, the monetary system was modified again under the Bretton Woods agreement, effectively giving the US dollar the exclusive world reserve currency status backed by gold.
  • In 1971, the US unilaterally closed down its gold window, defaulting on the Dollar-Exchange Standard. Since 1971 to the present, the global monetary system is effectively on the fiat Dollar Standard with the implicit backing of oil (petrodollar) as world oil is exclusively priced and settled in US dollars.

What is the meaning behind the evolution of global monetary reserve? By introducing a more flexible international official monetary reserve such as the fiat dollar (can create in unlimited supply, a debt-based reserve asset with counterparty risk), a highly unstable and systemic monetary cancer (mandating the world to save in debt) was injected into the global monetary system, where debts ultimately fail to perform in the long term. Much like the biological disease, the monetary cancer can also take decades to manifest itself. While the US and even the rest of the world have enjoyed the fruit of this flexible global monetary reserve system for some time, will the current fiat Dollar Standard turn out to be a curse in the end? The next section will explore this question.

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Why Systemic Global Monetary Crisis Is Inevitable?

Due to structural flaws in the design of the monetary standard, the monetary system has three components which will guarantee that the system will fail eventually: (1) required perpetual debt accumulation to work (2) savings in debt (3) leverage = fractional reserve banking.

  • Required perpetual debt expansion. Money is debt. At both the central bank and the banking system level, money is backed by debt that pays interest.
  • The economic system is built on debt (credit growth = economic growth). Debt allows future consumption to pull forward with an implicit requirement that future economic growth will always be bigger than the past. Basically, the system requires constant debt (credit) accumulation to fuel future economic growth, and it cannot function under a continued/prolonged credit contraction.
  • From the standpoint of debt mathematics, the conclusion is the same. Since debt carries compounded interest rates with an exponential growth function, the amount of debt in the system will always exceed the amount of money (the economy constantly experiences shortages of money). Without a constant and perpetual expansion of the debt/credit (money) supply, past debts would not be able to be serviced and defaults would cascade throughout the entire banking system. With the exponential growth feature, debt accumulation will grow and escalate exponentially higher when it reaches its terminal phase. [Just look at the US debt chart]
  • Can debt grow more than income forever? The answer is NO. By now, we know that the monetary system will inevitably fail due to the unsustainably high level of debt built up in the system over a very long cycle, caused by the monetary structural design.
  • Here is a useful analogy: Every country has its credit card (debt) limit. The only question is when it will reach its maximum limit. The time function depends on (a) productivity of debt usage (b) economy size (c) reserve currency status. For example, why have Latin American countries run into debt/currency crises every 7 to 10 years? Since they borrowed for consumption (not production) and have small economies (smaller credit card/debt limits), they’ve tended to reach their debt maximum more quickly. Like seasonal cycles, secular monetary cycles move through seasons (phases) within its LT (long-term) debt cycle. All monetary systems eventually mature through a build-up (saturation) of debt. When a central bank is in a hyperactive gear (QE, Operation Twist, ZIRP, NIRP, etc.), it’s a sure sign that the monetary cycle is entering its winter season.
  • Saving in debt. Under the current dollar standard monetary regime, most savings (store of value) are in the form of debt-based financial assets, meaning the financial assets represent someone else’s liability or promise of performance (stored as someone else’s debt). More specifically, the dollar and treasury bonds are elevated to be as good as gold and a substitute for real wealth assets (store of value) to be held in official reserve behind other currencies. With the passing of each business cycle, the mountain of paper assets grows bigger, while the sea of debt gets deeper. This debt trap is unsustainable and unstable as it requires perpetual debt accumulation. Specifically, it has no balancing mechanism. A monetary system reset is the only means of balancing. Theoretically, the system would at least be sustainable through periodic resets, meaning that the system has to go through large debt deflation periodically to cleanse excess debt. In practice, such periodic resets do not align well with politics. Instead, politicians resort to quick fixes (short recessions). Eventually, perpetual debt accumulation reaches a limit. When debt fails, systemic collapse is unavoidable as long as debt is used for savings.
  • Leverage and chain reaction effect. The system is always leveraged due to fractional reserve banking practices, which allow banks to create credit money without reserves backed. In addition, collateral rehypothecation adds another layer of daisy chain reaction effect in the system as the collateral can be borrowed multiple times like a revolving door.

On top of the traditional debt related to the real economy, which are already unpayable, there is a mountain of derivative debt (casino debts) which is growing like terminal cancer cells. In the wake of the 2008 global financial crisis, only a small segment of the derivative market (credit derivatives) got infected, yet created global financial gridlock [to refresh your memory, you can read my 2008 crisis prediction again]. When the next financial tsunami strikes at the heart of the global monetary system, interest rate and currency (biggest segments) derivatives will implode, swallowing the entire system like a black hole.

In past cyclical downturns, reflationary policies composed of monetary rate cuts, fiscal expansion, and a weaker dollar have cemented cyclical upturns to take hold, leading to a new round of LT debt accumulation. With the passing of each cycle, the debt level piles higher. In the recent cyclical downturn in 2008, the Fed resorted to extreme monetary tools (QE and ZIRP) to propel another bull cycle. Can the Fed prevent the inevitable demise of the dollar standard monetary system with its ability to create unlimited amount of fiat dollars and keep interest rate at the zero bound indefinitely? The answer is NO. The Fed can certainly print an unlimited amount of dollars, but it cannot print the value of the dollar (higher) at the same time. Otherwise, central banks in Zimbabwe and Venezuela would be able to print an infinite amount of money to solve all their economic problems (and get rich at the same time). The reality is the opposite. Like a magician, a central bank’s mythical power lies within its ability to perform an illusion (maintain confidence).

Let’s take the analysis one step further to see if we can clearly demystify the mythical power of the central bank and unveil its limitations. The Fed certainly has the power to print base money and buy all the assets (bailing out creditors), but the Fed is powerless on the debtors’ side: (1) it cannot solve the problem of indebtedness; (2) it cannot force over-indebted borrowers to get into more debt and banks to create more credit money (lend). Basically, buying assets is just swapping creditors’ ownership from private hands to the Fed itself. In the case of a systemic monetary crisis, this sleight of hand monetary trick is ineffective once the system reaches its debt saturation point during economic stagnation. Also, the size of the derivatives markets is too big (notional amount of over one quadrillion US dollars) even for the Fed to print money. In addition, there is a punitive cost associated with printing base money recklessly. It will destroy the currency and lead to hyperinflation. While central bank policies can work 99 times out of 100, failure is inevitable. When policies no longer work, failure will occur in spectacular fashion. Generally, the Fed can handle the typical speculative financial crisis, but it is ineffective in dealing with a monetary crisis.

The US monetary system has an additional structural flaw (Triffin Dilemma) which lies deep in its global reserve currency status. Since the rest of the world uses dollars as their official reserves, they implicitly require the US to run a perpetual (debt) balance of payments deficit to feed the dollar reserves to the rest of the world. Otherwise, their reserves will have to shrink, leading to monetary and economic contraction. To avoid (delaying the inevitable) this situation, the dollar standard system has been supported (put up with the US) by key world political powers. For Asian nations, their economies were built around US consumers. For European nations, time was being bought to erect their own monetary union, building the monetary levees to reduce the impact of the coming global dollar monetary tsunami. Currently, the geopolitical supports for the US dollar are eroding and under attack. Why? (1) US reaching debt saturation limit; (2) US foreign policy = more unilateral, militarily confrontational to defend its dollar hegemony. The next section below will show evidence to confirm that the foundation for the dollar system is cracking beyond repair.

Evidence for Confirmation

There are signs that concretely indicate that the current system is reaching its terminal phase:

  1. Debt saturation.
  • Debt levels in the system have already approached escape velocity and reached the saturation point: debt growing exponentially, negative marginal debt, size of financial derivatives exploding.
  1. Monetary ineffectiveness (ZIRP, QE)
  • ZIRP and QE policies only happen when a monetary cycle reaches its end. Once LT debt accumulation reaches its peak, changes in interest rate policy are ineffective to stimulate private credit growth and to reduce debt burdens, even with a zero-interest-rate policy (ZIRP). Eventually, policy makers will resort to the ultimate (last) monetary tool, money printing. If money printing could solve the problem of too much debt, the world would never experience any financial crises, and every central bank would print as much and as fast as possible. Money printing can only buy time and temporarily delay the day of reckoning.
  1. Budget deficit explosion + Issuing mostly in S-T debt [experiencing financing difficulty]
  • A budget deficit explosion and an inability to rollover debt are classic signals in all past debt This usually occurs when a monetary system is in its terminal phase. The US gov’t is running a $1+ trillion budget deficit a year with no end in sight. In 2010, I calculated that 70% of US debt was being financed by ST (short term) debt. By now, that number is likely bigger and the duration even shorter. The Fed has become the biggest buyer of Treasury debt. The latest trend of pushing for more centralized control and uncontrollable deficit spending is indicating that the dollar system is in its final stage.
  1. Crisis evolving and deepening
  • Crisis Evolution = subprime => banking crisis => sovereign debt crisis => currency crisis (next).
  • Crisis Deepening = going global + infecting more economic sectors + will move from periphery to the core + more CBs implement QE.
  1. Dollar monetary pillars support breaking down

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  1. Headlines of recent geopolitical support trend for the dollar system accelerating to the downside

These recent headlines below are indicating that the dollar monetary system is now in clear-and-present danger:

  • Australia and European countries (UK, France, Germany, and Italy) join a China-led Infrastructure bank (similar to the World Bank).
  • China welcomes Luxembourg’s application to be a founding member of the Asian Infrastructure Investment Bank.
  • South Korea is reportedly reconsidering a bid to join.
  • De-Dollarization accelerates as more of Washington’s allies defect to a China-led World Bank.
  • China and Germany Deepen Financial Cooperation, Germany Joins AIIB and Supports RMB Inclusion into SDR.
  • Putin Proposes Eurasian Currency Union.
  • Kazakhstan’s Central Bank announces it plans to de-dollarize its economy by the end of 2016.
  • Russia launches its own ‘SWIFT’-alternative, linking 91 credit institutions initially.
  • China Completes SWIFT Alternative.
  • AReuters report notes that China’s international payment system, known simply enough as China International Payment System (CIPS), which serves to process cross-border yuan transactions is ready, and may be launched as early as September or October.
  • Russia ratifies a $100 Billion BRICS Bank and expects to start fully functioning by the end of 2015.
  • Russia Dumps Most US Paper Ever As China Reduces Treasury Holdings To January 2013 Levels.
  • Austria expresses concern over their gold at BOE.
  • Germany resumes gold repatriation.
  • Central Banks Buy The Second Most Gold In 50 Years.
  • European Parliament’s Committee on Economic and Monetary Affairs agree unanimously to allow gold to be used as collateral in clearinghouses.
  • Moscow & Cairo to drop USD, use national currencies in bilateral trade.
  • Moscow Launches Ruble-Renminbi Futures to Facilitate Trade between China and Russia.
  • Gazprom Begins Accepting Payment For Oil In Ruble and Yuan.
  • Turkey’s recent de-dollarization discussions with Russia to move to settlement in local currencies.
  • Russia and Iran Replace Dollar With Rial, Ruble in Trade.
  • China Signs Currency Swap Deal With Qatar & Canada.
  • China and Malaysia announce the establishment of renminbi clearing arrangements.
  • China starts direct convertibility with Singapore.
  • UK becomes the first foreign government to issue debt in renminbi.
  • South Korean Renminbi Deposits Surge 55-Fold in a Year.
  • China will start direct trading between the yuan and the euro.
  • Sterling and yuan will be directly swapped without using the US dollar as an intermediary.
  • Germany’s KfW development bank issues its first renminbi bond.
  • China and Japan engage in direct currency trade.
  • China and Iran to bypass dollar.
  • Brazil signs China currency swap.
  • A “renminbi bloc” is formed in East Asia, as nations in the region abandon the US dollar and peg their currency to the Chinese yuan.
  • China and Chile Launch Currency Swap and Settle in Renminbi.
  • Korea makes currency swap agreements with Australia and Indonesia in an attempt to avoid using U.S. dollars.
  • Japan and India sign a currency dealing linking their currencies.
  • India Will Transact With Iran In Rupees.

 When (Timing)?

Although every nation has a credit limit with respect to how much debt it can accumulate before the market loses confidence, there is not a standardized threshold level that can signal a breaking point. The debt limit threshold level is different for each country, depending on whether you are dealing with emerging market or developed countries. More specifically, the threshold is linked to a loss in market confidence. This implies that one has to apply some subjectivity along with other indicators to accurately forecast a breaking point (tricky task).

Despite its reserve currency status, when the world geopolitical powers stop supporting the US, confidence will erode and the unraveling will commence [see evidence in previous sections]. Moreover, the breakdown is most likely to occur when the investment cycle inevitably hits an inflection point and markets turn south, as crises are unlikely during cyclical bull phases.

Where are we in the current investment cycle? Cyclical bull markets tend to last between 4 to 8 years, but on average, typically last about 4.5 years. In the most optimal global economic growth conditions, a cyclical bull phase can last around 7 – 8 years. In the current cycle, we can substitute high global economic growth with hyperactive CB policy (extreme monetary accommodation). The current cyclical bull market is already 6+ years old. In previous cycles, the Fed typically started to raise its policy rate while the bull market was in its speculative phase. On the heels of beginning its tightening cycle, it has generally taken about 12 to 18 months for previous bull markets to reach their respective inflection points.

Unlike other cycles, however, this current cycle is uniquely different: (1) the Fed ran the QE program for almost 6 years (almost the entire bull market cycle), while it continues to keep its zero-interest-rate policy; (2) the current bull market is already entered its Top phase of the bull cycle, yet the Fed hasn’t even begun to tighten policy. Since the Fed is having such difficulty raising rates in this cycle, one cannot depend on historical policies as a signal to read this current market cycle. However, when the Fed started to taper its QE program in January 2014, it was an equivalent to the Fed actually raising 25 bps (typical 1st policy rate change). It is going to take 12 to 18 months for the current bull to reach its maximum peak.

Moreover, based on my proprietary market-based investment cycle models, the market has now entered the Top (last) phase of the bull market. Therefore, I am anticipating that the current bull will top out in 2015, most likely during the Spring or Fall of 2015. If the Top does occur later this year, then 2016 will be the year of the unraveling. Since this current cycle is very different (entering  the winter season of the monetary cycle) and central banks around the world are in hyperactive mode to defend the system at all cost (including destroying own currencies), I am respecting their power to delay the time frame (possibly for another year), but also understand the outer limit is quickly approaching. I now have a defined market top timing zone. In this Top phase, one should exercise control in taking big market bets, while the market processes are working naturally (rising volatility) toward the inflection point. I am now on high alert mode and am actively monitoring how future events are unfolding, so I can refine and adjust the market top timing zone accordingly.

Golden Solution

I am anticipating a global monetary tsunami on the not-too-distant horizon. After a wave of destruction crashes through the financial and economic system, a global monetary reset is a certainty in its aftermath. What would be the most optimal and effective monetary solution to rebuild the system? The most desired new global monetary structure must satisfy two conditions: (1) demonstrable structural monetary and economic advantages and (2) political appeal to key world powers.

In the case of the ensuing systemic global monetary crisis (twin sovereign debt and currency crises), is it possible to recapitalize the monetary system itself through fiat debt? The answer is NO. The backing reserves (government debt and monetary base) themselves are the problems when government debt fails to perform and CBs monetize debt to further widen the monetary base. In short, you cannot use impaired (worthless) backing reserves to recapitalize the monetary system.

Since global monetary reliquification through fiat debt is not possible, how can gold fit into this new monetary recapitalization calculus equation?

Demonstrable structural monetary and economic advantages

  • Monetary escape valve.
    1. Creditor nation benefit. Central banks’ assets (reserves = representing the nations’ wealth) are composed mostly of fiat currency debt (majority in US treasury debt) and some gold. When the dollar monetary system fails, the fiat currency debt component will be completely destroyed, vaporizing the nations’ wealth. How can nations offset these losses? For these cash-strapped nations (all nations), embracing gold will provide an escape route by letting the gold price rise to the moon. Nations’ wealth = ( fiat currency debt) + ( gold); one will go down in value and the other will compensate the losses by rising. It’s a very powerful monetary trick. In addition, gold is a perfect diversification medium for nations that are running positive trade surpluses. China has been quietly and secretly acquiring gold for many years, and it’s also the largest gold producer in the world. Look at the size of gold in the Eurozone system. For the past few years, central banks became net gold buyers. Big creditor nation such as China will want to revalue gold higher to offset its FX reserve loss.
    2. Debtor nation benefit. Big debtor nations like the US are also interested in a much higher gold price to settle their huge debt load with as few gold bars as possible.
  • Economic logic dictates that gold will provide an optimal solution in which both creditors and debtors benefit in the event of a high gold price revaluation.
  • New world economic growth engine. With US consumers (fueled by debt accumulation) still anchoring the global economic growth engine during this terminal phase of the entire dollar debt structure, the world will soon desperately need a new source of economic growth. To replace US consumers, the solution obviously rests on the backs of consumers in emerging markets. How can one create a middle class in emerging markets? The normal course is through the economic growth model (creating jobs, incomes, savings, etc.) with the support of debt accumulation. This traditional economic growth route will require many years (decades long) at a time when the world is going through catastrophic debt deflation. The world really needs a new economic lubricant. The answer is gold. At an individual level, the citizens of India, China and for the most part Asian nations hold physical gold in their wealth portfolios. The Chinese government has been advising its citizens to own physical gold and silver. It began pushing its citizens to buy gold in September of 2009. China introduced its own silver bars as an investment, while China Central Television ran campaigns to push the citizens into gold and silver investments. In addition, it went as far as explaining the benefits of holding physical gold and silver and the logistics of obtaining them. Why? In the realm of politics, there is no such thing as kindness from the government– only calculated benefits. If China allows its citizens to move into a safe haven like gold and silver, logic dictates that China must obviously be anticipating some benefit in the future. How? Since US consumers are dwindling, the Chinese government desperately needs to create domestic consumption to take their place. There are billions of potential consumers in China waiting in the wings if only they had more purchasing power. What is a quickest strategy to achieve this goal? If Chinese citizens acquire gold at current low gold prices, their wealth and domestic purchasing power will increase many times over when the gold price spikes higher. Why sweat so hard to create an economic miracle when it can be done with the stroke of a pen? Scaling this up to include India and other Asian nations, the world will instantly have massive purchasing power to replace US consumers. Partially sheltered by the Euro during the dollar monetary system collapse, Europeans, too, will be able to better protect their savings through gold purchases at vending machines. Besides the economic advantages, there is also a clear political benefit. Without this golden lifeboat as the Titanic dollar monetary system sinks, current Chinese political elites (even with a strong and centralized political structure) are unlikely to survive if more than one billion Chinese citizens are desperate and angry.
  • No systemic global monetary collapse in the future. After the collapse of the dollar monetary system, no nation will accept the deception of holding paper debt as a substitute for real wealth assets. They will all prefer gold reserves over paper debt issued by other nations (of course, the debt, equity and FX markets will still be there for you to play). The wealth of a nation will truly be built on a golden foundation – wealth no nation can create via monetary expansion. The stability of this new global monetary system is superior. In the future, of course, a sovereign monetary system or economy can still completely collapse, but this new global monetary will inherently prevent a systemic breakdown.
  • Controlling currency inflation. With a floating gold price, gold can rise in value without restraint to reflect currency inflation, and people have a choice to buy gold and not hold currency. It’s an automatic counterbalance to the money printing press. The world will once again enjoy a rebirth of low inflation growth. Sound currency can achieve lower operating costs via lower taxation of inflation.
  • Taxation. When the dollar implodes, a nation’s public finances will be completely ruined. Instead of raising taxes to a detrimental level while the economy is in a depression, the revaluation of the gold price will provide some cushion. In addition, a very high gold price is an excellent source (via trading and production) of government revenue.
  • Sound currency. Without a sound and stable currency, no citizen will save in that currency. Without savings, there will be no capital formation for economic activity. All that is left is a printing press and hyperinflation. Gold can provide a basis for sound and stable currency as explained earlier. Nations must return gold to its monetary role or they will perish.
  • Little economic interference. People often characterize gold as a useless metal since it does not have much of any industrial usage. Its uselessness in the economic sphere, however, makes it extraordinarily valuable in the monetary sphere. For example, when the dollar monetary system fails, gold prices will be revalued higher to solve both global monetary and economic problems as explained above. If gold were to have many useful industrial usages, though, the input costs will be prohibitively high in that it would literally destroy many industries and economic activities, preventing or slowing down the recovery process. In addition, a higher gold price will absorb most of the currency hyperinflation with little economic cost. Still wondering why gold is sitting on the asset side of the CBs’ balance sheets?

Political Appeal

  • Governments can still print fiat currency. However, no single fiat currency will collapse the new global monetary system this time.
  • Gold will not be competing with fiat currency.
  • Gold will make it more difficult for any one country to overpower other nations through fiat dominance (like the US using the dollar).
  • Gold provides an escape route.
  • With certainty that the US will never be able to pay its debt load at par along with the collapsing dollar, it’s in the best interest of the world to see the transition away from the dollar monetary system as orderly and quickly as possible. All that is required is changing monetary rules with signatures to bring gold back to its monetary role. Gold is already currently sitting on the balance sheets of central banks around the world and is classified as a monetary asset.

We now know that gold will need to revalue itself much higher and transition back into a key monetary role as an international official reserve asset. What will be the new global monetary regime?

  • Will the world return back to gold standard?
    1. Comparing today’s dollar-based monetary system (with fractional banking) to a gold standard monetary system (with fractional banking), there is actually not much difference. Instead of gold acting as a disciplinary force, banking regulators would impose rules on credit money creation. If the rules were enforced forcefully, the fractional reserve dollar system could work just like the gold standard system. In essence, both monetary systems allow banks to create more loans than the reserves they have. In case of bank runs, the only difference is that the fiat dollar can be manufactured in unlimited amounts out of thin air to support the banking system. Therefore, under a fractional reserve fiat dollar system, debt expansion has more latitude. Indeed, the world, and US in particular, are so addicted to debt, there is no chance for rehabilitation.
    2. A gold standard is sometimes romanticized as an idealistic perception of a sound monetary system because some form of gold backing makes the currency sound by imposing fiscal and monetary discipline. In reality, the flaws of previous gold standard monetary systems were two-fold: (1) still ran on fractional banking and (2) no mechanism were in place to control the abuse of fiscal/monetary authorities, which are usually heavily influenced by the forces of politics and greed. Therefore, the gold standard system itself offered no discipline. History has repeatedly demonstrated that eventually monetary debasement occurs and even a gold monetary system collapses due to either war or greed (or both),
  • Beside its practical flaws, there are other issues which lead me to believe that the world will not return to a traditional gold standard monetary system. First, it will not be suitable to the modern global economy in which trade and capital flows are moving rapidly around the world. Second, keeping the gold price fixed is another problem with the gold standard because it does not adjust/reflect debt expansion under fractional reserve banking practices.
  • A new global monetary system is likely to be a hybrid system.
    1. Let’s first analyze the key weaknesses of past (gold standard) and present (dollar) monetary systems as key metrics for comparison with the new monetary system. First, both (past and present) systems deceptively created an illusion that paper gold receipts and debt assets are as good as real gold. Second, they integrated the medium of exchange and store of value functions into money. Third, the world is exposed to a global systemic monetary breakdown when the day of monetary reckoning arrives in which all pseudo wealth assets are deflated and evaporate, causing massive global financial losses and economic and political upheavals.
    2. To improve the deficiencies from previous monetary regimes, the future monetary system is likely to take a hybrid form based on the fixed gold standard and the floating fiat dollar system. First, it takes the physical gold part from the gold standard but removes the element of the arbitrary gold price fixing and convertibility – freely floating gold connected to real wealth reserves (store of value) will allow the gold price to adjust accordingly with debt expansion. In other words, we will have an international official reserve that can float in the sea of debt and not being drowned by debt waves. Second, it keeps the medium of exchange function of fiat currency, but eliminates the store of value component. Furthermore, the difference between the current dollar-based global monetary system and a hybrid global monetary system is that the dollar system incentivizes debt accumulation without discipline, while the new system prevents it from running too far off course (curtailing an unlimited Ponzi financing practice), mitigating the likelihood of systemic breakdown.
  • Politically, a new monetary system that presents the smoothest dollar debt transition settlement will win the most support. The new hybrid monetary framework is intuitive and simple (revalue gold price higher and float it); and it can be adopted expeditiously. In the absence of any major global war, the world political powers can cooperatively work together, and all can benefit with a shorter period of transition.

pic 6

Whether the coming future global monetary system is anchored by a gold standard or hybrid monetary model, the current gold price will have to revalue massively higher.

  • Under the gold standard, the current low gold price along with a limited gold supply is not sufficient (not credible) to back the massive amount of fiat currency existing in the system. To cover this, the gold price will have to rise much higher.
  • Under the hybrid model, gold will be freely floated as the wealth reserve asset for nations and world citizens. It’s meant so that an ocean of debt-based paper wealth assets can flow toward gold. Here, too, the gold price will experience a meteoric rise.

How high can gold prices go up? From the diagram below, the gold price still has a long way to transcend. To get a general price range, you can go back to my analysis: “The Barbarous Relic”.

pic 7

The final outcome to a golden solution is clear and a certainty, although the exact path it takes to get there remains undecided. Currently, the timing of the global monetary tsunami is more visible within a reasonable time frame, but the unraveling moment will continuously still need to be refined further as more events unfold.

China already openly signaled its “Golden” intention by Song Xin, Party Secretary and President of the China Gold Association.

 …For China, the strategic mission of gold lies in the support of RMB internationalization, as a means to let China become a world economic power and make sure that the “China Dream” is realized. 

 Gold is a monetary asset that transcends national sovereignty, and is very powerful in settling obligations when all else fails, solidifying it as a basis of a currency moving up in the international arena. When the British Pound and the USD became international currencies, their gold reserves as a share of total world gold reserves was 50% and 60%, respectively; when the Euro was introduced, the combined gold reserves of the member countries was more than 10,000 tonnes (more than the US). If the RMB wants to achieve international status, it must have popular acceptance and a stable value. To this end, other than having assurance from the issuing nation, it is very important to have enough gold as a foundation, raising the ‘gold content’ of the RMB. Therefore, to China, the meaning and mission of gold is to support the RMB to become an internationally accepted currency and make China an economic powerhouse.

Gold is the world’s only monetary asset that has no counter party risk, and is the only cross-nation, cross-language, cross-ethnicity, cross-religion and cross-culture globally recognized monetary asset. Gold is the last protection for a country’s economic security; it safeguards a nation’s sovereignty in times of crises.

That is why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

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