The Big Picture

by Alasdair Macleod in King World News^[1]

The fiat currency paradigm is revealed for what it is: a funny-money game that will go horribly wrong. There is only one escape from it, and that is to own the one form of money that is no one’s counterparty risk; the one form of money that always comes to humanity’s rescue when fiat fails. 

And that is gold. It is neglected by nearly everyone because it is the anti-bubble. The more that people believe in fiat-denominated assets, the less they believe in gold. That is until their funny-money games implode, inevitably triggered by sharply rising interest rates.

Those of us with grey hairs gained in financial markets can, or should, recognize that after fifty years the funny-money game is ending. Rising prices in the aggregate are nothing other than currency debasement. And currency debasement leads, as surely as night follows day, to higher interest rates. And higher interest rates lead to falling asset values. For the bullish investor, that is all he or she needs to know.

But that doesn’t reckon with crowd psychology, leading investors to prefer to see and hear no evil rather than reason. As individuals, we need to stand back from our own circumstances and prejudices to gain a sense of perspective, to turn our greed for ever-rising stock prices into a fear of losses before the crowd realizes that the outlook has changed for the worse and attempts to stampede into safety.

Two weeks ago, I pointed out that Jay Powell’s Jackson Hole speech on monetary policy did not mention money once. By buying fully into the Fed’s meme, most investing institutions have blinded themselves to the consequences for interest rates. They comfort themselves that the Fed is in control because it has been in control over markets for nearly all their professional lives. If the Fed says inflation is transient, it will be so.

It is not just America’s Fed. All the major central banks are captured by similar delusions about money, or rather over the management of their currencies which is no longer with the simple objective of controlling their purchasing power. Instead, currency and credit have become the essential tools for funding excess government spending.

No, the establishment is fully committed to currency debasement as a means of funding the state’s increasing need for revenue. It requires concealment of the true situation, which is why Powell and his fellow central bankers are encouraged to ignore any connection between the expansion of circulating currency, credit and prices.

Examining the true relationships between currency, credit and the economy strongly suggests that a price inflation shock is still in its early stages. The trend of rising prices is likely to accelerate as consumers reduce their cash liquidity by buying goods before prices rise even more. Together, these factors can be expected to lead to a generally unexpected fall in the dollar’s purchasing power, and we have further noted that the major central banks have pursued similar monetary policies, which will have similar consequences.

Fixed interest bond yields will rise substantially, which means that prices will fall. Higher interest rates and bond yields in turn will undermine equity values. To the extent that financial asset values are in a bubble, we can expect a substantial derating. In addition, an acceleration of the rate of monetary expansion can be expected to lead to higher gold prices.

While M3 has increased substantially in the last eighteen months gold has been left behind. In a sense, this is not surprising, because the current financial asset bubble and interest rates held at the zero bound can only be maintained if there is supreme and continuing confidence in the prospects for asset values and currencies. Put another way, when there is a financial bubble, gold can be regarded as the anti-bubble, so is bound to be out of fashion.

There is little doubt that the financial asset bubble will be burst by rising interest rates, which will be beyond the Fed’s control. That being the case, there is a strong argument for leaving the funny-money game to the madness of crowds and the madness of regulated institutions. The only credible way to insulate oneself from it completely is by retreating into the one asset for which there is no counterparty risk — physical gold, and perhaps some physical silver.

And on a final note, it is quite clear that the massive growth in money supply makes gold appear to be exceptionally undervalued.