Is it Even Possible?

 

From Alasdair Macleod:

In last week’s Insight, I analysed the current geopolitical situation and concluded that it was now in the interest of the Shanghai Cooperation Organisation to break from the US dollar completely, by establishing a new monetary and banking systemi. By linking the yuan and rouble to gold, the SCO’s principal currencies would be insulated from manipulation by means of dollar currency rates, and their use as a weapon to undermine the Sino-Russian partnership. This article addresses some of the practical difficulties of establishing such a sound monetary system.

A return to sound money will require a radical reform of financial markets, as well as the laws and regulations under which banks and investment houses work. The weaknesses of the current fiat-money system must be identified and understood by reforming governments. It also amounts to no less than discarding the entire evolution of mainstream economic thinking that has evolved in the welfare-states since the 1930s.

Revolutions of this sort normally occur after a major economic and financial failure, when the shortcomings of received wisdom are so glaringly obvious that it loses all credibility. Just occasionally, this can happen without the crisis occurring first. It appears, from what we can deduce as observers, that the assembly of the Asian and East European continent into a self-contained economic and financial unit presents such an opportunity. That was the thrust of last week’s article.

For those who have a thorough understanding of sound money and the benefits it brings to an economy, the opportunity presented by Asia rejecting the West’s unsound money system should be welcomed. The lunacy of expanding the quantity of money as a cure-all for every economic malaise, real and imagined, has led to the widespread expansion of debt to unsustainable levels. It is no exaggeration to say that the global financial system, being based on the dollar, is now exposed to a final collapse, worse than that of the financial crisis of 2008-09, and leading inevitably to the destruction of the fiat currencies we use today.

The destruction of unsound money will not happen overnight. It will come from the central banks’ response to the next global debt crisis. In such a crisis, the banking system, being geared through the fractional reserve system, will cease to exist without central banks bailing it out with unlimited quantities of raw money.

There is little point in trying to predict the timing of this increasingly certain event, or how the crisis will first manifest itself. We know that the credit cycle progresses remorselessly from rescue, to recovery, to bust. The bust is yet to come. The bust, thanks to the groupthink imposed by forums such as G20 meetings and central banks liaising through the Bank for International Settlements, is increasingly a global affair.

If China, Russia and the SCO can grasp the opportunity to escape the unsound money-system of the Western establishment, they will at least partially insulate three billion people from a global currency disaster. That will ultimately benefit the rest of humanity. We must applaud that, even though the introduction of sound money policies in Asia will almost certainly bring forward the crisis in the indebted welfare-states; that is going to happen anyway. For this reason, the change from unsound monetary policies to the rigid rules of sound money must be progressed in such a way that blame is not apportioned to China and Russia for the monetary disaster that will befall us. Instead, we should be grateful that a significant core of global economic activity will escape widespread monetary destruction. The return to a gold standard and the insulation from financial catastrophe that China and Russia will hopefully provide should guide us in our post-crisis monetary reform.

The effect on commodity prices

By remonetising gold into the monetary system of a large economic bloc, demand for gold will be increased. We saw the reverse of this effect on silver in the period 1875-1900. When most countries with a silver standard demonetised it in in favour of gold. In the late nineteenth century, its price relationship with gold moved from exchange ratios corresponding approximately to Sir Isaac Newton’s ratio of 15.5, to considerably higher levels through a collapse of the silver price. Today the ratio is over seventy. The reason for the relative collapse in silver was not hard to understand. The removal of its use as money (except as coin tokens) meant it was then priced for alternative uses. While industrial uses of silver over the years have changed, its value as an industrial metal was always considerably less than for its former use as money.

Thus, it is with gold, demonetised from the financial system, but with an added twist. Under the cover of limited convertibility with the dollar, the dollar was continually debased following the ban on public ownership of gold under the Gold Reserve Act of 1934. Since the official price was raised to $35, the quantity of dollars and dollar credit has increased at a monthly compounding annualised rate of about 5%, until the last financial crisis, when that rate sharply accelerated to 12%, measured by the fiat money quantity. The monetary arrangements were set by the Roosevelt administration and then by the Bretton Woods Agreement. The objective was to permit the expansion of the quantity of dollars, while retaining the pricing stability of gold. The removal of gold from the monetary system after the Nixon shock in 1971 was the inevitable conclusion of this dishonest arrangement, following which the gold price naturally rose, measured in dollars. Today, gold is approximately $1200 in its current demonetised form.

There can be little doubt that the remonetisation of gold for the currencies of a significant portion of the world’s population will drive up the price of gold against the other currencies. This is the reason I recommended that a period should be permitted for the gold price to adjust, before the rate of exchange with is set, first the yuan and then roubles.

It is also important that China, in the first instance, announces it has sufficient gold for the standard to stick, so that it has no need to acquire further bullion from the markets. It is likely, however, that other central banks, particularly the Reserve Bank of India, will want to build their own gold reserves, rather than accept a gold-backed yuan as backing for the rupee. These are political, rather than economic, judgements. India has for some time tried to acquire as a national asset the physical gold held by its citizens and the Hindu temples, with little success. India’s requirements for gold to back its own currency in the SCO is too great to be satisfied at current prices through market purchases. Furthermore, other Asian central banks will also want to add to their gold reserves.

We can conclude therefore that the remonetisation of gold will, with a high degree of certainty, lead to a substantial increase in the dollar price. On this basis alone, the dollar prices of energy and all industrial commodities will be heavily influenced by the decline of the dollar relative to gold. But there is a further consideration. The expansion of derivative markets since the 1980s has amounted to a synthetic supply of commodities generally, suppressing prices below where they would otherwise be without that synthetic supply. We are acutely aware of this effect in gold and silver, but it is not confined to these precious metals.

As the world’s largest importer of energy and industrial materials, this price suppression has been to China’s benefit, so far. Doubtless, China has been broadly content for dollar suppression of commodity prices to continue in the ordinary course of business. Maintaining a stable yuan/dollar rate has also allowed Chinese-based manufacturers to profit from export markets generally, setting in motion a wealth-transfer accumulation in favour of Chinese citizens. But things are changing. Most obviously, President Trump is determined to stop China from running an export surplus with the US, likely to lead to trade tariffs and barriers.

Fortunately for China, she is now almost ready to discard America as a strategic market, building on trade in Asia instead, and with Europe via the overland rail link. The days of exporting cheap goods are over, and the economy is being upgraded towards a greater content of technology, automation, and quality. The similarities with the development of the Japanese economy between 1950 and 1980 are striking. Additionally, China is causing an industrial revolution to occur throughout the Asian continent. In conjunction with Russia (which is along for the ride) Asia, through the SCO, is becoming an integral part of China for economic purposes.

It is now in China’s interest for imported commodities to be as cheap as possible, rather than the yuan being a held as a competitive currency to foster exports. Furthermore, the rapid expansion of bank credit since the great financial crisis has led to an accumulation of bank deposits that is likely in time to reduce the purchasing power of the yuan, unless this tendency is offset by a rise in the exchange rate.

This is the underlying logic for anchoring the yuan to gold. In doing so, the cost of imported commodities will fall at the same time as China faces price inflation pressures from earlier monetary expansion.

The economic effects

Preventing a fall in the purchasing power of the yuan will be a growing priority, as China’s middle classes increase in their numbers. Not only are factory workers and businesses accumulating wealth, but the Chinese authorities plan to redeploy yet more people from the land into the cities. This will add as many as 200 million people to the urban areas to alleviate a looming labour shortage.

The shortage of labour is bound to be reflected in higher wages for a population already holding in aggregate an uncomfortable quantity of cash deposits. The rate of increase in prices has so far been modest, with the CPI annual increase falling from 4.6% in 2010 to under 2% last year. It will be increasingly likely that prices will now rise at a faster pace, the consequence of a shift in preferences from holding excess money to owning goods. In short, the next phase of progress for China, in accordance with the current five-year plan, will require the purchasing power of the yuan to be stabilised.

This is the economic reason for the yuan to go onto a gold standard. It is likely to be a popular move with the people as well, who have been encouraged to accumulate gold in recent years. A golden yuan will reward savers, and it is savings that drive successful economies. Witness Germany and Japan in the post-war years, and compare them with the Keynesian failures of consumption-driven economies, notably that of the UK. Furthermore, the yuan will need enhanced credibility from gold, if it is to become the trade currency of choice throughout Asia, because gold is regarded as the saver’s money throughout the continent.

Modern economists will say that a sharply revalued yuan will undermine the terms of trade. This is to misunderstand the origins of trade imbalances, which arise principally from differentials in rates of growth of money supply and savings. So long as these are unaffected, a rising currency rate does not alter the balance of trade, only affecting the short-term profitability of exporting businesses. The response of an exporting business to a rising base currency is to invest in more efficient production to restore margins. Again, this is confirmed by the empirical evidence of Germany and Japan in the last century. China is already automating labour-intensive functions to a degree never seen before, rapidly improving output per worker.

The balance of trade will only deteriorate if the savings rate deteriorates, and if China’s savings rate remains significantly higher than those of her trading partners, she will continue to run a trade surplus, even on a stronger dollar/yuan rate. Furthermore, China, with the addition of the other SCO members, is due to become the largest internal market the world has seen since Roman times, marginalising the trade balance issue anyway.

We can therefore be sure China will continue to have a trade surplus, even with the yuan tied to gold. More worrying is the destabilising effect of introducing sound money on the other (unsound) currencies. If, as I suggested in my earlier article, China imparts a 4% yield to gold through the mechanism of an irredeemable bond yielding that rate on a currency-gold convertible basis, the effect on markets with gold lease rates of about 0.25% will be to drive the gold price sharply higher. This is another reason there must be a period between the announcement of the new gold standard and its implementation.

The effect on the dollar’s purchasing power would be to undermine it relative to that of gold. It will not take very long for this to be reflected in the dollar prices of other commodities, because commodity prices tend to be more stable expressed in gold than in fiat currencies. The undermining of the dollar’s purchasing power against commodities may not be immediate, but it is likely to accelerate as markets adjust to these new price relationships, making price inflation the dominant problem in America. The rise in interest rates that is bound to follow will certainly lead to systemic difficulties for the American banks.

Bank regulation

The reintroduction of sound money will have a major impact on the way banks operate. Fortunately, the Chinese government owns the major banks, so it can dictate banking policy without the repercussions that the Americans would face in the same situation from a powerful banking lobby. This is the crux of the argument in favour of a monetary system based on sound money, because the state must restrict the growth of bank lending to supress the credit cycle.

The degree to which sound money can be mixed with unsound money banking practices is necessarily very limited. If China embarks on a gold-backed yuan, it cannot continue to use unbridled credit expansion as a monetary or economic tool.

The history of the gold standard in the nineteenth century clearly showed that the expansion of bank credit always ended in a credit crisis. To avoid the crisis, the solution is to do away with bank credit. It is an open question whether the Chinese would be bold enough in its banking reform to do this, and whether they understand that the business cycle is in fact no more than a credit cycle. On this point hangs the durability of a sound-money arrangement.

If China does grasp this nettle firmly, it will need to separate deposit-taking from loan business. For customers, there must be a separation of spending liquidity from their savings. Spending liquidity can be maintained in cash or electronically in a custody account at a state bank, for which there will necessarily be service charges and no interest paid. Savings are recycled to borrowers through lenders who are forbidden to lend money they do not possess, only lending money they have already had pre-committed for the purpose. In short, public savings do not become the property of a lending bank.

Insurance companies are already in this business, as are peer-to-peer lenders. There will be plenty of alternative sources of funds for borrowers in an economy without fractional reserve banking, and modern advances in financial technology make both deposit-taking and the loan business cost-effective.

The arrangements of a banking system based on sound money are relatively simple to understand. The restrictions to its introduction lie elsewhere, because the global banking system as currently constituted has too many vested interests for sound-money systems to be adopted by Western governments. Bank regulators and bank executives have no experience of how a sound-money system works, instead seeking to control lending risk in a highly-leveraged fiat-money system. The essential flaw in this approach is to assume a state regulator understands commercial risk. And because the regulator is out of his depth, the system is always open to being gamed by the banks, while regulators are under political pressure not to admit to the presence of systemic weaknesses.

It is not only the regulators and the bank executives who are locked into a banking system that must ultimately fail. The economists that advise them are firm believers in the expansion of bank credit as a means of encouraging business activity and consumer spending. Keynesians and monetarists alike view the support of sound money policies as a form of mental aberration. But this is more than anything else a reflection of how far state-driven thinking has become removed from the realities of the markets.

Concluding remarks It is one thing to advocate sound money policies to replace the unsound money we all use today, but it is another to implement them. It requires a new revolution in economic thinking, and an understanding of why sound money matters with respect to prices. Its introduction is likely to disrupt the currencies and economies of the countries that remain with unbacked fiat money systems. Furthermore, if a sound-money arrangement for a currency is to be long-lasting, it will require the end of fractional reserve banking.

The purpose of this article has been to draw attention to just a few of the practical difficulties in reintroducing sound money. Sound money is radically different from what we have today, and so the only chance it will be reintroduced for the Western currencies is in the wake of a financial crisis so great that these unsound currencies are destroyed.

While this outcome is increasingly likely, no government or central bank is likely to give up easily the power of creating money out of thin air. This is certainly true in the West’s welfare-states, where there are enormous future commitments, considerably greater than can be covered through taxation. It is less true in China, Russia, and the member-states of the SCO, who could relatively easily adopt gold backing for their currencies, for the long-term benefit of their economies.

However, it would be a stretch of imagination to assume that the Chinese and Russians, as leaders of the SCO, fully grasp the implications with respect to monetary reform of this nature. Instead, the move towards gold backing for the yuan and then the rouble, if it happens, is likely to be on strategic grounds, or politically motivated.

That was the assumption in my original Insight article, published last week. This is a move that, if it happens, will be driven by evolving geopolitical interests, which appear to have accelerated since President Trump came to office. That being the case, we can only assume that once introduced, a sound-money yuan, or a rouble backed by gold, will be just the start of a revolution in economic thinking, exposing Keynesian and monetarist myths that are now so obviously undermining the future of the welfare-states.

 

  1. Once the US dollar goes bye bye, the Chinese will back the yuan to gold, or maybe the Russians back the ruble to gold, If China wants to wear the big boys pants, they will have to step up to the plate! China wants world economic power with there currency. 90% of the Chinese come from one tribe, the Huan. They are the new chosen tribe of economics steered by the chosenites of the ME. Can you say Rothchilds… always follow the new money.

    The federal reserve, wall street and politicians for the last 55 years have sold out the American people, we the people. We the American people need to start making citizens arrest of the above, if be with the help of the US military. 

    Stacking and packing

     

    • CentralTexan, Though I agree that arrest should and was needed to restore financial stability. It won’t happen as long as we the people have such low convictions and no discipline. I have hoped all my life for we the people to stand up and yet we the people have stooped as low as the political leaders who lead us to this muck standard.  In my sixties now, I now view myself in an economy of one, bracing myself for a major shift in the worlds economy. I hate seeing it this way, America has become pigs basking in the muck.

    • Can you say Rothchilds… always follow the new money.”

      Yes, I can.  But are not the Rothchilds the oldest of old Western money?

       

  2. Where is URFUTURE to tell us silver and gold are only going straight down and Bitcoin and Etherium are only going straight up?  I hope he has been short silver and long Bitcoin like he was telling us to do a few days ago.

  3. Last time I checked the periodic table there was just a single element for No.47 which was Ag.

    The crypto currency now number just shy of one thousand. This is up from just over one hundred a couple weeks back. Can you envision a foreseeable end to the gambit? Keep piling them on……….that’s a surefire way to add legitimacy and trust, after all there’s safety in numbers, right?

    https://coinmarketcap.com/

    • Precious Mental
      You get it!  The problem with cryptos is that while the issuance of any one X-coin, Y-coin or Z-coin may be limited there is no limit to the number of different cryptos that can be invented.  So as the most credible currency may be bitcoin it becomes less acceptable as it’s price rises and us speculators (who do little trading with them) decide to buy a cheaper crypto in the hope of making more moola.  The whole crypto paradigm thus decends into an infinity approaching ponzi of worthless variants with the most credible amongst them losing interest and thus credibility as it’s price attempts to rise.  At equilibrium all cryptos would become worth the same as any other of the cryptos: almost zero.  Equilibrium with never be approached however, there will be one crypto that emerges from the midden.

      There is only one way that any one crypto can triumph and that is by the legislation of “the” State including the Globalist State.

      Finally there will only be one crypto that anybody can use, issued by the global banking cabal.  With all other cryptos and currencies banned no one will be able to trade without having upon them or their digital (and recognisable) internet prescence the mark of Satan-coin!

      Currently Satan-coin is known simply as Ripple-coin.  I recommend you buy this as a hedge against gold, silver and resurrection risk.

      If my words did glow with the gold of sunshine
      And my tunes were played on the harp unstrung
      Would you hear my voice come through the music
      Would you hold it near as it were your own?

      It’s a hand-me-down, the thoughts are broken
      Perhaps they’re better left unsung
      I don’t know, don’t really care
      Let there be songs to fill the air.

      Grateful Dead – Ripple

       

       

  4. A gold standard will never work. It will never work for the same reason the price is at an insane point right now. The bad guys will always cheat. Every gold standard has been manipulated for the profit of the standard Enforcer.

    A hard cap Fiat like Bitcoin or Litecoin is a better option. Let the market determine the price of gold in a hard cap Fiat.

  5. @ natxlaw

    To fix that particular conundrum Nixon could have just raised the price of gold to absorb the fiat they printed. A dollar devaluation would have solved that problem as well. What could possibly go wrong with that? Those were the only 2 choices over a default. He chose default. Why didn’t Nixon just manipulate the issue away? No such option.

    On June 5, 1933, the United States went off the gold standard, a monetary system in which currency is backed by gold, when Congress enacted a joint resolution nullifying the right of creditors to demand payment in gold. The United States had been on a gold standard since 1879, except for an embargo on gold exports during World War I, but bank failures during the Great Depression of the 1930s frightened the public into hoarding gold, making the policy untenable.

    One of the chief virtues of a gold standard is that it serves as a restraint on the growth of money and credit. It makes runaway government deficit spending and major monetary catastrophes such as hyperinflation practically impossible.

    • @Justin Case

       

      “To fix that particular conundrum Nixon could have just raised the price of gold to absorb the fiat they printed. A dollar devaluation would have solved that problem as well.”

      Devalue the dollar OR raise the price of gold.  Is there a real difference between these two options?

       

    • Raising the gold price would devalue all fiat currencies.

      Devaluing the dollar would impact only USD exchange rates to all currencies and holders of USD reserves. Gold price would not change in their local currencies, but they could buy dollars cheaper. Good for US exports, they will have the advantage. Oh wait, that’s what everyone is doing now! 😉

  6. But, but, but, how is the FREE $#!T ARMY (FSA) going to steal the wealth of the producers without  Paper Theft Certificates or the proposed Digital THINGIES?

    The hangers-on mooching class? will just have to go and get a job under a Gold Standard.

    It is no wonder they are panicking.

    Never mind, if the Western world does not adapt to the coming ‘ONE BELT ONE ROAD’ being installed by China & Russia we will end up as so many educated people have said, as 3rd Countries.

    Stackin’ for the inevitable*. _JLG. 

    p.s. TROLLS should do a GGL search of the word ‘inevitable*. 

    • @JohnLGalt

       

      “But, but, but, how is the FREE $#!T ARMY (FSA) going to steal the wealth of the producers without  Paper Theft Certificates or the proposed Digital THINGIES?
      The hangers-on mooching class? will just have to go and get a job under a Gold Standard.
      It is no wonder they are panicking.”

      How, indeed?  It is my contention that this is what lies at the very heart of the hysteria that currently grips the American and European left.  The mere thought of their beloved nanny state going bye bye has them writhing in one conniption fit after another.  Being able to buy the votes of political whores in office is the essence of the whore’s and the left’s political power.  We have in fact taken a stab at their very heart.  Unless this blow is deflected somehow, it will destroy them utterly because they will then have nothing left with which to buy the votes they need to remain within the public trough.  Why, they might even have to get REAL jobs where they actually HAVE to produce something worthwhile!  Egads and all that!

  7. All currencies throughout history have fail without exception. Average life span is 60 yrs. With some tweaking of policies they can extend the life. The US is a cadaver with the lines still hooked up to it, to give the impression that it can still come to life. Extend and pretend. The biggest problem the FED has is the balance sheet. That is Pandora’s box.  Inflation is already apparent in some countries, like food prices in the UK for one. There is just too much debt for the economy to function. Low rates have allowed consumers to pull forward their future incomes to float the economy today. The merican economy is a low flying plane that is losing speed. 10  yrs and no organic recovery.

  8. “The return to a gold standard and the insulation from financial catastrophe that China and Russia will hopefully provide should guide us in our post-crisis monetary reform.”

    Sure… for those who survive the utter chaos and social upheaval that a financial collapse will cause.

     

    “A golden yuan will reward savers, and it is savings that drive successful economies.”

    Agreed.  The Keynesians have confused “debt” with “money” and tend to use these two terms interchangeably when they are anything but interchangeable.  Debt being the mere promise of payment while money being what is used to settle debts.  People can and will promise just about anything because that is a lot easier than actually handing over real wealth to settle a debt.

     

    “Furthermore, if a sound-money arrangement for a currency is to be long-lasting, it will require the end of fractional reserve banking.”

    So, herein lies the rub.  This is something that the Western bankers will give up only when the alternative to this license-to-steal is the certain loss of their lives or liberty.

     

    “Sound money is radically different from what we have today, and so the only chance it will be reintroduced for the Western currencies is in the wake of a financial crisis so great that these unsound currencies are destroyed.”

    Yes, it is but its loss will come at what price?  The complete destruction of all paper wealth?  Since about 97% of the people in the US have only paper wealth, how will they survive the loss of their entire life savings?  Some way will have to be found where the economic and financial damage that has been done over the past several decades is unwound slowly enough that people can adapt to the new reality.  This is particularly so of older people who simply don’t have the time to create a new life savings program.  Even the Fed has no plans to “unwind” their bloated balance sheet instantly.  Instead, they will attempt this over time because that is what has the best chance of success.  Are the citizens any less susceptible to economic chaos than is the central bank?  No, they are not.  In fact, a good case could be made that their resources are FAR less than the Fed’s, so even more time would be needed in their case.

     

    “However, it would be a stretch of imagination to assume that the Chinese and Russians, as leaders of the SCO, fully grasp the implications with respect to monetary reform of this nature.”

    It might be a bigger stretch to assume that they do not grasp the idea that a gold-backed currency is a tremendous strategic weapon in any sort of financial or economic warfare.  Sun Tzu’s The Art of War contains much wisdom that can be applied to many things other than military matters.  It would be foolish, indeed, to assume that the Chinese are not doing this in multiple ways.

     

  9. Jim Willie’s idea of a domestic dollar for the U.S. that is devalued say 30% straight away and then if that survives and is accepted locally this may buy a bit of time.

     

    There is going to be heaps of pain for the unprepared in the West.

     

    Once again, let me remind people that the Chinese Gov’t is advising their citizens to BUY GOLD. 

    • a domestic dollar for the U.S.

      I think this is where the SDR comes into play. There have been rumors that the SDR will be the global currency made up of a basket of many currencies and gold. That would explain why Russia and China are buying so much gold. The SDR might bail out the bankrupt US. China and Russia have wanted moar to say about global monetary systems and global trade, so they want to have moar gold to have moar say. As Putin and China have said, the uni-polar world is ending.

      I still don’t understand the true mechanics of how this will work or if it’s true. They (BIS,IMF) are playing their hands close to their chest as to not give anyone advantage of front running this, other than the ones that are part of the banking cabal and inner circles, not the goyim or plebs.

       

       

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