Global Monetary Architecture

The quarterly Incrementum Advisory Board meeting was held last week (the full transcript is available for download below). Our regulars Dr. Frank Shostak and Jim Rickards were unable to attend this time, but we were joined by special guest Luke Gromen of research house “Forest for the Trees” (FFTT; readers will find free samples of the FFTT newsletter at the site and in case you want to find the link again later, we have recently added it to our blog roll). Below we add a few remarks on a topic Luke Gromen is paying a great deal of attention to.

 

Special guest Luke Gromen of FFTT.

 

For readers not familiar with FFTT, Luke has a very special ”big picture” focus, namely the current global monetary architecture and the ways in which it might change. The US dollar has been the world’s senior currency for many decades, but history suggests that this mantle will eventually be passed on. Accumulation of dollar reserves by foreign central banks has soared since the turn of the millennium, and the most conspicuous increase has taken place in China, which has long surpassed  former top reserve holder Japan.

It is no secret that many foreign governments look askance (and perhaps with a bit of envy) at the “extraordinary privilege”, as Charles de Gaulle once put it, which the dollar’s reserve currency status bestows on the US. Presumably they have all the more reason to do so nowadays. Prior to Nixon’s unilateral suspension of the Bretton Woods gold exchange standard, it could at least be argued that the “privilege” was limited to some extent by the size of US gold reserves.

In addition to the economic advantage the dollar’s reserve currency status is deemed to convey, there is also a geopolitical dimension to the currency’s role. China and Russia in particular are not entirely happy with the current “unipolar” dispensation – despite the fact that they are largely tolerant of the so-called Pax Americana, and even seem to welcome it to some extent. Still, the governments of both countries clearly want to control their own spheres of geopolitical influence, and often state that they would prefer a “multi-polar” world.

 

China’s forex reserves (most of which are denominated in USD) have grown relentlessly for decades, but it appears as though a significant peak was reached in 2014 – click to enlarge.

 

In 2014 the trend in global reserve accumulation began to turn down, as exemplified by China’s reserves in particular (see above). Given that the lion’s share of global trade is invoiced in USD, the governments of countries like China and Russia probably feel as though they are funding their most powerful potential adversary, but they have had little choice in the matter so far – their central banks buy whatever currencies their export sectors earn.

Central banks then “recycle” these forex purchases and occasionally diversify them a bit, but then they are faced with the fact that the USD and the US treasury market are the most liquid currency and bond markets in the world,  hence diversification opportunities are limited as well. In light of all of the above, it is no surprise that China’s government has made every effort to promote the yuan as a trade and reserve currency. To date the success of these efforts was rather modest though.

Here is though where Luke’s observations come in. The fact that China had only  moderate success in establishing the yuan as a trade and reserve currency so far (this includes the symbolic success of the yuan becoming part of the SDR currency basket) doesn’t mean it isn’t continuing to pursue the matter. There are certainly numerous ways in which acceptance of the yuan could be boosted  – beyond the effects of bilateral trade settlement agreements China has entered into with a number of nations. An obvious one would be to make the yuan fully convertible, which the government apparently wants to implement very gradually. Anything that involves the government ceding a lot of control is usually handled at a glacial pace.

 

New kid on the block?

 

Luke is currently focusing on a different development though, one that reminds us strongly of an idea forwarded by Dr. Antal Fekete. Fekete essentially argues that one of the pillars on which the post-Bretton Woods fiat money system rests is the fact that there are highly liquid gold markets  – both futures and spot gold markets, with the former including the possibility of standardized physical delivery. In Fekete’s words, gold is the “ultimate extinguisher of debt” – and its availability in bullion and gold futures markets allows it to at least function as a “residual extinguisher of debt” these days.

Readers may well wonder what that is supposed to mean – after all, Federal Reserve notes are “legal tender for all debts, public and private” – it says so right above the treasury secretary’s signature. Moreover, experience suggests that dollars can certainly be used to discharge debts (the same holds for other fiat currencies in their respective countries of issue). An important wrinkle is also that governments won’t accept anything but the currencies they issue for payment of taxes.

These legal stipulations create demand for fiat currency. However, the salient feature of said demand for fiat currency is that it rests primarily on coercion –  both legal tender laws and taxation are coercive. Note that not even hyper-rich limousine socialists like Warren Buffett pay a single cent more in taxes than they absolutely have to. Although Mr. Buffett often talks about the alleged need for higher taxes, claiming to be saddened by his own far too low tax bill, we note that his commendable philanthropic endeavors so far do not involve any voluntary donations to the IRS.

In today’s world, the dollar is money and gold isn’t. Money is the general medium of exchange, the thing that is used as final payment for all other goods and services in the economy. The dollar clearly qualifies under this definition. Nevertheless, gold retains all its essential monetary characteristics; it is so to speak a currency without a passport, a money-in-waiting.

It is the money that originally emerged in the free market and the markets certainly continue to regard it as a monetary asset. The unspoken assumption is that it has the potential to rapidly reemerge as a medium of exchange if/when the current debt-money house of cards falters and joins its predecessors in the hereafter.

 

China is home to a great many gold aficionados. A number of them can probably be found in government circles as well.

 

There was certainly a good reason why it was considered necessary to initially base the post-WW2 monetary system on a gold exchange standard and why the central banks of the largest currency areas continue to hold sizable gold reserves even long after the collapse of the Bretton Woods agreement. Legal stipulations are quite effective, but they are definitely not enough to inspire acceptance of a fiat currency – especially global acceptance as a trade and reserve currency.

Dr. Fekete seems to imply that even though there is no longer a gold standard and thus no longer a fixed rate at which government scrip can be redeemed for gold, the fact that one can obtain gold at anytime in fairly sizable amounts in the markets, means that there is at least an escape hatch for dollar holders. Indeed, XAU-USD is the fourth-most liquid currency pair.

 

Mandarins Hatching Plans

Given Luke’s focus on the dollar-centric global monetary architecture  – which he considers highly vulnerable – he is a keen observer of what is happening in China. China has inter alia established very sizable financial markets, among them one of the world’s largest gold exchanges based in Shanghai (SGE). A particularly noteworthy feature of the SGE are the large amounts of physical gold deliveries effected there. The chart below compares bullion withdrawals from the SGE with CME deliveries.

 

SGE vs. CME gold deliveries, annually – click to enlarge.

 

Apparently China’s mandarins plan to open trading on the SGE to foreigners, which we assume would include physical delivery. Readers can probably see where this is going:  keeping in mind Dr. Fekete’s “residual debt extinguisher” idea described above, the possibility to purchase yuan-denominated gold contracts and  receive physical deliveries of gold for them would presumably have a similar effect on perceptions about the yuan as Western gold markets have with respect to strengthening acceptance of the dollar.

Provided gold obtained through the SGE can be easily exported, this would amount to a kind of back-door yuan convertibility, a pseudo Bretton Woods gold cover at freely fluctuating rates. And in keeping with Dr. Fekete’s notion, it would be the mere perception that it can be done that would be the decisive factor,  rather than the actual amount of delivery demands. We have pondered whether such deliberations are perhaps a tad too abstract, but we have tentatively concluded that they are not.

Consider for instance the euro area’s sovereign debt and banking crisis that culminated in 2011 (for the time being, anyway). Clearly a large number of people weighed the relative merits of the euro currency, European bank deposits and gold precisely in the terms implied by Dr. Fekete’s idea. Gold demand rose strongly as a result and between the summer and early fall of 2011 gold traded at a steep premium. The escape hatch was definitely put to use.

Lastly, China’s planners reportedly wish to change China’s economy on a structural level, by slowly moving the economic model away from the high fixed investment, export oriented approach pursued until now toward a more services and consumer focused economy. We suppose it would be easier to implement this plan if acceptance of the yuan as a global trade and reserve currency were to increase significantly. We think they would be quite happy to see the yuan and the dollar trade places; and while we believe that this will still take a very long time, the journey from A to B could get quite interesting.

 

Currency messenger service.

 

Other Topics & Transcript Download

As always, a wide range of topics was  discussed at the meeting; we just want to add to this that we will soon expand on the remarks regarding the stock market in these pages. Regular readers already know that we expect the recent sharp decline in US money supply growth to exert a noticeable lagged effect on asset prices and economic activity and we have put together a number of charts and ideas that may prove useful in this context in coming weeks and months.

The transcript of the meeting can be downloaded here: Incrementum Advisory Board Meeting, July 2017 (pdf).  Enjoy!

 

Charts by: TradingEconomics, ShareLynx

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

One Response to “Incrementum Advisory Board Meeting, Q3 2017”

  • Kafka:

    “Provided gold obtained through the SGE can be easily exported,”

    Good luck with that! Buying gold on the SGE for foreigners is de facto selling yuan. The Chinese will be glad to more “your gold” from one side of their Chinese warehouse to the other side, but it won’t be leaving China.

    But the most important step for China is to grow some balls and de-peg from the supposedly defective USD. They can’t and they won’t. But talk, they will.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • The Gold Sector Remains at an Interesting Juncture
      Technical Divergence Successfully Maintained In an update on gold and gold stocks in mid June, we pointed out that a number of interesting divergences had emerged which traditionally represent a heads-up indicating a trend change is close (see: Divergences Emerge for the details). We did so after a big down day in the gold price, which actually helped set up the bullish divergence; this may have felt counter-intuitive, but these set-ups always do. Consider now the updated chart below...
  • Confronting the Dragon with Peter Navarro
      Of No Real Use A young man might go to business school believing he is obtaining some sort of academic training that will enable him to make a comfortable living.  His degree may gain him entry into a large corporation, where he can work his way up to a good income.  This may even put him on the fast track to what he envisions as success.   Don't knock it: Being useless can lead to unexpected career opportunities... [PT]   But his academic training likely won't...
  • Trouble in Paradise
      Impressive Zeal for Faded Ideals Uncompromising independence, rugged individualism, and limitless personal freedom were once essential to the American character.  According to popular American folklore, they still are.  We have some reservations.   Rugged individualists suffer mid-life identity crisis. [PT]   The principles that gave rise to the American character died long ago.  Freedom.  Liberty.  Independence.  Limited representative government. Sound...
  • The United States of Terror
      Bombs Away! Two recent articles* have again demonstrated that the greatest “terrorist” entity on earth are not the bogymen – Russia, China, Iran, North Korea – so often portrayed by Western presstitutes and the American government, but the United States itself!   This is an old cartoon, but still a good one. It perfectly describes the trigger-happy Western political class and the depth of its “thinking”. By happenstance we recently reviewed the Libya intervention...
  • Gold – Macroeconomic Fundamentals Improve
      A Beginning Shift in Gold Fundamentals A previously outright bearish fundamental backdrop for gold has recently become slightly more favorable. Ironically, the arrival of this somewhat more favorable situation was greeted by a pullback in physical demand and a decline in the gold price, after both had defied bearish fundamentals for many months by remaining stubbornly firm.   The eternal popularity contest...   The list of gold fundamentals that have improved is...
  • Capitulation and Currency Pain - Precious Metals Supply and Demand
      Waving the White Flag The price of gold rose two bucks last week, though the price of silver fell 10 cents. We have seen several analyses recently predicting big price drops, in one case by at least $500 in gold by the end of the year. Is this what capitulation looks like? It’s said they don’t ring a bell at the top, but they don’t ring a bell at the bottom either.   The give-up moment arrives... [PT]   We have also seen technical analysis arguing that...
  • Maurice Jackson Interviews Rick Rule – Investing in Natural Resources
      Contrarian Investment Opportunities in Natural Resources Maurice Jackson of Proven and Probable has recently interviewed Sprott U.S. Holdings CEO Rick Rule, a well known specialist and “old hand” in the natural resource space. This is quite a wide-ranging and interesting interview, so we decided to present it to our readers. Below you find a summary and our comments on the main topics discussed, a video/podcast of the interview,  as well as a download link to a PDF file of the...
  • Black Holes for Capital - Precious Metals Supply and Demand
      Race to the Bottom Last week the price of gold fell $17, and that of silver $0.30. Why? We can tell you about the fundamentals. We can show charts of the basis. But we can’t get into the heads of the sellers.   Other people's fiat: in the global race to the bottom, it was recently the turn of emerging market currencies to tank. [PT]   We can say that in the mainstream view, the dollar is rising. The dollar, in their view, is not measured in gold but in rupees in...
  • The True Sport of MAGA
      Chest Bumps One of the more extraordinary things that investors have seen in living memory is unfolding at this precise moment. This goes for business leaders, money managers, veteran Wall Streeters, value investors, 401(k) holders, momentum traders, FX guys, gold bugs, technical gurus, chartists, pork belly speculators, quants, astrologists, Larry Summers, put option sellers, dweebs and geeks, millennial index fund enthusiasts, and everyone in between.   Pork belly speculators...

Support Acting Man

Item Guides

j9TJzzN

The Review Insider

Dog Blow

Austrian Theory and Investment

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com