Currency wars and bond collapse
The latest round of currency wars has begun. Countries all around the world are lowering interest rates and printing money with the aim of devaluing their currencies in order to boost exports and stimulate growth. This is just the inevitable reaction by politicians and central banks around the world as it becomes clear that there really is no recovery, and that the world has been in an ever-deepening economic depression for at least the last 4 years.
Swiss, Japanese and Brazilian officials have publicly stated that they are manipulating exchange rates to keep their currencies weak.
The governor of the bank of England, the Japanese prime minister and the Brazilian finance minister have all declared that there is an intensifying international currency war.
There is no long term net benefit in currency devaluation if many countries engage in the currency wars. The devaluations cancel each other out, and the only eventual effect is inflation.
One of the main goals of quantitative easing and keeping interest rates low, is to keep bond yields low and prices high in order to maintain the impression of a particular country’s bonds being a safe haven for investors during times of turmoil. Central banks’ low interest rates and constant injections of cheap money into the system to bail out banks and keep the system afloat can’t last forever.
Sooner or later, the markets must realize that these countries have huge amounts of debt, and future unfunded liabilities, which can never, in real terms, be paid back. Inflation is already picking up around the world as central bankers try to inflate the debt away.
Countries like Japan and Britain are in particularly bad shape. Japan’s new prime minister had already said that they will print as much money as they think is needed. Britain has been rocked by the horsemeat scandal, whereby massive amounts of horsemeat was sold as, and mixed with beef. This ‘debasement’ of beef is just one form of inflation, and one wonders how much longer the UK can go without devaluing their currency significantly.
When market forces can no longer be escaped, and interest rates start going up, the world economy will be forced onto its knees. Governments will either have to massively slash their spending (in many countries, government spending is a major part of GDP, cutting spending will lead to mass unemployment, and economic contraction) or they will buy their own bonds, or simply print the money, all of these actions will cause hyperinflation.
It seems that the major central banks of the world won’t stop printing money until they run out of paper.
There is a real risk that when currency wars don’t have the desired effects (and they won’t), history will repeat itself. A major catalyst of World War 2 was the currency wars that started in the 1930's in Europe. When the currency wars going on at the moment fail to stimulate growth, there is a risk that real wars will start.
This may sound unimaginable, but unless drastic change takes place in the world, coming from the bottom up, we may be facing world war type scenario within 4-5 years.
The European house of cards is beginning to tumble. Much focus is placed on the peripheral debt laden countries in Europe, such as Greece, Italy and Spain. These countries are suffering from the effects of being chained up in a European Union, which blatantly disregards national sovereignty and the will of the people in these countries. This has led to increasing unemployment, stagnant growth, and a drop in the quality of living.
The scary thing is that the European crisis has only really just begun. For the first time, the very core of the European Union is starting to head into trouble. The economic data coming out of France, the Eurozone’s second largest economy has been sobering, vehicle sales are down 13% in 2012, new home sales are down 25%, and high end apartment sales in Paris are down 42% in 2012.
Add to this the fact that French unemployment is at a 15 year high, GDP growth in 2012 was 0%, and that government spending is responsible for 56% of GDP anyway. The French employment minister has admitted that the country is now “totally bankrupt”.
German industrial production is back down to 2007 levels, and GDP growth across the Eurozone is stagnant despite quantitative easing and bailouts.
Spanish and Italian bond yields will keep on rising, as the façade of a recovery is being torn down. Unemployment in Spain is higher than that of South Africa, and there is an increase in riots and protests against the unelected, unaccountable bureaucrats of the European Union whose policies are forcing them into austerity.
We are seeing the 21st century rise of European nationalism. The real European Crisis is only beginning.
Stock Market Crash
A major stock market crash in the US is imminent, some correction is due sometime in the near future. The Dow Jones Industrial Average is up 6.4% so far this year after a six week rally which has left it at its highest since July 2011. Markets are at euphoric levels. Historic data from the last 30 years shows that recoveries typically peak in the 5th year post crash before taking a dip. We are entering the period in the cycle now where risk appetite is peaking and reality starts sinking in.
Financial prosperity and median income for individuals and families all over the world are falling quite significantly. Real wages of the middle class in most countries around the world are stagnant if not declining. Ultra low interest rates do not help either, in fact it is destroying the middle class by wiping out savings. The average person can’t get any sort of interest return on the money they are saving for the future; meanwhile central banks are printing money to create inflation.
Stocks are overpriced, and do not correspond with the actual economic conditions. Currently, equity prices are driven by the actions of central banks and not actual economic growth and this could very well lead to a very big crash in the stock market, perhaps as soon as April. Whether this crash is only going to affect the stocks, or whether it will spill over to bonds and commodities remains to be seen.
“The market can remain irrational longer than you can remain solvent” – Maynard Keynes.
Based on historical trends and the business cycle, we are on the brink of a contraction in the stock market. What increases the risk of a more serious crash however is the fact that markets are already trading at artificial highs due to low interest rates.
The implication of this is a bigger fall in the markets, causing a bigger shock.
Such a shock in the bond market will lead to central banks' printing of more money, firstly to try keeping interest rates from skyrocketing, and secondly to bail out banks who are caught up in highly leveraged derivatives tied to bond markets.
Despite the massive increases in money supply and the low primary interest rates, inflation has been relatively low.
The hyperinflation monster is almost impossible to destroy once its unleashed, but the tipping point is moving closer.
This may sound far-fetched and overly pessimistic. But the truth is that governments can’t keep on spending recklessly, print more and more and bail out banks without having to face disastrous consequences. Governments probably would have gotten away with this if there were subsequent growth and recovery, which would have allowed for the bad debts to be written off over time. But this isn't happening. Whatever little bit of capitalism left in the world before the bailouts of 2007/08 were obliterated. Taxpayers were forced to subsidize failure. Capitalism wasn’t allowed to work, capital was allocated to institutions that shouldn’t exist, either because they couldn’t operate responsibly or allocate resources efficiently.
The only people in favor of the bailouts were politicians who rely on campaign contributions, bankers whose jobs were on the line, certain delusional academics and central bankers who are responsible to their shareholders (central banks are not government institutions, they are owned by commercial banks).
Gold and Silver
When considering the implications of the impending bond apocalypse, the 2 most obvious questions that arise are: a) What will set it off?, and, b) Where will all the money go?
Money from a selling off of bonds probably won’t go back into currencies (dollars, euros, sterling etc.) because there is a fundamental link between a country’s bond prices, and that country’s currency strength. The money will go into hard assets. Precious metals are the only things, which have consistently been used as money for roughly the past 6000 years (a medium of trade and a store of value).
The world has been and always will be on a gold standard. At different times different systems are used, but these systems are unreliable and typically don’t last very long.
The world has been off the gold standard since at least 1971, when Nixon declared that dollars would no longer be redeemable in gold. Politicians and central bankers favor the “flexibility” of a paper money system. A paper money system allows governments to launch extensive wars, create generous social programs, bail out banking corporations, pile up debt and devalue currencies for export boosts. This may produce artificial short-term prosperity. However there will always be unfavorable consequences.
"We contend that for a nation to try to tax itself into
prosperity is like a man standing in a bucket and trying
to lift himself up by the handle." – Winston Churchill
Once you cut through all the quantitative easing, unfunded liabilities, deficit spending, manipulated interest rates, trillions in debt, quadrillions in derivatives and smoke and mirrors that come with a paper money system, the only thing left is gold. Since 2009, central banks have become net buyers of gold for the first time since 1964.
Central banks know that if there were sudden crises, or a dumping/devaluation of a major currency, like the dollar, foreign reserves will be useless, and the only resource of undisputable value will be gold.
Countries like Russia and China have been especially interested in increasing its gold reserves.
China is the world’s largest gold producer (overtaking South Africa in 2006), but exports very little of what is mined. Officially, Chinese gold reserves stand at just over 1000 tons, but many experts believe that the actual number is much higher. If China were to ever announce that they have increased their reserves to 2000 or 3000 tons, it would be a massive shock. China has no interest in upsetting an already very fragile world economy, due to their reliance on exports to the west. At some point however, they will work out that the costs of trading in a currency-war torn dollar-dominated world are higher than the benefits of propping up a declining world economy.
In recent times, when panic is high, gold (the traded commodity) goes into brief spells of backwardation. This means that the spot price of the commodity is higher than the future price. This is because investors would rather take delivery of the physical immediately, and not be subject to counterparty risk. An interesting figure to keep an eye on is the London gold offered forward rate (GOFO). This is the interest rate that has to be paid to lend out gold and borrow currency.
The GOFO is currently at historical lows, and has the potential to go negative (which means that someone will pay you interest to borrow your gold). This indicates stress in the gold market, and may coincide with backwardation. If there is a bond, or currency crisis of some sort, gold will go into long-term backwardation, and potentially lose its currency value, this means that gold owners will be unwilling to trade their gold for the particular currency at any price. For example, as a result of their hyperinflation, no one will trade their gold for Zimbabwean Dollars.
So far, this year gold prices have been declining, but that is partly due to bullish equity markets, and recovery propaganda. I don’t think the gold price will fall below $1600/oz again this year. It has hit its cyclical low, and will be stable, until some sort of shock hits the system.
A fish rots from the head down. Positive economic and social change always comes from the bottom. We can only change things when we learn self-respect. We need to educate others and ourselves about the problems we are facing and the possible resolutions.
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