From 2007 the crises have grown - Central Banks can't fix it alone!
Whether it is Bill Gross of Pimco, Marc Faber, ourselves or so very many competent analysts in the financial world, to a man, are warning of the destructive power of rising interest rates. Now in addition to all of us, we have the central banker of central bankers, the Bank of International Settlements, giving a serious warning to developed world governments that it is perhaps too late to rely on growth to rescue the global economy from deflation.
To their credit, central banks in the developed world have, in their supportive way, given muted recommendations of a similar nature, that governments and the entire political system should be instituting programs that stimulate economic activity from the ground up. But over the last six years after discussion after discussion, they have failed to give fundamental stimulative support to central banks to get developed world economies going. The democratic process itself, whether in the U.S. or in the Eurozone has conspired through partisan or national agendas to defeat a united move to stimulate growth even without intending to!
Governments have made considerable efforts to reinforce the banking system, on which they depend for the working of the system, but have largely ignored the needs and aspirations of their voting base. We now look at not only 'hung' governments, but a disjoint from the people they represent. Consequently, the most pressing problems facing their electorate, the economic ones, have been badly mishandled, neglected or just plain ignored.
After the 'credit crunch' of 2007/2008, involving 'just' the banking system, which nearly brought it down, U.S. efforts to 'fix' the problem simply let it continue with some capital buffers, but the underlying problem has not really been addressed [the levees have been raised but another 'storm surge' could still knock them down]. After that we have seen the Sovereign debt crisis of the Eurozone nearly spread a destructive solvency crisis among the weaker members of the E.U. Not only have the problems there not been fixed [yes, the levees have been raised there too], but the structural problems have been starkly highlighted through awful unemployment levels, [56% among the youth 26% overall in the weaker member nations] but not fixed.
Out of these structural problems not only do we find social unrest rising, but the people generally are expressing their disappointment in the democratic system as never before, feeling as they do the victims of government and banking failures.
And now we are warned of a coming storm surge that so many now forecast, that of rising interest rates. Despite the fact, known from the beginning of the 'credit crunch', that central banking 'cures' are not enough by themselves, the developed world has relied on them to solve the crises. No doubt they will also be the scapegoats when the storm surges overwhelm the levees.
The Bank of International Settlements Warning
The Bank of International Settlements has warned that Banks face another global financial crisis worse than 2007-8 as a $10 trillion central bank bond mountain leaves them perilously exposed to higher interest rates.
The Federal Reserve recently triggered a global tightening of interest rates with hints it may start to wind down its money printing as soon as this September.
Bondholders
The problem is that higher interest rates mean lower bond prices, and the banks are full of this supposedly safe debt. HSBC perhaps the most conservative of the world's large banks has 42% of its balance sheet in U.S. bonds.
When interest rates go up the banks make losses on their huge bond portfolios as yields rise and prices fall. Global central banks have accumulated $10 trillion in bonds that will also face massive losses. The B.I.S. says, 'Someone must ultimately hold the interest rate risk. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.'
The B.I.S. has issued an urgent appeal for fiscal and monetary prudence well after the horse has bolted. They continue, "Public debt in most advanced economies has reached unprecedented levels in peacetime,' says the report. 'Even worse, official debt statistics understate the true scale of fiscal problems. The belief that governments do not face a solvency constraint is a dangerous illusion. Bond investors can and do punish governments hard and fast. Governments must redouble their efforts to ensure that their fiscal trajectories are sustainable. Growth will simply not be high enough on its own. Postponing the pain carries the risk of forcing consolidation under stress which is the current situation in a number of countries in southern Europe.'
The BIS sees the global economy heading for a 1994-style bond market crash.
A 'credit crunch' in China?
A recent spike in short-term interest rates well above 30% caught China and the world by surprise. Today the overnight repurchase rate today is 6.5%, which is more than double this year's average. While the Chinese government has almost total control over its banking system, if the situation is manageable, they will manage it.
But what can the Chinese government really do now, having made its policy errors many years ago?
China, because of Capital Controls is largely immune from any storm surge that may come from outside, as interest rates rise in the U.S., but with its $3.3 trillion in reserves mainly invested in the U.S. dollar and its bonds, the actions they must now be taking could have a severe impact on the US. Treasury markets.
Consequences
The picture being painted since 2007 is one of a steadily decaying monetary system that has been 'patched up' as we have moved along. No real reformation needed to halt the decay has taken place. If it had the B.I.S. would not have needed to issue such a warning and a dire one at that. The measures taken over the last six years have averted a collapse of the monetary system but not much more. And now we have one that could see the reinforced levees giving way under the weight of interest rate rises.
The concept that 'cash is king' usually took hold ahead of interest rate rises at the end of a boom, but the only 'boom' we have had has been cosmetic. Growth remains fragile at the early stage of a recovery even at 2%, in the U.S. and in a recession still in the Eurozone. This means that interest rate rises will undercut any economic recovery and send it into a long deflation, because of the failure of the last six years to resuscitate economies. Confidence will collapse, taking hope away.
But the legacy of the massive increases in money supply over the last few years, combined with a slip into deflation, will, as we have persistently forecast over the last six years, take away the ability of the central bankers to keep the banking system solvent. As prices fall in bank held debt, balance sheet problems of asset values will once again create the crisis the B.I.S. is warning about. But this time higher levees will just not be enough.
The consequences to gold
The gold price has fallen of late, 20+%. Most of this was a well-engineered 'bear-raid', but it is still deterring buyers and the price is still slipping. As we saw in 2007/8 the gold price fell similarly among fears of deflation then too. But then came the facet of gold that it has always had. It is both an asset and international cash. And we live in a global world now, where the effect one major economic bloc has on the next is huge. They just can't ignore one another's financial plights. It is the global nature of gold's acceptance that is likely to cause it to be recognized once more as global money facilitating the functioning of the monetary system.
In the past when interest rates rose, gold as an asset did fall, but this time interest rates will not rise because of the growing health of economies, but will undermine economic growth. Will central banks then return once more to QE to bring rates down? Undoubtedly they will, but by this time financial markets will be fully mercurial. Interest rate rises will then not be a confidence builder, as economic recovery proves resilient, but a destructive force on confidence, as economic growth once more sags. At this point the developed world, at least, will have moved into 'extreme times', such as leave financial and monetary systems in doubt.
Many analysts look at gold in the context of 1933's confiscation as solely a function of the internal monetary system. But now such a confiscation could easily happen in the context of the global monetary system, where gold reinforces the international roles of local currencies. Indeed, the reasons behind the 1933 confiscation of gold will not apply in the future, because gold has an entirely different monetary role now. It is its international role in the global economy that becomes pertinent. When global extreme times take hold the number of ounces of gold a nation has to back up its currency on the international scene, will be critical to the level of confidence its national currency inspires.
In a multi-currency monetary system, gold will have a place, one that supports and facilitates it in its present form. Bearing in mind that the interest rate rises will not be restricted to the U.S. but spread far and wide, many economies will slide into recession. "Carry Trade" dollars will be unwound and return home hitting exchange rates the world over and likely undermine growth in countries where the dollars were invested. It is in such extreme times that currencies will need to have confidence in them reinforced. This is where gold comes in.
We believe the B.I.S. warning should also be seen in that global context.
Hold your gold in such a way that governments and banks can't seize it!
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