by Alasdair Macleod, GoldMoney:
It has been a disappointing year for profit-seeking precious metal investors, but for those few of us looking to accumulate gold and silver as the ultimate insurance against runaway inflation it has been an unexpected bonus.
After reviewing the current year to gain a perspective for 2022, this article summarises the outlook for the dollar, the euro, and their financial systems. The key issue is the interest rate outlook, and how that will impact financial markets, which are wholly unprepared for the consequences of the massive expansions of currency and credit over the last two years.
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We look briefly at geopolitical factors and conclude that Presidents Putin and Xi have assessed President Biden and his administration to be fundamentally weak. Putin is now driving a wedge between the US and the UK on one side and the pusillanimous, disorganised EU nations on the other, using energy supplies and the massing of troops on the Ukrainian border as levers to apply pressure. Either the situation escalates to an invasion of Ukraine (unlikely) or America backs off under pressure from the EU. Meanwhile, China will continue to build its presence in the South China Sea and its global influence through its silk roads. Less appreciated is that China and Russia continue to accumulate gold and are ditching the dollar.
And finally, we look at silver, which is set to become the star performer against fiat currencies, driven by a combination of poor liquidity, ESG-driven industrial demand and investor realisation that its price has much catching up to do compared with lithium, uranium, and copper. The potential for a fiat currency collapse is thrown in for nothing.
2021 — That was the year that was
This year has been disappointing for precious metals investors. Figure 1 shows how gold and silver have performed since 31 December 2020.
Having lost as much as 11.3%, gold is down 6.5%. And silver, which at one stage was down 19.3% is down 15%. Admittedly these returns followed strong gains in 2020, so 2021 could be described as a year of consolidation.
But this outcome was counterintuitive, given the monetary background. Total assets of the five major central banks (Fed, ECB, BoJ, PBoC and BoE) rose from $20.4bn to $32.5bn between February 2020 and today, which works out at an average annualised increase of 32% for each of two years on the trot. Since 2006, total assets for these central banks have increased by 500%.
Since February 2020, US M2 money supply has increased at an annualised rate of 20.2%, for nearly two successive years, and now stands at over 90% of GDP, having started the millennium at 44.4% of GDP. But as will be demonstrated later in this article, adjusted for the temporary withdrawal of liquidity through reverse repos, the true quantity of M2 money is practically 100% of GDP.
Without doubt, there is a surfeit of dollars and similar excesses of all other major currencies in circulation, a global condition which has worsened considerably since March 2020. The rate of inflation of currency and credit has never been so high on a global basis, ever. Yet gold and silver hardly reflected it.
Behind it all is the fatal but common mistake to fail to connect rising prices with currency debasement. No statements from any of the major central banks on monetary policy have mentioned the quantity of currency, only the consequences for prices and interest rates. And there is a broad consensus between central banks that rising interest rates are to be deployed only in the last resort. The right to issue as much currency as central banks desire will remain sacrosanct. That prices are rising above the common target level of 2% and will remain there must be denied.
For now, ovine investors accept this narrative unquestioningly. Officialdom is also wrongly committed to inflationary policies to increase the GDP total. Policymakers, establishment economists, and investment strategists alike fail to understand that increases in GDP are not indicative of an improvement in economic conditions — progress is intangible and unquantifiable. GDP is only a reflection of the quantity of currency and credit in the economy. The remarkable recovery from the collapse in GDP in 2020 was not an economic recovery; it was simply a reflection of ramped-up unproductive government deficit spending. And the savings ratio which shot up was no more than a temporary reservoir of stimmy-inflated bank deposits. What should worry us all is that no one in charge of economic and monetary policy, let alone the wider public, appears to understand this basic error.
It is not in their interest to do so, because take away GDP and the entire argument for state intervention collapses. For this reason, the commitment to monetary inflation must be total. We can conclude, to paraphrase Noël Coward, “Hurray-hurray-hurray, Inflation’s here to stay!”[i]
The antipathy to recognising this fundamental error is behind the confused market response to inflationary conditions — with the notable exception perhaps of cryptocurrency enthusiasts. But even for them, the inflation argument only goes so far as to recognise the difference between an open-ended facility to issue national currencies and the hard restrictions on the issue of bitcoin. No hodler has yet to come up with a convincing explanation of how bitcoin will replace failed fiat currencies as a widely accepted medium of exchange. It has been this confusion over what money truly is and the difference between money and fiat currency which in 2021 has suppressed a wider interest in physical gold and silver.
To this confusion has been added structural changes in the banking system with the introduction of Basel 3’s net stable funding ratio. Most banks now must comply with the NSFR, with the notable exception of UK banks so far, until that is, the New Year. The intention is to ensure that bank liabilities are stable with respect to the funding of assets, thereby lessening the risk of financing instabilities and their systemic consequences. Under the new rules a bank that maintains principal positions in derivatives of all types must accept a financing penalty. And even if a bank finds that dealing in derivatives is so profitable that it is worth paying the penalty, its management is unlikely to freely embrace business lines that could adversely affect its reputation with the regulators.