The Global Monetary Order May Not Survive This

Jun 25, 2020 News

The global monetary order — meaning, the existing core arrangements of finance and trade, with the U.S. dollar as the centerpiece — will be 49 years old in August.

Yet this almost-49-year-old system might not make it to its 50th birthday, some 14 months from now, because the Federal Reserve is undermining the U.S. dollar, the lynchpin of that system, at hyper speed.

The current system was born on August 15, 1971. That was the day President Richard M. Nixon shut the gold window, unilaterally ending the convertibility of U.S. dollars into gold.

Ever since the demise of the Bretton Woods system, the world’s major currencies have had free-floating fiat status. Modern currency values fluctuate based on supply and demand, with no intrinsic worth other than the credibility of issuing governments.

The current order has the U.S. dollar as anchor and lynchpin, via the dollar’s role as world reserve currency and the dominant use of dollars for international trade transactions.

The Federal Reserve is a threat to destroy this system — not on purpose, but with the same degree of likelihood as if it were acting on purpose — by destroying faith in the soundness of the dollar, and thus crippling the global monetary order as we know it.

The Federal Reserve will do this, in partnership with the U.S. Treasury, by flooding the world with a vast quantity of dollars, eventually to the point where supply overwhelms demand. Shortly after that, supply will overwhelm a sense of faith and confidence in the system itself — and at that point all, or nearly all, could be lost.

Faith in the other major fiat currencies, like the euro, yen, and renminbi, could ultimately be torched too, as a result of frenzied currency debasement efforts in Europe, Japan, and China. Rather than a bonfire of the vanities, call it a bonfire of sovereign credibility.

A veritable biblical flood of currency will be unleashed on struggling, stagnating economies, and the medicine won’t work. Investors will fear for the soundness of the system, then more or less bet against the system as they flee from it, by piling into haven assets like precious metals, gold stocks, silver stocks, and Bitcoin.

Why are we confident all of this is quite likely to happen? Because it has already started.

The remarkable thing is that Jerome Powell, the Chairman of the Federal Reserve, has already taken the Fed to Armageddon levels of emergency policy response — and the real crisis hasn’t even happened yet.

The real question is: What happens when the true crisis arrives? If the Federal Reserve has already gone to the moon; where do they go when the United States stares down the next threat of economic implosion? Neptune? Alpha Centauri?

The chart below, via the St. Louis Federal Reserve, shows the size of the Federal Reserve balance sheet from December 2002 through June 2020. The gray shaded areas indicate recession.

This is how we interpret the chart:

  • Prior to the global financial crisis of 2008, the size of the Federal Reserve balance sheet had never exceeded $1 trillion.
  • As a result of the global financial crisis, and the need to absorb toxic bank assets, the Fed’s balance sheet ballooned more than 140%, from roughly $900 billion to $2.2 trillion, in the last four months of 2008.
  • After more than a decade of various “quantitative easing” programs — and a botched attempt to shrink the balance sheet, later abandoned — the Fed’s balance was at $4.24 trillion heading into March 2020 — more than 370% above pre-crisis levels.
  • Then the pandemic hit, and the balance sheet ballooned yet again — this time to nearly $7.1 trillion, a 67% increase over the course of three months.

There are at least two horrifying problems here.

First, the ratchet only goes one way, meaning it is hard if not impossible to shrink a central bank balance sheet in a dangerously indebted system.

And second, the inflating of a new paper asset bubble increases the odds of follow-on deflationary bust when the bubble pops.

As the heavily indebted private sector takes on even more debt — with the blessing and encouragement of the Federal Reserve — the risk of a debt-driven collapse increases.

The system becomes so over-leveraged, and so vulnerable to dislocation, that even the thought of a minor downturn, let alone a normal business recession, becomes intolerable. This forces the Federal Reserve to become more and more proactive at every turn, adding size to its balance sheet in perpetuity through a string of de facto corporate bailouts in real time.

Then, too, as investors become more and more convinced that markets can’t go down and credit markets can’t be impaired — because the Federal Reserve won’t let it happen — the more that investors become willing to be outright speculative, not just in equity markets but credit markets.

This activity leads to the inflating of asset bubbles that ultimately become doomed to implosion, Fed or no Fed, simply due to the gravitational pull of sheer absurdity as valuations leave the stratosphere.

And then, when the paper-driven asset bubble inevitably bursts — as all bubbles do sooner or later — the resulting fallout threatens to be psychologically and logistically catastrophic, due to all the debt and leverage that had built up in the system.

The fallout from a burst bubble then forces the Federal Reserve to expand its balance sheet again — perhaps even more aggressively this time, to overcome the carnage born of speculative implosion.

The end game is that the chart line depicting the size of the Fed’s balance sheet just keeps going up, and up, and up, as the numbers progress in geometric leaps that combine for a net exponential function.

After going from $1 trillion to $2 trillion, and then to $4 trillion and on to $7 trillion, what is next? $12 trillion? $25 trillion? More?

As the balance sheet expands, by way of the Fed buying up government securities — and now corporate securities, including junk bonds — new dollars are released into the system.

To paraphrase a popular quote on federal spending: A trillion worth of liquidity here, a trillion there, and soon enough you’re talking real money.

As we have explained in various ways in these pages, there is no way off this train. The Federal Reserve has one move: Keep expanding the balance sheet. Keep pumping in liquidity. This leads to asset bubbles, which lead to even more intense deflationary pressures when the asset bubbles burst, which ratchets up the cycle yet again.

If you add “de facto MMT” into all this — in the form of the U.S. federal government cranking out trillions in stimulus, huge portions of which go to individuals and entities who never needed it, in addition to the ones that do — the net effect is like pouring kerosene on a fire.

Previously we wrote about “exploding debt dynamics” in relation to Argentina. Now we are looking at “exploding balance sheet dynamics” with respect to the Fed. The more they pump, the more they destabilize the system, the bigger the next round of pumping has to be to counter the last round’s destabilizing side effects.

It keeps going this way until the currency itself dies — or gets debased within an inch of its useful life, which is effectively the same thing.

And then, at some point, when the chaos, frustration, and turmoil feel almost unbearable, a new monetary order has the potential to emerge: One that is no longer based on fiat money.

Right now, as of this writing, we are more bullish on gold and silver stocks — and Bitcoin — than we have ever been.

This is due to the dynamics just described, and the way they are now playing out before our eyes — not just for the Federal Reserve and U.S. Treasury alone, but for central banks and governments all around the world.

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