What do you get when the producer of the world's reserve currency takes on too much debt? Nothing less than the end of the US Treasury-based monetary system.
So says Eric Jansen, economic and financial market analyst and proprietor of iTulip.com. In chronicling the decline of the global economy over the past decade, Eric has formulated a framework called the "Ka-POOM" theory, which endeavors to understand how the immense run-up in global debt will be resolved.
In short, it looks at the at the credit bubble that began in the early 1980's, started accelerating in 1995, and has now reached epic proportions. The amounts are so staggering at this stage that Eric believes it is too politically undesirable to let natural market adjustments clear them away - the magnitude of the deflationary pain this would create is simply unacceptable for politicians looking to get re-elected. The only other available option left is to service these debts via a dramatically devalued currency. Hence the key role the Fed is playing today.
The Fed is at the epicenter of this process, intervening heavily to keep the natural corrective market forces at bay. In this, it has a dual strategy. The first is to keep asset prices high (i.e., fight asset deflation), which it is doing by keeping interest rates historically low. The second is to keep wage and commodity costs under control, which it primarily does via devaluing the currency (maintaining a "weak dollar").
And, of course, through its intervention, the Fed is doing all it can to keep the current financial system in place to perpetuate the process for as long as possible. The end result is a fundamental shift in risk from Wall Street to the taxpayer.
So the big question is: how long can this last? Is there a point at which confidence in the system breaks and market forces finally overwhelm the intervention?
Eric's answers: "Much longer than most people expect." And "Yes."
First off, as the most important central bank in the world, the Fed has supernormal powers. In theory, it can expand its balance sheet infinitely. It's ability to absorb massive amounts of new liabilities is theoretically limitless - much of which can be easily concealed from an accounting standpoint.
And since the US is both the world's largest economy as well as the provider of its reserve currency, other countries are compelled to support the current regime. A mortal crack-up in the US economy would deliver undue pain to all its trading partners, so they continue to buy Treasuries in sufficient amount to fund US economic activity.
But that's not to say they're happy about it. And here's where attention should be paid (and where the importance of gold comes in).
For much of the past century, the United States comprised approximately 54-58% of the global economy. Today, it's share has shrunk down to about 18%. Meaning: it's relative importance to the global system has diminished.
Issuing the world's reserve currency is a privilege that must be continually earned through transparency and sound stewardship - qualities the US has been in flagrant lack of in the past several decades as it has been blowing asset bubbles and running trillion-dollar deficits via incurring massive debts and increasing its money supply tremendously. So, even as they continue to support the current Treasury-backed monetary regime, the world's central banks have begun hedging their exposure.
After several decades of being net sellers, the world's central banks became net buyers of gold in the second quarter of 2009. As Eric puts it:
There was no plan B in the global monetary system when it switched over to the US Dollar reserve basis for global monetary reserves. The only fallback is gold. Gold is the only reserve asset that central banks hold other than dollars and to some extent euros - but it is mostly gold. So gold is the fallback. What I thought was going to happen is that, over time gradually, that there would be an increase at some point in gold holdings by central banks as they hedged the marginal increase and the number of Treasury bonds that they needed to hold as a result of conducting trade with the US and also simply maintaining the US economy through low interest rates and providing sufficient investment to continue to offer the US government.
What is very interesting to me is starting in the second quarter of 2009, right after the financial crisis is when global central banks became net buyers of gold which to me indicated that they had as a group, determined that it was time to more seriously hedge their dollar assets, even as they continue to buy Treasury bonds to increase their hedging.
Before that there were effectively two teams, there were the buyers who were countries like India and Russia and China, and the sellers which are most of your European countries and that structure of the gold market occurred and was maintained until the second quarter of 2009 and it shifted to a much broader base increase in the number of governments participating in the gold market including Saudi Arabia, Mexico and other allies of the United States.
Eric sees this move by central banks of positioning themselves closer to the door as a natural step to the inevitable endgame here, which is the dissolution of the US Treasury dollar-based monetary system. Due to entrenched special interests, politics, escalating commodity scarcity, and other factors - he does not see the US taking necessary corrective action before confidence in the solvency of the US and its currency collapses.
As such, Eric advises investors position themselves into gold and assets that take advantage of rising rents and energy prices.
Link to interview