There is a deeply distressing discussion on social media that attempts to describe the relationship between gold and the US Dollar. Let’s start by flatly asserting: THERE IS NO SUCH RELATIONSHIP.
There’s no one specific factor that can be listed here that perfectly encompasses the uncertainty that can move gold, but political uncertainty and/or instability is probably the most important driver of gold prices.
This is not a piece about the gold standard or the fleeting fiat currency that has no substance. It is a contemporary look at our economy and the world economy, where we are headed, and what we can expect down the road in these truly unique and uncertain times.
We read a lot that 2020 looks much like 2009 or 2000 or 1987 or 1929. Each of these stock market crashes had utterly and completely different exogenous causes and took place in different contexts for different reasons. They simply cannot be compared, and should not be compared. If you try to compare them, you are seeking to establish a faulty and fallacious starting point, i.e. that the set of variables in play were enough alike, and that exercise will get you into trouble when you try to extrapolate your argument into expected and anticipated outcomes.
We must start with a tabula rasa, a clean slate, and develop a base set of conditions unique to our own economic situation. What are these?
Debt began its march 40 years ago, and today every sector, from the nation’s debt to corporate debt, to households is at record levels. This is a global issue, not confined only to the United States. In an economic expansion debt can goose growth, but there is a law of diminishing returns that applies to incremental debt.
We can measure the productivity of debt, and that amount, expressed as incremental productive cents on the next dollar of debt, has been steadily decreasing over the period of the past four decades. For this reason we witnessed economic growth, GDP, at a moribund 2%/year following the treatment of even more debt by the Fed as policy was to avoid the austerity that deleveraging would have entailed. Today we are seeing the implementation of this same policy, this time debt on steroids, in the context of the present economic pandemic-induced collapse.
How did we manage to create such a mountain of debt? Let’s start with the national debt:
- A recent study by Brown University pegs the total costs of post-Sept. 11 actions by the U.S. at $3.2 trillion to $4 trillion — and counting.
- The wars in Iraq and Afghanistan have cost U.S. taxpayers nearly $5 trillion dollars and counting, according to an independent analysis conducted by a political science professor at Brown University.
- Entitlement spending’s share of government spending. Entitlement spending has increased from about five percent of all government spending in 1900 to 48 percent of all government spending, federal, state, and local, in 2015. In 2019 social security alone required over $1 trillion and Medicaid $651 billion. Baby boomers are living longer and the cost of that longevity is skyrocketing.
- U.S. nonfinancial corporate debt of large companies now stands at about $10 trillion dollars, 48% of GDP. This represents a rise of 52% from its last peak the third quarter of 2008, when corporate debt was at $6.6 trillion, about 44% of 2008 GDP.
- Total corporate debt is actually much higher. Adding the debt of small medium sized enterprises, family businesses, and other business which are not listed in stock exchanges ads another $5.5 trillion. In other words, total US corporate debt is $15.5 trillion, 74% of US GDP.
- In the recession corporations are loading up with more debt, knowing they will need it just to survive the downturn.
- Toward the end of 2019, economic experts began noticing a new trend in household debt. That’s because the state of household debt experienced a dramatic upswing in 2019, according to a recent New York Federal Bank Study.
- Total household debt in the United States, including mortgages, auto loans, credit card and student debt, climbed to $14.15 trillion in the fourth quarter of 2019, eclipsing the previous peak at the height of the great recession in Q3 2008 by $1.5 trillion in nominal terms.
- In 16 years time household debt has doubled.
We are likely going to witness a 50% collapse in GDP in Q2’2020. So how is it the US Dollar remains so strong relative to the other world currencies, and why haven’t we seen inflation?
The economic history of the Netherlands (1500–1815) is the history of an economy that American-Dutch scholar and economist Jan de Vries calls the first “modern” economy.
Around 1670 a combination of politico-military upheavals (wars with France and England) and adverse economic developments brought the Dutch economic boom to an abrupt end.
The economy struck out in new directions, including whaling, colonial plantations in Suriname, and new types of trade with Asia. However, these riskier ventures were profitless.
The conflicts put an enormous strain on the resources of the Republic, and for that reason the Republic (like its opponent, the France of Louis XIV) was deeply in debt at the end of the War of the Spanish Succession. The Kingdom of the Netherlands was faced in 1815 with an economy that was largely de-industrialized and de-urbanized, but still saddled with a crippling public debt, which it was forced to repudiate (the first time that the Dutch state defaulted since the dark pre-independence days of the Revolt).
In the long period of crisis, disinvestments from the commercial and industrial sectors (in the face of unprofitability, high risks, taxation, and forced lending) and the destruction of asset value through foreign and domestic default undermined the remaining international stature of the commercial and financial sectors. Domestically, the disruption of institutions and the irregular access to markets plunged the once-protected sectors of employment … into a crisis that tore at the venerable structure of the labor market and overwhelmed the Republic’s charitable system.
The United Kingdom
During the 19th century and the 20th century up to the beginning of the Second World War, many of the countries of the world owed the UK money for financial debts and needed Pounds Sterling to pay them. And many of those that did not, needed pounds to buy natural resources controlled by the UK and to buy technological goods which were only available from the UK or were most cheaply available from the UK. As a result the Pound formed a good reserve currency because it could be used to settle debts for nearly all international goods and services.
After the Second World War, this was no longer the case. While the UK still controlled many of the world’s natural resources, it was deeply indebted and its manufacturing capabilities were damaged. During the next fifty years its manufacturing and debt situations improved but it did not regain its former pre-eminence. Moreover it lost control of the resources markets as its empire dwindled. One consequence was that the pound became less and less useful as a reserve currency as time went on.
In the 21st century the Pound Sterling is still a secondary reserve currency, one of several, but it has been replaced as the primary reserve currency by the US dollar, which can now be used to buy all the resources, goods and services which formerly could only have been bought using Pounds Sterling.
The Dutch Guilder and the British Pound had this in common: indebted and over-stretched empires found that at a level of excessive debt the currency collapses and thus likewise the empire. So how will the US Dollar ‘collapse’ and what will that mean for America?
When a nation resorts to debt, the reliance upon it becomes increasingly addictive. There is no immediate cost or consequence and if it is cheap, as the Federal Reserve has engineered low interest rates, the temptation to load up with more is simply too hard to resist. The solution for all of America’s economic distress has become a four-letter word, and it must be fed or the economic disaster that would occur would be enormously painful.
For there is only one way to unwind debt, and that is through deleveraging. That means less is spent on goods and services and more is redirected to pay down debt. That ushers in a period of great austerity, high unemployment, bankruptcies and poverty. The higher the debt, the more painful and longer the amount of time it takes to go through the cleansing process of deleveraging.
Today we see waves of trillions being poured out to resuscitate crippled and cratered commerce. National debt has breached 100% of GDP and is accelerating. The Fed and Treasury are working together to engineer creative ways to prop up asset values and suppress interest rates, while at the same time getting free money into the hands of people and corporations.
We are not paying down our national debt, we are monetizing the debt. That means we are replacing debt with more debt, and adding debt to the mountain of debt. So why haven’t we seen inflation or the collapse of the US Dollar?
The US Dollar is the preeminent world reserve currency today, much as was the Guilder and the Pound Sterling historically. The world is awash in debt and much of that debt is US$-denominated.
Paying for goods and services like oil and paying down debt means dollars are in demand in order to do so. There is no other place to go. Other currencies are relatively weaker, in nations that are also in recession.
The World’s Top Reserve Currencies in 2019:
- U.S. Dollar: $6.74 trillion (61.82%)
- Euro: $2.21 trillion (20.24%)
- Japanese Yen: $572 billion (5.25%)
- Pound Sterling: $495 billion (4.54%)
- Chinese Renminbi: $213 billion (1.95%)
In due course the nations of the world will emerge from recession. But the problem of debt must first be resolved or all will continue on a course first charted by Japan – virtually no growth, mired and anchored in debt. Some of these nations will become stronger and grow faster than others, and when they do, they may find themselves in an advantaged place to dominate in terms of their own currency.
More likely a great reckoning will dawn on the nations that all of this debt simply cannot ever be repaid. It will need to be renounced, monetized, canceled and forgiven. This is the only means for economies to regain their strength and health without the life support systems of central banks. The debt must be discharged and done away with.
A new currency will have to be established as the world will not tolerate the US getting off the hook for far more trillions than other nations. When it becomes clear that the US Dollar related debt obligations cannot possibly ever be repaid, this will force a Great Reckoning, a necessary cooperation among the nations to create a new global currency, likely digital, and a new global monetary authority to oversee and regulate the currency.
Until that happens, economic war, including ripping up and creating new trade deals, tariffs, sanctions and trade will only worsen and tensions continue to increase (accounting for the rise in gold prices).
Bottom line? We are fast approaching the Great Reckoning, when the massive accumulation of debt must finally be dealt with and discharged.
“…and forgive us our debts, even as we forgive our debtors.”