The following article is longer and more technical than I would normally put up here but if you have the patience and the interest, it is an excellent analysis by Alasdair Macleod who is someone I have followed for many years.
Long story short, he is predicting that Western (and Japanese) fiat currencies are likely to be toast in the near future, starting probably with the Yen and then the Euro.
China and Russia appear to be “commoditising” their currencies which will give them a degree of protection from the turmoil, but the big winners will be commodities, especially gold and silver.
Harry Editor in Chief
Before Russia invaded Ukraine and the Western alliance imposed sanctions on Russia, we were already seeing prices soaring, fuelled by the expansion of currency and credit in recent years.
Monetary planners blamed supply chain problems and covid dislocations, both of which they believed would right themselves over time.
But the extent of these price rises had already exceeded their expectations, and the sanctions against Russia have made the situation even worse.
While America might feel some comfort that the security of its energy supplies is unaffected, that is not the case for Europe.
In recent years Europe has been closing its fossil fuel production and Germany’s zeal to go green has even extended to decommissioning nuclear plants.
It seems that going fossil-free is only within national borders, increasing reliance on imported oil, gas, and coal. In Europe’s case, the largest source of these imports by far is Russia.
Russia has responded by the Russian central bank announcing that it is prepared to buy gold from domestic credit institutions, first at a fixed price or 5,000 roubles per gramme, and then when the rouble unexpectedly strengthened at a price to be agreed on a case-by-case basis.
The signal is clear: the Russian central bank understands that gold plays an important role in price stability.
At the same time, the Kremlin announced that it would only sell oil and gas to unfriendly nations (i.e. those imposing sanctions) in return for payments in roubles.
The latter announcement was targeted primarily at EU nations and amounts to an offer at reasonable prices in roubles, or for them to bid up for supplies in euros or dollars from elsewhere.
While the price of oil shot up and has since retreated by a third, natural gas prices are still close to their all-time highs.
Despite the northern hemisphere emerging from spring the cost of energy seems set to continue to rise. The effect on the Eurozone economies is little short of catastrophic.
While the rouble has now recovered all the fall following the sanctions announcement, the euro is becoming a disaster.
The ECB still has a negative deposit rate and enormous losses on its extensive bond portfolio from rapidly rising yields.
The national central banks, which are its shareholders also have losses which in nearly all cases wipes out their equity (balance sheet equity being defined as the difference between a bank’s assets and its liabilities — a difference which should always be positive).
Furthermore, these central banks as the NCB’s shareholders make a recapitalisation of the whole euro system a complex event, likely to question faith in the euro system.
As if that was not enough, the large commercial banks are extremely highly leveraged, averaging over 20 times with Credit Agricole about 30 times. The whole system is riddled with bad and doubtful debts, many of which are concealed within the TARGET2 cross-border settlement system.
We cannot believe any banking statistics. Unlike the US, Eurozone banks have used the repo markets as a source of zero cost liquidity, driving the market size to over €10 trillion.
The sheer size of this market, plus the reliance on bond investment for a significant proportion of commercial bank assets means that an increase in interest rates into positive territory risks destabilising the whole system.
The ECB is sitting on interest rates to stop them rising and stands ready to buy yet more members’ government bonds to stop yields rising even more.
But even Germany, which is the most conservative of the member states, faces enormous price pressures, with producer prices of industrial products officially increasing by 25.9% in the year to March, 68% for energy, and 21% for intermediate goods.
There can be no doubt that markets will apply increasing pressure for substantial rises in Eurozone bond yields, made significantly worse by US sanctions policies against Russia.
As an importer of commodities and raw materials Japan is similarly afflicted. Both currencies are illustrated in Figure 5.
The yen appears to be in the most immediate danger with its collapse accelerating in recent weeks, but as both the Bank of Japan and the ECB continue to resist rising bond yields, their currencies will suffer even more.
The Bank of Japan has been indulging in quantitative easing since 2000 and has accumulated substantial quantities of government and corporate bonds and even equities in ETFs.
Already, the BOJ is in negative equity due to falling bond prices. To prevent its balance sheet from deteriorating even further, it has drawn a line in the sand: the yield on the 10-year JGB will not be permitted to rise above 0.25%.
With commodity and energy prices soaring, it appears to be only a matter of time before the BOJ is forced to give way, triggering a banking crisis in its highly leveraged commercial banking sector which like the Eurozone has asset to equity ratios exceeding 20 times.
It would appear therefore that the emerging order of events with respect to currency crises is the yen collapses followed in short order by the euro.
The shock to the US banking system must be obvious. That the US banks are considerably less geared than their Japanese and euro system counterparts will not save them from global systemic risk contamination.
Furthermore, with its large holdings of US Treasuries and agency debt, current plans to run them off simply exposes the Fed to losses, which will almost certainly require its recapitalisation.
The yield on the US 10-year Treasury Bond is soaring and given the consequences of sanctions on global commodity prices, it has much further to go.
The End of the Financial Regime for Currencies
From London’s big bang in the mid-eighties, the major currencies, particularly the US dollar and sterling became increasingly financialised.
It occurred at a time when production of consumer goods migrated to Asia, particularly China.
The entire focus of bank lending and loan collateral moved towards financial assets and away from production.
And as interest rates declined, in general terms these assets improved in value, offering greater security to lenders, and reinforcing the trend.
This is now changing, with interest rates set to rise significantly, bursting a financial bubble which has been inflating for decades.
While bond yields have started to rise, there is further for them to go, undermining not just the collateral position, but government finances as well.
And further rises in bond yields will turn equity markets into bear markets, potentially rivalling the 1929-1932 performance of the Dow Jones Industrial Index.
That being the case, the collapse already underway in the yen and the euro will begin to undermine the dollar, not on the foreign exchanges, but in terms of its purchasing power.
We can be reasonably certain that the Fed’s mandate will give preference to supporting asset prices over stabilising the currency, until it is too late.
China and Russia appear to be deliberately isolating themselves from this fate for their own currencies by increasing the importance of commodities.
It was noticeable how China began to aggressively accumulate commodities, including grain stocks, almost immediately after the Fed cut its funds rate to zero and instituted QE at $120 billion per month in March 2020.
This sent a signal that the Chinese leadership were and still are fully aware of the inflationary implications of US monetary policy.
Today China has stockpiled well over half the world’s maize, rice, wheat and soybean stocks, securing basics foodstuffs for 20% of the world’s population.
As a subsequent development, the war in Ukraine has ensured that global grain supplies this year will be short, and sanctions against Russia have effectively cut off her exports from the unfriendly nations.
Together with fertiliser shortages for the same reasons, not only will the world’s crop yields fall below last year’s, but grain prices are sure to be bid up against the poorer nations.
Russia has effectively tied the rouble to energy prices by insisting roubles are used for payment, principally by the EU.
Russia’s other two large markets are China and India, from which she is accepting yuan and rupees respectively.
Putting sales to India to one side, Russia is not only commoditising the rouble, but her largest trading partner not just for energy but for all her other commodity exports is China. And China is following similar monetary policies.
There are good reasons for it. The Western alliance is undermining their own currencies, of that there can be no question.
Financial asset values will collapse as interest rates rise.
Contrastingly, not only is Russia’s trade surplus increasing, but the central bank has begun to ease interest rates and exchange controls and will continue to liberate her economy against a background of a strong currency.
The era of the commodity backed currency is arriving to replace the financialised.
And lastly, we should refer to Figure 2, of the price of oil in goldgrams.
The link to commodity prices is gold. It is time to abandon financial assets for their supposed investment returns and take a stake in the new commoditised currencies.
Gold is the link. Business of all sorts, not just mining enterprises which accumulate cash surpluses, would be well advised to question whether they should retain deposits in the banks, or alternatively, gain the protection of possessing some gold bullion vaulted independently from the banking system.