Central banks around the world are selling fiat currencies to buy gold. They are cashing in credits, trading paper obligations for real money. That single move tells you what the official story hides.
Credit is not money
Start with what credit is. Credit is any obligation to deliver something. Take stocks. If you hold shares, the company owes you an income stream, so your shares are a form of credit. It gets worse. In today's world of certificateless trading you do not actually own your shares. A central counterparty owns them. The company's obligation runs to that central counterparty, which then owes the claim to you. You own nothing directly.
A bank deposit works the same way, with two layers of obligation. First, the bank owes you the value on your account. Second, the central bank stands behind the currency that the deposit is written in. For Americans that is dollars. If you think dollars are money, look at the Fed's balance sheet.
The Fed is the issuer, not the US Treasury. On the Fed's balance sheet the liabilities include notes in circulation and bank reserves. Bank reserves are currency owed to commercial banks, because those banks hold deposits at the Fed.
Real money is different. Going back to Roman times, real money means final settlement with no obligation on the other side. It has always been physical and metallic, evolving from bronze to silver to gold. Today gold is the money. That is why central banks are selling fiat and buying gold, swapping obligations for something with no counterparty.
For over 50 years the American administration has said dollars replaced gold, that dollars are real money and everything else refers to dollars. That is wrong. It is a lie they are selling you. Almost everything you hold is credit.
The diversification trap
Holding credit is fine while the risk on those obligations stays small. Right now that risk is rising, so it is time to get out of credit and into real money, gold and to a lesser extent silver. For over a year I have said the same thing. It is the only defense you have.
Most people think they are diversified. They put 1%, 5%, or 10% into gold and hold stocks, bonds, and housing for the rest. If you have 1% in gold and silver, you have 99% in credit obligations. You are not diversified at all. Moving out of credit into gold is moving out of risk, and you have to see where that risk actually sits. The next 2 to 3 months should make it clear.
The debt trap
China is selling every dollar she can. Japanese institutions, by far the largest holders of US debt, are stepping out of the market. A US debt crisis is mounting. A 5% yield on the 10-year Treasury will not stop it. Would 10% stop it? I would not know, and I do not think so.
This is a debt trap. The higher bond yields rise, the worse the position gets for foreign investors and for US institutional investors alike. The only real fix is for the government to cut spending, balance its budget, even run a surplus so it stops borrowing from the market. I cannot see that happening. You have a spendthrift president in one war directly and another indirectly, expensive in munitions and troops and expensive in its side effects, chiefly higher oil prices.
Diesel is going to run very short very soon, and diesel is crucial to all logistics. It drives trucks, trains, and ships, where in the form of bunkers it is close to diesel, and diesel itself sits close to heating oil. None of this looks good. I expect bond yields to break higher, stocks to fall because they are already very expensive relative to Treasuries, and the Fed to print, print, print.
From cash to gold
At some point people will shift their idea of the safe position. First they will sell financial assets for dollar cash, thinking cash cannot go down. Then they will realize the purchasing power of that cash is also falling, and that the only exit is gold or silver. We are not quite there, but we are getting very close.
Japan pulls back
Japan's finance ministry, not its central bank, urged domestic funds and firms to take up more of the buying of Japanese debt. We can already see the fallout in French government bonds, the OATs. Japanese institutions have been big buyers of OATs in recent years and are now liquidating. The OAT yield has risen almost half a percent in the last month alone, which is a big move in these markets. That is your evidence, and it will not stop there.
The carry trade is a large part of this. For now it is fine while the yen keeps weakening. Once yen interest rates rise, the carry trade will have to stop cutting its positions.
Japanese institutions, meaning pension funds and insurance companies, are the largest holders of US Treasuries, far larger than China, which is second, maybe third by now. China is dumping dollars as fast as she can too. Over the next month or two it is hard to see how the US funds both its current deficit and its maturing bonds. The figure needing financing over the next 12 months is around 10 to 11 trillion dollars. This is a major and mounting problem, so bond yields should keep going higher and higher.
Deflation met with inflation
The Gulf price effects will be very significant. This is deflationary for the private sector, and it will be countered by heavy inflation in the government sector, because the government will create credit to try to stop the economy and financial markets from tanking. So where does it go? It is a huge dilemma, all part of the end of the fiat currency era.
Here is how to see fiat currency. A government uses it to grow its debt without appearing to hurt its voters. Voters are taxed at a set rate. Whatever the government wants beyond that, it prints. That difference accumulates, and the US now has about 40 trillion dollars of its own government debt. How much further can it go? The major buyers of government debt, the ones supplying what amounts to crazy inflation for everyone else, are reaching the end of the road. The result is a crash in financial markets and a crash in the value of the currency. This is the end game for the dollar as a fiat currency, and it is dragging down other currencies with it.
Sentiment, not fundamentals
In the fog of war, truth is the casualty, and gold and silver prices will reflect the uncertainty over outcomes. Bond yields must rise further. Today's markets run on sentiment, not fundamentals, which is what you expect in a credit bubble where greed beats caution.
The system has a built-in bias. Brokers rarely survive by telling clients to sell. They survive by telling them to buy, and they keep doing it. After years of rising markets that recover even after they fall, everyone believes stocks will rise forever. That is the mood around US stocks. But the relationship between the yield on US Treasuries and equities is more stretched than at any point in financial history. That marks a bubble, in both sentiment and valuation.
The mother of all crashes
This bubble is probably bigger than the one in late 1929, though we lack the statistics to prove it. When it breaks it will be the mother of all crashes for stocks. Then ask what follows. Foreigners hold 22 trillion dollars of US equities and will sell dollars. American institutions will realize they must lighten their own portfolios and those of their clients. A move from extreme optimism to extreme pessimism could easily wipe out 90% or more of the S&P 500's value. It is that relationship between bonds and equities that matters, and if bond yields rise from here as I expect, it will break the equity market.
