The Ongoing Depression Could Force A Return To The Gold Standard

This is an excellent interview with Jim Rickards. He explains that we are in a depression currently. The answers to that problem from the US government and central bank will likely force them to impose monetary discipline through the return to a gold standard. The longer the dollar based monetary system is suppressed, the more likely that market forces will induce a dollar collapse.

This piece provides deep insights in a complex matter, brought in an easy to understand way. Courtesy: Jim Rickards and FutureMoneyTrends.

We are in a depression although it does not “look” or “feel” as such.

First of all I’d say this depression started in 2007. 2008 was the panic and it was an emergency liquidity response to that, but the roots of this really go back to 2007. That’s when the sub-prime crisis erupted, that’s when the Bear Stearns hedge funds melted down. That’s when the Fed first started in to cut the discount rate and respond a little bit, even though they were way behind the curve and didn’t see it coming.

So the depression started in 2007. It could be over tomorrow if we had the right policies, but we don’t have the right policies. It will continue indefinitely.

We look like Japan. Japan has said, people talk about the lost decade, we’re in the third lost decade; it’s been over 20 years of depression, depressionary symptoms or depressionary economy in Japan.

The U.S. is now in the same mode, it’s kind of ironic because for decades Bernanke and other scholars criticized the Japanese, saying, “What’s the matter with you guys, don’t you know how to run monetary policy, don’t you know how to get out of a depression?” Then they said, you know, in 2007, “We are going to avoid the mistakes of Japan.” But we’ve made every single mistake that Japan made.

We should have shut down banks in 2008. We didn’t. We propped them up instead of shutting them down, which is exactly what the Japanese did. They locked the problems into place and financed them instead of writing them off, shutting them down, putting bankers in jail, closing the banks, breaking the mob, stripping out the bad assets, putting them under a rock in trust for the American people, sell them over 20 years or however long it takes. Then re-IPO the clean banks.

They didn’t do that. Instead they did what the Japanese did, which is they propped up the system, they kept their buddies in place. There was no real prosecutorial effort, and so we shouldn’t be surprised that we have the same result as Japan, because we went down the same path structurally. Now we printed more money than the Japanese did, but that’s not the solution, so it’s not going to work.

So having said all that, I just think that you will have this hyper-inflationary response at some point. Not right away, because it’s behavioral. The Fed needs to change behavior first. But when they change it, they may find it spins out of control, as it did in the ’70s. At that point the price of gold will soar or, if we go into a depression, the Fed may raise the price of gold as a way to create deflation. Either way, gold goes up in the end.

The return to the gold standard – a deliberate choice by today’s political leaders or an imposed event driven by market forces?

One is that we get to a gold standard by design. In other words, people look at the system and they say that it really is not sustainable, it really is based on confidence, but we’re in the process of eroding confidence. There is no exit from quantitative easing. We should say there’s no good exit. You can back away from it, but then you’ll implode the economy in a deflationary crash.

Or you can keep going and eventually cause a loss of confidence in the dollar and then have a hyper-inflationary crash, so you have a crash either way. One looks like the Great Depression, one looks like the late ’70s but worse. Those are the only two paths, but there’s no other path. There’s no way we can just sort of taper, reduce it, finesse it, try to get growth on a self-sustaining path.

The reason for that is we’re in a depression. And depressions are structural problems; they require structural solutions. You cannot use a liquidity solution for a structural problem. You need a structural solution. So there’s nothing the Fed can do to solve the depression or to change the structural problems in the U.S. economy. I mean, they’re assuming, they’re saying, “We’re gonna print money until unemployment gets to 6 and a half percent.” Who says there’s any relationship between printing money and unemployment? There’s no necessary relationship there. One’s monetary, one’s structural, so you need to do other things. So therefore they’re gonna keep going, but they think they’re right.

I may be a critic and I may be able to point out why they’re wrong, why their models are wrong and why this says “No Good Exit,” but they think they’re right and they’re gonna keep going and kind of drive the bus over the cliff.

Now, at that point, when the crisis emerges, they may have to go to a gold standard. They don’t want to, but they may have to, to restore confidence. But I’m very doubtful that they’ll do it as a matter of choice and say, “Look, we need to do this, let’s just do it now, let’s be honest, let’s be transparent, let’s be thoughtful.” You could do that but I think that’s very unlikely.

Financial repression is here …. interest rates are suppressed by the Fed each time they want to move higher (signaling unrest)

That’s what financial repression is. That’s what quantitative easing is. Every time the rates want to go up, the Fed can just buy more bonds. Of course, they buy bonds with printed money, but it just keeps the lid on rates.

I’ve spoken to people in the primary dealer community. They’re completely relaxed because they’re just middle-men; they’re intermediaries between the Fed and the banks; the institutional investors. They buy bonds from the Treasury, they can finance them or sell them to the Fed or they can sell them to institutions.

Now, the risk there is that they’ll get caught out. They’ve got long maturities, so they’ve got five-year notes or ten-year notes and they’re financing them overnight in the repo market. Well, what if the repo rate went up? All of a sudden the trade is profitable, it goes upside down, if the short-term rate gets above the long-term rate. Or if long-term rates go up they have capital losses on the bonds. It’s a very risky trade, but the Fed has told them, “We’ve got your back.” That’s what forward guidance is. When the Fed says “We’re not going to raise rates for two years or three years, etc., then you can do the overnight financing for three years and know that you’re going to be paying zero rates.”

They’ve taken the risks out of the trade. So the primary dealers are relaxed, the Fed is going to keep the lid on the interest rates.

If we follow the Japan scenario, and I expect we will, I can see ten-year no-rates coming down to 80 basis points. If they go from 250 to 80, that’s the greatest bond market rally in history.

So everyone is worried about the bond bubble, but they’re focused on nominal rates. They’re not looking at real rates. Nominal rates could come down a lot more as a way of getting real rates lower, because inflation is low it may even dip into deflation. So we could be set up. But in the long run rates would go way up and the country would go bankrupt and we’ll all have hyper-inflation. That could be two or three or four years away. Over the course of the next year you can see a very strong bond market rally.

Gold and silver are weak given the monetary context – how is that possible?

There are a number of reasons. There’s certainly some Central Bank manipulation. There’s some fundamental reasons having to do with what we’ve been talking about, which is deflation.

Gold should go down in a deflation environment initially. But if deflation gets bad enough, the government will make the price of gold go up because they get desperate to create inflation.

If you’ve tried everything, if you want inflation, and you’ve tried everything to create it, so you tried money printing, cutting rates, currency wars, Operation Twist, QE, forward guidance, nominal GDP targeting, you’ve tried everything, you still didn’t get the inflation. There’s one thing that always works, which is devaluing your currency against gold.

There could come a time when deflation gets so bad that the Fed and the treasury actually raise the price of gold, not to enrich gold investors, but to get close to generalized inflation. Because if gold goes up, silver and oil will go up along with it. It’s exactly what happened in 1933.

That’s one path. But the other, perhaps more likely path, is that the Fed just keeps printing money and finally succeeds in changing behavior, velocity of the turnover money picks up and inflation goes up on its own. Then gold will race way ahead of that. That’ll just change the psychology.

My advice for gold investors today is to kind of do what the Chinese do: just buy the dips. The Chinese bought a tonne, hundreds of tonnes of gold at the lows in July, July 2013.

Now, again, we had that smash in April and gold went down over 20 percent between April and June. Well, right there at the end of June, the Chinese were buyers, so my advice to investors: don’t use leverage. Buy physical bullion. Don’t buy paper gold. Do what the Chinese do, which is buy the dips, put it away and don’t read the papers.

So gold is volatile. You just have to get used to it. And if gold is down a lot, it’s because deflation has the upper hand.

But nothing moves in isolation. If gold traders down to, let’s say, $800 an ounce, that is a highly deflationary world. That probably means the stock market’s crashing, other commodities are going down, so you might actually like your gold better in that environment, because even though it went down a nominal space, it can outperform these other asset classes and still preserve wealth.

Of course, in the opposite case, if inflation takes off, we all know what’s going to happen: gold is going to go way up.

China is one of the most important owner of US dollars (through US Treasuries). How can they exit those huge positions and de-Americanize the monetary system?

China is actually reducing its purchases. They’re not dumping them. This idea that suddenly they’re going to dump two trillion dollars of treasury. That’s not going to happen. Because it would be too disruptive; they would shoot themselves in the foot. They would crash the market, the U.S. could actually freeze their treasury accounts.

People don’t realize that, but the president has the legal authority to freeze the Chinese accounts. We wouldn’t have to steal their money, just say, “Hey, we’re freezing it. We’ll get back to you later about when you can collect.”

You have to get back to them and make good behaviors, so to speak. And the Chinese know that, so they’re not gonna go there because the U.S. has very powerful tools to preserve its interests and preserve its markets.

But at the margin, as they get more reserves, as they run a continuing current accounts surplus, they get direct foreign investments. They get their hands on more dollars. They don’t have to invest new dollars in treasuries. What they’re doing is swapping it for Euros, they’re investing very heavily in Europe, they’re buying direct assets, they’re buying mines, they’re buying companies, buying stocks, etc.

So they’re not dumping what they have, but they’ve slowed down the purchases. They’re selling a little, and most importantly, at the margin they’re diversifying into other assets.

That’s going to put a lot of pressure on U.S. interest rates, because in the past the Chinese have been buyers, so the question is: Who’s going to step in and fill the void, so to speak, as what’s called “the buyer of last resort” of treasury? Well, the answer, of course, is the Fed.


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