Could The Ongoing Financial Crime Affect The Gold Price?

Hera Research released an extremely interesting paper. The research company focuses on relationships between macroeconomics, government, banking, and financial markets in order to identify and analyze investment opportunities with extraordinary upside potential.

In their paper, Hera analyzes the potential triggers of a collapse in the US dollar, which in turn would trigger a hyperinflation. The research company clearly expects we are approaching such an epic event, quoting Austrian economist Ludwig von Mises: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” The only question is when this could happen and what be the main trigger will be.

Hera believes that the following three factors could result in a US dollar collapse:

  1. The rejection of the US dollar as being the world reserve currency
  2. An eventual consequence of US federal government insolvency
  3. A domestic failure of confidence, which is within the US

Although some analysts expect one of those events to happen rather soon, in Hera’s view those events will not occur in the near future. Here is a summary of their expectations:

  1. A world reserve currency is not easily replaced. Moreover there is simply not a valid candidate in the short run to take over the position of a world reserve currency. Although there is evidence that gold is being used in transactions (for example in the oil for gold transactions between countries in the East and Iran), it will take some time till another reserve currency is in place (whether it’s in the form of gold or another currency).
  2. The burden of the US government spending is worsening every day. Currently government spending represents 40% of GDP. The mathematical probability of a hyperinflation is almost 100%. Still, the US government has the power to delay their insolvency. The proof is in the events of the past years and recent bubbles, where it always took much more time till a collapse occured.
  3. A collapse triggered by the own citizens seems unlikely in the short run. A series of bank runs for instance, or an excessive demand for banknotes, could be solved quickly by turning up the printing press. Moreover the US citizens don’t have an alternative currency to use.

Interestingly, Hera reports that the trigger for a collapse could come from a different and less anticipated angle: a loss of confidence in the financial system, triggered by the increasing number of financial scandals. If the current trend continues and scandals remain unsanctioned, it could result in the loss of confidence in the “perceived legitimacy” of the financial system. Ultimately, if a tipping point is reached, an hyperinflationary collapse could hit. In their paper, Hera Research reports the following:

Before the 2008 financial crisis, confidence in the U.S. financial system was shaken by fraudulent subprime mortgage lending and securitization practices. The collapse of the housing bubble and the 2008 financial crisis revealed profound systemic risks. In 2010, the so-called “Flash Crash” reopened questions about the stability of U.S. financial markets and, in 2011 “robo-signing” and other foreclosure frauds were reminiscent of sub-prime lending.

In late 2011 and 2012 perception of the U.S. financial system suffered a staccato of blows, including the  failure of MF Global Holdings Ltd., with the loss of $1.6 billion in customer funds; JPMorgan Chase & Co.’s $6.2 billion “London Whale” OTC derivatives trading loss; the failure of Peregrine Financial Group Inc., with the loss of over $200 million in customer funds; money laundering by HSBC for drug cartels, including Mexico’s most violent criminal organization, Los Zetas, and for states that sponsor terrorist organizations; Knight Capital Group Inc.’s high-frequency trading (HFT) loss of $440 million; as well as a growing number of civil and criminal cases linked to mortgage, foreclosure and securities fraud.

Scandals elsewhere in the world, such as the rigging of the London Interbank Offered Rate (LIBOR) by Barclays, in cooperation with other banks, including JPMorgan Chase & Co. and Citigroup, Inc. in the U.S., further undermine confidence in the U.S. financial system.

How exactly could such a scenario play out? Hera argues that it will probably not be in the form of a traditional bank run or rush into cash. The likely scenario would play out as follows:

If investors, pensioners, private institutions and fund managers withdraw from the markets in order to preserve their capital, it could potentially cause not merely a stock market decline but a crash. In the worst case, a domestic breakdown of confidence and trust could lead to a near total collapse of U.S. financial markets.

Neither the federal government nor the Federal Reserve can fix the U.S. financial system if its perceived legitimacy were to fail. An inflationary policy response, at that point, would only exacerbate the problems of the U.S. dollar. History may record yet again that “there is no means of avoiding the final collapse of a boom brought about by credit expansion” because the escalating moral hazard engendered by limitless bailouts is itself a cause of collapse.

Hera Research is not a lonely voice in this matter. A similar view was shared recently byJohn Butler, financial expert and author of the book “The Golden Revolution“:

When you look at history you find that essentially all financial booms and busts are associated with unusually high degrees of fraud. During a bubble, the evidence of fraud is obscured by monetary manipulation and a generally rising asset price level. Indeed, those inclined to fraud are lured into ever more aggressive forms when they sense that their activities are being ‘cloaked’ by the bubble.

What does all of this mean for gold? First, a loss of confidence in the current financial paper-based system would clearly cause a rush into the alternative currencies gold and silver, obviously impacting significantly the price of gold. But from another point of view, gold and silver themselves could become part of the story of financial scandals. There is a growing stream of believers who suspect and even provide evidence of an ongoing gold and silver price manipulation in the form of suppression of the spot price. They argue that manipulation happens in the paper (futures) market and by artificially adding supply to the physical market as bullion banks lease the gold of central banks. Moreover, there is a growing belief that Central Banks’ gold reserves are not there in the quantities as reported in their bookkeeping, as described in our latest article Central Banks’ Paper Gold vs Physical Gold: Is The Dust Settling. What would happen if one or both of these assumptions prove to be true? We can guess what the impact on the price would be, but undoubtedly the awareness that gold and silver are indeed the most trusted currencies will reemerge on a very large scale.


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