Nick Barisheff, CEO of Bullion Management Group Inc. and author of the book $10,000 Gold: Why Gold’s Inevitable Rise Is the Investor’s Safe Haven did an recent interview with Investor’s Digest of Canada. In it, he explained how an hyperinflationary period does not occur by accident. It is rather a process which comes at the end of five stages. The pattern is recurring. This article covers the process which leads to hyperinflation and the answer to the question why Wall Street inclines to discredit the yellow metal.
Five stages towards hyperinflation
A history of paper currencies or, perhaps better, a study of inflation, is essential if we wish to understand the role gold plays as money. Almost every irredeemable paper cycle goes through the same stages from birth to death. The cycle begins life with the promise of healing all the country’s economic woes, while promising prosperity for all. It also promises to do this with the least amount of pain and discipline, which is why this phase is so appealing and so seductive. Although the cycle can vary, it appears countries that break free of gold, choosing instead to introduce fiat currencies, go through the following stages.
Stage one is often characterized by unbridled optimism and euphoria. If a country moves off the gold standard, there’s relief, since the fiat system has few restrictions. Fiscal responsibility can move from being a demand to an empty slogan that politicians use to make themselves sound conservative. Initially, there are many promises to print only what a country needs, so as to live within its means. Usually, this period is short-lived, as the temptation to print more currency to stimulate further growth is simply too great for politicians and bankers to resist.
During stage two, restrictions start to be removed from the currency creation process. At this point, the discussion moves from surpluses to managing debt.
The idea of paying off debt is no longer as important as it once was, as debt allows growth and growth per se are the single most important driver of the fiat system. Without perpetual growth, the system collapses. At first, debt appears to create growth, as it did between 1900 and 1950, when money was spent on infrastructure. We know, for example, that the first casualty of this artificial growth is loss of prosperity, which we can define as quality of life. As their currency loses value because of debasement through money creation, people find they have to work longer hours to afford the same standard of living.
Meanwhile, during stage three, excess liquidity starts making its way into the stock markets. This is the gambling/bubble stage. By now, growth is starting to slow, which means more money needs to be created. Moreover, interest rates must be kept as low as possible, as any increase will burst the bubbles and most certainly slow growth which, of course, is unthinkable. As each successive bubble breaks, more wealth is transferred into fewer hands. Then, too, with interest rates so low, everyone is forced to buy stocks in order to keep pace with inflation.
In addition, thanks to the wealth effect, people usually go much deeper in debt than they normally would. That’s because bubbles cause consumers to believe they have more money than they actually do. Indeed, because of the inflated price of their home or their stock portfolio, these people think they’re paper rich. But at this point, inflation measures are so skewed that people simply lose touch with the standards of value they once used.
Stage four typically sees the underfunding of services and infrastructure. This is the penultimate stage of the fiat cycle, the one in which we now find we ourselves. Growth is slowing to the point that financial services are forced to find other ways to make money than through financings and brokerage fees. This is the corruption stage, where fundamentals are ignored and so much wealth is concentrated in the hands of so few that the few can afford to influence the law. In an interview on BBC television in 2011, trader Alessio Rastani said he and other traders dreamed of a depression, seeing in it the potential for profit. “Governments don’t run the world,” Mr. Rastani opined. “Goldman Sachs does.” Don’t believe this? Well, consider the case of Greg Smith, once head of Goldman’s U.S. equity derivatives business in Europe, the Mideast and Africa. In March 2012, he wrote a scathing piece about his former employer in the New York Times, giving the reasons why he’d quit. “I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity,” said Mr. Smith. “And I can honestly say that the environment now is as toxic and destructive as I’ve ever seen it.”
At this point, individuals must look out for themselves, given the lack of importance of governments or financial advisors. Those who fail to take the step of protecting themselves will suffer the most in the later part of stage four and certainly in stage five.
So what’s stage five? Hyperinflation, the worst economic phase of the fiat cycle — a period in which currency becomes essentially worthless. Hyperinflation has struck the world 56 times since 1795. In fact, in Weimar Germany in the 1920s, things got so bad that only gold was accepted as for reparations.
To avoid global hyperinflation, it’s probable a big structural change will occur, likely involving the formal recognition of gold as money. At each stage of this five-stage cycle, the individual loses economic freedom by increments as government restrictions grow. The elite, who have the highest concentration of wealth, can pass laws that protect them from litigation — laws that often benefit the rich at the expense of the taxpayer. Towards the end of this fiat cycle, people lose all faith in government; in some cases, they actually try to bring it down, as evidenced by the recent “occupy” movements.
Leverage is the real problem
If gold helps to stabilize the economy, why does physical ownership of the yellow metals is being discredited by Wall Street and mainstream media? Barisheff explains how the leveraged gold products are the real issue. There is a relatively small amount of bullion underpinning the many derivatives of the paper gold market. He says:
It’s hard to pin down just how many investment derivatives there are that are based on gold. But removing even a small amount of bullion from the available supply weakens the leverage potential of many derivatives. And the amount of leverage in the physical gold market may be even higher than suspected.
The computer-driven financial services industry depends on its power to create derivatives. Indeed, it’s possible to create derivatives from almost any underlying asset. This is shown by the success of Wall Street’s “geniuses” in creating derivatives from toxic, underfund- ed, under-qualified sub-prime mortgages. Yet precious metals are the one asset class that doesn’t lend itself to this practice, given the limited quantity of gold and silver, as well as the actual inability to manufacture the underlying asset class. When we look at exchange-traded funds and the many vehicles for proxy ownership of gold, we’ll see there’s been an attempt to work around this problem. But success is predicated on the assumption that people cannot take physical delivery en masse.
(Article originally published in Investor’s Digest of Canada)