Mises Wire

The Debt-Inflation Spiral Is Driving up the Demand for Gold

Measured in dollars, the current bull market for gold started in December 2015, since which its price in dollars has almost doubled. Other than the odd headline when gold exceeded its previous September 2011 high of $1,920, only gold bugs seem to be excited. But in our modern macroeconomic world of government-issued currencies, which has moved on from the days when gold operated as a monetary standard, it is viewed as an anachronism—a pet rock, as Jason Zweig of the Wall Street Journal called it in 2015, only a few months before this bull market commenced.

Despite gold almost doubling, Zweig’s view of it is still mainstream. His comment follows the spirit of today’s macroeconomic hero John Maynard Keynes, who called the gold standard a barbaric relic in his 1924 Tract on Monetary Reform. Keynes went on to invent macroeconomics on the back of his 1936 General Theory, and whether you profess to be Keynesian or not, as an investor you will almost certainly kowtow to macroeconomics. It has been well nigh impossible to have a successful career in the investment industry unless you subscribe to inflationist Keynesian theories. You are required to substitute the economics of aggregates for those of the human action of individuals, upon which classical economics was based. And with it you must unquestionably accept the state theory of money.

Well, we are now witnessing the cataclysmic ending of the Keynesian fallacy—the destruction of macroeconomics in a systemic failure centered on paper markets for gold and silver.

The Rescue Attempt Has Already Failed

You may have missed the establishment’s last-ditch attempt earlier this year to save itself. Figure 1 below shows its failure:


Comex open interest peaked in January, when the gold contract was being overwhelmed by global demand. Never before had open interest been this high: the previous all-time record had been in July 2016, when it hit 658,000 contracts. At that time, the market had recovered strongly from a deeply oversold condition, the price rallying from $1,049 to $1,380, the December low in our headline chart. That was successfully crushed with open interest taken down to 392,000 and the gold price to $1,120. However, the takedown which commenced in earnest in January this year did not succeed.

There is no question that it was a coordinated attempt by the bullion bank establishment to contain a developing crisis. From its peak of 799,541 contracts on January 15, open interest fell to 553,030 on March 23. Initially, the gold price continued rising, to $1680 on March 9, but on March 18 it finally reacted, falling to $1471 in only nine trading sessions. But while open interest went on to fall to 470,000 in early June, the price exploded higher, with unprecedented price premiums developing on Comex from March 23 onward. The bullion banks’ short exposure net of longs on Comex in a rising market had risen to $35 billion and the gross position was $53.5 billion before the attempt to drive the market lower. Today, the respective figures are $38.3 and $53 billion.

The failure of this well-worn tactic precludes it from being used again. 

The Financial System Depends Entirely on Inflationary Fiat

In the investment industry it is monetary debasement that gives you your living, for the rise in the general level of prices of financial assets, measured by various indices, is little more than a reflection of the loss of purchasing power of your state’s currency. The world has been enjoying this phenomenon particularly since the mid-1970s, four years after President Nixon removed the last vestiges of Keynes’s barbarous relic from the monetary scene. A continual decline in the dollar’s purchasing power ensued. Apart from the occasional hiccup, from 1982, when the S&P500 Index rose from 291.34, to today’s 3,270, the general public has appeared to make money.

It has not been an easy environment to convincingly challenge, being populated by groupthinkers who believe their stock and property gains have been the consequence of their individual financial acumen. But one of those periodic hiccups is now upon us, threatening to be more disruptive than anything seen hitherto in our lifetimes, and which the macroeconomists in the central banks and governments tell us will require virtually unlimited inflationary finance to resolve.

The distinction between gold and unlimited fiat currency being issued by the state is important, because gold was always the money of the people, disliked by governments because its disciplines are limiting. History has always seen the right to issue money taken away from kings, emperors, and governments by their failures and handed back to the people, so the empirical evidence suggests that it will happen again. But macroeconomists argue that their science is an advance on former economic science, so what went before is irrelevant. Therefore, so is gold.

For these reasons, the investment industry is not attuned to gold. Physical gold is not even a regulated investment, which means that government regulators do not permit the funds they license to hold physical metal beyond a small exposure, if they permit it at all. The uncontentious position, taken by nearly all compliance officers, is for investment managers not to hold any. But besides mining stocks, today there are exchange-traded funds that do offer some investment exposure to gold for fund managers. Assuming, that is, that they are willing to contradict the Keynesian views of their colleagues.

Forget Currency Resets

In recent years, suggestions monetary authorities are planning a monetary reset centered on the dollar have been made by a number of observers. Central bank research into blockchain solutions have added to this speculation, but a recent paper by the IMF shows there is no consensus in central banks as to how and for what purpose they would use digital currencies—the central banking version of cryptocurrencies.1

In any event, it is likely to take too long for a central bank digital currency to be implemented given the speed with which monetary events are now unfolding. Empirical evidence suggests that once initiated, a fiat currency collapse happens in a matter of months. Today, the Fed has tightly bonded the future of financial asset values to the dollar—one goes and they both go. The credibility behind financial asset values is already stretched to the limit, and the inevitable collapse, taking fiat money with it, is likely to be sudden.

As a side note, the last time a collapse in financial assets took the currency down in similar circumstances was exactly three hundred years ago—in 1720, when John Law’s Mississippi bubble failed. Interestingly, Richard Cantillon made his second fortune by shorting Law’s currency, the livre, and not his shares. His first fortune was made as a banker, lending money to wealthy speculators and taking in Mississippi shares as collateral, which he then promptly sold, pocketing the proceeds.

An attempt at a currency reset, with or without blockchains, can only be contemplated after the public has begun to abandon existing currencies. But the speed with which events unfurl when fiat currencies die precludes advance planning of currency replacements. Any attempt to produce a new fiat money after the existing one has failed will also fail—rapidly. The idea that the state can take control of the valuation of a new currency in a fiat reset in order to make it durable is the ultimate conceit of macroeconomics, the denial of personal freedom to make choices in favor of the management of the aggregate.

One of the specious arguments that arises time and again is that inflation reduces the true burden of debt. This is true for existing debt, but those who advocate it as a remedy for government indebtedness fail to understand that it also increases the cost of the government’s future debt. And while it similarly reduces the burden on private sector debtors, by destroying savings inflation it leads to capital starvation and hampers any recovery.

It is possible, and desirable, that the ills of fiat currencies will be properly addressed. But that will require an abandonment of inflationism, and a commitment to balanced budgets. It requires governments to rein in their spending, reducing their role in the economies they oversee. Statist interventions, both regulatory and mandated by law have to be axed, and full responsibility for their own actions handed back to the people. And only then can sound money, preventing governments from reverting to their inflationary ways, be successfully introduced.

Assuming all this is possible, the only sound money is one with a track record and over which governments have no control as a medium of exchange. In other words, metallic money. Governments will have no alternative to turning their currencies into substitutes fully convertible into gold, with silver in a subsidiary coinage role. Coins in both metals must be freely available on demand from all banks at the fixed rate of exchange for gold, and for silver equating to its monetary value.2  The circulation of gold and silver coins will ensure that the public fully understands their monetary role, thereby deterring future governments from inflationary policies. Bank credit must also be backed by gold, and not expanded by banks out of thin air.

But the pervasive and mistaken belief in macroeconomics appears to be an unsurmountable impediment to an orderly change toward sound money. Imposing their fervent denial of economic reality, macroeconomists are in charge of both economic and monetary policy in America, Europe, and Japan—and by extension that of almost all other nations. It is not even certain that a currency collapse will dislodge them from their position of power, prolonging the chaos that will ensue.

Talk of a monetary reset only makes any sense if those doing the resetting understand what they are doing. And one thing will become immediately clear: the Americans, who stand to lose power over global affairs, will be the most reluctant of all nations to accept that the days of its hegemonic currency are numbered and that a return to a credible gold standard is the only solution.

  • 1See John Kiff et al., “A Survey of Research on Retail Central Bank Digital Currency,” IMF Working Paper no. 20/104, June 26, 2020.
  • 2Attempts at bimetallic standards have always proved impractical. The answer is to ensure that silver coins circulate with marginally higher values than their silver content to ensure that they remain in circulation.
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