a global recession should follow should the dollar strengthen too much...
These are the reasons why a stronger dollar at this moment in time simultaneously punishes both the United States and the rest of the world. Donald Trump identified these issues and regularly bashed the Federal Reserve for not allowing the dollar to weaken against other currencies. He argued that in order to make America great again we must allow the U.S. dollar to weaken. Doing so would allow more investment at home for energy infrastructure, technology, biomedical development, and updating our outdated electrical grid.
It’s all coming to a head today. Right now there is massive divergence between the world’s major central banks.
The Federal Reserve is promising 15 rate hikes and a $1 trillion worth of quantitative tightening, while at the same time the Euro cannot even hike 25 basis points and Japan is still buying bonds in an effort to continue their policy of yield curve control. This divergence is pushing Europe into recession. A global depression could follow should the dollar continue to strengthen too much.
Our global system relies on dollars. The dollar is the blood that flows through the organism of the world economy. Eighty eight percent of all currency trades are performed in dollars. It’s why we need to consider the dollar's impact on the world when thinking about our currency, because most assuredly the world is thinking about us. Less dollars is the equivalent of “bloodletting” across the global money system.
The west has backed themselves into a corner. Debt expansion makes higher interest rates an impossibility for the long term. Russian aggression seeks to take advantage of this impossible predicament. Should Russia “turn off the gas” we could see a worldwide depression. This is the most likely scenario unless there is a dramatic devaluation of the dollar.
The Unipolar Dollar System
An understanding of history will help us to recognize the reality today. It will also help us consider what comes next and why gold provides the ultimate solution.
The dollar has officially been the reserve currency of the world since 1944. It was formalized by the Bretton Woods agreement, which reset the world monetary system after World War II. The deal was simple. Every major currency would be pegged to the dollar and the dollar would be backed by gold. The agreement allowed the dollar to become the reserve currency of the world.
However, more was needed for the free world to fully adopt the dollar.
The Truman doctrine enacted in 1947 sealed the deal of Bretton Woods by establishing that the United States would provide political, military and economic assistance to all democratic nations under threat from external or internal authoritarian forces. This doctrine initiated what would come to be known as the ”cold war” between the United States and the Soviet Union and their respective allies. The cold war then led to the formation of the North American Treaty Organization (NATO) in 1949. NATO was a unified military command to resist the Soviet presence in Europe.
These consecutive pacts permitted the dollar to quickly be adopted as the trading currency of the free world. This occurred not only because of disproportionate American gold holdings and our strong economy, but also because of our promise to militarily protect all democratic nations who supported it.
Bretton Woods was built on a promise to maintain the integrity of the dollar.
This meant that we would not increase the money supply without a corresponding increase in our physical gold reserves. The promise was not built on faith alone, but also collateralized by the reality of physical gold. Countries holding dollar reserves could exchange them for gold at any time. It’s important to note that during this time the gold price was fixed. The prevailing fix in the 1960’s was $35 dollars per ounce of gold.
Having the dollar as the world’s currency provided significant advantages to the United States. It effectively allowed our country to run budget deficits without concern of default. In the 1960’s, French President Charles de Gaulle, referred to the dollar as the United States’ “exorbitant privilege.” His description defined our ability to expand the money supply without concern of default since we could always print more dollars to cover our debts.
De Gaulle recognized that the United States was not holding up her end of the bargain. The expansionary fiscal and monetary policies of the United States from 1956 to 1971 would witness a 500% increase in the money supply relative to our gold holdings. The only remedy for foreign central banks against this dollar devaluation was to demand gold instead of dollars.
on a monetary basis, Russia is winning the war...
Germany in particular is suffering among the most as they above all European economies are most dependent on Russian energy. This was a specific point made by Donald Trump in a NATO speech. Trump argued that Germany was “controlled by Russia” by putting all of their energy security into the hands of Putin.
Interestingly, the Chinese Renminbi and the Russian Ruble have not devalued accordingly. The ruble has gotten incredibly stronger this year. On a monetary basis, Russia is winning the war. The Ruble, which dropped to lows of 158 against the dollar after their invasion, has soared back to 55, a level of strength that puts the ruble in stronger stead than any year since 2015.
Globally, our partners are suffering while China and Russia are not, at least as measured by currency valuation. Unfortunately, the pain may have to get worse before it gets better and brought to the world by the Federal Reserve.
Today witnessed the release of June CPI numbers. Economists predicted that inflation will hit a headline number of 8.8%. The actual number came in much higher at 9.1%. This is the highest inflation print in the United States since November of 1981. It’s what comes next that is crushing global markets. The Federal Reserve has vowed to do whatever it takes to stop inflation. They have already executed 150 basis points of rate hike in the last several months and have indicated they are open to another 75 basis point hike at their next meeting. The political pressure on the Federal to follow through with their 75 basis point hike at the end of the month will be strong. The market odds of a 100 basis point hike rose to 42% today.
The Fed will lose face if they pivot too hard. This is why the world is now stuck. While the world needs a dollar that weakens, here at home we need inflation to end. We are now forced to put ourselves ahead of the rest of the world. The impact of the strong dollar could lead to more pain in financial markets in the coming weeks. The moment CPI numbers were announced today the stock market dropped 1.5%. Keep in mind that one of the biggest impulses for investors when the Federal Reserve tightens monetary policy is to move out of financial assets and into cash. Selling stocks to buy cash is likely to drive the relative value of the dollar even higher.
By raising rates the Fed could effectively be ushering in a recession here and abroad.
It’s all odd timing. As the United States seeks to unify our NATO alliances against Russia and China, we are simultaneously hurting these very same partners with our tightening monetary policies at home. Russia’s control of European energy punishes all of Europe and is very likely to feed a serious depression overseas as the Euro attempts to overcome supply shortages. Federal Reserve policies that continue to foster a stronger dollar only put more pressure on what is already a global inflationary spiral.
The Fed is not stupid, they understand all of this. We anticipate the Fed will ultimately be forced to pivot away from the uber hawkish policies.
Russia's Endgame –
A New Monetary System
Now that we have explained the world through the eyes of the United States it is worthwhile to look at the world from the perspective of our enemies. It would be a mistake to believe that China and Russia are not aware of this critical moment or that it's not their ultimate intention. We believe the events in Ukraine are designed to usher in a new monetary system. We believe this is the precise goal for Putin as he forges ahead in his war against Ukraine.
Putin spoke about trust in global currencies and breaking the unipolar world order at the World Economic Forum in 2021. He reiterated these sentiments two weeks ago at the 25th St. Petersburg International Economic forum. The following excerpts from Putin’s speech make clear the Russian agenda:
Putin identified the monetary policies of the west as “a zero sum game.”
History is repeating before our very eyes. Putin is calling out the exact monetary situation that forced France and other countries to repatriate gold in the 1960’s. The unipolar power of the dollar which has been supported by the G7 countries, has robbed Russia and other labor and commodity exporting nations of their savings. We must acknowledge the expansionary monetary policies of the G7 countries over the last 14 years since the global financial crisis are no different than the expansionary policies undertaken in the 1960’s. The United States, Europe, Japan, and Great Britain have dramatically expanded the money supply of their currencies.
The pie chart below is from the International Monetary Fund and shows the balance of reserves that are held amongst central banks globally. Every central bank in the world holds G7 currencies. The Dollar (58%) and the Euro (20%) are the two most held currencies in the world by central banks amounting to 78% of global reserves. The third largest central bank reserve holding is physical gold.
Reserves represent a country's savings which come from productivity. When Russia sends Europe oil, when China sends the west labor and goods, we pay them in Euros and in dollars and other diluted G7 currencies. Much in the same way the U.S. was “robbing” other countries with our expansionary policies in the 1960’s as we held the price of gold fixed while expanding our money supply by 500%, a similar theft has occurred over the past 14 years as the United States, Europe and Japan the have taken on tremendous debts and expanded their balance sheets by more than 10X and seen their currencies expand 500% relative to the value of gold
...citizens have been acquiring physical gold...
The autocratic East has been getting paid in diluted currencies with no remedy other than inflation. It is why central banks have been net buyers of physical gold over the last decade. This is a trend that will continue, especially since the sanctions on Russia have made it clear that we can now freeze the dollar reserves of any country, at any time.
When the primary currencies central banks are forced to hold in reserve are devalued via massive monetary expansion and ultra low interest rates, it is effectively a tax on the savings of all of the central banks holding them. This is no different than what happened in the 1960’s as the U.S. employed massive monetary expansion forcing France and other nations to repatriate their gold in the 1960’s. Unfortunately, the remedy of gold repatriation has not existed for the last 50 years. Inflation is all that is left.
Putin’s argument is one the west would do well to appreciate. It’s why Russia’s central bank has sold off their holdings in U.S. dollars and replaced them with gold over the last seven years. China has also been accumulating massive reserves of gold. As G7 currencies devalue against necessary tangible commodities of food and oil, gold prices will rise. Keep in mind that gold prices are at all time highs in every nation in the world except the United States and Canada. As these other currencies are falling, their citizens have been acquiring physical gold.
We believe Putin and Xi Jinping methodically and purposefully planned the military action in Ukraine. The poor policies of Germany which made them completely dependent on Russia for their energy have exposed the weakness of the entire system. It’s also not a coincidence that Russia is attacking grain silos and other critical food and energy infrastructure in the Ukraine.
remedy to fight inflation is to put our own economies into recession...
They understand that our only remedy to fight inflation is to put our own economies into recession. The more pressure that Russia can put on the supply chains for the most critical commodities of energy and food, the more they force the existing monetary system to implode on itself. The more sanctions we impose the more we punish ourselves.
When we connect the dots and remember history, we recognize that the exorbitant privilege that allowed the U.S. to dramatically expand the money supply in the 1960s against gold was a detriment to all who held our dollars in reserves. Back then there was recourse to repatriation of gold and a massive inflationary spiral. Gold no longer is a part of that equation. Inflation is all that’s left.
So what is likely next? We look to history for our guide.
A similar situation played out from 1980 through 1985 when the tight monetary policies of the Federal Reserve under Paul Volcker caused the dollar to appreciate significantly against other currencies. In January of 1980, the dollar index was at 89. Just 5 years later in March of 1985 the dollar had risen to highs of 164. Our tight monetary policies caused our currency to strengthen against the major currencies of G5 countries.
The Plaza Accord was an agreement entered into in 1985 between the G5 nations, France, Germany, the United States, the United Kingdom, and Japan which manipulated exchange rates by depreciating the U.S dollar relative to the Japanese Yen and the German Deutsche Mark.
The goal of the Plaza Accord was to weaken the US dollar in order to reduce the mounting U.S trade deficit. The accord led to the mark and the yen both dramatically increasing in value relative to the dollar. Over the course of the next decade from 1985 to 1995, the DXY would fall 50% from highs of 164 back to lows of 80.
When we consider what’s happening in Europe and around the world today we must be thinking about a new accord, one that allows the dollar to weaken dramatically relative to other currencies. As Trump himself highlighted, our long term interests are likely best served by a U.S dollar that is substantially weaker. A weaker dollar eases pressure on the world economy. This, we believe, is precisely the aim of the Russian invasion in Ukraine.
remember, the dollar sits opposite gold
Which leaves us thinking about gold.
Remember, the dollar sits opposite gold. While we are no longer on a gold standard, gold is still the standard by which our currency is measured. When the dollar rises in value relative to other currencies it leads to a programmed trade to sell gold. Algorithms that have become the main driver of the market automatically sell gold when the dollar strengthens.
However, this time looks different. The DXY has risen from 91 to over 108 over the last year. This type of currency move would ordinarily see a massive sell off in gold prices. That has not occurred. While many people are questioning why gold is not performing better in this environment they are missing a critical fact: it actually is. Gold prices have only fallen 2% against the dramatic 20% increase in the dollar over the last 12 months.
What happens next will certainly be historic.
The first is a Fed pivot where they intentionally choose to lose credibility. Imagine if the Fed underdelivers with only a 50 point or a 25 basis point hike in July? In that case we would likely see the DXY fall as the dollar loses value to other currencies. This would be good for the world and would reduce inflation everywhere but the United States. It would likely witness a big move higher in precious metals.
When we couple the current situation with the recognition that we are technically already in recession, and that in recessions the Fed always cuts interest rates, then the path to a weaker dollar becomes all the more obvious. It is why we are so bullish on gold and silver at this moment. Not only does the world need a weaker dollar to avoid a depression, we also need a weaker dollar to lift us out of recession at home. As the Fed is forced to pivot we expect to see the dollar weaken. As that occurs, gold and silver prices could launch much higher.
Of course, this would only be a band aid on a much bigger problem. The truth of The Great Devaluation remains. Triffin's dilemma is one that has torn our country apart. The best outcome for the United States is one where the strength of our reserve currency status is weakened and voluntarily restructured.
The way out before is the way out once again.
A weaker dollar is coming. Unfortunately, we may ultimately only get there after something terribly bad has happened.
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