The financial reset is near

The world is drowning in a sea of debt

By JAN KRIKKE

“We are in a world of irredeemable paper money – a state of affairs unprecedented in history.” – John Exter (1910-2006), economist and central banker

Central banks around the world have been on a gold-buying spree. Gold purchases this year have reached 673 metric tons, more than the total amount purchased in any full year since 1967. Until recently, much of the financial world regarded gold as a ‘barbaric relic” of the past.

Why the renewed interest in gold? The short answer is that the world is drowning in a sea of debt that has passed the US$300 trillion mark. Independent macroeconomists like Luke Gromen and Brent Johnson believe global debt has reached critical levels and they predict a costly and very painful financial reset.

The Exter Pyramid, named after its inventor John Exter, makes clear that global debt touches everyone. It includes pensions, social security, stocks, bank deposits, and the very solvency of nations. Governments have used their central banks to bring us to what could become the Mother of all Monetary Meltdowns.

Gold vaults

Central banks evolved from gold shops in Europe. Goldsmiths sold gold coins and jewelry and offered their customers vault services. People deposited their gold for safekeeping, and the gold banks gave them a “banknote” as proof of ownership.

Banknotes were typically kept at home but were also used as paper money for trading goods. The holder of a banknote could buy a shipload of lumber. The seller could collect the gold from the bank with his banknote or use it for another trade.

The banknote was a way to distinguish between “what’s mine and what’s yours.” But the gold banks, sitting on idle gold deposits from their customers, started to blur the line between what was theirs and what was not theirs.

Using their reputation as guardians of gold, banks started issuing banknotes to borrowers in excess of their actual gold holdings. (Modern central banks would virtually repeat this practice and called it “fractional reserve banking.”)

A typical gold bank would own $1,000 worth of gold and have $9,000 worth of gold deposited by its customers. But it would issue banknotes with a nominal value of $100,000, 10 times their actual gold reserves. This enabled the gold banks to earn interest on an asset that didn’t exist.

These trust-busting practices would lead to the first bank runs. Rumors about an overleveraged bank would spread through the city and depositors would run to the bank to withdraw their gold before it was all gone.

When bank runs became more frequent and disruptive to society, banks pooled their resources. If a bank was subjected to a bank run, the other banks would pitch in with their gold to stop it from spreading.

A window closes

The gold shops-cum-banks were the precursors to central banks. Growing international trade required better stewardship of the financial system, and central banks were tasked with managing the monetary system.

The Bank of England was founded as early as the 17th century, but its primary function was funding the war against colonialist rival France. Britain came out on top, and the pound sterling became the currency of the British global empire.

In the 20th century, nearly every country in the world had a central bank. The US created the Federal Reserve Bank in 1913. Fort Knox, the world’s biggest vault, was built in Kentucky by the US military in 1918. The US had the world’s largest gold reserves.

Fast-forward to the Bretton Woods Agreement of 1944, which created the postwar monetary system and made the US dollar the world’s de facto reserve currency. The price of gold was set in dollars, and all other currencies were linked to the dollar at a fixed rate. With the dollar as the benchmark, all currencies were implicitly backed by gold.

Bretton Woods lasted until 1971, when US president Richard Nixon announced that the Federal Reserve would stop redeeming dollars for gold. The dollar was no longer backed by gold but by trust and by US economic power.

After the “gold window” closed, the US quickly accumulated debt. During the 1960s, when the US government spent large sums of money on “guns and butter” (the Vietnam war and poverty reduction programs). After 1971, when the US closed the gold window, deficits and the national debt gradually got out of control.

No longer constrained by the limits of its gold holdings, the US government spent liberally on everything from social programs to corporate bailouts, infrastructure, foreign wars, and frequent economic stimulus packages. The US government issues debt to finance its deficit spending. The Federal Reserve buys the debt and sells it to the public in the form of bonds or Treasury Securities. Buyers of government debt receive interest, which is paid by the government.

For decades, investors regarded bonds and Treasuries “as good as gold.” Government debt yielded moderate but stable returns. US Treasuries typically make up 40% of the portfolio of institutional investors with long-term obligations, such as pension funds.

After the financial crisis of 2008, when the US government spent hundreds of billions to bail out over-leveraged Wall Street banks, investors in Treasuries began to wonder if the US would simply issue more debt whenever a crisis occurred.

In 2020, to soften the economic impact of the Covid crisis, the US government spent $5 trillion, in real dollars more than it spent on World War II. Economists compared it to wartime finance.

It seemed there was no limit on how much the US could borrow. In the 50 years since Nixon closed the gold window, US debt increased from $371 billion (35% of gross domestic product) to $31 trillion (126% of GDP). This year, the US Congressional Budget Office projected that annual net interest costs would total $399 billion……..MORE HERE

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