With G7 national finances spiraling out of control, debt traps are being sprung on all of them, with the sole exception of Germany.

Malinvestments of the last fifty years are being exposed by the rise in interest rates, increases which are driven by a combination of declining faith in the value of major currencies and contracting bank credit. The rise in interest rates is becoming unstoppable.

Do not be surprised to see a US Government deficit exceeding $3 trillion this fiscal year, half of which will be interest payments. And in the run-up to a presidential election, there’s every sign of deficit spending increasing even further.

We now face America and her allies being dragged into another expensive conflict in the Middle East, likely to drive oil and natural gas prices higher; far higher if Iran becomes a target. With the Muslim world united against Western imperialism more than ever before, do not discount the closure of Hormuz, and even Suez, with unimaginable consequences for energy prices.

The era of interest rate suppression is over. G7 central banks are all deeply in negative equity, in other words technically bankrupt, a situation which can only be addressed by issuing yet more unproductive credit. These are the institutions tasked with ensuring the integrity of the entire system of bank credit.

This is not a good background for a dollar-based global credit system that is staring into the black hole of its own extinction.

The end for the dollar is nigh

There are a number of events coming together that suggest we are about to undergo a major upheaval in world economic, financial, and monetary affairs. It’s like one of those bush fires, which you fight in front of you, only to find that suddenly the flames are behind you as well, then on your right and your left. It becomes so hot that things are spontaneously combusting all around you and there is no escape. This is the condition currently faced by central bankers.

Just when interest rates have risen to a peak, they seem to be rising again. Surely, investors argue, the firefighting central banks must lower rates to save debtors, to save the banks, and to save themselves. But they do not control interest rates. They are being set by debt traps and over-leveraged banks trying to control lending risk. Accelerating demand for credit to pay higher interest rates is meeting a growing reluctance to lend. And to top it all, an alliance of Russia, the Saudis, and Iran are deploying control of the global oil supply, with the intention of forcing prices higher. Energy is the lifeblood of any economy. The last thing the West needs is another war in the Middle East. And now we look like having that as well.

The history of the dollar as the world’s reserve currency has been one of struggling from crisis to crisis on a worsening trend. Recent history saw the credit bubble of the nineties ending with the dot-com madness and its collapse, followed by what was commonly termed the Great Financial Crisis of 2008—2009. Given our current predicament, that description seems like mere hyperbole, because we now face an even greater crisis. Is it possible to kick the tin can down the road once again?

It seems unlikely, even allowing for the past experience of successful statist rescues from financial crises: somehow, the authorities have always been able to calm a crisis. But this time, the Global South, the nations standing to one side of all this but finding their currencies badly damaged by unfavorable comparisons with a failing dollar, a dollar forced into higher interest rates in a world that knows of nowhere else to go — this non-financial world is on the edge of abandoning American hegemony for a new model emerging from Asia.

The transition from the global status quo is bound to be a difficult affair. That the US Government is ensnared in a debt trap and is being forced to borrow exponentially increasing amounts just to pay the interest on its mountainous debt is not the fault of other nations. But many of them in turn are being forced to pay even higher interest rates, irrespective of their budgetary positions, and irrespective of their balance of trade. Yet their currencies continue to weaken even against a declining dollar.

The lesson for all of them is to not listen to the mathematical economists spouting Keynesian and monetary theories. The Russians with a trade surplus and a debt-to-GDP ratio of under 20% even when it is at war compare extremely well statistically with the US Government. If it wasn’t Russia, we would rate its financial condition highly. But the rouble still collapses, forcing Russia’s central bank to raise its short-term interest rate to 15%. The reason is simply that no one trusts roubles, but they still believe in the dollar as a safe haven.

However, there is every sign that the 52-year era of the purely fiat dollar is ending. Some foreign governments appear to be liquidating their US Treasury holdings to protect their own currencies. Japan, which is fighting to keep its yen from further collapse, has been selling recently, as has China (though for her there may be political reasons as well). The knock-on effects of the dollar’s debt trap are vividly apparent in weakness for the yen, yuan, rupee, and euro whose charts against the dollar are shown below. The effect of the dollar’s strength on lesser currencies is even worse.

Everyone assumes that the Fed must and will end this madness, not least because of the consequences for overindebted American businesses, the banks, and the Treasury itself. But what if the Fed is powerless, what if the situation is escalating beyond its control, and what if by reducing its funds rate the dollar would simply weaken pushing up consumer prices? And what if the Treasury finds funding the Government’s massive borrowing difficult even at higher interest rates?

Suddenly, that appears to be increasingly likely. The global south, which is the new name for those either in the Asian hegemons’ camp or considering joining it will need to find an alternative to being compared unfavourably in the foreign exchange markets with a failing dollar. The pressure for a whole new monetary system for the emerging nations is increasing.

In the past, currency boards linking a failing currency firmly to the dollar have been an effective solution. The problem for all currencies not formally tied to the dollar is that they will always be secondary forms of fiat. There is only one answer, and that is to abandon the dollar and return to tried and trusted gold standards.

Gold is real legal money internationally, whose value is constant over time. The world is learning the hard way that it is unattached credit which is unstable. And as the US sinks deeper into its debt trap a fiat currency credit crisis is just beginning.

In this article, we look at the major moving parts that are leading to the end of the entire fiat currency system. It is not just the dollar in crisis. By following the same monetary and economic policies, the Eurozone, Japan, and the UK are in similar difficulties, not to mention a host of other advanced nations.

The US Government’s debt trap

Last May, the Congressional Budget Office forecast a budget deficit of $1.5 trillion for fiscal 2023, which ended last September, including net interest payments on government debt of $663bn. The St Louis Fed’s chart below shows that the interest element was wildly underestimated. The outturn was actually $981bn, 48% higher than the CBO expected.

In its debt interest forecast, the CBO estimated the net interest rate to be 2.7%. At the time the forecast was published, the 3-month T-bill rate was over 5%, but the yield curve was deeply negative, with the 10-year US Treasury note yielding 3.7%. In the current fiscal year, the CBO estimated the interest cost to average 2.9%. But with the current year’s deficit likely to be considerably higher, and $7.6 trillion of maturing US Treasury debt required to be refinanced at current and potentially higher rates, official estimates of interest costs are far too low. In fact, the CBO didn’t expect interest costs to exceed 3% until fiscal 2030.

More realistic estimates will emphasize the debt trap danger. The deficit outturn was officially stated as $1.69 trillion, to which a further $300bn must be added back because when President Biden’s proposal to pay off student loans was rejected by the Supreme Court, the money “saved” was simply added back as a reduction in expenditure. A truer figure for the 2023 deficit was $2 trillion.

Nevertheless, at $981bn debt interest was approaching half the total deficit. The deficit for the current fiscal year commences with interest on $33.5 trillion of which $26.3 trillion is in public hands, and the average interest rate is not going to be the CBO’s estimate of 2.9%. Already, we see the cost of funding the $7.6 trillion of debt being refunded this year plus the $1 trillion of existing interest costs having risen to over 5%, adding an extra $200bn on interest costs alone.

To this must be added additional interest costs for the underlying budget deficit this year. There is no knowing how high this will be. But allowance for the consequences of higher interest rates must be made, which are essentially recessionary. Much has been made of recent figures showing US GDP growing persistently, with the third quarter outturn up 4.9%, leading to the Fed’s tight monetary policy being justified. But there are fundamental errors in this way of thinking which radically affects the budget outcome.

If we look at raw GDP figures, we see that in the 2023 fiscal year, GDP increased by just under $1.9 trillion. Including the student loan accounting trick, this is remarkably close to the $2 trillion budget deficit. While we cannot equate the two numbers absolutely, particularly when nearly half the deficit is interest expense, we should not ignore the fact that some of this interest enters the real economy, there are additional deficits from state governments, and that the rest of the deficit contributes almost entirely to GDP.

Therefore, instead of nominal GDP increasing 7.5%, private sector GDP probably increased hardly at all. But the rate of CPI inflation for the fiscal year was recorded at 3.6%, or according to Shadowstats.com based on the original 1980-based calculation method about 12% — take your pick. We can therefore say that despite the bullish growth headlines and allowing for CPI inflation, the US is already in recession.

This is the background to the US Government’s revenue income and expenditure prospects for fiscal 2024, confirmed by business surveys and anecdotal evidence. Already, we can see that estimates of tax revenue will fall short because profits decline in a recession and unemployment rises (with respect to unemployment, government statistics are notoriously unreliable and can be safely disregarded). While tax revenue declines, mandated welfare and other costs increase. Taking the last fiscal year’s ex-interest deficit of about $1.1 trillion as our base, the current year’s deficit will be significantly more due to the recessionary consequences of higher interest rates. And President Biden is trying to get a revised version of student loan relief past the courts, emblematic of yet more increases in government spending. After all, the current fiscal year is the last in the Presidential election cycle when traditionally electors are bribed with extra government spending.

Let’s pencil in a reduction of revenue by $500bn and an increase in outgoings of a similar amount to increase the deficit ex-interest by about $1 trillion to $2 trillion.

The interest bill is already growing exponentially. We can see that the funding requirement for new debt will be $2 trillion in excess spending, plus at least another $1.3 trillion of interest (allowing for the $7.6 trillion of debt to be refinanced), totaling over $3.3 trillion in total. Clearly, it won’t take much more of a credit squeeze and the increasing likelihood of a buyers’ strike to push the interest bill to over $1.5 trillion.

Higher interest rates are accelerating the debt trap

I have recently written about why in a world of fiat currencies interest rates do not represent “the cost of credit” except perhaps to borrowers. It is more about what a depositor thinks the purchasing power of the currency will be at the end of a loan period, plus something for counterparty risk, and plus another something for the temporary loss of the use of the depositor’s funds, the last of which is known as time preference. Unless the Fed understands this (and there’s not much evidence that this is so) then interest rate policy is fatally misguided.

There are two categories of lenders to consider — domestic who are generally captive, and foreign who are not. The reasons foreigners hold dollars and dollar assets are to do with trade settlement requirements, including the purchase of commodities which are nearly always priced and valued in dollars, and investment. On both these grounds, their requirements are changing, probably for the worse. Higher interest rates are hitting global production, leading to less demand for trade dollars, and at some stage higher interest rates will lead to portfolio losses and widespread portfolio liquidation of dollar assets by foreign investors.

Foreign interests in dollars are split as shown in the following table.

Other than the short-term debt of $7.293 trillion, the rest of these financial assets are highly interest rate sensitive, equities acutely so which is the largest investment category. The next chart shows the valuation gap that has already opened up between rising bond yields and equities represented by the S&P 500 Index (arrowed).

The chart shows the tight negative correlation between the yield on the long bond (right-hand scale) and the S&P 500 Index (left-hand scale) by inverting the yield. Since the Lehman crisis, the falling bond yield has led the S&P higher, to an extreme divergence in July 2020. Since then, the divergence has reversed spectacularly, indicating that the S&P is now wildly overvalued relative to bond yields and a sharp fall in equities is almost certain. On this basis, a target for the S&P (currently 4,120) of between 500 and 1000 can be justified if this valuation gap is to close and if the long bond yield remains at current levels or higher.

If, as seems very likely, US bond yields rise from here, US equities are due for a significant crash. In that event, with financial asset values falling there can be little doubt that foreign investors will be reducing their exposure dramatically. Some of this reduction is likely to lead to higher short-term balances in banks and T-bills. But it is hard to envisage foreign liquidation of US assets not leading to dollar selling. Some of this liquidity is bound to return to its currencies of origin because, from an accounting point of view, that is always the risk-free option. But some of it is bound to go into physical gold because that is the risk-free international money.

Why interest rates will rise from here and the consequences

The valuation gap between bonds and equities is not unique to the US, being in common with other financial jurisdictions as well. That it exists indicates investors are discounting lower interest rates in time. But what if this is wrong, and interest rates are headed higher still?

In the introduction, I mentioned the alliance between Russia, Saudi Arabia, and Iran, who with the Gulf Cooperation Council dominate global oil and gas supplies. These nations have an interest in ensuring that oil’s value, priced in declining dollars, is maintained in real terms. Furthermore, Russia sees energy prices as an economic weapon useful for putting pressure on European NATO members with a view to splitting them off from American control. And now we face a new flashpoint between Israel and Hamas, which is likely to spread to a conflict involving America and Iran, which could lead to the closure of the Straits of Hormuz, and possibly Suez as well.

For now, markets appear to be complacent in the face of these factors. But as the situation evolves this is unlikely to last, and oil and gas prices could rise significantly as these risks grow.

European energy stocks are insufficient to see Europe through the winter, and the US’s strategic reserves are depleted. There is no better time for this OPEC+ cartel to force prices higher, and by recently cutting the supply of 1.3 million barrels of oil per day that is precisely what the Saudis and Russia are doing. Heating oil and diesel prices are likely to rise strongly as well, if only because Russia has stopped exporting these distillates. The relevance of diesel is that over 95% of all European distribution logistics are delivered by diesel power, increasing the production and delivery costs of all consumer goods.

Consumer prices are what the central banks watch when setting interest rates. And due to energy factors, the outlook is for rising consumer and wholesale prices to accelerate again. Additionally, commercial banks’ balance sheets are highly leveraged, and they have been caught with bond investment values declining while funding costs have risen above their yields. They find that commercial property loans and lending to businesses are threatened by higher interest rates and recessionary conditions. In the current interest rate environment, there are very few buyers for these assets if banks are forced into liquidating collateral against loans.  Consequently, they are reducing bank lending and de-risking their balance sheets where they can.

This is why irrespective of central bank policy, the shortage of credit is driving borrowing rates higher, and the cost of novating maturing debt is rising, if the credit is actually available — which increasingly is rarely the case. It is an old-fashioned credit crunch, not really seen since the 1970s. And it has only just started.

These conditions are very different from the long decline in interest rates from the 1980s, and the subsequent period when they sat at or below the zero bound. The world of fiat currencies has become destabilized, not by the detachment from gold and the market’s adjustment to it as was the case in the 1970s, but by extreme interest rate suppression, inflationary excesses, unproductive debt creation, and massive government debt overhangs. Debt-to-GDP ratios of the G7 group of countries in 2022 averaged 128%. This list was headed by Japan at 260.1%, followed by Italy at 144%, the US at 121.3%, France at 111.8%, Canada at 107.4%, the UK at 101.9%, and Germany at 61.8%. The conditions of currency instability of the 1970s with their higher interest rates have returned, giving rise to an overriding question: how are these budget deficits going to continue to be financed?

US deficits were financed since the early 1980s against a long-term trend of declining bond yields, so every participant in bond auctions began to know that in time bond values would always improve, even if the short-term outlook was uncertain. That is no longer the case.

While it would be a mistake to ignore the skills with which the authorities and the primary dealers manage debt auctions, with a trend of rising rates there will be times when auctions are bound to fail. In the 1970s, this happened several times in the UK, primarily because the UK Treasury effectively managed the debt management office through its control of the Bank of England and Treasury officials didn’t understand markets. Nevertheless, we saw gilt issues with coupons of 15% and over. Imagine what similar funding rates would do to government finances today, with the G7 debt ratio averaging 128% last year.

Relatively quickly, some governments are bound to run into severe funding difficulties, which can only be resolved by overtly inflationary means.

The entire G7 banking system is broken

A further problem arising from the excesses of the past is that the entire banking system from central banks downwards is in dire straits. Central banks that implemented QE did so in conjunction with interest rate suppression. The subsequent rise in interest rates has led to substantial mark-to-market losses, wiping out their equity many times over when realistically accounted for. Central banks claim that this is not relevant because they intend to hold their investments to maturity. However, in any rescue of commercial banks, their technical bankruptcy could become an impediment, undermining faith in their currencies.

As the reserve currency for the entire global fiat currency system, the dollar and all bank credit based upon it is likely to be the epicenter of a global banking crisis. If other currencies weaken or fail, there could be a temporary capital flight towards the dollar before a wider financial contagion takes over. But if the dollar fails first, all the rest fail as well.

The condition of the US banking system is therefore fundamental to the global economy. But there are now signs that not only is US bank credit no longer growing but it is contracting sharply.

The chart above is the sum of all commercial bank deposits plus reverse repurchase agreements at the Fed. While the latter are technically not in public circulation, they have been an alternative form of deposits for large money market funds that otherwise would be reflected in bank deposits. Recently, having soared from nothing to a high of $2,334.3 billion last September, reverse repos subsequently declined by $1,250 billion. Subtracting this change from bank deposits shows the truer contraction of bank credit to be $1,918 billion, which is a 9.4% decline from the high point earlier this year.

This contraction of credit in the banking system is likely due to reverse repo funds switching into Treasury bills, short-term government debt deemed to be the safest form of investment. It is wholly consistent with bank and shadow bank credit being de-risked.

The situation facing the other major fiat currencies differs mainly in the details. It is a sad fact that Basel III regulations have addressed balance sheet liquidity problems but failed to contain excessive expansion of bank credit relative to shareholders’ capital. Consequently, regulators in the Eurozone and Japan have tolerated asset-to-equity ratios of over twenty times for their global systemically important banks, when in the past ratios of twelve to fifteen times were deemed to be dangerously high. The contraction of bank credit is therefore likely to be more catastrophic in these jurisdictions than in the US, where ratios for major commercial banks are commonly less than twelve times.

Estimating balance sheet ratios does not tell the whole story. There are off-balance sheet factors as well, principally liabilities in regulated and over-the-counter derivative markets, which for the G-SIBs are larger than their entire balance sheets combined. According to the Bank for International Settlements, open interest in regulated futures totaled $37 trillion in June 2023, and in December last year, the notional value of OTC derivatives stood at an additional $630 trillion, giving us a total of $667 trillion. Banks, insurance companies, and pension funds are the counterparties in these transactions, and the failure of a significant counterparty acting in these markets could threaten the entire Western financial system.

The big picture is of an asset bubble which has come to an end. And by any standards, this one was the largest in recorded history.

Geopolitics and gold’s renaissance

The fiat currency problem is likely to be made more immediate by a new factor of nearly four billion people rapidly industrializing under the leadership of China and Russia. The evidence strongly suggests that these two hegemons see monetary matters similarly to the author of this article and that they are now ready to protect themselves from an impending collapse of their western enemies’ currencies.

China and Russia have accumulated significant quantities of gold, and by gold mine output is the world’s largest by far. The prospect of the Asian hegemons returning to gold standards is bound to draw attention by contrast to the weaknesses and fallacies behind fiat currencies.

For those of us under the yoke of fiat credit detached from any corporeal values, there is only one escape from a banking system that is now imploding. And that is to possess legal money as much as possible, which by both longstanding law and human habit is gold in bar and coin form. Physical silver is the money for smaller purchases. That is why Goldmoney was founded over twenty years ago, with the objective of providing a safe haven from a monetary system that was eventually bound to collapse. That moment now appears to have arrived.

The likelihood of a dollar collapse is being enhanced by the string of failed US foreign policies. Iraq, Syria, and Afghanistan are on the list, with other ventures, such as the collapse of Libya creating refugee havoc for Europe. It appears that Ukraine is a lost cause as well. And now, the Western alliance is swinging behind Israel in her attempt to root out Hamas from Gaza.

Any objective analysis indicates that US involvement is very likely to bring Hezbollah into the conflict, which involves Syria and Iran. There are US assets in Syria, which would then become a target for Iran, and Iran can easily block the Straits of Hormuz, choking off 20% of the world oil supply, and 18% of LNG. In that event, energy prices would obviously spike far higher, sharply pushing up G7 interest rates. Rational analysis suggests that this possibility would ensure that America and her NATO partners should back off and attempt a diplomatic solution.

The evidence is to the contrary, with America and Britain sending aircraft carriers into the Eastern Mediterranean, and Russian Mig fighters patrolling the Black Sea in striking distance of the Western alliance’s carriers.

What has changed is Muslim unity, fused together even more by Israel’s collateral damage against Palestinian citizens. Both Sunni and Shia Muslims, representing two billion people are now united against the Western alliance and its culture. The US’s policy of divide and rule is no longer appropriate.

US foreign policy is in tatters. If it presses ahead to reassert its dominance over the Middle East by getting involved militarily, the US will lack the support of former regional partners, and inevitably the threat to oil supplies will divide her NATO partners. If she decides not to get involved, that will confirm to the Middle East and the Global South that her days as the global hegemon are over.

Either way the prospects for King Dollar are not good. In a war scenario, there may be a temporary flight to the dollar before the implications for interest rates and financial asset values are better understood. If the US backs off, there may be a temporary relief rally in financial assets, but the message for the dollar is it is over-owned, and with the decline of US power, it should be sold on the foreign exchanges for gold.

How do you protect your paper wealth from this outcome? Some swear by bitcoin and others by gold.

This article looks at what is likely to emerge as a replacement currency system, and concludes that from practical and legal aspects, bitcoin and the entire cryptocurrency industry will fail with fiat, while mankind will return to gold, as it has always done in the past when state control over currency fails

Introduction

It is gradually dawning on market participants that the era of fiat currencies is drawing to a close. Monetarists, who first warned us of the inflationary consequences of the expansion of money and credit were also the first to warn us that the slowdown in monetary expansion would lead to recession, and since then we have seen broad money statistics flatline, with bank lending beginning to contract. This is interpreted by macroeconomists as the end of inflation, and the return to lower interest rates to stave off recession.

Unfortunately, this black-and-white interpretation of either inflation or recession but never both has been challenged by bond yields around the world which are rising to new highs. And the charts tell us that they are likely to go considerably higher. Consequently, conviction that inflation of producer and consumer prices will prove to be a temporary phenomenon is infected with doubt.

For those of us steeped in free market economics and with experience of the monetary and economic scene in the 1970s, the possibility of both inflation and recession occurring at the same time is less of a surprise. They called it stagflation, though the Keynesians never managed to reconcile the existence of the two conditions being present at the same time. The error, surely, is in Keynes’s denial of Say’s law, which postulates that we produce to consume. The Keynesian error was to ignore the plain fact that rising unemployment is the consequence of falling production first, so there can never be a general glut of goods in a slump which is the basis of Keynesian assumptions.

Consequently, we should concede that a return to stagflation, or worse, is eminently possible. And that rising bond yields from here are also possible, indeed even likely as the charts so clearly indicate. In the coming weeks and months as bond yields continue to rise dragging interest rates up behind them, the debate as to how to hedge this unexpected condition is bound to intensify. In one corner, we have gold, and in the other cryptocurrencies, headed by bitcoin. Both have their vocal enthusiasts.

But enthusiasm is not a sensible basis for an investment or trading strategy. It misleads investors and those seeking to protect their wealth from the debasement of currencies, which is what continuing and rising inflation of prices represents.

Sentiment driven investment tends to overlook important facts. In this article, I compare the relevant facts from very basic legal and monetary standpoints, first for cryptocurrencies represented by bitcoin and then for gold.

Bitcoin as practical money

Bitcoin and crypto currency fans argue that they are the future money. Bitcoin in particular is seen as incorruptible, secured, and self-audited on a blockchain. It is strictly limited to its hard cap of 21 million coins. It is this limitation which has led to estimates of its future value in fiat currency, depending on how much more fiat currency debasement a forecaster expects. And it can be convincingly argued that the fiat currency debasement rate is likely to accelerate further as stagflation returns, leading to ever greater government deficits and escalating increases in government debt. This might be expected to lead to a resurgence in interest in bitcoin, taking it to new highs.

Enthusiasts argue that bitcoin will increasingly replace fiat as the general public begins to realise that fiat currencies are losing purchasing power, which is why the general level of prices is rising. But we must make a distinction between using a currency, crypto or otherwise for day-to-day transactions and as a store of value. In the former case, the possession of currency resulting from the sale of something is temporary, so its changing value in terms of goods over time is of little interest to the seller of goods who receives it in payment. But it does matter to the saver with a longer time horizon.

Saving, or more correctly hoarding in the case of bitcoin, is the issue which we must address. To a saver an increasing purchasing power for currency units in which his savings are denominated is desirable. Therefore, it is likely that savers will hoard their bitcoin instead of letting them circulate because the hard stop on their quantity would be expected to continually increase its value. So powerful is this deflationary tendency likely to be that other than for bare essentials, all commerce, currently depending on credit, would grind to a halt. Taken to its logical conclusion, the world would simply regress to a feudal state with mass poverty.

The solution can only be for holders of bitcoin to lend their bitcoin to borrowers so that commercial activities could take place. This is credit and is the basis of all banking and all economic progress. The need for credit will not go away with the end of fiat currencies, nor will its counterpart, debt. Indeed, the possession of debt obligations is wealth and makes up the majority of it. I shall go into this topic later in this article. But for now, let us consider the difference between bitcoin and bitcoin credit.

In order to produce anything, capital is required. It is a simple fact that production precedes consumption. It can take years for factories to be built, and people with the relevant skills trained and employed. Most if not all of this funding requires credit. It entails a business plan to take all cost factors including the cost of funding into account in order to estimate a project’s viability.

When assembling a business plan, not only does an entrepreneur have to estimate all the input costs and the product’s final sales value, but he has to estimate the cost of repaying borrowed capital. But presumably, a hard stop of 21 million bitcoins will lead to higher bitcoin costs of future capital repayments. Uncertainty as to what bitcoin’s future value would be will likely scupper most projects, even before the difficulty of predicting future demand for goods priced in rising and volatile bitcoin. Bitcoin’s limitations would almost certainly lead to an intensely deflationary outlook, because it is simply not suited as a basis for valuing credit.

In this respect, bitcoin is fundamentally different from gold, the extraction of which in the long term has grown roughly in step with the world’s population. Furthermore, there are substantial reserves of above ground gold in the form of jewellery, which can be reallocated to monetary functions if markets demand its change of use. The flaw in the bitcoin as money argument is gold’s strength: its unsuitability to act as backing for credit, and its total inflexibility of supply.

I am not aware that anyone in the bitcoin camp has properly addressed these issues or is even aware of them. It appears that hodlers do not understand how dependent humanity is on credit. Instead, they tend to dismiss credit as being the problem. Nor is there any understanding of the relationship between money and credit in a functioning, stable economy. The very conditions which are supposed to give bitcoin its value as incorruptible currency are enough to render it entirely unsuited to act in that capacity.

The dismissal of credit is even before we are asked to swallow the fact that it is wholly inappropriate for the vast majority of users who are not tech savvy enough to even understand it. A currency must be simple enough to be understood by its users. The promotion of bitcoin and other cryptocurrencies is the dream of an elite of technological literates and speculators hitching a ride on its concepts.

Then there is the legal position. In the absence of specific legislation passed to give bitcoin or any other cryptocurrency the legal status enjoyed by gold it does not have the legal status required. Hodlers do not appreciate that legally only certain things can act as money.

In order to understand the distinction between what can pass as money and what cannot, we must define the difference between the right of possession and the right of property. If I lend a book to a friend, I allow him to have a right of possession for a period of time, but it still remains my property. The property in the book has not been transferred to him. If I went to his house to collect the book, and he was not at home, I would be free to recover the book if I saw it (though out of politeness I should let him know that I’ve recovered my property). This in Roman law was referred to as a commodatum, which is defined as “a gratuitous loan of movable property to be used and returned by the borrower”.

Money and credit are treated differently, along with consumable items, such as food and drink. When these are loaned, the property in them transfers absolutely, in return for which an obligation by the receiver is created to restore the equivalent of similar quality and quantity. To continue on from the example of the commodatum, if instead of a book I had loaned my friend $100, and going to his home to recover his obligation to me I found he was away but saw his wallet left behind, and I took $100 from it, I would be guilty of theft.

In Roman law, the loan of money, credit, and items to be consumed is a mutuum, which is defined as “a loan of a fungible thing to be restored by a similar thing of the same kind, quality and quantity”.

While in the English language the use of the terms lend and loan are ambiguous, the difference between commodatum and mutuum is still clearly recognised by us all to this day, as the examples of the different treatment of a loaned book and $100 illustrate. The same conditions apply with respect to criminal theft. If a thief steals your car and sells it on to an unsuspecting buyer, it remains your property and you are fully entitled to recover it without compensating the hapless buyer. But if a thief steals your wallet, or empties your bank account, you only have recourse against the thief and your property in the money or credit is lost.

In this legal context, the question arising is in the treatment of fully identifiable bitcoins, whose possession is recorded on a blockchain. Clearly, if someone sells you a bitcoin in return for currency you receive it as entering into your possession. But if the bitcoin had previously been stolen, say from a crypto wallet, it was nobody’s to sell and it almost certainly remains the possession of the person it was stolen from. The point is that while each bitcoin, or fraction of a bitcoin has the same value as another, the blockchain means that each bitcoin or part of it has a specific identity. Therefore, it is not fungible like banknotes or credit, nor is it consumed and so it almost certainly cannot be a mutuum. The precedents in law therefore point to the property in it having not been transferred if in the past it was the proceeds of crime, so it must be regarded as a commodatum.

This is a significant problem for bitcoin, which has become the money laundering medium of choice for criminals and tax evaders. While in Roman times, criminality was more basic, today governments have extended it to include mere suspicion as grounds for property confiscation. Software allows investigators to link bitcoin wallets with real world identities, which are easily available to the authorities from crypto exchanges. Companies such as Chainalysis have been working with the FBI successfully to identify wallets linked with criminal activity. The trail from these wallets clearly leads to those who subsequently bought bitcoin and are under the impression they are now their property.

Therefore, you cannot be sure that the bitcoin you have bought through an exchange will not be seized by the authorities on the grounds that a previous owner acquired it through the proceeds of crime. You cannot be certain you have clear title. On legal grounds alone, without the certainty of ownership bitcoin cannot act as a general medium of exchange.

Why credit matters

In discussing the practicality of bitcoin as money, its unsuitability as a medium from which credit takes its value has been mentioned, and that enthusiasts appear to have overlooked this vital function. Indeed, the creation of bank credit is seen by many in both gold and bitcoin camps as evil and therefore they say that one of the key benefits of bitcoin is it does away with the creators of credit. Those following this line of reasoning fail to understand that all money and obligations to pay are in fact credit, representing the temporary storage of unspent production. Because all of our consumption has its origin in production, the medium of exchange is a matter of intermediation.

There are two distinct forms of this credit, one in which there is no counterparty, and it is only in the form of gold, silver, or copper coined for convenience. It cannot be anything else if we rule out barter. The proper term for coin is money, to distinguish it from promises to pay in money at a future date, which is credit.

As a right to future payment, credit is always matched by an obligation on the part of the debtor. Ultimately, that right and corresponding obligation are to be settled in money — though in practice, today they are novated by way of settlement into other credit. It is not the transfer of money, but nevertheless credit is a form of property. That credit is property and has value in terms of goods and services arises from its transferability. This is apparent in valuations of financial assets, which together with the possession of the property in physical objects make up a person’s wealth.

In any economy which has progressed beyond a feudal state, it is credit which makes up the vast bulk, if not all of the circulating medium. And the more perfected the economic system becomes the less money circulates. It is simply more convenient to use credit, whether it be bank notes, bank deposits, or individual credit agreements, such as exist between families and friends.

Legally, money has a general and permanent value, while credit has a particular and precarious value. The problem we have today is that these distinctions between money and credit are poorly understood. Those who profess to support “sound money” rarely appreciate this vital distinction, routinely stating that sound money is a policy and not a definition. Accordingly, they incorrectly assume that bank notes issued by a central bank is money when it is in fact credit with counterparty risk, whose value in terms of goods and services can become subverted.

This leads us into the topic of how credit is valued. All credit, including bank notes issued by government authority, must take its value from something. But without being a credible substitute for what the Romans originally defined as money the value of credit obligations becomes inherently unstable. Furthermore, abandonment of credit’s attachment to money encourages a government to spend beyond its tax revenues by debasing the currency, and that is what is happening today at an increasing rate. It is not credit, which is the evil, but its detachment from money.

The legal position and history of gold as money

As a medium of exchange, the function of money is to adjust the ratios of goods and services one to another. Thus, the price expressed is always for the goods, money being entirely neutral. It is therefore an error to think of money as having a price. This should be borne in mind in the relationship between legal money whether it be gold or silver, which is habitually given a price nowadays in fiat currencies, and the fiat currencies themselves which, given the status of legal tender, are erroneously assumed to have the status of money. The relationship between money and credit has become stood on its head. The magnitude of this error becomes clear with understanding what legally is money, and what is credit. Again, this understanding starts with Roman law.

Roman law became the basis for legal systems throughout Europe, and by extension those of European settled regions, from North America, Latin America through Spanish and Portuguese influence, the Dutch in the Far East, and the entire British Empire. In common with the Athenians, Rome held that laws were the means whereby individuals would protect themselves from each other and the state. But it was particularly Rome which codified law into a practical and accessible body of reference generally.

The first records of Roman statutes and the case law which followed were the Twelve Tables of 449BC. These became the basis upon which individual jurors subsequently expounded, developed, and evolved their rulings over the next thousand years. The whole legal system was then consolidated into the Emperor Justinian’s Corpus Juris Civilis, otherwise known as the Pandects. When the empire relocated to Constantinople, the Corpus was translated into Greek and eventually reissued in the Basilica, at the time of the Basilian dynasty in the tenth century. It was that version which became the foundation for European law in the Middle Ages, except for England. As an eminent nineteenth century lawyer specialising in banking put it, the reason common law differed in England was that:

“The Romans abandoned Britain at the end of the fifth century and the common law of England on the subject of credit was exactly as it stood in Gaius which was the textbook of Roman law throughout the empire at the time when the Romans gave up Britain.  But on the 1st of November 1875, the common law of England relating to credit was superseded by equity which is simply the law of the Pandects of Justinian.”[i]

In all, two thousand years of legal development had elapsed between the Twelve Tables and the reaffirmation of Justinian’s Pandects in Dionysius Gottfried’s version in Geneva of the Corpus Juris Civilis, translated back into Latin in 1583AD from the Greek Basilica.

It is the Digest section of the Corpus which is relevant to our subject. The Digest is an encyclopaedia of over nine thousand references of eminent jurors collected over time. Prominent in these references are those of Ulpian, who died in 228AD and was the juror who did much to cement the legal position and distinction between money and credit. The Digest defined property, contracts, and crimes. Our interest in money and credit is covered by rulings on property and contracts.

The regular deposit contract is defined by Ulpian in a section entitled Deposita vel contra (on depositing and withdrawing). He defined a regular deposit as follows:

“A deposit is something given another for safekeeping. It is so called because a good is posited (or placed). The preposition de intensifies the meaning, which reflects that all obligations corresponding to the custody of the good belongs to that person.”[ii]

Another jurist commonly cited in the Digest, Paul of Alfenus Varus, differentiated between the regular deposit contract defined by Ulpian above and an irregular deposit or mutuum. In this latter case, Paul held that:

“If a person deposits a certain amount of loose money, which he counts and does not hand over sealed or enclosed in something, then the only duty of the person receiving it is to return the same amount.”[iii]

So, a mutuum is taken into the possession of the person receiving it. In return for a right of action in favour of the depositor to be exercised by him at any time, the receiver has a matching duty to return the same amount until which it becomes the receiver’s property to do with as he wishes. This is the legal foundation of modern banking.

Clearly, the precedent in the Digest is that money is always metallic. While anything can be deposited into another’s custody, it is the treatment of fungible goods, particularly money, which is the subject of these legal rulings. It is only through an irregular deposit (or mutuum) that the depositor becomes a creditor. By laying down the difference between a regular and irregular deposit, the distinction is made between what has always been regarded as money from ancient times and a promise to repay the same amount, which we know today as credit and a matching obligation to pay.

There is still one issue to clarify, and that is to do with credit rather than money. As noted above, Justinian’s Pandects were compiled a century after the Romans had abandoned Britain. From what was subsequently unified as England and Wales out of diverse kingdoms, common law differed in that debts were not freely transferable. The transferee of a debt could only sue as attorney for the transferor. This placed debt as property in a different position from other forms of transferable property. Justinian took away this anomaly as a relic of old Roman law (the laws of Gaius, referred to above), allowing the transferee to sue the debtor in his own name. Without this amendment, the status of a particular and precarious debt as an asset would be in doubt.

This anomaly in English law was only regularised when the Court of Chancery merged with common law by Act of Parliament in November 1875. Since then, the status of money and credit in English law has conformed in every respect with Justinian’s Pandects.

While the legal position of money is clear, the economic position is technically different. Jean-Baptiste Say pointed out that money facilitates the division of labour. Technically, money is unspent labour, and is therefore a credit yet to be used. Various other classical economists made the same point. Adam Smith wrote that a guinea might be considered as a bill for a certain quantity of necessaries and conveniences upon all the tradesmen in the neighbourhood. Henry Thornton said that money of every kind [including credit] is an order for goods. Bastiat and Mill opined similarly.[iv] The similarity of function between money and credit has undoubtedly led to confusion over the true meaning of terms.

But it is the legal difference which is of overriding importance because it was founded on the principal that there is a clear distinction between metallic money and a duty to pay. Money is permanent while credit is not. Money has no counterparty risk, whereas credit does.

The modern belief that money can be done away with and substituted with banknotes is therefore incorrect. And it is common ignorance of the established relationship between money and credit both in law and in practice which has led to the error of thinking that bitcoin can be the new money for modern times. Accordingly, we must put any such thoughts out of our minds.

The future of cryptocurrencies

It has been easy to point to the benefits of the cryptocurrency revolution. The blockchain concept promises a transformation in the recording of property ownership. And the popularity of bitcoin has alerted a wider public to the debasement of fiat currencies by governments — that surely is a public good. But it appears to have done nothing to enhance anyone’s understanding of money and credit.

The crypto revolution has created a potential evil in the form of central bank digital currencies, originally conceived by central bankers, seemingly ignorant of their own craft as a response to the threat from private sector money to their fiat monopolies. Their ignorance is of the legal position described above: after all, to detach a national fiat currency from legal money requires a denial of the true, legal position on the part of the perpetrator.

Central banks further demonstrated their denial of the laws of money by appointing a committee of the Bank for International Settlements, which coordinates central bank policies, to examine the benefits of a CBDC to a central bank and its government. Pursuing statist interests, the BIS committee’s conclusion is that CBDCs could give governments totalitarian control over economic activity. Nowhere has the legal position established millennia ago been respected, or even mentioned in their deliberations.

The reason the legal position of gold as money has persisted as authoritarian governments have come and gone is that the Romans defined an entirely natural relationship between money, what it is, and credit. Originally, money was and still is determined by people who are its users. And they create credit based upon money’s value. The practice evolved from the creation of credit based on goods that could be bartered. Credit must have been the way the Phoenicians financed their trade long before their city-states took to the convenience of coining metals, thought to be at about the same time as Rome’s Twelve Tables.

While the Romans paid close attention to the practicalities of trade and the natural evolution of payment in gold, silver, copper, or bronze coin and embodied it in their law, the state theory of money has always failed. The introduction of CBDCs is just another state theory of money. And while it promises to further the objectives of authoritarianism, it is bound to fail as well.

The sheer impracticalities involved have already caused the Bank of England in its White Paper to reject the BIS’s central proposition, that a sterling CBDC will bypass the commercial banking system and be totally under a central bank’s control. The reasons for the Bank’s approach are entirely sensible: the bureaucracy involved in setting up a CBDC, with everyone and every business required to open an account at the Bank of England would take years in the planning, testing, and implementation. And in the US, where the large majority of lawmakers depend on contributions from the banks to fund their election expenses, we can be certain that if any CBDC proposition was to be put forward by the Federal administration, it would be heavily watered down so as to not undermine existing banking interests.

The fate of the entire CBDC saga is likely to turn out to be a red herring. And in this article, I hope I have demonstrated convincingly the impossibility that bitcoin or any other cryptocurrency can fulfill the role of a currency. There only remains the question over their future if this role is denied to them.

It is now 52 years since the dollar and all other currencies with it became entirely fiat. While it is beyond the scope of this article to describe the factors involved, there is growing evidence that the current dollar-based fiat currency episode, like all others before it, is coming to an end. That being so, we can expect a new monetary system to replace it. But with bitcoin not suited to the task, we can be sure that the reason for bitcoin’s existence will turn out to have been purely speculative.

Therefore, when fiat dies, we can expect the whole cryptocurrency and the CBDC phenomenon to die with it. Mark it down as a modern Mississippi venture, or South Sea Bubble, both of which owed their existence to speculative excesses financed by credit — just like bitcoin.

• [i] See HD Macleod’s The Elements of Banking, Longmans Green & Co, 1877
• [ii] See de Soto’s Money, Bank Credit, and Economic Cycles, Chapter 1.
• [iii] ibid
• [iv] Listed in HD Macleod’s The Elements of Banking.

This is a mistake. China and Russia know that if they are to succeed in removing the dollar from their sphere of influence, they have to come up with a better alternative. They also know they have to consolidate their trade partners into a formidable bloc, so plans are afoot to consolidate BRICS, the Shanghai Cooperation Organisation, and the Eurasian Economic Union along with those nations who wish to join in. It will be a super-group embracing most of Asia (including the Middle East), Africa, and Latin America.

The groundwork for the new currency has been laid by Sergei Glazyev and is considerably more advanced than generally realised.

This article explains why Russia and China are now prepared to fully back Glazyev’s expanded project. For Russia, it is also now imperative to destabilise the dollar as a deliberate escalation of the financial war against America and NATO. China’s priority is no longer to protect her export trade, but to ensure that her African and Latin American suppliers are not destabilised by higher dollar interest rates.

Introduction

“The BRICS’s introduction of a gold-backed currency, which is supported by 41 countries with large and influential economies, will weaken the dollar and the euro and will benefit countries such as Iran, while Iranians in possession of gold will experience a wealth increase,” Mousavi added [the head of the South Asia Department at Iran’s Foreign Ministry]. The Russian government confirmed a day earlier that Brazil, Russia, India, China, and South Africa would introduce a new trading currency backed by gold. — Iran’s MEHR News Agency[i]

The quote above encapsulates why a new gold-backed currency is desired: it will undermine fiat currencies which have been no friends to oil producers and benefit individuals who own gold making it popular on the streets. RT, the Russian government-financed English broadcasting service had confirmed on last Friday the intention to introduce a new gold-backed currency for BRICS members. The announcement was completely missed by mainstream media, partly because RT and other Russian news sources are censored in many countries in Europe including the UK, and any news out of Russia is disbelieved anyway. 

Reactions from those who saw it, even among gold bugs, vary from the opinion that neither China nor Russia could make a gold backed currency stick, to it taking years in the planning and implementation so is irrelevant to today’s markets. But there are good reasons to believe that this complacency will turn out to be wrong, and that events are likely to evolve considerably more rapidly than expected. 

The problem for capital markets is that they are dominated by Keynesians, automatically programmed to believe gold is bad and fiat is good. As a stockbroker in London, when President Nixon suspended the Bretton Woods Agreement, I recall there was a similar level of confusion over those implications. And now, 52 years after putting the world on a fiat dollar standard, the majority of the world has had enough of dollar hegemony, has found safety in numbers, and is going back onto a gold standard. Like all life, the pure fiat era is ephemeral after all, defined by its birth and death. Macroeconomics will have to be rewritten.

The move away from fiat has been evolving for a considerable time, with de-dollarisation the ultimate objective of the Asian hegemons. Those tracking developments in gold bullion markets in recent decades have noted the drift of bullion from west to east, and the rise in gold mine output in China and more recently in Russia. Central banks, predominantly in Asia, have been accumulating bullion reserves and adding to declared and undeclared state funds in record quantities. Ultimately, this activity can only be to use gold to secure currency values as the dollar dies or is done away with. 

A sudden turn of events occurred when the western alliance imposed sanctions against Russia following her attack on Ukraine. They set off a train of actions that has unified Asia and many of its supplier nations into a rebellion against American hegemony, stoked up by Putin and led by Saudi Arabia and the Gulf Cooperation Council. And since the western alliance turned its back on fossil fuels, the low-cost producers throughout Asia have banded together representing nearly half global oil output, and a third of natural gas. As a cartel, OPEC is now just an appendix to the Asian mega-energy producers. 

The new cartel is dominated by President Putin, whose degree from Leningrad University was in energy economics and well qualified to be energy ringmaster. Not only has he demonstrated an understanding of the importance of controlling global energy supplies, but he also has a clear understanding of the importance of monetary gold. 

Since the western alliance’s sanctions, the signals coming out of Moscow have been clear: Sergei Glazyev, who is Putin’s point-man for macroeconomic policy has been waving the gold flag since then in plain sight. As a board member of the Eurasian Economic Union Commission (EAEU) since 2019, he was tasked by Putin to design a trade settlement currency for the EAEU. The initial statement through a news agency in Bishkek in early March 2022 reported that it was to be based on the currencies of the member states and a basket of undefined commodities. According to Glazyev, his brief was to create a Eurasian monetary and financial system to the exclusion of foreign currencies, particularly the dollar and euro. 

The intention was also to remove exchange controls for cross- border settlements within the Eurasian membership, replacing the dollar as the commonly used settlement medium between them. A week later, in an article for Goldmoney[ii] I concluded that as stated the new currency would not work, and the only logical solution was to do away with the currency basket proposal and use gold backing solely to represent commodities. That way, it would be easy for other nations in the Shanghai Cooperation Organisation (SCO) to join in, which was the ultimate objective from the outset.

In July 2022, Glazyev was behind a move to beef up the Moscow gold exchange, the official line being that having been sanctioned from the London market Russian miners needed a more effective local market. But working in conjunction with the Shanghai Gold Exchange this was an important signal about the way Galzyev’s monetary thinking was developing. Confirmation came on 27 December last year, when he wrote an article for Vedomosti, a Moscow business paper, describing why the rouble needed to return to a gold standard. That article was co-written by his deputy on the EAEU committee designing the new trade currency and was a thinly veiled indication of the committee’s view. 

Therefore, you did not have to be particularly astute to discern the trail of clues presented to us. We could assume with justification that gold was intended to be the sheet-anchor for this new currency probably from the outset, but some political hoops had to be jumped through to convince the EAEU member states that it was the solution. 

The impracticality of basing a new trade currency on anything else other than gold had been established. It now turns out that this project is almost certainly a Trojan horse for something far larger. It was obvious that other members of the Shanghai Cooperation Organisation should be able to join in, and now it turns out that the invitation is being extended to members of the BRICS club as well. But that’s not all. The entire membership of the SCO, its dialog partners, and associate members will be attending the BRICS conference in Johannesburg on 22—24 August. I am assuming that the original list of 36 nations, which according to most recent reports has expanded to 41, includes the members of the EAEU who were not on the original list — at the time of writing this is yet to be confirmed.

That being the case, the BRICS currency project is not a cold start and not something to be planned for a distant future. The groundwork has already been prepared by Glazyev and the structure can be rapidly assembled once the necessary resolution is adopted. It is even possible that the necessary institution(s) exist waiting to be deployed.

It is also beginning to look like there will be another proposal on the Johannesburg agenda, to merge the SCO, the EAEU and BRICS into a supersized trading block. In terms of both combined population and GDP on a purchasing power parity basis, it is already in excess of half the world, dwarfing the western alliance which kowtows to America.

The US Treasury would almost certainly have known about the BRIC proposals when the agenda was first circulated, which probably explains why at short notice Janet Yellen, US Treasury Secretary flew to Beijing. From her department’s point of view, if the new currency proposal was to be adopted its financing of the budget deficit would be adversely affected, not to mention the threat to the dollar’s hegemony. The principal card up her sleeve was to threaten greater sanctions against China’s exports, not just to America, but to her allies as well, but we don’t know if it was actually discussed in these terms.

The Chinese view

For too long and too often China has been threatened over access to markets by the Americans. We can be sure that ahead of the BRICS currency proposal the Chinese have gamed this possible threat being acted upon and come up with their own conclusions about its economic consequences. Russia’s experience, which harmed the sanctioning countries considerably more than the sanctioned, will have been fed into these calculations. One suspects that other than signalling to the Chinese and Russians that there is an increasing level of alarm in Washington, Yellen’s mission will have achieved little. And an important factor for the Chinese attitude is their experience of the US’s attempts to destabilise Hong Kong, which led to it being taken directly under Beijing’s control. It is therefore important to understand China’s analysis of America’s objectives and methods in order to define her own position.

In April 2015, Qiao Liang, the People’s Liberation Army Major-General in charge of intelligence strategy gave a speech at a book study forum of the Chinese Communist Party’s Central Committee.[iii] Qiao commenced by stating the obvious, that the U.S. enforces the dollar as the global currency to preserve its hegemony over the world. And he concluded that the U.S. would try everything, including war, to maintain the dollar’s dominance in global trading. But what he then went on to say is extremely relevant to the current situation. He described US’s actions with respect to foreign national debts. 

Qiao made the case that both the Latin American crisis in 1978—1982, and the Asian crisis in 1996—1998 were engineered by America. By reducing dollar interest rates to below their natural level they would weaken the dollar and encourage an investment boom in the targeted jurisdictions, funded by dollar credit. They then increased interest rates and strengthened the dollar to create a financial crisis. These events did, indeed, happen, but perhaps driven by the cycle of bank credit, as much as by foreign policy.

The relevance of Qiao’s analysis is that today, the same conditions appear to be targeted not against China, which does not borrow dollars, but at the dollar indebted nations around the world with which China trades — the BRICS nations. Informed by Qiao’s analysis, it must appear to China that America’s persistent strategy is to continue to raise interest rates even after the inflation dragon is slain, and by bankrupting them the US will attempt to bring the nations seeking to join BRICS back under her control.

That being the case, China will have weighed up the consequences for her export trade against the likely sanctions America and her allies could threaten and decided that the real threat is against the emerging economies in Africa, Latin America, and elsewhere which have received substantial Chinese investment. In financial terms, it is therefore imperative that this threat be addressed in a pre-emptive attack on the dollar, which can only be achieved by exposing the dollar’s weakness as a fiat currency. At least since the Lehman crisis, China and more recently Russia have had the power to do this.

Furthermore, the New Development Bank, which is headquartered in Shanghai, will be able to provide credit either in yuan or the new BRICS currency at lower interest rates to offset the undoubted strains imposed on BRICS members as a result of rising US interest rates. Therefore, China is fully prepared to counter what General Qiao Liang described as the American strategy of “harvesting” assets in foreign countries.

It is important to understand what China believes and motivates her, not whether Qiao is right or wrong. But given that his view is inculcated in the Chinese government, China is ready with Russia to mount an attack on America’s fiat currency by returning to a gold standard for trade, and ultimately for their own currencies.

The Russian view

It should be clear that the current plans for a trade currency originated in Russia, and not China. Indeed, until now China will have been reluctant to destabilise the currencies of the western alliance, because of her export interests. But not only has the relationship with America deteriorated over Taiwan, not only is it clear (in China’s view) that America plans to bankrupt the BRICS members and all those seeking to migrate away from the dollar’s hegemony by raising interest rates, but it is now also clear that neither Russia nor America can back down over Ukraine. Consequently, unless China and Russia together take the initiative, shortly Russia will be directly at war with America and her NATO allies and China will almost certainly be dragged into the conflict over Taiwan. World War 3 must be forestalled.

It is clear that NATO, under the thumb of America, is determined to defeat Russia, remove Putin, and gain control of its massive natural resources. The proxy war being fought in the Ukraine appears to be failing with Zelensky’s summer offensive having ground to a halt. And following the Wagner debacle, Russia is now in a strong position to counterattack. This has led to President Biden being prepared to send the Ukrainians cluster bombs, increasing the urgency for a Russian counter-offensive.

Furthermore, with Ukraine’s summer offensive failing, NATO’s theatre of operational strategy is moving to Poland and the Baltics (Biden was in Vilnius this week for a NATO summit), with Poland particularly becoming a client state of America through NATO. The build-up of military personnel and missiles in Poland will become increasingly obvious in the coming weeks and is already anticipated by Moscow. We await Putin’s reaction, but he is unlikely to just sit on his hands and let NATO build its forces in Poland and the Baltics.

Compromise is out of the question, because it is plain to Putin that America cannot back down. Imagine the consequences for Biden, who started his presidency with the withdrawal from Afghanistan if he ends it with a withdrawal from Eastern Europe. Furthermore, the neo-cons are firmly in charge of policy, determined to defeat Putin, add Russian territory to their sphere of influence, and leave China isolated. 

Putin’s terms for peace would be unacceptable to America because he insists on protecting Russia’s borders, which means that all missiles and American bases be removed from Eastern and Central Europe. For Moscow, this raises the question as to whether Russia should simply secure its current position or take Ukraine, which can then be set up as a buffer state. A Russian attack is bound to drive up energy, cereal, and fertiliser prices, worsening price inflation in western alliance countries and causing division with America and Britain, but to the benefit of Russia’s finances which are coming under pressure. Additionally, a successful attack on their currencies’ credibility would undermine the alliance’s military capability, so the dollar should be attacked financially as well.

No one can be sure whether destroying the dollar would avert a nuclear war, but there is little doubt that so long as America can finance its aggression that events are drifting in that direction. From Putin’s viewpoint, undermining the dollar must now be a priority, perhaps combining it with taking Kiev now that Zelensky’s summer thrust has failed.

An advantage of a financial war is that it need not be declared, therefore there is no official victor, and no need for a post-war reconciliation.

Designing a gold-backed trade currency

A new trade currency has the advantage that it will not ever be used as a means of funding government deficits. And given that its role is limited to cross-border trade settlement and and dealing in physical commodities it has to be institutionally acceptable and does not have to appeal to public confidence. Much of the credit will be self-extinguishing. It is additional to national currencies, leaving individual nations to manage their own currency policies, which is why such a currency can enjoy widespread support. It is not to be used as a medium for capital investment.

As the groundwork appears to have been already established by Sergei Glazyev, it could be ready to use as soon as it is approved in August. Besides a strict and simple set of rules, all it needs are two things: the establishment of an issuing entity, and physical gold. The first can be done in a flash, if it is not already established, and the gold will be allocated from the reserves of participating central banks. This is almost certainly why central banks of many of the putative membership of BRICS have been adding bullion to their reserves. They must be extremely thankful for actors in the western financial establishment who trade paper gold in ignorance of this outcome.

The bulleted list that follows is a brief outline of how a new trade settlement currency based on gold can be quickly established to replace the fiat dollar in all transactions between member nations, updated from an earlier Goldmoney article on this topic.[iv] It will be interesting to see how its elements compare with Glazyev’s proposition.

It is designed to be politically acceptable to all involved, as well as a long-term practical solution to facilitate the Russian Chinese axis’s ambitions for an Asian industrial revolution, encompassing Africa and Latin America, free from interference by America and her allies. The essential elements are as follows:

• The announcement of the creation of a new issuing central bank (NICB, not to be confused with the existing New Central Bank in Shanghai, whole purpose is to fund investment in the BRICS members) and a new gold-based currency on the lines below is the first step. 
• The NICB is established with the sole function of issuing a new digital currency backed by physical gold. It will be designed to be a fully trusted gold substitute, independent of existing fiat currency values.
• The new currency will only be redeemable for gold between the NICB and participating central banks. They will be free also to add to their NICB currency reserves by submitting additional gold to the NICB at any time.
• The NICB’s eligible participants will be the central banks of participating nations, broadly limited to member nations, associates, and dialog partners of the EAEU, SCO, and BRICS, and additionally nations applying for membership of any of these organisations on an approved list. 
• The NICB’s currency is issued to approved national central banks against their provision of a minimum 40% gold backing for it. For example, currency representing one million gold grammes secures an allocation of 2,500,000 currency units denominated in gold grammes. The gold does not have to be delivered to a central storage point but can be earmarked[v] from within a central bank’s gold reserves, on condition that it is securely stored in vaults on a list approved by the NICB. This list is likely to exclude gold stored at central banks of the western alliance and must not be leased or swapped. 
• A participating central bank records the new currency units allocated to it as an asset on its balance sheet, balanced by an increase in its liabilities as equity. A participating central bank’s balance sheet is thereby strengthened.
• A participating central bank can offer credit and take in deposits tied to the new currency’s value, to and from the commercial banks in in its national network. Note that the new currency is available exclusively to participating central banks, upon which they can base their own credit dealings with commercial banks.
• Commercial banks trading in member nations and elsewhere will be free to create and deal in credit denominated in the NICB’s new currency. They will have no credit relationship with the NICB, but their regulating central bank will. 
• Commercial banks whose central bank does not have access to the NICB currency can clear through wholesale credit markets and will be always free to acquire physical gold in the markets, should they wish to back credit created in the new currency with gold itself. 
• All taxes and restrictions on gold ownership must be fully rescinded by participating nations, recognising its historic and legal status as money.
• An efficient central clearing system for commercial banks dealing in credit based on the new currency will be established.
• Asian commodity exchanges in the expanded BRICS will price all products in the new NICB currency as well as in dollars. Intra-BRIC imports and exports will similarly be priced. This will ensure that physical markets and their derivatives are insulated from a fiat currency collapse, a likely consequence of gold’s return to its true monetary status.

The purpose of the new currency is to provide the basis for trade finance and other cross border financial settlements on a sound money basis. The expansion of credit based upon it will grow strictly in line with economic activity and therefore will not be inflationary, undermining its purchasing power. Last week, in an article for Goldmoney I explained why when tied convincingly to gold, commercial bank credit grows on a non-inflationary basis when distortions from the lending cycle are removed. This is the key to understanding why a new trade currency constructed on these lines will endure.[vi]

It is also likely to lead to participating nations placing a greater emphasis on their own currencies’ stability while providing a safe haven from the consequences for the dollar following its introduction. Once the new currency is established, it will be in Russia’s interests to put the rouble back on its own gold standard, and China may follow with the renminbi.

All empirical evidence informs us that when gold becomes the means by which credit is valued, credit’s own value becomes tied to that of gold and is not dependent on stability in the quantity of credit. Operating as a gold substitute imparts pricing certainty to trade and investment and leads to stable, low interest rates giving the necessary conditions for maximising economic development in emerging economies.

Constructed on the lines above, it should be simple and quick to establish. It must be free from attack by members of the western alliance trying to preserve their own fiat currency systems. And the 40% gold backing rhymes with the basic requirement for a metallic monetary standard set by Sir Isaac Newton, when he was Master of the Royal Mint. 

For participating central banks, the replacement of gold in their reserves for allocations of the new currency would represent a significant increase in their balance sheet equity. As confidence in the scheme builds, it could be argued that only minimal gold reserves need to be retained by participating central banks, with the balance swapped for the new currency. For example, the Reserve Bank of India officially possesses 787.4 tonnes of gold. Converted into the new gold currency, its value in reserves is uplifted to 1,968.5 tonnes equivalent, added to its equity capital. 

The impact on gold

Throughout history, money has been gold, and the rest credit. When you detach credit from gold, there are consequences. Pricing goods and services in credit diverges from pricing them in gold. It is really that simple.

It is widely assumed that fluctuations in prices have nothing to do with the medium of exchange, and for individual transactions it is certainly true that both buyer and seller will share this view. But over time, with official policies aiming for a 2% fall in purchasing power for the dollar and other major currencies it is not true that price fluctuations are entirely due to changes in the demand/supply balance for commodities and other manufacturing inputs. In fact, since the end of Bretton Woods, measured in real money which is gold, the loss of purchasing power has been considerably in excess of the 2% annual target. The chart below puts it directly in a gold versus fiat context.

Since the suspension of Bretton Woods, the dollar has lost 98% of its value relative to gold. The other major fiat currencies have been similarly impoverishing for their users and savers, and only now is the final act in their destruction looming due to the introduction of a new BRICS gold-backed currency. 

Through the medium of gold, participating central banks will exchange their reserve dollars for the new NICB currency. Immediately, this rejection of the dollar by a large number of central banks will devalue it further, followed by foreign non-government entities seeking to reduce their exposure. Initially, this will be seen as a run on the dollar into gold, similar to that which followed the suspension of Bretton Woods on 15 August 1971. The market was similarly nonplussed then as it appears to be today, with the London morning fix on Monday 17 August at $43, slightly down on the previous week. It wasn’t until 19 November that the morning fix exceeded $43 again for the first time. It took two whole months for the implications to sink in. But when they did, the price rose to $197.50 on 27 December 1974.

The lesson for us in this Keynesian world is that two months of static prices following the suspension of Bretton Woods is proof that gold was poorly understood in financial markets, and still is today. Derivative markets, particularly the London forward market and Comex futures for the last forty years have lost sight of gold being money and assumed it is a trading counter which plays on irrational fears of instability of the modern currency system. But with the return of gold as the anchor for credit values for the Asian hegemons and their sphere of influence, those fears will suddenly become rational.

The wider consequences of a BRICS currency gold standard

We can assume that the consequences of Asian trade settlements backed with gold will have been carefully considered by the Asian superpowers, particularly by the Russians who have faced weaponised dollars.

Besides bringing stability to export values there are other advantages to reintroducing gold into currency systems. Interest rate stability at lower rates is an obvious benefit. Currently, the Bank of Russia’s key interest rate is 7.5% and price inflation has collapsed to 2.3% (April). The yield on Russia’s 10-year OFZ bond is still 11.3%. If the rouble becomes a credible gold substitute, price inflation, interest rates, and bond yields can be expected to decline and maintain levels that reflect gold’s long-term stability, particularly in more normal times when the Russian government runs decent budget surpluses. And assuming that credit expansion by Russia’s commercial banks is not cyclically excessive, there is no reason to expect otherwise than that financial stability for the currency and the Russian economy would continue in the long-term. Coupled with low taxes (Russia’s income tax is a flat 13%) this stability can be expected foster genuine economic progress and the accumulation of personal wealth for the Russian people. It would be a far better outcome than the current situation and it would secure Putin’s legacy.

However, a move towards gold backing for their currencies by the Asian hegemons can be expected to undermine the purchasing power of western fiat currencies. International capital will abandon ephemeral fiat currencies for real values in commodities, with nations rebuilding stockpiles of energy, metals, and other raw materials instead of accumulating fiat paper. Precious metals, specifically gold, will be sought and its price can be expected to reflect the demise of fiat currencies.

The consequences for wholesale and consumer prices in the western nations would rapidly become obvious, with central banks forced to revise their expectations for price inflation sharply higher. Bond yields can be expected to rise further, undermining all financial and property values. As this negative outlook clarifies, measured against gold fiat currencies will likely enter a substantial relative decline.

The consequences of the emergence of gold backing for currencies in Asia on the currencies and economies of the western alliance are bound to differ in their detail for the currencies in the western alliance.

The reliance on inward foreign investment has protected the dollar from continual trade deficits and played a key role in funding US Government debt since the end of Bretton Woods. It has allowed the US Government to run budget deficits more or less continually. The ending of the fifty-two years of a fiat regime changes all that. The US Government will face significant funding hurdles against foreign liquidation of Treasuries. Bond yields and funding costs for the government are bound to rise significantly.

The consequences for the EU and the eurozone would be both politically and economically divisive. If it were not for political constraints, Germany would naturally drift towards cooperation with the sound money regimes emerging to her east, particularly as the finances of the Mediterranean club deteriorate. With rising bond yields, the entire euro system comprised of the ECB and its national central banks would need to be recapitalised, being already deeply in negative equity. The eurozone’s global systemically important banks (G-SIBs) are extremely highly leveraged and unlikely to survive the combination of falling asset values and bad debts that would be the certain consequences of the euro’s declining purchasing power. Having been assembled at the behest of a political committee and now managed by a political cabal, the euro is at risk of losing all market credibility.

The consequences for the UK pound will also be significant. In a similar debt trap to that of the US Government, the British have the further disadvantage of an economy suffering under increasing taxes. Furthermore, with London being the international financial centre, the UK will be at the epicentre of a fiat currency crisis. For the size of her economy, the UK has little in the way of gold reserves, hampering any future escape from the fiat currency trap.

The major governments aligned both economically and intellectually with the fiat dollar will be left at a comparative disadvantage by a BRICS gold-backed currency, possibly followed by Russia and China adopting gold standards. Interest rates, which are escaping from central bank control, will rise due to two factors: there is the credit crunch from the turn of the bank credit cycle, and the deteriorating outlook for fiat currency purchasing powers. It is the worst of both worlds. Furthermore, economists in governments and central banks would be reluctant to abandon their embedded economic and monetary policies. And will be slow to react.

The only salvation will be for western governments to jettison Keynesian macroeconomics entirely and revert to classical economic theories. The false assumptions that have built up over the fiat currency era will have to be overturned. Crises of this sort nearly always emanate in the foreign exchanges because it is foreign holders of currencies who are the first to recognise a currency’s weakness. Usually, it involves a specific currency. But this time, it will affect all the major currencies in the western alliance.

• [i] Official Iranian news release. See https://en.mehrnews.com/news/203015/BRICS-currency-to-benefit-Iran-undermine-US-dollar-euro
• [ii] See https://www.goldmoney.com/research/designing-a-new-currency-is-impractical
• [iii] See http://chinascope.org/archives/6458
• [iv] See https://www.goldmoney.com/research/cbd-cs-the-good-the-bad-the-ugly under the sub-heading, The Good.
• [v] Earmarking is the technical term whereby one central bank acts as custodian for another central bank’s bullion.
• [vi] See https://www.goldmoney.com/research/the-real-determinants-of-currency-value

Article cross-posted from Goldmoney.