Saturday, April 2, 2022

Russian Ruble Relaunched, Linked To Gold & Commodities

 This article is similar to the previous one about gold but in a Q and A style. The paradigm shift to a gold based monetary system is THE event of the year so far. It will have short and long term implications. We are about to see a sharp acceleration of "history". What is interesting is that I thought the reset would be triggered by China and conversely they are wisely staying in the shadow, for the time being...

By Ronan Manly of Bullionstar.com

With Russia’s central bank having just profoundly altered the international trade and monetary system by linking the Russian ruble to both gold and commodities, journalists in Moscow asked me to write a Q and A article on what these developments mean, and the ramifications of these changes on the Russian ruble, the US dollar, the gold price and the global system of currencies. This article has been published on the RT.com website here

Since RT.com is now blocked and censored in many Western locations such as the EU, UK, US and Canada, and since many readers may not be able to access the RT.com website (unless using a VPN), my Questions and Answers that are in the new RT.com article are now published here in their entirety.

Who would have thought that citizens of ‘free speech’ Western countries would need a VPN to read a Russian news site?

Why is setting a Fixed Price for Gold in Rubles significant?

By offering to buy gold from Russian banks at a fixed price of 5000 rubles per gram, the Bank of Russia has both linked the ruble to gold and, since gold trades in US dollars, set a floor price for the ruble in terms of the US dollar.

We can see this linkage in action since Friday 25 March when the Bank of Russia made the fixed price announcement. The ruble was trading at around 100 to the US dollar at that time, but has since strengthened and is nearing 80 to the US dollar. Why? Because gold has been trading on international markets at about US$ 62 per gram which is equivalent to (5000 / 62) = about 80.5, and markets and arbitrage traders have now taken note, driving the RUB / USD exchange rate higher.

So the ruble now has a floor to the US dollars, in terms of gold. But gold also has a floor, so to speak, because 5000 rubles per gram is 155,500 rubles per troy ounce of gold, and with a RUB / USD floor of about 80, that’s a gold price of around $1940. And if the Western paper gold markets of LBMA / COMEX try to drive the US dollar gold price lower, they will have to try to weaken the ruble as well or else the paper manipulations will be out in the open.

Additionally, with the new gold to ruble linkage, if the ruble continues to strengthen (for example due to demand created by obligatory energy payments in rubles), this will also be reflected in a stronger gold price.

Gazprom – Natural gas powerhouse and Russia’s largest company

What does this mean for Oil?

Russia is the world’s largest natural gas exporter and the world’s third largest oil exporter. We are seeing right now that Putin is demanding that foreign buyers (importers of Russian gas) must pay for this natural gas using rubles. This immediately links the price of natural gas to rubles and (because of the fixed link to gold) to the gold price. So Russian natural gas is now linked via the ruble to gold.

The same can now be done with Russian oil. If Russia begins to demand payment for oil exports with rubles, there will be an immediate indirect peg to gold (via the fixed price ruble – gold connection). Then Russia could begin accepting gold directly in payment for its oil exports. In fact, this can be applied to any commodities, not just oil and natural gas.

What does this mean for the Price of Gold?

By playing both sides of the equation, i.e. linking the ruble to gold and then linking energy payments to the ruble, the Bank of Russia and the Kremlin are fundamentally altering the entire working assumptions of the global trade system while accelerating change in the global monetary system. This wall of buyers in search of physical gold to pay for real commodities could certainly torpedo and blow up the paper gold markets of the LBMA and COMEX.         

The fixed peg between the ruble and gold puts a floor on the RUB / USD rate but also a quasi-floor on the US dollar gold price. But beyond this, the linking of gold to energy payments is the main event. While increased demand for rubles should continue to strengthen the RUB / USD rate and show up as a higher gold price, due to the fixed ruble – gold linkage, if Russia begins to accept gold directly as a payment for oil, then this would be a new paradigm shift for the gold price as it would link the oil price directly to the gold price.  

For example, Russia could start by specifying that it will now accept 1 gram of gold per barrel of oil. It doesn’t have to be 1 gram but would have to be a discounted offer to the current crude benchmark price so as to promote take up, e.g. 1.2 grams per barrel. Buyers would then scramble to buy physical gold to pay for Russian oil exports, which in turn would create huge strains in the paper gold markets of London and New York where the entire ‘gold price’ discovery is based on synthetic and fractionally-backed cash-settled unallocated ‘gold’ and gold price ‘derivatives.

Russian gold bars stored in wooden boxes in the Gokhran vaults, Moscow

What does this mean for the Ruble?

Linking the ruble to gold via the Bank of Russia’s fixed price has now put a floor under the RUB/ USD rate, and thereby stabilized and strengthened the ruble. Demanding that natural gas exports are paid for in rubles (and possibly oil and other commodities down the line) will again act as stabilization and support. If a majority of the international trading system begins accepting these rubles for commodity payments arrangements, this could propel the Russian ruble to becoming a major global currency. At the same time, any move by Russia to accept direct gold for oil payments will cause more international gold to flow into Russian reserves, which would also strengthen the balance sheet of the Bank of Russia and in turn strengthen the ruble.

Talk of a formal gold standard for the ruble might be premature, but a gold-backed ruble must be something the Bank of Russia has considered.     

What does this mean for Other Currencies?

The global monetary landscape is changing rapidly and central banks around the world are obviously taking note. Western sanctions such as the freezing of the majority of Russia’s foreign exchange reserves while trying to sanction Russian gold have now made it obvious that property rights on FX reserves held abroad may not be respected, and likewise, that foreign central bank gold held in vault locations such as at the Bank of England and the New York Fed, is not beyond confiscation.      

Other non-Western governments and central banks will therefore be taking a keen interest in Russia linking the ruble to gold and linking commodity export payments to the ruble. In other words, if Russia begins to accept payment for oil in gold, then other countries may feel the need to follow suit.

Look at who, apart from the US, are the world’s largest oil and natural gas producers – Iran, China, Saudi Arabia, UAE, Qatar. Obviously, all of the BRICS countries and Eurasian countries are also following all of this very closely. If the demise of the US dollar is nearing, all of these countries will want their currencies to be beneficiaries of a new multi-lateral monetary order.  

“It was once said that ‘gold and oil can never flow in the same direction’.”

What does this mean for the US Dollar?

Since 1971, the global reserve status of the US dollar has been underpinned by oil, and the petrodollar era has only been possible due to both the world’s continued use of US dollars to trade oil and the USA’s ability to prevent any competitor to the US dollar.

But what we are seeing right now looks like the beginning of the end of that 50-year system and the birth of a new gold and commodity backed multi-lateral monetary system. The freezing of Russia’s foreign exchange reserves has been the trigger. The giant commodity strong countries of the world such as China and the oil exporting nations may now feel that now is the time to move to a new more equitable monetary system. It’s not a surprise, they have been discussing it for years.  

While it’s still too early to say how the US dollar will be affected, it will come out of this period weaker and less influential than before.      

What are the Consequences of these Developments?

The Bank of Russia’s move to link the ruble to gold and link commodity payments to the ruble is a paradigm shift that the western media has not really yet been grasped. As the dominos fall, these events could reverberate in different ways. Increased demand for physical gold. Blowups in the paper gold markets. A revalued gold price. A shift away from the US dollar. Increased bilateral trade in commodities among non-Western counties in currencies other than the US dollar.

Edging Towards A Gold Standard

 As discussed earlier: The real war is not in Ukraine and no China is not in the Western camp. It would be madness. The Chinese may be wicked but they are not mad! Whoever has a modicum of financial understanding must scramble now to untangle it's currency and resources from the West. A crash is coming and it will be historic.

Authored by Alasdair Macleod via GoldMoney.com,

Commentators are trying to make sense of Russian moves... However, there is a back story which differs from much of the speculation, which this article addresses.

The Russians have not put the rouble on some sort of gold standard. Instead, they have repeated the Nixon/Kissinger strategy which created the petrodollar in 1973 by getting the Saudis to agree to accept only dollars for oil. This time, nations deemed by Russia to be unfriendly will be forced to buy roubles – roughly 2 trillion by the EU alone based on last year’s natural gas and oil imports from Russia — driving up the exchange rate. The rouble has now doubled against the dollar from its low point of RUB 150 to RUB 75 yesterday in just over three weeks. The Russian Central Bank will soon be able to normalise the domestic economy by reducing interest rates and removing exchange controls.

The Russians and Chinese will be acutely aware that Western currencies, particularly the yen and euro, are likely to be undermined by recent developments. The financial war, which has always been in the background, is emerging into plain sight and becoming a battlefield between fiat currencies, and it is full on.

The winner by default is almost certainly gold, now the only reliable reserve asset for those not aligned with Russia’s “unfriendlies”. But it is still a long way from backing any currency.

Putin is losing the battle for Ukraine

President Putin is embattled. His army as let him down — it turns out that his generals lack the necessary leadership qualities, the squaddies are suffering from lack of food, fuel, and are suffering from frostbite. It is reported that one brigade commander, Colonel Yuri Medvedev, was deliberately run down by one of his own men in a tank, a measure of the chaos at the front line. And Putin is not the first national leader to have misplaced his confidence in military forces.

Conventional wisdom (from Carl von Clausewitz, no less) suggested Putin might win the battle for Ukraine but would be unable to hold the territory. That requires the willingness of the population to accept defeat, and a lesson the Soviets had learned in Afghanistan, with the same experience repeated by America and the UK. But Putin has not even won the battle and word from the Kremlin is of accepting a face-saving fall-back position, perhaps taking Donetsk and the coast of the Sea of Azov to join it up with Crimea.

There was little doubt that if Putin came under pressure militarily, he would probably step up the commodity and financial war. This he has now done by insisting on payments in roubles. The mistake made in the West was to believe that Russia must sell commodities, and even though sanctions harm the West greatly, the strategy is to put maximum pressure on the Russian economy for a quick resolution. It is obviously flawed because Russia can still trade with China, India, and other significant economies. And thanks to rising commodity prices the Russian economy is not in the bad place the West believed either.

Besides nations representing 84% of the world’s population standing aside from the Western alliance’s sanctions and with some like India sorely tempted to buy discounted Russian oil, we would profit from paying attention to some very basic factors. Russia can certainly afford to sell oil at significant discounts to market prices, and there are buyers willing to break the American-led embargoes. The non-Western world is no longer automatically on-side with American hegemony; that is a rotting hulk which the Americans are desperately trying to keep afloat. Observing this, the Kremlin seems relaxed and has said that it is willing to accept currencies from its friends, but Western enemies (the “unfriendlies”) would have to pay for oil in roubles or, it has also been suggested, in gold.

On 23 March the Kremlin drew up a list of these unfriendly countries, which includes the 27 EU members, Switzerland, Norway, the United States, the United Kingdom, Canada, Australia, New Zealand, Japan, and South Korea.

Payment in roubles is easy to understand. We can assume that all oil and natural gas long-term supply contracts with the unfriendlies have force majeure clauses, because that is normal practice. In the light of sanctions, the Russians are entitled to claim different payment terms. And it is this that the Russians are relying upon for insisting on payment in roubles.

Germany, for example, would have to buy roubles on the foreign exchanges to pay for her gas. Buying roubles supports the currency, and this was the tactic that created the petrodollar in 1973 when Nixon and Kissinger persuaded the Saudis to take nothing else but dollars for oil. It was that single move which more than anything confirmed the dollar as the world’s international and reserve currency in the aftermath of the temporary suspension of the Bretton Woods Agreement. That’s not quite the objective here; it is to not only underwrite the rouble, but to drive it higher relative to other currencies. The immediate effect has been clear, as the chart from Bloomberg below shows.

Having halved in value against the dollar on 7 March, all the rouble’s fall has been recovered. And that’s even before Germany et al buy roubles on the foreign exchanges to pay for Russian energy.

The gold issue is more complex. The West has banned not only Russian transactions settling in their currencies but also from settling in gold. The assumption is that gold is the only liquid asset Russia has left to trade with. But just as ahead of the end of the cold war Western intelligence completely misread the Soviet economy, it could be making a mistake again. This time, intel seems to be misled by full-on Keynesian macro analysis, suggesting the Russian economy is vulnerable when it is inherently stronger in a currency shoot-out than even the dollar. There is no need for Russia to sell any gold at all.

The Russian economy has a broadly non-interventionist government, a flat rate of income tax of 13%, and a government debt of 20% of GDP. There are flaws in the Russian economy, particularly in the lack of respect for property rights and the pervasive problem of the Russian Mafia. But in many respects, Russia’s economy is like that of the US before 1916, when the highest income tax rate was 15%.

An important difference is that the Russian government gets substantial revenues from energy and commodity exports, taking its income up to over 40% of GDP. While export volumes of energy and other commodities are being hit by sanctions, their prices have risen substantially. But it remains to be seen what form of money or currency for future payments will be used for over $550bn equivalent of exports, while $297bn of imports will be substantially reduced by sanctions, widening Russia’s trade surplus considerably. Euros, yen, dollars, and sterling are ruled out, worthless in the hands of the Central Bank. That leaves Chinese renminbi, Indian rupees, weakening Turkish lira and that’s about it. It’s hardly surprising that Russia is prepared to accept gold. Putin’s view on the subject is shown in Figure 1 of stills taken from a Tik Tok video released last weekend.

Furthermore, Russia’s official reserves are only a small part of the story. Simon Hunt of Simon Hunt Strategic Services, who I have found to be consistently well informed in these matters, is convinced based on his information that Russia’s gold reserves are significantly higher than reported — he thinks 12,000 tonnes is closer to the mark.

The payment choice for those on Russia’s unfriendly list, if we rule out gold, is effectively of only one — buy roubles to pay for Russian energy. By sanctioning the world’s largest energy exporter, the effect on energy prices in dollars is likely to drive them far higher yet. Additionally, market liquidity for roubles is likely to be restricted, and the likelihood of a bear squeeze on any shorts is therefore high. The question is how high?

Last year, the EU imported 155 billion cubic meters of natural gas from Russia, valued at about $180bn at current volatile prices. Oil exports from Russia to the EU were about 2.3 million barrels per day, worth an additional $105bn for a combined total of $285bn, which at the current exchange rate of RUB 75.5 is RUB 2.15 trillion. EU Gas consumption is likely to fall as spring approaches, but payments in roubles will still drive the exchange rate significantly higher. And attempts to obtain alternative sources of LNG will take time, be insufficient, and serve to drive natural gas prices from other suppliers even higher.

For now, we should dismiss ideas over payments to the Russians in gold. The Russian gold story, initially at least, is a domestic issue. Though it might spill over into international markets.

On 25 March, Russia’s central bank announced it will buy gold from credit institutions at a fixed rate of 5,000 roubles per gramme starting this week and through to 30 June. The press release stated that it will enable “a stable supply of gold and smooth functioning of the gold mining industry.” In other words, it allows banks to continue to lend money to gold mining and related activities, particularly for financing new gold mining developments. Meanwhile, the state will continue to accumulate bullion which, as discussed above, it has no need to spend on imports.

When the RCB’s announcement was made the rouble was considerably weaker and the price offered by the central bank was about 20% below the market price. But that has now changed. Based on last night’s exchange rate of 75.5 roubles to the dollar (30 March) and with gold at $1935, the price offered by the central bank is at a premium of 7.2% to the market. Whether this opens the situation up to arbitrage from overseas bullion markets is an intriguing question. And we can assume that Russian banks will find ways of acquiring and deploying the dollars to do so through their offshore facilities, until, under the cover of a strong rouble, the RCB removes exchange controls.

There is nothing in the RCB’s statement to prevent a Russian bank sourcing gold from, say, Dubai, to sell to the central bank. Guidance notes to which we cannot be privy may address this issue but let us assume this arbitrage will be permitted, because it might be difficult to stop. And if Russia does have undeclared bullion reserves more than those allegedly held by the US Treasury, then given that the real war is essentially financial, it is in Russia’s interest to see the gold price rise in dollars.

Not only would Eurozone banks be scrambling to obtain roubles, but the entire Western banking system, which takes the short side of derivative transactions in gold will find itself in increasing difficulties. Normally, bullion banks rely on central banks and the Bank for International Settlements to backstop the market with physical liquidity through leases and swaps. But the unfortunate message from the West to every central bank not on Russia’s unfriendly list is that London’s or New York’s respect for ownership rights to their nation’s gold cannot be relied upon. Not only will lease and swap liquidity dry up, but it is likely that requests will be made for earmarked gold in these centres to be repatriated.

In short, Russia appears to be initiating a squeeze on gold derivatives in Western capital markets by exploiting diminishing faith in Western institutions and their cavalier treatment of foreign property rights. By forcing the unfriendlies into buying roubles, the RCB will shortly be able to reduce interest rates back to previous policy levels and remove exchange controls. At the same time, the inflation problems faced by the West will be ameliorated by a strong rouble.

It ties in with the politics for Putin’s survival. Together with the economic benefits of an improving exchange rate for the rouble and the relatively minor inconvenience of not being able to buy imports from the West (alternatives from China and India will still be available) Putin can retreat from his disastrous Ukrainian campaign. Senior figures in the Russian army will be disciplined, imprisoned, or disappear accused of incompetence and misleading Putin into thinking his “special operation” would be quickly achieved. Putin will absolve himself of any blame and dissenters can expect even greater clampdowns on protests.

Russia’s moves are likely to have been thought out in advance. The move to support the rouble is evidence it is so, giving the central bank the opportunity to reverse the interest rate hike to 20% to protect the rouble. Foreign exchange controls on Russians can shortly be lifted. Almost certainly the consequences for Western currencies were discussed. The conclusion would surely have been that higher energy and other Russian commodity prices would persist, driving Western price inflation higher and for longer than discounted in financial markets. Western economies face soaring interest rates and a slump. And depending on their central bank’s actions, Japan and the Eurozone with negative interest rates are almost certainly most vulnerable to a financial, currency, and economic crisis.

The impact of Russia’s new policy of only accepting roubles was, perhaps, the inevitable consequence of the West’s policies of self-immolation. From Russia’s failure in Ukraine, Putin appears to have had little option but to go on the offensive and escalate the financial, or commodity-currency war to cover his retreat. We can only speculate about the effect of a strong rouble on the international gold price, but if Russian banks can indeed buy bullion from non-Russian sources to sell to the RCB, it would mark a very aggressive move in the ongoing financial war.

China’s position

China will be learning unpalatable lessens about its ambition to invade Taiwan, and Taiwan will be encouraged mightily by Ukraine’s success at repelling an unwelcome invader. A 100-mile channel is an enormous obstacle for a Chinese invasion that Russia didn’t have to navigate before Ukrainian locals exploited defensive tactics to repel the invader. There can now be little doubt of the outcome if China tried the same tactics against Taiwan. President Xi would be sensible not to make the same mistake as Putin and tone down the anti-Taiwan rhetoric and try the softer approach of friendly relations and economic integration to reunite Chinese interests.

That has been a costless lesson for China, but another consideration is the continuing relationship with Russia. The earlier Chinese description of it made sense: “We are not allies, but we are partners”. What this means is that China would abstain rather than support Russia in the various supranational forums where the world’s leaders gather. But she would continue to trade with Russia as normal, even engaging in currency swaps to facilitate it.

More recently, a small crack has appeared in this relationship, with China concerned that US and EU sanctions might be extended to Chinese entities in joint ventures with Russian businesses linked to sanctioned oligarchs and Putin supporters. The highest profile example has been the suspension of a joint project to build a petrochemical plant in Russia involving Sinopec, because of the involvement of Gennady Timchenko, a close ally of Putin. But according to a report from Nikkei Asia, Sinopec has confirmed it will continue to buy Russian crude oil and gas.

As always with its geopolitics, we can expect China to play its hand with great care. China was prepared for the consequences of US monetary policy in March 2020 when the Fed reduced its funds rate to zero and instituted quantitative easing of $120bn every month. By its actions it judged these moves to be very inflationary, and began stockpiling commodities ahead of dollar price rises, including energy and grains to project its own people. The yuan has risen against the dollar by about 11%, which with moderate credit policies has kept annualised domestic price inflation subdued to about 1% currently, while consumer price inflation in the West is soaring out of control.

China is not therefore in the weak financial position of Russia’s “unfriendlies”; the highly indebted governments whose finances and economies are likely to be destabilised by rising energy prices and interest rates. But it does have a potential economic crisis on its hands in the form of a collapsing property market. In February, its response was to ease the credit restrictions imposed following the initial pandemic recovery in 2021, which had included attempts to deleverage the property sector.

Property aside, we can assume that China will not want to destabilise the West by her own actions. The West is doing that very effectively without China’s assistance. But having demonstrated an understanding of why the West is sliding into an inflation crisis of its own making China will be keen not to make the same mistakes. Her partnership with Russia, as joint leaders in the Shanghai Cooperation Organisation, is central to detaching herself from what its Maoist economists forecast as the inevitable collapse of imperial capitalism. Having set itself up in the image of that imperialism, it must now become independent from it to avoid the same fate.

Gold’s wider role in China, Russia, and the SCO

Gold has always been central to China’s fallback position. I estimated that before permitting its own people to buy gold in 2002, the state had acquired as much as 20,000 tonnes. Subsequently, through the Shanghai Gold Exchange the Chinese public has taken delivery of a further 20,000 tonnes, mainly through imports from outside China. No gold escapes China, and the Chinese government is likely to have added to its hoard over the last twenty years. The government maintains a monopoly on refining and has stimulated the mining industry to become the largest national producer. Together with its understanding of the West’s inflationary policies the evidence is clear: China is prepared for a world of sound money with gold replacing the dollar’s hegemony, and it now dominates the world’s physical market with that in mind.

These plans are shared with Russia, and the members, dialog partners and associates of the Shanghai Cooperation Organisation — almost all of which have been accumulating gold reserves. Mine output from these countries is estimated by the US Geological Survey at 830 tonnes, 27% of the global total.

The move away from pure fiat was confirmed recently by some half-baked plans for the Eurasian Economic Union and China to escape from Western fiat by setting up a new currency for cross-border trade backed partly by commodities, including gold.

The extent of “off balance sheet” bullion is a critical issue, because at some stage they are likely to be declared. In this context, the Russian position is important, because if Simon Hunt, quoted above, is correct Russia could have more gold than the US’s 8,130 tonnes, which it is widely thought to overstate the latter’s true position. Furthermore, Western central banks routinely lease and swap their gold reserves, leading to double counting, which almost certainly reduces their actual position in aggregate. And if fiat currencies continue to decline we could find that the two ringmasters for the SCO have more monetary gold than all the other central banks put together — something like 30,000-40,000 tonnes for Chinese and Russian governments, compared with perhaps less than 20,000 tonnes for Russia’s adversaries (officially ,the unfriendlies own about 24,000 tonnes, but we can assume that at least 5,000 of that is double counted or does not exist due to leasing and swaps).

The endgame for the yen and the euro

Without doubt, the terrible twins in the major fiat currencies are the yen and the euro. They share much in common: negative interest rates, major commercial banks highly leveraged with asset to equity ratios averaging over twenty times, and central bank balance sheets overloaded with bonds which are collapsing in value. They now face rising interest rates spiralling beyond their control, the consequences of the ECB and Bank of Japan being trapped under the zero bound and being in denial over falling purchasing power for their currencies.

Consequently, we are seeing capital flight, which has accelerated dramatically this month for the yen, but in truth follows on from relative weakness for both currencies since the middle of 2021 when global bond yields began rising. Statistically, we can therefore link the collapse of both currencies on the foreign exchanges with rising bond yields. And given that rising interest rates and bond yields are in their early stages, there is considerable currency weakness yet to come.

Japan and its yen

The Bank of Japan has publicly stated it would buy an unlimited amount of 10-year Japanese Government Bonds at a 0.25% yield to contain the bond sell-off. A higher yield would be more than embarrassing for the BOJ, already requiring a recapitalisation, presumably with its heavily indebted government stumping up the money. Figure 2 shows that the 10-year JGB yield is already testing the 0.25% yield level (charts from Bloomberg).

Fig 2. JGB yields hits BoJ Limit and Yen collapsing

As avid Keynesians, the BOJ is following similar policies to that of John Law in 1720’s France. Law issued fresh livres which he used to prop up the Mississippi venture by buying shares in the market. The bubble popped, the venture survived, but the livre was destroyed.

Today, the BOJ is issuing yen to prop up the Japanese government bond market. As the issuer of the currency, the BOJ is by any yardstick bankrupt and in desperate need of new capital. Since it commenced QE in 2000, it has accumulated so much government and corporate debt, and even equities bundled into ETFs, that the falling value of the BOJ’s holdings makes its liabilities significantly greater than its assets, currently to the tune of about ¥4 trillion ($3.3bn).

Ignoring the cynic’s definition of madness, the BOJ is doubling down on its commitment, announcing on Monday further unlimited purchases of 10-year JGBs at a fixed yield of 0.25%. In other words, it is supporting bond prices from falling further, echoing Mario Draghi’s “whatever it takes” and confirming its John Law policy. Last Tuesday’s Summary of Opinions at the Monetary Policy Meeting on March 17 and 18 had this gem:

“Heightened geopolitical risks due to the situation surrounding Ukraine have caused price rises of energy and other items, and this will push down domestic demand while raising the CPI. Under the circumstances, it is necessary to improve labour market conditions and provide stronger support for wage increases, and therefore it is increasingly important that the bank persistently continue with the current monetary easing.”

No, this is not satire. In other words, the BOJ’s deposit rate will remain negative. And the following was added from Government Representatives at the same meeting:

“The budget for fiscal 2022 aims to realise a new form of capitalism through a virtual circle of growth and distribution and the government has been making efforts to swiftly obtain the Diet’s approval.”

A virtuous circle of growth? It seems like intensified intervention. Meanwhile, Japan’s major banks with asset to equity ratios of over twenty times are too highly geared to survive rising interest rates without a bank credit crisis threatening to take them down. It is hardly surprising that international capital is fleeing the yen, realising that it will be sacrificed by the BOJ in the vain hope that it can continue to maintain bond prices far above where they should be.

The euro system and its euro

The euro system and the euro share similar characteristics to the BOJ and the yen: interest rates trapped under the zero bound, Eurozone G-SIBs with asset to equity ratios of over 20 times and market realities forcing interest rates and bond yields higher, as Figure 3 shows. Furthermore, Eurozone banks are heavily exposed to Russian and Ukrainian debt due to their geographic proximity.

Fig 3: Euro declining as bond yields soar

There are two additional problems for the Eurosystem not faced by the BOJ and the yen. The ECB’s shareholders are the national central banks in the euro system, which in turn have balance sheet liabilities more than their assets. The structure of the euro system means that in recapitalising itself the ECB does not have a government to which it can issue credit and receive equity capital in return, the normal way in which a central bank would refinance its balance sheet by turning credit into equity. Instead, it will have to refinance itself through the national central banks which being insolvent themselves in turn would have to refinance themselves through their governments.

The second problem is a further complication. The euro system’s TARGET2 settlement system reflects enormous imbalances which complicates resolving a funding crisis. For example, on the last figures (end-February), Germany’s Bundesbank was owed €1,150 billion through TARGET2, while Italy owed €568 billion. It would be in the interests of a recapitalisation for the Italian government to want its central bank to write off this amount, while the Bundesbank is already in negative equity without writing off TARGET2 balances. Germany’s politicians might demand the balances owed to the Bundesbank be secured. This problem is not insoluble perhaps, but one can see that political and public wrangling over these imbalances will only serve to draw attention to the fragility of the whole system and undermine public trust in the currency.

With Germany’s CPI now rising at 7.6% and Spain’s at 9.8%, negative deposit rates are wildly inappropriate. When the system breaks it can be expected to be sudden, violent and a shock to those in thrall to the euro system.

Conclusion

For decades, a showdown between an Asian partnership and hegemonic America has been building. We can date this back to 1983, when China began to accumulate physical gold having appointed the Peoples’ Bank for the purpose. That act was the first indication that China felt the need to protect itself from others as it ventured into capitalism. China has navigated itself through increasing American assertion of its hegemony and attempts to destabilise Hong Kong. It has faced obstacles to its lucrative export trade through tariffs. It has been cut off from Western markets for its advanced technology. China has resented having to use the dollar.

After Russia’s ill-advised invasion of Ukraine, it now appears that the invisible war over global financial resources and control is intensifying. The fuse has been lit and events are taking over. The destabilisation of the yen and the euro are now as certain as can be. While the yen is the victim of John Law-like market-rigging policies and likely to go the same way as France’s livre, perhaps the greater danger is for the euro. The contradictions in its set-up, and the destruction of Germany’s sound money principals in favour of the inflationism of the PIGS was always going to be finite. The ECB has got itself into a ridiculous position, and no amount of conjuring and cajoling of financial institutions can resolve the ECB’s own insolvency and that of all its shareholders.

History shows that there are two groups involved in a currency collapse. International holders take fright and sell for other currencies and assets they believe to be more secure. They drive the exchange rate lower. The second group is the public in a nation, those who use the currency for transactions. If they lose confidence in it, the currency can rapidly descend into worthlessness as ordinary people accelerate its disposal for anything tangible in a final crack-up boom.

In the past, an alternative currency was always the sounder one, one backed by and exchangeable for gold coin. That is so long ago that we in the West have mostly forgotten the difference between money, that is gold and silver, and unbacked fiat currencies. The great unknown has been how much abuse of money and credit it would take for the public to relearn the difference. Cryptocurrencies have alerted us, but they are not a widely accepted medium of exchange and don’t have the legal standing of gold and gold substitutes.

War is to be our wake-up call — financial rather than physical in character. Western central banks and their governments have been fiddling the books, telling us that currency debasement is good for us. That debasement has accelerated in recent years. But by upping the anti against Russia with sanctions that end up undermining the purchasing power of all the West’s major currencies, our leaders have called an end to the reign of fiat.

Long-Term Oil Prices Beginning To Reflect The Coming Oil Shortage

 This is extremely important. Oil is the basis of our modern society and the petrodollar the basis of our financial system...  

Via GoldMoney Insights,

Brent crude oil prices rallied $100/bbl since the lows in 2020. This reflects very tight fundamentals, where petroleum inventories are at extremely low levels relative to consumption and supply is struggling.

The war in the Ukraine has worsened the near-term supply outlook further.

The current conditions in the oil market are critical and we could see real oil shortages by this summer if the disruptions to Russian oil supplies persist or even worsen. This would put even more upward pressure on current prices and overall inflation. However, we think an even bigger and more permanent issue has been brewing in oil markets for years and it is finally filtering through to the back end of the forward curve.

Longer dated prices have broken out of their 5-year range and have been moving up relentlessly.

We think the oil markets finally begin to understand that a lack of investments in large oil projects over the past years is threatening supply over the entire next decade, at a time when demand will still be growing as the electrification of the transportation sector will not impact demand meaningfully for years to come.

The sharp upward moves in oil prices amidst a broader commodity prices rally have pushed realized inflation and near-term (0-2y) inflation expectations up strongly. But inflation expectations beyond that time horizon have proven to be resilient. So far the back end of the oil curve moved up only $15/bbl. However, we think that once back end prices are moving in a similar fashion to what we currently witness in the front, longer term inflation expectations will likely begin to move up too.

In this two part report, we look first at how we got to the current price environment and in the upcoming second part we do a deep dive into the long term outlook for crude oil markets.

Oil prices have reached the highest levels since the all-time highs in 2008. The most obvious explanation for the sharp rally is the military conflict in Ukraine and the threat of a loss of Russian oil supplies. However, oil prices are only up $20 since the war started a month ago. In fact, Brent crude oil prices have been rising relentlessly ever since the lows of around $20/bbl we saw during first lockdowns in spring 2020, to $95/bbl just before the invasion (see Exhibit 1).

Exhibit 1: Oil priced rallied close to $80/bbl from their lows before the Ukraine invasion started

$/bbl

Source: Goldmoney Research

While everybody points to the Ukrainian conflict to explain high prices, just a month ago there was a vigorous debate among analysts, media, and politicians about what was behind the fact that oil had broken out of the $60-80 range it has mostly been trading in for the past years (except the quick lockdown crash in early 2020) and started to rally relentlessly. Was it exceptional demand, reflective of a strong economy coming out of the pandemic as some claimed? Or rather supply bottlenecks, similar to the supply issues that plagued many other industries at the moment. Was it OPEC? Or just broad based inflation filtering into oil, given that almost any other commodity has shown similar or even higher price increases over the past two years.

First, it wasn’t (and still isn’t) exceptionally strong demand. While global oil demand has significantly recovered from the lows in spring 2020, for 2022 it is still slightly below where it was before the pandemic (see Exhibit 2).

Exhibit 2: Global oil demand has strongly recovered but remains below pre-pandemic levels so far

Mb/d, 12 month moving average, change vs 2019

Source: Goldmoney Research

This means it is lagging overall economic activity, which, according to the World Bank and the IMF, is roughly 7% higher in 2022 than it was in 2019 (see Exhibit 3). A rule of thumb is that global oil demand grows roughly at the rate of GDP -2% efficiency gain per annum. In this case, a 7% GDP growth over two years plus 2% compounded efficiency gains would suggest that oil demand – if it wasn’t for the remnants of the pandemic – should be roughly 1 million b/d above 2019 levels.

Exhibit 3: cumulative changes to real GDP vs 2019

%

Source: IMF

The reason why oil demand is lagging is mostly due to the lack of jet fuel demand. Jet fuel accounts for about 10% of global oil demand and air traffic is still quite a bit lower than it was before the pandemic. Globally commercial air traffic is still down 20% vs. pre-pandemic levels according to Flightradar24, a site tracking commercial air traffic (see Exhibit 4).

Exhibit 4: Commercial flight activity is still 20% below pre-pandemic levels

Source: Flightradar24.com

During the first wave of the Covid19 pandemic, oil demand crashed like it never had before. At it’s lowest point, oil demand was down 20%. As a comparison, during the great recession of 2008-2009, oil demand was down just about 3.5% at any point in time (see Exhibit 5).

Exhibit 5: The demand destruction from the lockdowns dwarfed the demand destruction from the recession that followed the 2008-2009 credit crisis

Kb/d year-over-year

Source: Goldmoney research

This demand destruction in early 2020 lead to a massive build in global inventories. Global total petroleum stocks rose at the fastest rate and reached their highest levels in history as producers didn’t curb production fast enough (see Exhibit 6).

Exhibit 6: Total commercial petroleum’s stocks, including floating storage, reached their highest levels in history in 2020

Kb

Source: Goldmoney Research

Which is where OPEC+ comes in. After taking a very different direction during the February meeting (Saudi Arabia, upset about Russia’s refusal to agree to production cuts, ramped up production to all-time highs and flooded the market with crude, promptly crashing prices), OPEC+ swiftly decided to act when it became clear what the global lockdowns did to demand. The group cut oil production by around 10 million b/d (see Exhibit 7). And surprisingly, all group members stuck to their quotas since that decision was made.

Exhibit 7: OPEC swiftly cut production by a record amount when the effects of the lockdowns on demand became clear

Kb/d (OPEC crude oil only, auxiliary states in OPEC+ not included)

Source: Goldmoney Research

Subsequently, the group provided a roadmap for the return of these barrels. For the first couple months of this oil production recovery, OPEC+ was careful that the oil market remained in deficit. As a result, oil inventories kept falling until they reached their 5-year average in mid-summer 2021 (se Exhibit 8).

Exhibit 8: Global petroleum stocks were back to 5-year averages by mid-summer 2021

Kb, levels vs 5-year average

Source: Goldmoney Research

However, actual OPEC+ production is lagging the quotas for many months now, and the gap between actual and target becomes increasingly wider. The reason is that some of the smaller OPEC members struggle to produce as much as they would be allowed under the plan (see exhibit 9). These are not voluntary cuts. It has become obvious that the capacity of many OPEC members simply isn’t there as these countries are plagued with domestic issues that prevent full production. On top of that, the non-OPEC members of OPEC+ are also producing about 200kb/d below their quotas, and that was before the war in Ukraine reduced Russian exports.

Exhibit 9: Many OPEC members keep producing below their quotas

Kb/d

Source: OPEC

Interestingly, the core OPEC members Saudi Arabia, UAE, and Kuwait are for once not stepping in to fill the gap. In our view, this may be partially politically driven due to some tensions between the US and some OPEC members, but more likely it is also due to their own capacity constraints. In April 2020, Saudi Arabia briefly ramped up production to 12mb/d as the Kingdom reacted to Russia’s’ refusal to commit to a production cut (see Exhibit 10). This strategy backfired as it meant raising output right into the largest demand crash in history. However, it does give some insights to what Saudis production capacity is. We think Saudi Arabia went beyond their sustainable production capacity at that time. It is unlikely that they could sustain this output level for an extended period. Their production capacity for the medium term is likely closer to 11-11.5mb/d. Any capacity increase would require substantial investments in our view, and it would take years to achieve.

Exhibit 10: Saudi Arabia demonstrated that they can push production to 12mb/d over a very brief period, but sustainable production capacity is likely significantly lower

Source: Goldmoney Research, OPEC

While Saudi Arabia is still producing below their sustainable capacity, the country can’t really step in and fill the production gaps left by the less stable OPEC producers, as it would mean it could not increase production anymore when it is supposed to according to the OPEC+ roadmap. The country has no choice but to stick to their own predetermined production path. The same is true for other core-OPEC members. As a result, demand continued to exceed production in 1Q22 at a time when in theory, we should have already shifted to an oversupply in the first two months of the year.

This has pushed global inventories lower and lower. As we have explained in earlier reports, there is a very strong relationship between the level of inventories and crude oil time-spreads, the difference between the prompt prices and longer-dated prices on the forward curve (see Exhibit 11). In a nutshell, when inventories are low, consumers of a commodity – in this case petroleum products – are willing to pay a premium for immediate delivery. It is preferable to pay this premium than to face the risk of having to shut down the business because they run out of oil (jet fuel, diesel etc.). In such a situation, prompt prices trade over future prices which is called “backwardation”. When inventories are high, consumers have no preference for immediate delivery. Instead, storage, insurance, and financing costs mean that consumers rather not sit on inventories, but would prefer delivery in the future. In that situation, prompt prices will trade below forward prices and the curve is in “contango”.

Exhibit 11: Crude oil time-spreads are inversely correlated to inventories

% time-spread 1-60 months, prediction based on inventory levels

Source: Goldmoney Research

The extent to which a forward curve is in backwardation or contango is strongly correlated to the level scarcity or abundance of inventories relative to demand. At the moment, we see an extreme level of backwardation in the front of the curve. The market signals extreme scarcity of oil stocks and the risk of further supply shortages. This is the result of the persisting undersupply discussed above that led to a situation of very low inventories, but also due to concerns over potentially even larger shortages due to missing Russian crude oil supplies.

To what extent the Ukraine conflict has exacerbated this issue from a fundamental perspective is difficult to assess at the moment. So far the US is the only nation that has outright banned imports of Russian oil and products. While this might create challenges for some refiners that rely on specific grades of imported Russian crude, it doesn’t alter the global supply and demand picture. US refiners will be forced to switch to an alternative grade but the Russian crude that used to go to the US (only about 670kb/d in 2021, of which 200kb/d was crude and the rest products, mostly fuel oil and VGO that was used in the US refinery system) will find its way to Asia (see Exhibit 12).

Exhibit 12: US import volumes of Russian petroleum are relatively small

Kb/d

Source: Goldmoney Research, EIA

The EU has imposed some sanctions on Russia that impact the commodity sector overall, but it has so far refrained from banning energy imports. However, over the past weeks it has become apparent that the voluntary sanctioning by Western companies – sometimes as a result of public outcries – is having an impact on Russia ability to export crude to the West regardless. There have been several reports that international commodity trading giants were forced to offer Urals (a Russian crude oil grade) at discounts of up to $30/bbl as they could not find a willing buyer. Russian crude exports are dependent on pipeline flows to Europe. These flows can’t be entirely substituted by seaborne exports at the moment. Hence the reluctance of Western oil firms, merchants, banks, shippers, seaports, and insurance companies to refrain to deal with Russian entities or outright stop dealing with anything that could be related to Russia can still lead to substantial reduction of Russian exports even as there is no legal ban. At the moment this probably affects around 1mb/d of Russian crude supplies. On top of that, Russia just announced that the CPC pipeline – a Kazakh-Russian Caspian Pipeline Consortium – is undergoing unplanned maintenance of up to two months, reducing global supplies by a further 0.5mb/d.

Exhibit 13: Russian oil and gas exports are dependent on pipeline flows to Europe

Source: National Geographic https://www.nationalgeographic.org/photo/europe-map/

On the flip side, IEA member states agreed to release 60mb of petroleum from their strategic reserves to alleviate the current shortages. Most of it will come from the US, and 29 other countries have committed to smaller volumes. However, that covers the current losses from Russia by just one to two months. The US had already orchestrated a coordinated SPR release last November to deal with high prices prior to the Ukraine war. The reaction was a short sell-off and an immediate recovery with prices pushing much higher.

There is no easy way to predict how this picture changes over the coming months.

  • It’s certainly key how the Ukrainian conflict progresses. On one hand, Europe is unlikely to ban oil and gas imports unless the conflict escalates in a dramatic way. On the other hand, while European sanctions are unlikely to be eased in the short term even if Ukraine and Russia come to some sort of agreement, such a scenario would likely ease the pressure on Western firms to maintain their voluntary sanctions.

  • Core-OPEC members do have spare capacity, and they will bring it back as planned and not faster. But they run out of spare capacity in 2H2022.

  • US production is also growing again, but not unlike OPEC, the shale oil producers made clear that they are also sticking to their production targets and are undeterred by higher prices, Non-OPEC (non-shale) production is growing as well, but it is recovering from the declines over the past 2 years rather than incrementally growing. This means it’s a one off and most of the increase have already happened.

  • Finally, there is a significant chance that the Iranian nuclear deal will be reactivated, allowing for about 1 million b/d of crude production to come back online relatively quickly.

  • This uncertain supply picture is facing a rapid improvement in global demand on the back of what seems to be the rapid abandonment of Covid19 mandates worldwide, which would allow air travel to rebound strongly over the coming months.

We think the near-term risks are skewed to the upside as demand keeps exceeding supply despite the OPEC ramp up, and Russia supply issues only exacerbate this situation. This would lead to even stronger backwardation until prices start to impact demand enough to balance the market. The current conditions in the oil market are critical and we could see real oil shortages by this summer if the disruptions to Russian oil supplies persist or even worsen.

So it appears that the strong crude oil prices are mainly the result of a very backwardated curve because supply is struggling over the short term. While this adds to the overall inflation pressure coming from generally higher commodity prices, breakeven inflation expectations suggest that the market is expecting these pressures to remain only over the near term. In other words, the market thinks the supply issues will be transitory. However, we think an even bigger and more permanent issue has been brewing in oil markets for years and it is finally filtering through to the back end of the forward curve. Longer dated prices have broken out of their 5-year range and have been moving up relentlessly. We think the oil markets have finally begun to understand that a lack of investments in large oil projects over the past years is threatening supply over the entire next decade, at a time when demand will still be growing as the electrification of the transportation sector will not impact demand meaningfully for years to come. The sharp upward moves in oil prices amidst a broader commodity prices rally have pushed realized inflation and near-term (0-2y) inflation expectations up strongly. But inflation expectations beyond that time horizon have proven to be resilient.

So far the back end of the oil curve moved up only $15/bbl. However, we think that once back end prices are moving in a similar fashion to what we are currently witnessing in the front, longer term inflation expectations will likely begin to move up too.

Friday, April 1, 2022

Is Russia the REAL target of Western sanctions?

 I don't know about this. I just find the idea interesting. Clearly some of the sanctions were ready long before the start of the war and the financial reset being unavoidable, a war is most certainly convenient after the virus. 

 Our governments are not capable of thinking that far. They are just being manipulated. But are the manipulators able to organize something so complex? Or more like channeling every opportunity as they come, towards a goal? 

Guest Post by Kit Knightly

The first tweet I saw when I checked my timeline this morning was from foreign policy analyst Clint Ehlirch, pointing out that the Russian ruble has already started recovering from the dip created by Western sanctions, and is almost at pre-war levels:

Ehrlich states, “sanctions were designed to collapse the value of the Ruble, they have failed”.

…to which I can only respond, well “were they?”

…and perhaps more importantly, “have they?”

Because it doesn’t really look like it, does it?

If anything, the sanctions seem to be at best rather impotent, and at worst amazingly counterproductive.

It’s not like the US/EU/NATO don’t know how to cripple economies. They have had years of practice starving the people of Cuba, Iraq, Venezuela and too many others to list.

Now, you could argue that Russia is a larger, more developed economy than those countries, and that’s true, but the US and its allies have previously managed to hurt the Russian economy quite drastically.

As recently as 2014, following the “annexation” of Crimea, Western sanctions were tame compared to the recent unprecedented measures, but crucially the US massively increased its own oil production, then later that year (following a visit by US Secretary of State John Kerry) Saudi Arabia did the same.

Despite objections from other members of OPEC – Venezuela and Iran chiefly – the Saudis flooded the market with oil.

The result of these moves was the biggest fall in oil prices for decades – collapsing from $109 a barrel, in June 2014, to $44 by January 2015.

This kicked Russia into a full recession and saw Russia’s GDP shrink for the first time under Putin’s leadership.

Again, just two years ago, allegedly as part of competing with Russia for a share of the oil market, Saudi Arabia once more flooded the market with cheap oil.

So, the West does know how to hurt Russia if it really wants to – by increasing oil production, flooding the market and tanking the price.

But has the US increased its oil production this time round? Have they leant on their Gulf allies to do the same?

Not at all.

In fact, in a point of beautiful narrative synchronicity, the US claims it’s “unable” to increase its oil production due to “staff shortages” caused by that gift that keeps on giving – Covid.

Similarly, Saudi Arabia is not tanking the oil market, but deliberately increasing prices.

Yes, right now, with the Western allies locked in an alleged economic war with Russia the price of oil is soaring, and may continue to do so.

This is good news for the Russian economy, to the point it may even make up for the damage done by the brutal sanctions.

The high price of oil and need “not to rely on Putin’s gas” or “de-Russify” our energy supply will doubtless result in millions being poured into “green” technology.

Those Western sanctions are targeting other Russian exports too, including grains and food in general.

Russia is a net exporter of food, meaning they export more food than they import. Conversely, many countries in Western Europe rely on imported food, including the UK which imports over 48% of its food supply.

If Europe refuses to buy Russian food, the net effect is that Russia has food…and the West doesn’t.

And, just as with oil, increasing food prices will help rather than hinder the Russian economy.

Take wheat for example, of which Russia is the biggest exporter in the world. The vast majority of this wheat is not even sold to Western countries – but instead to China, Kazakhstan, Egypt, Nigeria and Pakistan – and so is not even subject to sanctions.

Nevertheless, the sanctions, and the war, have actually driven the price of wheat up almost 30%.

This is good for the Russian economy.

Meanwhile, according to CNN, the US is likely to enter a full-blown recession by 2023, France is considering food vouchers and countries all over the world are expected to begin rationing fuel.

So, the sweeping sanctions imposed against Russia by the West, allegedly in response to the invasion of Ukraine, are not having their stated aim – tanking the Russian economy – but they are driving up the price of oil, creating potential energy and food shortages in the West and exacerbating the “cost of living” crisis created by the “pandemic”.

You should always be wary of anybody – individual or institution – whose actions accidentally achieve the exact opposite of their stated aim. That’s a simple rule to live by.

Remember how Orwell described the evolution of the concept of war in 1984:

War, it will be seen, is now a purely internal affair. In the past, the ruling groups of all countries, although they might recognize their common interest and therefore limit the destructiveness of war, did fight against one another, and the victor always plundered the vanquished. In our own day they are not fighting against one another at all. The war is waged by each ruling group against its own subjects, and the object of the war is not to make or prevent conquests of territory, but to keep the structure of society intact.

Recall that “the worst food shortages for fifty years” were predicted as a result of Covid. But they never materialised.

Likewise, we were due to experience Covid-related energy disruptions and power cuts. Short of the UK’s damp squib of a “petrol crisis”, they never really arrived.

But now they are heading our way after all – because war and sanctions

Increased food prices, decreased use of fossil fuels, lowering standards of living, public money poured into “renewables”. This is all part of a very familiar agenda, isn’t it?

Regardless of what you feel about Putin, Zelensky, the war in general or Ukrainian Nazis, it’s time to confront the elephant in room.

We need to be asking: What exactly is the real aim of these sanctions? And how come they align so perfectly with the great reset?

Thursday, March 31, 2022

Did Russia Intentionally Trigger A Monetary System Reset?

 This to my opinion is the case and so the "real" war has started.

Did Russia Intentionally Trigger A Monetary System Reset?

Written by Dave Kranzler, Sprott Money News

March 30, 2022

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“We are witnessing the birth of Bretton Woods III – a new world (monetary) order centred around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.” – Zoltan Pozsar, Bretton Woods III

Fiat currency is a “promise” to repay a debt obligation and nothing more. A hard asset-backed currency is a guarantee that repayment will occur.

On March 7th Zoltan Pozsar, who formerly worked at the NY Fed, was an advisor at the U.S. Treasury and currently is a strategist as Credit Suisse, published a research report titled “Bretton Woods III.” Anyone familiar with the Bretton Woods agreement understands the reference. Nixon’s snipping of the final thread connecting currency to gold is considered to be Bretton Woods II. Pozsar makes the case that Bretton Woods III is a reversion back to a monetary system in which currency is backed by commodities as opposed to being backed by a sovereign issuer’s “full faith and credit.”

A crisis is unfolding.  A crisis of commodities. Commodities are collateral, and collateral is money, and this crisis is about the rising allure of outside money over inside money. Bretton Woods II was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia’s FX reserves. – ibid

The post-1971 fiat currency reserve banking system enabled by the removal of gold from the monetary system is nothing more than a Ponzi scheme. “Inside money” refers to the interbank repo/lending mechanism from which the fractional bank reserve monetary system blossoms. Pozsar distinguishes “inside money” from “outside money.” “Inside money” is created by the Central Bank/inter-bank lending mechanism that can magically turn one dollar of reserve capital into nine dollars of “credit” capital. And the one dollar of reserve capital is backed by nothing tangible – just the “full faith and credit” of the issuing entity.

Think of this monetary system as an inverted pyramid – eg something like Exter’s Pyramid.  In bankruptcy law, “full faith and credit” would be considered, at best, an unsecured loan.  Get in line and pray that there’s value left over to be distributed to the unsecureds.

In contrast, Pozsar references Bretton Woods III as the “rising allure of outside money over inside money,” where “outside money” is “commodities collateral,” meaning tangible assets for which definitive value can be determined, as opposed to the sovereign promise of “full faith and credit.”  In periods of banking crises, banks are reluctant to participate in the “inside game” (see 2008 and September 2019, for instance) because, at that point in time, they don’t trust the fiat currency collateral on which the fractional reserve banking system is predicated and thus are reluctant to lend money to their banking peers. Every time this occurs, the Central Banks have to print more money to “lubricate” the system enough so that it functions. This in turn further devalues the “inside money” on which the system is predicated.

But if currency issued by Governments and printed by Central Banks is backed by hard assets, this problem is avoided. In this system, the counterparty to trade or financing transactions would have the option of demanding payment in the hard asset or assets backing the currency – most likely gold or possibly a pre-agreed upon commodity asset. Remember, fiat currency is nothing more than an unsecured debt instrument of the issuing entity.

It’s likely that Putin knew ahead of time that the west’s response to Russia’s invasion of Ukraine would be to freeze Russian currency reserves held at western Central Banks. Of course, this response by the U.S./west brought to light the inherent Achilles’ Heel of the modern Central Bank fiat currency reserve system. Any country that keeps currency reserves for trade settlement purposes at foreign Central Banks, specifically the Federal Reserve and the ECB, is at risk of having those reserves confiscated, thereby rendering them worthless.

In response, Russia is now demanding payment for energy in either rubles or gold from what it deems to be “unfriendly” countries. Whereas in the “inside money” banking system, settlement of trade is merely a matter of accounting ledger adjustments at the respective Central Banks, in this trade settlement arrangement, a country purchasing oil or gas from Russia in exchange for gold would need to 1) demonstrate that the gold being used for trade payment actually exists and 2) transfer the ownership rights to Russia. Russia ultimately would likely demand repatriation of the gold. The U.S./G7 made it crystal clear that possession of assets is 100% of the law.

The response by the west – led by the U.S. and its control of the global reserve currency – in all likelihood has triggered a reset of the global monetary system. I actually do not like the term “Bretton Woods III” because it references an agreement that, in its essence, destroyed the gold-backed global monetary system. Regardless, it appears for now that Russia – likely with China’s tacit support – has set in motion a global monetary system reset. In the new system countries which supply the world with goods that have price inelasticity of demand – oil, natural gas and food commodities, for instance – will have the power to enforce trade settlement in hard currencies – e.g. gold or other hard assets – rather than fiat currency Central Bank accounting ledger adjustments. This is the nature of the monetary system reset that has been triggered. Welcome to Galt’s Gulch…

“Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion–when you see that in order to produce, you need to obtain permission from men who produce nothing–when you see that money is flowing to those who deal, not in goods, but in favours–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed. Money is so noble a medium that it does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half property, half-loot

...Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, ‘Account overdrawn.'” – Francisco’s Money Speech, Atlas Shrugged

Tuesday, March 29, 2022

GotGoldorRubles? Did Russia Just Break The Back Of The West?

 Clearly the war in Ukraine is a proxy war and the stakes are much higher than a corrupt country that very few people care much about, save Hunter Biden... maybe?

  The protagonists are New York and the City of London on the Western side, and Russia and China on the multi-polar side. China, maybe reluctantly as the country needed another two or three years of strengthening before such a direct challenge to the Occidental world order.

But now that the dices are rolling, all the protagonists will have to take the gloves off. China of course, but also India, Saudi Arabia, South Africa and all the other raw material producers who will less and less accept valueless currencies for actual resources. This is the real start of the real war of the 21st century. Buckle up for the ride!

Authored by Tom Luongo via Gold, Goats, 'n Guns blog,

I don’t think everyone has yet caught the significance of Russia announcing they are putting a floor under the price of gold.  

But, to be clear, Russia just broke the paper gold suppression scheme.

On Friday the Bank of Russia announced:

RUB5000 to the ounce at an exchange rate of 100 RUB/USD implies a $1550 per ounce gold price.

For a few days previous to this announcement, which they knew was coming, The West was running around with multiple bits of legislation to try and keep the Russians from selling their gold.

The G7 think the sanctions are hitting so hard that Putin will be forced to sell his gold to evade sanctions to pay for things.  They are literally running a script in their heads that is not actually playing out in the real world.

But, whatever, Neocons never met an ugly stick that they didn’t want to use to beat someone over the head with.  Too bad all they’re doing is hitting a rubber tire.

Boing!

Because here’s the gig, Russia won’t be selling any gold. They’re buying it.

These are supposed to be the architects of the global monetary system and you would think they are the ones that understand it the best.  But, clearly they do not.

What they think they understand is that they still control the flow of commodities around the world through price suppression schemes on the CRIMEX, LBMA and ICE.

They do not.

Ultimately, ‘outside money’ trumps ‘inside money.’  

Austrians, like myself, have always understood that eventually Inside Money [money that exists within the financial system] fails because it is ultimately nothing more than a Ponzi Scheme built on top of Outside Money — money that exists outside the financial system, like commodities and bitcoin.

Money, It’s a Hit!

Let’s start with the basics. Why do we create money? To act as a way to mitigate the time risk between selling what we have and buying what we want. So we sell our labor today to buy gasoline, printer paper or blow jobs tomorrow. In the meantime we hold money.

It is a way to turn thought and personal application of energy and time into a token which can procure for us real goods in the real world.

With that in mind, now think about the current financial system where all inside money is created by first selling a debt instrument to someone willing to hold it for a vig.

Back to the ruble and gold. Because once I lay out the new incentive structure it will be clear as to why the G7 has no friends in this fight anymore.  

Davos’ power rests on the ability to create credit and sell it at a positive interest carry to commodity producers.  Since base commodity production in any kind of efficient market should be a very low margin enterprise, think 1-4% real annual return, selling them debt to extract oil or gold out of the ground at higher rates than that ultimately sucks all the profit out of the venture.

Free markets when allowed to function properly grind out profit through competitive arbitrage. It is both brutal and the spark of new innovations and efficiencies.

It is the desire for higher profits over baseline that does this.

In base commodities that is difficult, at best, to do. Why? Because they aren’t anything more than a second order good. First order would be the ore or timber harvested. Second order would be the ingot or lumber produced. The higher order the good, the more specialized it is and the higher opportunity for profit through product differentiation on something other than price emerges.

That’s most difficult to do in improving resource extraction because, it follows, most of the major gains in efficiency occurred in the past when the economy was less specialized.

Confusion Over ‘The System’

If the banks are on both sides of the trade setting the price of money, then they ultimately control who wins and who loses while this goes on. And let’s not mince words, it’s them. The profit rolls up to those that produce the highest order goods with the most complex supply chains.

The banks plough the profits from getting interest on the original debt into the very companies producing the higher order goods needed to ensure the lower order goods produce no wealth through the grinding out of profit via arbitrage throughout the supply chain.

Don’t believe me? Ask cattle farmers.

In this respect the current financing of these industries is nothing more than a virtualized version of the colonial economic model of the 15th through 19th centuries.

Instead of using physical men to subjugate the locals through superior weaponry and bribes to get them to extract the mineral wealth which the colonialists take back home, today we use the post-WWII institutions to run that same system through debt issuance for capex and the interest payments (in this case pure economic rent – unearned wealth).

The producer countries of all the mineral wealth in the world are nothing but debt slaves to the money masters in Brussels, City of London and New York.  That’s the gig.

Since we’ve reached the point of debt saturation where no more debt can be issued to extract mineral wealth and have the markets believe it could ever be paid back at these real yields, the system has to be reset.

The whole Great Reset is a way to crash the existing system but leave the same colonialists in power legally.

It’s not really more complicated than that.

When you understand that dynamic now you can understand why Russia, in particular, is the vanguard of the Global South’s desire to change the System of the World.

It is also the one country that has the commodity production power to expose the vulnerabilities of this System.

That’s Nice… #GotRubles?

And that’s where pegging the ruble to gold comes in.

The Bank of Russia is now a buyer of gold at 5000 rubles to the gram, or 155,500 rubles to the troy ounce.  At a Friday March 25th closing price of RUB96.62 vs. the USD that implies a gold price of $1610 per ounce.

The ruble is now freely strengthening versus the US dollar.

Now, that is not that remarkable on its own. 

As I explained on Twitter that day:

  • 1: At $1550 per ounce the first order effect here is that is implies a RUB/USD rate of around 75. Incentivizing those holding RUB to continue and those needing them to bid up the price from current levels.

  • 2: This creates a positive incentive loop to bring the ruble back to pre-war levels.  Then after that market effects take over as ruble demand becomes structural, based on Russia’s trade balance.

  • 3: Once that happens and the RUB/USD falls below 75, then the USD price of gold rises structurally draining the paper gold markets and collapsing the financial system based on leveraged/hypothecated gold.  Now we’re into the arb. phase @Lukegromen postulated w/ 1000bbls/oz.

So, this scheme incentivizes Russians to hold savings in rubles, because the ruble is undervalued.  It also incentivizes foreign traders to hold rubles because the ruble is undervalued relative to an overvalued open gold price.

Clearly currency speculators in Moscow, Shanghai, Singapore, Mumbai and Hong Kong are having a field day with this.

Coupled with Putin demanding ‘unfriendly countries’ paying for their Russian imports with either gold or the ruble, the natural choice is for them to buy rubles until such time as the price of gold and the ruble are in sync on international markets.

The howls of pain from the G-7 and Germany in particular are equal parts pathetic and hilarious as they complain that Putin is in ‘breach of contract’ for demanding a different payment currency for gas other than the euros stipulated in the contract.

Earlier Monday German Economy Minister Robert Habeck said from Berlin that the Kremlin demand for natural gas contracts to be paid in rubles is a “one-sided and clear breach of contracts” – saying the contracts must be honored under prior conditions, according to Bloomberg“That means that a payment in rubles is not acceptable and we urge the relevant companies not to comply with Putin’s demand,” Habeck said. “Putin’s effort to drive a wedge between us is obvious but you can see that we won’t allow ourselves to be divided and the answer from the G-7 is clear: the contracts will be honored.”

The Kremlin’s quick shooting down of the German economy minister’s comments and the G-7’s stance on the ruble came Monday via a Russian lawmaker to state-run RIA Novosti: “Russian lawmaker Abramov says G7’s refusal to pay in Russian roubles for gas will definitely lead to a halt in supplies.”

Pissed off Russians certainly have a way with words, as a writer, I appreciate this greatly. According to TASS:

Moscow is handling the details of its gas delivery plans to unfriendly countries for payment in rubles, but it won’t engage in charity if Europe refuses to pay in the Russian currency, Kremlin Spokesman Dmitry Peskov told reporters on Monday.

…The Kremlin spokesman remained tight-lipped on what measures Russia might take if Europe refused to pay for gas in rubles, noting that these “issues should be sorted out as they develop.” “But we will definitely not supply gas for free, that’s for sure. It is hardly possible and reasonable to engage in charity in our situation,” he emphasized.

Do you hear that Davos? That’s the sound of the ticking clock.

The Trade’s the Thing…

The reason why this current scheme is already working is that Russia runs a positive trade balance mostly in base commodity exports. Davos doesn’t want them making any money selling those commodities to the world and will continue to put sanctions on to get people to not use rubles.

They are however fighting the invisible hand of Adam Smith’s market. The demand for the ruble will rise above the pre-war exchange rate of around 75:1 vs. the USD.

The price point for gold/ruble implies that exchange rate. Russia will revisit this at the end of Q2.  This also implies they expect the ruble/dollar rate to fall to 75 by the end of Q2, if not earlier.

After that if the ruble strengthens beyond that they can adjust the gold buying price.  

If the ruble/dollar rate dips below their pegged price, buyers are getting oil at a discount when paying in gold. That will force the CRIMEX and LBMA into a supply shortage situation or they will have to end the expansion of paper gold versus real gold and allow real price discovery to the upside.

If the sanctions are successful in scaring everyone into not using rubles gold Russian commodities then the exchange rate will stay stubbornly above 75 and the boycotting world will lose competitive advantage versus those willing to brave the US’s ire by getting Russian commodities on the cheap.

As I talked about in previous articles, this sets up the opportunity to end the suppression of the price of gold through rehypothecation of physical gold in the paper markets which is the basis for the entire financial colonization system I described above.

FYI, this same scenario is going to play out in Bitcoin now that Russia has said ‘friendly countries’ can pay for imports with Bitcoin.  Has anyone noticed the current rally in the World’s Most Hated Cryptocurrency?

We now have a full gold/bitcoin/ruble (and soon Yuan) interconversion system that completely and utterly cuts out Davos and destroys their colonial debt model while also taking away their power to crash economies through hot money in and out flows.

Because the next step in all of this is for Russia to close their capital account and nationalizing the Bank of Russia making the only source of international rubles be the Russian government.  

Internally, the ruble will be de facto backed by gold and can circulate freely.  

The War Without End, Ended

The war is over folks.  Russia, China and the rest of the Global South have already won. As Luke Gromen replied to me., “in the end there’s nothing they can do about it.” 

What scares me is the last thing I tweeted out in that thread: 

“Other than widen the war on the ground.  That’s the part that scares me.”

And that’s exactly what I expect to happen next, sadly.  Biden is in Brussels saying the quiet parts out loud talking with the 82nd Airborne about going into Ukraine and calling for regime change in Moscow.  

These people still believe their own bullshit to the point where they think this becomes a war the Russians can’t win.

Putin let the world down easy with this announcement.  He could have walked right in and said 8000 rubles to the gram or $2575/oz and that would have broken the markets Friday going into the weekend, by selling his oil and gas at a steep discount.

He waited until after OpEx last Friday and the Fed’s interest rate hike plan was announced.

Timing matters guys.

But, by doing this he has very subtly also supported the Fed and it’s plan to withdraw dollars from Europe, because this will keep the price of gold in check for a little while and keeping the ECB from offsetting spiking Eurobond yields with higher gold reserves on its balance sheet.

Putin on the left arm, Powell on the right and Lagarde is about to get pulled apart at the seams if Davos doesn’t play ball and give up.

The problem there is the unquenchable arrogance of these European elites who simply do not believe they could be bested by the “colonies” in the US and the “dirty slavs” in Russia.  I’ve told you for years now that it is their inherent racism that drives their actions. 

So, do not be surprised if they empower the neocons in the UK and US to escalate from here. The signs are piling up that the Pentagon and the White House are at odds over the planned escalations. The State and Treasury Depts. are nests of vipers having usurped Congress to wage war without declaring it.

I can only hope that serious and adult people within the Pentagon will finally end this nonsense before we wind up in a war no one wants except a bunch of inbred Eurotrash well past their ‘use-by’ date.

I always say that spooks start civil wars but militaries end them. Let’s hope that we never get to the point of needing any other military than the Russians’ to end this war.

In the meantime, the message is clear, #GotGoldorRubles?

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