A Roman lesson On Inflation

“While it is the duty of the citizen to support the state, it is not the duty of the state to support the citizen” – President Grover Cleveland

The point President Cleveland made back in the 1880s was that individuals and vested interests had no rights to preferential treatment by a government elected to represent all. For if preference is given, it is always at the expense of others.

Those days are long gone, and the last president to take this stance was Calvin Coolidge in the 1920s. He was followed by Herbert Hoover, who was very much an interventionist. As Coolidge reportedly said of his Vice-President, “That man has given me nothing but advice, and all of it bad”. Hoover was criticised for his disastrous intervention policies by Franklin Roosevelt, who succeeded in ousting him in the 1932 election, and then outdid him with even more intervention. The outflows of gold generated by accelerating government spending and the Fed’s monetary policies led in 1933 to the suspension of gold convertibility for American citizens and the devaluation of the dollar in 1934 from $20.67 to $35 per ounce of gold.

Interventionsism has increased ever since, not just in America but in all other advanced nations. The socialisation of earnings and profits and the regulation of our behaviour by governments dominates economic activity today. Despite the warnings of sound-money theorists, a process that commenced nearly a century ago has not yet led to economic collapse, though the dangers of escalating state liabilities are a growing threat to economic stability.

A point that is ignored by nearly everyone is that government spending is an expensive luxury for any economy, tying up capital resources in the most inefficient way. Furthermore, governments, through tax and the diversion of savings and monetary inflation, destroy personal wealth. Yet, it is clear both through observation and economic logic that a successful economy is one that instead maximises personal prosperity.

This is clearly illustrated by observing the difference between Venezuela and America. Venezuela overtly and covertly has transferred nearly all personal wealth to its socialist government in the name of equality for all. The costs of government have increased exponentially relative to its sources of available finance, bringing forward the day when economic and civil order cease entirely. America, despite decades of growth in government spending, has not yet sequestered the majority of its citizens’ wealth, though the process has been accelerating in recent years.

However, the problem is likely to become more of a public issue in the coming months, triggered perhaps by an increase of US Government bond issues at a time of a cyclical downturn in bond demand. This downturn is driven by improving global economic prospects, which means banks will increase lending to non-financial businesses at the expense of purely financial activities.

At the same time as President Trump’s administration is increasing its budget deficit, the Fed is trying to normalise its balance sheet by running off its bond exposure. Add to the mix marginal reductions in an estimated $17 trillion of dollar exposure in foreign-owned portfolios, and we have the potential for a perfect storm in the reserve currency’s bond market.

We have already seen a sharp increase in bond yields over the last six months, with the benchmark 10-year US Treasury yield increasing from 2.06% to 2.94% currently. On an historic basis, and given the Fed’s inflation target of 2%, the time-value on this bond is still on the low side, despite the increase in yields so far. Assuming, that is, the Fed genuinely limits inflation to 2%.

Readers should give more credence to ShadowStats.com and the Chapwood index as better measures of price inflation, currently registering between 6-10%, than clearly biased government estimates.

We should not be surprised if these dynamics soon result in a derating of US Government bonds, and of the US Government’s finances. Instead of passively accepting the Fed’s monetary cool-aid, proper assessments of bond risk can be expected to dominate valuations. Assuming the Fed continues to restrain interest rates, bond yield curves will steepen, and the interest cost to the Treasury will increase for all its new debt, except for very short-term borrowing. After snoozing through the period of zero interest rates, we are bound to awaken with some suddenness to the risks we have been collectively ignoring for too long.

Therefore, when thinking about risk, the economics of inflation are likely to become central to our thoughts. And as bond yields adjust by rising, we will be increasingly aware of the debt trap faced by the US Government. A one per cent increase in interest costs it an extra $216bn. Will President Trump pay for this by cutting the overall budget? Unlikely, on the evidence so far. And when we begin to think in terms of what the time-value on US Government debt should be, possibly two per cent above a rising, but heavily doctored, CPI, how will an increase of borrowing costs of perhaps three or four per cent or even more look on the government’s books?

The pressure to increase the rate of wealth-transfer from the productive private sector will simply increase as bond yields rise. And the more wealth is transferred, the less there is left to transfer. This was the underlying reality faced in the Roman Empire, when the spendthrift Nero reduced the silver content of the denarius to pay his soldiers, having run out of money. Among other costly acts, he set much of Rome on fire in order to rebuild it, through which legend has it he fiddled. This was perhaps a metaphor, because according to Suetonius, Nero was dedicated to the arts, sex and debauchery, and was obviously a pyromaniac to boot. If Nero fiddled with anything, it was the currency. Some forty-three emperors following Nero continued the debasement process until the final monetary destruction under Diocletian over two centuries later.

The current century’s-worth of spending-led monetary debasement includes the additional burden (that is additional to Roman profligacy) of promises to the general public, in defiance of President Cleveland’s maxim. Depending on the rate at which these future financial liabilities are discounted, these are anything between five and ten times current GDP for America, and probably considerably more proportionately for Japan and many EU member states. Not even heavily-doctored price inflation figures can suppress the debt trap in which governments are now visibly ensnared, which all precedence tells us will be met with accelerating monetary debasement.

Since Herbert Hoover’s presidency, the US Government has been unconsciously rhyming the American economy with the Roman. Just as Rome’s emperors debased the coinage to pay for their profligacy and soldiery, so have America and her western allies debased their currencies to pay for welfare and military spending.

Excessive military spending was a Roman theme: pay the soldiers or the emperor dies. Diocletian 225 years after Nero went on to issue an edict in stone, banning traders from raising prices. Trade ceased, and Rome and other cities emptied for lack of food.

Donald Trump and his predecessors have overseen more sophisticated methods of achieving the same result. For the last forty years, prices for goods and services have been officially controlled by doctoring the inflation figures, though the reality is prices have continued to rise. The government’s inflation-linked spending commitments have been curbed and the state’s beneficiaries cheated. That cannot go on for ever.

Wage increases, which normally keep pace with rising prices, have been replaced by the simple expedient of encouraging the expansion of bank credit to fund personal consumption, along with discouragements to saving. Consequently, US Household debt now stands at $13.15 trillion funding personal consumption expenditures of $13.717 trillion. It amounts to modern smoke-and-mirrors deflecting attention from an underlying problem.

The comparison with Rome has a further, worrying similarity. Roman silver and gold coins were the principal currency for the known world. The US dollar is the world’s reserve currency today, and nearly all the other 170-odd government fiat currencies are aligned with or refer to it. An accelerating dollar collapse takes most of them down, just as surely as the Roman debasement propelled the world into the Dark Ages.

So far in this article, we have seen that the US economy has provided us with an example of a modern debt trap, which if not faced up to, will inevitably lead to an acceleration of monetary inflation and ultimately a collapse of purchasing power for the dollar.  Most other nations are in the same position, though the high levels of personal borrowing are more endemic to America and the UK than anywhere else. Consequently, when the final currency collapse happens, profligate Anglo-Saxons will suffer a slightly different fate from the citizens of nations who habitually save.

The next phase of today’s monetary debasement

The next major expense facing governments and their central banks is a future credit crisis, likely to tip the inflation story into hyper-drive. Possibly, it will be a modern Diocletian moment, the final act of debasement before the lights go out, and we (only metaphorically, one hopes) leave the cities to forage in the country. A credit crisis is always the culmination of a credit cycle, endemic to economies destabilised by central banks trying to stimulate consumption by monetary cheating.

The time for the next credit crisis is rapidly approaching, as explained in my recent article, “When will the next credit crisis occur?” We should be prepared for it to happen by the year-end. Crucially, inflation prospects for the following year or two will be set by the response of central banks. If they do not bail out the commercial banks with monetary inflation, the global banking system will almost certainly collapse. Assuming this disaster will be prevented, it will require the injection of enormous quantities of extra money, potentially far larger than was required to bail out the global banking system in 2008/09.

That was itself of historic proportions. But there is the risk they won’t succeed next time, because since the last credit crisis all G20 nations agreed to introduce bail-in procedures to replace bail-outs. The reasoning was governments shouldered the cost of the Lehman crisis, when bondholders and large depositors should have borne it instead. That is logical for rescuing single banks, or the banking system of a small country, but is likely to cause difficulties in a broader systemic crisis, because bondholders will game the system to protect themselves.

Large depositors have only two escapes, now the alternative of withdrawing cash notes in quantity is effectively closed. They can buy physical assets, at any price, to get rid of bank balances, or alternatively buy physical commodities. And top of the list of commodities must be gold, followed by silver, because they are widely accepted as the mediums of exchange everywhere. To these alternatives we can now perhaps add cryptocurrencies, their ownership is peer-to-peer, amounting to an alternative store of value.

But when you sell a currency to buy an asset, you are simply passing the currency to a willing buyer of it. The observant reader will detect that in all likelihood, there will be no bid for the riskiest currencies, and possibly no bid for the dollar itself. In other words, what in the past has been a systemic crisis for the global banking system could rapidly become a systemic crisis for the currencies themselves?

A Currency Crash Is A Growing Risk

The future is by definition unknown, and we can only speculate how things will evolve. However, unlike the Roman experience, which took 225 years to completely destroy the denarius, its successors, and the empire itself, today’s wave of monetary destruction looks like terminating soon, after only a century or so.

Central banks have been aware of some systemic dangers, which is why they are keen to move us to a cashless society. With no cash, there cannot be an old-fashioned bank run. Their response to every successive credit crisis has been to restrict how businesses and people can protect themselves in the event of a systemic meltdown.

But now, long after President Cleveland made the remark that heads this article, his successors’ attempts to curry electoral favour have led to escalating costs, demonstrably out of control. The combination of a debt trap sprung on governments by higher interest rates, and the unsustainability of private sector debt threatens a financial and monetary crisis world-wide, from which any rescue through money-printing is likely to be short-lived.

The rate at which inflation and the destruction of paper currencies accelerates from hereon will be determined by how swiftly the financially aware and the ordinary public wake up to the true scale of the monetary fraud governments have perpetrated so far. The expansion of base money and bank credit has not been reflected in official price statistics, which have been hedonically manipulated to hide the evidence. An awakening to the reality, that fiat currencies have been badly abused by all governments, can be expected to have a suddenness about it, and rather like entrapped vermin, ordinary folk will find all escape routes have been closed.

Prices are bound to adjust, more suddenly than if more of the monetary fiddling had been discounted as it occurred. If the effects of Roman inflation over more than two centuries progressed with the lumbering speed of a laden oxcart, today’s could suddenly accelerate like an Italian Ferrari.

Alasdair Macleod

HEAD OF RESEARCH• GOLDMONEY

MOBILE: +44 7790 419403