What an interesting couple of weeks we have had! By my count, at least 2 major bank failures with two bank rescues followed right behind them. Certainly, the public is beginning to pick up on the risks in the banking system. The initial reaction resulted in a withdrawal of between $100 and $500 billion from the US banking system, depending on which recent media report you believe.
Most of the withdrawals were electronic and hence we did not see long banking lines. I suspect that is also why the sliding scale on customer cash withdrawals is so wide – there is no single way of tracking money flows in today’s electronic banking system which is one of the things the government is trying to change with central bank digital currencies (CBDC). The government wants to track and manage all money flows with this system, which we have written about before and will cover again in future articles.
The Dollar Value Problem – Eurodollars Emerge as a Threat
Back to the banking system, we know that there is a lack of liquidity resulting from depressed asset values. Those assets are mostly bonds because that is the banker’s currency in the current system. Short-term debt, especially, acts as a form of tradable money much like the banker’s paper certificates did back in the early days of American banking. This is the essence of the Repo market, which we will discuss in a future article as well.
When bond values fall, and you have banks holding lots of them, it creates problems when the value of those bonds plummets and depositors get nervous about whether the bank will be able to open its doors the next day due to having more liabilities than assets.
As an aside, there is good and bad news on the dollar liquidity front, depending on your viewpoint. With the BRICs nations (Brazil, Russia, India, China, and some others) in the process of building non-dollar trade contracts for energy and other trade, the dollar is about to become a lot more liquid here in the US. I expect billions of US dollars sitting in foreign accounts (aka Eurodollars) will eventually come flooding back to the US as the world simply stops using them.
This will occur gradually and then quickly and will lead to the devaluation of dollars overall as the world demands less of them. So, the good news is that dollar availability will be going up, with the bad news that the dollar value will correspondingly be coming down over time. In the following chart, we can track the recent move down in dollar index terms, which compares the value of the dollar against a basket of other world currencies.
If the index starts crashing, it is an indication that the world is using less and less US dollars in their transactions and we have the transition into a new monetary regime underway. While that process is not completely visible at this point on the chart, I suspect given recent events in American banking that it has already started and is building up momentum.
Why is the Eurodollar so important? Because history shows a direct link between Eurodollar flows and inflation, which just happens to be running pretty hot right now. Professor Leonard Gomes of Middlesex Polytechnic University in the UK writes the following regarding the US dollar problems of 1971 – 1973.
“Central bankers have had an unusually hard time these last five or six years. Added to their problem of having to contend with severe inflation they have had to cope with the disruptive effects of vast flows of short-term capital. These capital flows have undermined the effectiveness of national monetary policies and have precipitated currency crises.
The effects have been particularly felt in Europe, but even the United States did not remain unscathed during the international monetary whirlwind of 1971 and 1973. Speculative flights out of U.S. dollars forced two devaluations on the United States during these years, wrecking the Bretton Woods fixed exchange rate system in the process.”
As we can see, the use of dollars around the world is of vital importance to the stability of our current economy. Eurodollars could be classified as a black swan threat to the larger financial system, should the rest of the world decide to stop using them, and consequently dump them back on US markets.
What About Gold and Silver
Well, I mention bonds and the US dollar because they are gold’s biggest competitors. During times of uncertainty, people flock to safety assets. There has been no more accepted bastion of safety in the last 100 years than the US dollar and US Treasury debt. After all, the whole world based its trade networks on them.
That period is over, and it opens the door for gold and silver to take over as the safe haven, wealth-preserving asset held widely in investor portfolios. We are in that new era, though it has taken a while to get here.
Gold and silver started recovering in 2016 from their 5-year swoon after the last financial crisis. I considered that to be a consolidation phase, meaning that traders were biding their time for the next move up. There was not a pressing reason for generalist investors to own gold and silver while the printing presses were running, stocks were flying high, and US GDP was expanding. We are no longer in that era; however, and so things must change.
And they are. The generalist investor is starting to wake back up to gold and silver.
Right now gold is flirting with $2000 and silver with $24.50, which are both important technical levels for the metals. Meaning, we need a really good reason for gold and silver to keep pushing much higher so they can break through the soft, psychological limits that the traders have placed on them. Gold has broken out against the dollar, which aligns with our story on de-dollarization by the rest of the world and the establishment of alternative currency trade agreements.
Much of trading in the gold and silver derivative markets, where spot prices are determined, is done on a psychological basis. Traders randomly pick their price targets based largely on what has happened before in similar situations. Granted, this current banking situation is a bit unique and I think that is why gold and silver investors are perching here and waiting for the next shoe to drop.
Final Thoughts
The last two weeks have been a good exercise in measuring risk. Surely nobody woke up and expected two major bank failures in one week with two more banking problems the following week. However, maybe we should have.
The signs are increasing that the current dollar debt system is being replaced by a system of regional trade networks and multiple central bank digital currencies, all competing against one another in the open marketplace. While that transition is underway and not nearly completed, many steps have been taken to update the trade and currency systems around the world.
Expect more casualties in the small and medium banking sector as this transition matures and the dollar is de-emphasized in international trade, as the new system is designed to be used without a system of regional or state banks.
I think most of them will fail as the new digital dollar is rolled out, and US banking changes its spots. We will likely see a period of banking consolidation with the big banks absorbing the failing smaller ones, and getting bigger.
During these times, I want gold and silver in my portfolio as a stabilizer that prices itself appropriately in any fiat currency, especially during a changeover in currency systems that we are likely about to go through.
Coin of the Week
Since we are on the topic of US European banking, I thought I would mention the 20 Francs Swiss gold coin. These coins are abundant and easy to buy and sell while having a nice measure of European History included. Per the coin facts:
“The 20 Francs denomination was introduced in Europe by Napoleon for France back in 1803, and before the continent had its modern Euro, there was the Franc as an international monetary piece. Nations across the continent adopted the 20 Francs denomination.”
Perhaps we will see a united European gold coin again in the future. It could not hurt, what with the Eurodollar on its way out they will need a new, regional currency. We can skip the digital Euro and just go straight back into honest money, can’t we? Well, at least it never hurts to suggest it.
Summary: The recent banking failures and rescues have drawn attention to the risks in the banking system, leading to a withdrawal of up to $500bn from the US banking system. The lack of liquidity from depressed bond asset values is a major challenge, leading to nervous depositors and possible bank failures. The world’s transition away from the US dollar and towards multiple central bank digital currencies poses a threat to the stability of the financial system, making gold and silver attractive safe haven assets.
