The Great Tightening
After more than a decade of ultra-low interest rates and limitless money printing, central banks all over the world, following the Fed’s lead, are now reversing course. This historic U-turn was seemingly forced upon policymakers as the only way to fight inflation, a threat that was the direct result of their previous policy stance, and is bound to have far-reaching and severe consequences, both on stock markets and on the real economy itself.
The biggest challenge they face today, at least according to the mainstream financial press, is in determining “how much is too much” tightening to combat inflation without triggering a recession. However, looking back at the excesses of the last decade, and especially of the last 2 years, the better question to ask might indeed be whether this entire policy shift is actually “too little, too late”.
A long time coming
Despite the mainstream narrative that blames inflation on whatever current disruptions or challenges happen to be in the headlines at the time, the roots of this problem run much deeper and are much more straightforward than those presented by politicians and their central bankers. As any student can tell us after taking their first economics class, the more abundance there is of any one thing in an economy, the less value that thing is perceived to have. In our case, that “thing” is money itself. After record amounts of newly-printed cash were injected into the system after the 2008 recession, and after it became extremely cheap to borrow it and to recklessly spend it for so many years, the inflationary consequences of all this monetary support were in the pipeline for quite some time already.
And yet, central bankers and politicians alike appeared to be in denial, declaring anyone that raised any concern over the long-term consequences of this policy direction an “alarmist”. They consistently dismissed the threat of inflation as a non-issue, even as asset prices climbed to record highs. Even before the covid crisis, we saw stock markets running red-hot, with worthless stocks reaching record highs, stock buybacks becoming a common and expected practice, and chronically unprofitable companies executing successful IPOs. Instead of reading a clear warning signal into this trend, policymakers used it as “evidence” of a roaring economy and as proof that their “remedies” were working.
It is therefore hardly surprising that they decided to double down on this policy direction when the covid crisis hit. In the US, the Fed launched a monetary stimulus campaign the likes of which we’ve never seen before. Extreme new measures where adopted, like the (in)famous Paycheck Protection Program (PPP) loans, while the central bank’s balance sheet exploded to new record highs. Most likely, these steps alone would have been enough to accelerate the inflationary trajectory we were on already. What made sure of it, however, was that this time, central bank efforts were accompanied by unprecedented fiscal stimulus programs too. From direct checks to the public (including our own Scott Schamber here in Switzerland) to all kinds of other “relief” payments, fresh cash truly flooded the economy.
To make matters even worse, this all coincided with the most severe supply-side disruptions in recent memory. Supply chains were crippled due to pandemic restrictions and forced shutdowns, while at the same time preexisting, chronic underinvestment and other longterm problems ensured that the most essential commodities would be in short supply, even without the covid pressures. Taking all this into consideration, it should be clear that there is simply no other scenario we could have been facing today.
It should also be clear that the present and escalating inflationary pressures have little to do with the Ukraine conflict and that the efforts to rebrand this problem as “Putin’s price hike”, as Mr. Biden put it, are purely attempts at political misdirection. The ongoing war might have aggravated grain or energy shortages, but it most centrally didn’t cause the CPI jumps we saw long before it actually broke out.
Taking with one hand...and giving with the other
This policy pivot has been promoted by central bankers as essential to fight inflation and whatever adverse effects it may have on the markets, or the economy, have been justified as “necessary evils” to protect the average household from out-of-control consumer price increases. The impact on the markets is already clear of course, with the S&P 500 briefly touching bear market territory in late May, slipping more than 20% from its record high.
As for the impact on consumers and taxpayers, that remains to be seen. However, early indications are far from positive. Extreme levels of household debt and wage growth that has long been left behind by price growth, clearly suggest that higher interest rates are more than likely to create serious pressures for countless ordinary workers and taxpayers.
Of course, it could be argued that all of this pain might indeed be worth it, if it meant getting inflation under control. However, that is very doubtful too. For one thing, the “aggressive” half-point or 0.75% rate hikes that the Fed has planned appear to be symbolic at best, while the central bank’s plan to “unwind” its $9 trillion balance sheet, the suggested monthly wind downs of about $60 billion for Treasury securities, and $35 billion for mortgage-backed securities, also seem likely to prove insufficient to “mop up” enough of the extra liquidity in the system. Here in Europe, the situation is even more dire: The ECB hasn’t even begun its tightening shift yet. Rates in the Eurozone still remain in negative territory, as they have been for 8 years now, at -0.5%, even though inflation is running at a record 8.1%.
In addition to the insufficient steps taken by central bankers, the fight against inflation is also seriously hampered by the actions of governments. Quick to realize the political consequences of “pain at the pump” and of essential grocery items, such as beef and veal, which are seeing price hikes of up to 20% in the US, governments across the West have rushed to take out the taxpayers’ wallet in order to placate voters. New Zealand recently announced it will hand out extra cash to help citizens fight the “inflation storm”, joining a growing number of US states that adopted similar measures involving “inflation relief checks”, like California, New Mexico, and Oklahoma. There were also fuel tax cuts in the UK and energy subsidies in the Eurozone, with indi- vidual member states going further to deliver additional financial aid directly to households that are struggling with higher food and energy prices.
In any other context, other than a populist one, “solutions” like these would be too absurd for any adult in any position of authority to even consider. Attempting to solve a problem that is caused by having too much money around by throwing even more money at it might seem like a self-defeating idea than ultimately harms everyone. But for politicians, it makes perfect sense to focus on short term career gains rather than on the long term prosperity of the population.
While the economic implications of this new era we have stepped into are as clear as they are dire, the social and political outcomes are also very important to keep in mind. In this context, it really doesn’t matter if the Great Tightening will prove ineffective or if it achieves its stated aim to control inflation but results in a recession. As history has taught us, inflationary pressures or a severe economic downturn by themselves are more than enough to create frictions in any society and as they intensify, so does public discontent with those in power. However, this time, we have more than just a few months of climbing prices to take into account.
To start with, we need to bear in mind that the average Western citizen, worker, business owner, saver and taxpayer, has been through two years fraught with fear, uncertainty, financial hardship, and overall disappointment with those in charge for their handling of the pandemic. Whatever one might think about the various containment measures, whether they went too far or not far enough, there is no denying that they caused considerable pain to the public while they lasted. And in many cases, they still do.
It is also worth remembering that the covid crisis itself came after years of escalating social and political divisions, especially in the West, with Brexit, Trump, and anti-establishment sentiment creating deep tears in our social fabric. Since then, and all the way though the pandemic until this day, social media has been steadily fanning those flames and ensuring the gap between the opposing camps can never be bridged.
In this backdrop of already heightened tensions and of rising discontent with governments, inflation can very easily become the straw that breaks the camel’s back. For the ordinary worker, who already had their livelihood taken away or saw their paycheck slashed during the pandemic, yet another financial hit, caused by skyrocketing prices or by debt payments they can no longer afford, might be more than they can bear.
And, much like we saw during the lockdowns with the BLM protests and all the violence and destruction they led to, this kind of financial pain, when it becomes widespread enough, is ripe to be taken advantage of by political opportunists seeking to weaponize fear and uncertainty and turn them into hatred. Dividing lines across race, gender, faith, or any other kind of human attribute are quick to pop up during economic downturns, a danger much more serious than inflation itself.
“Flight to safety”: Gold’s safe haven status reaffirmed in wartime
Within days of Russia’s invasion of Ukraine, the US, the EU, and their allies responded by imposing severe sanctions on Russia. As the conflict went on, they continued doing so. Today, the country is facing the most extreme and far-reaching punitive measures, restrictions and bans the world has ever seen, targeting not only state entities or state-controlled corporations, but also individuals with links to the government. Overall, the sanctions effectively cut off Russia from most important financial markets and western banks, while they also froze Russian central bank overseas assets, paralyzing around half of the nation’s foreign exchange reserves.
The response was swift and decisive. The Central Bank of Russia (CBR) sharply increased interest rates, from 9.5% to 20% in late February, and imposed strict capital controls, in a bid to prevent a run on its currency. All this was extensively covered by mainstream media, however, there was another development, arguably one of the most important ones to emerge since conflict began, that received much less attention. That was the decision by the CBR to peg the nation’s currency to gold. Though this policy was initially set to remain in place between March 28th and June 30th , it is unclear whether it will be extended. With a fixed price of RUB5,000 for a gram of gold, this move marks a historical shift. After decades of seeing governments and central banks move their currencies further and further away from gold, or from any real asset backing it for that matter, Russia’s embrace of the yellow metal and its reliance on it to defend the ruble, especially in a time of war, speaks volumes.
The US and its allies were also quick to counter, with an announcement from the Treasury Department stating that American individuals, including gold dealers, distributors, buyers, and financial institutions would be banned from buying, selling or facilitating any kind of gold transaction involving Russia and all sanctioned parties. While this step was widely seen as an attempt to close the “gold loophole” and limit Russia’s ability to bypass previous restrictions, in practical terms, the ban goes further than that. It does, in effect, impose secondary, or indi- rect, sanctions on individuals and entities who trade gold with the country that holds the fifth biggest stash of gold in the world.
Mainstream financial news sources, in line with the official narrative from US and allied leaders, have largely downplayed the resilience that the Russian economy and the nation’s currency have exhibited over the last months, despite the unprecedented sanctions. And even when the topic is covered, it is not uncommon to find many causal fallacies in the arguments and explanations offered to account for Russia’s swift bounce-back. Most “experts” and analysts tend to attribute it to the strict capital controls that Kremlin enforced early on, in order to prevent, or at least limit, capital flight. Others blame it on developing nations that still do busi- ness with the country and refuse to join the allies in “blacklisting” Russia, or on those EU members that, being desperately reliant on it, kept importing Russian oil and gas months after the conflict began. And yet, there is a very straightforward explanation for the stability of the ruble that most mainstream analyses seem to miss.
Whether western central bankers and politicians openly acknowledge it or not, the fact remains that linking any fiat currency to gold inspires confidence in and of itself. And in the case of Russia in particular, that has been on a gold buying spree since the Crimea annexation in 2014, that confidence is now backed up by over $140 billion worth of bullion. In this context, it is also interesting to examine the latest round of sanctions, targeting Russian gold specifically. If the reserves played no part in the country’s continued economic resilience and offered it no strategic advantage, why would the US and its allies move so quickly to ban gold transactions?
As the conflict goes on, and as the sanctions keep piling up, it is very likely that Russia’s decision to triple its gold holdings in a mere 8 years will prove to have been a wise one. The yellow metal is providing options and maneuverability to the Kremlin that the isolated nation would not otherwise have. Apart from its role in shoring up the ruble, Russia can use it to soften the impact of the sanctions, or circumvent them altogether, especially since most countries on the planet haven’t signed on to the US gold transaction ban. It can also sell it through smaller gold markets and dealers, or it can be used to directly buy goods and services from willing sellers.
The cost of war
Of course, in times of war (but also in times of peace in recent years), official narratives from all sides should be taken with a pinch of salt. Governments, their institutions, and central banks are known to twist facts, to omit inconvenient truths and to present a version of reality that may or may not contain any accurate information at all. However, a report by the CBR released at the end of May did contain some interesting observations.
After the unprecedented sanctions and the recent talk by European officials about actually seizing the frozen Russian assets and using them to rebuild Ukraine, the Russian bank noted in its statement that this move could cause other central banks, mainly in Asia and the Middle East, to reconsider their strategies for their savings. The report also went on to highlight that “one could expect an increase in demand for gold and a decline in the U.S. dollar's and the euro's role as reserve assets”.
Meanwhile, economic activity indicators are improving in Russia. It took less than two months for the ruble to climb back to pre-invasion levels. In fact, it went from an all-time low in March to being the world’s best performing currency this year. Inflation has slowed dramatically too, and “the Russian economy continues to recover from the initial shock in late February and early March and concerns about financial stability are fading”, as Goldman economist Clemens Grafe recently put it.
On a sociopolitical level, it is naturally very difficult to get an accurate picture of the domestic situation. Due to a near-total lack of reliable news reports by the country’s state-owned and state-controlled media and the government’s severe restrictions on free speech, especially the dissenting kind, gauging public support for President Putin and for the war is highly problematic. On the other hand, precisely because of the Russian government’s control over the media and the information released to the public, there is just one narrative that the average citizen is being presented with. It paints this war as one of “necessity” and not of choice and it propagates a “siege mentality”, and the idea that Russia is the one actually under attack, economically, politically and culturally. Therefore, every new round of sanctions and any fresh attempts at further isolation could serve as confirmation of the narrative and will be used to bolster support for the Russian President.
On the other side of this conflict, the US and its allies haven’t been able to stop or even slow down the Russian campaign. The sanctions haven’t had the impact they hoped for, while the jury is still out on how overall effective the billions provided in aid to Ukraine and direct military support have been. In fact, it can even be argued that the sanctions have backfired, at least when it comes to Europe and its energy crisis. As for the West’s own economic outlook, it seems to be getting more dismal by the day. Inflation is raging in the US and in the Eurozone, and a recession appears to be just around the corner.
As the situation stands today, this conflict appears to be more similar to a game of chicken rather than a geopolitical chess match. As the economic, financial and political costs pile up, the question is which side will be able to outlast the other.
In any case, let’s be sure not to forget that in the back- ground of all this, there is real human suffering. Thousands of innocent people have already been killed, injured, displaced and dispossessed. Apart from the direct victims of the war, there are collateral human damages elsewhere too.
They might be physically safe, far from the front, but millions of ordinary citizens are also paying a steep price for the geopolitical ambitions of their governments. While this war certainly didn’t cause it, it certainly accelerated and exacerbated a severe economic downturn that could last much longer than anyone could have expected.
Through it all, no one could have ever anticipated that gold would get pulled into the mix and play the role it has in this conflict. How and whether it will work in Russia’s case is hard to say. We’ve argued for 50 years if the US coming off of the gold standard was right to do, and ultimately, Russia could find itself quickly in a similar situation with a major decision on its hands in this regard. But again, gold found it’s way into the spotlight, shining with its safe-haven status and special role during economic volatility.
Sometimes It’s Not Only the Gold You Own, But How You Own it
I find myself taking it for granted sometimes that our prospective and existing clients know that they can hold metals in storage with us in the name of a trust or a legal entity. However, I recently found out from a long-time client that they would have preferred to have their holdings held in their trust and didn’t realize they could. Let’s set the record straight!
I was in a video call with a long-time client and close friend of ours recently when the subject of the ownership of his metals with us came up. When he had applied to and originally purchased with BFI Bullion several years back, he was under the impression that he could not have a storage account with us in the name of his trust. Since I joined BFI Bullion after he had already been a client for a few years, I couldn’t speak for what had happened at the time, but even now, it would be pos- sible for him to change ownership to a storage account he could open with us.
In a Trust...with Gold
For us at BFI Bullion, the fact remains that as long as we can conduct our proper due diligence on a legal entity and on the origin of the funds, we can accept trusts, LLCs, companies, etc. as counterparties.
Why would you apply for gold purchase and storage with a trust or a legal entity? For the purpose of keeping this easy to read, lets keep the focus on a trust, understanding that some of the points will be the same and some different when using different legal structures.
First, one of the great reasons to use a trust is just the fact that things don’t necessarily need to change if the grantor and/ or trustee of the trust passes away. In other words, using a trust simply means that the investment in gold can perpetuate even after the death of a key person. Having a trust own the gold means it doesn’t need to be affected by the death of the grantor and/or trustee.
Secondly, another reason is continuity. For example, a trust might already help during an illness or disability. If the grantor or the trustee of a trust is suddenly not able to manage their gold, the trust would have provisions to activate the designated successor trustee who would step in and be able to manage assets for the trust and, for example, generate liquidity from the gold if and when is needed. These provisions could be godsends, averting assets from getting tied up because of a sudden disability.
Succession planning is another crucial advantage. Since the trust would include provisions as to what happens to the gold it owns, the trust beneficiaries can avoid a lengthy and costly probation process and access to gold in a more efficient manner. Also, there can be situations where an investor finds themselves with depend- ents or beneficiaries that have limited financial skills, or to be frank, might not trust their next of kin to take care of assets as well as they hope. Using a trust could help to dictate the distributions of benefits, ensuring that family is taken care of properly even in the event they are not investment savvy.
Finally, using a trust or other entity to hold gold can help protect those assets from unlawful creditors, predatory lawsuits, or the likes. This can be a game-changer, especially for Americans, where lawsuits are quite prevalent, and wealth literally can be taken away in a blink of an eye.
Are there any caveats?
My main goal here is to let you know that you CAN own and store gold with us in the name of a trust or a legal entity. There are obviously different types of entities that exist, and each one can offer different benefits. It might not be for everyone and having any type of legal entity will always mean additional costs in upkeep of that entity. But yes, those costs might be worth the insurance of protecting your gold longer, even after you are gone. The point is that there is no “one size fits all” and some real homework needs to be done before settling on the legal entity that might be right for your investment purposes.
It is important to note that if you store metals with us as an individual, you could change the ownership of the metals to a trust or a legal entity. However, it would be likewise important to see if making that change could result in a taxable event for you in any way. And don’t forget, it is even possible to apply online with an entity using our new online onboarding option.
At BFI Bullion, our goal is always to try and help our clients get everything they can out of the metals they store with us. And we would be remiss not to mention that using a trust or a legal entity for ownership of stored metals is completely possible, and could prove beneficial for some. While we can’t advise you on the entities themselves, thanks to our BFI Capital Group’s network and being in the business of protecting and growing wealth for nearly 30 years, we can always do our best to connect you with partners that can help answer these questions for you.
We believe you should own gold in any case. But sometimes it’s not only about owning gold, but how you own it!
"It is important to note that if you store metals with us
as an individual, you could change the ownership of the
metals to a trust or a legal entity. However, it would be likewise
important to see if making that change could result
in a taxable event for you in any way."
Gold price check up
After hitting a record high in March, fueled by fears over the Ukraine conflict and rising inflation worldwide, gold has since entered a consolidation phase that might, on the surface, present concerns for investors. However, seasoned, long-term precious metals holders are bound to recognize this period for what it really is: a solid buying opportunity.
Of course, one of the reasons that the yellow metal is still under significant selling pressure is the Fed’s policy reversal and the return to tightening and higher interest rates. This alone could be construed as a negative development for precious metals in general and it could cloud gold’s performance outlook. Nevertheless, context is everything and it is essential for investors to bear in mind the bigger picture here.
The reason that the Fed and other central banks were forced to reconsider their extremely loose monetary policies of the last decade is the inflationary pressures that have been building for months in most advanced economies. After dismissing steadily climbing prices as “transitory” for too long, they eventually backed themselves into the corner they remain stuck in today. The enacted and planned rate hikes, as we already discussed in this issue of the Digger, are unlikely to tame inflation. In this case, investors and ordinary savers are more than likely to start flocking to gold once again in an effort to protect their purchasing power.
But even if or as the Fed and other major central banks decide to step up their fight against inflation, there is a very real risk that any further hawkishness and more aggressive tightening measures could very easily trigger a serious economic downturn or even a full-blown recession. In this scenario, gold investors are bound to emerge victorious again. In fact, it wouldn’t even take a severe crisis for precious metals, especially in their physical form, to regain their safe haven appeal. Most investors, institutional and individuals alike, have much lower tolerance for volatility after the events of the last two years. From the covid crisis to the Ukraine war, we all know how easily market swings can turn violently and the present economic and geopolitical conditions paint a very worrying picture of what lies ahead.
Another development that we see as very encouraging for gold’s outlook is the recent crypto market downturn. While we fully expect a rebound ahead and we remain very optimistic about the future of this new asset class, this latest investor exodus from Bitcoin and its peers once again confirmed that any comparison between physical gold and any cryptocurrency was and continues to be entirely misguided. Those that hailed Bitcoin as the new safe haven and those who predicted it would easily and swiftly replace gold as a store of value have once again been proven wrong. These are two very different asset classes that serve two distinct roles in any portfolio. And the fact that gold escaped the $1 trillion wipe-out that crypto assets recently suffered due to shaken investor trust goes to show that precious metals still retain their safe haven allure in the minds of most investors.
Overall, we expect gold prices to retrace the highs we saw over the last months, although we must highlight that nothing goes up in a straight line. Central bank rate decisions and other developments might very well cause further price retreats along the way. However, the fact remains that in the current, extremely precarious, global economic and market conditions, investors cannot afford not to have a precious metals allocation.