A Simple Solution to the World’s Debt Problem

The world’s biggest and most complicated problem is the growing devaluation of currencies and increasing amount of debt. This week, Ivan Lo shares his simple solution to the problem of the devaluation loop.

The last time something like this happened, the price of this resource more than doubled.

In just a bit, I’ll not only tell you why a similar opportunity may be presenting itself once again but why it could be even bigger than before.

But first, I want to touch on the topic of gold.

There has obviously been a huge surge of interest in gold lately.

Everywhere you look, there’s a different story of why gold is rising – everything from a new gold standard to safe haven investing, and even the idea that paper bills or fiat currencies will be worthless.

While most of the stories seem logical – yes, even the failure of fiat currencies/paper bills – I believe there is a far more sensible and simpler reason.

And it’s one that you haven’t even heard of.

Let me explain.

One Bailout to the Next

Throughout history, there has always been something to “bailout” a major crisis.

When the tech bubble burst, lower interest rates and housing came to the rescue. This led to the subprime mortgage crisis in 2008, which toppled financial markets and economies around the world. To fix that, central banks stepped in and injected the world with trillions upon trillions of dollars. These trillions were then leveraged to create other financial instruments and loans.

Last year, we discovered that global debt not only increased by more than $57 trillion dollars from 2007 to 2014, but world debt hit over $200 trillion – and is still growing!

That’s nearly three times the size of the entire world economy.

We wouldn’t even be able to pay off this debt if we gave up every dollar of goods or services the world produces this year, and the next, and the next after that.

Yet, without this growing debt, the world’s most powerful nations will fail. In fact, the world will fail altogether.

Just imagine what would happen if interest rates go back to the average 200-year US historical rate of 5.18%? How many countries will go bankrupt? What would happen to Europe? Heck, what would happen to Canada? Imagine all of the homes that would foreclose at that rate!

Whatever the outcome, I can tell you that it won’t be pretty. Perhaps that’s why there’s a recent surge of news surrounding the underground bunkers and panic rooms for the rich.

Via Daily Mail:

“The panicked 0.01 per cent are reportedly buying up underground bunkers carved out of bedrock to escape civil unrest and natural disasters.

Bespoke hidden chambers in Germany and the US are being snapped up as the world’s wealthiest look to secure a safe spot if crisis strikes, according to their promoters.

And while numbers are difficult to ascertain, experts say more and more of the wealthy are installing ‘safe rooms’ in their apartments – or at least fortifying rooms to hide in should disaster strike.”

A Simple Answer to a Complicated Problem

Now that exhausted every possible “bailout” – low-interest rates, stimulus, stock market intervention – what could possibly be next?

Some say that central banks will simply continue to balloon our debt problem by continually adding more money into the system. And in the short term, I bet that is exactly what they will do.

But in the long term, something will break, and then what? What could possibly be the next bailout?

I believe the answer is right in front of our faces.

The Devaluation Loop

Over the past years, I have written about currency wars – how it works, why nations do it, and what is really happening.

It may be helpful to read one of my letters on this subject, The Truth About the Currency Wars.

The eventuality of currency wars is simple: no one wins.

When one country devalues, another has to suffer the consequences. And since the world’s biggest nations also happen to be significant trading partners, everyone eventually has to take turns suffering.

I call this the devaluation loop.

This devaluation loop makes it impossible for countries to win; everyone loses, but the loop continues.

Here’s the current loop:

In 2009, the yuan devalued; in 2011, the dollar devalued; in 2012, the yen devalued through Abenomics; in 2014, the euro devalued as a result of negative interest rates, followed in 2015 by QE; in 2015, China announced another stimulus plan and once again devalued the yuan.

All of the major world economies have taken turns in devaluing their currency.

We’re now back to the cycle of the loop where it’s the dollars turn to devalue. And, like clockwork, that is precisely what’s been happening.

Take a look at the US dollar index this year:
In fact, the devaluation of the dollar within this loop was so precisely timed that rumours and conspiracies have already spread that the G20 nations gathered together and agreed to weaken the US dollar during the recent Shanghai Accord in February.

Via Market Watch:

“Rumors are flourishing that global policy makers made a secret deal at the G-20 meeting in Shanghai late last month. This “Shanghai Accord” to weaken the greenback was aimed at calming the financial markets, which had gotten off to an awful start to the new year, according to the chatter.”

You might be thinking: “Why would the G20 nations want to devalue the dollar?”

First, if the US raises interest rates and the dollar goes up, it makes it very difficult for nations to service much of the debt they borrowed. A wave of defaults in emerging markets would be very bad for the global economy.

Second, an increase in the dollar hurts US exporters. When China devalued against the dollar last August and this January, US stock markets fell.

So while it’s the dollar’s turn to devalue, we know it will be temporary because – just as we discussed – when one country devalues, another gets hurt.

Especially China.

The Rickety Rise of China

China is responsible for much of the world debt that has accumulated over the last decade.

In fact, as I mentioned in The Great US Debt Rotation, China’s total debt has nearly quadrupled, rising from $7 trillion in 2007 to $28 trillion by mid-2014.

The amount of risk associated with China’s debt problem and extreme stimulus measures, combined with a rising dollar that’s forced Chinese corporations to pay down their dollar-denominated debt, has led to extreme capital outflows.

It’s like the chicken or the egg.

When money exits China, liquidity risks become greater and the yuan devalues because fewer people want to own yuan. This leads to more capital outflows because people want to exchange their yuan for something more secure.

When money exits China, the yuan devalues; when the yuan devalues, money exits China.

This is a major problem for the Chinese, but what can they possibly do?

If you think the Chinese haven’t already come up with a solution, think again.

They have, and it’s not what the media is telling you.

Earlier last month, we were told that Chinese capital outflows have slowed because, via WSJ:

“Much of the outflow from China last year that took place was a result of Chinese companies paying down U.S. dollar and Hong Kong dollar-denominated borrowings in the expectation that a weaker yuan could increase the cost of servicing their debts, which shouldn’t recur this year, Mr. Tinker added. “A lot of it was actually people paying down their dollar debt,” he said. “That’s largely done now.”

While that may be true, it’s not the main reason why Chinese capital outflows are slowing.

In fact, the real reason is a solution that has been many years in the making.


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China’s Years of Preparation

Over the past few years, I have talked about how China has been aggressively spreading the use of its yuan around the world through currency swaps and direct currency trade agreements.

Via my Letter, Yuan as an International Currency:

“The support of China’s currency and its role in world trade continues to grow stronger.

… long time U.S. economic ally South Korea announced that it has replaced many of its dollars for the Yuan in its foreign reserve holdings, doubling its holdings of Yuan in the last year.

It also announced last month that the Industrial and Commercial Bank of China (ICBC), China’s largest bank, plans to sell Renminbi-denominated bonds in South Korea.

In Singapore, one of Asia’s primary financial hubs, China announced direct trading between the Renminbi and the Singapore dollar, marking another step toward internationalizing the Chinese currency, further removing the dependence of the U.S. dollar, and protecting itself against Japan’s currency manipulation.

… In Europe, direct trade with China using the Yuan and Euro as compatible currencies has already begun.”

By doing all of these things, China’s yuan has infiltrated nations all around the world.

And in just six months, its efforts are about to pay off.

A New World Reserve Currency

On October 1, 2016, China’s yuan will be informally crowned with the status of ‘reserve currency’ when it becomes part of the Special Drawing Rights (SDR) of the IMF – an organizations with no debt, half a trillion dollars of SDRs (worth about $659 billion based on the devaluation of currencies within the basket), and a world of power.

If you are unfamiliar with what an SDR is, see my newsletter, China’s Next Move in Becoming a World Power, for a more detailed explanation.

In short, the SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is currently based on a basket of four key international currencies (currently the US dollar, Euro, Japanese Yen, and the British pound), and SDRs can be exchanged for freely usable currencies.

On October 1, that’s going to change.

Via the IMF:

“In the most recently concluded review (November 2015), the Executive Board decided that effective October 1, 2016, the Chinese renminbi (RMB) will be included in the SDR basket as a fifth currency, along with the U.S. dollar, euro, Japanese yen, and pound sterling.

Specifically, the IMF decided that the RMB meets the existing criteria for SDR basket inclusion.

As the world’s third-largest exporter (in the past five years), China met the first inclusion criterion.

The IMF also determined, effective October 1, 2016, the RMB to be freely usable, thus meeting the second criterion for basket inclusion.

…The following weights based on the new formula will be used to determine the amounts of each of the five currencies in the new SDR basket that will take effect on October 1, 2016:

  • U.S. dollar 41.73 percent (compared with 41.9 percent at the 2010 Review)
  • Euro 30.93 percent (compared with 37.4 percent at the 2010 Review)
  • Chinese renminbi 10.92 percent
  • Japanese yen 8.33 percent (compared with 9.4 percent at the 2010 Review)
  • Pound sterling 8.09 percent (compared with 11.3 percent at the 2010 Review).”

With 189 member countries, the IMF is the world’s most powerful bank from a geopolitical standpoint. That means if they say China’s yuan is “freely usable,” every one listens – even if the yuan is still not fully convertible since China maintains the power to engage in capital controls (that’s a topic for another letter).

Once China’s yuan officially becomes a “freely usable” currency as per the IMF, China’s outflows will be backstopped by its inclusion in the SDR.

And that has been China’s solution to the chicken or the egg of its capital outflow problem.

But while that solves one of China’s biggest problems, it still doesn’t solve the problem of its increasingly growing debt as a result of the devaluation loop.

The Next Major Bailout

China has followed in the footsteps of the US by infiltrating foreign countries with its own currency.

It has been doing this by creating alternatives to Swift (one of the largest payment networks in the world), creating an international lending network like the World Bank and the IMF, creating new alliances with foreign countries to transact in currencies outside the Dollar, becoming a part of the SDR, and by buying gold.

Gold? What role could gold possibly have in today’s modern global fiat system?

Could China be preparing for a new gold standard? There’s certainly evidence that other countries are preparing for such an event.

In fact, many very well-educated contrarians believe that’s the case.

But I think they’re wrong.

In the world of currency wars, we talk about owning gold to prepare for an upcoming gold standard.

Being that central banks control the world, and we are in an age of globalization and financial convergence, that likely won’t happen.

The reality is that moving to a gold standard could effectively destroy China – and the current financial system as a whole. And because we now rely on debt to grow, a gold standard would send the world into the worst-ever global depression through hyperinflation because as central banks inject more money into the system, the higher the price of gold must climb to keep the peg.

Such an increase in the price of gold would bring about hyperinflation as gold is re-priced to reflect the major devaluation of currencies around the world.

So we know things are getting worse. The world is more leveraged than ever – even more so than in 2008. Central banks have already unleashed a record amount of money, which means that there isn’t an entity that can bail them out if things should turn and collapse.

Not even the IMF has the funds to bail out the central banks.

So what happens when there comes a point where the central banks have printed too much?

The financial system becomes unstable and liquidity begins to fade. All of a sudden, a country like China is stuck with this massive amount of debt and no way to pay it off, except with more debt.

Surely the world’s second-largest economy can’t go belly up because of its financial instability? That would ruin China for years, and bring down the world along with it.

So what is China’s only hope of avoiding that scenario?

Couldn’t China just print more money? Yes, they could – and they will.

But as we have just learned, when one currency devalues, another follows suit.

Some suggest that China could buy US treasuries. But, of course, that would prop up the US dollar and devalue China’s currency and we run into the same problem of the devaluation loop.

There really is only one solution. And it’s rather simple.

The Real Reason for Gold

Before you call me an old coot gold bug with a tin hat, gold – even in our modern financial system – plays an important role.

Foreign exchange reserve is often used as an indicator of the ability for a country to repay foreign debt and is used in sovereign credit ratings. Reserves are also often used for currency defense – to stop downward or upward pressure on a currency against another currency.

In other words, the bigger the reserves, the better the ability for a country to fight financial problems.

Within these foreign reserves, there is only one asset class that cannot be printed at will and doesn’t fall prey to the devaluation loop: gold.

And that is why central banks around the world continue buying gold.

In fact, even the IMF owns gold.

The IMF’s gold holdings amount to about 90.5 million troy ounces (2,814.1 metric tons), making the IMF one of the largest official holders of gold in the world.

On the basis of historical cost, the IMF’s total gold holdings are valued at SDR 3.2 billion (about $4.5 billion), but at current market prices, their value is about SDR 80.1 billion (about $112.7 billion).

Clearly, gold has shown its ability to protect against the monetary policies of central banks.

Of course, the IMF’s Articles of Agreement strictly limit the use of this gold.

If approved by an 85 percent majority of total voting power of member countries, the IMF may sell or accept gold as payment by member countries but it is prohibited from buying gold or engaging in other gold transactions.

In other words, if a member nation needs to fulfill the IMF quota or pay back a loan, it could use gold to do so.

Hint: Don’t be surprised if we begin to see debts repaid with gold.

Debt for Gold

I don’t think that we’re moving to a gold standard anytime soon, but being that gold is a major part of foreign reserves all around the world, and that it doesn’t participate in the devaluation loop, countries such as China could use gold to backstop both its monetary policies and currency devaluation.

Countries around the world could essentially use gold to pay back their loans without directly influencing the currency market.

Gold can’t have a negative interest rate and it can’t devalue itself by increasing production at a rate as fast as fiat currency.

Countries such as China can use printed currency to buy gold, instead of interfering with foreign exchange when buying US dollar. As debts come due, and China needs a backstop, it could sell some of its gold as a form of protection – just as Switzerland did back in 2011.

But in order to make gold-for-debt a noticeable trade, the price of gold has to increase.

Which means China has to maintain some influence in the pricing of gold.

And China has been working on that, too.

China’s Influence on the Price of Gold

On May 16, 2016, the Industrial and Commercial Bank of China (ICBC) will join the twice-daily electronic auction process to set the benchmark price of gold.

Via ICE:

“Intercontinental Exchange, Inc. (NYSE:ICE), a leading operator of global exchanges and clearing houses and provider of data and listings services, today announced that the Industrial and Commercial Bank of China (ICBC) has been approved by ICE Benchmark Administration (IBA) to participate in the gold auction, which is used to determine the LBMA Gold Price, from May 16, 2016.”

There are currently 12 participants including big banks such as JP Morgan, Scotiabank, HSBC, Société Générale, UBS, Barclays, and Goldman Sachs.

Two of the 12 participants are already Chinese and include the Bank of China and China Construction Bank (CCB).

ICBC will be the third Chinese direct participant to join the LBMA Gold Price, which brings the number of participants to 13.

That means Chinese banks will represent a quarter of the banks responsible for setting the price of gold.

Which brings us to the next phase of why gold (and silver) prices may soon move higher.

Guilty as Charged?

Six years ago, on April 2010, I wrote “the Silver Conspiracy,” and suggested we may see some short coverings from banks that were exposed to price manipulation.

At the end of April 2010, the price of silver closed at US$18.38.

Less than a year later, on March 26, 2011, the price of silver more than doubled, closing at US$46.47.

Could the investigations have forced some of the alleged banks to cover their short positions, forcing the price of silver violently upward?

Maybe. All I know is that silver doubled during that time and those who invested in the sector made a lot of money – myself and many readers included.

Today, we may soon see a similar action.

Manipulation Revealed

For nearly 100 years, the price of gold was set by five banks: Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc and Societe Generale SA.

It was called the London Gold Market Fixing.

In 2014, this changed when London Gold Market Fixing faced scrutiny with regulators in London, Bonn, and Washington — who were already looking into manipulation of interest rates and currencies — investigating how prices are set in the market.

I talked about this in my Letter, The Outlook for Canadian Stocks, where I said:

“Germany’s top financial regulator said possible manipulation of currency rates and prices for precious metals is worse than the Libor-rigging scandal, which has already led to fines of about $6 billion.”

As a result, the London Bullion Market Association (LMBA) created a new pricing platform for gold and included more members such as Chinese banks.

But that didn’t stop the investigations or the lawsuits.

Just last week, member Deutsche Bank reached a settlement in US litigation alleging the bank conspired to fix both gold and silver prices.

Via Reuters:

“Deutsche Bank AG agreed to settle U.S. lawsuits accusing it of conspiring with other banks to manipulate gold and silver prices at investors’ expense, court papers show.

The settlements were disclosed in letters filed in Manhattan federal court by lawyers representing investors and traders who accused Deutsche Bank of violating U.S. antitrust law.

Terms were not disclosed, but both settlements will include monetary payments by the German bank.”

But that’s not the end of it.

Deutsche Bank may also begin to reveal others who were involved, opening a media frenzy of gold and silver manipulation.

Via Bloomberg:

“…The German financial firm also agreed to help the plaintiffs pursue similar claims against other banks as part of the settlements, according to the letters.

Vincent Briganti and Robert Eisler, attorneys for traders in the silver-fixing lawsuit, said Deutsche Bank will turn over instant messages and other communications to help further their case. Financial terms of the settlements weren’t disclosed.

“In addition to valuable monetary consideration to be paid into a settlement fund, the term sheet also provides for other valuable consideration such as provisions requiring Deutsche Bank’s cooperation in pursuing claims against the remaining defendants,” attorneys Daniel Brockett and Merrill Davidoff said in their letter Thursday in the gold-fixing lawsuit.”

The last time banks were accused of silver manipulation, no one settled; yet, the price of silver doubled.

This time, Deutsche bank not only settled the dispute, but it has agreed to pursue claims against other defendants.

While the Bank may never directly admit to manipulating prices, settling and telling us that they will cooperate in ratting out other banks suggests there was some manipulation going on.

Signs of Short Covering?

A month ago on March 20, 2016, I said silver was about to break out.

Via Why the People are Voting for Donald Trump:

“…Silver may also be looking to break out.

Silver is still trading at a low of US$15ish per ounce, but I suspect we could see this price move to the upside soon. Perhaps that’s why silver stocks have been on the rise.

The smart money is piling in, and I think the move has just begun.”

This week, newsletter writers and sector journalists everywhere finally joined my sentiment and began to talk about silver’s breakout.

Silver just hit an 11-month high of over $17/ounce.

It’s good to be early.

With this recent Deutsche Bank settlement involving gold as well, we could see similar action in gold.

Time to Get Back In

Last year, I said it was time to start buying gold stocks because I felt gold was about to break out.

Both of the gold stocks I introduced last year have continued to break new highs, and others have followed.

Today, many gold stocks are climbing.

As global trade accelerates and the devaluation loop continues, the mechanics of gold trading evolve – especially as more regulation is placed on its pricing.

There is are reasons why Germany, and numerous countries, want their gold stored at home.

There is a reason Russia and China, and numerous other central banks, continue to buy gold.

Gold is the next bailout.

And you can bet I am aggressively looking for more undervalued opportunities.

Comments 6
  1. Great. Canada has less than a ton of gold on hand. We used to have 1000 tons. But hey, we do owe about 1.3 trillion. Austerity for plebs, junkets for Wynne, Notley,Trudeau and company. Next stop: UN protectorate paying annual carbon tribute to crooked overlords. Enjoy servitude kanuckleheads.

  2. Do you mean gold bail out as with Rickards view, that gold could be revalued in an attempt to solve the growing debt problem?

  3. First, let me say that I truly enjoy reading your thought provocative articles.
    In response to the New World Currency question, I believe it was somewhat misleading in how it was worded. If you want to know what “should” happen, my response would be not a whole lot. The USD drops from .419 to .4173 as a percentage of the magical SDR. I doubt that a drop of .0017 is enough to sink the country. Now, if you want to know what “will” happen, my response is “exactly what the deep state wants to happen”; an eventual one world government, one world currency (or payment mechanism) and a one world leadership council. FYI, with regards to a previous article, I purchased my property in Novs Scotia 25 years ago. Better early than late, I guess.

  4. I have followed your splendid comments and analyses for several years, and I simply want to say thank you.

  5. “Not even the IMF has the funds to bail out the central banks.” LMAO!!!! it never did! and if it wasn’t for the “greek crisis” scam used as the “weakest link” in the EU to help bail out the banksters and save the IMF from collapse, it wouldn’t even have enough to buy that bimbo a cappuccino!

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