PSE Divergence Confirmed — The September Breakout That Redefined Philippine Mining in the Age of Fiat Disorder

 

The choice of the good to be employed as a medium of exchange and as money is never indifferent. It determines the course of the cash-induced changes in purchasing power. The question is only who should make the choice: the people buying and selling on the market, or the government? It was the market that, in a selective process going on for ages, finally assigned to the precious metals gold and silver the character of money. For two hundred years the governments have interfered with the market’s choice of the money medium. Even the most bigoted étatists do not venture to assert that this interference has proved beneficial—Ludwig von Mises 

In this issue 

PSE Divergence Confirmed — The September Breakout That Redefined Philippine Mining in the Age of Fiat Disorder

I. April 2023: The Thesis That Time Has Now Validated

II. September’s Seismic Shift: Mining Index Outpaces the PSEi

III. The Fiat Fracture: Gold's Three-Legged Bull Market and the Chronicle of Monetary Rupture

IV. Gold as Signal of Systemic Stress

V. Fracture Points: Tumultuous Geopolitics and the New War Economy

VI. A Militarized Global Economy and The Fiscal–Military Feedback Loop

VII. Economic Warfare: Tariffs, Fragmentation, and Supply Chain Bifurcation

VIII. World Central Banks Signal Distrust: The Gold Accumulation Surge and Fiat Erosion

IX. The Paradox of Philippine Mining Reform: Bureaucratic Control over Market Forces

X. The Philippine Mining Index Breakout: Gold Leads, Nickel Surprises, Copper Lags and the Speculative Spillover

XI. Conclusion: The Uneasy Return of Hard Assets in a Soft-Money World 

PSE Divergence Confirmed — The September Breakout That Redefined Philippine Mining in the Age of Fiat Disorder 

Beyond the PSEi: Tracking the Philippine Mining Index's decoupling, the gold-fiat fracture, and the systemic risks that power resource equities. 

I. April 2023: The Thesis That Time Has Now Validated

Figure 1 

Back in April 2023, we predicted that rising gold prices would boost the Philippine mining index for several reasons: (see reference) 

1. Unpopular – It is the most unpopular and possibly the "least owned" sector—even "the institutional punters have likely ignored the industry." As proof, it had the "smallest share of the monthly trading volume since 2013." 

2. Lack of Correlation – "its lack of correlation with the PSEi 30 should make it a worthy diversifier" 

3. Potential Divergence – We wrote that "the current climate of overindebtedness and rising rates seen with most mainstream issues, the market may likely have second thoughts about this disfavored sector. Soon." 

4. Formative Bubble – We posed that "If the advent of the era of fragmentation or the age of inflation materializes, could the consensus eventually be chasing a new bubble?" 

Well, media coverage hardly noticed it, but the relative performance of the Mining sector vis-à-vis the PSEi 30—or the Mining/PSEi ratio—made significant headway last September. It critically untethered from its 5-year consolidation phase. (Figure 1, topmost chart) 

Recall: mines suffered a brutal 9-year bear market from 2012 to 2020. The Mining/PSEi ratio hit its secular low during the pandemic recession, pirouetted to the upside, peaked in September 2022, but remained rangebound—nickel lagged, and gold lacked sufficient momentum to lift the index. 

II. September’s Seismic Shift: Mining Index Outpaces the PSEi 

That dramatically changed in September. The Mining/PSEi ratio experienced a seismic breakout, powered by a decisive thrust in gold mines, buoyed further by surging nickel mines. 

But this time may be different. The 2002–2012 bull cycle was driven by Mines outrunning a similarly bristling PSEi 30. Today, the Mines are diverging—operating antithetically from the broader index—a potential reflection of gradual and reticent transition of market leadership. (Figure 1, middle graph) 

The September numbers underscore the shift (Figure 1, lowest table) 

PSEi 30: –3.28% MoM, –18.14% YoY, –6.46% QoQ, –8.81% YTD

Mining Index: +25.86% MoM, +47.97% YoY, +35.07% QoQ, +63.96% YTD 

So yes, it fulfilled our projections of a bull market in motion while validating our ‘diversifier’ thesis. Still, despite its massive run, the sector remains disfavored—its share of the monthly main board volume remains the smallest.

Figure 2

Even with the gaming sector’s bubble showing cracks, speculative interest in PLUS and BLOOM (at 4.38%) nearly matched the ten-issue Mining Index (4.46%) in September. In short, market sentiment still favors gaming over mining. (Figure 2, topmost image) 

Ultimately, the mining sector’s performance—and its transition to a potential secular bull market—will hinge on its underlying commodities. 

In 2016, we wrote, 

Divergence or rotation can only be affirmed when gold mining stocks will move independently from the mainstream stocks. The best evidence will emerge when both will move in opposite directions. This had been the case from 2012 through 2015 when miners collapsed while the bubble industries blossomed. It should be a curiosity to see when both trade places. Time will tell. [italics original] (Prudent Investor, 2016) 

That’s a bullseye!

III. The Fiat Fracture: Gold's Three-Legged Bull Market and the Chronicle of Monetary Rupture 

Gold’s long-term ascent is a chronicle of monetary rupture. (Figure 2, middle chart) 

The first major break came under Franklin D. Roosevelt, with Executive Order 6102 (1933) and the Gold Reserve Act (1934), which outlawed private gold ownership and revalued the dollar’s gold peg from $20.67 to $35 per ounce. This statutory debasement set the modern precedent for political interference in money. 

The second rupture—Nixon’s 1971 “shock” ending Bretton Woods convertibility—ushered in the fiat era. Untethered from monetary discipline, gold surged from $35 to ~$670 by September 1980, a 19x return over nine years, driven by double-digit inflation, oil shocks, and institutional distrust. This marked the first leg of the post-gold-standard bull cycle under the U.S. dollar’s fiat regime. 

The second leg (2001–2012) unfolded over eleven years, beginning around $265 in February 2001 and peaking near $1,738 in January 2012—a 6.6x return. 

This phase reflected a response to cascading financial crises and aggressive monetary easing: the dotcom bust, 9/11, the Global Financial Crisis, and the Eurozone debt spiral. Central bank interventions—QE and ZIRP from the Fed and ECB—amplified gold’s role as a hedge against fiat dilution. 

The third leg (2015–) began in late 2015, bottoming near $1,050 in the aftermath of China’s devaluation. Over the next decade thru today, gold climbed past $3,800—a ~3.6x return—driven by global central bank accumulation, geopolitical fracture, asset bubbles, inflation spillovers, and record leverage across public and private sectors. 

As a sanctuary asset, gold has not only preserved purchasing power but also signaled systemic fragility. Real (inflation-adjusted) prices have reached all-time highs, underscoring gold’s function as a monetary barometer. (Figure 2, lowest diagram) 

Today, its strength reflects more than cyclical momentum—it mirrors the widening cracks of the fiat era. 

Gold’s trajectory—marked by 9-, 11-, and 10-year legs—suggests that mining valuations may be more tightly coupled to global monetary dysfunction than domestic policy alone. 

With gold now approaching USD 4,000, history suggests we may well see prices reach at least USD 6,000.

For resource-driven economies like the Philippines, this episodic repricing offers a potent lens for evaluating mining equities.  Rising gold valuations, persistent inflation, and the flight to real assets amid waning faith in fiat systems suggest that mining performance may be more tightly coupled to global monetary dysfunction than domestic policy alone. 

Still, each leg has emerged from distinct fundamentals—past performance may rhyme, but not reprise. 

IV. Gold as Signal of Systemic Stress 

Last March, we launched a three-part series forecasting that gold would sustain its record-breaking run. 

In the first installment, we argued that gold has historically served as a leading indicator of economic and financial stress: "gold’s record-breaking runs have consistently foreshadowed major recessions, economic crises, and geopolitical upheavals."

Figure 3 

Today, that reflexive relationship remains in play. 

As global growth falters under the weight of fiscal imbalance and geopolitical strain, central banks have turned decisively toward rate cuts, reversing the tightening cycle that began in 2022. By September, the scale of collective policy easing has already approached pandemic-era levels, underscoring a synchronized monetary response to mounting economic stress. (Figure 3, topmost window) 

V. Fracture Points: Tumultuous Geopolitics and the New War Economy 

In the second part, we explored how monetary disorder underpins gold’s sustained upside. "Gold’s record-breaking rise may signal mounting fissures in today’s fiat money system, " we wrote, “fissures expressed through escalating geopolitical and geoeconomic stress. "  

Those fissures have widened. Over the past month, geopolitical tensions have intensified across multiple fronts, amplifying systemic risks for both commodity markets and global capital flows. In Europe, the Ukraine war has evolved from proxy engagement to near-direct confrontation, punctuated by Putin’s claim that "all NATO countries are fighting us." 

Hungarian Prime Minister Viktor Orbán echoed this unease, posting on X: (Figure 3, middle picture) 

"Brussels has chosen a strategy of wearing Russia down through endless war… sacrificing Europe’s economy, and sending hundreds of thousands to die at the front. Hungary rejects this. Europe must negotiate for peace, not pursue endless war." 

Paradoxically, Hungary is part of EU and NATO. 

In the Middle East, Trump’s proposed Gaza peace plan has been welcomed by parts of the EU but criticized by both Israeli hardliners and Hamas, exposing deep political rifts that could derail any lasting truce. 

Washington has also expanded its Caribbean military buildup apparently eyeing Venezuela—a Russian ally—under the pretext of targeting “drug smugglers.” 

Compounding these tensions are the looming U.S. government shutdown, ICE-fueled riots, EU fragmentation, and territorial disputes across Asia (including the Thai-Cambodia and South China Sea flashpoints). Together, these developments erode international interdependence and deepen the sense of global instability. 

VI. A Militarized Global Economy and The Fiscal–Military Feedback Loop 

Adding fuel to the fire, debt-financed fiscal stimulus through military spending has reached unprecedented scale. According to SIPRI, global military expenditures rose 9.4% in real terms to $2.718 trillion in 2024—the highest total ever recorded and the tenth consecutive year of increase. (Figure 3, lowest visual) 

This war economy buildup echoes historical patterns, where militarism became not just a tool of statecraft but a structural imperative. 

Modern defense economies increasingly resemble historical warrior societies such as Bushido Japan, Sparta, and Napoleonic France, where militarism evolved from a tool of power into a systemic necessity. 

In these societies, idle warriors or elite military classes threatened internal stability, compelling leaders to redirect aggression outward. Hideyoshi’s invasion of Korea, for instance, was less about conquest than about pacifying a restless samurai class. 

Today’s massive defense spending serves a parallel function: sustaining industrial output, protecting elite interests, and demanding perpetual geopolitical justification. The result is a fiscal–military feedback loop in which peace itself undermines the architecture of power. 

This militarized economic order breeds a dangerous paradox: when growth depends on arms production and deterrence, the line between defense and aggression dissolves. As nations over-arm to preserve influence and momentum, the world risks sliding into a self-fulfilling conflict dynamic—where fiscal expansion, political ambition, and national pride coalesce into the very forces that once ignited global wars. 

VII. Economic Warfare: Tariffs, Fragmentation, and Supply Chain Bifurcation 

These geopolitical flashpoints are layered atop escalating geoeconomic risks that mirror economic warfare. 

The U.S. has rolled out sweeping new tariffs—10% on lumber and 25% on furniture and cabinetry—adding to earlier steel and aluminum levies that have rattled European industries. With a stronger euro hurting export competitiveness and rising trade barriers disrupting supply chains, Europe’s manufacturing base faces mounting stress. 

The U.S. recently raised tariffs on Philippine exports to 19%, part of a broader “reciprocal” trade posture that threatens ASEAN and EU economies alike. Export controls targeting Chinese tech and semiconductor firms underscore the growing bifurcation of global supply chains, especially in the AI and chip sectors. 

VIII. World Central Banks Signal Distrust: The Gold Accumulation Surge and Fiat Erosion

Figure 4

Amid this widening fragmentation, central banks have accelerated their gold accumulation—buying despite record-high prices. 

As the World Gold Council reported, central banks added a net 15 tonnes of gold in August, consistent with the March–June monthly average, marking a rebound after July’s pause. Seven central banks reported increases of at least one tonne, while only two reduced holdings. (Figure 4, topmost and middle charts) 

Notably, as political institutions, central bank reserve management decisions are not profit but politically driven. 

The Bangko Sentral ng Pilipinas (BSP), additionally, was the world’s largest seller of gold reserves in 2024, citing profit-taking at higher prices. Yet in 2025, it resumed small purchases—ironically, at even higher price levels. (Figure 4, lowest graph)  

Figure 5 

Measured in Philippine pesos, gold and silver prices are extending their streak of record-breaking highs (Figure 5, upper window) 

As history reminds us, the BSP’s massive gold sales in 2020 preceded the 2022 USD/PHP spike, suggesting that the 2024 divestment—intended to support the peso’s soft peg—could again foreshadow a breakout above PHP 59, perhaps by 2026? 

Most strikingly, global central banks’ gold reserves have grown so rapidly that their aggregate gold holdings are now nearly on par with U.S. Treasury holdings—a clear sign of eroding faith in the contemporary U.S. dollar-based order. (Figure 5, lower image) 

The modern-day Thucydides Trap—intensifying hegemonic competition expressed not only in geopolitics, but also in economic, financial, and monetary spheres—has increasingly powered the gold-silver tandem. 

Viewed in this light, as gold rises against all currencies, the message is clear: it is not gold that’s appreciating, but fiat money that’s depreciating. Gold is no longer just insurance asset— it is, and remains, money itself. 

IX. The Paradox of Philippine Mining Reform: Bureaucratic Control over Market Forces 

In the absence of commodity spot and futures markets—a critical handicap to price discovery, risk management, and capital formation—the state’s default response has been to expand taxation and administrative controls instead of developing genuine market mechanisms. 

Rather than pursuing market liberalization or introducing commodity exchanges to improve efficiency and productivity, the Philippine social democratic paradigm of reform remains fixated on taxation, administration, and bureaucratic control. 

The passage of the Enhanced Fiscal Regime for Large-Scale Metallic Mining Act (RA 12253) and the push for the Mining Fiscal Reform Bill mark the government’s latest attempt to "modernize" the fiscal framework of the mining industry. 

On paper, these reforms promise stronger oversight, greater transparency, and a "fairer share" of mineral wealth between the state and the private sector. The new regime introduces margin-based royalties, a windfall profits tax, and project-level accounting rules meant to simplify tax compliance and reduce leakages. Yet, beyond the reformist veneer lies a system still anchored on bureaucratic discretion—where regulators retain broad authority to interpret profitability thresholds, accounting standards, and tax computations. 

In practice, this discretion perpetuates the opacity and arbitrariness that the law sought to correct. Rather than institutionalizing transparency, the framework risks entrenching regulatory capture, enabling bureaucrats to negotiate or manipulate fiscal obligations behind closed doors. 

The very mechanisms intended to enhance oversight—royalty audits, windfall assessments, and transfer pricing reviews—may instead become new venues for rent-seeking and selective enforcement. This tension between statutory ambition and administrative reality leaves the industry vulnerable not only to corruption but also to uneven enforcement across operators and regions—cronyism. 

In the short term, elevated metal prices could conceal these governance flaws, boosting fiscal receipts and lifting mining equities under the illusion of reform-led success. But when the commodity cycle turns, the cracks will widen: weak oversight, inconsistent standards, and arbitrary taxation could resurface as deterrents to investment and valuation stability. 

Thus, what was framed as a fiscal modernization drive may ultimately reinforce the industry’s old paradox—where boom times mask systemic fragility, and reforms collapse when prices fall. 

X. The Philippine Mining Index Breakout: Gold Leads, Nickel Surprises, Copper Lags and the Speculative Spillover 

Lastly, while gold mining shares primarily contributed to the breakout of the Philippine Mining Index, nickel mines also sprang to life and added to the rally. The Philippine Stock Exchange recalibrated the composition of the Mining Index last August to reflect sectoral momentum. 

Gold-copper Lepanto A and B replaced Benguet A and B, while gold-silver miner Oceana Gold was newly included.

Figure 6

This partial reconstitution, combined with price action, reshaped the index’s internal weightings: as of October 3, gold-copper mines accounted for 74.65%, nickel 23.53%, and oil just 1.83%—a notable shift from March 31’s 68.3%-27.44%-4.25% distribution. (Figure 6 topmost graph)

From March 31st to October 3rd, gold mining shares surged 112%, driven by tailwinds from soaring gold and silver prices. Nickel mining shares, surprisingly, jumped 66.4% despite depressed global nickel prices. Meanwhile, solo oil exploration firm PXP Energy sank 16.5%. 

The biggest ranked mines in the index, in descending order, were Apex Mining, OceanaGold, Philex, Nickel Asia, and Atlas Consolidated. (Figure 6, second to the top image) 

USD prices of Silver and Copper surging while Nickel consolidates. (Figure 6 second to the lowest visual) 

While gold’s rally was the primary engine of the index breakout—amplified by the inclusion of more gold-heavy names—the rebound in nickel miners was more ironic. 

With easy money fueling an “everything bubble,” a rising tide appears to be lifting all mining boats. 

Another factor is that local nickel miners have mirrored the moves of international ETFs such as the Sprott Nickel Miners ETF [Nasdaq: NIKL], which advanced largely on global liquidity flows rather than on improvements in the underlying metal market. (Figure 6, lowest diagram) 

In essence, the surge in nickel shares reflects financial rotation and speculative spillover—capital chasing laggards and cyclical exposure amid abundant liquidity—rather than any meaningful recovery in nickel fundamentals. If the bids are to be believed, nickel prices would eventually have to rise and remain elevated; otherwise, the rally risks running ahead of earnings reality. 

Meanwhile, despite a resurgent copper price—also mirrored in ETFs like the Sprott Copper Miners ETF [Nasdaq: COPP]—some local copper mines have made little progress in scaling higher. 

We are yet to see substantial breakouts from the peripheral mines, suggesting that speculative flows have been highly selective, favoring liquidity and index-weighted names over broader participation. 

Ironically, the divergence between copper and nickel prices underscores the fragility of the latter’s mining rally. 

While copper’s surge has been confirmed by both spot prices and mining equities—reflected in the coherent ascent of ETFs like COPP—nickel’s stagnation contrasts sharply with the outsized gains in nickel mining shares and ETFs like NIKL. 

This disconnect suggests mispricing: a speculative equity bid front-running a commodity rebound that hasn’t arrived. Without confirmation from the metal itself, the feedback loop sustaining nickel equities risks collapse, exposing the rally as a liquidity mirage rather than a durable trend. 

XI. Conclusion: The Uneasy Return of Hard Assets in a Soft-Money World 

The Philippine mining sector’s transformation from pariah to rising star is both cyclical and structural. It reflects not only higher commodity prices but also the global search for hard assets in an era of currency debasement, geopolitical fracture, and policy incoherence. 

Gold’s rise tells a story of distrust in fiat money; nickel’s divergence, of speculative excess born of liquidity overflow. 

The mining index’s ascent thus mirrors the world’s economic psychology—a blend of fear and greed, of safe-haven accumulation and ultra-loose money–financed speculative rotation. 

Whether this is a sustainable repricing or a liquidity mirage will depend on whether global monetary and fiscal regimes stabilize—or fracture further. The former seems close to impossible; the latter, increasingly probable. 

Either way, the Philippine mining story has become a proxy for something much larger: the uneasy return of hard assets in a soft-money world. 

Postscript: No trend moves in a straight line. Gold, silver, and Philippine mining shares are now extensively overbought—inviting a countercyclical pause, not an end, to their ascent. 

____

References 

Ludwig von Mises, The Real Meaning of Inflation and Deflation, January 2, 2024, Mises.org 

Prudent Investor Newsletter, Investing Gamechanger: Commodities and the Philippine Mining Index as Major Beneficiaries of the Shifting Geopolitical Winds! Substack, April 27, 2023 

Prudent Investor Newsletter, Phisix 6,650: Resurgent Gold, Will Mining Sector Lead in 2016? Negative Yield Spread Hits 1 Month Bill-10 Year Treasuries!, Blogspot February 15, 2016 

Prudent Investor Newsletter Do Gold’s Historic Highs Predict a Coming Crisis? Substack, March 30, 2025 

Prudent Investor Newsletter, Gold’s Record Run: Signals of Crisis or a Potential Shift in the Monetary Order? (2nd of 3 Part Series), Substack, March 31, 2025 

Prudent Investor Newsletter, How Surging Gold Prices Could Impact the Philippine Mining Industry (3rd of 3 Series), Substack, April 02, 2025 

Prudent Investor Newsletter, The Long-Term Price Trend and Investment Perspective of Gold, Blogspot, August 02, 2020  

Inflation is a process: 1960-80 Edition

One observation I recently received concerned about how US Federal Reserve policies allegedly produced an “immediate inflation” in the 1970s (via stagflation) while today’s massive over $4 trillion of balance sheet expansion as of December 2013 hasn’t produced the same effect.

graphics via the CNN

Well inflation don’t just appear, like a genie, from nowhere. Inflation is a process.

This applies as well to during the 1960s to 1980s

From Wikipedia: (bold mine)

In 1944, the Bretton Woods system fixed exchange rates based on the U.S. dollar, which was redeemable for gold by the U.S. government at the price of $35 per ounce. Thus, the United States was committed to backing every dollar overseas with gold. Other currencies were fixed to the dollar, and the dollar was pegged to gold.

For the first years after World War II, the Bretton Woods system worked well. With the Marshall Plan Japan and Europe were rebuilding from the war, and foreigners wanted dollars to spend on American goods – cars, steel, machinery, etc. Because the U.S. owned over half the world's official gold reserves – 574 million ounces at the end of World War II – the system appeared secure.

However, from 1950 to 1969, as Germany and Japan recovered, the US share of the world's economic output dropped significantly, from 35 percent to 27 percent. Furthermore, a negative balance of payments, growing public debt incurred by the Vietnam War and Great Society programs, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s. The drain on US gold reserves culminated with the London Gold Pool collapse in March 1968.

By 1971, America's gold stock had fallen to $10 billion, half its 1960 level. Foreign banks held many more dollars than the U.S. held gold, leaving the U.S. vulnerable to a run on its gold.

By 1971, the money supply had increased by 10%. In May 1971, West Germany was the first to leave the Bretton Woods system, unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, this move strengthened its economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark. Other nations began to demand redemption of their dollars for gold. Switzerland redeemed $50 million in July. France acquired $191 million in gold. On August 5, 1971, the United States Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against "foreign price-gougers". On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland left the Bretton Woods system. The pressure began to intensify on the United States to leave Bretton Woods.

The above chart from economagic reveals that price inflation didn’t just “appear”. 

The US government had already indulged in monetary inflation as far back in the advent of the 1960s (as seen via M2 blue line). Meanwhile price inflation (CPI red line) began its upward trek only 5 years after. (both are measured via % change from a year ago).

When the Bretton Woods era came to a close, US M2 soared in two occasions. This  led to accompanying spikes in CPI which resulted to ‘stagflationary’ recessions.

Former Fed Chair Paul Volcker was widely credited for wringing out inflation by massively raising interest rates. Although Dr. Marc Faber already noted that the supply side glut from the early inflation has began to impact prices and that Mr. Volcker’s action may have complimented on this adjustment phase. The US economy had 3 agonizing recessions in the late 1970s to the early 1980s following the monetary experiment from the Nixon Shock before the imbalances brought about by previous monetary inflation had been reversed.

The point is inflation is a process which undergoes different stages

As the late Austrian economist Percy Greaves Jr. explained in simple layman terms

The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.

From the US ‘stagflationary’ experience, market developments combined with policy actions prevented the third stage (crack-up) boom from transpiring. But the policy tradeoff had been to induce harrowing periods of recessions.

Some notes:

-The foundation of the stagflation era of 1970s went as far back to the inflationary policies by the Fed during the early 1960s. The sustained inflationist policies eventually led to consumer price inflation.

-US inflationist policies largely due to the Vietnam war and US welfare (New Society) programs put an end to the Bretton Woods Standards.

-Recessions are necessary to reverse previous monetary abuse. The Bust serve as necessary medicine and therapy for the inflationary boom ailment.

There are also other factors that influence price inflation. For one, productivity growth from globalization helped reduced the impact of US Federal Reserve policies in the post Volcker era. This has been wrongly construed as the Great Moderation.

The massive explosion in the growth of the asset markets supported by debt that have also been instrumental in shifting the nature of the impact of inflation since a lot of monetary inflation today have been absorbed by asset markets (trillion dollar derivatives, bond markets, currency markets, etc...).

Bottom line: Just because statistical consumer price inflation seem subdued today, doesn’t mean there won’t be price inflation tomorrow or sometime in the future.

As one would note from the experience of the 1970s when price inflation emerges, it comes rather quickly. 

And in my view, the highly volatile financial markets today are symptoms such transition, but in a different light: asset inflation boom morphing into asset bust.

The next question is how will central bankers and the government react? Will their response lead to a crack-up boom (ruination of a currency via hyperinflation) or deflationary depression? I call this the von Mises Moment

Quote of the Day: The goal of Nixon Shock is to get foreign governments to hold US debts

Nixon unilaterally abolished the monetary agreement established in 1944 at Bretton Woods, New Hampshire. At that meeting, the United States, Great Britain, and other Western nations established a new monetary order. It would be supported by the United States Treasury. The United States Treasury would guarantee that any central bank or foreign government could buy gold from the Treasury at a price of $35 per ounce.

The goal of the Treasury was simple: to get foreign governments to hold Treasury debt instead of gold. Because Treasury debt was supposedly as good as gold, foreign governments and central banks could hold Treasury debt instead of holding gold. This enabled the United States government to run fiscal deficits, and foreign governments and central banks financed a portion of this debt. They did so by creating their own domestic currencies out of nothing, and then using these currencies to buy U.S. dollar-denominated debt, meaning U.S. Treasury debt. It was a nice arrangement. Foreign governments and foreign central banks gained an interest rate return on holding treasury debt, which they could not get by holding gold. Yet the dollars that they were being promised by the Treasury were supposedly as good as gold.

This is an extract from Austrian economist Gary North’s article in remembrance of the Nixon Shock or the closing of the Bretton Woods Gold Exchange Standard 42 years ago today.  

This shift towards the fiat money US dollar standard regime magnifies the Triffin Dilemma, where recent improvements in US trade and budget deficits could mean trouble ahead for global markets and economies.

Will the Triffin Dilemma Haunt the Global Financial Markets?

As measured by the Dow Jones Industrials US equity benchmark suffered their first loss in 7 weeks. Are these signs of fatigue or are these signs of an overheating or climaxing bubble? 

My impression is should US markets begin to wilt in earnest, then current downdraft in Asian markets are likely to intensify.

The US reportedly posted a substantial 22% reduction in the deficits of her trade balance owing to record exports and to a shrinking oil import bill according to the Wall Street Journal[1]. 

Shrinking US trade deficits can signify a symptom of unsustainable imbalances from the current monetary order, the US dollar standard.

The US dollar remains the largest international foreign exchange reserve with over 60% share (right window[2]).

International currency reserves are over $10 trillion with the US Dollar also having the biggest share (left window). Perhaps a big segment of the undisclosed reserve currency may also be in US dollars.

Over 50% (right window) of the $12 trillion (left window[3]) of international debt securities has been denominated in US dollars.

The point of this exercise is to demonstrate of the world’s continuing dependence on the US dollar as medium of exchange and as reserve currency.

Yet the US dollar standard seems to operate on the principle of the Triffin Dilemma, formulated by the late Belgian American economist Robert Triffin.

The eponymous theory by Mr Triffin elucidates of the economic conflict emanating from a world reserve currency particularly on meeting short term-domestic interests as against long term international objectives[4]

Under the Triffin dilemma, the issuing reserve currency makes it easy for a nation to consume more goods and services via an overvalued currency.

The same overvalued currency easily allows for financing of either budget deficits and or trade deficits, aside from having more latitude in “determining multilateral approaches to either diplomacy or military action”[5].

In short, a reserve currency provides the issuer the privilege of an interim “free lunch” or to quote the French economist Jacques Rueff “deficit without tears”[6]

One of the other side effects of the Triffin dilemma has been the intense deepening of the financialization of the US economy[7]. 

Instead of producing goods, the US economy evolved towards shuffling of financial papers partly required by foreigners to recycle their dollar holdings. As one would note, the gist of expansion of financialization came as the US dollar became unhinged from the Bretton Wood System in August 1971.

Of course the other side effect of the Triffin dilemma has been the growing frequency of global bubble cycles as evidenced by the greater incidences of global banking crises since the Nixon Shock of 1971

Aside from the massive accumulation of reserve currency by foreigners that would eventually undermine the reserve currency status, a dynamic which the world seems headed for, an equally detrimental factor to a reserve currency status is the proportional devaluation that would shrink these deficits.

Mr. Triffin actually articulated the problems of the Bretton Woods System where the failed system seemed to have validated his thesis. 

In a testimony before the US congress in November 1960, Mr Triffin argued that “If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.[8]”

Given the deep reliance by global markets and global economy on the US dollar system, improving US trade deficits are likely to extrapolate to reduced liquidity in the ex-US global system. Such dynamic will only provide more muscle or ammunition for bond vigilantes, and equally, would mean a tightening of a system deeply dependent on the largesse of US dollar steroids from US authorities.

In the recent past, a reduction in the deficits of US trade balance coincided with strains in the global ex-US equity markets as measured by the MSCI[9] (lower pane)

Diminishing trade deficits here functioned as symptoms to dot.com bubble bust and to the 2008 Lehman bankruptcy. When financial markets collapsed as consequence to a bubble, international trade grinded to a near halt. This led to a substantial reduction of US trade deficits. Thus the narrowing trade balance coincided with recessions.

The causal flow may or could be reversed today; perhaps reduced liquidity from US exports of her currency the dollar may incite instability in the global financial markets.

The effect of shrinking liquidity on the global system will likewise affect US corporations. With 34% of the revenues of US S&P 500 companies coming from non-US sales[10], the adverse effect is that shrinking global liquidity will eventually land on US shores.

And it’s not just trade deficits that has contracted, US budget deficits have also dwindled to 4.2% of the GDP from 7.7% a year ago[11]. So this could be a one-two punch against the global markets and economy. And should the FED taper, such will exacerbate on the effects of the Triffin Paradox.

Will the European Central Bank, the Bank of Japan, the Bank of England and the People’s Bank of China fill in the vacuum from improving US twin deficits?

Or will Triffin’s ghost haunt the global financial markets?

Interesting times indeed.

---

[1] Wall Street Journal Oil Boom Helps to Shrink U.S. Trade Deficit by 22% August 6, 2013

[2] The European Central Bank THE INTERNATIONAL ROLE OF THE EURO July 2013 p.19

[3] The European Central Bank, op cit., p23

[4] Wikipedia.org Triffin dilemma

[5] See The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency April 20, 2009

[6] Jacques Rueff, The Monetary Sin of the West, Mises.org

[7] Wikipedia.org Financialization

[8] IMF.org The Dollar Glut Money Matters: An IMF Exhibit—The Importance of Global Cooperation System in Crisis (1959-1991)

[9] MSCI.com World Ex-US MSCI Index Performance

[10] Businessinsider.com CHART: The S&P 500 Is Not The US Economy, May 10, 2013

[11] National Forex Calculated Risk; US Deficit is Shrinking August 10, 2013

Video: F.A. Hayek at BBC (Masters of Money)

Glad to see the great F. A. Hayek go mainstream

  

Somewhere in the video, Paul Krugman (Darth Vader) said that "unregulated banking and financing system is prone to financial crisis". Really? 

 

(the number of banking crisis since the Nixon Shock; chart from the World Bank) 

Jeffrey Sachs (Count Dooku) said that one of Hayek’s “badly failed” predictions is that of Hayek’s claim that “moving to a social welfare society would eat away at the health of democracy”. Really? 

To use the US as example,

chart from Heritage Foundation

from yesterday’s chart of the day

Maybe all these has nothing to do with America’s growing police state?

Or perhaps Professor Hayek had been just too early.

The US Dollar Standard on its 40th Year

Known as the Nixon shock, the US dollar-Gold convertibility was closed in August 15, 1971, that’s 40 years ago.

How this came about, Cato’s Dan Griswold explains, (bold highlights mine)

In a surprise televised speech on Sunday evening, August 15, 1971, the president announced that he would immediately impose wage and price controls, slap a 10 percent duty on imports, and suspend the international convertibility of the U.S. dollar into gold. All were to be temporary measures, of course, to promote jobs, dampen inflation, and combat “international money speculators” betting against the dollar. (You can read the entire speech here.)...

The centerpiece of the Nixon Shock was its controls on prices. In a market economy, freely fluctuating prices are the nervous system that coordinates supply and demand. Yet in one of the more chilling statements delivered by a U.S. president, Nixon told the nation that evening,

“I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days.

The price controls did tame inflation temporarily, but it came roaring back within three years to double-digit levels and persisted through the 1970s because of loose monetary policy. A tight lid on a boiling tea pot can only contain the steam for a time before it explodes.

The controls continued on gasoline, causing artificial shortages (as price controls usually do) symbolized by gas lines during the 1970s. Only when President Reagan finally lifted the controls on oil and gasoline in 1981 did the specter of short supplies finally disappear. (The 10 percent import surcharge did prove to be temporary, lasting only until the end of 1971.)

Closing the gold window was arguably inevitable given the lack of monetary discipline by the U.S. central bank. By 1976, the dollar and other major currencies were floating freely, which has turned out to work rather well, as Milton Friedman predicted it would. It also turned out that pressure on the dollar to depreciate was not driven by speculators after all but by the surplus of dollars that had been created to finance the Vietnam War and the Great Society.

The lessons:

One lesson of the Nixon shock is that if politicians are granted “emergency powers” they will tend to abuse them in situations that were never envisioned when the powers were originally granted. A second lesson is that “temporary” measures have a habit of becoming permanent. The big lesson is that the power of politicians over the economy should be limited. Any request for temporary emergency powers should be greeted with the deepest skepticism.

Of course there is another more important lesson: 40 years ago TODAY, ONE US dollar is now only worth 18 cents of buying power.

From the BLS

82 cents of every dollar accounts for how much worth of resources that has been surreptitiously and illicitly transferred from her citizenry to the US government and their cronies. This represents 40 years of mass deprivation, deception and delusion.

And to consider, the CPI inflation may have even been grossly underestimated as the method to compute this has changed over the years or as argued by John Williams of the Shadow Statistics via substitution, hedonic regression and etc… here

Henry Ford was right when he said

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

It’s been 40 years of infamy.