The Center Cannot Hold…(2024)
As we say goodbye to the eventful 2024, multiple crises continue to gather momentum. Just in the past two months, Americans voted for a radical change in direction; the governments of France and Germany collapsed in no-confidence votes; Canadian and South Korean governments were rocked by disarray; Romania’s top court annulled the presidential vote; Georgia withstood an attempted color revolution; Syria’s Assad regime fell after a 53-year rule further destabilizing the region; and the wars in Ukraine and the Middle East have seen sharp escalations across multiple fronts. Notably, consensus had not envisioned these events before they happened.
Such great acceleration in the velocity and severity of unexpected developments around the world is a hallmark of all global systemic crises (“Fourth Turnings”), which, throughout history, have presaged new geopolitical, economic, and monetary arrangements. We are watching the world order and financial system in which we spent most of our lives and took for granted receding into yet another “world of yesterday” (if one has not read The World of Yesterday by Stefan Zweig, I highly recommend it). The incoming US Treasury Secretary Scott Bessent not only agrees that radical changes are inevitable but also considers them imminent:
"We're also at a unique moment geopolitically, and I could see in the next few years that we are going to have to have some kind of a grand global economic reordering, something on the equivalent of a new Bretton Woods or if you want to go back like something back to the steel agreements or the Treaty of Versailles, there's a very good chance that we are going to have to have that over the next four years and I'd like to be a part of it." Scott Bessent, via Manhattan Institute, June 6, 2024
This is an environment where “black swans” travel in flocks and, while we cannot predict what will happen next or when, it takes no prophet to know that a warpath does not lead to peace any more than leveraged profligacy leads to sustainable prosperity. Since history has shown that the only certainty during fourth turnings is increasing uncertainty and risks, the only way to navigate such periods is to rely on first principles thinking, i.e. break down complexity into its foundational blocks and focus on what we know to be true.
For example, we know that our current financial and economic systems have been built with debt and that growth has relied on credit expansion. This has happened many times throughout history and while every case has been different, past experience and common sense suggest that the current situation isn’t all THAT different from the others.
Consider the touting of GDP as evidence of economic growth, despite the fact that a large portion of government spending, a key GDP component, has been made possible by heavy borrowing and money printing. Over the past five years, the US government deficit has averaged ~9% of GDP vs. the average GDP growth of under 3%. Clearly, without deficit spending, US GDP would have
been contracting instead of expanding and the S&P 500 would not have risen ~85% as it has since 2019. Looking further back, since 1981 the US debt to GDP ratio has quadrupled while the US private debt to GDP ratio has doubled.
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig von Mises, Human Action, 1949
If anyone is unsure what von Mises’ “boom brought about by credit expansion” feels like, the well-off have been enjoying it for over 40 years. And since the early 2000s, the credit and financial asset booms have been further supercharged by widespread bailouts and the Fed’s suppression of discount rates, which have sent all risk asset values into the stratosphere. How could this debt- fueled boom last for so long? The answer lies in the US’s dual hegemony as the issuer of the world’s premier reserve currency and the sole military superpower (since the fall of the USSR). Despite being fundamentally unsound, this state of affairs could have persisted for many more years which, judging by market action, most Western investors still believe it will.
But, in my opinion, the end game is now coming into view, even if most are yet to see it and the markets are yet to price it. As often happens in history, the wheels of the now-unfolding systemic crisis were set in motion by an obscure development in a distant land that few noticed, but I addressed in my December 2021 letter. That month, Russia presented the US with an ultimatum - renegotiate the European security architecture or prepare for war. What happened next started a chain of events that have since destabilized the entire post-WWII geopolitical order and undermined global confidence in the US as an absolute military hegemon. Furthermore, freezing Russia’s sovereign reserves and confiscating wealthy Russians’ private assets has undermined non-Westerners’ confidence in the Western financial system as an apolitical counterparty and in the USD as a neutral reserve currency.
The end result of everything that has happened is that neither our balance sheet problems nor geopolitical disagreements can be reconciled without there being winners and losers. For all its enthusiasm and bold promises, the incoming Trump administration can no more painlessly restructure the US system than Gorbachev could painlessly restructure the Soviet system. Every dollar of debt is someone’s asset and there is no getting around this fundamental reality. Big changes lie ahead and, while some of them will be positive and beneficial, most will be painful and potentially disruptive on an individual level.
Whatever policies the new administration pursues, we all know that triggering a national crisis through a “voluntary abandonment of further credit expansion” has always been and remains sure- fire political suicide, which is why every prior generation of politicians has chosen to deal with excessive debts via the least obvious, but no less pernicious, method of currency debasement coupled with financial repression (negative real rates, capital controls, etc).
"There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the
side of destruction, and does it in a manner which not one man in a million is able to diagnose." John Maynard Keynes, 1919
Since another immutable truth is that human nature is immutable, it is a safe bet that this generation of politicians is no different from all those who preceded it. Which brings us to gold.
The price of gold has always been inversely correlated to confidence in property rights and counterparties’ promises since gold is the only universally liquid financial asset that is inherently neutral and no one's promise. It therefore makes sense that demand for it rises whenever confidence in promises declines. And so, it is not remarkable that gold rallied ~40% since the start of the war in Ukraine. What is remarkable is that gold would rally ~40% in the face of persistent selling by Western portfolio investors. Since peaking at 3,707 tonnes in mid-April of 2022, the holdings of European and North American gold ETFs have declined by 21% to 2,947 tonnes as of December 20, 2024. Notably, during the same period, holdings of the Asian gold ETFs have increased by 66% and central banks have been on an epic buying spree driving the over-the-counter physical demand and prices to record highs. Clearly, when it comes to confidence in the sustainability of the status quo, there is now a significant gap between the West and the rest.
I believe that the lack of interest in gold at a time when most risk assets trade near record highs confirms that Western investors and politicians expect the pre-2022 status quo to continue indefinitely and are not positioned for any material adversity. In light of the unfolding facts on the ground, this lack of demand for the only cyber-immune, inherently neutral reserve asset speaks to hubris and fragility. We know, however, that holding gold reserves and growing them in times of high uncertainty has always been a key to resiliency and a means of generational wealth creation, especially during unanticipated crises. This is because the greatest opportunities arise out of the greatest gaps between consensus expectations and reality. Like now.
As to why gold, no one said it better than my friends at Edelweiss Holdings:
“What makes gold compelling (as a reserve asset) are the risks we do not take by owning it. No forecasting or guesswork is required. The risks we do not take owning gold could fill volumes. With gold, there is no duration risk, credit risk, or liquidity risk. The metal is not moved by financial instability nor threatened by national insolvency or chaos in foreign exchange markets. There are no margin calls and no refinancing risks. There is no risk of technological obsolescence, depletion, depreciation, or decay, nor does it require cheap energy, cheap credit, or cheap trade to remain viable. It does not care about your national energy policy or who you buy your gas from or how many pipelines are running. You do not have to keep the lights on or even keep it warm. There are no financial accounts to pore over, no balance sheet to blow up, no cash flows to dwindle, no stale inventory and no margin pressures in difficult times. There are no key manpower or supplier risks, no competitive risks, no management to squander its future. It does not depend on the character, skill, or enthusiasm of any one. It does not require the faith or good will of others. It does not require you to trust anyone at all, except that you must hold it in a very safe place.”
TBR’s raison d’etre is to serve like-minded investors by providing “a very safe place” for their bullion reserves. This mission is our single-minded focus and we are deeply grateful for your trust, which we value above all else.
In conclusion, even though our financial problems and geopolitical challenges cannot be fixed without disruption and pain, the current system badly needs changing and any genuine attempt at substantive reform would be a source of hope for a better future. As Vaclav Havel, the Czech dissident and later President, wisely observed: “Hope is definitely not the same thing as optimism. It is not the conviction that something will turn out well, but certainty that something makes sense regardless of how it turns out.” Exactly.
With best regards,
Simon Mikhailovich
PS: A cautionary tale -
Once upon a time, not so long ago, another superpower was having a hard time. After twenty years of stagnation, foreign wars, declining real wages, growing inequality and senescent leadership, the previously-effective state propaganda was losing credibility and geopolitical rivals were straining the superpower’s resources by igniting a new arms race. The country badly needed change.
Eventually, a new leader was chosen to turn things around. Although a member of the elite, he had built his career away from the capital and was not a “deep state” insider. At first, the elites did not take him seriously - they thought he was out of his depth and made fun of his plain speech and radical ideas. But the new leader was set on reforming the status quo and making his superpower great again. Externally, he sought to end foreign wars and negotiate a modus vivendi with geopolitical rivals in order to free up resources for his “huge” domestic agenda. He believed that telling the truth would restore the government's credibility and enable a smooth restructuring that would reinvigorate the system by cutting government waste, reducing regulations and encouraging entrepreneurship. He also wanted to make his citizens healthy (again) by tackling the national substance abuse epidemic.
This superpower was the USSR, the new leader was Mikhail Gorbachev, and the pillars of his grand plan were known as detante, glasnost and perestroika. As it turned out, geopolitical rivals didn’t let up the pressure and the citizen’s propaganda-addled minds could not “handle the truth” any better than the dysfunctional system could handle reform. Gorbachev tried rearranging cards in a house of cards and inadvertently brought the house down.
Something to keep in mind as we embark on our own attempt at reforming a broken system.