If you have been reading this blog for any length, it should be clear that we try to arm you with the facts and warn you about current and future economical dangers. We also show how precious metals can protect your family from those dangers. Today, we will discuss a not-well-understood element of high finance, posing one of the most significant portfolio threats we have ever discussed. The risks we will discuss today dwarf the coming collapse of the Petrodollar agreement, which seems to be almost guaranteed economic Armageddon.
Hold onto your hats. Today we will discuss a potential economic nuclear bomb preparing to detonate: the international currency market, also known as the foreign exchange market (FX). In their quarterly report, the Bank of International Settlements (BIS) warned that banks and pensions have more than $80 trillion of off-the-books high-risk dollar swaps. (pages 76-82). In comparison, the financial crisis of 2008 was nearly $10.2 trillion in distressed assets. We are talking about an international risk eight times the size of the build-up to 2008.
The off-the-books swaps represent more than twice the recorded debts, and most analysts may not even know of their existence. The report says, “Currently, in order to assess the level and maturity structure of foreign currency gross and net debt, analysts tend to rely on benchmark international statistical collections, which generally cover only the on-balance sheet positions. It is not even clear how many analysts are aware of the existence of the large off-balance sheet obligations. This makes it difficult to anticipate the scale and geography of dollar rollover needs” (P.79). In other words, policymakers cannot regulate or set policy on the debt and Dollars they can’t see. Considering their track record, what could go wrong with bankers and pension managers holding $80T of unrecorded, high-risk debt instruments? In a word, everything. Let’s dig into it.
Who is the BIS?
The Bank of International Settlements (BIS) is considered the central bank to central banks. The BIS mission statement is “to support central banks’ pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks.”
What is Happening?
FX and currency swaps have special accounting permissions which don’t require cash involved recorded until settlement. The BIS estimates at least $80T worth of hidden debt, which poses a significant threat to the system. The $80T-plus outstanding debt obligations are recorded off the balance sheet creating a blind spot for policymakers and more than double the debt recorded. The $80T is mostly short-term debts and totals more than combined by the U.S. Treasury bills, repo, and commercial paper markets. Putting $80T into further perspective: the U.S. housing market is worth around $42T.
Since these are short-term swaps, liquidity is paramount. The challenge is that the market is squeezed easily during hard economic times. In 2008 and 2020, the FX swap market developed liquidity problems and became a flashpoint. Borrowers had to pay high rates to borrow Dollars, if they could borrow Dollars at all. The BIS conducted a survey earlier this year. It found $2.2T of $7.5T daily transactions pose a high settlement risk, which means there is a growing liquidity problem in around 30% of the market.
What Does it Mean?
History may not repeat itself, but it usually rhymes. Bankers don’t have an excellent record of integrity and restraint. In 1907, bankers speculated wildly on copper, leading to the panic of 1907 and, ultimately, the creation of the Federal Reserve. Bankers engaged in risky derivatives and dishonest practices leading to the Great Depression. Bankers created the savings and loans crisis of the 1980s. Bankers made high-risk loans and manipulated the mortgage-backed-securities market leading to the Great Recession of 2008. These are only a few examples of bankers’ greed leading to financial ruin for countless people. They are at it again, but the numbers are more significant than all previous times, and there is no oversight this time.
Maybe things will be different this time because they have supercomputers, teams of analysts, and the lessons of history to reel in their worst instincts. Let's hope they are all super smart with impeccable integrity for our kids, grandkids, and great-grandkids. However, hope is not a strategy, and it is probably not appropriate to think only good outcomes are possible. There are too many examples of questionable banker behavior in typical markets. What behavior should we expect when times are tough and the widespread acceleration of liquidity issues due to inflation and rapidly rising interest rates?
The problem is that the numbers are so substantial. It would only take a small number of incompetent or bad actors/transactions to turn the global economy into a dumpster fire covered in gasoline. The current economic situation shows a 30% chance of FX swap defaults, representing at least $2.2T at risk daily. As the economic pain grows, default likelihood will also continue to grow. One or two significant defaults would send shockwaves through global markets. It seems inevitable that a handful of transactions will fall apart as rates continue rising and nations try to protect their currency positions.
Eventually, a major economy (probably Japan) will no longer be able to manage its liquidity needs. Around this time, owning physical assets like precious metals could be the most important financial decision you have ever made. The reason is that every war is fought over resources. As countries and populations face more profound economic challenges, desperation becomes a variable. Desperation leads to desperate actions, i.e., trying to take things by force or war. War is the fastest way to grow an economy but also the fastest way to destroy one.
History has repeatedly shown that war is the best way to change the reserve currency. One result of WWII was that the Dollar became the reserve currency. The BRICS nations want to overthrow the Dollar hegemony and use Russia's war in Ukraine to do it. Four days into the Russian invasion of Ukraine, I warned Russia was not trying to conquer Ukraine. Instead, they were going to draw out the conflict to draw the U.S. into a spending frenzy to put inflation pressure on the Dollar. Unfortunately, it appears I was correct.
Wars are expensive. They lead to debt, which for the U.S., means even more printing. The U.S. may be increasingly entangled in more wars and proxy wars to defend its dominant position. Russia is using the lessons of history. The U.S. seems to be ignoring them.
When the reserve currency changes, the Dollar will collapse. A new currency will take its place, and Dollars won't be able to buy it. Instead, people will need something with intrinsic value, like real estate, commodities, or precious metals, to purchase the currency. Since most people won't want to give up their house or store oil in their garage, precious metals will be the best option to buy the new currency.
Are you using the lessons of history or ignoring them? Will you be prepared when history rhymes again?
Call the U.S. Gold Bureau