“Debasement” is an ugly word. The definition is “the action or process of reducing the quality or value of something.”
Currency debasement has a long history, from the practice of reducing the precious metal content in coins to modern monetary policies that involve printing money to finance debts. Roman emperors diluted gold and silver with base metals. Modern governments have printed huge amounts of fiat currency, leading to hyperinflation.
It’s not a good sign when the financial press begins to discuss current market moves in terms of the debasement trade. It means that investors are losing confidence in fiat currency. The fact that the USD index is stable shows that all the central banks are suspected of collaborating with governments to finance unsustainable deficits.
https://www.wsj.com/economy/central-banking/gold-price-central-bank-28eac30f
Gold Rally Points to Eroding Faith in Central Banks Worldwide
In Japan, as in the U.S., a new leader wants the central bank to make government debt more bearable, which could feed inflation
By Greg Ip, The Wall Street Journal
…
It turns out the U.S. isn’t the only country where massive debts and populist politics threaten the value of “fiat” currencies like the dollar—i.e., those backed by nothing tangible—and the central banks that issue them….
Gold’s rally has come in several stages. The first began after Western nations froze Russia’s foreign currency reserves in the wake of its full-scale invasion of Ukraine in 2022. Central banks and foreign governments, in search of something that adversaries couldn’t seize, began piling into gold.
The second came this past April with President Trump’s trade war, which undermined faith in the U.S. as a stabilizer of the global economic system and the dollar’s pre-eminent place in that system.
The third began in late August, when the Federal Reserve signaled it would cut rates to counteract weak labor markets, despite inflation running above its 2% target….
Gold’s rally is starting to look like a speculative frenzy. Wall Street has dubbed it the “debasement trade.”…
A simple formula determines how sustainable that [government] debt is. When the average interest rate on that debt is below the nominal growth (i.e., unadjusted for inflation) of GDP, debt tends to fall as a share of GDP. When the interest rate is higher, that ratio tends to rise….
In a new report, Morgan Stanley noted that across developed markets, “In the last year, on average, nominal growth has slowed, cost of debt has risen, and deficits deteriorated—a triple whammy for debt sustainability.” It predicts that by 2030, the average cost of debt service will equal growth rates. Preventing an explosive rise in debt would require a sizable budget surplus excluding interest—i.e., steep spending cuts or tax increases. That is proving politically unpalatable….
Trump thinks there is an easier way to lower deficits: Get the Fed to lower rates and thereby make servicing the debt cheaper. When central banks shift their priority from inflation to helping the Treasury, it is called fiscal dominance, and it usually leads to inflation…. [end quote]
Fiscal dominance is really the beginning of the end for a stable currency. The government spends more than the economy can support. The bond market demands higher interest rates to compensate for the risk of inflation and potential default. So the central bank buys the debt from Treasury to suppress interest rates. That eventually leads to inflation, a collapse of confidence and even higher interest rates.
TIPS, which show the real yield of Treasuries, can be used to mitigate the risk of inflation. Currently, the 10 year TIPS yield is trending upward after a downward move that was related to the Fed’s cut in the fed funds rate.
Trump undermined the trust in government statistics by firing the director of the BLS because he didn’t like the employment numbers. It’s easy to picture Trump ordering the BLS to publish falsified (understated) inflation numbers which would reduce government expenses by reducing the COLA for Social Security. (Not to mention the political impact of high inflation numbers.)
One of the fund managers quoted in the WSJ article said, “You know what? I now see gold as a safe harbor asset in a way that the dollar used to be viewed.”
That “used to be” will be the downfall of the U.S. economy if it becomes entrenched.
Debasement is a loss of quality, of integrity, of trust. It would mean the loss of U.S. world leadership and much more hardship at home.
Wendy