Book Review: The Big Reset by Willem Middlekoop

Summary

• Middlekoop provides readers with a broad history of banking and money before discussing the unsustainability of the current Dollar-based global financial system.


• He argues that we are close to a tipping point at which actions by politicians and central bankers cannot prevent this debt-laden system from a game-changing restructuring: a "big reset".


• He proposes numerous scenarios which all mean the end of the Dollar's reserve currency status.


• While he doesn't provide investment advice, it is clear that Middlekoop is bearish of bonds and fiat currencies, and bullish of hard assets.

I recently had the opportunity to read through Willem Middlekoop's

The Big Reset

, a title I came across after reading Duane Poliquin's - chairman of Almaden Minerals (NYSEMKT:

AAU

) -

blog

. I read the book on his recommendation and it turned out to be such a good one that I went through twice.

While the language and structure is fairly simple, this is actually a fairly complicated work with a lot of references, and had I not come into it with a lot of knowledge of money, banking, gold, and debt, this would have been a difficult read. But as it turns out I was quite pleased to find that it was a succinct summary and bibliography of my views.

The book is divided into 6 chapters which are again subdivided into very short sections that are a couple pages each. Middlekoop essentially does four things in this book. First, he provides readers with a history of money, banking, debt, and the Dollar. Second, he argues that the current monetary system is unsustainable given the amount of debt that has accumulated relative to the size of the global economy. Third, he shows what central bankers and politicians have done in order to miraculously maintain the Dollar's reserve status despite the fact that we have been off the gold exchange standard for 43 years, 11 days. Fourth, he concludes by saying that a new financial system is inevitable and proposes some scenarios that our political and financial leaders might wind up implementing.

Let's look briefly at Middlekoop's argument.

1--The Historical Context

One essential element in demonstrating the fact that the current debt based fiat money system is unsustainable is to demonstrate that

such systems have failed in the past

. Banking and money go back thousands of years. So does currency debasement. Middlekoop explains how, for instance, currency debasement in Ancient Rome - whereby the government replaced silver with base metals in the coins it paid to soldiers - coincided with the fall of the Empire. He further shows how this process started out slowly and imperceptibly until it spiraled out of control,

much like a modern-day hyperinflationary scenario

. The following graph shows the silver content in the Ancient Roman Denarius.

Readers of my work that share my interest in the gold market and my skepticism in the long-term value of the Dollar have probably seen a similar chart of the Dollar's value since the Federal Reserve's inception.

The fact that we have seen seemingly countless currency collapses and debasements throughout history, coupled with this chart, gives us proper perspective regarding Middlekoop's point that the current Dollar based global financial system is unsustainable.

Middlekoop goes on to explain how currency debasement seems to be the norm throughout history. Governments often start by having a gold or silver backed currency such as the Dollar in 1944 or the Roman Denarius 2000 years ago. But for good reason this is restrictive, as it means that governments cannot spend more money than they take in. Governments wishing to spend more than they have use their power to debase money or to dub paper money as valuable by fiat, a practice first initiated in China.

As time went on, we saw the development of modern banking - i.e. fractional reserve banking - emerge from the gold smith business when gold smiths realized that they could issue more claims on gold than their total reserves on the assumption that at any given time most of the gold that they held for clients wouldn't be redeemed. This led to a very lucrative business model that grew to the point that wealthy bankers wanted to lend this money to governments, which had the power to tax its citizens. It also led to economic theories similar to Keynesianism and the idea that governments and bankers could generate economic prosperity by increasing the money supply. Middlekoop recounts the story of John Law - an 18th century Dutch businessman who convinced the French King - Louis XIV - to give him a monopoly on currency creation similar to that of the Feds today. By increasing the money supply he created prosperity in a struggling France.

But he also created a massive bubble which inevitably burst

.

This is an all too familiar story that we have seen throughout history from the stock market bubble of the 1920s to the housing bubble of the early 2000s. Easy money and an increase in the money supply generates near-term prosperity that enriches many people who in turn laud their "brilliant" politicians who wind up being pariahs. John Law was effectively banished from France. Herbert Hoover and George Bush became pariahs and among the most hated presidents in American history as these bubbles burst on their watches.

Ultimately, this historical context shows us what we should expect going forward - governments and bankers can create temporary prosperity by manipulating the value of the currency,

but this inevitably ends in disaster

.

2--The Dollar Is No Exception

While this hasn't happened with the Dollar yet, it is inevitable. Since Bretton Woods and the end of World War 2, the United States has been the most powerful nation on Earth and the Dollar has been the world's reserve currency. The rest of the world accepted the first point given America's military might, and the second on the condition that the Dollar would be backed by gold, which it was. But since then the U.S. has abused its reserve currency status by borrowing more money than it can ever hope to pay back.

We've reached the point where foreigners are largely unwilling to finance our enormous debt and where this debt load has engendered skepticism regarding the Dollar's value. As our historical context has shown us this is to be expected.

3--The Cover-Up

Where we have a deviation from history is in the ingenuity that politicians and bankers have displayed in covering up the inevitable demise of the Dollar. The Dollar was officially taken off the gold exchange standard in 1971 and 43 years later it remains the world's most important currency.

Middlekoop discusses how this can be the case at length, but basically there have been two strategies: finding new buyers of Dollars and Dollar-based assets

and gold price suppression

.

Comment:

Lately, this gold price suppression has been accompanied by a policy of financial repression.

Financial Repression

is a term that describes measures by which governments channel funds to themselves as a form of debt reduction, measures such as:

• Caps or ceilings on interest rates


• Government ownership or control of domestic banks and financial institutions


• Creation or maintenance of a captive domestic market for government debt


• Restrictions on entry to the financial industry


• Directing credit to certain industries

Let's start with the second strategy. Middlekoop actually devotes an entire chapter to the topic of gold price suppression and for good reason. Despite talk over the past several decades that gold is a barbarous relic, it has been and remains central to the global monetary system. The Bretton Woods agreement was only accepted because the Dollar was backed by gold with American politicians - led by the plan's mastermind Harry Dexter White - hoping that the gold backing would be forgotten.

As Americans took advantage of the reserve currency status in the late 40s and through the 50s, some foreigners, notably the French, were becoming skeptical that the Americans couldn't meet their obligations. This was true, but at the same time the Western world was heavily invested in the success of the Bretton Woods system, and so the first attempt to preserve it was a joint effort. As foreigners accumulated Dollars, they began to redeem them for gold. As you can see on the following chart, this led to a rapid depletion of America's gold reserves starting in the mid 1950s.

This started to put upward pressure on the gold price despite the fact that it was technically pegged at $35/oz., and as a result the London Gold Pool was set up. This is a topic I discuss

at length

, but in short 8 central banks acted in concert until 1968 - when France balked - to maintain the $35/oz. gold price.

After the London Gold Pool failed, the $35/oz. level was maintained for 3 more years before Nixon denied Britain some gold in exchange for Dollars, and on August 15th he imposed capital controls and defaulted on the Dollar's gold backing.

Since then the U.S. has done an amazing job of retaining faith in the Dollar, although the gold price is up 3,500% since that time.

Gold price suppression has been a continued tool for supporting the Dollar. This has taken two forms. The first has been talking down the importance of gold. The Americans and interested Western powers have not been buyers of gold, and their officials have openly spoken out against gold's importance to the financial system. As Middlekoop points out, there have been laws restricting pension funds from owning gold, laws against banks recommending gold as an investment, and other similar measures that keep gold out of the mainstream financial discussion.

We have also seen a substantial amount of gold leasing whereby central banks lease gold out and justify doing so by claiming that they can earn some interest on what is otherwise a dead asset. They conveniently forget to mention that they don't differentiate between gold and gold receivables on their balance sheets, and so to an outsider looking in it appears as if there is more gold on central bank balance sheets - and by extension in the world - than there actually is.

The second means by which the U.S. has kept the Dollar afloat is by getting foreigners to buy Dollars and to trade using Dollars. Since the value of a currency, or any asset for that matter, depends on both supply and demand, you can increase the supply of an asset without decreasing its value so long as you can keep demand up. America's great breakthrough on this front was Henry Kissenger's ingenious petrodollar idea, whereby he convinced Saudi Arabia, and eventually other OPEC nations to trade their oil only in Dollars. This creates an enormous global demand for Dollars and it has kept the Dollar from totally collapsing in value.

4--The Big Reset

These measures, however, were only temporary. While the gold price remained in a bear market for the 1980s and 1990s thanks to the aforementioned policies, we have seen a new secular bull market. While the price has corrected over the past few years in the broader scheme of things, this is hardly a trend reversal, as the following chart - courtesy of Middlekoop - illustrates.

In addition to a rising gold price, we have also seen several oil producing countries try to get out of the petrodollar system.

Saddam Hussein and Muammar Gaddafi wanted to trade oil in Euros and in a gold-backed North African currency, respectively

. These leaders' fates, and the fact that the American military was brought into both Iraq and Libya upon these developments speaks to the fact that the Americans, who are now desperately trying to hold the Dollar system together, were having none of this.

More generally all of this speaks to the fact that the Dollar's role as the world's most important currency is waning, and quickly at that.

We don't know how the transition is going to play out, and we don't know how the new system will look, but Middlekoop does propose some ideas, and there are some aspects that are relatively constant. Two in particular are increases in the role of gold and in the role of the Chinese Renminbi in the new financial system. The two are interconnected. The Chinese have been accumulating gold and have become the world's leading producer of gold despite the fact that they don't export any of it. The PBoC along with Chinese citizens are accumulating gold, and while the amount is down in 2014 over 2013 - a point that bears are quick to point out - this misses the bigger picture, which we can see in the following chart.

Even a sizable decline in 2014 demand puts it multiples above where it was just a few years ago. We have also seen a rise in bilateral trade agreements between the Chinese and its trading partners, whereby these countries are agreeing to trade in their own currencies (e.g. Renminbi, Australian Dollars, Brazilian Real, and so forth). China has even bought oil with gold from Iran,

demonstrating that gold is, in fact, still money despite the propaganda arguing to the contrary

. In fact, Middlekoop points out statements from Chinese officials that indicate that they are well aware of the shenanigans that are going on in the gold market, and while Middlekoop doesn't discuss this point, there have been allegations that the Chinese are complicit in gold price suppression efforts so that they can accumulate the physical metal at a lower price.

The Chinese have also suggested that the Euro could play a significant role in the new global financial order

. The EU is China's largest trading partner, and despite all of the troubles we have seen in Europe over the past few years, the Euro has outperformed the Dollar considerably since its inception, and this is in part due to the fact that it is taking on an increasing role as a reserve currency.

So, while we don't know the specifics, we do know that the new financial order will feature gold, the Renminbi, the Euro, and the Dollar in a more limited role. Whether we get there suddenly or gradually, with or without war, in 5 years or in 15 years is up in the air, but they are all possibilities.

Conclusion

I found this to be a phenomenal book given how Middlekoop is able to succinctly outline such a complex topic. As somebody who was admittedly familiar with a lot of the topics found within, I was still able to get something out of the way that Middlekoop puts the ideas together. And last, but not least, he provides readers with an extraordinary bibliography that will probably keep me busy for years.

While

The Big Reset

contains a lot of ideas that people don't want to hear, they need to hear them.

People are far too invested in the current financial and political paradigms and it leaves them without perspective of the broader picture. Once you can take a step back and realize how seriously flawed the current system is then your existing investment and political paradigms (stocks vs. bonds or Democrat vs. Republican) will be shattered

. I can't say definitively that this is a book capable of giving you that perspective because I've already started from a place where I find these paradigms to be relatively useless as an investor and as

homo politicus

, but Middlekoop is a clear writer with a wealth of information, and this is a book that every intelligent English speaking individual should read