The Great Dollar Short Squeeze

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Gold prices pulled back today, but that may only be a temporary situation if one expert is right about the dollar short squeeze. Daniel Oliver of Myrmikan Capital said in a note this week that the value of the U.S. dollar is being held in place by a short squeeze, which is only temporarily holding gold prices back.

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He expects gold prices to eventually soar into the “multi-thousand dollars per ounce,” although he doesn’t expect a smooth ride to get there.

Dollar short squeeze restricting gold prices

Oliver said one of the fatal flaws of the current monetary system is that it creates money in the form of debt. The lower the interest rate is pressed by the massive piles of credit, the easier it becomes to hold debt, and the more debt entities will take on.

He explained that there is about $7 trillion in base money in the market right now, but that must support a massive $90 trillion in debt and related interest payments. He added that when the short squeeze breaks, the market will look to the Federal Reserve‘s balance sheet to see what backs the dollar, and that’s where gold prices come into play.

In January, the Fed had $4.2 trillion in liabilities that were 10% backed by the gold on its balance sheet. Gold prices were at $1,550 an ounce at the time. Oliver said gold prices would have had to rise to $5,000 an ounce to reach a one-third backing of the balance sheet at that time.

The market has required a one-third backing of the Bank of England’s balance sheet for centuries. To reach a 54% backing of the Fed’s balance sheet, gold prices would have had to climb to $8,500 an ounce. The Fed maintained a 54% backing level from inception to 1933 when then-President Franklin Roosevelt made it a felony to hold gold.

After the latest rounds of quantitative easing and gold prices at $1,800 an ounce, the yellow metal only backs the Fed’s balance sheet by 6.8%. Gold would have to hit $8,800 an ounce to back one-third of the Fed’s balance sheet.

Oliver said in January that due to the worsening quality of the Fed’s assets, the ratio will reach much higher than one-third when the market finally turns on the central bank.

More printing on tap

This week he said he expects the Fed to keep printing money. He noted that the sudden inflex of $5.5 trillion into the market has stabilized financial conditions, but it has also caused inflation. He explained that the inflation it has caused isn’t the way inflation is measured by the Fed.

The CPI Inflation number has a 42% weighting for housing, while transportation is another 15% weighting. However, people can’t eat their cars or house, and food prices and other real living expenses are what have been rising.

He added that at some point, investors will demand higher interest rates to make up for the increases in the cost of living. Unfortunately, the economy can’t handle higher rates right now, so he said the Fed will have to “act more forcefully.”

Gold prices and the end of the dollar short squeeze

Oliver also talked about yield-curve control, which New York Fed President John Williams said in May is being considered by the Fed. Oliver pointed out that the Fed committed to the Treasury to buy enough bonds to hold rates at 0.5% on short-term bills and 2.5% on long-term bonds to fund World War II.

The Fed wrote in a paper during the 2008 financial crisis that the practice between 1942 and 1947 provided evidence that the Fed can cut long-term rates by committing to keep short-term rates low. However, Oliver added that what’s lost on the Fed is that in 1942, the Fed’s liabilities were 84% backed by gold, which amounted to one-quarter of the global supply.

He added that the central bank could spend its capital controlling bond yields if it chose then, but it can’t today. He said if inflation takes off, and the market rate for Treasuries rises above the Fed’s targets, it will have to buy the entire stock just to control rates. While the Fed could do that, it would also bring the end of the dollar, Oliver added.

What will happen to gold prices?

When a currency is debated, gold prices increase, but he said volatility also increases when that happens.

“It is unlikely (though possible) that gold will simply leap into the multi-thousand dollars per ounce without some sickening lurches lower, throwing some off the trade,” he wrote. “Those who weathered the trough and are playing with profit are well positioned to withstand the emotional trials that such volatility brings.”