Dear Prime Minister

Mar 26, 2020·Alasdair Macleod

This is an open letter to Boris Johnson about the inflationary consequences of the global action against the coronavirus with which his government is conjoined, and the policies he will have to implement to protect the pound from a collapse in its purchasing power.

Dear Prime Minister

An exit strategy from the domestic and global monetary debasement arising from the combined economic effects of the coronavirus and a downturn in the credit cycle

Clearly, you have little or no alternative to your policies to rescue the nation from the coronavirus plague currently afflicting all nations. While it is common to describe it as a war, a more apt description would be it is like a civil war, driving people apart with lasting social consequences. But least understood by nearly everyone are the consequences for money and credit and how to remedy them, which are the subject of this letter.

At the outset, I should iterate the importance of understanding the inevitable consequences of expanding the quantities of money and credit. There is much evidence that they are not fully understood by economists at the Treasury and the Bank of England. You, as someone who instinctively appreciates the importance of free markets, even having quoted the nineteenth century French economist Frédéric Bastiat on occasion, will understand the economic consequences of extending government control over the private sector. But I’m not convinced your advisors understand the monetary consequences.

The role of money as a destructive force for the economy has come about through an accumulation of repetitive policy failures. Through fractional reserve banking a regular cycle of bank credit expansion followed by sudden sharp contractions has been the feature dominating economic activity in England and Wales ever since the Napoleonic War and was legitimised in Sir Robert Peel’s Bank Charter Act of 1844. And because Britain with her empire dominated global finance in the decades that followed, fractional reserve banking was adopted as the international banking standard.

It was to deal with this error that the Keynesians sought to simulate the economy to limit the fallout from what economists mistakenly refer to as the business cycle, which is in fact the consequence of the boom and bust cycle of bank credit. The means of neo-Keynesian stimulation has become increasing deficit spending by governments coupled with the virtual destruction of voluntary saving in favour of boosting immediate consumption. This lead to the progressive replacement of sound money policies, particularly since the 1920s by inflationism.

By the time you became Prime Minister, the inflation of money and credit had become a continual feature over the whole credit cycle. While the Treasury attempted to balance its books over the cycle, the Bank was supressing interest rates and encouraging the creation of money out of thin air through the expansion of bank credit. Some time ago the justification had become an objective of full employment consistent with a CPI growth target of 2%. While presumably minutiae of prices are less of a personal concern for you, everyone else will confirm their personal experience that real-world prices are rising at a far faster clip than the CPI’s 2% target. The US uses a similar standardised CPI method of calculation to target 2%, but two credible independent statisticians by different methods show that the rate of price inflation in America is closer to 10% and has been for some time.[i]

That being the case, while the inflation numbers will continue to be suppressed by statistical method, there is an acute danger that the pound’s purchasing power will be even more noticeably undermined by your Treasury’s new policy of deficit spending, both to deal with the coronavirus fall-out and the investment promises in your election manifesto. In the absence of a resurgence of personal savings, it can only be financed by monetary inflation and increases in bank credit. So great are the numbers and so implausible official price inflation statistics that at some point financial markets will no longer buy the statisticians’ Kool-Aid and rate financial assets in line with monetary reality.

Furthermore, these events follow a period of rapid expansion of US dollar-denominated global debt following the Lehman crisis. The period since Lehman accords with the expansionary phase of the current credit cycle. A decade of monetary expansion in the reserve currency and similar expansions in other major currencies, combined with the US policy of trade protectionism against China when taken together are similar to the policies that led up to the Wall Street Crash in October 1929. On 30 October that year, Congress passed the Smoot-Hawley Tariff Act which jacked up US tariffs by an approximate average of 20% (President Hoover signed it into law the following June) from the Fordney-McCumber Tariff Act of 1922. This time is different, in that US tariffs have been predominately targeted at just China, and therefore are not as draconian as Smoot-Hawley. But the credit and monetary expansion since the Lehman crisis is far greater in real terms than that of the 1920s.

If there is a synergistic effect between monetary and trade interventions, for which there is some compelling evidence, then not only are we witnessing a major deflation of the stock market bubble, but even without the economic effects of the coronavirus we are probably heading for a repeat of the 1929-32 Wall Street crash. And lest we forget, that was followed by the depression years.

Therefore, evidence from the credit cycle informs us that when the coronavirus has abated, far from a return to business as usual we face not just an economic slump, but one that reflects the accumulations of the monetary and trade distortions since the Lehman crisis, and to the extent previous distortions persisted through that crisis, the accumulation of those as well.

As a separate issue we must consider the consequences of consumer demand being deflected from the bulk of CPI constituents into the essentials for personal existence. Doubtless, statisticians will still manage to put a goal-sought lid on a 2% rate of price inflation for the benefit of monetary policy planners, but at some stage the evidence of inflationary experience will persuade foreign holders of sterling and the investing public that the currency is the problem. If and when the general public reach that conclusion, the pound will, without the right policies, rapidly lose purchasing power.

The pound is not alone. For decades, the dollar has been used to inflate financial asset values to create a wealth effect, and a managed decline in interest rates has led to dollar-denominated bond markets being overvalued for the facilitation of government borrowing. The realisation in bond markets that for domestic purposes the dollar’s purchasing power is not losing 2% annually but approximately 10% on independent assessments exposes them to being badly mispriced and therefore due to fall heavily. The trigger is likely to be sharply higher prices for food and other essentials. The US Government’s finances, along with the UK’s, will then be exposed as untenable.

Only this week, proposals have been brought forward by President Trump’s administration to give $1200 to each adult and $500 for each child as part of a $2 trillion coronavirus relief package. Given that the retailers open for business are food stores, supermarkets and pharmacies, the inflationary effect on prices for essentials are bound to be acute, making the timing of a collapse of US Treasury bond prices more immediate.

There is compelling empirical evidence for how this will play out. Exactly three hundred years ago in France John Law had established a prototype central bank in the Banque Royale, which issued currency out of thin air to puff the shares of his Mississippi venture. He planned to merge the bank with the venture on 28 February 1720. Despite his efforts, and doubtless not helped by the King deciding to release 100,000 shares at 9,000 livres ahead of the scheme of arrangement, the purchasing power of his unbacked livres began to fail, followed by the Mississippi share price. By September 1720, the shares had fallen to a fraction of their former highs, and there was no exchange rate for Law’s livres. In other words, the currency had become worthless and shares in the venture with it.

Historians tend to view John Law’s scheme as an ill-founded episode, without seeming to realise that today’s reliance on inflationism as a means of maintaining financial asset values differs in the detail but has disturbing similarities. So similar, in effect, that we can credibly expect that on unchanged monetary policies, i.e. unlimited monetary inflation, today’s fiat currencies will not exist in a year’s time.

The initial course of events

So far as I’m aware, such an outcome is completely unexpected, even by monetarists and long-standing critics of inflationism. But the initial steps towards it can be foreseen to a degree, and I would suggest they will occur in the following approximate sequence over the next month or so:

    1. Not only will the British economy switch from supplying consumers with the widest range of consumer goods demanded, but all other advanced economies will experience a similar shift to consumption of essentials only. Imported food prices will inevitably rise, and our some of our trading partners might even restrict exports of fresh food in an attempt to protect their domestic supplies. As a nation which imports roughly half its fresh food, Britain is likely to see food prices rise significantly before local produce becomes more freely available in the early summer.

     2. Consumers’ jobs will be on hold, and despite government promises of help, uncertainly over the future is bound to severely restrict demand for durable goods and other spending that can be deferred or abandoned. You may or may not be aware that roughly eighty per cent of employees in the UK live paycheque to paycheque and do not have accessible savings to help ride out the crisis. The initial slump in activity is therefore likely to exceed even pessimistic expectations.

     3. The collapse in financial asset values has already commenced. Besides the very public fall in share prices, the economic damage at this stage is acute in corporate bond markets with interest rate spreads widening dramatically, driving formally healthy businesses into junk status. Consequently, the overall mind-set in markets is no longer an unquestioning optimism that the authorities are in control, and therefore the crisis in financial asset values, including those used by the banks as loan collateral, will worsen.

    4. Business failures will rapidly escalate, not just through a catastrophic loss of consumer demand, but due to the previous accumulation of debt burdens to record levels. Despite efforts by your Chancellor and the Bank of England to persuade banks to keep lending, bank credit will have an overwhelming tendency to contract as bankers try to contain lending risk.

     5. Company directors are becoming nervous of potential personal liabilities if they continue to trade in the knowledge that their businesses are insolvent, and auditors may be unable to sign off accounts for 31 March year-ends due to prevailing trading conditions.

     6. Further tranches of monetary expansion will soon be needed to support these failing businesses by providing banks with the liquidity to maintain revolving credit facilities. But this is unlikely to stop the banks from withdrawing credit from customers deemed to be risky, predominantly SMEs. Furthermore, there will be an increasing problem of payment dislocation in production chains for goods and services which the Bank will have to address if it is to continue with a policy of rescuing the economy by monetary means. This alone could become the largest monetary commitment (see #8 below).

     7. Undercapitalised European banks will face a shock increase in their illiquidity, requiring unlimited support from the ECB, which has separately committed to buy eurozone member states’ added debt arising from the coronavirus’s economic impact. If failures of illiquid undercapitalised banks commence in the eurozone, there will be counterparty issues arising for UK-regulated banks, and some may need to be bailed out. The risk of a global banking crisis starting in the eurozone and spreading outwards should not be underestimated. A collapse of the eurozone’s banking system and the knock-on effects in other jurisdictions can only be prevented by yet more monetary inflation from the ECB as well as by the other major central banks, including the Bank of England.

     8. The Federal Reserve Board (the Fed) in America is already fighting a major liquidity crisis in the repo market, that appears to emanate partly from payment failures in domestic and foreign supply chains. As is the case in the UK, the coronavirus is wiping out consumer demand for non-essential goods and services, and therefore for the majority of US business output. Payment failures in supply chains for both goods and services will amount to a figure not limited by GDP, but will be a significant portion of gross output, which reflects the payment chains in production rather than the final values captured by GDP. The US gross output measure stands at nearly $40 trillion. And that is before taking into account semi-manufactured imports which depend on dollar payments outside America, of which Apple’s supply chain extending into China and South-East Asia is the obvious example.

     9. The immediate portfolio effect of recent developments has been to drive financial liquidity and global investment funds into dollars and US Treasuries, being the risk-free investment standard. But those who think foreign demand for dollars will continue to drive the dollar’s exchange rate higher fail to recognise that foreign ownership of dollars and dollar assets is already high, totalling some $25 trillion, significantly more than US GDP.[ii] To gain liquidity, foreigners will almost certainly sell down dollar assets, giving the Fed an extra burden of managing the absorption of foreign-owned Treasury bonds as well as funding a rapidly expanding US Government budget deficit.

     10. In noting its dubious history as a reliable currency relative to dollars, foreign holders of sterling will increasingly sell it in the foreign exchanges, either for dollars or for their currencies of accountability. The contraction of bank credit in all currencies will be a major factor in the reduction of holdings of foreign currencies, a process that has already started with sterling falling from US$1.35 in December to as low as US$1.15 last week.


Let us take stock of the position outlined so far. Roughly by mid-April, it will have become obvious that the domestic UK economy and that of her trading partners are in a deep economic and financial crisis that cannot be resolved by a post-viral return to normality. Shortages of fresh food and other essentials will begin to drive up their prices, and we should expect exports by our trading partners of fresh food to be restricted, leading to higher prices for all foods as people substitute canned, dried and frozen goods for fresh. Your government’s pledge to pay up to 80% of employees’ wages and to underwrite much of the private sector’s expense will be extremely costly. In addition to noting the precariousness of our national finances, gilt yields are bound to take their cue from the US Treasury bond market. The yield on US Treasury bonds will begin to rise, initially reflecting the market’s appreciation of the sheer quantity of bonds to be issued both in the US and globally. This will be followed by the liquidation of existing dollar portfolio and bond investments by foreign holders.  Perhaps being alerted by rising food prices, dollar-based financial assets will be further undermined by a growing realisation the dollar is losing purchasing power at a far greater rate than officially admitted. Gilt yields are bound to mirror these developments, making gilt funding more expensive and damaging to the nation’s finances than currently anticipated.

The probable collapse of the currency and financial markets

It is in the nature of financial markets that they reflect an initial shock before a pause in the collective evaluation of future prospects. Today, we all depend on financial markets in one way or another, and the motivation for misplaced optimism after markets have stopped falling will be high. But it would be a mistake to read into any such pause that the crisis is over.

If such a pause occurs, it will be almost certainly be followed by the consequences of the initial phase outlined in the nine points listed above. What then follows will be the effect on prices of the monetary expansion proposed so far and anticipation of yet more monetary debasement to come.

The end-purpose of inflationary financing in all welfare-driven states is to finance government deficits. The new burden on governments from rising welfare costs and expenditure commitments in connection with the coronavirus will be unprecedented in peacetime. Governments in all advanced economies will coincide in their increasing funding requirements. Meanwhile, genuine savers are a rare quantity, having been taxed and inflated into insignificance, and so for practical purposes nearly all of the increase in government debt will be financed by the inflation of money and bank credit. The size of central bank balance sheets will balloon to many multiples of their current size.

To sum up, monetary inflation is being committed to address the following issues, admittedly with some overlaps:

• Excess government spending in connection with the coronavirus

• Government promises of monetary distribution to support businesses and prevent unemployment.

• Budget deficits arising from falling tax revenue and rising welfare costs.

• The increase of base money replacing the cyclical contraction of bank credit.

• The costs arising from the temporary nationalisation of parts of the private sector deemed essential to the national interest during the epidemic.

• Support and rescue of the banking system.

• The provision of liquidity to ensure supply chain payment flows throughout the economy are met in order to prevent widespread insolvencies throughout the private sector. 

Presumably, your advisers in the Treasury and the Bank of England believe that the funding required can be achieved at the low bond yields prevailing in capital markets, and that by means of quantitative easing the Bank can set the prices at which government debt is funded. In the short-term this may be true, but the recent fall in the dollar-sterling rate should serve as a warning it will not be that simple.

At some point market participants will question the impact of monetary expansion on prices, and with prices for food and other essentials rising they are unlikely to accept the CPI as a valuation reference point. Foreign holders of sterling assets are always the first to note sterling risk, with which rising gilt yields are bound to be associated.

Given the combination of all these factors both here and abroad, bond yields will almost certainly rise dramatically, and if the secondary market for US Treasuries begins to reflect the true rate of US price inflation, that would cut the price of a 10-year US Treasury currently priced at par to below $50. That and a similar move for gilts would expose the extent of the debt trap ensnaring both the US and the UK.

Resolving the currency problem

We can now begin to see how the fates of unbacked fiat currencies, including both for the US dollar and the pound, have become entwined with those of financial assets, which have now entered vicious bear markets. The similarities with John Law’s experience in France three centuries ago are alarmingly clear, when his livres took only nine months to collapse. Future students of economic history will probably realise that the cast-iron welfare commitments of today’s governments and their increasing reliance on rigged bond markets to fund them is a John Law experiment writ long and large on a global scale.

That being the case, all fiat currencies that tie their fortunes to the dollar as their reserve currency, including sterling, are at risk of losing all utility by the end of this calendar year, assuming similar timescales to the Mississippi collapse.

Notwithstanding the requirement to underwrite the economy at a time of immense difficulty the currency can be prevented from a total collapse in purchasing power, but it will require a full return to sound money and all that it entails. Sound money is gold, chosen with silver by economic actors as the most stable and suitable medium of exchange over millennia. The contrast between a relatively static above-ground stock and a state-issued currency which can be expanded at will accounts for its soundness and desirability as trusted money.[iii]

The benefits of gold, or the return of sterling as a credible gold substitute[iv], will be found to be a practical solution when the cost of funding government borrowing in sterling’s unbacked form is higher than it would be if the currency circulated as a gold substitute. The cross-over point is likely to be somewhere between a gross redemption yield for long-dated or undated gilts of perhaps between three and five per cent, depending on how credible sterling as a gold substitute is in the context of Britain’s financial stresses.

The point is that without stabilising the currency in this way, the higher the cost of government funding will rise, and in the absence of genuine savers the higher the rate of monetary inflation will be required to fund it, a process that leads inexorably to the extinction of all value. It will not be long before first the foreign exchanges and then the general public will abandon the currency as being on a path to worthlessness.

Therefore, the first urgent recommendation will be for the Treasury to add to the national reserves sufficient bullion to back the currency for its return to a fully exchangeable gold standard, where for practical purposes it operates as a gold substitute.

There is a strategic imperative as well. Russia has already abandoned the dollar as its reserve currency and rebuilt its gold reserves. As a major gold producer, it is likely to have undeclared holdings of gold as well. Similarly, China with substantial undeclared gold bullion and widespread gold ownership in its population is well placed to escape a global fiat currency collapse.[v] It should be noted that the central banks that have actively accumulated gold in the main are either members and future members of the Shanghai Cooperation Organisation or have strong trading ties with Russia, such as the central European states.

Your government should recognise the implications of Halford Mackinder’s prophecy when he advanced his heartland theory in 1904 and 1919,[vi] which informs both Presidents Putin and Xi in their partnership. By stabilising their currencies while the dollar collapses, America will have lost the financial and trade war against these powerful nations, and adequate gold stocks will become necessarily a strategic asset for Britain as well as a stabiliser for sterling.

Assuming the Americans cling to their dollar in preference to capitulating to a gold exchange standard, the choice will inevitably boil down to saving the alliance or saving the pound.

Debt considerations and future policies

We must assume that counterpart to most of the expansion of the money supply will be the Bank of England’s acquisition of gilts through quantitative easing. Following the coronavirus and the subsequent economic slump, in real terms national debt levels are likely to be on a scale relative to that which followed the Napoleonic War.

We can learn lessons from the brightest minds of that era. They built upon the polices of a previous Prime Minister, Henry Pelham, who in the 1750s consolidated government debt into undated 3% Consolidated Annuities. During the Napoleonic War, finance was raised by issuing further tranches of this and other Consols at a discount to par value to yield the prevailing market cost of borrowing. For example, before Waterloo, this would have entailed issuing 3% Consols at 60 to give a yield of 5%. Investors who were prepared to back the government in those uncertain times by buying Consols were rewarded with a capital gain after victory and when the gold standard was reinstated. Much of the wealth created by this financing strategy was invested in post-war industry and innovation and became the foundation for Britain’s remarkable prosperity. And a point which is often missed is that because Consols were undated there was no requirement to repay or refinance them, relieving the government of that burden.

Today, a similar gilt funding policy can be made to work when sterling returns to a credible gold standard. But it would also require a radical change in government attitudes, particularly with respect to its role in the broader economy and future debt financing.

If it is to observe the disciplines of sound money, the government must shed the bulk of the burden of the welfare state. The current policy of wealth redistribution must be abandoned in favour of allowing individuals to accumulate wealth, and to return to an ethos of saving. You must remove all taxes on savings and capital. Only then can the capital be created for the economy to progress towards better living standards for all.

Such a radical realignment of government policies should not be impossible, when it will be obvious to the wider electorate that socialism and unsound money do not just cripple the crony capitalists, but have impoverished themselves as well.

Other safeguards for the future will have to be enacted. To prevent banks from stoking a credit cycle by the creation of bank credit, they must be segregated into two distinct functions: deposit taking institutions acting as custodians, and arrangers of finance as agents[vii]. Keynesian debt finance theory must be abandoned, and all neo-Keynesian economists and econometricians cast into the wilderness. The former are little more than latter-day John Laws. And as for econometrics, Sir John Cowperthwaite, who with a few other post war cadets in Hong Kong rebuilt its economy from total destruction put it, statistics are used as ammunition by those who want to justify more government intervention.[viii]

I think Prime Minister, I should leave it at that, though there are other issues that follow. I believe you will have an advantage that Winston Churchill lacked when as Chancellor of the Exchequer in 1925 he introduced the Gold Standard Bill. He had the disadvantage of a backdrop of a rising tide of socialism, making it impossible to implement sound money policies and make them stick. Like Calvin Coolidge in America, he also failed to appreciate that the inflationary actions of Benjamin Strong at the Fed and Montague Norman at the Bank of England would ultimately destabilise their economies the following decade.

You can use the impending economic and financial crisis to take the electorate with you away from socialistic inflationism on a journey to sound money and lasting prosperity for our nation.

Yours sincerely

Alasdair Macleod

Head of Research, Goldmoney.


[i] See and

[ii] See US Treasury TIC figures. The total is comprised of $19.4 trillion in securities including equities and bonds with maturities of more than a year and $5.6 trillion of securities maturing in less than a year as well as bank balances and deposits through the correspondent banking system.

[iii] It might be presumed that my motivation as an associate of Goldmoney’s is to promote gold. My motivation is to promote an understanding of the benefits of sound money compared with the pitfalls of unbacked state currency. It just happens that sound money is gold.

[iv] The definition here of a gold substitute is a currency fully backed by gold and freely exchanged for it. It differs from a gold standard where currency is freely exchanged for gold but the quantity of money in circulation exceeds the gold available for exchange. In practice, a gold standard will be adopted but it must have the credibility to pass for a gold substitute.

[v] Chinese legislation in 1983 appointed the Peoples’ Bank with sole responsibility for managing national gold and silver reserves. By 2002 sufficient gold bullion in state ownership had been accumulated for the authorities to permit private individuals to accumulate gold and the Shanghai Gold Exchange was established. Based on withdrawals from the SGE vaults, it is estimated private sector ownership amounts to about 17,000 tonnes. China is also the largest miner of gold by far and now dominates physical markets.

[vi] The Geopolitical Pivot of History, (The Geographical Journal – 1904) and Democratic Ideals and Realism (1919).

[vii] There is no reason for arrangers of finance not to invest their own money alongside other investors. The point is their funds must not appear on their balance sheets.

[viii] Obituary, Daily Telegraph 25 January 2006.

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