Gold pumped 15 trillion in a year! A revolution in money supply is coming, the Federal Reserve (FED) QT has been completely offset.

The Federal Reserve spent more than two years on QT to shrink the balance sheet by 2.4 trillion dollars, resulting in gold's market capitalization expanding by 15 trillion dollars in just one year, leading to a dramatic change in the modern monetary supply system. Traditional banking theories have failed to keep up with the times because they overlook two counterexamples: cross-border capital flows and the substitution of assets like gold for fiat. At the beginning of 2024, the London Spot gold price was less than 2,000 dollars, and it has now skyrocketed to 4,200 dollars.

The Failure of Traditional Currency Theory: Why Interest Rate Cuts Harm U.S. Stocks

Generally speaking, traditional banking theory strongly relies on fiat debt expansion. In this system, on one hand, the central bank expands excess reserves, and on the other hand, commercial banks expand credit, leading to the inflation of fiat debt scales such as loans and bonds. Ultimately, we will observe the expansion of deposits and the expansion of risk asset prices (assuming that risk appetite remains unchanged, i.e., the residents' willingness to hold cash/risk asset ratio).

This theory is indeed classic, so the vast majority of people adopt this framework to analyze problems. Thus, there are two undisputed inferences: The Federal Reserve (FED) expands its balance sheet to stimulate risk asset prices; The Federal Reserve (FED) cuts interest rates to stimulate risk asset prices. However, this theory is really too old and even somewhat out of touch with the development of the times. For example, this theory strongly relies on fiat debt expansion. However, in the real world, there are two counterexamples: cross-border capital flows and assets like gold serving as substitutes for fiat.

The effects of cross-border capital flows reveal a contradiction. We can view the US system and the non-US system as two commercial banks, where the flow of existing currency strongly depends on the interest rate differential between the US and non-US systems. It is evident that if the interest rate in the US system is higher than that in the non-US system, there is a tendency for deposits to migrate to the US system. If the money supply relies on incremental fiat debt, then low interest rates are favorable for increasing the money supply; if the money supply relies on the cross-border flow of existing currency, then high interest rates are favorable for the money supply.

The traditional model implies an assumption - that the impact of cross-border capital flows is weak, and that the vast majority of central banks will align with the Federal Reserve (FED). However, this assumption has now broken down. Since 2022, the Federal Reserve (FED) has rapidly raised interest rates, while China's policy rates have remained low, leading to a misalignment of monetary policies between China and the U.S. According to traditional monetary banking theory, U.S. stocks should be in a bear market, while A-shares should be in a bull market. However, the result is exactly the opposite. This indicates that the effect of cross-border capital flows is primary, while the stimulus of low interest rates on fiat debt expansion is secondary. China's credit growth rate has continued to decline during this period, and the real issue for most people is that they have misunderstood the relationship between policy rates and housing prices.

Gold 15 trillion inflation: Safe-haven assets reshape the money supply

The development of modern financial instruments has led to a variation in the form of money supply. The popularity of all-weather strategies that are essentially “shorting cash” has made hedging assets such as gold, gold contracts, BTC, and BTC contracts increasingly strong alternatives to cash. Consequently, the pricing formula for risk assets has undergone a variation:

Traditional Formula: Risk Asset Price = Cash Size × Risk Appetite

Modern Formula: Risk Asset Price = Cash Size × Hedge Asset Coefficient × Risk Appetite

It is not difficult to see that under the modern monetary supply system, “hedging assets” occupy a central position. They can completely bypass the constraints of “cash scale” — the constraints of The Federal Reserve (FED) — by increasing the hedging asset coefficient to inflate the prices of risk assets. Currently, the global M2 is approximately at the level of 123 trillion dollars, and the market capitalization of gold is about 30 trillion dollars, so the inflation of gold prices will indeed significantly change the global monetary supply mechanism.

At the beginning of 2024, the spot price of gold in London was less than 2,000 USD, and it has now soared to 4,200 USD. In other words, the market capitalization of gold has nearly inflated by 15 trillion USD in the past year. What does this mean? The Federal Reserve spent more than two years conducting QT, shrinking the balance sheet by 2.4 trillion USD, and as a result, gold has inflated by 15 trillion USD in market capitalization in just one year. Therefore, the modern monetary supply system has undergone a dramatic change.

The “savings” inflation mechanism of gold is extremely clever. In the traditional model, the increase of fiat currency relies on the increase of fiat debt, which is a very costly form of money supply, as borrowers must continually pay high interest rates. In the new model, the expansion of decentralized currency does not rely on the expansion of fiat debt but solely on the expansion of decentralized currency prices. This is a very clever way of expansion, with no increase in fiat debt, only a change in the concentration of gold holdings.

The Mechanism of Collective Rise in Gold Prices

Average holding period of central banks: greater than financial institutions, and financial institutions greater than individuals.

Herding Effect: Central banks selling US dollar debt to replace it with gold, significantly raising gold prices.

Unlimited Characteristics: As long as there is a reason for central banks worldwide to continue increasing their gold reserves, prices will keep rising.

Theoretically, the rise in gold prices caused by central bank solidarity has no limits. Gold prices are not driven up by retail investors, but rather by central banks and large financial institutions. It is not difficult to see that as long as there are incentives for central banks around the world to band together in gold, then “the rise in gold prices” will become a new source of monetary supply, competing with The Federal Reserve (FED) and the U.S. government for global minting rights.

Debt Magic: Shifting Support from US Treasuries to US Stocks

The behavior of central banks in various countries banding together around gold may superficially lead to a depreciation of the dollar, as central banks have swapped reserves from U.S. Treasury bonds to gold. However, according to the pricing formula for risk assets, the inflation of gold's market capitalization will result in an increase in the “hedge asset coefficient,” which strongly supports the rise of U.S. stocks, ultimately causing the dollar to strengthen due to this mechanism.

For any economy, the essence of the exchange rate issue lies in the fact that the migration rate on the liability side is higher than that on the asset side. Specifically, this means that domestic currency deposits are more easily converted into foreign currency deposits, but domestic currency government bonds do not have such high cross-border liquidity, so the country has to rely on foreign exchange reserves to smooth out the discrepancies. However, the rapidly rising US Treasury bonds have changed this situation, as central banks around the world have increased their gold reserve ratios, leading to a decrease in the cross-border migration rate of US bonds, and ultimately the uniqueness of the dollar has diminished.

On the surface, it appears to be a deadlock. The United States can only implement financial tightening once to restore international investors' confidence in U.S. Treasury bonds. However, the elites on Wall Street have come up with a more clever way, riding the wave of central banks increasing their gold holdings to further boost the price of gold. Thus, a situation of “losing something in the east and gaining something in the mulberry” has emerged—although the attractiveness of U.S. Treasury bonds has decreased, the appeal of U.S. stocks has increased. In other words, even though central banks are replacing U.S. Treasury bonds with gold, leading to a depreciation of the dollar, the liquidity released by rising gold prices has propelled the increase in U.S. stocks, guiding foreign capital inflow and stimulating the appreciation of the dollar.

The U.S. government is willing to see the prices of safe-haven assets rise, injecting cheap funds into the system. Overall, during the entire process, the support pillar for the dollar has shifted from U.S. Treasury bonds to U.S. stocks, from central banks of various countries to international investors. The rise in the prices of safe-haven assets such as gold has played a crucial mediating role. When U.S. stocks enter a bear market, international investors will once again consider U.S. Treasury bonds as a desirable asset. In other words, this transition benefits the U.S. government in managing its debt.

Through the cost differences of three tools - “fiat debt > interest rate hikes > gold price increases”, we can derive a kind of debt magic - driving risk assets up through interest rate hikes and the expansion of safe-haven assets, and completing debt exchanges with overseas investors during the process of rising risk assets. When the tide goes out, some overseas investors are locked into expensive fiat debt, and the tragic experiences of these unfortunate ones will serve as a warning to other investors, prompting them to re-evaluate the value of long-term US Treasuries.

Counterintuitive conclusion: Interest rate cuts harm the stock market and gold saves the market

We should not be constrained by the specific form of currency; instead, we should directly examine the ultimate result of currency expansion—the inflation of risk asset prices. In other words, as long as risk asset prices are rising, we consider currency to be expanding; as long as risk asset prices are falling, we consider currency to be contracting. Through this “liberation of thought,” we will not be bound by traditional illusions such as “interest rate hikes” and “interest rate cuts.”

The actual supply mechanism of currency is more complex than we imagine. Currency expansion can come from fiat debt expansion or from cross-border capital flows induced by interest rate hikes; the rapid expansion of safe-haven assets such as gold can also drive up the prices of risk assets. Thus, we have three tools that stimulate the rise of risk assets: fiat debt expansion, domestic policy interest rate hikes, and rising gold prices.

Comparison of Costs for Three Currency Expansion Tools

Fiat Debt Expansion: The most expensive, requiring domestic governments, businesses, and residents to take on long-term debt.

Domestic policy interest rate hike: Secondly, the overall debt maturity is relatively short.

Gold Price Increase: The cheapest and purest way to stimulate, just need the central banks of various countries to band together.

Finally, we will arrive at the following basic conclusions. Rather than saying these conclusions are counterintuitive, it is more accurate to say they contradict the “classic monetary banking model”: The Federal Reserve's interest rate cuts are detrimental to the U.S. stock market. As the federal funds rate continues to decrease, funds will ultimately flow back to non-U.S. assets on a large scale; the continuously rising gold prices are beneficial to the U.S. stock market as they expand the hedge asset coefficient, offsetting the negative impacts of the Federal Reserve's interest rate cuts; when both the ten-year U.S. Treasury yield and gold prices are declining together, it is the most dangerous time for the U.S. stock market, as the original flow of funds is reversed, and the entire system faces significant chaos.

The ultimate conclusion is that the ten-year U.S. Treasury yield and the federal funds rate will fall together, and the U.S. debt crisis will ultimately be resolved. Only when the tide goes out do we see who is swimming naked, but we need to thoroughly study the tide. On the surface, Powell is a hawk, but in reality, he is a dove; on the surface, Trump is a dove, but in reality, he is a hawk. The biggest expectation gap in 2026 will be the new dove who can no longer be a dove FOMC, doing hawkish things in the name of being a dove. We will miss Powell.