Economics

Roubini attacks the gold bugs

Earlier this month, in an article for “Project Syndicate” famous American economist Nouriel Roubini joined the chorus of those who declare that the multi-year run up in the gold price was just an almighty bubble, that that bubble has now popped and that it will continue to deflate. Gold is now in a bear market, a multi-year bear market, and Roubini gives six reasons (he himself helpfully counts them down for us) for why gold is a bad investment. Roubini does not quite go so far as to tell his readers that there is no role whatsoever for the yellow metal. Investors should have a “very modest” share of gold in their portfolios, as a hedge against extreme risks, which, the good professor assures us, are almost so negligibly small that they are “irrational fears”, really, but beyond that there is little reason to bother with gold.

Interestingly, “very modest” is indeed a good description of gold’s share in the global asset mix. According to some studies gold accounts for only around 1 percent of global asset holdings. In terms of asset breakdown we already are where Roubini thinks we should be. So why bother? Those of us – such as yours truly – who hold a more pessimistic outlook as to the efficiency of current policies and the sustainability of the current monetary infrastructure, and who accordingly hold a bigger share of their wealth in gold, are evidently “paranoid”, and as they now reap the deserved reward for their dreadful negativity courtesy of a declining gold price, why not ignore them? It is, after all, a tiny minority. But it is evident from Roubini’s essay that he not only considers the gold bugs to be wrong and foolish, they also annoy him profoundly. They anger him. Why? – Because he thinks they also have a “political agenda”. Gold bugs are destructive. They are misguided and even dangerous people.

Roubini’s case against gold

But let’s first look at his arguments for a continued bear market in gold. They range, in my view, from the indisputably accurate to the questionable and contradictory to the simply false and outright bizarre. Here is the list (with some of my commentary. Apologies to Professor Roubini.):

1)   Gold is only useful in extreme economic scenarios (such as 2008/2009) but even then its price is highly volatile (and so it was in 2008/2009).

2)   Gold is only useful when there is risk of rising inflation. Despite unprecedented policy measures, such as multiple rounds of QE, there is no inflation, according to Roubini. – Why is there no inflation?- Because the newly created money is stuck in the banking system and the wider financial system where it finances a happy merry-go round of asset trading without boosting broader monetary aggregates. Outside finance (and government, I might add) nobody wants to take on more debt. The normal transmission mechanism is not working. – Additionally, Roubini makes some heroic assumptions about there being no pricing power and no wage inflation.

3)   Gold produces no running income and will thus be at a disadvantage in a recovering economy when equities and bonds do better. – Wait a minute. Recovering economy? Where did that come from? I thought none of the monetary stimulus was getting through to the real economy and hence failed to ignite inflationary pressures? How can it then stimulate real activity? Or are the two somehow unrelated?

4)   Gold does best when interest rates are low or negative but the present recovery – recovery, again! – will allow central banks to unwind their present easy monetary policy stance and to hike interest rates. –- OK. Good luck with that. But again we are asked to take the present talk of recovery at face value. On the one hand Roubini cites ubiquitous deleveraging pressures, “lack of pricing power” and “excess capacity” (these are his words!) as reasons for why the extraordinary expansion in base money supply is not translating into money growth in the wider aggregates that usually drive the wider economy, and why therefore standard inflation measures remain benign and, on the other hand, evidently sees none of this as an obstacle to the self-sustained recovery story. — And if the economy indeed does recover without the help from easy money then, maybe, monetary policy is easy for other reasons, such as keeping an overstretched banking system from collapsing. In that case, better growth momentum as such may not be sufficient to allow central bankers to exit their present policy program.

5)   Fears of sovereign default have been driving people into gold but now the greater risk is that struggling sovereigns may sell their gold holdings. – This is potentially a risk but I would counter that while selling from official sources could affect the gold market in the short-term, liquidating the family silver (no pun intended!) and removing the remaining smidgeons of hard assets at the bottom of the inverted pyramid of the über-leveraged paper money economy and replacing it with government IOUs is not going to instil a lot of confidence on the part of the public. Gold liquidation is a further sign of stress, of a check-mated policy elite running out of options, and the public may end up scooping up willingly whatever desperate politicians sell. But I guess that reasonable people can disagree on this point. – But now it gets really interesting:

6)   In large parts the gold bull market was the work of, wait for this, “extreme” political conservatives, of the “far-right fringe” and conspiracy theorists. That hype is now coming undone. According to Roubini gold is not simply another asset but an indicator of political extremism, of an unhealthy mistrust of the established order. Roubini: “These fanatics also believe that a return to the gold standard is inevitable as hyperinflation ensues from central banks’ ‘debasement’ of paper money.” – Well, I guess it is time for the IRS to conduct a couple of customized tax audits!

Monetary policy prevents economic healing

Roubini does not provide much explanation for his claim that we are now in a self-sustained recovery that will allow central bankers to exit the extreme policy positions they adopted in recent years. He seems to rely on the healing forces of the market. I am the first to agree that these forces do exist in a capitalist economy and that they are incredibly powerful. That is why the market should always be left to its own devices, be allowed to unwind and liquidate accumulated dislocations that are now barriers to renewed growth, and to bring the economy back into balance. But these are precisely the very processes that present monetary policy sabotages with all its might: zero interest rates and unlimited bank funding, plus ongoing asset price manipulations, numb the market’s power to cleanse and heal and re-adjust, and instead allow banks and other financial operators to continue in their policy of pretend and extend, to keep on their books underperforming, bad or even toxic assets at unrealistic prices. Policy makers have to decide whether they want the market to operate its healing powers (even if some of the healing imposes near-term pain on the patient), or whether they rather trust their own powers to continuously drive the economy, imbalances and all, to higher levels of performance with their money-printing, market manipulation and deficit spending. We know which path they have followed so far, and that is why placing your hope on self-healing market forces is naïve. Strangely, Roubini himself has on numerous occasions warned against a strategy of kicking the can down the road and has repeatedly warned of new credit bubbles. I wonder which Roubini wrote this article.

At the core of Roubini’s argument is a paradox: easy money – the monetary ‘stimulus’ – is stuck in the banking industry and the wider financial system, and that is his explanation – together with excess capacity, deleveraging and the absence of ‘pricing power’ – for why the standard measures of inflation – consumer price inflation in particular – have not risen more dramatically. Unless you are a derivatives trader or a hedge fund manager you have not seen any of the money. But when you will, finally, believe me, then the prices that matter to you will also go up. Roubini cannot have it both ways: easy money has no effect on inflation but a stimulating one on growth – not even his funny New Keynesianism can square that circle.

But the real criticism of present policies is not that they will lead to instant hyperinflation – I believe they will eventually lead to much higher inflation and probably hyperinflation – but that they don’t solve anything but make economic imbalances much worse. They do not have an exit, and this is why they will ultimately destroy money. Roubini is overstating the ‘healing’ argument considerably, and in the course makes some big blunders: “Ongoing private and public debt deleveraging has kept global demand growth below that of supply.” – This is evidently not supported by the facts. As I have argued before, private sector deleveraging is minor, and in most countries, governments are issuing massive amounts of new debt, certainly in the US, the UK (contrary to what the public debate there would make you believe), and Japan.

Are owners of gold ‘extremists’?

But what is most worrying, and most disturbing, is Roubini’s pathetic attempt to label gold bugs political extremists. Central banks run policies today that only a few years ago would have set the average middle-of-the-road central banker’s hair on fire. Of course, the public is worried, scared and skeptical. Because the political and monetary elite, the establishment of which Roubini – senior economist for the Council of Economic Advisors under Bill Clinton and senior economic advisor to Timothy Geithner when at the United States Treasury Department – is a member, has lost the plot. The paper money bureaucracy has painted itself into a corner. The public has very good reasons to be worried, skeptical and scared.

Early in his article, Roubini makes the following observation: “During the global financial crisis, even the safety of bank deposits and government bonds was in doubt for some investors.” [my emphasis.] – What does he mean, for some investors? Banks did fail and governments did go bankrupt in the crisis. Was that just a figment of the imagination of some investors? – The only reason that not more banks went under (yet) and more governments went bankrupt is unlimited money printing. Unless monetary policy changes meaningfully we won’t even know which entities are truly solvent and which are not. And then we might find out the hard way.

Of course, people who are already predisposed to skepticism towards the political elite and their ongoing meddling with the free market will be more inclined to buy gold. But that only makes them libertarians, or individualists, or simply people who are suspicious of power and politics. I have met many of them and have yet to meet anyone who deserves the label ‘far right’, with all the connotations that Roubini invokes here, deliberately, I assume. — I am the first to acknowledge that the pro-gold community – and it is not even a real community – has its fair share of eccentrics but the majority of those who piled into gold is simply worried about where our unhinged monetary system will take us next – and justifiably so.

Roubini simply resorts to smear tactics. The same approach has been shamelessly employed for many years by Paul Krugman. The idea is to unilaterally determine the acceptable parameters of enlightened economic debate. The high gospel of John Maynard Keynes is not to be questioned, and the wisdom of having highly-trained academicians running a central bureaucracy in charge of monetary policy, administratively setting interest rates, creating bank reserves at will, and manipulating the prices of a growing number of assets to the benefit of the greater good, a system that not only did not exist 50 years ago but that back then nobody even advocated, is not to be challenged under any circumstances. Those who do are not worthy of debate. They are evidently members of the Montana Militia. They are crackpots and dangerous subversives. As Roubini stated: advocates of a gold standard are fanatics.

This is, of course, utter gibberish. A well-articulated, rational and sophisticated theory exists for why paper money systems are unstable and why they fail, and why hard money systems work better. The Austrian School of economics explains this convincingly. Its leading intellectual light was Ludwig von Mises (1881 – 1973) – urbane, sophisticated, highly intelligent, and a man of principle, one of the greatest economists of the twentieth century, who lived and taught in Vienna, Geneva and New York. – Not your average backwoodsman.

Roubini may be right on one thing: maybe gold will go down to $1,000. So what? – It won’t stay there. For whatever happens next to the gold price, or whatever the Fed does next, Roubini’s over-geared paper money economy will not survive in its present form.

In the meantime, good luck with that ‘exit strategy’!

This article was previously published at DetlevSchlichter.com.

11 comments to Roubini attacks the gold bugs

  • Paul Marks

    Let us go to the basics.

    This 400 tons of gold that was sold (in a few minutes) to reduce the gold price in April – can Nouriel Roubini please PHYSICALLY SHOW this gold.

    If there is no fraud involved, if this 400 tons of gold (the gold that was sold to reduce the paper price of gold) exists, surely Nouriel Roubini will have no objection to people SEEING this gold?

    Where is this physical gold?

  • Roubini looks at gold as strictly an investment with an anticipated return, as do those whose trades create the “volatility” he mentions. The “fanatics” have a different view of the possibilities of the survival of the current fiat money regime. The price of gold is the pari-mutuel betting on the outcome.

  • Michael Swaby

    I have read and heard Roubini before, without realising he is quite so daft.
    Gold per se is not volatile, it is today’s money that is unstable. It is unsuitable as a unit of account.
    Gold produces no running income, but only because it is not being used for its intended purpose.
    As for the “self-sustained recovery”, it will last until interest rates rise, the next bank crash, or the next threatened sovereign default, whichever comes sooner.
    Roubini’s comments are very much those of a trader, not a sage.

    • mrg

      “Gold per se is not volatile, it is today’s money that is unstable”

      It’s true that today’s money is unstable, but gold’s purchasing power is also undeniably volatile.

      The GBP price of everyday items at the supermarket stays fairly stable throughout the year (rising slowly but steadily).

      By contrast, the basket of goods you can buy for a given amount of gold fluctuates wildly from month to month. On the 26th of March a tenth of an ounce would have bought you £106 worth of food; by the 15th of April that same tenth of an ounce would only buy you £89 worth.

      Obviously things would be different if gold were money, but as things stand, it’s not.

      • Craig Howard

        By contrast, the basket of goods you can buy for a given amount of gold fluctuates wildly from month to month. On the 26th of March a tenth of an ounce would have bought you £106 worth of food; by the 15th of April that same tenth of an ounce would only buy you £89 worth.

        That’s only because you are converting gold into Sterling to make those purchases [a point you later admit]. On the other hand, let me point out that, in 1973, an ounce of gold would purchase about 12 barrels of oil. Today it would buy about 13 barrels of Brent Crude.

        Now, that’s stability.

  • James

    Roubini’s been bearish on gold for at least the last four years (see: http://www.businessinsider.com/roubini-gold-has-topped-2009-6) during which time the price is up by $400+ per ounce.

  • Paul Marks

    Surely the “fanatics” are people who support a system where government spending is about half the entire economy, and where huge deficits are fianced by Central Banks creating “money” from NOTHING so that (de facto) governments can buy their own debt.

    Fanatics such as Roubini himself.

  • Paul Marks

    A very good reply Craig Howard.

    If someone wants to look at gold – they should look at GOLD (not convert the gold into fiat money – and then look at how much stuff the fiat money buys). The only honest way of looking at gold (or silver or….) is to get a certain WEIGHT of physical gold (of a certain purity) and see what goods and services this weight of physical gold can get. And I have never found any private person who has turned up their nose at being paid in physical gold.

    By the way – I notice that noone has answered my question about that 400 tons of gold that was “sold” to reduce the price of gold in April.

    Where is this gold?

    Show it to me.

  • Michael Swaby

    mrg is correct, in that in the current highly unsatisfactory situation, the nominal price of gold, like everything else, is all over the place. I feel that this proves, rather than disproves my point that it should be used as money.
    Under the form of gold standard known as the Bretton Woods system, not only was gold itself stable, but so also were other crucially important assets like oil and property.
    I would argue that, in today’s world, instability itself is a huge and growing problem, and that fiat money is the cause.

  • I was hesitant about buying gold when it dropped recently. I saw Roubini’s article and realising he was a Keynesian Mystic, increased my holding by a third. It’s not a case of what is the gold price but the weight.

    By the way, no economy needs ‘growth’. That is like a company wanting turnover. An economy needs to get back into ‘profit’ – Not spend more in taxes than it raises and these should be low to encourage the profit motive (not the profit motive of socialists who want their fair share of what is yours) and production.

  • Paul Marks

    abolishincometax is correct – in all he says in this comment (good name as well).