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Economics

Money printing: not what it was

There are lots of reasons why QE hasn’t yet created inflation in the rich West…

SO HEADLINE writers everywhere got to say money really does grow on trees today.

Gold, in fact, has been found in minute quantities in eucalyptus trees in Australia. Analyzing tree leaves and bark could now unearth gold deposits up to 30 metres below ground elsewhere in the world, geochemists say.

Good news perhaps for the mining sector. But unearthing that ore won’t be easy like picking a leaf. Making money is never cost-free. And not even money-printers are making as much profit as you might imagine right now. 

UK firm De La Rue today gave its second profits warning of the year. Weird as it sounds, there is over-capacity in note printing worldwide, it claims. That may seem hard to believe, what with quantitative easing still rolling ahead at record levels. But money printing isn’t what it used to be, even without the US Fed daring to taper its $85 billion per month. And De La Rue is lagging profit targets set back in 2010, when asset purchases with newly-minted central bank cash was hitting its stride.

De La Rue Plc is the world’s largest independent printer of banknotes. It has printed 150 different currencies over the last 5 years, and designed two-fifths of all new banknotes issued anywhere in the world since 2008. 

You might think that was (ahem) a license to print money. But volumes actually fell this year, De La Rue says, down 10% in the first half of 2013.

Surely quantitative easing means there’s more money around? Near-zero interest rates are also bringing more credit and spending to the economy, right? And what about the revival of real estate prices, most notably in UK housing but also worrying German politicians as even Berlin rents soar?

All that money, however, is electronic, not physical paper. Indeed, the central banks’ printing presses are today an “electronic equivalent” as current Fed chair Ben Bernanke put it way back in 2002. Urging the Japanese to debauch the Yen just as he’s since attacked the Dollar, Bernanke only used “printing” as analogy, however. Whereas it was paper money, not photons blinking on a bank-account balance, which fired inflation in the basket-case economy of Zimbabwe when Bernanke spoke a decade ago, and in Argentina today.

Digitized cash, in contrast, is now the real thing, as military strategist, historian and consultant Edward Luttwak noted this month in an aside on Italian gangsters. Starting in the 1990s, says Luttwak, the Calabrian family gangs pushing cocaine north into Europe as far as the new markets of the old Soviet states found their “Colombian [cocaine] suppliers refused to accept cash, because it was no good for investing in Miami real estate or local hotels or restaurants. The Calabrians needed real money: not bundles of paper but deposits in bank accounts that could be wired.”

Fact is, legitimate businesses cannot use cash. And worldwide, reckons Mastercard (with a vested interest, of course), business transactions now account for 89% of the value of payments. Consumers, meantime, are also moving away from cash (at least, outside the black economy they are; and those immoral earnings still need laundering into the “real money” of digitized bank databases in the end). As a proportion of retail transactions by number, cashless payments now make up 80% in the United States, 89% in the UK, and all but 7% in Belgium according to Mastercard. Even ignoring the plastic PR team, nearly half of UK consumer transactions are now done without cash, with currency payments sinking almost 10% by value in 2012 from the year before, according to the British Retail Consortium. The bulk of non-cash growth came from “alternative” methods, notably PayPal, with “new ways to pay and new ways to shop shaping the retail landscape like never before.”

Might this explain why consumer price inflation hasn’t taken off in the developed West? Yes, there’s lots more money around. Yes, people keep buying gold as protection. Because basic economics says this should push the general price level higher, as the value of each monetary unit is shrunk. But all this extra money sits on hard drives, servers and in the cloud, rather than in purses and wallets. That’s where money is transacted too, in intangible code. Lacking a physical presence, perhaps this wall of money loses its impact.

There are lots of other reasons you could give for why inflation hasn’t surged with the money supply. It’s all locked up in banking reserves, for instance, instead of reaching the “real” economy. Increased spending power since 2008 has gone almost entirely to the richest households, who use it to buy shares, property and fine art rather than Doritos and donuts. Or perhaps central bankers really have kept that credibility which they fought to attain after the 1970s’ inflation. Western households are now sure that the cost of living will never be let loose again.

But the birth of physical money back in ancient Greece changed our brains and our world. Coins made kings of anyone holding them, with the “universal equivalent” marking the beginning of the end of feudal society just as it created an independent yard-stick for all values – mercantile, religious and personal. This is what the myth of King Midas is about, after all.

The human brain and how it conceives of the world is being changed again by digitization today. Just ask a 20-year old (go on, ask them. Ask them anything, and see if they can answer without checking online. Ask a 45-year old come to that). Plenty of people worry that it’s all changing us for the worse, twiddling their fears about the internet by writing, of course, on the internet. Plenty of other idiots think the posthuman world will prove a new joy, with the internet’s jibber-jabber of lies, confusion and stupidity taking us back to some forgotten Eden where everyone’s views are equal. Like, y’know, in the way opinions were freely allowed to medieval peasants who couldn’t read? Today’s infotainment and readers’ comments let knowledge morph and shift just like knowledge was shared and communal pre-Gutenberg. Who needs the Enlightenment?!

Either way, perhaps our brave new digital world also revokes the iron law of money. Perhaps our flood of new cash will never end in higher living costs in the way it always has – always has – in the past. Because money we cannot touch cannot in turn touch prices as surely as paper or metal did.

Yeah right. And money really does grow on trees.

This article was previously published at BullionVault.com.

Economics

Legacy’s big one

“Hello London, this is the mayor, and this is the big one.”

– Tannoy announcement replayed endlessly over the last month to London commuters waiting for the city’s creaking transport system to cough out their train

Last the UK government backed and boosted a major export industry, we got the banking and finance crisis. This time they got smart – and spent lots of taxpayer cash in advance.

Last time the UK government backed and boosted a major export industry, we got the banking and finance crisis. This time they got smart – and spent lots of taxpayer cash in advance.

More than 7.5 million foreign tourists came to London in 2011, very nearly matching the resident population. More than a third came during the peak summer months. And given that one in twelve UK jobs “is currently either directly or indirectly supported by tourism,” as the data would claim, it makes sense – if you’ve got none – to give it all the support you can. Using other people’s money, of course. And in return for Soviet-style ZIL lanes – cleared of plebian traffic – plus VIP seats from which to ogle the beach volleyball.

“Tourism is the UK’s third highest export earner behind chemicals and financial services,” gushes the London press, “with tourists spending more than £16 billion annually and contributing over £3 billion to the Exchequer.” The Olympic games will add another £2.3 billion to that, reckons prime minister David Cameron. Albeit over four years. Dave added the hilarious claim in June that a further £10 billion will also be generated over the next four years as a result of him schmoozing foreign dignitaries to “drum up business for Britain” as well.

Net cost to the Exchequer then? Zero on the government’s maths, if not better. Which is handy, what with austerity as doomed today as chancellor George Osborne’s leadership ambitions now that the UK is officially suffering its worst economic contraction ever. Yet already, the egg-and-spoon fillip is looking frail.

Foreign sports fans heading for London, for instance – variously forecast around 290,000 and so needing to attend nine events each to take up the 2.2 million tickets they’ve been allotted – have left their bookings terribly late. The European Tour Operators’ Association said last November that advance bookings for late-July to early-September were down 90% from the same period for 2011. Even now, central London hotels are reporting summer bookings down by one-third, with August “completely dead” according to a 3-star hotelier in Paddington – right next to the Heathrow-London VIP lane on the A40.

So room rates are being slashed, further denting the tourism bump. “The Olympics is still proving to be a challenge for most hotels,” according to one hotelier. Because the regular tourists who would have come to the world’s #2 most visited city anyway “are scared away” by the expectation of crowds and premium pricing, as a tour operators’ executive says. Even theatre bookings are apparently down by one fifth from 2011.

Outside London, the same story – just with less national coverage to date. Hoteliers in the north-west of England worry that Japanese visitors will all head for London instead. What little rush for beds there has been so far has failed to break even 3 miles beyond London’s M25 orbital motorway, according to Kent’s local papers.

Still, the opening and closing ceremonies for both the Summer and then Paralympics should look awful grand, thanks to the “austerity” Tory-led coalition government doubling the budget for fireworks and cheerleaders. Choosing from a menu of jamboree costs, “We decided to go in at the higher figure for the benefit of the country,” as sports minister Hugh Robertson put it in December. The same man who admitted six months later to under-estimating the cost of signage, stewarding and crowd control by one third. So at least he got his priorities right.

What about the immediate locale of the Games themselves? You might imagine that £9.3 billion – or £8.5 billion, if not £24 billion – spent clearing, rebuilding, preparing and staffing some of the UK’s most depressed and deprived boroughs for the Olympic Games would have already flooded, not trickled onto the local economy.

Yet five years after the spending began, 2010 data show that unemployment across the five boroughs hosting the Olympics had risen from 6.9% to 7.7%, peaking above 9% in Newham. Nearly 18% of those people in work were making less than £7 an hour, peaking at 28% in Newham. How’s that for Keynesian stimulus?

Sure, things may improve for the duration of the Games. Number-one security contract winner G4S claimed in May that 40% of the 10,500 temporary staff it would hire were to come from the local area. But that was before it admitted failing to meet its own quota – apparently thanks to using just 10 full-time managers to try and run the whole thing – forcing Whitehall to draft in and billet 4,700 army soldiers as it starts arguing the toss with G4S over the contractor’s £284 million invoice.

At that price, and paying that measly £7 per hour earned by nearly 1-in-5 local workers – scarcely half the national average – the State could have given 21,000 people a full-time job for a year. For the £9.3 billion estimate of all public costs, in fact, central government could have employed 98,000 people for each of the seven years since London won the Games with its 2012 Olympic bid.

But who’s counting? Think of the tourists! And then think of the PR for Britain. Starting with our glittering transport infrastructure…

“There is a big question mark over whether [the London Olympics organizers] secured a good deal for the taxpayer,” said  one MP from the Commons Public Accounts Committee back in March, guessing a total £11 billion drain on central government in total. The MPs’ report accused the Games’ organizers of making “a finger in the air estimate” for the number of security staff needed. Either way, they’ve certainly given a one-finger salute to everyone else.

Some 70,000 people get off the train at London Bridge station each day. Seventy per cent of them do it each and every weekday, getting back on in the evening to commute home again. It’s no fun. Trust me. But next Monday evening, we get a night off. Because half of the station will be closed to these poor drones, struggling to get home as usual. Because London Bridge is being cleared to give 69,000 horse-riding fans – apparently all piling through platforms 1-6 from Greenwich Park, despite no scheduled trains stopping there – the impression that London’s transport system runs to schedule free from over-crowding or angry, over-tired natives.

This Potemkin village-on-Thames has already spread out onto some of the UK’s busiest roads, closing one lane on each of the major arteries to ordinary serfs, going about their serfdom, so that athletes and panjandrums both native and foreign can glide past en route to the mayor’s big one. The ZIL lane on the A4 starts some 35 miles west of the Olympic Park. Stray in as an ordinary mortal, and you’ll be fined £135. Because if the roads aren’t cleared, how will the International Olympic Committee ever get to East London from their Park Lane hotel?

Still, let’s not be churlish just because getting to work will be even uglier for London commuters over the next seven weeks. On Goldman Sachs’ maths, London 2012 should be a net winner for the UK economy. Here’s the hard facts:

“A significant portion of the government’s bill will be recouped through the sale of land and other facilities. However, as yet there is no publicly available estimate of the likely proceeds from those sales…

“There are also likely to be indirect (or multiplier) effects from the additional expenditure related to the Olympics…[They] could be larger than in Beijing, Athens and Sydney, when the host economies were already operating close to full capacity…

“Hoteliers, restaurateurs  and retailers are also likely to witness…additional demand from overseas visitors. However, some tourists may avoid coming to the UK because of the Olympics, and the output of other businesses is likely to suffer as a result of transport disruption…”

Could, likely, maybe. All told – and “as a central estimate” – Goldmans reckon the net addition to UK output during the July-September period, if annualized, will be worth 1.2% to 1.6% of GDP. The timing couldn’t be better! But you might have expected some of the spend to have boosted GDP while it was happening, before the Games began. And anyway, “this short-term benefit will be largely reversed in Q4,” says Goldmans, leaving the UK firmly inside its depression.

Legacy is the key thing, however. So even though “London is already a high-profile city for tourism and investment,” as Goldman notes – and so “the incremental benefit from this promotion may be more limited” – there’s no end to the happy smiling faces turning towards our bright post-Olympic dawn. At the very least, as David Cameron said in his first speech as prime minister back in June 2010, he would “make sure the Olympics legacy lifts East London from being one of the poorest parts of the country to one that shares fully in the capital’s growth and prosperity.”

Never mind that Canary Wharf, annex to London’s financial district, sits in pretty much the same spot (public subsidy: £7 billion). As does the Millennium Dome, now the 02 Arena (public cost estimated at half-a-billion). Because this time, the legacy (not vanity) project will pay off for the residents of Tower Hamlets, Newham and the rest. Yes, really.

“[The] games allow people to dream of a better life,” says 10,000-metres Ethiopian legend – and now proud mentor for security provider G4S’s young athletes support program – Haile Gebrselassie. Funny thing is, with a quarter of the £9 billion public cost being paid for by UK Lottery players – whose £1 wagers would otherwise go to the Exchequer – it’s actually the other way round. People’s dreams are allowing the Games to happen. People’s dreams of winning big for a small price, fleeing deprived and depressed boroughs, and getting better than £7-per-hour wages.

“Wang would have to work for around 10 hours just to afford to buy 1 pin badge, which retails in the UK for around £6.50,” says PlayFair2012 of a 29 year-old Chinese factory worker making London 2012 badges for Honav, an Olympics brand licensee.

“Sometimes I buy a lottery ticket and hope I get some luck,” he says. Just like the Olympic dream says.

This article was previously published at BullionVault.com.

Economics

The meaning of money

So a Dollar was still a Dollar, as Richard Nixon told US citizens 40 years ago this summer.

Whether the Euro will be worth anything next week, who can say? But since then, 15 August 1971, that’s all the Dollar has been – one dollar alone, rather than a quantity of rare, indestructible gold bullion, that “barbarous relic” of pre-Industrial superstition, and beloved of the 21st century’s fastest-growing, wealth-accumulating societies today.

Does it matter? The day before President Nixon’s announcement, only a foreign central banker could have exchanged dollars for metal, demanding gold bullion from the US Treasury’s hoard with a fistful of what were in effect receipts. (The citizen’s right to swap the Dollar for gold had gone four decades sooner, along with that freedom to own or trade bullion finally revived under Nixon’s successor, Gerald Ford, on 31 December 1974.) But now the token replaced the metal entirely, and the Dollar became the thing in itself. Instead of representing a deeper, apparently “truer” money in underground vaults, the Dollar was all.

If this risks sounding metaphysical, so it should. “By nature, my friend, man’s mind dwells in philosophy,” as Plato wrote 2,400 years ago, and money is no mere idea within our thinking. It’s part of the fabric, the alphabet of how we conceive of the world, second only – if that – to language.

Imagine there’s no money? A world without money is literally unthinkable, never mind easy. Yet here we are, barely discussing – outside a handful of websites and chatrooms – how the basis of money has utterly changed inside one lifetime.

Yes, under the post-war Bretton Woods system, the almighty Dollar already underpinned the rest of the world’s currencies – the Deutsch Mark, Yen, Franc, Peso, Lira and the rest. But until 1971, that underlying asset was merely a staging post between all those monetary units and what was still deemed the real stuff, gold bullion. Swapping, say, Sterling for Dollars, and then Dollars for gold, a central bank could in effect redeem British Pounds for US gold bullion (an ever-more attractive play during the prolonged collapse of Britain’s international credit). Closing the gold window at the New York Fed, Nixon put in train that “eliminat[ion] of gold as the common denominator” of money worldwide announced seven years later by the IMF. And without rare, tightly supplied, indestructible gold to restrict it, money has run riot since.

“With all its faults, gold does exercise the only important objective restraint upon that process of evolving a costless and limitless means of payment toward which the banking economy persistently progresses,” wrote John Henry Williams, then Harvard professor of political economy and soon to become vice-president of research at the New York Fed, in a 1932 essay, The Crisis of the Gold Standard, in Foreign Affairs magazine.

Put another way, 78 years later, “The heavy reliance on cash in most societies [still] represents a huge opportunity for banks and non-banks,” as McKinsey consultants said in a special report on non-cash transactions. By their maths, the payment-processing industry had just enjoyed its first $1-trillion year in revenues. Creamed off a global economy generating $63 trillion of business all told, that’s one hell of a rent.

Costless money has plain benefits, of course. Today’s photons and digits are no less “money” than yesterday’s wampum, paper or nickel alloy. Just much more efficient. They’re universally accepted too, unlike Bitcoin’s tragi-comic stab at creating a “new” money via the magic of computing code alone. But with no limit on money as a means of exchange, its second key function – holding its value, at least between when you receive and then spend it – looks increasingly shaky. Unlimited and costless, weightless and countless, isn’t money at risk of losing its meaning?

“The legend of King Midas has been generally misunderstood,” reckoned Nobel economist and Princeton professor Paul Krugman in a 1996 column, just as the death of gold was about to be proclaimed worldwide, together with the end of history. “Most people think the curse that turned everything the old miser touched into gold, leaving him unable to eat or drink, was a lesson in the perils of avarice. But Midas’ true sin was his failure to understand monetary economics.

“What the gods were really telling him is that gold is just a metal.”

All very true, and utterly wrong. Gold is “just a metal” on the chemist’s periodic table alone (and even there it’s unique). In every other sphere of human activity, it has always been very much more than “just” anything, bearing a religious, social and emotional power only an academic economist could dismiss. Silver too has also been used to store wealth since long before the myth of Midas, and also revered as sacred and eternal in every culture which ever mined or encountered it.

But what the legend of Midas really says isn’t about gold, however, nor greed. It’s about coined money – and how, right around its emergence sometime in 6th century BC Greece, the world was changed beyond recognition.

“However fascinating for us is the culture of premonetary Egypt and Mesopotamia,” writes Richard Seaford, professor of Greek at the University of Exeter, in his book Money and the Early Greek Mind, “it remains irreducibly alien. The earliest Greek poetry and wisdom, on the other hand, we citizens of a thoroughly monetised society recognise as…somehow more akin to us than anything from those earlier civilisations.”

How come? Tracing the role of gold and silver, gift-exchange, plunder and sacrificial rites through the writings left to us, Seaford spots “two unprecedented phenomena: the construction by individual ‘philosophers’ of impersonal cosmology, and [in tragic drama] the extreme isolation of the individual from the gods and from his own kin.” Any of us can feel those two pull on us today, in just the way that cat-headed ghouls blessing mummified souls on a pyramid’s wall do not.

Greek religion was previously built on creation myths, with all-too-human deities on Mount Olympus taking out their spite and passions on the people formed from clay below. Deep social rituals then kept things together on earth, most notably through the equal sharing of sacrificial meat on silver, copper or bronze skewers (called obols, which just happened to become the name of an early Greek coin) and the less-equal sharing of plunder and booty by war parties. Coined money ripped these certainties open, most obviously by making each man a king – metaphysically – able to turn anything he fancied into his personal treasure by presenting a round, stamped lump of silver or gold in exchange.

Hierarchy, family ties and tribal loyalties still counted, of course. But coined money cut across them more surely than a Persian scimitar. It was as a unit of account, however, and a yard-stick for the value of anything and everything, that money really fired synapses in the ancient Greek mind.

“The myth of Midas represents the reaction of the Greek mythical imagination to the novel and startling power of precious metal as universal equivalent,” writes Seaford. “[His] touch turning everything into gold expresses early Greek experience of money as a universal means of exchange.”

Money means everything in the Midas myth. He even saves himself by washing the curse off in the river Pactolus, from whose alluvial gold the first coins were most likely made. Another Greek legend attributes the invention of coinage to the real King Midas of Phrygia’s wife.

China and India also saw coined money develop around the 6th century BC, which surely deserves deeper study. The role of religion and rite in the emergence of Greek money has been noted for over 100 years. And we have plenty of what sound like our own money myths today. “The Fed believes in a strong Dollar…The ECB will not monetize government debt…I promise to pay the bearer on demand the sum of five pounds.” But these are just lies and absurdities, not parables to reveal anything useful, let alone to someone trying to understand or keep hold of their money.

Meanwhile, the meaning of money in our utterly monetized world – four decades after breaking 2,500 years of human tradition, and with its newest currency, the Euro, facing an existential crisis thanks to Athens and Rome – is less studied and more opaque than the ancient Greek myth of a king who, in yet another tale, also sprouted donkey’s ears because he upset the god of song.

How the ancient immortals would laugh! If only money hadn’t helped kill them first.

This article was previously published at BullionVault.com

Economics

Pricing the World in Gold: 4 Charts

Equities, housing, commodities and bonds viewed through the prism of what money once was…

WHAT WOULD the world look like if, as a handful of economists, investors and politicians hope, gold really was money again?

In a word, cheap…ish. Cheaper, at least, than much of it was a decade ago.

Long used (together with silver) as a means of exchange and unit of account, gold had already lost those functions by the time it ceased backing the world’s currency system in 1971. But gold retains the third function of money – as a store of value – now beating, now lagging the unbacked fiat money (i.e. created at will) which replaced it.

Since then, gold’s value has also varied more widely against other, competing stores of wealth as well as cash, amplifying the swings in its relative worth against equities, real estate, commodities and government bonds.

Perhaps you’ve seen the above chart before, for instance. Simply dividing the Dow Jones Industrial Average by the Dollar-price of gold per ounce, the Dow/Gold Ratio might sound an arbitrary yard stick. But it tracks the relative worth of US equities against an increasingly popular, if still minority store of wealth, gold bullion. Dividends are excluded, leaving just the market-price – rather than income or earnings potential – of business assets in the world’s largest economy, measured by a lump of dumb metal.

Why? Because unlike corporate equity, gold doesn’t do much. It can’t even rust, much less grow (or shrink) its return-on-capital-employed. And from the recent low (7.2 ounces per Dow unit, hit in Feb.2009), US stocks have gained 20% vs. gold. (Priced in nominal dollars, they’ve risen 73% in the last two years.) The historic low stands beneath two ounces of gold, the all-time high above forty. Today, the Dow/Gold Ratio sits just shy of nine – a little beneath its 12-decade average of ten.

Note those two lows (or rather, peaks for gold ), hit in the mid-1930s and early ’80s. Because they show up elsewhere, as well.

The average US home – a term so broad, it’s quite possibly worthless beyond the very broadest historical sweep – has averaged 202 ounces of gold over the last 120 years, at least on the data we’ve constructed from a collection of sources to cover more than a century’s worth of different housing, styles, sizes, locations and amenities.

Let’s put the methodological doubts to one side, though. Currently priced around 112 ounces, US housing hasn’t been this cheap in three decades, dropping over 75% from the 2001 high (478 ounces; the 1971 peak was 485 ounces). Returning to the very lowest prices on BullionVault’s series would see residential property lose another third. It hit 77 ounces in 1980, just above the 1934 low of 71 ounces. Whatever the national US housing stock gained in utility or comfort over that time, in short, unrusting gold priced it just as lowly amid first a deflationary and then an inflationary depression.

Commodities are a separate matter. Because they have never been cheaper in terms of gold, slumping by more than 70% since 2001, even as the much-touted “commodity super-cycle” took energy, base metal and now food prices to record highs in terms of the Dollar.

Buying commodities in the hope of growing your capital means you’re “selling human ingenuity” reckons SocGen strategist Dylan Grice, and (over the last 300-odd years) he’s got a point. Because raw materials are “generally cheaper to produce over time [as] human innovation has lowered the cost of production.” Yet ironically, Grice’s point is best made in gold, that least ingenious, least human of all pricing yard sticks. Indeed, the difference between gold-priced commodities and gold-priced stocks or housing is that raw materials failed to surge and recover their previous highs after the 1970s’ bear market. For the last six decades and more, gold has grown consistently more valuable in terms of the world economy’s natural-resource inputs.

Our chart takes the Reuters-Jefferies CRB index – a weighted basket of the 19 most heavily traded raw materials, including aluminum, crude oil, live cattle, orange juice, and gold itself – and divides it by the Dollar-price of gold. As with housing and stocks, gold’s most dramatic gains and highest valuations came during economic turmoil, outpacing the price of industrially useful natural resources even amid the severe cost-inflation of the 1970s as well as during the last four years of global financial crisis. Further back, once again, the Great Depression also saw gold’s relative worth rise sharply against raw materials, as commodity prices sank but gold was revalued higher by governments, who – then tied to its physical limits as money – were desperate to devalue currency and so reduce debt burdens in a bid to reflate the economy.

Last in our little survey of gold’s relative worth, therefore, come government bonds. There’s a problem here, because governments are constantly paying old and raising new debt, issuing bonds with a vast range of maturity dates which (unless they default) all revert in the end to par value, redeeming $100 (or £100, €100 and so forth) for every $100 originally lent by investors.

A broad price basket is hard to construct, in other words, with the various indices – such as those offered by S&P and Dow Jones – also including annual yields to give “total returns”, and only running back a few years at best.

One solution is to weigh gold’s total value against the sum total of debt outstanding – the par value of government bonds in issue. Data from the International Monetary Fund, running from 1980, at least enables us to cover the world’s “advanced” economies. And here, based on what we may as well call the “market capitalization” of gold – and in contrast to stocks, housing and industrially useful resources – government debt looks very highly priced, albeit on a mere three-decade horizon.

All the gold above-ground – swelling to some 165,000 tonnes or more today, and including central-bank reserves and that mass of jewelry used to store wealth in Asia, as well as the coins and gold bars more typically favored by Western investors – has been swamped, in terms of relative value, by advanced-economy government debt. Back in 1980, their nominal cash values were pretty much identical. Yet the doubling of gold’s Dollar-price from that year’s (then) record high, plus the two-thirds increase in above-ground gold stockpiles over the last 30 years, has still left the metal worth less than one quarter of what it was at the start of the ’80s in terms of rich-world government debt.

That debt, now 18 times larger in Dollar terms at $36 trillion, has swollen from 25% of those rich-world economies’ GDP to more than 87% of their annual output. There’s very much more of it around in 2011 than in 1980. On a relative basis – and given that the par value of debt outstanding cannot fall without default or “restructuring” – gold’s steady appreciation against equities, US housing and raw materials has barely begun to play out against government bonds.

Economics

A Moment of Clarity

Is the bond market finally catching on to the “forced risk” trade…?

AS NIALL FERGUSON never tires of reminding us, bond markets rarely react early to bad news, no matter how plain it looks to everyone else.

“In the years leading up to the First World War,” as the Harvard historian explained in 2006, for instance, “the London bond market – then the biggest in the world – appears to have become markedly less sensitive to international crises than it had been in the nineteenth century.” So despite much gnashing of teeth over the Russian/German/Yellow/Turkish threat to empire in the ever-xenophobic British press, the catastrophe of August 1914 still caught bond holders napping (holidaying in fact), oblivious to their imminent risk and the decades of negative real returns that lay ahead.

Similarly, in the 1970s, real yields – after accounting for inflation – consistently paid less than nothing, yet the bond-market sell-off only really began after nearly a decade of sub-zero returns. Bond holders again needed a lot of telling, in short. Which makes this month’s new Investment Outlook from Bill Gross – head of the world’s largest bond-fund manager, Pimco – signal.

“Central bankers have lowered the cost of money for 30 years now,” writes Gross, finally catching up with what us nutty gold bugs have long pointed out, “legitimately following global disinflationary forces downward, but also validating increased leverage [in the financial sector] via lower real interest rates.”

Today’s Fed promise of “low or negative real interest rate for an ‘extended period of time’ is the most devilish of all policy tools,” Gross goes on. Because “to rebalance debt loads and re-equitize financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders [savers and retirees] and giving it to another [bank bosses and the other finance croupiers].”

Negative real interest rates are nothing new, of course. As our chart shows, British cash savers have long suffered periodic bouts of sub-inflationary yields.

Absent the apparent noise of the first 125 years above, however – when real rates, denominated and paid in gold bullion of course, in fact averaged 3.8% per year – the last 140-odd years first rewarded cash savers, then whipped them wildly as the First World War  struck, and then denied them a balancing positive return to make up for their previous losses, right up until the start of the 1980s.

Paying the strongest real rates since the Great Depression, but without any hope of gold bullion to back its currency, the Bank of England – like the US Fed and German Bundesbank – finally got the inflation Gremlin back in the blender. Peace, general prosperity, and the “long boom” of ever-rising equity and bond prices ensued. Right up until those slowly declining real rates brought about a global financial bubble which demanded (or so policymakers believe) sub-zero real rates to fix its collapse.

What comes next? Bill Gross advises bond buyers to seek out positive real returns outside major-economy government bonds, basically recommending the “forced risk” trade which Japanese savers have long had to embrace. Other observers, fearing emerging-market volatility or default, might also want to consider hard assets. Because – and lacking all hard-money backing for currency – the common denominator between the last 10 years of rising gold prices and the inflationary 1970s remains miserable returns from other asset classes, most notably the negative real rate of interest paid to bank savings.

Here in the UK, for example, last month’s VAT tax increase, together with the zero returns still being offered to cash savers, have most likely taken the real return on bank deposits to new 30-year lows. The last time cash savings were losing value at this pace – worse than 4 pence in the Pound annualised – inflation stood at record peace-time levels, threatening to crush the economy. But the net effect today is just the same for retained wealth. With money under constant attack thanks to growth-at-any-cost policy, gold and silver are becoming increasingly attractive alternatives.

And for all the chatter about raising interest rates, seven of the nine policy-makers at January’s Bank of England meeting voted against hiking the base rate by even just 0.25%. Chief “hawk” Andrew Sentance will leave the committee in May, and with annual interest costs on the government’s debt set to double to £63 billion between 2010 and 2014 – and with a further £154bn of outstanding debt due for repayment by then as well – the political imperative for rates to stay low is clear, present and overwhelming. At the start of the ’80s, gross national debt was a fraction of today’s burden.

Bank depositors, in short, look set to continue paying for both the banking bail-out and the gently declining real rates of the last 3 decades which required it. Little wonder a growing number are opting out of official currency and national debt entirely, choosing industrial commodities and precious metals instead.

Economics

Hard Money, Soft Metal

Soft gold prices without hard-money rates? Not for long, says the world’s 40-year unbacked money so far…

JUST HOW MUCH ABUSE can soft money take? Two-thousand-and-eleven sees a big, but so far little-noted ruby anniversary. Expect to hear lots more about it as August 15th draws near.

Because that day will mark 40 years since the United States’ government finally stopped redeeming its dollars for gold. That ended over 250 years of formal “gold backing” for the West’s dominant currencies. It also took the entire world off precious-metal money for the first time in 5,000 years of civilization.

Gold wasn’t being used as money in Aug. ’71, of course. Long banished to central-bank vaults, the ageless metal was represented instead by paper notes – the medium of exchange – in purses, wallets and tills. Nor did gold bullion bars back more than $1 in every four in circulation, gradually slipping from the 40% cover-ratio set during the Great Depression. And unbacked money had also been tried many times in the past as well. Persian kings, Mongol emperors, Scottish chancers in the French court, desperate men at the Reichstag…they all thought they’d found “the secret of the alchemists”, as Marco Polo called China’s paper-note chao in his Travels of the late 13th century – and they all found it disastrous.

But irredeemable money had never been applied worldwide before, and never without some element of “hard money” (meaning gold or silver-backed notes) running alongside. Since US citizens were pretty much barred from owning physical gold, however, removing the metal from inter-government settlement looked a small, inconsequential step to most, especially next to the wage and price controls Richard Nixon also announced in his “Sunday special”. (Tricky was apparently worried about upsetting voters by delaying the latest episode of Bonanza on TV, but he was more anxious still to break the news before markets opened on Monday 16th August.)

Indeed, refusing to redeem foreign governments’ Dollars for US gold bars should have played well to the crowd. Because Nixon was defending the States’ ultimate hoard against those overseas partners who dared to doubt Uncle Sam’s promise to…ummm…redeem his paper dollars for gold. France alone had swapped $250 million for gold in “recent months”, the Financial Times reported on 5th August, helping draw the US gold reserve down to “just over $10,000m, the lowest point since the early 1930s,” as the paper said four days later.

“There has naturually been a revival of the traditional theory that when the gold stock hit $10,000m, the US would simply close the gold window,” the FT explained on 9th August, adding that “There is no evidence that the Nixon Administration plans such action,” even as the Dollar crisis continued to make its front page each day.

Slamming the window shut, just as the “theory” suggested, “We must protect the position of the US Dollar as a pillar of monetary stability around the world,” Nixon told the nation (and the world) on 15 August, 1971. But as his central-bank chairman, Arthur Burns of the Federal Reserve, had feared (“What a tragedy for mankind!” wrote Burns in his diary) the early results soon proved as awful as they were entirely predictable.

Freed from gold’s seemingly arbitrary limits, money bred so fast – everywhere – that wholesale and consumer-price inflation reached untold peace-time levels, crushing savers in both the equity and bond markets pretty much worldwide. Freed from its official peg, in contrast, gold prices rose 20-fold. The public grew so discouraged that, within a decade of Nixon’s decision, his Republican successor, Ronald Reagan, ordered a commission to consider reversing it.

But thanks to those falling bond prices, however – which came thanks to bond buyers everywhere demanding ever-higher interest rates if they were lend money for any period of time to government – Washington got to ignore the Gold Commission’s minority report, and extend the world’s experiment with unbacked money for another 31 years (and counting…).

Because by 1980, and thanks to those soaring bond yields, central bankers had already stumbled upon the solution to unbacked money’s first global crisis…

Hike interest rates so high that cash-on-deposit actually starts paying a positive real return, post-inflation. The effect on gold – and so on any thought of returning to gold-backed money – was signal, as you can see.

Over the first-half of the 1980s, real interest rates – paid over and above inflation – averaged nearly 5% per year. Major-currency savers hadn’t seen anything like it since Great Britain fought to defend (and lost) its own Sterling Gold Standard half-a-century before. And together with those desperate Gold Standard-style interest rates, the Dollar recovered something like a Gold Standard poise.

Peaking at almost 15% in 1980, the pace of US inflation then fell by more than two-thirds in the following half-decade. The Dollar gold price did the same, sliding from its (then) record peak of $850 per ounce to less than $285 five years later.

Why? Mining supplies rose, and the peak prices of 1979 and 1980 unleashed a torrent of scrap-metal supply back to market, too. But negative real rates had forced a growing number of otherwise cautious savers to abandon money for gold throughout the 1970s, just as they have again since 2001. Whereas strongly positive rates, in contrast – and positive like nothing since the scramble for gold of five decades earlier…when global bullion flows determined (and were thus targeted to maintain) international currency values – worked the opposite way. Because no one needs an inflation hedge, a defense against devaluation, when cash-in-the-bank pays 5% more. And that victory was so hard-won, the stability it brought to unbacked money continued even as real rates eased back…pretty much until they neared zero a decade ago.

Here in early 2011, cash savers and central bankers alike stand so far removed from gold-backed currency, let alone from gold-as-money itself, the idea of returning to redeemable notes seems ridiculous. But those killer rates of 1980-85 remain the only sure lesson of how confidence in unbacked money can be won back once it’s begun to dissolve. This month’s gold-price jitters, therefore, are both understandable and absurd. Most sensitive of all assets to a switch in interest-rate sentiment –and so clearly buoyed by the Fed’s repeated promise of “exceptionally low levels…for an extended period” – gold has turned 6% lower on inflation data that points higher, even as Western central banks make plain they’ve no plan of responding, and China holds its real rates some 1.5% below zero for cash savers.

Soft gold prices without hard-money rates? Not for long, we’d guess…not after faith in unbacked money has begun to dissolve. But the feint of 1975-76, however, might say otherwise.

Check the chart above. Gold prices halved even as real US rates stayed sub-zero but pushed upwards. Gold then rose 8-fold as rates fell again, finally forcing those very same hard-money rates which confidence in unbacked money demanded.