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By Adrian Ash, on 15 December 11
The markets are telling us that there is a painful abscess in Europe, with the Euro at its core, writes Paul Tustain, founder and director of BullionVault.
We believe it is driving Germany and France a little mad, and that they are abusing their European partners as a result. They are about to commit an injustice which will strip away the profound goodwill which they have built up over 50 years, and they risk tearing Europe apart.
All our European friends are today irritated by Britain’s refusal to come with them. Not for the first time we are the odd man out, and being pointed at by the shallowest politicians in Europe. It’s OK. We can live with a little name-calling for the moment, and we look forward to quietly rebuilding our friendships with every one of you in the future. We hope it will be soon, although we fear it may not be.
You are right. Our British financial system contributed – in part – to the mess we are in. But you are wrong as to the reason and the solution.
What really happened is that over a period of years the political classes in New York and Europe (including the British) worked together to hold down the cost of credit. Ever since 2001 western politicians suppressed the will of the market to enter into a mild recession. What is this ‘market will’? It is the combined message from a thousand million transactions a day, expressing the free choices of 400 million people. Looming recession is the evidence that free people think it sensible to cut back a bit.
In 2001/2 that’s what western people chose to do. But the politicians wanted them to go on spending. “Put off recession to ensure re-election” said their advisors. How? By making central bank money available cheaply to the banks.
Of course we agree that bankers’ bonuses are a problem which badly needs addressing. But politicians, not bankers, created the febrile and ultimately ruinous deal-making atmosphere of 2004-2006. They skewed the economic landscape by continually releasing funny money from the central banks, and opposing the tendency to mild recession which was the judgement of the market; that means our judgement.
Politicians created a world where the only bankers who could keep their jobs were credit addicts. The villages around London are full of redundant and cautious 60 year old bankers who lost their jobs when their natural risk-aversion allowed credit-fuelled junior banks to win all the business, take them over, and clean out the old guard. Easy, state-sponsored credit found its home under the control of inexperienced and overenthusiastic bankers. They thrived only because politicians had skewed the economic landscape in their favour.
Yes, we can blame ‘the free market’ because those who acquired credit got it freely in trade with a supplier of credit. But to take this line is to wilfully misunderstand what the market is. The market is your freedom to choose. The marketplace is what you get when one billion purchasing decisions are made every day by 400 million individuals who are exercising free choice. The problems occur when people exercise those choices unwisely, which they will certainly do if they are being pushed and shoved into purchasing decisions which suit politicians seeking re-election.
Ever since 2007 the market – that is everyone who has made a choice about it – has been waking up to the deep contradictions within the Euro. Gordon Brown (let’s give him some rare credit) was one of the first. He had understood that no-one was asking the key question of how the Euro could hold together when the weaker nations were bound into union with the extra-ordinary productivity of Germany.
In Europe nothing so simple as an awkward question is allowed to get in the way of government progress. They marched forward regardless, and now the pesky market is expressing the opinion of a billion votes a day that the Euro is going to fail. Why? What went wrong?
This did. The false market in borrowed money which the politicians created back in 2002 made money accessible mostly to people who were a good risk to lenders – which means mostly older, richer people. To begin with they bought houses, which dragged the price up to impossible levels for first time buyers. The money continued to be pumped in by the central banks. Next to bubble was investment assets, and once again it suited those who were already wealthy. Poorer people got to keep their jobs, but investment assets, the bedrock of a retirement income, were becoming ever more expensive, making nice capital profits for richer people but yielding less and less in income. So it was again profiting those who already had money, and condemning hard-working people to a lifetime of slog, crowned with a tiny pension.
Yet whenever the government looked at the numbers there always seemed a risk that if they took their foot of the monetary accelerator the economy would stall; and it would have. So still the money was pumped in, and now bond yields descended to 1.5% as their values bubbled (a bubble which remains un-pricked) and hundreds of billions started accumulating at the banks.
Houses and a comfortable retirement were by now out of reach of hard-working, deserving and particularly younger people. But the enemy was not the free market, still the only practical embodiment of their freedom; the problem was the corruption of the market by monetary politics.
It was the irresponsible and self-serving policy of elected representatives – seeking re-election all over the western world – which is without any doubt the root cause of the explosion of credit which we now have to pay for. Politicians have hoodwinked you if you believe ‘the market’ or ‘the bankers’ are at fault, and you should not be taken in. The market is not a thing you can meaningfully blame. It is simply an expression of a billion private votes cast every day in what appears to both buyer and seller to be sensible and private trade, under the prevailing conditions set by the politicians. The problem was the prevailing conditions set by the politicians, not the mechanism of the market which was, as it always is, simply an expression of the judgement of free people.
But still easy money aggregates to richer people, not poorer ones, and we had ended up with an enormous pile of their savings. It had already bought houses, and investments, and still more kept on coming. Eventually vast quantities accumulated at banks, and for want of remaining opportunities it was lent to underfunded governments. As it turned out this was extremely unwise, because those governments are now threatened by default. That always looked possible, because none of them could keep up with German economic growth.
Bad lending happens from time to time. Usually it means the creditors lose their money, and gain some wisdom. Only this time some of the creditors – particularly Germany and France – don’t want to lose their money. Rather than see their banks suffer they want to force two or three generations of Greeks, Irish, Portuguese, Italians, Spanish and Belgians to pay, pay, pay. Germany and France lent stupidly to your father, yet you become the indentured slave.
That should never be how bad money-lending is resolved. The lender should take the hit when the borrower cannot repay; it helps to focus his mind before he lends. In Britain we got rid of inter-generational debt servitude 200 years ago, and it is not progress to return to it.
But default now would be particularly bad for German and French banks, so our European friends are deluding themselves that what is at fault here is ‘the market’, which is why they are trying to devise ways to tame it. What they want to do is to stop it from making its judgement against the Euro, so that they can follow on with their agenda, controlling first one market, then the other, and always with the officers of Brussels making the decisions which are ordinarily made by people exercising their free market choices. The current European plan is to disenfranchise your judgement upon them by making the financial marketplace somewhere which is too expensive for you to cast a vote, because it will be taxed by them.
Right now they have the financial services market in their sights. If – they reason – they can stop those votes being cast in the marketplace then they can carry on doing what they do (which obviously must be right) and no-one and nothing will hold them to account.
To be fair that is not their conscious intention. They are simply trying to repair a difficult situation of massive debt. But they are failing to make the intellectual connection between free choice and markets. That is a common weakness in governments, and this is what caused David Cameron to be hauled before his Franco-German counterparts and be instructed to accept a tax on financial services.
As it happens in Britain we made the same policy errors as Europe, we created the same mountain of money, we have a similarly bust government, and so we have in one country a microcosm of the entire European mess. But we are going to resolve it in a very different way. We are not going to turn into slaves the subordinates and the children of people who borrowed our money. Nor are we going to take the money explicitly from those who lent it (though perhaps we should). That won’t happen because that would mean our government would go into default, which it will not do while it controls the issue of money. So, instead, we will use a third way.
Our government is going to live with a profound devaluation of Sterling, which will eliminate the government’s own debt without explicit default. In this way it will share the pain of default across all creditors. All savers – even those whose debtors are perfectly solvent – are going to share in setting this thing back on a sustainable course.
At different stages through this process of adjustment we will experience interest rate hikes, currency crises, and sharp inflation, which will continue until twenty five years of savings, and twenty five years of a credit-fuelled house price bubble, have been removed from the system by devaluation. By the time it ends the creditors – taken collectively – will have paid. By then houses will be again affordable by anyone with a half decent job, the bond market bubble will have burst, long standing pension savings will be near worthless, equities will again yield sensible dividends, student loans will have inflated to irrelevance, our freedom to choose our private actions in our marketplace will have been preserved, and Britain will again be a great deal fairer than it currently is. It’s going to be a very unpleasant journey and it looks like we are making it alone.
In Europe many will doubtless laugh quietly as all this happens to us. But they will have no reason to hate us for our problems, which will be wholly independent of theirs. Besides, they will probably be too busy hating each other. The creation of the Euro has caused 1,000 years of carefully constructed and often hard fought mutual independence to be sacrificed on the altar of monetary union. We think that Europe’s political class is making a monumental error in holding on to it because it carries all their political credibility. Their resulting policy is to enslave half of Europe, and to kill the messenger – the financial market. This happens to be the section of the European economy which we in the UK have specialised in, while we have been buying German cars, and French aeroplanes. So let’s be clear, David Cameron did not have much of a choice.
In summary then, the proposed Franco-German policy is built on the lie that it is the market which is the cause of the problem. We think their policy is dangerously brutal to European debtors, that it is unfair to Britain, and that it transgresses the existing treaties whose laws were designed to stop governments doing exactly what the leaders of France and Germany now want – which is to suppress the rest of Europe into servitude. We think it will end in deep loathing of Franco-German power, and destroy the one part of Europe which we wanted to join, and which can be saved if we stick to the existing treaties. That is the single market. To us it is a single market of free choices which guarantees the freedom and the prosperity of our continent, yet that is what is being destroyed in an effort to cling on to the Euro.
Contrary to popular belief most of the British love Europe and the Europeans. But we also love our free market and the way it exposes the vanities of overreaching politicians. Last week Germany and France forced David Cameron to choose between the two, and he chose well.
Paul Tustain is the editor of www.Galmarley.com and director of BullionVault. This article was previously published at BullionVault.com.
By Adrian Ash, on 17 November 11
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
By Adrian Ash, on 2 June 11
A good article from BullionVault founder Paul Tustain:
Tuesday, 31 May 2011
Would you – or China – rather own gold 8 years from now, or US Treasury bonds…?
ON THE LETTERS’ page of The Economist last week, Nils Sandberg from Cambridge University’s Judge Business School presented a common argument against gold’s current value.
According to him, gold is in bubble territory because it has few industrial uses. Disproving Mr Sandberg’s thesis is childishly simple.
- Take one £20 note out of your wallet;
- Consider the industrial applications of the paper it is printed on;
- Now burn it.
Well, why didn’t you? After all, its value – according to Mr Sandberg’s thesis – rests on the paper’s usefulness in industrial processes.
Nevertheless it’s still interesting to understand why gold (like £20 notes) is valued above its manufacturing relevance. Unsurprisingly the answer lies in marginal utility.
Gold offers humanity one exceptionally useful property; it has an extraordinarily stable stock. There are 166,000 tonnes of the stuff above ground – worth about $8 trillion (£5 trillion) – of which about 88% is held as a value store of sorts, in jewellery (52%) and bullion (36%). The stock is growing by about 1.5% a year, from the combined efforts of all the world’s miners.
It is because gold is each of (i) geologically rare, (ii) elemental (i.e. incapable of being manufactured) and (iii) industrially useless, that it has this reliable stock quantity. Nothing else can do it; not silver, which is 80 times more common in the ground, nor platinum, which is far too useful as a catalyst to offer stock stability.
Reliable scarcity is the key property savers require of money, which otherwise fails to store value. But of course we don’t need gold to deliver reliable scarcity, we can usually create that reliable scarcity artificially, as we do with our modern currencies.
Now the marginal utility explanation. When new currency is too freely issued reliable scarcity becomes under-supplied, and savers go in search of it. Having seen artificial reliable scarcity fail in one currency, the promise of it in another is unconvincing, so they turn to natural reliable scarcity, and demand for it increases dramatically as governments print money. This is what drives gold up.
Mr Sandberg is right though, that gold will eventually go down again, when currencies’ artificial scarcity once more becomes reliable, and when those currencies start to generate a yield. But in the meantime it looks irrationally optimistic to hope that the US government – faced with a $21 trillion debt – will not print more and more money.
The question, therefore, is whether the savers who own $100 trillion of dated debt instruments in the bond markets will take fright at continuing money printing policies of the US and other governments. That $100 trillion of dated debt has already started running down the clock. It is shifting to the short end, where it behaves more and more like cash. Maybe its holders will demand cash (as is their right) at its redemption. The sums involved would swamp the $15 trillion of cash and near-term deposit instruments currently in issue.
People who choose to buy gold are increasingly aware of this possibility. We don’t know whether the Dollar, the Euro, the Yen and the Pound (all of which have started a debt market drift to the short end) will ultimately go into the currency death spiral. We are just mindful that it is the usual destiny of currencies driven by political expedience toward the printing press. It looks like a possibility at least.
To finish with here’s the brainteaser which the Chinese are currently wrestling with. Now that you know the US debt profile is slowly shifting to the short end, and represents about six times the currency in issue, you are required to choose today something to own in 2020. What would you (or China) rather have – a tenth of the US Treasury’s paper bond debts, or five times its very large gold reserve?
At current market prices these two are worth about the same. But in the intervening 8 years, the US government has budgeted to issue $8 trillion net of its own bonds, representing an increase in the stock of 57%. A further $1 trillion of gold will be mined worldwide, an increase in the global stock of 12%.
By Adrian Ash, on 10 February 11
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.
By Adrian Ash, on 4 February 11
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.
By Adrian Ash, on 31 January 11
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.
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