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Dow down slightly yesterday. The FTSE was flat. Oil falling further below $100. And gold still going up.
What is most interesting is the movement in the price of gold. It seems to be heading up again – almost no matter what else is happening.
So, let’s look at what might be going on.
If investors sensed a recovery, they would expect banks to lend more freely, people to shop more freely and prices to rise.
This would raise consumer prices; the price of gold should go up.
But if the market sees growth and inflation ahead, why is oil slipping? And why is the Baltic Dry Index – which measures shipping prices – at a 25-year low? And how come last month’s US employment figures were disappointing? And why aren’t stock market prices going up?
Most important, if the economy is really recovering, why is the ten-year note yielding only 1.82%? And what about the long bond? Shouldn’t it be trading at a yield higher than 3%?
And how come house prices fell over the last year, and the last month?
And how come incomes are falling?
Or, to look at it from the opposite point of view, how is it possible for a real recovery to take root in the hard, barren soil of falling house prices and slipping consumer earnings?
But if the economy is not improving, then there should be no increase in inflation and no pressure on the price of gold, right?
Maybe investors don’t anticipate a recovery at all. Maybe they’re buying gold because they see the economy getting worse, not better. We associate a rise in the price of gold with inflation. But gold is much more versatile than we think. It protects your wealth when paper money loses its value. It also protects your wealth when paper money gains in value. It protects you when you are right and when you are wrong.
How so?
During the Great Depression, for example, the price of gold rose against dollars even though the prices of food, clothing and other consumer items, as well as the prices of investment assets were falling in dollar terms. Why? Because money gains value – relative to things – in a depression. Gold is money. It is the best money. It is the only money that has stood the test of time.
Besides, there is more going on. In a financial crisis or a depression, investors begin to doubt that their counterparties will make good. Banks fail. Investors go broke. You own a mortgage, and then you discover that the homeowner has left town and the house has lost half its value. You own a note, and then you discover than the payer is bankrupt; your note is worthless. You own shares in a company; and then the company goes out of business.
When you are in a de-leveraging phase, you discover that many of the assets of the previous credit bubble are not assets at all. And while you’re waiting to find out, the best thing to have in your safe is gold.
As uncertainty rises; so does the price of gold.
The price of gold also rises when the return on other assets declines. At 1.82%, the real return on a 10-year T-note is negative. Consumer prices are rising faster. So, the reward for lending to the government is less than zero.
Normally, holding gold costs you money. You give up the return you could get from ‘risk free’ investments (Treasury debt). Now, you give up the risk from reward-free investments.
Gold goes nowhere. It produces no yield. It pays no dividends. It makes no profits. You can’t live in it. You can’t drive it. You can’t hang it on your wall and admire it.
But when the return on Treasury debt is negative, what do you give up by owning gold? You give up a loss!
You also give up the risk of a much bigger loss. The Fed is bound and determined to bring up the inflation rate. Ben Bernanke has suggested that he might set the inflation target higher than 2%. He has announced that he will keep the Fed’s key lending rate near zero for the next three years. He has hinted that he is ready to print more money – QEIII – if conditions warrant.
Holding gold protects you from Bernanke’s success. For if he succeeds in raising the rate of inflation, gold will surely soar. And there is substantial risk – bordering on certainty – that he will be no better at creating moderately more inflation than he has been at creating moderately more GDP growth.
It is quite possible that he will overshoot.
Normally, inflation is a feature of the banking system. The system takes the Fed’s monetary grubstake and parlays it into the nation’s money supply. Banks magnify the money supply by lending... and thereby create more demand, which raises prices. They do this by making loans to people who then spend the money.
This sort of inflation is controllable, by raising interest rates and tightening banking credit rules. But there’s another form of inflation. The kind that starts with an 'h'.
Hyperinflation happens when the banking system breaks down. People lose faith in the money itself and the people who control it. Foreign dollar holders may worry that the Fed is printing too much money. It may even be good economic news that causes them distress; they may anticipate higher inflation rates, and a sell-off of the dollar, which would lower the value of their dollar reserves. They may figure that they are better off diversifying into yuan or gold.
Then, when other investors and householders see the dollar falling... they get panicky too. Pretty soon, people are digging around in drawers, bank accounts and mattresses looking for dollars – just so they can get rid of them.
That is when dollars hit the hyperinflationary fan. Our old friend Michael Checkan tells what it was like in Argentina in the late ‘80s:
“Imagine a $2.00 gallon of milk spiking to $775.40 within a year – like in Argentina, 1988.”
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And more thoughts
• The Financial Times has continued its series on ‘Capitalism in Crisis’ much longer than we expected. Longer than seems decent, actually. The crisis will be over before the series ends.
Each of the Davos-list celebrities to write on the subject basically ‘talks his own book’. The politicians tell us that they can fix what is wrong with capitalism. The regulators want more regulations; do-gooders urge us to rely more on good works. The economists have their economic solutions. The entrepreneurs put their faith in can-do hustlers.
Bill Clinton used to be a sharp politician. Now, judging from his comments in the FT, he has moved rapidly from becoming an elder statesman to the kind of senility that affects aging world improvers. Try to figure out what this means:
“Governments, businesses and extra-governmental organizations [can] work together to share expertise and implement lasting solutions. ...
“What we need is innovation, imagination and commitment. The most effective global citizens will be those who succeed in merging their business and philanthropic missions to build a future of shared prosperity and shared responsibility.
Those are words that could have been written by a dull-witted robot, or Thomas Friedman.
The words were empty; at least they were not stupid. But there were plenty of stupid words, too, in the series. A representative of Occupy London wrote to say that Friedrich Hayek had “helped us to find capitalism’s flaws”. Hayek pointed out that the widely distributed knowledge of a market economy was much better for making decisions than the centralised information and planning of a state-directed system. But the Occupy writer missed the point completely. He quoted Hayek and then went on to suggest the very sort of meddles that Hayek warned against.
Some writers seemed to have nothing to say whatever. Others seemed to have nothing to say about capitalism; it was as if they had not thought about it. And some, we couldn’t figure out what they were talking about.
All in all, the series has been a big letdown. Capitalism has no real friends and no clear defenders, not at the FT.
We will have to do the job ourselves. Look for our ‘Capitalists’ Manifesto’ next week.
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