“…If we allow governments to control finance, we give them extraordinary power over which projects are allowed and which are deemed inappropriate…”

The BRITISH PRIME MINISTER, Gordon Brown, says the current mess in world finance and credit is the fault of “irresponsible” bankers.

Well, he would say that, wouldn’t he?

Let’s not forget that Mr. Brown claimed the credit for 10 years of unbroken growth here in Britain. For those 10 years he copied Alan Greenspan — the ex-U.S. Fed chairman — by holding interest rates unusually low, aiming to encourage investment and demand, which is a near-sighted economist’s way of avoiding mild recessions.

But this low-interest rate medicine stimulates both the supply and the demand for those products which Mr. Brown now blames bankers for promoting. It leads directly to a world of crazy finance, because low rates punish caution.

In a time of state-sponsored easy credit all projects get financed by incautious banks with cheap, centrally supplied money. There is no market for cautiously lent money, priced correctly for the risk involved. Why would anyone pay more for funds from a cautious bank when cheaper funds are available from easier sources?

This is why the profits of incautious banks grew, and why their stock prices multiplied. Meanwhile careful bankers sunk. As Brown (and Greenspan) injected ever more money into the economy the cautious banks began to lose their customers, their managers, their share values, and their independence. This Darwinian extinction of caution is the direct result of a monetary environment which was hostile to cautious bankers, one which favored those banks with an appetite for cheap money.

So be in no doubt about the cause of the credit crunch. It was too much cut-price credit, and the blame for the supply of it rests squarely on the likes of Gordon Brown and Alan Greenspan.

So much for the blame. What now?

It seems almost everyone — from both the right and the left of the political spectrum — agrees that the world needs more government intervention in the form of bailouts and increasing regulation. We’re getting it, too.

Yet once we have grasped that the underlying cause of this disaster was credit creation by government itself, we should perhaps be a bit wary of putting governments ever more in charge.

Governments operate a cheap credit policy in order to defer pain, stay popular, and get re-elected. The U.S., British, Australian, Russian and now pan-European bank rescues are intended to create and promote a higher volume of cheaper and easier credit than the market really wants. They aim to supply yet more of the wretched stuff which got us here in the first place.

Is that really so wise?

If we allow governments to control finance through regulation, we give them extraordinary power over the direction of the economy. Because they can (and will) deny finance to some projects and grant it to other, more politically appropriate ones. Such government control has repeatedly shown itself to be much worse than our imperfect marketplace at handling the power of economic direction — both in this case, where their efforts at economic stimulation are the root cause of the fiasco, as well as in recent history, particularly with communism.

The new rush of bailouts, and their associated tighter regulation, pushes us further towards the socialized “command” we thought the world had abandoned in 1989. That is bad — and there is a better way to rapidly re-configure our economies in the right way:

More than ever we need to trust the market. Let interest rates rise (without government interference) and allow the market to kill off those institutions whose functioning depends on limitless supplies of cheap credit.

Yes, there would be pain, but it would right a long list of wrongs. It would make houses affordable for younger working people. It would make saving worthwhile again. It would make borrowing less attractive. It would increase the use of equity in the financing of enterprises, and significantly decrease their use of debt, making all of them much safer in future downturns.

Each of these moves in the right direction are, sadly, the moves which yet another dose of rescue money will now suppress. This won’t be understood by our politicians, however, so we will get yet more patched-up bailouts — and lots more regulation besides.

Did you notice? While the United States, Britain, the Netherlands and Australia were banning short selling on their local stock markets, the Chinese were relaxing restrictions on it. This is enormously telling. Asians — suppressed by the command economy for decades — aspire to a world of free enterprise. Unlike us they are now prepared to accept the costly consequences of those repeated errors which the free enterprise system allows people to make.

When we finally wake up under the yoke of our new, improved and over-sized government regulators, we will have lost the privilege of benefiting from free and highly profitable financial centers. It’s the turn of Hong Kong, Mumbai, Shanghai, and Singapore.

Oh well — it was nice while it lasted. And from an avowedly selfish point of view, I think it is almost certain that these tax-funded bailouts will be good for me personally, because they will be good news for BullionVault.

I believe we will now avoid the pain of a sharp correction. Instead we will get many years of miserable underperformance in shares, bonds and deposits — the classic backdrop to a strong bull market in Gold.

With no bailout, gold would probably rocket even faster than it has this week, and within a few months it would have fully appreciated. That would be time to exit gold and start buying bombed-out productive assets instead.

The speed of such an ascent in Gold Prices would be highly profitable for gold owners (including me), but it would probably prevent BullionVault from aggregating more than a few thousand new customers in total. My personal ambitions for the business would never be met.

Instead, as all this bailout money seeps in, I anticipate some temporary relief for the stock market, followed by a long, slow, miserable slide in mainstream investment performance, accompanied by a steady rise in the value of Gold Bullion.

Every month, this on-going shift from paper to gold…from debt to hard assets…will cause a few thousand more people to join BullionVault, buying and selling solid gold bullion — safe and secure in their choice of Zurich, London or New York — at ever-higher live market prices.

So — entirely hypocritically — I believe one outcome is required, yet hope for another! Knowing governments won’t allow the incautious banks to fail, I can only look forward to helping more investors each day move a portion of their wealth into gold.

Regards,
Paul Tustain
October 10, 2008
BullionVault

The Tragic Consequence of Centralized Manipulation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In English, please? The bulls got suckered.

Gold prices fell through their $850 May low now, which means that I was wrong to think that the market had discounted a reversal in oil and the dollar, both of which we fully expected.

But could the market be setting up the bears here?

The last time that we saw two false signals in a row was in 2004, when a marginal new high reversed sharply and turned down to break a key support level, trapping the bears before turning up for good. Interestingly, this happened when Greenspan started his tightening campaign.

It is significant that he didn’t have to deal with a financial and economic crisis, and that his gradual rate increases didn’t do anything to gold, anyway — though they were enough to derail the housing boom.

Today’s Fed is constrained from even a small tightening by the condition of the economy.

Of course, we’ve already had two false signals in the chart, so if this is a bear trap it’ll be the third, which would make it different than in 2004, or at any other juncture in this bull so far.

The gold stock charts tell a more bearish story.

Now, you must keep in mind that while deceptive moves have been rare in gold itself over the course of this bull market, bear traps have been common in the gold share averages — especially the Amex Gold Bugs Index below. For the record, a bear trap is a move, like a breakdown, that suckers the shorts; a bull trap is a move that suckers the bulls:

A bear trap has occurred as a false breakdown in the chart on at least three noticeably separate occasions — 2001, 2005 and 2007. In each case, a bullish move followed immediately. I don’t know if history will repeat itself, but the record says breakdowns in the HUI are a buy.

For the Love of Gold

I keep telling you, gold is next! No one believes it yet. Who can blame them?

We all would have done better owning oil stocks, at least after 2004. In fact, you would think the only reason gold ever went up is because of oil. But you’ll find some truth in every lie.

Undoubtedly, energy is vitally important to the economic engine of growth.

It’s used in every imaginable process. Oil is important only because it is the most convenient source of this energy, but tomorrow, it might be something else that does this job. Gold, of course, is jewelry. It’s not technically money, except in select circles. But I want to draw your attention to the need for money…it is just as vital to the economic engine as energy.

Given the record of fiat money, invariably the debate will shift to the best kind of money in the same way that it currently revolves around the best kind of energy.

So what would it take to see the same love in gold that we saw in tech stocks in 1999, the housing market in 2003-05 or oil recently? The answer is simple: More of the same…

You will see it in gold when all the usual anti-gold arguments fall flat on their faces… when people no longer believe that the “modern-day” central bank has a handle on inflation and interest rates; that inflation is “caused” by oil, growth or a shortage of goods; or that prices will one day come down.

You will see it when people realize that the bubble in commodities is really a destruction of confidence in the medium of exchange. Yes, this can get overdone, like anything else in the market. But unlike a specific bubble, it will repeat itself generally, against some other asset, commodity or maybe all goods.

Why?

Simply because the central bank and government are afraid to address the root cause.

All that the central banks have to do is abandon the boom by letting the market determine the proper interest rate level. This is the only lasting solution to the current inflationary quagmire.

They won’t do it. The short-term costs are too high, and rise with each new asset bubble.

No, the bull market in gold is not over.

The best is yet to come.

Top 10 Reasons to End Cheap Gold

I can understand why investors are selling their large-cap gold stocks. They aren’t making any money — at $900 gold! And they’re trading at 20-50 times earnings. Still, while the rising cost of producing gold is trouble for gold stocks, it is also one of the most bullish factors underpinning gold values.

Effectively, $700 gold would be as catastrophic for the industry today as $300 gold was in 1999.

With jewelry demand alone, the supply side is already tighter than it is in oil.

As I went through my 18-point model, I was looking for reasons to buy gold that have not been widely discounted, aside from the big one above — i.e., in which the masses wake up and fall in love with gold:

• Cost inflation slowing down development pipeline, hence future production growth
• Political risks in frontier countries also shrinking available supplies
• Faltering global economy persuading central bankers to abandon tightening plans
• Soaring government deficits
• Saber rattling between Iran and Israel and other geopolitical tensions heating up
• Another GLD ETF just listed on Hong Kong Exchange
• Some countries already experiencing crackup and heightened gold demand
• Shrinking official gold supply
• Seasonal trends turning bullish again into the new year
• Large producer Anglo has yet to cover all its hedges.

Regards,
Ed Bugos
September 2, 2008

The Gold Market was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.