We had never commandeered a table, set up our laptop and worked away in the moody lighting amid the pleasant, folksy music.

Today, we resolve to change all that. Today, we Occupy Starbucks!

The unusually high amounts of caffeine in our system may help to explain the figurative hair up our editorial butts this morning, a hair that has to do with Occupations around the world…

We’ve been feverishly posting other people’s articles on our Facebook page, the kind of articles that explain well our view of the Occupy Wall Street movement. We just can’t let this one go, good patrons…All those protesters who know they ought to be mad about something…but who have yet to realize that that something is not Wall Street.

As we’ve been maintaining — along with others with an Austrian understanding of the world — it’s not Wall Street. It’s not “capitalism.” It’s the damned central banks and the nonmarket money whose creation they monopolize.

The central bank’s mandates include “stabilizing prices” and creating full employment. But the powers of the central bank to create new money tend to destabilize economies, create boom-bust cycles, increase joblessness, and destroy the purchasing power of savings.

And really…”stabilizing prices”?

We shot Michael Pento a note for his take on this. His reply:

“The general trend in a productive economy is for a benign level of deflation to exist. A stable price environment or one with slowly falling aggregate prices is optimal for economic growth in that it encourages savings, which are the building blocks of investment and capital formation.

“When an economy is operating under high levels of productivity growth, the supply of goods and services outstrips the supply of money and credit when under a gold or bimetal standard money. Therefore, prices tend to fall over time.”

The central bank rationale is that prices should remain “stable” while incomes rise, along with employment. To this end, they print money and inject it into the economy, mostly by lending it to the government (buying the government’s bonds).

Buying all that debt with the new money puts an extra-market downward pressure on interest rates. This is supposed to make borrowing easier for starting and expanding businesses.

It also spurs consumer spending. Artificially low interest rates tempt consumers while new money erodes the value of saved money.

The free market model, however, tends to keep incomes relatively steady while prices fall. That’s what’s sort of forced to happen with a stable money supply. In fact, incomes — which are just a special form of price — could also fall over time…but as long as general prices fall just a bit faster, the purchasing power of those incomes are still on the up.

Haven’t you noticed this? That life gets better, society gets richer, as goods and services initially thought of luxuries — maybe even science fiction — become commonplace…and cheap?

What makes the free market way better than the central bank’s inflationary habits? It’s been demonstrated repeatedly that printing money does not equal creating wealth. But printing money and injecting excess credit — that beyond what the market would provide — causes misallocations of capital and distortions that lead to bubbles. Then busts.

You see, if all the money everywhere increased exactly the same at once, there would be no distortions…nor would there be any increase in wealth. Just an increase in the amount of money.

But as Murray Rothbard pointed out in The Mystery of Banking, inflation doesn’t work that way.

Inflation is a process, not an “all at once” phenomenon. It’s legally protected counterfeiting that benefits the first recipients of the new money. Those who borrow it first (governments) and collect interest for lending it out after the Feds lend it to them (big commerical banks) benefit.

And thanks to the state-backed legerdemain of fractional reserve lending, the banks themselves can lend out many times the money the Fed deposits with them. The new credit based on the new money causes waves of price inflation, along with not a few credit-fueled bubbles that eventually burst.

This is great work if you can get it. As the financial industry people at the front of the line for the new money will tell you. The rest of us get to watch general prices increase while our wages fall further and further behind.

The free market’s “deflationary” process is lambasted by most modern economists. We’re told that we must fear deflation, both in prices and the money supply…that the central bank is the righteous guardian of inflation and, therefore, of stable prices and economic growth…

While we suppose the Fed could actually inflate the money supply safely, in some safe range as proposed by Milton Friedman….

…We’d just rather let the market handle what gets used as money…and also let it handle how fast those various currencies gets issued or mined.

Down with central banks. Down with their government-backed monopoly on issuing currency which they then use to undermine capital accumulation and swell debt in the economy.

I wonder what that would look like on a protest placard.

It’s The Central Banks, You Dumb Kids was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

I think it is coming. In fact, in many ways, it’s already here, just not yet widely recognized. The deflationists still hold sway in the bond market, where investors happily accept puny yields.

The deflationists argue that the dollar will buy more tomorrow than it does today. It is inflation’s opposite. When most people talk about inflation and deflation, this is what they mean. This definition would pain the old economists who were more careful in their use of language.

Be that as it may, deflation today is an argument facing death by a thousand cuts. Every day, evidence rolls showing that the dollar is buying less. Today’s Wall Street Journal points to the whale in the aquarium. One headline reads, “From Cereal to Helicopters, Commodity Costs Exert Pressure.”

The article goes on to point out what is painfully obvious to anyone who follows commodities and companies. The cost of nearly everything is going up.

General Mills will boost the price of a quarter of its cereals to reflect rising prices for grains. Kraft is raising prices. Domino’s Pizza hasn’t said it will yet, but it did say the price of cheese is up 29% from a year ago. Profit margins are suffering in the meantime.

There is a long list of companies battling rising costs of the commodities. As the Journal notes:

“Corn is up 44%, milk is up 6.5%, hot rolled coil steel is up 4%, copper is up 29% and oil is up 14% from a year ago… Across Corporate America, more companies are wrestling with when and how much to raise prices as raw materials costs climb.”

Still, the Journal’s article had no discernible effect on the optimistic bondholders. (Or I should I write “bag holders”? For soon, they will be left holding the bag.) The bond market seemed bored and yields inched up just a touch today, such that the 10-year note pays a whopping 2.506%.

By the time the bond market says inflation is here, it will be too late — too late for bondholders.

In the meantime, the prices of gold and silver are up too. All of these things point to the obvious: The dollar is buying less.

Why?

Let us the count the ways. There is the U.S. government bleeding red ink and heavily in debt. Both portend bad things ahead. How will they square the circle? The easiest — and the most politically expedient — way is to print more money.

There is the jawboning going between central banks of the world all trying to cheapen their currencies. The rationale is to stimulate exports, but don’t be fooled. The real effect of a cheapened currency is that your dollar will buy less.

There are kinds of fancy names for what the Fed is doing — “quantitative easing” comes to mind. But at bottom, they all mean the Fed will create more money.

I was at Grant’s Fall Conference in NYC this week. Jim Grant, the host and editor of the excellent newsletter Grant’s Interest Rate Observer, said: “Don’t you sometimes get the feeling that the economists are pulling our leg? A bartender would call it watering the whiskey.”

That is a good way to think about it. More dollar printing simply dilutes the buying power of all dollars. And so we see today the beginnings, the mere sprouts, of a fully fledged inflation. It can and will get much worse.

Don’t pay attention to that thing called the Consumer Price Index, or CPI. It is running at about 2%. It is an engineered figure and not to be trusted. Oskar Morgenstern, who along with John von Neumann contributed so much to game theory, once described it as a “mere index of doubtful validity,” as Grant relayed.

Nonetheless, on the basis of this suspect fluff, the Fed tells us inflation is under control. In fact, it is complaining that the inflation rate may be too low. As Grant quipped, “That’s like the New York Police Department complaining about the lack of crimes.”

Bernanke would have us believe the Fed can calibrate inflation within tolerances of 100 basis points. But it way overestimates its powers. Once the inflation train gets going, it will be very hard to slow down. One day, the Fed will wish inflation were only 2%.

Regards,
Chris Mayer
Whiskey & Gunpowder

October 29, 2010

Inflation Is Already Here with Lots More to Come was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Wall Street’s notorious trading house published a report on gold last week setting a price target of US$1,300 in the next six months. The report cited several factors. But before we get into them, we’ll confess it made us a bit nervous. Whenever any broker is saying one thing, you have to wonder if they’re actually doing the opposite.

That said, Goldman did make a point that is true of an asset in a bull market: it requires corrections to shake out the speculators and weak hands from time to time. Following the June high north of $1,250 the net speculative long positions declined. Traders took profits. And so did momentum players in the exchange traded funds market.

But then something happened that Michael Pascoe and Rory Robertson did not expect. The gold bubble did not pop. Because it’s not a bubble. The momentum players departed and the price found plenty of support. It’s now around US$1,220.

Goldman says the big catalyst for a move higher (other than its announcement leading to a stampede of money into gold short-term) is a repricing of U.S. growth expectations for the rest of this year and all of next. Maybe it’s a fear trade, or just bearishness on U.S. corporate profits when unemployment keeps rising.

Either way, about the only dubious chart we saw in the whole report is the one showing lower U.S. real interest rates and the gold price (exhibit five). As those cool cats in statistics say, correlation is not causation. It’s possible low rates give speculators fuel to play in the gold market. But it’s more likely, we reckon, that U.S. rates are low because the bond market is pricing in a deflationary scenario.

So why would gold rise in a deflationary scenario? Good question! It brings us full circle to the argument fund manager David Einhorn made when we announced his gold position: you buy gold when you think monetary and fiscal policy are bad (we’re paraphrasing). Whether it’s inflation or deflation matters less than something unconventional and bad is going down. Gold does well in that environment, what with it being real money and all.

Whether you like it or not, more and more governments across the world are spending out of an empty pocket. They’re spending to give money to people who have lost jobs as a result of the structural shift in the labour markets. That shift came from globalisation. The money might keep people above water for a while, but it’s no replacement for a real job making real things.

More and more spending is going to simply pay the interest on previously borrowed money. This is probably the most dangerous aspect of a credit bubble. You borrow and spend all that money and, and the end of the day, you have nothing to show for it…no bridges…no roads…no factories…no real increase in the capital stock. Just a lot of over-priced residential housing that suddenly isn’t in such short supply as you thought.

And now Australia finds itself at an interesting crossroads. Just a little debt didn’t seem like such a bad idea at the height of the GFC. Both parties now promise to pay it off quickly, with all the bounty from mineral and energy royalties. Both will increase spending too, but in different places, cutting other spending priorities.

But should the housing bubble pop sooner rather than later, and should Aussie banks find themselves last in the queue for global capital in another phase of the Great Correction, the temptation for more government borrowing will be nigh irresistible. Why?

Well, our stance against government debt may seem dogmatic. But if it is, it’s because the modern State always abuses the power to borrow. Always.

Whether it’s to fund politically popular but economically unproductive projects, or whether it’ just a way of putting off tough choices about actually reducing government spending and, thus, the reach of the State into private life, it’s always easier to borrow and kick the can down the road.

Debt is the health of the State in the same way that liquor is the health of the alcoholic. The relationship is inherently destructive. But we reckon that in the face of so much unproductive debt (household and sovereign) the only politically palatable policy response will be to monetise that debt: pay it off or buy it from bank with new money. The deflationists can enjoy their moment in the sun while it lasts. But it won’t last for long at this rate.

Regards,
Dan Denning
Whiskey & Gunpowder

August 16, 2010

Is Deflation Looking to Pop the Gold Bubble? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Useless for pretty much everything except storing wealth (its economic value is social, not industrial), gold acts as inflation-proof money when investors need it most — right in the middle of an asset-price deflation.

At least, that’s how people choosing to buy gold amid today’s global deflation in risk assets see it. Why else do you think German coin and small-bar dealers are being emptied, even at 5% (and worse) premiums to “melt” value? Why else did gold-hoarding deliver secure, rising purchasing power amid the Great Depression of the 1930s…?

Given central banks’ default response to any level of financial stress, it’s a unique and appealing attribute. Because rather than leaving cash hoarders alone, sub-zero real rates of interest — plus the ever-present threat of massive devaluation — force sleepless nights on cautious savers. (The risk of banking collapse is an extra, but non-government-inspired threat.)

So when there’s a dash for cash, it’s little wonder that “worried wealth” finds gold better even than Dollars. Because gold cannot be inflated, nor destroyed. And it has 5,000 years of human use as a secure store of value behind it.

Yes, last month’s flight from everything into cash (which still means US Dollars worldwide) has knocked the gold price 6% off its recent record high vs. the greenback. But compared with all other assets bar Treasuries, however, gold shows phenomenal strength so far. Oil is down 20%. Platinum is 15% off. Aussie Dollars have dropped 10%, despite paying 450 basis points above cash deposits at the US Fed.

And should the slump continue, investment demand for physical gold is likely to put a floor under gold prices much sooner than other “risk assets” find their floor, just as it did during the Lehmans Crash.

Amid financial stress, physical gold hoarding creates a source of deep and widening demand that no other asset class enjoys. Not even silver comes close, because institutional and high-net worth buyers would rather get gold’s significantly deeper wholesale liquidity and much lower storage costs.

Indeed, it’s hard to class all “precious metals” together — in terms of price behavior — when the inevitable hits the fan.

Gold unlike platinum and silver, commands a “safe haven” premium that industrial commodities can’t — a critical point when credit dries up and risk assets are converted back into cash.

Compare gold’s price-action with any other raw material, in whatever currency. When confidence and economic demand sink, gold attracts capital. Whereas crude oil, copper, soybeans, even silver and platinum…they’re all vulnerable to risk aversion, because their bull markets tend to rely on economic growth, whether or not it’s fed by money-supply inflation.

Gold, in short, is not merely the “inflation play” that most analysts and journalists think (if, indeed, they’re thinking at all). Hoarding physical metal may not seem a “sophisticated” reaction to current events. Hedging your move into cash may not even outperform an all-Dollar position, short or long term. But it is perfectly normal, historically evidenced, and sane response.

It also remains a minority sport at present.

Regards,
Adrian Ash
BullionVault
Whiskey & Gunpowder

June 3, 2010

Gold Is an Inflation-Proof Deflation Hedge was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Doug: I just don’t know where they find these people… On the other hand, Slime magazine has always said that those named Person of the Year are not necessarily the most laudable people, but those who’ve had the greatest impact on the events in a given year. That would explain Hitler’s achievement of the same honor, and Stalin getting the nod twice.

L: Not to mention Bin Laden.

Doug: Yes, let’s not mention him. This is different: Bernanke isn’t being held up as a villain, but as a hero.

L: The tagline Time puts on it is: ”The story of the year was a weak economy that could have been much, much weaker. How the mild-mannered man who runs the Federal Reserve prevented an economic catastrophe.”

Doug: Right. And Bernanke is always presented as a Ph.D., a scholar of the Great Depression, its causes, and how to cure such an economic downturn. But he hasn’t prevented an economic catastrophe — he’s done just the opposite of what needs to be done, and there’s going to be hell to pay.

It’s quite perverse. Look at Alan Greenspan. In the 1960s, he was an acolyte of Ayn Rand and wrote a famous essay defending the gold standard, which I read in her book, Capitalism: The Unknown Ideal. And then he goes on to become the most inflationary Fed chairman in history until Bernanke superseded him.

The really shameful thing about Greenspan is, not only were his policies the igniters of the giant bubbles we saw in the stock market and then in real estate, but since he was associated with pure capitalism through Rand, his failures through government intervention in the market have falsely discredited capitalism as a system in many people’s view.

L: The same could be said of Ronald Reagan. He got elected on a libertarian platform, speaking of free enterprise and getting the government off the back of the little guy. So now many people think that the chronic deficits and other problems of the Reagan years proved that limited government doesn’t work. It’s the same swindle you see in intro economics courses that teach young people that the Great Depression proved that laissez-faire capitalism doesn’t work when it was, again, government intervention in the market that created the Great Depression.

Doug: That’s right. Reagan allowed Congress to run gigantic, greater-than-ever-seen-before deficits that still have to be paid for, either through higher taxes or debasing the currency, or both or selling off the assets of the United States to foreign creditors. The Reagan deficits are nothing, of course, compared to the current ones.

L: I wonder how much we could get for the Statue of Liberty? She’s got to be feeling uncomfortable in a country that no longer wants anyone’s tired, poor, huddled masses, yearning to breathe free.

Doug: That’s a good question. The copper alone is worth a lot of money at this point.

L: A quick web search shows two frequently cited figures for Miss Liberty’s copper skin: one of about 60,000 pounds, the other 179,000 pounds. At three bucks a pound of copper, that’s either $180,000 or something over half a million bucks — a drop in the ocean of America’s national debt.

Doug: I would have thought it was more, but of course the dollar isn’t worth a damn anymore. The real value would be as a work of art, of course. Although it must be said that considerations like that didn’t stop peasants in the Middle Ages from melting down Roman bronzes and disassembling classical buildings because they needed the raw materials. I wonder what it would fetch at a Sotheby’s auction? I’d guess the Chinese might be willing to pay half a billion or even a billion dollars to take the lady home. It’d be a good deal, since the ideals behind the statue are as dead as the Constitution itself.

L: Yes… we’re not using the Constitution either, maybe we should sell that to them as well. But even a billion dollars would still be a drop in America’s ocean of debt.

Doug: A billion is only a thousandth of a trillion, and they’re now thinking in trillions. Obama may soon have to ask his science czar what comes after a trillion.

Getting back to Bernanke, the situation just shows one more time how corrupt the U.S. educational system is. That someone can get a Ph.D. and become known as a scholar of the depression era, and draw exactly the wrong conclusions about absolutely everything concerning it — what caused it, how to cure it — and then be held up as a model of relevant and useful academics… It just goes to show how utterly beyond hope the situation is.

L: Well, given what you’ve said about the education system teaching mostly worthless BS, especially when it comes to business and economics, why should we expect anything other than BS from someone who’s got it Piled High & Deep?

Doug: [Chuckles] Yes, that is what Ph.D. stands for, after all. In areas other than hard science, it has value mostly as a trade credential with the chattering classes. Its value in the real world is usually negative.

L: Is it possible that he actually does know what really caused the Great Depression and our current economic difficulties, but is caught by politics and can’t do or say anything other than what he is doing? Back in Greenspan’s day, there were people who thought Greenspan still believed everything he wrote in his essay on the gold standard and was trying to balance what was politically feasible with what he knew to be right that he was doing things he knew were harmful because if he didn’t do them, someone worse would do much more harm.

Doug: I asked Barbara Branden that one time, and that was her opinion.  She thought he still believed in the free market and gold money. But a person who believes one thing and does another is usually called a hypocrite.

L: I think it was Ron Paul who once told me that he’d asked Greenspan about his essay defending the gold standard, and that Greenspan had told him that he still believed everything he wrote in the essay.

Doug: I think I’ve heard that story too. It’s an interesting conundrum. I’ve thought about what I’d do if I were president of the United States, or chairman of the Fed, if my choices were limited to what’s politically possible. The right thing now, which is to bring on a deflationary collapse that would liquidate much of the malinvestment of recent decades, is not politically possible. With more than 50% of the people in the United States being net recipients of government largesse, no one can get elected, nor stay elected, who applies the breaks to the gravy train. The system is totally corrupt at this point.

I think I read the other day that something like 15% of the population is now on some level of food stamp subsidy, and another 15% are eligible but don’t know it, or are not yet willing to accept the stigma.  In the face of these kinds of facts, if anyone in power did what was necessary to liquidate past mistakes and get the economy back on a sound and sustainable path upwards, it would probably bring on a social revolution.

We’re going to have a social revolution anyway, and it’s probably better to have it sooner rather than later. This whole house of cards should have been collapsed back in the ‘60s, as opposed to having been built 40 stories higher since then. That just means it’ll be an even bigger mess when it does collapse. But it would take immense courage to set that collapse off deliberately. Whoever did it might well end up dead. And the same people who are cheerleading the current leadership’s disastrous moves would blame that courageous person for bringing on the United States’ second and Greater Depression. So, from at least a personal point of view, there’s nothing to be gained by doing the right thing. Although history would vindicate you, you’d be ostracized now.

L: That just raises an already impossibly high bar. The U.S. won’t be able to pay, when the bill comes due.

Doug: Yes. One of the most distressing things about this whole debacle is the total lack of intellectual honesty among any of the participants and decision-makers responsible for what’s going on with Bernanke being perhaps the worst of all.

On July 1, 2005, Bernanke stated with great confidence that the U.S. was not experiencing a housing bubble, saying: ”I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit.”

L: Wow could he possibly have been more wrong about anything more important?

Doug: In November of the same year, he talked about derivatives, saying, ”With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.” He also said, ”The Federal Reserve’s responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.”

And a couple months after that, back on housing again, he said, ”Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.”

L: So much for the wisdom of the expert…

Doug: Well, he’s not stupid, not in the sense of being unintelligent (he’s obviously very intelligent) but I would say he’s stupid in a better, more sophisticated sense of the word. One that I think is more useful, that being: an unwitting tendency towards self-destruction. And I’m afraid his stupidity is not just going to drag down the U.S. financial system, but the U.S. itself with it.

What he said about the housing and derivatives bubbles shows that he either has no idea what’s going on, or he’s a pathological liar. Reality was totally absent from those two statements.

And in February of 2008, he said, ”I expect there will be some failures of smaller banks.” Bear Stearns collapsed just a couple weeks later…

L: You’re kidding!

Doug: I wish I were. I’d like to believe the second most powerful man in the world weren’t either a knave, or a fool, or both. Remember, this is the same guy who told the world that Fannie and Freddie were ”adequately capitalized” and ”in no danger of failing.”

Earlier this year he said, ”Currently, we don’t think [the unemployment rate] will get to 10 percent.” Wrong again and if you actually count people who are out of work, rather than the government’s phony subset of that number, we already have over 17% unemployment.

This guy is truly pathetic but nobody points any of this stuff out. That he can be so dead wrong about so many vital things and not get called on it is simply amazing to me it makes me feel like I’m living in some sort of demented parallel universe.

L: This has to be the worst case of ”the emperor’s new clothes” on record.

Doug: Quite possibly. After all, who can gainsay the word of the second most powerful man on the planet? And a Ph.D. expert on the Great Depression to boot. Which makes perverse sense, as only an expert can screw things up as royally as he has.

I’m afraid the U.S. dollar is going to be totally destroyed. The consequences of that are going to make everything that’s going on now pale by comparison. I mean, as bad as the consequences of propping up all these dinosaurs like General Motors and AIG and General Electric and Goldman Sachs, among many others, might be next through direct theft from the U.S. taxpayer are, that’s nothing compared to what will happen when things get really bad, which they haven’t yet.

It’s really going to be bad when they destroy the dollar that’s when it’s really going to hit the fan. Runaway inflation is bad enough in a place like Zimbabwe, where most of the people are still living on a subsistence level. And it was bad enough in Germany in the 1920s, when most Germans were still living on farms or making things with their own hands. But in an advanced industrial society, as heavily urbanized as the U.S. is, runaway inflation is going to be unbelievably disastrous. As dim as the average American is, he’s bound to get perturbed when his quality of life nose-dives, and who knows what the social consequences of that will be.

L: Social revolution… Massive social change.

Doug: Yes. Runaway inflation in the U.S. would be the ultimate disaster. Think about all those people who have dollars set aside, which is to say the prudent middle class; they’ll be totally wiped out. Even huge corporations that have massive cash reserves, like Microsoft and McDonald’s, if they don’t hedge that cash with the utmost skill, could find those hoards wiped out and themselves bankrupted as well. Remember that people all over the world are holding U.S. dollars. There’s far more U.S. currency outside the U.S. than there is inside the U.S., and all those foreigners are going to resent it personally and hold it against Americans when their U.S. dollars are wiped out. On top of that, most central banks around the world hold U.S. dollars as their main asset, and that will be wiped out as well. It’s going to be a complete, worldwide disaster.

It’s going to be much worse than what happened in Germany or Zimbabwe. This is a couple orders of magnitude greater seriousness and it seems to me that this is almost certain to happen with a monumentally stupid person like Bernanke steering the ship of state into a reef.

L: Is there really any possible way he could not see the reef he’s got the U.S. pointed straight at?

Doug: Another interesting question, because, as I say, he’s not an unintelligent man but a stupid man, as I use the word.

L: But some people don’t see the world the way we do. Is it possible that he actually believes his own spin? Some people see price destruction and asset devaluation in some areas offsetting the inflation of the money supply, and believe there is some super-economic formula that really smart people like Bernanke can figure out, for the U.S. to spend its way back into prosperity.

Doug: I just don’t see how someone who’s studied the history of economics can so completely set aside its most pertinent lessons. It’s possible that he knows he’s caught between a rock and a hard place in technical economic terms, that he knows he and the economy are totally screwed and sees no choice but to carry on as long as he can and hope for a miracle. He probably knows that giving the economy the medicine it really needs would bring on a deflationary collapse, and losing his job would be the least of his worries.

As I’ve explained before, deflation is not only not a bad thing, it can be a very good thing. In a deflationary environment, the purchasing unit the dollar becomes worth more. That rewards people who have saved dollars, the prudent middle class upon which so much in modern society depends, and makes them prone to save more. Inflation makes people very loathe to save because what they’re saving is going down in value. And the solution to this depression we’re entering is not more spending, it’s not more consumption, it’s just the opposite of what these morons in Washington are saying: it’s less consumption and more savings. Savings are capital accumulation, and that’s what’s needed to start new businesses, create more jobs, and so forth in a sustainable way. Creating phony make-work jobs with more debt only serves to make things worse, come reckoning day.

So, switching from an inflationary policy to a deflationary one would be the right thing to do, but it would be such a sharp adjustment, this whiplash would hurt a huge number of people in the short term. And though most people don’t see it, the U.S. is on such a shaky political foundation at this point… It’s really become a question of ”Do you want to die by fire or by ice?” Either way, the U.S. is going to crash into a brick wall at high speed.

L: So, caught between the rock and the hard place, maybe he doesn’t believe anything he’s saying he’s just trying to hold off the noose as long as he can.

Doug: That’s a possibility. You and I will never get an interview with him, of course, and whoever does get an interview with him will get the kind of meaningless convoluted answers that Fed chairmen are notorious for giving. Answers so opaque as to be worthless. The only solution to this problem is, ultimately, to abolish the Federal Reserve. As we’ve argued many times in The Casey Report, it serves no useful purpose whatsoever it’s nothing more than a convenient instrument for inflation, which is to say, indirect taxation. But is that going to happen? I don’t think so. And that’s why I think the whole socio-political system in the U.S. is on the ragged edge of being overturned at this point.

L: The hollow oak that looks so mighty to all but is so rotten through its core that it collapses in the next storm. Do you suppose Bernanke could be doing it on purpose? Could he and Greenspan before him (who apparently claims to still believe in the gold standard) be orchestrating this crash on purpose, deliberately doing everything opposite of what’s necessary, carefully postponing the catastrophe each time to make it bigger and bigger, so that when it finally does all come crashing down, it does so in such a spectacular way, it teaches the world an unforgettable lesson on why you should never ever use paper for money?

Doug: That might explain their actions, but the odds on that scenario are slim to none. And Slim is out of town. Besides, I’m not a fan of conspiracy theories. I don’t think anyone could pull such a scheme off… But the bankruptcy of the U.S. government is baked in the cake. And that’s a good thing, in that they’ll have less ability to intervene in everyone’s lives domestically and in foreign countries. The bad news is that the government may bankrupt the country in a vain effort to keep itself alive.

L: So… Investment implications?

Doug: Everything we’ve been saying for years now and as Casey Report readers know, we did see and write about a credit crisis leading to a currency crisis before it happened about rigging for stormy weather is all the more vital now that the storm is upon us.

What, specifically, does that mean?

First and foremost, all of your savings, money that you don’t want to lose but need in a liquid form, should be in gold or gold proxies. To a lesser degree, silver as well, silver being a sort of poor man’s gold. That’s number one. You should have a very large position in these two things.

Second, regarding the speculative funds that you have, remember how much money Washington is creating. That’s definitely going to inflate other speculative bubbles to be on the watch for. I think it’s possible to make serious money spotting these early and cashing in before they pop. That’s number two: position yourself for taking advantage of speculative opportunities.

Third and I can’t emphasize this enough is that since what we’re really looking at is a political disaster causing the economic disaster, you must diversify your assets politically. And since the epicenter of this meltdown is the U.S., it’s absolutely vital that you diversify your assets, including the gold and the speculative investments, outside the U.S. That’s number three, but not third in importance there will be foreign exchange controls, and once we have those, your alternatives will be severely circumscribed.

These are the three most critical pieces of advice I can think of to give to anyone.

L: Heavy stuff, Doug thanks for laying it out so clearly.

Doug: You’re welcome. I just hope our readers will actually act on this, because it can not only make the difference between going under and surviving, but this basic approach and the details we spell out in The Casey Report can help them to turn crisis into opportunity. Some people will prosper during these difficult times; I hope it’s our readers who do.

Gary’s Endnote: This Conversation with Casey was originally released in December of last year, just after Time announced Ben Bernanke as its Person of the Year.

January 27, 2010

Bernanke Versus Deflationary Collapse was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Apart from the stark self-contradiction in this quote from The New York Times, you have to love the fatuous ‘it’s all good’ self-assurance where global banking is concerned. No problemo y’all! A mere overdraft incident, a cash-flow hiccup… and yet “the main fear” [among whom?] is that investors [where and in what? Like, everywhere?] could flee risky markets all at once in search of safer havens for their money [WTF?]. Gosh, well, as long as they don’t flee the New York Stock Exchange, the Hang Seng, the FTSE…. And, hey, do you suppose anybody bought any credit default swap “insurance” on the deals that financed scores and scores of super-giant condominium skyscrapers and hotels amounting to the greatest spec construction folly in the history of the world?

Snapshots of the stupid ****ing work-in-progress have been circulating around the Internet for five years, the disbelief was so monumental. I confess, when I first saw the Palm Island I was impressed at what a superb air strike target it presented. And then, when the real estate assemblage of artificial islands arranged like a map-of-the-world came along, I could only imagine the megalomaniacal glee rising in the throat of a jet bomber pilot (nationality unspecified) as he closed in on it.

Whom the gods would punish, they first make completely crazy. That includes us, here in the USA, by the way, but pound-for-pound Dubai is the current champeen. The monstrosity they built in their waterless convection-oven of a city-state makes Las Vegas look like a mere strip mall in comparison. Throw in a few other affronts to nature, such as an indoor ski “mountain,” a beach cooled by an under-the-sand refrigerated pipe network, golf courses that have to be hosed down with acre-feet of desalinated sea-water, and forget about “the gods” — one begins to see the monotheistic hand of “Old Scratch” himself working the levers of the construction cranes out there.

Frankly, I have no idea whether the Dubai fiasco will send seismic ripples thundering through a global banking establishment that is already crippled in more ways than you can count. But it does remind those in thrall to the dazzlement of “green shoots” that debt comes a’creeping, and runs so far, deep, and wide through the broken system of mutual assurances constituting international finance, that Ben Bernanke and his counterparts in central banks ’round the world could drop helicopter loads of paper cash on every rooftop, intersection, parking lot, field, forest, and camel raceway and never make a dent in the fatal web of false obligations we have woven for ourselves.

But you do wonder what was going through their minds as this ridiculous organism took shape on the horn of the Persian Gulf, just as one wonders at loathsome aspirations that Las Vegas presents in our own so-called culture — essentially a wickedness that exceeds the wildest fantasies of the most demented clergymen, be they closeted sado-masochistic Southern Baptist teleministers, Vatican-approved child molesters, or mullahs dispatching suicide bombers to the marketplaces frequented by housewives and their children.

Lately, the much-repeated aphorism has circulated around the Web that civilizations build their most extreme monuments at the very moment of collapse. If this is true — and it is hard to argue with the historical record — then it’s time to organize a new Third Party for the 2012 election with Jared Diamond and Cormac McCarthy heading the national ticket (and Roland Emmerich for EPA chief). By then, if we don’t stop lying to ourselves about the destruction we have induced, every other suit-and-tie wearing authority figure in America, from the county clerk to Barack Obama, will take on the aura of the archetypal Evil Clown from a Stephen King yarn. Imagine living in a country where absolutely nobody in a leadership position is credible. This is the kind of country we’re becoming and it will not keep running that way for long.

The markets have begun digesting the Dubai news in earnest, making for a holiday season of possibly momentous thrills-and-chills. The big debate going into Thanksgiving was whether the dollar would continue its downward trajectory, leading to some kind of currency failure, hyper-inflation, take your pick… or turn briskly around as investors bailed out of risk vehicles for the conventional safe-haven paper parking lot of US Treasuries. This debate between the inflationists and deflationists has defied resolution all year. Personally, I side with the deflationistas these days, though I believe our ultimate destination, in a year or so, is destruction of the dollar.

In keeping with the wickedness theme, isn’t it interesting that our society now vests all its hopes and wishes for thriving — indeed survival! — on a yearly ceremony we have come to call Black Friday. I was raised in a religion-free household, but I confess the signs are just everywhere that we’ve taken some turn to the Dark Side. I’m a little surprised that “consumers” were not caught on video wringing the necks of chickens in the Wal-Mart parking lots the other day in the hopes of winning supernatural favor for that race down the aisle to the flat-screen TV loss leaders. The cinemas are full of blood-sucking teenagers. Grown men swarm in the unemployment offices wearing sideways hats and butt-crack trousers. Why not just tattoo a message on your forehead that says: “Moron for Hire”?

Regards,
James Howard Kunstler

December 2, 2009

Dubai Malinvestment Outdoes U.S. was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

They talking, of course, about the Australians decision to hike their central bank index rate. And instantly the howls of recovery were on the lips of all the pundits.

But the recovery at large is still not on the horizon.

We may be facing a serious battle with deflation, and that the evidence is all around us, Australia notwithstanding. And now we have seen more than just anecdotal evidence.

A few days ago, the United Kingdom, which has been struggling with a weakening currency, released inflation numbers far below expectations. Not only was inflation lower than expected; the figures were actually negative.

What does that mean? Well, when inflation numbers turn negative, that is deflation. And England wasn’t alone.

The number one economy in the Eurozone, Germany, released numbers that said the same thing. Prices are not increasing, they are decreasing… and at a surprising rate!

That’s contrary to conventional wisdom, which says that the bloated money supply should be raising prices. But as I explained last week, that money supply isn’t natural — it’s being created on a whim by the central back and being pushed into its member banks.

From there, it is being held against the mountain of derivative losses, bad loans and investments, instead of flowing into the economy at large through lending.

That lack of lending is what’s preventing inflation. It won’t show up until the money is released to the public. Until then, the money supply has not effectively changed or expanded… and we’ll continue to see deflation.

Deflation, in turn, will lead to longer periods of extended “non-growth” and lower interest rates — at least in the places where they can be lowered. Where they cannot be lowered, “stimulus ad nauseam” will remain the protocol of the day.

But, of course, a flat-broke country can’t stimulate unless it can borrow. We are not like China with $2 trillion in reserves. Staying afloat requires borrowing unparalleled in history. The problem is, now that we aren’t buying the world’s widgets, the world is far less inclined to loan us anything. After all, that’s the way the game has been played. They lend to us — we buy from them. And everybody was happy. But you just can’t borrow forever.

So if deflation is going to be the name of the game, what happens to the currency markets?

Thomas Jefferson Fears the Federal Reserve

To answer that question, first we need to determine which currencies are going to move in which direction. That will continue to unfold over time. But it will likely lead to the currencies of the West doing a slow gyrating dance. Neither currency is better than any of the others, so they will just move back and forth until one of them gets their debt and banking situation under control.

Very possibly, the first nation to get rid of its central bank will be the first to really break out.

Because as we all should be well aware by now, central banks exist for one purpose and one purpose only: to bailout their banker buddies who, in the pursuit of greater profit, have made risky loans… to bail out large industries in order to preserve the job base… and to make sure that the taxpayers foot the bill. They will masquerade it in the best of terms, but at the end of the day, we are paying for their foolish business practices.

The sooner we do away with a central bank, the richer we all will be. This is not our first experiment with a central bank in the United States, but it has been our most costly. Our forefathers vehemently opposed the idea of a central bank for just this reason.

They believed that such a cartel would rape and pillage the public and increase poverty on a massive scale, until there is nothing left to take.

“I believe that banking institutions are more dangerous to our liberties than standing armies,” Thomas Jefferson wrote. “The issuing power of money should be taken away from the banks and restored to the people to whom it properly belongs. The modern theory of the perpetuation of debt has drenched the earth with blood and crushed its inhabitants under burdens ever accumulating.”

Amazing, isn’t it? Here’s a man who, two centuries ago, understood why central banks brought themselves into existence. The Federal Reserve in the United States has done nothing to improve our lot and has done everything it can to extort our wealth by the tax of inflation, then to export it to economies and dictators who live like massive welfare recipients off of the taxes your fathers have paid, and you continue to pay, and your children will have to pay.

And it will remain like this until the Fed is abolished again. As I mentioned, the population of the United States has closed more than one central bank. Former presidential hopefuls even lost their bids to the White House over their stand in favor of a central bank. Until such a day as we are sufficiently educated again to see them as a menace to our wealth and way of life, until we take it in hand to dismantle the Fed as it is, we will continue to suffer the expropriation of our hard-earned money to those who act as our overlords.

Problem is, I seriously doubt that will happen within our lifetimes. Look how long it’s taken us just to consider a bill that audits the Fed.

In the meantime, I recommend you take your capital to the place it’s treated best.

That specific place, however, is yet to be determined. Will it be Australia — the first ones to hike rates? Will be China – the almighty ones holding a financial nuclear option?

I can’t say for sure.

But I can say that, over the long run, it won’t be the greenback.

If you’re looking for a way out, diversifying your savings into another currency through the FOREX markets is an easy way to do it.

Regards,
Bill Jenkins

October 15, 2009

Who Needs a Central Bank? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Not to crunch too many metaphors right here at the top, but a consensus seems to be firming up in the animate jello of the Internet that we have entered the Season of the Witch. An odor of ripeness fills the virtual air — something between dead carp and apples baking. Whatever else appears to be going on in the upper stories and verdigris-tinged turrets of capital finance — currency rackets, gold switcheroos, interest rate arbitrage games, concealment of losses under rugs and behind curtains, Chinese fire drills performed by Spanish prisoners, executive three-card-monte set-ups, boardroom work-arounds, accounting quicksteps, Peter-to-Paul-shuffles, check kitings, pigeon drops, Ponzi schemes, hugger-muggers, bezels, shucks, jives, and enough monkeyshines to make Lord Greystroke cry for mercy — apart, in other words, from business-as-usual, such as it is these days, on Wall Street, there is a rising collective sense of anxious expectation that things are about to shake loose in the sad-ass shell of what remains of our economy. And the most perplexing part is that there hardly seems any safe place to preserve one’s savings.

The showmen over at the Financial Sense website, have put on an excellent month-long series of interviews and debate podcasts between leading inflationistas and deflationistas — Daniel Amerman, Peter Schiff, Robert Prechter, Mark Faber, Michael “Mish” Shedlock, Harry Dent — and after weeks of sedulous listening I still remain flummoxed as to where to stash the dwindling cash.

Harry Dent was a curious case in point this week. He has made some howlingly wrong calls before (e.g. in 2006, predicting a Dow 40,000 at the conclusion of the post-2001 bubble). Perhaps he missed the crack-up aspect of the most recent boom. He did not foresee the long gruesome meltdown of late 2007 to March 2009, or rather, his timing was off, since he called for the commencement of a new Great Depression in 2010. (And I hasten to insert here that my own timing of events has not been so great either.) Anyway, Dent sees a “winter” of finance and economy looming from here forward, characterized by extreme deflation, based on his view that the amount of private debt going bad (est. $40 trillion) far outweighs government’s ability to create new “money” (a few measily trillion) and hence that there is no chance in hell we’ll find ourselves in an inflationary situation for some time ahead. The private debt workout has to be completed first.

Most curious, though, was when the interviewer, Jim Puplava, probed Dent about his views on Peak Oil. Dent said he didn’t believe in it; that when he was in college in the 1970s (remember the OPEC oil embargo of ’73), he learned to disregard any suggestions that we are “running out of oil.” He stated this, by the way, as a simple assertion, without any further explanation, and Puplava didn’t belabor him with arguments. But it was a weird moment. Of course, it hardly need be said that Peak Oil story has never been about “running out of oil” per se, but rather about declining flows, geopolitical management of flows, and the effects of depletion on industrial economies — in particular the effect on regular, expected, cyclical “growth” of the type that financial markets utterly depend on to power the trade in investment paper.

It is exceedingly odd that this does not factor into Dent’s thinking, because what Peak Oil inescapably does is introduce the very sobering idea of discontinuity — that is, that the game has changed radically, especially where all our assumptions about continued “growth” are concerned. In that brief exchange on Peak Oil, Dent seemed to take the position that the “winter” part of any historical financial cycle always produced “new technology” that invariably saves the day, putting this seemingly very smart man in the camp of so many techno-cornucopian triumphalists all wishing for the same outcome: that some mythical “they” will “come up with” a set of rescue remedies to keep all the cars circulating on the freeways, and all the WalMarts groaning with swag.

Like so many major league prognosticators, Dent arrives at his ideas by building models of reality, assembling “data” to create charts of trends in prices, interest rates, and especially demographics – what age group of people are buying a lot of what in which stage of their lives. The whole business seems very rational and reasonable except when you realize that it is just another “narrative” — to borrow one of Nassim Nicholas Taleb’s terms — girded with statistical justification. One can hardly fault it from a strictly procedural point of view — since, in our culture, conclusions ought to proceed from evidence — but one can’t escape the feeling that it amounts to little more than old-fashioned augury… that someone examining the entrails of a dead chicken, spread over the front page of The Wall Street Journal, might arrive at very similar conclusions. All that said, Dent was an appealingly confident personality on-the-air, the kind of authoritative voice you’d like to believe, if only it were possible.

Prechter was much the same a few weeks earlier, and he, too, foresees a darker American future, based on a different set of models called Elliot Wave principles. His forecasts derive from a picture of “social mood” as much as economic data flows. He, too seems to disregard the Peak Oil story and its implications as the master resource driving growth in industrial economies.

Personally, I am not at all sure that the Peak Oil story, or its associated general resource scarcity story, will shed a whole lot of light on the question of inflation-or-deflation. I say this because I think it is a short way down the road of depletion-and-scarcity before the major complex systems we depend on for daily life become so unstable that general socio-economic collapse ensues. After all, capital finance is only one of these many complex systems — some other biggies being food production, trade and manufacture, transportation, electric power distribution, infrastructure maintenance, the military, and governance. Inflation-or-deflation will only be symptomatic of larger failures and instabilities in these systems necessary for modern, civilized life.

All of it begs the question not only whether you or I will have two nickels to rub together, or two gold eagles, or a bundle of six month US Treasury bills, or a zillion shares of Apple, or a gainful vocation, or a roof over our heads, or a hot meal at the end of the day, or a safe place to sleep, or a country we can recognize. I’ve done my share of forecasting, with some episodes of notably bad timing. I don’t do it for grandstanding effect but to provide some basis for knowing what to do in the years directly ahead, so we can hope to construct lives worth living. I’m impatient with models, charts, and statistical analysis. Perhaps this is childish. I’d rather tell a story or paint a picture. So, I’m going to spend the rest of the week finishing the last chapter of World Made By Hand Two: The Witch of Hebron while the US economy wanders where it will.

Regards,
James Howard Kunstler

September 29, 2009

Inflation, Deflation, Peak Oil and Complex Systems was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

-Jude Wanniski, former Reagan advisor, April 1982

So does the price of gold rise or fall in a deflation?

Hint: It’s a trick question, already tripping up plenty of would-be advisors. Because gold must fall during deflation, since it rose during the ’70s inflation. Right?

“Gold prices, in real inflation-adjusted terms, unsurprisingly tended to increase during inflationary times,” nods one commentator, writing in London but posted at the Business Times in Singapore. “Its purchasing power tended to sag during depressions and deflation.”

The source for this claim? Besides syllogism (“The ’70s gave us inflation and a gold bull market; ergo, the opposite must be bad for gold…”) it was apparently Roy Jastram’s The Golden Constant, that dusty study of gold’s enduring stability across the very, very long run by the end of which we will all be deader than Austrian disco hits.

First published by Wiley in 1977, The Golden Constant has just been updated by Jill Leyland, former chief economist at the World Gold Council, for Edward Elgar Publishing. I’ve not seen the re-issue yet (not at £72 a pop! Some $120). But unless Jill’s scrapped Jastram’s research entirely and written a wholly new monograph, the conclusions should in fact be precisely the opposite.

Gold, like silver, gained in purchasing power during deflation but lost out to inflation. The only things to rise during commodity-price inflations were commodity prices and social unrest.

Three centuries of data are hard to ignore, but it seems they can be misread – not least when skim-reading for a quick book review. (If you care for the big picture, Jastram’s charts are available free at the Golden Sextant.) Those three centuries of data can also prove a real bore to analysts without a library pass, as Jastram apparently makes for “a very dense read” says a recent Seeking Alpha post. And all those numbers can also mislead the unwary if the key point’s neglected:

Gold, like silver, rose in value during deflations when it was still used as money. It lost out to inflation back when that role applied, too. But since the end of WWII, we’ve not suffered the first and only endured the second…and gold has risen sharply in purchasing power as the supply of what we’ve come to call “money” has swelled by an order of magnitude or twenty.

Meantime – and not coincidentally – gold ceased being money beyond offering a store of value (and free from default risk, as well). Little wonder that inflation really took off after the limits to money-supply growth set by the post-war Bretton Woods deal were cut by the Nixon White House at the start of the ’70s.

And we all know where that little trick got us…

“What the press and policymakers are calling ‘disinflation’ is simply deflation, the deterioration of the monetary standard characterized by falling prices,” wrote Jude Wanniski, former Wall Street Journal editor and advisor to Ronald Reagan, in 1982 – slap bang in the middle of what he’d come to call the “Volcker Deflation” in honor of the tall, cigar-wielding inflation-fighting Fed chairman.

Volcker took US rates to double-digits and left them there, wringing inflation out of the system and squashing the gold price—then (as now) a key marker for the stable value (or not) of money.

“There is a confusion because commodity prices [in 1982] are falling even as the cost of living continues to rise. [But] the price of gold, the ‘commodity money par excellence’ is the surest proxy for all prices, goods and bonds…[and] the recession that threatens to become depression could also swiftly turn into a major bull market if the Fed arrests the gold-price decline at $300, signaling an end to continued deflation and the monetarist policies that have guided the open-market desk.”

Fast forward the best part of three decades, and here we are again, trying to heat-treat the mutant spawn of a new “monetarist experiment” that’s also broken out of the lab and started to munch bystanders on the corner of Wall Street and Main.

Wanniski’s point back then was that, to prevent the end of the world, the gold price should be forced higher, making dollar devaluation explicit and pumping cash into the economy that could then be lent and spent to unwind that “deterioration of the monetary standard characterized by falling prices.” And only an idiot would pick a fight with Wanniski’s terms of reference.

So please – if you’ll glance at that chart of gold both sinking and rising as deflation failed to hit during the ’80s. Then hold my jacket a second…

Gold is no longer money, not as a means of exchange. Anyone who tells you it should be forgets that the Pound, Dollar, Yen and Euro have yet to expire. Whereas gold has signally failed in that role, not being used to make payment anywhere in the world today. The gold-money survival rate is zero, and so are the chances of a near-term return to any kind of gold-backed currency. (What do you think politicians and central-bank chiefs read for fun if not Brad DeLong and Barry Eichengreen?)

Absent the money-supply limits which the gold standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.

Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero, between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. And now even the European Central Bank is pumping out money – a near half-trillion euros today alone – in a bid to revive bank lending, swamp the currency markets, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the gold standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the dollar can outpace the euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for gold prices, all other things being equal, just doesn’t matter. Because the gold price will not get a chance. All other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, quantitative easing or a half-trillion euros proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the gold price worldwide hit rock-bottom and turn higher, a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded.

But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer – a trick that might not beat deflation, but might just spur a whole new rush into gold.

Regards,
Adrian Ash
BullionVault

June 29, 2009

Gold and Deflation: A Trick Question was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

It’s common knowledge that gold bullion proved the most reliable wealth-store during the vicious inflation of the late 1970s. Yet almost un-noticed, gold has once again been the best-performing asset bar none this decade, too.

Gold has dominated the 21st century so far, in fact – something which will look plain to future investors, although only a handful appreciate it today.

Whether gold can now extend or repeat this performance, of course, is less clear. But “People rightly buy gold when they fear inflation ahead,” as William Rees-Mogg, a keen historian of gold, puts it. And just as during the Great Depression of the 1930s, many people now fear inflation, sparked by the very threat of deflation driving government interventions and central-bank money creation.

That’s why global demand for gold jumped throughout 2008, rising 26% on the GFMS consultancy’s data, just as the US, British and Swiss central banks moved to begin quantitative easing – a.k.a. printing money.

Gold prices had already trebled and more against the world’s major currencies, gaining an average 14% per annum in Sterling terms since the start of 2000.

Yet gold still remains a “fringe” asset class for most funds and advisors. High-margin offers and outright scams are starting to trap the unwary, while good information about how to buy, own and trade the metal remains scarce. Quite how much of your wealth you allocate to this “ultimate insurance” is something to decide for yourself. But buying and selling gold can now be much simpler and safer than during gold’s last multi-year run. It should be dramatically cheaper as well.

The Story So Far

The spark for this decade’s bull market in gold? It came from the huge central-bank gold sales of the late 1990s. Because whatever Gordon Brown sells, a few bloody-minded investors agreed, must be worth buying. It wasn’t just the UK Treasury, however.

Gold sales by those central banks about to join the Euro reached such levels, they signed a deal (the so-called Washington Agreement) to cap annual sales and limit uncertainty on the open-market price. (Renewed in 2004, the Central Bank Gold Agreement expires in September this year. Annual sales undershot the 500-tonne ceiling by one-third or more in both 2007 and 2008. The Agreement may be rolled over to accommodate the sale of 400 tonnes by the International Monetary Fund (IMF), first proposed in February 2008.)

At the same time, in the mid- to late-90s, the Financial Times and Economist both declared “the death of gold”, tempting a similar fate to the famous “death of equities” cover published by BusinessWeek just before the US stock market began its two-decade bull market of the 1980s and ’90s. The Dot.Com Crash that followed between 2000 and 2003 led a growing number of people to seek out alternative wealth stores. Whilst institutional funds overwhelmingly chose fixed-income bonds, a growing number of private investors began to buy gold, especially as the central bank fix – led by the Bank of Japan and US Federal Reserve – was to encourage a tide of cheap credit into all asset markets via (then) record-low interest rates of just 1.0%.

This flood of money washed into house prices, debt investments and emerging stock markets, and it also pushed gold higher thanks to two key events:

1. Leveraged speculation

Financed by the prime brokerage departments of the big investment banks, hedge funds the world over piled into gold derivatives as interest rates fell behind inflation in the middle of this decade. Between 2004 and 2008, they doubled the outstanding volume of US futures and options contracts, for instance, helping gold prices to double as well.

2. Exchange-traded gold funds (gold ETFs)

As early as 1999, research for mine-industry marketing group the World Gold Council (WGC) showed that very large investment portfolios could have made better returns with reduced risk if they had included a four to seven per cent allocation to gold, even during the gold bear market of the previous two decades. Many retirement and mutual funds, however, were blocked under the terms of their deeds from owning physical property, especially in the United States, and derivatives were seen as too risky.

How could these large institutions gain exposure to gold prices? The WGC responded by sponsoring a series of funds that hold physical gold bullion in trust, securitising it for shareholders and thus tracking the gold price. First launched in Australia in 2003, and soon followed by South Africa, the UK and then the United States, these exchange-traded gold funds (gold ETFs) can be traded only during stock market hours. They charge 0.40% per year for storage (typically at HSBC’s bank vaults in London), reducing the gold backing each share down to 98.3% and below of the nominal value.

Already surging by 30% in 2009 to a total valuation of $38 billion, gold ETFs are clearly attracting significant new allocations from mainstream pension and mutual funds. Yet the metal remains “institutionally under-owned” according to James Montier, London strategist for Societe Generale. Pointing to conflicting signals about whether the global economy now faces inflation or deflation, Montier recommends gold as “insurance” against both outcomes. Because while “gold is the one currency that can’t be debased” by inflationary policy, “a significant prolonged deflation would see what’s left of our financial system likely to collapse. Holding a money substitute isn’t such a bad idea against this cataclysmic outcome.”

A Case of Mistaken Identity

Several big-name hedge fund managers have also taken sizeable positions in gold so far this year, including John Paulson of Paulson & Co. (who bet against sub-prime mortgages in 2007) and David Einhorn of Greenlight Capital (who bet against Lehman Brothers’ stock while publicising its 40-to-1 leverage). But the broader universe of hedge-fund investors, however, has been pulling in the other direction, reducing their exposure to gold amid the collapse of Bear Stearns, Merrill Lynch and then Lehman Brothers. Gold futures and options were sold off alongside crude oil, emerging markets and non-Dollar currencies as hedge funds were forced to unwind their leveraged positions, first by their investment-bank brokers raising the level of margin calls and rolling costs, before withdrawing credit entirely, but also by their clients withdrawing funds and demanding redemptions.

Call it “mistaken identity”, as John Hathaway of Tocqueville Asset Management has said. Because while the boom in gold derivatives required credit that was both cheap and freely available, physical gold in contrast only grew more attractive as the banking crisis wore on.

No one’s obligation and no one’s liability, gold owned outright is quite literally the opposite of debt, giving you the same tangible security as owning real estate free of a mortgage, but instantly priced in a 24-hour international market with deep liquidity. London’s gold bullion market, still the centre of professional gold-dealing worldwide, turns over $60 billion per day, and this wholesale dealing in physical gold would be the least likely market to lose liquidity in a true financial crisis. That’s why, largely as a result of the crisis in the credit markets, a small but growing number of high-net worth individuals have already begun investing heavily in physical metal.

Rush to Physical Gold

By March 2008, the very earliest gold buyers had seen its price move from $250 above $1,000 an ounce, making newspaper headlines alongside the collapse of Northern Rock, Countrywide and Bear Stearns. Come July of last year, a sharp drop in price from the all-time dollar-high then drove many existing physical gold owners, especially coin buyers, to accumulate more gold as the world economy slowed and financial markets went into a tailspin. The leading metals refineries, however, weren’t expecting a rush until the usual autumn-time spree, typically driven by India’s usual post-harvest surge of gold buying at Diwali. (Rural India has no formal banking system, so “investment” gold jewellery acts as a hard-money savings account for many millions of people, making India the world’s No.1 consumer market.)

Last summer’s sudden jump in gold-coin demand also caught the world’s largest mints napping as well, and so their clients, especially coin shops in Germany, the UK and United States, hit a genuine shortage of gold coins and bars. The upshot today is that gold-coin supplies remain tight the world over, pushing the average premium charged above professional “spot” market prices by US retail dealers up from five to ten per cent and more – even for the most heavily-minted coins such as the South Africa Krugerrand. (The Rand Refinery has issued well over 50 million gold Krugers since launching in 1969. So there’s little rarity value compared to the plain “lump” of gold you can buy in large bar form.) German-based Heraeus says furnaces worldwide are still booked solid to try and catch up. But with stock-market investors still bruised after the crash of 2008, demand from new buyers only continues to grow, thanks not least to “the biggest interest-rate cuts in history…an unprecedented fiscal expansion,” as Gordon Brown put it at the recent G20 summit in London.

Injecting $5 trillion into the world economy between them by 2010, the world’s leading economies are receiving “more money than ever before,” said Brown. These historic doses of cash, plus the money creation of quantitative easing, lead many new and existing gold buyers to feel that “price falls should be seen as buying opportunities,” say London professional dealers Mitsui, “given the impact of global spending programs on long-term inflation.”

The plan, remember, is to reflate the economy – and asset prices – by weakening the value of money. That’s what central banks mean by “fighting deflation”. The concern amongst gold investors, however, is that reflation will tip into inflation long before global spending programs and central-bank money creation face any genuine attempts to cap, curb or reduce them.

The last decade of gold prices might then prove only a prelude to the price gains ahead.

Regards,
Adrian Ash
BullionVault

May 18, 2009

Gold: The Best Insurance Against Inflation and Deflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.