Monday, June 27, 2011

How Would Gold perform in the Next Crisis?

The world economy is a complex matrix of money flows. No one really appears to have a grip on how it all hinges together. It's unpredictable, almost life-like.

There are the Keynesian theorists who believe that fiat money is the answer. But maybe they don't factor in enough the one true variable in markets; greed. Then there are the Austrian School economists. Hard money people. Their mantra: If you don't work for it and earn it, you can't have it. Debt and market manipulation is unhealthy for the economy. Yet, don't we need to raise debt in order to produce goods and services?

A return to a gold standard has often been mooted as the elixir for our current problems. Gold would be the stable underpinning of capital growth. We wouldn't be able to print our way out of trouble, thereby misappropriating capital. Bringing forward production and consuming it now, when we cannot afford it.

So does gold have a role to play in the next monetary system? What does gold do in a deflationary scenario. Let's look at this a bit.

Over the past few decades fiat currency derivatives have grown exponentially. Money has been cheap as interest rates have been low. This artificial manipulation of the money supply has distorted the market demand and supply of capital. If the interest rates are too low, this will distort the investment demand in risk related investments. Note the 10 months from August 2010 to May 2011 when the Fed printed $600 billion and pumped that into the market; commodities, and other risk assets, went ballistic. You see, gambling with cheap money holds little downside risk when prices are going up.

The growth in paper derivatives, caused by this misallocation, flowed through the system to Mums and Dads who thought the increases in their house values would last forever. But what they didn't realize was that the value they were looking at was a paper derivative of another flow of investments by someone elses paper derivative.

This cannot last, derivative bubbles have an end. The end may be near.

Look at the bank's balance sheets. They hold property and derivatives as assets, but these 'paper' asset values don't actually exist. They record them because the regulators allow banks to record them at the value they purchased them for. But good luck with getting that money bank when it is time to sell.

If this is true, then now look at the liabilities on that same balance sheet. That's the money banks owe you through your deposits and fund investments. It is actually not there.

How can we be sure it doesn't exist. Because in September 2008, when the global financial crisis hit, the US Federal Reserve and Government bailed out the world through currency swaps. You see, people were wanting their money out from banks and institutions. The balance sheets said it was there, but it wasn't. Hence the bailouts to increase confidence.

If there is a huge sudden loss of confidence in the near future, perhaps caused by Greece, then how would gold perform?

If the above 2008 scenario repeated (if the authorities don't step in with more printing), it would probably cause massive deflation. Suddenly those 'derivative happy' balance sheets would be marked down to true value. Money would disappear in a flash. Gold though, would go up in price, or value, eventually. Why, because after all these defaults have worked through the system, the attempt to store value by investors will cause gold to rise.

This would happen even as people who had bought gold as a 'wealth preserver' or as an insurance' begin to sell in order to make up losses. Because gold will find it's true market value under any circumstance.

How this value will be measured is another discussion. But gold has traditionally purchased a similar basket of assets over time. Perhaps 1 oz of gold would buy around 2 weeks of goods and services with the average Western income (a rough estimate).

Naturally, though, the Politicians would not like a deflationary scenario and probably come up with some other hair-brained scheme to halt the decline and provide stability. This may include a new currency. Perhaps regionally based (like the Amero) or globally based.

They could extend the fiat game for a bit longer, but the pressure would still be on them to deal with the debt. Under any new currency, creditors would not want to be shafted, and would muster considerable political clout in order to be repaid the value of their investments. Remember, they bank-roll these very same politicians.

So debt will be transferred to the new system and away we go again.

How do you think gold would perform in a deflationary scenario? Let me know your thoughts.
Gold in New Zealand dollars: $1869.96 per oz
Previous all time high: $1955.10 per oz

Silver in New Zealand dollars: $42.5 per oz
Previous all time high: $48.58
per oz
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The Anglo-Far East Company
The Original Private Bullion Custodian
Your reference: an-001
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1 comment:

  1. Hi Andrew,

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