Yesterday we discussed Bernanke’s abominable interpretation of the gold standard and his hazy recollection of the financial history of the inter-war years. We neglected to mention another hoary old ‘golden’ chestnut he banged on about.
This chestnut is that there’s not enough gold (which is money) to satisfy a growing economy. Therefore, a gold standard can restrain economic growth because of the tight rein it imposes on the money supply. Most people instinctively agree with this.
But when you think about, you’ll realise such an interpretation is one-dimensional.
Let’s start with the concept of money.
Money is simply a representation of wealth. It is not wealth itself. Most people derive wealth from their labour. Money is a way for them to disperse (spend) their wealth in many different ways (via consumption) or defer consumption by saving.
The creation of wealth in an economy happens irrespective of the amount of money circulating. If real economic growth rises by 10 per cent, and the money supply increases by just 2 per cent, then the price level adjusts to reflect the change.
In this case the price level would adjust downward (deflate) to reflect a greater relative increase in wealth. If on the other hand money grows faster than wealth then the price level will rise. An increasing money stock divided by a stable pool of wealth is just another way of expressing inflation.
It doesn’t matter if the money stock grows slower than the rate of real wealth creation. ‘Money’ is just a numerical representation of that wealth.
But here’s why central bankers and statists don’t like it: it causes deflation. Not bad deflation, like the type you get when an asset bubble bursts. We’re talking good deflation, where an economy’s natural tendency to innovate and make technological improvements lowers the price level over time.
Such deflation is great for consumers because it puts a little more purchasing power in their pockets year after year. But it’s bad for…guess who?
Politicians, bankers and whoever else rely heavily on debt.
Under a gold standard, where the money supply grows very slowly (usually around 2 per cent per annum) there is a tendency toward mild deflation. In such a scenario households gain a little purchasing power – via the advances of technology – each year.
But a monetary system that bestows minor benefits on a broad swathe of society cannot benefit special interest groups. And a government hamstrung by such a system finds it difficult to buy votes.
In short, a gold standard – except in rare times of major gold discoveries – prevents an inflationary outbreak of the money supply. It tends towards deflation instead.
Inflation is the monetary policy of the 20th and, so far 21st centuries. It is favoured by bankers (it encourages people to get into debt), central bankers (it justifies their existence) and politicians (it provides them with the funds to selectively bribe the electorate).
Unfortunately, the general population also favours inflation because it provides the illusion of wealth. People fall for the fallacy that money equates to wealth.
Thanks to Bernanke and the central bank brigade, there is now more ‘money’ in the world than at any other time in history. Yet our ‘wealth’, or living standards, has not kept up with the recent historic surge in the money supply.
But for some reason the world continues to look at Bernanke as the font of all monetary wisdom. We’re not suggesting the world should immediately return to a classical gold standard. That will probably never happen. Not at least until there is a crisis so bad that the clowns still running the show are completely discredited.
But gold still plays a very important role in the financial system whether Bernanke wants to recognise it or not. Despite the absence of an official gold standard, humans are still digging gold up in all parts of the world and redepositing it in a vault somewhere.
In a monetary system completely abused by special interests and the banking elite, gold remains in more demand than ever. It is the monetary North Star for an idling and listless system.
China knows this. It’s why they are accumulating physical gold at the same time as the western banking cartel do their best to keep the price down. Why is China accumulating gold?
Gold is power. China has a very fragile financial system. The lending boom of 2009 has created another bad loan problem for the banks. This won’t be a real problem as long as the yuan remains an inconvertible currency. That’s because Chinese savers are trapped within the banking system. Their deposits effectively finance the loans of the banking system.
If China freed the movement of capital now, the yuan would probably crash and there would be a run on the banks. So don’t expect it to happen for some time.
But China is taking its first steps to internationalise its currency. The front page of today’s AFR reports that the People’s Bank of China and the RBA have established a $30 billion currency swap arrangement. This is a way for China to avoid dealing with the US dollar as a settlement currency for trade. It’s also a way for them to avoid dealing with the western banks that provide US dollar based trade finance.
But to truly internationalise the currency its needs a solid foundation. It needs to offset the fragilities brought about by an imbalanced economy, a credit boom that channelled trillions of yuan into unproductive investments, and a financially repressed household sector where the return on bank deposits is less than the rate of inflation.
As far as we can tell, that solid foundation will be gold.
And as soon as this becomes apparent Ben Bernanke will go from teacher to class dunce.
As a side note to all this, gold, and especially gold equities, have put in an ordinary performance of late. We put it down to the frustrations and machinations of a bull market. If bull markets climb a wall of worry, then you’re seeing it in action in gold.
We’ve followed the gold market for many years. The current angst and worry is nearly as extreme as we’ve seen it (apart from the 2008 episode). Could it get worse? Yes. If this 6-month stock market rally continues, gold will continue to flounder.
But there are reasons why we think the end of the rally is near. A few weeks ago, we presented the chart of Apple (AAPL) as an example of a market getting a little carried away. The Apple share price has added another $50 since then. If you missed it, here it is again in its full, overbought, parabolic glory.
And just yesterday Goldman Sachs came out with a report saying equities are now a once in a generation buying opportunity. They’re trotting out the old “equities are good value compared to bonds” argument. That’s been the case for about the past 5 years so we’re not sure why Goldman is telling this to their ‘muppet’ clients now…perhaps a last, desperate attempt to continue to justify buying?
Goldman Sachs is probably right – they’ve just got the asset class wrong. We think gold is close to bottoming and the bear market rally is close to topping out.
We watch and wait…
for Markets and Money
The “After America” Archives…
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2012-03-14 – Nick Hubble
The Final Countdown
2012-03-13 – Nick Hubble