Until August 15, 1971, wealth was tallied in units of a real and natural thing – gold. It measured out the world’s other real things – its resources and its output. Its main advantage was that it couldn’t be diddled. That turned the authorities against it; they couldn’t make more of it.
Nuestra Senora de Atocha, a Spanish galleon, sank in a storm off the Florida coast in 1622. When it was found in the 1970s, its treasure of gold doubloons was just as valuable as it was when the ship left Havana 350 years before.
But, post 1971, we have a new, avant-garde money system. Wealth is counted up in pieces of paper…or as electronic ‘information.’ Each unit has no real value of its own. It only represents a claim against real goods and services. And each year, it purchases fewer of them.
What is most remarkable about this freakish new money system is that it is always on the road to Hell but never seems to get there. Since 1971, paper currencies have lost value at a breakneck speed. You’d think their necks would be broken by now. In 1972, we bought a gallon of gasoline for 25 cents. Now, it is 16 times that much. Gold has gone up 50 times…for a 98% loss to the dollar holder. If this pattern continues for another 40 years, a gold doubloon will buy about what it does today. A dollar will buy nothing.
And then, along came S&P with more bad news: not only is the dollar disappearing, but if you lend money to the US government you might not get it back. The stock market took the news badly. But bond investors bought with even more lusty recklessness than before. It was as if they really didn’t want the money back anyway. Yields on US 10-year notes fell from around 3% to scarcely more than 2%, giving investors a negative real yield.
But the fall in yields should not come as a surprise. Japan’s government debt lost its Triple A status in 2002. Yields did not rise. Instead, they stayed between 1% and 2%. Then, last week, Japanese 10-year notes – IOUs of the most deeply indebted nation on earth – reached an all-time high. Yields fell below 1%, briefly.
You may think that investors have lost their minds. But no more than usual. It’s not the nominal rate that investors care about; it’s the real rate. For 20 years, stocks and property in Japan have gotten hammered. Bond buyers are the only ones who’ve made any money. Deflation takes prices down. Even a zero interest rate gives them a positive return. And it isn’t even taxable.
And now the US Fed follows in Japan’s footsteps. The Fed announced last week that it would continue to lend money for two more years, asking little more than a ‘thank you’ in return. Zero is the going rate at the Fed’s lending window – just as it is in Japan.
When Richard Nixon implemented his new monetary system, 4 decades ago, he set in motion a huge expansion in the world’s supply of cash and credit. Gold was limited. Paper money was left to run wild. Ben Bernanke famously announced how it worked in a 2002 speech, entitled “Deflation: Making Sure it Doesn’t Happen Here,” he explained:
…the US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Bernanke made it sound like a piece of cake. He should have appended a footnote. Inflating is easy when the credit cycle is expanding. When an economy transforms itself from grasshopper to ant, it gets harder. People switch from borrowing, spending and investing to exterminating debt and hoarding cash. That’s why none of the stimulus measures – fiscal or monetary – has done any significant good. And it is why no policy adjustment, short of debt cancellation or hyperinflation, will make any damned difference.
The whole situation is one for the history books. Four decades of paper money – with effectively no limit on credit expansion – have created mountains of debt in all the developed countries. Now, private sector debts are being sloughed off and asset prices wobble – making investors fearful and skittish. The more they sweat, the more they seek the safety of US Treasurys, and the lower interest rates go. Low rates delay Armageddon…if Japan is any indication…almost indefinitely. The economy continues on the road to Hell…and picks up speed. When it finally arrives, we don’t know. But we bet the price of gold will be higher when we find out.
for Markets and Money