Here is a new angle on the debate because a lots been said already that I could repeat but I wont, here in 2005 I predicted the real estate crisis and pop of the credit bubble. You will notice in those days I was in the hyperinflationary camp (a good point to note for those who accuse me of being inflexible). While I was right about the impending collapse very early what I have had to reconsider is the limits of how far the credit cycle can be inflated by monetary measures.
http://golddebtinflation.blogspot.com/
Gold, Global Debt and the Currency Time Bomb It depends in which camp you fall, if you have an unwavering belief in the value of the Fiat monetary systems and the intervention of central banks the continuing interest in gold as an investment seems like investing in dinosaur futures. Its ironic that those who urge us to invest in the future innovations of robotics , biotechs , nanotechnology and other technologically based innovation refer to gold investment as speculative and non productive defensive investment , when in reality the US dollars that these innovation stocks are denominated in may prove to the most speculative investment in history..
That's not to say that throughout history gold has not seen similar politically motivated abuses of it value, its just that now we are in a Fiat debt bubble not a gold bubble. If we want to rationalize that gold has become purely an industrial commodity, subject to the normal laws of supply and demand we need to remember that gold has been in deficit industrial production for many years and the demand that's been out there is substantially industrial demand and not an investment demand.
Ignoring gold's historical and current psychological relationship with the investment market , or further suggesting that gold's run as a store of value in troubled times , is all but over seems at odds with the history of money and/or civilization. Asset inflation in the financial economy through the monetization of debt will eventually destroy the US currency. In the long run I don't think the world will have much use for a reserve currency that's only purpose for being is to provide the vehicle for the never ending consumption and asset inflation of the American people.
I think we should also be thoughtful of the relative quantity of money and gold in the market today versus any other time in history, the reality is that there is allot more money in the market so if there is a turn in sentiment and confidence against fiat in general there is allot more money in the system to buy gold. The fiat system must rebalance toward equilibrium at some point in the future , its very unlikely to revert back to gold but allot of money might seek its traditional role as a store of value during the fiat crisis.
Its also ironic that if our bread and milk rise in price we refer to it as inflation , but if the cost of our housing rises we refer to that as investment growth. Inflation is every currencies nightmare and the US is quickly diluting its credibility as a potential reserve currency by the constant politicization of its economy. It's a sign of the psychological times when we hear constantly in the media about America being the wealthiest nation on earth when in reality it's the biggest debtor.
My definition of inflation is basically an increase in the quantity of money in an economy. Taking this definition we need to define exactly what 'money' is, because we could have an increase in the quantity of money, and it not be reflected in money supply figures. It can be reflected in debt growth which would is not captured entirely by money supply figures. It can manifest itself in high wage inflation as in the 60's or real estate or stocks like the last decade. You don't always see it in the price of consumer goods.. In these long wave discussions we et very caught up in whether stocks are going up or down , when in reality economic and business cycles are poorly reflected in stock indexes.
Since 1930, paper money has lost over 98% of its purchasing power. Inflation shifted in 1980 into asset prices and now commodity prices seem to have bottomed in 1999-2001 and the yield on bonds are at all time lows, I think there is a real threat is that inflation will migrate back into consumer prices via interest rates and oil.
The financial economy has become gigantic in terms of GDP. If you look at the earnings of the S&P500, whereas in the 1950s and 1960s corporate profits were still derived 50% from the manufacturing sector, and only about 10-15% from the financial sector, today, more than 50% of S&P earnings - if you add the financial subsidiaries of industrial companies such as GE Capital and GM Acceptance Corp, etc., - are derived from the financial sector, and only 10% from the manufacturing sector .
This makes the US economy amazingly fragile if the bubble bursts across the credit driven markets of real estate; equities; and bonds, the manufacturing economy has been in recession for a decade but the bubble economy , that based on debt has supplied all the GDP and job growth over the last decade. If this debt had been channeled toward Schumpeter type innovation the future for the US economy would be very different. The problem that the US faces is that most of the debt has found its way toward non innovative asset speculative sectors like real estate.
Allowing politicians to make decisions with respect to monetary issues eventually creates distortions in the system, no politician wants to be the bearer of bad economic news so the US constituents have come to believe in a never ending utopia of materialism and consumption. The concept of wealth created by innovation and production is completely alien to the US economy, that is wealth created by selling and trading goods that the economy has produced from its investment in innovation is taking the very back seat in the bus, while investment in financial sector is reaching manic levels.
The fed will print money every time there is a crisis, so inflation (defined here as the growth of money) will continue. The reality is that even if the underlying economy is doing badly a government that is willing to borrow and moneterise debt can keep the populace pretty happy for a long period. Job growth in areas like Real estate markets replace job losses in manufacturing. , because there is net growth no one complains because they all feel they are getting richer.
If the feds stop we will face deflation and lunatic America wont stomach that, so the fed will keep printing and printing and printing. The cost is obviously that if you have one country (the US) that inflates, obsessively printing money and other countries don't do the same, then the currency collapses.(it has to eventually). Then you can get deflation through the exchange mechanism. The problem with asset inflation is the asset inflation leads to a boom, say, in stocks or in real estate, and people stop producing things, "why should I be so stupid and work my butt off when my friend, he buys a piece of land or a few homes, financed on credit, and makes a few million by just speculating on real estate."
The CPI in the US is a total utter fraud and its manipulated so I don't mean inflation hyper or otherwise as seen in the CPI. I mean the real inflation, that is the growth of money and the decline in purchasing power of the US dollar. Weimer Germany was faced with very high reparation payments. These were so huge that they then embarked on printing money in order to meet these payments and that then led to the hyperinflation and to the impoverishment of the poor and the middle class, because there is relatively little investment activity in these asset inflationary times. The rich people move their assets outside the country (look at what Buffet is doing) where the high inflation takes place, and carry out their investments elsewhere, by and large. And so employment doesn't do particularly well in these very high inflationary times, and wages always lag behind the rate of inflation. The Fed in its efforts to avoid deflation create fiscal stimulus through tax cuts etc, and then monetize those tax cuts to create money.
The US is likely to move into a recession; real estate prices will start to deflate and then the Fed will continue to print money at even a greater rate; and then we get to a stage where foreign central banks become risk adverse to the level of US dollar exposure, or worse they see a geo political opportunity to pull the house of cards down, think about it ! What if China decided to sell all their bonds/treasury, they could set off a domino effect that wouldn't stop across all the central banks , the Chinese are still Red and they aren't friends of the US so you will see an economic war initially, there would be a fire sale of US assets, companies like GM would sold to the Chinese.
To keep the US dollar stable and to continue their asset inflation path they will have to continue to drive interest rates up to keep the east Asian banks churning their export dollars back into US dollars. In a way the longer it keeps going the more both sides have to loose , the lender doesn't want their investment in US$ to devalue through a US currency depreciation, nor do they want their exports to decline due to recession in the US, so they have to keep buying US dollars as much as the US needs to keep borrowing them. Lets not forget that they can print money as well in order to buy US dollars. So my guess is that there will be another round of tax cuts to keep the asset bubble bandwagon on the road because a downturn in consumption will bring down the house of cards. By adopting a fractional reserve banking system, the money supply- can be expanded tenfold by every dollar on deposit.
The process becomes more complex since reserve requirements are applied only to transaction accounts such as checking, which is a component of M1. Savings accounts and time deposits, which are components of M2 and M3, representing broader measures of money, have zero reserve requirements. Since time deposits and savings accounts have no reserve requirements, they can expand indefinitely. Banks can also expand the money supply by drawing down their reserves and replacing their reserves through money market loans at the prevailing cost of money (the federal funds rate). In addition to banks increasing the money supply by expanding loans made through deposits, the government can also expand and depreciate the money supply through debt monetization.
When a government needs money, they have three ways of obtaining it. 1) they can get the money by raising taxes, 2) they can issue debt, or 3) they can issue debt that is monetized by its central bank. In its simplest form, debt monetization is simply the government issuing bonds, which are bought by the central bank. The central bank buys the bonds by creating money "out of thin air." The Fed did not earn or save to get the money used to purchase the government's bonds. They simply created it out of nothing. (printing money). At some pint the this extra money has be absorbed by the global currency market if not the currency will devalue.
Historically Japan, China and Europe have been happy with to lend what has been required because its in their best interests, China for instance needs US dollars to import from Oil (which the US has forced to be denominated in dollars) and other materials to go grow their economy , Japan in the past has had to park their savings surplus somewhere . Japan is still by far the largest creditor to the United States(+700B) Japan's economic and financial symbiosis with the United States began right after World War II. Japan has become the most important flender of the U.S. trade and budget deficits. This linkage is tight enough that Japan's financiers could only move out of U.S. bonds by committing fiscal suicide. However, even more so than Europe, Japan is faced with a rapidly ageing population, and the pension burden is rising. With less income generated at home, Japan must resort to its overseas financial investment, i.e., its savings that have been parked in th! e United States.
As these deficits grow an increasing share of foreign funding to the US is being absorbed by pure debt financing, less and less remains for the U.S. to continue with the import of foreign goods, which in turn will reduce exports to the United States through a reduction in consumption. This will impact directly on China's appetite for US dollars The Asian central banks as creditors to the United States will reduce and finally stop lending. These funds maybe diverted to western energy or brand assets.
There will come a time when China bids for GM , moving all the manufacturing to China and maintain the brand asset so the American consumer can continue to buy their beloved automobiles . the only US jobs that will be involved will be the ones in the showroom.With the pool of available external savings shrinking, the United States will be confronted with the task of generating sufficient savings at home . This requires a reduction of private consumption and will put a hard pressure on governmental expenditures.
Jens O. Parsson's "Dying of Money." Quote "Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of al traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation." Consumer price inflation and asset inflation are just different sides of the same coin, inflation is inflation, if houses double in price the consumers must allocate more of their wages to live in those houses, when housing bubbles burst asset inflation transfers itself to price inflation in the downturn.
During a recession the government must raise taxes eventually to cover ever expanding deficits. The current regime in Washington wont have the stomach for that so they will continue to expand money supply and lower taxes to keep the titanic afloat till the inevitable happens. This has happened many times before, including times where gold has created similar inflationary problems not dissimilar to the monitorised Fiat inflation we are are experiencing currently, after Columbus discovered America the Spanish shipped massive amount of gold which in turn was spread across Europe creating inflation. Of course this accidental action of a massively inflated money supply also created an economic boom as had never been seen before. Here even with gold there was inflation and in a way gold became fiat. The gold bugs would have you think the history of gold based currencies is paved with gold, the reality is that all gold or fiat currencies become subject to political dilution at similar stages in the business cycle as the system seeks equilibrium. Ludwig Mises defended the gold standard because he was convinced that a managed fiat money would prove less stable than gold. Fiat money is likely to be mismanaged, not only owing to the multiplicity of price- index targets, but also owing to constant pressure to target other economic variables, such as employment or interest rates. A regime aimed at stabilizing the value of fiat money is therefore likely to be short-lived... Mises beelieved that the merits of particular monetary policies and regimes should be assessed according to theirinfluence upon money's purchasing power or ''objective exchange value'' (Mises 1980: 258).
Like modern-day monetarists, Mises recognized the potentially distorting effects of changes in money's objective exchange value, including the tendency of such changes to alter the distribution of income and wealth ''because individuals are apt to overlook the variability of the value of money'' and ''because variations in the value of money do not affect all economic goods and services uniformly and simultaneously'' (p. 225). The displacement of relative prices following excessive or deficient growth of the money stock ''falsifies accounts of profit and loss''and thereby distorts real economic activity (p. 235). Although steady appreciation or depreciation of money may be fully anticipated and allowed for in the drawing of long-term money contracts, a variable objective exchange value of money is bound to distort other terms of exchange (p. 225).
He believed that "the managers of a fiat monetary standard would inevitably yield to political pressure, and especially pressure from advocates of inflationism who would exploit the measurement problem by arguing for repeated revisions of the monetary policy target in a direction allowing for greater and greater monetary expansion. practical result of this would be persistent depreciation of the fiat monetary unit. If there is an argument for an American renaissance it must come from innovation. If debt is to be flushed out of the system it has to come either via a recession - depression or via innovation.
Three key characteristics must exist for significant innovations to have a major impact on the economy. First, they must have a generality of purpose and, as such, affect a wide range of industries and activities within industries. Second, the diffusion and dynamic effects of these general-purpose technologies may take as long as several decades before they have dramatic effects on the macroeconomy. Third, these new technologies must act as engines of growth (Petsas, 579).
Schumpeter economic analysis is divided into a study of equilibrium, the "circular flow," and a study of change, or "economic development." He conceived of a "circular flow" running on in channels essentially the same year after year. The Theory of Economic Development, however, Schumpeter makes clear that it is economic development-comparative dynamics-that deserve the most attention.
Development in our sense is a distinct phenomenon, entirely foreign to what may be observed in the circular flow or in the tendency towards equilibrium. It is spontaneous and discontinuous change in the channels of the flow, disturbance of equilibrium, which forever alters and displaces the equilibrium state previously existing. The new sciences of nanotechnology, robotics, genetics and computing will provide the displacement of the previous equilibrium when meet the criteria mentioned above.
Clearly the mind boggling innovation described by futurists like Ray Kurzwell will provide 200,000 years of innovation during the next 100 years, but the question remains to be answered when this innovation will reach the point of macro economic impact.
This pattern of economic development derives from intellectual creativity, which Schumpeter describes simply as the ability to undertake "new combinations." Globalization and global complexity, is all about new combinations within corporations, within nations, and among nations. Schumpeter writes that these new combinations come in five types: new goods, new methods, new markets, new sources, and new forms of organization.
More from Schumpeter "The depression excursion lasts until painful readjustments brought about by the innovation have taken place. Once the process of adjustments has run its course, the system finds a new equilibrium in which the economy is again at rest. Also Schumpeter says the decline will continue below the point of equilibrium, and only when the debt structure has been restored to a sound basis will the economy again reach its point of equilibrium. Thus the length of the cycle is not measured from one peak to another, or from trough to another, but from one point of equilibrium to another." Clearly fiat monetization and debt growth have not reached the equilibrium required to bring the debt under control , in fact debt is growing at an extraordinary pace . Further innovation is not ready to take the baton of economic growth from the dinosaurs industries that die off during the period of creative economic destruction that has to occur for these sectors.
A persuasive argument can be made that semiconductor-driven "high-tech" innovations led to the boom of the 1990s. The stock market and economic growth of that decade were manifestations of the expansion phase of an innovation cycle. In fact, in his 2001 presidential address to the American Economic Association, Dale Jorgensen presented evidence that American growth resurgence in the 1990s was a result of the development and diffusion of semiconductor technology. Jorgensen pointed out that intensifying competition in the market for semiconductors led to shortened product cycles and lower prices - all of which helped the diffusion of the technology through the economy. The result of this diffusion of technology was accelerated growth in output, labor productivity, and total factor productivity (Jorgensen, 1, 2, 15).
To summarise I think gold will rise because we are heading into the cleansing depression described by Schumpeter and Mises.
It wont replace fiat but it will serve as a useful counterpoint during the readjustment of global fiat currencies. The other constraint on growth will be commodities. Fossil derived energy economies will be replaced by new energy technologies , but the pain in the process will be monumental., If you read the annual reports of the big energy, mineral and metal miners they are all cautioning that there is a limit in the growth in production expansion. The limits are coming in the form of skill shortages. Even if you don't believe in the kind of supply issues envisaged by the Peak Oil folk the reality is that investment in expansion and exploration has been historically low for a long time.
