The Gold Bull Market Is Over

I tweeted on Friday morning:

Unfortunately, I didn’t start writing immediately. But between then and now, the market fell to a new recent-low:

gold_30_day_o_b_usd

So, what’s up with gold?

Well, gold tends to really do well when real interest rates are heavily negative:

fredgraph (20)

Right now they’re higher than they’ve been since 2011.

And a lot of gold buying has been based on the assumption that massive inflation is coming. Now inflation could really take off in the coming years. But the predictions that quantitative easing would heavily raise inflation (and thus lower the real interest rate) haven’t come true yet. That may well be because most of the quantitative easing money hasn’t really found its way into the wider financial system — banks are sitting on massive excess reserves. Or it may be because of the innate deflationary bias in the economy due to deleveraging effects. Eventually, so long as excess reserves are sitting there the chance of it multiplying out into the wider financial system and generating some significant inflation approaches 1. But for now, people who bought gold for inflation (or more accurately negative real interest rate) protection bought insurance against something that hasn’t happened yet. So nobody should be surprised to see a pretty significant selloff.

Of course, gold is lots of other things to purchasers. It’s a shiny tangible semi-liquid asset, and insurance against counterparty, financial system risks. BRIC central banks are still buying it, because they claim to want to insure against counterparty and financial system risks. Maybe in a few years if there’s another systemic financial crisis (something which is more likely than not) all that gold people were buying in the $1400s, and maybe $1300s or $1200s may end up looking super-cheap. But that would be a whole new bull market from the bull market that took gold from less than $300 in 1999 to over $1900 in 2011. The run is over. The price floor for gold in the medium-term without some intervening event like a massive financial crisis or a war or a global catastrophe is production cost. And right now, that’s just over $900.

And if there was a stock market crash or systemic crisis today (as some indicators are implying) gold’s price would almost certainly go down and not up as it did during the crisis in 2008 as gold-holders (e.g. hedge funds, investment banks) liquidate to cash to  settle other liabilities. Only afterward could we see significant gains.

Now, I think gold is an important part of the global financial system. The fact that it has retained its status as a store of purchasing power and as a kind of reserve currency for over 5,000 years is pretty amazing. That doesn’t mean that it’s immune to bear markets, though.

There were signs in 2011 that there was a psychological bubble in gold when a plurality of Americans named it the safest investment type.

For people holding physical gold as a long-term investment or insurance policy, all of this may be irrelevant. If your plan is to hold it until there’s a seismic shift in the global financial system, then this is totally irrelevant. An ounce of gold is an ounce of gold. On the other hand for people trading for dollar-denominated gains, the jig is up.

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The Return of Mercantilism

Mercantilist trade policies have returned in a big, big way.

Dani Rodrik:

The liberal model views the state as necessarily predatory and the private sector as inherently rent-seeking. So it advocates a strict separation between the state and private business. Mercantilism, by contrast, offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives, such as domestic economic growth or national power.

The mercantilist model can be derided as state capitalism or cronyism. But when it works, as it has so often in Asia, the model’s “government-business collaboration” or “pro-business state” quickly garners heavy praise. Lagging economies have not failed to notice that mercantilism can be their friend. Even in Britain, classical liberalism arrived only in the mid-nineteenth century – that is, after the country had become the world’s dominant industrial power.

A second difference between the two models lies in whether consumer or producer interests are privileged. For liberals, consumers are king. The ultimate objective of economic policy is to increase households’ consumption potential, which requires giving them unhindered access to the cheapest-possible goods and services.

Mercantilists, by contrast, emphasize the productive side of the economy. For them, a sound economy requires a sound production structure. And consumption needs to be underpinned by high employment at adequate wages.

These different models have predictable implications for international economic policies. The logic of the liberal approach is that the economic benefits of trade arise from imports: the cheaper the imports, the better, even if the result is a trade deficit. Mercantilists, however, view trade as a means of supporting domestic production and employment, and prefer to spur exports rather than imports.

Today’s China is the leading bearer of the mercantilist torch, though Chinese leaders would never admit it  – too much opprobrium still attaches to the term.

I have three things to add.

First, states around the world including in the West, and especially America, have massively adopted corporatist domestic policies, even while spouting the rhetoric of free trade and economic liberalism publicly. One only has to look at the growth trend in American Federal spending to see that America has drifted further and further and further away from its free market rhetoric, and toward a centrally planned economy.

Second, the key difference between a free market economy, and a corporatist command economy is the misallocation of capital by the central planning process. While mercantile economies can be hugely productive, the historic tendency in the long run has been toward the command economies — which allocate capital based on the preferences of the central planner — being out-innovated and out-grown by the dynamic free market economies, which allocate capital based on the spending preferences of consumers in the wider economy.

Third, these two facts taken together mean that the inherent long-term advantage of the free market system — and by implication, of the United States over the BRICs — has to some degree been eradicated. This means that the competition is now over who can run the most successful corporatist-mercantilist system. The BRIC nations, particularly China, are committed to domestic production and employment, to domestic supply chains and domestic resource strength. America continues to largely ignore such factors, and allow its productive base to emigrate to other nations. And the production factor in which America still has some significant advantage — design, innovation, and inventions — has been eroded by the fact that the BRIC nations can easily appropriate American designs and innovations, because these designs are now being manufactured predominantly outside of America, and because of (American) communication technologies like the internet. This is the worst of both worlds for America. All of the disadvantages of mercantilism — the rent-seeking corporate-industrial complex, the misallocation of capital through central planning, the fragility of a centralised system — without the advantage of a strong domestic productive base.

Americans Want Smaller Government and Lower Taxes

From Rasmussen:

A new Rasmussen Reports national telephone survey finds that 64% of Likely U.S. Voters prefer a government with fewer services and lower taxes over one with more services and higher taxes. That’s unchanged from last month and consistent with findings in regular surveys since late 2006. 

In fact, a plurality of Americans have called for small government and lower taxes ever since the days of Reagan.

But it has never worked out like that:

So what’s the difference? Is it that voters outwardly claim to be in favour of smaller government, and then when it comes down to it choose the advocates of big government? I don’t think so — I think it is that voters aren’t being given a real choice.

Here’s the increase in national debt by President:

The reality is that — with the exception of Obama — Americans have again and again opted for a candidate who has paid lip-service to small government. Even Bill Clinton paid lip service to the idea that “the era of big government is over” (yeah, right). And then once in office, they have bucked their promises and massively increased the size and scope of government. Reagan’s administration increased the debt by 190% alone, and successive Presidents — especially George W. Bush and Barack Obama — just went bigger and bigger, in total contradiction to voters’ expressed preferences.

The choice between the Republicans and Democrats has been one of rhetoric and not policy. Republicans may consistently talk about reducing the size and scope of government, but they don’t follow through.Today Ron Paul, the only Republican candidate who is putting forth a seriously reduced notion of government, has been marginalised and sidelined by the major media and Republican establishment. The establishment candidate — Mitt Romney — as governor of Massachusetts left that state with the biggest per-capita debt of any state. His track record in government and his choice of advisers strongly suggest that he will follow in the George W. Bush school of promising smaller government and delivering massive government and massive debt.

As Libertarian presidential candidate and former New Mexico governor Gary Johnson put it:

Pick Obama, pick Romney, government’s going to be bigger. Government’s going to be more intrusive.

So will the American people eventually get what they want? To do that, they have to ditch the hierarchies and orthodoxies of the past. Ron Paul and his tireless band of youthful supporters look set to achieve a strong showing at the Republican convention, as well as so far winning party chairs in Iowa, Colorado, Alaska, and Virginia. The Republican party — currently dominated by ageing tax-and-spend boomer Republicans — is being taken over by the libertarian youth who crave small government at home, as well as a smaller foreign policy. Ron Paul has taken the majority of youth votes in a plurality of states in 2012. And even if Ron Paul is not on the presidential ballot, Gary Johnson — a consistent advocate for lower debt, lower taxes, and smaller government — seems set to take a large slice of the vote in November.

As the mainstream parties continue to defy a majority of voters’ will and accrue more debt and make government bigger and bigger (while failing to address problems of unemployment and underemployment)  it seems natural and inevitable that more and more Americans — especially young Americans (who tend more and more to be unemployed and underemployed) — will abandon the sclerotic big-government Republicans and Democrats.

Trouble is, things may go badly wrong before Americans get the chance to put a practitioner of smaller government into power. Already a majority of Eurasian manufacturing and resource-producing nations have ditched the dollar for bilateral trade. Dollars and treasury bonds have long been America’s greatest export — and the greatest pillar of support for growth in spending and welfare. With the dollar’s downfall, smaller government may not be a choice.

Why the Debt Ceiling is a Dead Issue.

The Elephant in the Room?

I spent the last three days writing blog posts on economics without ever mentioning the “hot button” issue of the day: the United States Treasury running out of juice, and having to yet again raise its debt limit. For those with a short memory, or a lack of interest, here’s a figure of the U.S. debt, first in absolute terms:

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If We are in a Depression What Can We Do About It?

Optimism & Pessimism

In my last post in this series, I ended by musing that in reality we are in a depression, that most of the government-led actions to “save the world” have not really helped very much, and that most benefits have gone to the rich and to corporations. Why am I so pessimistic? After all, as Franklin D. Roosevelt put it:

The only thing we have to fear is fear itself

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