Paper vs Gold

Last month I explained why gold is not an asset to hold in every kind of market. But here’s an even more extreme piece of evidence.

During the last 200 years — an era of unprecedented growth and development — paper investments have trounced gold:

Now there are two perspectives on this:

  1. Gold is so far behind because it has no inherent value, it creates no product or new income, or innovation. It just sits.
  2. Gold is so far behind because stocks, bonds and dollars in a humungous, history-shattering bubble.

We shall see which case is correct.

Investors need to remember that the reasons for gold’s present strength — above all else mismanagement of the global economy and international financial system by governments and large financial corporations which has resulted in a low-growth, high unemployment, negative real rate environment — although historically abnormal, will eventually subside, and we will return to the historical norm where gold significantly under-performs paper. That’s because gold just sits, whereas other assets either produce a net return, or are a net liability.

As I explained last month:

I believe that in order to restore growth, what the system needs, and what it is driving toward is restructuring. This can either be accomplished intentionally through explicit haircuts or defaults, through high inflation, through a slow painful private deleveraging process or through strong organic growth.

I don’t know how debt reduction will take place. It could be three months or years away, or it could be another grinding, unemployed and depressed ten years, full of false dawns. Certainly that is what has happened to Japan since its stock market and real estate bubbles burst twenty years ago. Maybe the West will perform better than Japan in the deleveraging trap — maybe new technological innovations like cheap decentralised solar energy will provide the necessary organic growth to overcome the debt problem. Or maybe not.

Until the private debt load is significantly reduced, it will act as a huge weight tying down economic growth, tying down employment, and structurally weakening both the financial system and society. High debt loads require low interest rates to sustain — which with a little inflation means negative real interest rates. Gold has traditionally done very well in low real rate environments.

Once the deleveraging trap has been left behind, it will be the time to ditch gold and plough all of that purchasing power into productive assets: industrial stocks, real estate, farm land, inventory, and labour force.

And gold will once again settle into significantly under-performing stocks.

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The Economist: “Be Afraid (Unless We Print a Lot More Money)”

While most readers of this blog will be convinced of (or at least open to) the idea that the global financial system is fundamentally broken, and either needs to fail or at the very least needs to undergo a radical transformationsome of us believe that the problem is basically a lack of demand, and that the entire solution lies in printing fuckloads of money, giving it to the people who brought us Solyndra, and hoping for the best.

From today’s issue of the Economist:

Lacking conviction and courage

In the aftermath of the Lehman crisis, policymakers broadly did the right thing. The result was not a rapid return to prosperity in the West, but after such a big balance-sheet recession that was never going to happen. Now, more often than not, policymakers seem to be getting it wrong. Their mistakes vary, but two sorts stand out. One is an overwhelming emphasis on short-term fiscal austerity over growth. Fixing that means different things in different places: Germany could loosen fiscal policy, while in Britain the reins should merely be tightened more slowly. But the collective obsession with short-term austerity across the rich world is hurting.

The second failure is one of honesty. Too many rich-world politicians have failed to tell voters the scale of the problem. In Germany, where the jobless rate is lower than in 2008, people tend to think the crisis is about lazy Greeks and Italians. Mrs Merkel needs to explain clearly that it also includes Germany’s own banks—and that Germany faces a choice between a costly solution and a ruinous one. In America the Republicans are guilty of outrageous obstructionism and misleading simplification, while Mr Obama has favoured class warfare over fiscal leadership. At a time of enormous problems, the politicians seem Lilliputian. That’s the real reason to be afraid.

The alternative view (as I have spelled out many times before) is that no amount of monetary policy without at the same time addressing the underlying real-world problems will solve the problems. Problems will just be kicked down the road, to re-emerge at a later date:

Those troubles are non-monetary — they are systemic and infrastructural: military overspending, political corruption, public indebtedness, withering infrastructure, oil dependence, deindustrialisation, the withered remains of multiple bubbles, bailout culture, the derivatives-industrial complex, and so forth. The real question is when will America tire of the slings and arrows of fortune? When will America take arms against her sea of troubles? And how long will she last on this mortal coil? To die? To sleep? For in that sleep of death what dreams may come…

Until we address the underlying problems, the market — in the long run — will keep crashing. And in the long run, we’re all dead. So that’s twice as bad. Junkiefication leads to junkification.

There was always the hope that kicking the can down the road might give us an opportunity to address those underlying problems. But it doesn’t seem like we have. Risk and leverage are greater than they were in 2008. Moral hazard is ready to rear its ugly head. The global trade structure is as fragile as ever. America is just as dependent on foreign energy and manufacturing. Deleveraging is proving costly and painful. Worst of all, many of the dangers inherent in the financial system have  now been transferred via bank bailouts to the sovereign level — like in Europe.

So no — the real reason to be afraid is not that policy-makers are not showing Bernanke’s famous Rooseveltian resolve. The real reason to be afraid is that what occurred after 2008 merely suppressed the symptoms of an underlying sickness.

They can’t. Only real reform — solving the underlying problems — can.

Why Warren Buffett Is Wrong

From the Telegraph:

“Gold really doesn’t have utility, the 80-year old told shareholders at Berkshire Hathaway’s annual general meeting. “I’d bet on a good producing business to outperform something that doesn’t do anything.”

And so would I. My entire economic position is founded on the idea that productivity is better than non-productivity. So why am I so bullish on gold? And why am I so convinced that Warren Buffett — a man who has had such a successful investment career — is so out of step with reality?

The answer is really very simple — Warren Buffett’s investment career, starting seriously in 1947, has existed in the shadow of the greatest sustained gains in stocks & GDP in the history of the world. Let’s look at the S&P500, mapped against GDP from 1950 to 2010:

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