The full-scale attack on gold by
global central banks officially began with the
provision of swap lines by the Bank of England and
the European Central Bank (ECB) to the US Federal
Reserve in the days following the rescue of Bear
Stearns. In effect, the emergency provision of
liquidity to the financial system has been aimed
at re-inflating the US economy by creating exactly
the same kind of unnecessary and irresponsible
lending that caused the latest mess.
There
are necessarily two elements to this story that
must be understood separately: first, the need to
preserve the US status quo as is being suggested
by the world's central banks, and second, the
mechanisms aimed at restoring the purchasing power
of fiat currencies - in effect pushing gold off
its perch.
As I have written in recent
articles, the death of the US dollar (see
The dead dollar
sketch Asia Times
Online, March 4, 2008) as the
global reserve currency elicited
a search for suitable alternatives, with the
putative contender the euro being dismissed pretty
much out of hand by most people (see Euro-trash Asia Times Online, March 11, 2008).
Into this vacuum, investors globally found
that the sole store of purchasing power was
something of value that central bankers couldn't
manipulate for their own dirty ends, namely gold.
That created a huge problem of sorts for the
global economy, because a collapse of faith in
fiat currencies - so called because their value
rests entirely on a stated nominal denomination
rather than any notion of intrinsic purchasing
power - also means the unwinding of the global
financial system. Simple translation: these
central bankers would no longer have any power
through their inane market policies to wreak
destruction willy-nilly.
A secondary and
perhaps more lethal result of investors flocking
to a fixed-value currency like gold would be to
reduce the velocity of the global financial system
to essentially zero as gold doesn't lend itself to
value manipulation.
In the finance-based
economy of the US and Britain, if not the rest of
Europe, this collapse in monetary system velocity
would be the equivalent of a thousand bank runs:
simultaneously. This was the key stake that the US
was playing for, ie to avoid a complete
destruction of risk-taking in the economy that
would in turn paralyze the unreal economy of
excessive consumption that underpinned it.
What did Europe have to fear from all this
- after all, wouldn't the destruction of the US
system of capitalism provide a boost for its own
alternate method, namely market socialism? Why
then should the ECB and others help the Fed
instead of letting it slide to its own doom?
The answer is that no one really wants to
live in Europe, not even the Europeans: thanks in
equal part to the stupidly high tax rates and low
economic dynamism prevalent in these economies.
These explain the low birth rates across the
continent, which have pushed most countries (eg
Italy, Spain, Germany as well as all the
Scandinavian countries) into sub-replacement
demographic trends.
Simply put, as a bunch
of old people sitting around like the Japanese,
the folks in Europe need the US consumer to
continue buying their ridiculously expensive goods
because they couldn't really do much of it
themselves. This is also the reason that the Bank
of Japan has been anxious to support the policies
of the US Fed, even when it hasn't been asked for
any explicit support. The exporters' lobby in
Japan has been screaming blue murder ever since
the Japanese yen slid below 120 to the US dollar
for its spin-off effects on the rest of the
economy.
The second reason for the ECB
(and the Bank of Japan) to want to help the US
Fed, as I referred to in the previously cited
article, was the simple fact that European banks
(and their Japanese counterparts) held most of the
subprime junk originated in the US. The reason
for them to purchase these US assets was the
paucity of domestic assets due to the lack of
intrinsic consumption in most European economies,
which in turn reduced the opportunity for banks to
lend. European banks had and still have more to
lose from the collapse of the US financial system
than even the US banks. In effect, the ECB wasn't
trying to save the US; it was actually trying to
save Europe when it offered to help the Fed.
Mechanism to reinstate the
US dollar Have you heard of the
alcoholic who promised you that the best cure for
his hangover was to drink a bit more alcohol? This
is the same position of the US economy today,
where the Fed is bravely attempting to re-inflate
the economy and in effect create the same spiral
that contributed to the most recent market
eruptions. What I wrote last year in "Cracks" in credit (Asia Times Online, August 25,
2007) has certainly come to pass, as the
increasingly aggressive behavior of the central
bankers shows.
As most goods have seen
their prices rise in US dollar terms, the best way
out for global central bankers is to inflate the
value of the dollar again. This in turn reduces
demand for gold. Now, if the US actually makes
anything useful, central banks could act in
concert to increase the demand for that widget,
and in turn boost the US economy.
Unfortunately, the US doesn't really make
anything anymore, except lousy cars and delayed
airplanes. What it does create a lot of is, in
contrast, something that requires a leap of faith
- namely financial risk. The description of the US
economy as a giant stack of people selling
inflated housing to each other, while simplistic
and slightly exaggerated, isn't too far off the
truth. This financial risk though needs to be
parlayed to the rest of the world so that US
consumers can buy real goods such as washing
machines made in South Korea and toasters made in
China.
The mechanism to kill off gold as a
viable substitute for the US dollar rests
essentially on taking a number of steps that are
designed to reassert the primacy of financial risk
in portfolios. Remember that most of the world's
openly traded gold is owned by the likes of
pension funds through their alternate investment
arms in a choice that vastly irritates central
banks for reasons I mentioned above.
Following the rescue of Bear Stearns and
opening up its balance sheet to all comers, the
Fed has effectively underwritten the biggest parts
of the US financial system. Investors looking at
these banks and other institutions are now
confronted with a simple paradigm of an asset that
has fallen a long way from its highs of last year,
but will never reach nil value because the Fed
stands in the way to catch a falling knife. This
is what I call moral hazard - unintended insurance
of risky activities by people who really should
know better.
Thus, when Lehman announced a
share issue on Monday, March 31, it was rapidly
oversubscribed because, ignoring the fears of a
mere two weeks ago, no one really expects another
US investment bank to go bust again. The equity
subscription to Lehman also opens the floodgates
for credit investors to come running back to the
financial sector where credit spreads have
dramatically tightened to highlight the reduced
bankruptcy risks. Don't forget also that with the
increased capital at their disposal, US investment
and commercial banks will be indulging in a new
bout of financial asset purchases aimed at
restoring their profitability.
Increased
demand for assets such as equities and credit
diminishes the demand for alternate assets such as
gold. A return of confidence in the US dollar
takes the sheen off the prices of commodities, and
helps engineer a slow increase in the purchasing
power of the US dollar.
At least, that's
the theory.
Where it will
fail So far so good - but try as they
may, the fact of the matter is that the rest of
the world will find it difficult to buy any US
financial asset that isn't implicitly or
explicitly guaranteed by the US government. In
turn, increasing the amount of financial
guarantees could well imperil the credit standing
of the US government itself, which is already
stretched from years of fiscal mismanagement and
budgetary blowouts.
That is what virtually
ensures that the US economy will go down the same
path as Japan, ie as growth prospects diminish,
the chances of attracting new immigrants goes down
and with it the potential for generating further
consumption in the economy. As de-leveraging and
de-consumption bite hard, the US will find that
its inability to actually make things will stand
in the way of any economic revival.
When
that happens, I rather suspect that the world will
not want to own any US financial risk, thereby
starting the cycle of last year all over again.
The economy, in effect, will have to suffer from a
Chinese death by a hundred cuts.
So where
does this leave gold? Not in a good position for
the immediate future, I am afraid. As the world
tries to re-inflate and stock market enthusiasm
once again blinds all investors, it is but natural
for gold and other precious metals to suffer. The
fact that, rather than any meaningful economic
improvement, it is the machinations of central
banks that caused this slide will come as cold
comfort for gold bugs.
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