Part II
mips1.net
Gold: Silver Lining to Dark Economic Clouds
Part II
Bernard Connolly
AIG Trading Group
What of the third element of the American illusion about EMU, that EMU was a milepost on the way to some marvellous form of "global governance"? Well, it is certainly the intention of the EMU proponents to use the putative superpower status of "Europe" to take the US "hyperpower" down a few pegs and force America to engage in negotiations across a wide range of issues. But that desire is not flowering of a global "solidarity": it is a quite explicit attempt to subjugate the US and to move the world away from the dominance of market forces and towards a more bureaucratic mode of international decision-making.
A former member of the Monetary Policy Council, as it then was, of the Banque de France put it very clearly a few years ago: monetary union in Europe, he wrote, would increase the attractiveness of the euro to international investors. That would, it was hoped, suck capital out of the US, drive up American interest rates, create unemployment in the US and force the a weakened and chastened US to the negotiating table with "Europe". One can argue about the economic reasoning he employed, and things have certainly not worked out as he intended, but the intention was perfectly clear.
The economic analysis above certainly points to problem in the concept of economic "globalization" and international capital market integration. There is definitely an inconsistent triad. Global financial market integration, national political independence and imperfectly flexible exchange rates cannot all exist together. One of the three has to go. In the Bretton Woods era, it was capital market integration that was sacrificed, a sacrifice that kept most of the non-OECD world in poverty. Under the Classical Gold Standard, fixed exchange rates in peripheral countries were abandoned from time to time, even though the social and political acceptability of the safety valve of mass migration was much greater then than now. One can, it is to hoped, remain confident that the US, will not, despite the ominous utterances of the "world governance" advocates, ever willingly give up its political independence.
But if the US neither wishes to nor is capable of enforcing a global empire as away of producing world political union, and if Europe is willing to do so but is incapable of doing so, which of the two other elements of the inconsistent triad will be abandoned? Europe has never abandoned a preference for fixed exchange rates and has no intention of doing so: leaving the exchange rate to be determined by the private sector has always been anathema to many European, particularly French, minds. There is undoubtedly a current of opinion even within the United Sates that would like to see a return to fixed rates, preferably via a system of pegs to the dollar or even widespread dollarization.
The outcome is far from clear. But it does seem likely that we shall go through a "mixed" period, a kind of "Third Way" if you like, in which there are more and more attempts to restrict the ability of the private sector to move exchange rates around and that this restriction takes the from not only of government-imposed pegs, target ranges and the like (and a collapse of the yen under the strain of Japan's unsustainable public finances could well provide an excuse for such G-3 target ranges this year) but also from capital controls, whether explicit or, more likely, implicit.
Measures against money laundering, however necessary and justified in current circumstances, will, one has to fear, be used for all sorts of purposes other than fighting terrorism, including that of imposing implicit exchange controls. The Market Abuse Directive currently going through the EU legislative mill, which allows the authorities almost unlimited discretion in deciding, ex post, what constitutes a criminal offence of abuse, will be a weapon of ex ante intimidation in their hands). The ominous and sinister article 59 of the EU treaty permits the imposition of capital controls between the EU and the rest of the world. Like every other article of the treaty it is there for a purpose -- it is intended to be used. It can be activated by a qualified majority vote of the member states -- a financial nuclear weapon aimed at London above all. All in all, there are just too many straws in the wind to be ignored.
This, too, is an aspect of the bull market in government which has now begun. It is by no means the only one. Fiscal policy is back in vogue everywhere. Budget deficits will rise and, soon after, so will taxes. Government subsidies to firms are back in a big way, everywhere. In Europe, just in one three-week period in the autumn of 2001 one saw: the effective nationalization, socialization, corporatization, or whatever, of Swissair; the effective re-nationalization by the Swedish government of the forestry interests of the firm, Assidomän; and the expropriation by the British government of Railtrack. It is possible that telecommunications companies in Europe, only recently de-nationalized, will face some from of re-nationalization in the next few years. The airline sector will be "rationalized", "restructured" or "consolidated" not by market forces but by Brussels fiat. In Japan, further bailouts of the banking system so extensive as to amount to de facto nationalization appear close to inevitable. Former Communists are now in power in Poland, and former Communists have made stunning gains in local elections in Berlin.
Free trade is coming under strain: the US government has imposed import duties on steel and the EU is likely to retaliate. The recriminations begun by the Merrills suit and the Tyco and similar affairs will be carried further, bringing the possibility of re-regulation both of financial markets and of corporate America.
The problems afflicting the dollar and the yen are not so nakedly political in origin: certainly, they are not deliberately pre-programmed in the way the manifold disasters that will engulf Europe have been, at least in part, deliberately pre-programmed. But they still pose serious risks for world financial markets.
The problems of Japan are wholly intractable. The public debt catastrophe alone is enough to justify that conclusion. A crisis, although its precise timing cannot be predicted, cannot be avoided for very much longer. With a debt-to-GDP ratio of around 250% and a true budget deficit in double figures as a percentage of GDP, there is no feasible alternative to a choice between outright default, government expropriation of private sector assets and a massive inflationary repudiation of government debt. Default or expropriation would bankrupt the life insurance sector, with potentially alarming social and political consequences. Inflation is the more likely outcome. The route to very rapid inflation will be through a massively-depreciating yen. What would that involve? Once the process began, no-one in the private sector would willingly hold any government debt except at massively-increased yields. So the BoJ would have to acquire the whole government debt stock. That would involve something like a twenty-fold increase in the monetary base.
All economists, whether monetarists or not, would accept that such an increase would mean hyperinflation and a dollar/yen level of at least 1000 if there were no attempt by other countries to restrain yen depreciation. In response, even though yen depreciation on such a scale would soon create Japanese inflation and claw back some of the initial real depreciation, other countries would panic and intervene to attempt to support the yen, implying excessive liquidity creation and inflation at home (if foreign governments bought up the Japanese debt stock and were ultimately forced to leave interventions unsterilized, the world monetary base would about double). An attempt to institute exchange rate target zones would be very likely. And in the changing political environment in the world, governments would be much more likely than in recent years to attempt to buttress their exchange-rate policies with capital controls, whether implicit or explicit.
In the United States, the late-80's boom got out of hand, involving over-investment, over-consumption, a stock-market boom and generalized financial excess, largely because the Fed did not raise interest rates aggressively enough and soon enough. As a result, the downturn, when it came, was violent as far as the business sector was concerned. A similar adjustment has not yet taken place in the household sector. That is largely because the Fed's very substantial rate cuts last year provided households with ample incentives – via increased housing market wealth; equity release made possible by mortgage refinancing; and zero-rate financing offered by car firms – not to adjust their balance sheets. Just last week Greenspan was implicitly encouraging households to carry on spending by assuring them that their balance sheets were sound, especially if, he claimed, they owned their own homes.
To an extent, the Fed's hand has been forced by the ongoing appreciation of the dollar last year, an appreciation that has only recently begun to reverse. Unless the dollar's depreciation is much bigger than we have seen so far – which is possible but not assured -- and, importantly, a weaker dollar is maintained for several years – unlikely given the problems of Japan and euroland – the Fed will have to maintain interest rates below "neutral" levels for a long time to come, in an attempt to keep the consumer spending. But such a strategy will only delay, not avoid, the necessary balance sheet adjustment and lay the ground for a crisis, in two or three years' time, that will involve a choice between liquidation and inflation. The choice will dictated by whether or not it has to be made just before or just after the next presidential election, but on balance inflation is likelier to be chosen.
In short, there are many politico-economic trends in place or clearly in prospect that suggest a return to the world of the 1970's: inflation (probably triggered first in Japan, but with euroland and the US also prone to inflation); deficits; taxes; subsidies; regulation; government intervention and control; reduced freedom of financial markets and perhaps of international capital movements in particular; political instability and social unrest. All of these trends will be aggravated by the efforts of the European imperialists to achieve their ends through an economic and financial disaster deliberately created by EMU.
With a bull market in government in place, the prospect of prolonged period of a high rate of return on capital looks remote. Given that, the recent bear market in stocks will be reversed – as the Fed is currently unsuccessfully trying to reverse it in the US -- only through deliberate action by central banks to sustain stock prices at overvalued levels, a policy that ultimately must lead either to general inflation or a crash in stocks. The inflation route – more likely to be chosen – would mean a bear market in bonds. So what about gold?
In the absence of a return to the Gold Standard, a return that is neither likely nor desirable (though it would be less bad than inevitably-politicized world monetary "co-ordination"), three things are necessary for the secular bear market in gold to be replaced by a bull market. First, there must be inflation or expectations of inflation. Second, investors must seek an inflation-proof asset that is an "outside" asset – that is, an asset that is not the corresponding liability of someone else. Third, the palate of available financial assets must be restricted. Sadly, these preconditions are likely to be met within the next few years.
Inflation is likely for the reasons analysed above. And all the factors that will lead to inflation will operate through first weakening balance sheets, whether of the private sector or of the government or both. Credit worries will mushroom, increasing the attractiveness of "outside" asset such as gold.
Finally, the accelerating trend in the world towards the restriction of free capital movements and towards a contraction in the financial services industry in general will reduce the available alternatives to gold.
There are many dark clouds in the sky. If they have a bright lining, it is perhaps, if not gilt-edged, at least gold-coloured. |
