Monday, September 19, 2011

Trust Is the Foundation of All Asset Valuation

Jim Grant on Gold

The latest Barron's includes an interview with Jim Grant titled Jim Grant:  Gold Still Looks Good, Japan Doesn't.  Jim's remarks included his opinion of how markets arrive at a price for gold, which appears to be independent of such familiar and tangible things as earnings, dividends, and business prospects:

What I do think is gold is simply the reciprocal of the world's faith in the institution of managed currencies.  It is one divided by T, where T stands for trust.  And trust is a shrinking number and will continue to shrink.  Therefore, I am still bullish on gold.

Jim traces the origins of this relationship directly to the world's central bankers and their extraordinarily easy monetary policies:

If a bubble connotes absurdity, what is absurd are the monetary conditions that supported this gold bull market.  Gold is an expression of the world's justifiable distrust of the way our central bankers conduct their affairs.
I am not sure that I would limit the origins of this inverse relationship to central bankers.  Legislators in numerous countries have made egregious errors over the course of decades in piling up unsustainable levels of public debt, and too many citizens have imprudently acquired unsustainable levels of private debt.   All of these absurdly foolish conditions justify the world's distrust of the way its affairs are conducted.

The Problem with Repression

 Jim admits that his simple "1/Trust" equation is metaphorical: "The poetry of it is that it can't be quantified."  But we get his point, and in citing central bankers as the cause, Jim rightfully draws attention to the possibility that their policies could harm us even more than they have so far:

And the governments of the world are taking under advisement this notion called financial repression -- short-circuiting market mechanisms, capital controls, punitive taxes or intrusive taxes and the like.
Grant is right in warning of financial repression, and it is already here.   Can you invest your money in a safe fixed income instrument that offers a decent rate of interest?  Of course, you can't.  As others have observed, the Fed is sacrificing savers in the interests of Wall Street bankers, and present policy distorts the signals that markets send to investors.  It is no wonder that the world distrusts the monetary authorities.

Central bankers are in a bind, because monetary policies alone are clearly failing to solve the developed world's growth and debt problems.  Given this failure, governments will undoubtedly turn to fiscal and regulatory instruments to address these problems.  As Grant warned, our future may include capital controls, intrusive taxes, and other additional forms of financial repression.

The Future of Repression

This coming week we should see the beginning of Operation Twist, which is intended to distort the shape of the yield curve yet again.  The Fed's repressive intent is obvious:  Push investors farther out the yield curve, away from riskless, short duration assets.   They will happily sacrifice your wealth in order to support asset prices and make it cheaper for the over-indebted to deleverage.

As with the Fed's earlier monetary tricks, Operation Twist seems likely to encourage speculation only temporarily, and the authorities will have more tricks up their sleeves, however repressive those tricks may be.  However much we may hope for more meaningful, structural change, we will not see it because it would undermine the system that supports the elites who control a growing proportion of our nation's wealth.   As Jesse's Crossroads Cafe wrote recently, "the monied interests ...  will burn down society rather than give up their seats at the top of the hill."

The Reciprocal of Trust

For the time being, we see investors flee Europe and park their money in dollars, and in such a situation we see even the price of gold waver in response.  At some point the situation in Europe will stabilize, at least temporarily, and the world's attention can then refocus on the profound and seemingly intractable economic and debt problems of the US, and on the flaws of its managed currency.  Where then will investors place their trust?  Can they doubt that the Fed intends to continue devaluing the dollar?  If gold is the reciprocal of trust in the institution of managed currencies, as Jim Grant asserted, the fundamentals of those currencies argue that the "barbarous relic" should see a continued bull market.