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.

Deterministic Debt

We Have Seen It Coming

We had sufficient warning that another economic downturn was coming.   Economic statistics signaled a slowdown, gurus talked about it, and a burst debt bubble required it.   Now the idea has become more widely accepted, but what can we do about it?

Lockhart Says the Fed Could Purchase Assets

The Fed wouldn't expand QE, would it?  Well, it could, and it looks like the Fed is starting to prepare the country for it.  In a speech the other day, Federal Reserve Bank of Atlanta Dennis Lockhart let the country know that the Fed is ready to act and has the means if the economy stalls.  “If additional actions are required, I can assure you the Federal Reserve is not out of bullets.”  What kind of bullets?  “Expansion of the balance sheet or changes in the composition of the Fed’s asset portfolio are available, in my view."

"Treasonous" QE

Isn't expansion of the Fed's balance sheet what set off a commodity bubble and got the world to worry about the soundness of the dollar?   We know that it is ineffective against debt deflation.

Rick Perry wants us to consider QE as treason.  In the Texas governon's first day on the Iowa campaign, he said that it would be "almost treacherous, or treasonous in my opinion" for Federal Researve Chairman Ben S. Bernanke to "print money" before the 2012 election.  We know that QE can't touch the economy, but it was nice of Rick to disqualify himself as a serious candidate.

The Real Treason

I wonder what Rick thinks about the real treason:  Ronald Reagan's avowed goal to bankrupt the United States, just to make it impossible to finance Social Security and Medicare.  Reduce taxes and forget promises about reducing the size of government.  Sacrifice everything to ideology.  That was the real treason, and Reagan's successors, like Rick, gleefully play their ignorant and hateful part.

Who accumulated the national debt after Reagan got the ball rolling?  Nearly half of the national debt since Reagan was accumulated under the administration of George W. Bush.  Bush's tax cuts for the wealthy, expanded Medicare, Wall Street bailouts, and endless war are the things that finally piled up the debt to dangerous levels, and they absolutely dwarf the debt added by the Obama administration.

The Real Cause of the Problem

The economic problems of the United States -- high debt, lack of competitiveness, unemployment, real estate glut -- all have their genesis in the lies and broken promises of decades of earlier administrations.  Excuses were made to stimulate current consumption and fund pet programs, all at the expense of savings that could have funded investments in the future of the nation.

Will Congress Dare to Help?

More QE seems likely to accomplish nothing for unemployment and the real economy.  What we need instead are structural changes, which we are unlikely to get.   If the economic pain gets bad enough, Congress may finally align itself with the suffering electorate, forget its promises to reduce the deficit, and try some fiscal stimulation.  Unfortunately, real structural change seems beyond Congress's intellectual depth.  Also, expanding the federal budget is likely to bring the world's attention back to the ungovernable US debt load.  Policy makers are in a bind.

A Familiar Historical Pattern

None of this is a surprise.  Debt bubbles (balance sheet recessions) take years to work out, and there are no nice ways out.  Worse, this debt cycle is taking place as the competitive position of the US is declining.  The US is standing still or falling back, as hard-working people around the world continue to climb up the economic ladder and compete on the world stage.  Inflated expectations in the US will continue to be frustrated as the nation pays the price for decades of waste.

A Period of Elevated Risk

It still looks like we face a long "muddling through" period, but the trouble with "muddling through" is that it leaves little room for error.  The political impasse over the federal budget and S&P downgrade woke people up to the dangers of the out-of-control US debt load, and more people are looking for exit strategies now.  They know that there is no guarantee that the disastrous debt trajectory will be corrected. 

More QE will only stoke the fires of speculation.  Macro risks seem elevated now, and it looks like a bumpy ride ahead.  Treasuries and gold are already soaring.  Some people are asking:  "Is gold the only safe haven left?"

Zeno's Way -- Part 3

LIE:  High taxes are hampering businesses in the US, preventing hiring, discouraging new businesses from forming.

TRUTH:  Business taxes in the US are historically low.  Business gets a much better break with taxation now than at many times in the preceding century.  Just see the charts below.  Taxes on business revenues today are low both as a percent of GDP and as a percent of government revenues, compared to the past 60 or 70 years.

Low taxes were supposed to encourage investment in plant and equipment, leading to higher economic growth and more employment.   Did it work?   I don't think that anyone would say that we are having a good period of employment and economic growth right now.

The government certainly isn't getting much of its funding from business taxes today.  Of course, that's part of the problem.  We are experiencing a budget crisis now in part because wealthy business interests have been getting a break.  Business and the US can both afford a balanced budget.

The rest of us aren't getting a break.  It's about time the special business interests paid their share of the burden of government.  They get more than their share of the benefits of government. 

Zeno's Way -- Part 2

LIE:  It is Obama's fault that high unemployment and low growth are still with us.

TRUTH:   This downturn is a secular process caused by unsustainably high debt levels and precipitated by a financial crisis, NOT a standard inventory cycle recession.  It will take YEARS to work this out, and the country has in fact been PERMANENTLY changed.  The good old days will NEVER come back.

Don't expect one President to solve a problem that the Republicans and Democrats both worked DECADES to cause.  Decades of misdirected investments cannot be reversed overnight.  The damage to the country's capital is permanent, and high growth won't come back. 

Other nations are rising, productive technologies are spreading, and the competitive environment has permanently been leveled.  The overwhelming advantage that the US had for a short time after WW II is gone forever.  If America is declining now, it is because short-sighted leaders protected their own interests by playing it safe rather than acting like true leaders.   

Don't blame reality on a political party.  NEITHER party wanted to look at reality.

Zeno's Way -- Part 1

Ever since the Federalists and Anti-Federalists duked it out in 18th century newspapers, political interests have used the press to peddle partisan lies and half-truths to the American people.  Today, political interests on the extreme right continue to spread lies and half-truths in an attempt to influence the debate about the US government's budget deficit.   Right-wing ideologues in the service of elitist special interests have done the country a grave disservice in poisoning the debate with their lies about the budget deficit, lies which many so wrongly believe.  These servants of the radical special interests are, in fact, steering the nation in a direction will do nothing to solve the problems underlying our economic and budgetary problems.  Their proposals will instead bring hardship to millions of Americans.  Today's blog entry is the first of a series to restore a more balanced dialectic by contrasting those lies to the simple truth. 

LIE:  If we get the government's fiscal house back in order, everything will be hunky-dory with the economy in short order.

TRUTH:   Those expecting an immediate comeback in the economy are either totally deluded or vicious liars.  The spending reductions needed to balance the US budget are so large that they cannot fail to cause a severe reduction in the pace of economic growth.  Economic activity can only contract if the government reduces transfer payments to the elderly, the poor, and the disabled.  If the military budget is cut back, there will be immediate reductions in industrial activity and in consumer spending by military personnel, their families, and the civil servants who are let go.

MORE TRUTH:  The economy is not coming back in any recognizable way for years.  We are experiencing a period of debt deflation, not an ordinary inventory cycle.  Private citizens, the financial sector, local and state governments, and the US government are all buried under excessive debt loads.   Excessive debt cannot be worked off in weeks or months in the absence of confiscatory policies that would frighten our creditors and land the nation in an even worse mess. 

     

Strike Scene, Louis Lozowick, 1934.

Hiatus

The lack of new posts on Caliban's Market is only temporary, to allow time for travel, genealogical research, and other activities.  Look for new posts in a few weeks.