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Jeremy Grantham's GMO group has produced
an interesting study showing the performance of three asset classes against
inflation.
I think the true correlation is with negative real interest rates rather than
inflation itself. In an inflationary period, interest rates tend to lag the
increase in inflation, producing negative real rates.
But in a period of economic decline in which the Fed lowers rates
artificially, negative real rates can also be created and rather more easily
than some amateur economic theorists believe.
To slightly complicate matters, the markets tend to anticipate,
tend to act on expectations before the reality of something. So we might see
something like gold or interest rates signaling a period of inflation well
ahead of its appearance, if they are allowed to seek their own levels in the
market.
If you think about it, the correlation with negative interest rates makes
sense. In a period of negative rates, all currency heavy financial
instruments are probably facilitating the confiscation of wealth by the
official banking system. Since gold has relatively little counterparty risk
if properly held, it is likely to be considered a safe haven, in addition to
other hard assets and stronger alternative currencies if such things are
available.
Unfortunately for analysis, things are never so simple in real life.
In addition to negative interest rates, there are other forms of wealth
confiscation, including the fraudulent mispricing of risk, outright fraud
itself, and currency devaluation.
And finally, there is the sort of price manipulation which the Western
central banks engaged in for a long period of time in strategically selling
off portions of their gold in order to hold the price lower in a disastrous
attempt to manage the financial markets and silence the warning signal from
gold as asset bubbles began to build in the credit markets and the Bretton
Woods global monetary agreement began to fall apart.
And so what might have been a gradual price increase in gold and silver
instead became a powerful rally as the markets sought to correct to the
primary trend once the banks stopped being net sellers of gold. Now the
financial system can only use other means in order to try and control their
ascent to a genuine market clearing price based on years of monetary
inflation. There are various estimates of what that eventual price might be,
but it most certainly is much higher than where the price is today.
Years of underinvestment in mining has created a dangerous shortage of gold
and silver relative to potential demand. Various financial instruments have
been introduced to provide 'paper gold and silver' to meet that demand. In
addition, even physical exchanges like the LBMA have been pushed to
dangerously high rates of leverage as demand for bullion outstrips available
supply. And so the markets drift inexorably into great opaqueness and
repeated frauds because the world of paper has unhinged itself from reality
across multiple fronts. The problem is that the state of the currency feeds
into all finanical markets and so a mischief done
there spawns its children everywhere.
As one might suspect, the credibility trap in which the financial
engineers find themselves causes occasional outbursts of hysterical animosity
and antagonism against the reactions of the markets, and the reality of their
own economic chickens coming home to roost.
This is a recipe for disaster, and we can thank the Anglo-American banking
cartel, and their gullible accomplices in the other western banks, for it
when it happens. When Dick Cheney said, "Reagan proved that deficits
don't matter" what he did not realize was that he was reading the
epitaph for the dollar reserve currency system that had been in place since
the end of WW II. They do matter, but sometimes the lags in time between
cause and effect can be deceptively reassuring.
Debt may not matter in the short run, and Keynes had some very good and valid
points to make about government stimulus during short periods of economic
slumps to avoid feedback loops and the spiral of decline. As an aside I
wonder, if Keynes came back and saw what his
acolytes were saying in his name, if he could stop throwing up. When he found
new facts he changed his mind, and I suspect he might have changed his and
strongly cautioned against turning a remedy into an addiction to support
habitual corruption and unsustainable privilege. But I do not know if he was
that honest of a intellect, or would have merely
gone along with the rest for the benefits of his class.
Huge deficits over long periods of time to finance non-structural consumption
and underwrite malinvestment and currency
manipulation are almost invariably toxic. The 'vendor financing' that gave
rise to the age of 'Asian miracles' is the rope which will be used to hang
the capitalist system unless strong measures are taken to clean up the
corrupt system that grew up to support and profit from this economic
Frankenstein.
The only reasonable course of action is for the West to nationalize its TBTF
banks, dismantle them gracefully while keeping their depositors whole, and
give up their dreams of global and domestic financial domination by adopting
a system of real capitalism based on market pricing, price discovery,
competition kept intact from monopoly through effective regulation and law
enforcement, transparency and a climate of honesty. But that would visit
restraint, inconvenience, and even some pain on the powerful and privileged,
those who have benefited greatly from this long charade, so it will be
resisted to their bitter end.
While the stock and housing market bubbles have burst, the bond bubble, which
includes the US dollar as a bond of zero duration, remains to be resolved and
marked to market.
 
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