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Often has it crossed
my fancy, that the city loves to deal
With the very best and noblest members of her commonweal,
Just as with our ancient coinage and the newly-minted gold.
Yea for these, our sterling pieces all of pure Athenian mould,
All of perfect die and metal, all the fairest of the fair,
All of workmanship unequalled, proved and valued everywhere
Both amongst our own Hellenes and Barbarians far away,
These we use not: but the worthless, pinchbeck coins of yesterday,
Vilest die and basest metal, now we always use instead.
Aristophanes, The Frogs
For the past
2½ millennia, the Lydian king Croesus has been a byword for fabulous
wealth, the prime beneficiary of vast riches accumulated partly by the
trading skills of his subjects and partly as a result of the copious alluvial
deposits of electrum – a naturally-occurring alloy of gold, silver, and
copper – which were to be found in the country’s rivers (placed
there when the even more legendary Midas washed away the curse of his golden
touch, we are told).
Indeed, it was here
in Lydia that the first stamped and standardised coins began to circulate, at
the turn of the 6th century BC; a development which allowed for a
wider monetization of trade and hence unleashed what some historians have
called a "commercial revolution" across the Ancient world.
The idea that
financial innovation can provide a stimulus to real activity –
warranted or otherwise – is one with which we should all be very
familiar, but there is a slightly darker parallel at the core of
Croesus’ extreme affluence: namely, that the official Lydian coins show
a suspiciously low 50–60% gold content, in sharp contrast to the 80%
and higher constituency to be found in the unadulterated local alloy.
The strong
implication is that, not content with earning a modest degree of seignorage
from the royal mint and too impatient to wait for genuine economic growth to
add to his storied pile, Croesus greatly enhanced his status as the
prototypical Über-High Net Worth individual by practising the
world’s first recorded instance of surreptitious currency debasement
and by profiting all the more from the ensuing inflation.
The analogy goes
further, for Croesus, professing himself alarmed at the rise of Persian power
on his borders, decided to spend some of his immense hoard in launching a
pre-emptive strike on his neighbours’ upwardly-mobile ruler Cyrus (does
this all sound horribly familiar?), having been bolstered in his aggression
by a quintessentially Delphic prophecy that if he crossed over the border
into hostile territory he would bring down a great empire.
Alas! Our
Pre-o-Neocon plutocrat forgot to ask the Pythia just which empire she
meant exactly and nearly paid the ultimate price for "sexing up"
the intelligence in this manner when, shortly thereafter, he found himself at
Cyrus’ mercy, having been delivered into his conqueror’s hands
during the sack of the Lydian capital, Sardis.
Even if we
can’t link Croesus’ inflationary policies directly to his
subsequent military humiliation, we can share Hemingway’s sour
observation that for such "political and economic opportunists" as
he, the "first panacea for a mismanaged nation is inflation of the
currency; the second is war" and that while "both bring a temporary
prosperity," they also both lead to "permanent ruin."
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The Lydian trite
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The role of gold
today
Morality tales aside,
however, does this have any relevance to the role of gold in one’s
portfolio today? We think the answer is, yes.
But, before expanding
upon this assertion, the first thing we have to make clear is that –
however ardently the Goldbugs may wish it were – gold is no longer, in
any sense, a "money," that is, it does not function as the present
good par excellence, the medium of exchange, the one thing universally
accepted, on demand and at par, for all the other goods and services one
wishes to buy with it.
In short, you
can’t easily settle your bar bill with a bar of bullion, nor –
under current political circumstances – are you ever likely to be able
to, no matter how much better off we all might be were the yellow metal to be
reinstated in its rightful place at the heart of economic life.
Accordingly, the fact
that gold is no longer money means we have to turn its historic function
upside down and accept that it is no longer able to provide protection during
those rare periods when money itself becomes painfully scarce – i.e.,
during a deflation (properly defined).
In microcosm, we can
see an example of this axiom at work whenever we suffer that lesser species
of contraction which is a margin-driven liquidation of market positions
– hence gold’s ~7% decline when the credit crunch first began to
bite in August of this year.
Conversely, ever
since this uniquely liquid, highly fungible, easily storable, durable,
scarce, real asset has been denied its monetary birthright by virtue of its
intrinsic lack of compatibility with the workings of populist-democracy
welfare states, it has had to be thought of as a kind of anti-money:
one largely to be held during periods of inflation, when the impaired
currency we actually use is in a dangerous overabundance.
Gold’s late run
has therefore come about since the Bernanke Fed was first panicked into
cutting the discount rate, since the ECB abandoned its stance of "strong
vigilance" to send the Eurocopters flying over its shaky banks, and
since the Old Lady begrudgingly bailed out Northern Rock (and hence all its
counterparts) under explicit government duress.
The arguments may
still be raging about exactly who, or what, was responsible for the recent
financial turmoil, or to what extent it will come to affect the wider
economy, but one unavoidable conclusion can already be reached: namely, that
the sustained inflation of money and credit has become such an integral part
of our modern way of life that our rulers fervently believe that it must
never be allowed to slow (much less reverse) for fear of toppling over the
whole, precarious house of cards which we have so painstakingly built about
ourselves.
During the past few
months, the stark truth is that our central bankers have once more revealed
– both in word and deed – that, as Charles Goodhart explicitly put
it a few years back, "deflation is a policy choice": the unspoken
corollary to which is that "inflation is, and always will be, the preferred
policy choice."
‘…towards
carrying on the War against France’
The prudent investor
cannot afford to ignore the implications of this doctrine. He must realise
that the money which he holds in his hands – and in which he routinely
calculates both his profit and loss and his overall wealth – is
not to be trusted: that it is doomed to lose value – now at a slower,
now at a faster, rate – but always diminishing in worth.
Not only must he
contend with this broad, underlying current of depreciation, but he must also
be aware that the quickening and slowing of its stream, as well as the twists
and turns which make up its course, give rise to the business cycle itself
and so make the longer-term preservation of capital an all the more difficult
task to accomplish.
Forget all the fine
words about containing "inflation expectations" or "preserving
price stability." From their very first incarnations in 17th
century Sweden and England, central banks have been purposeful mechanisms for
shoring up profligate governments (whether these are buying guns or
butter without properly funding the purchase) while serving as a backstop to
the inherently flawed and highly unstable practice of fractional reserve
banking.
Thus, at the first
sign that a crisis is about to erupt in a financial system which could only
have become so perilously over-extended because of a prolonged episode of
central bank laxity, the first priority will invariably be to rescue the
principal culprits by dousing the wildfires raging about them with exactly
the same brand of flammable liquid which was used to fuel them in the first
place.
In running true to
form at this particular juncture, we can only underline that we feel the
price risks being run by the central banks are extraordinary. Not the least
of these is the danger that the US will provoke the fourth great reserve
currency crisis in a century – the previous three being the abandonment
of the gold standard during the Great War, the collapse of the gold exchange
standard during the Great Depression, and the break-up of Bretton Woods at
the start of the Great Inflation.
Since this is a
chronicle of the successive adulteration of money and of the serial
acceptance of a more bastardized replacement when the burdens of the previous
one become too much for political expediency to bear, we can expect profound
consequences to follow – social and political, as well as purely
financial – if the ailing dollar does, indeed, end up being widely
forsaken by its anxious sponsors.
A flight to real
values might well be unleashed in such a pass, potentially boosting the price
of our anti-money, gold, to unheard of heights along the way.
At the same time, the
full panoply of protectionism, export bans, income support, wage freezes, and
the direct administration of prices – already surfacing in several
countries around the world – could devastate entrepreneurial activity
and usher in a nasty and protracted recession.
Should this
transpire, the thing to bear in mind is that, in the two years from the first
quarter of 1973, annualised, quarterly real GDP in the US plunged from 10.6%
to –4.7%, yet the price of gold tripled, that of oil quadrupled, and
wheat’s gain to the monthly peak was 160%.
Nor was this an
isolated incident, for worse was to come, just five years later, during the
two years from the second quarter of 1978, when US GDP underwent an even more
remarkable swoop from +16.7% to –7.8%. That time, wheat rose 70%; the
price of a barrel of crude was well on its way to tripling; and the number of
rapidly shrinking dollars needed to buy an ounce of gold quintupled.
Along the way, the
world painfully re-learned the truth that inflation and recession were not
mutually exclusive. Perhaps the lesson is about to be repeated for a
generation which has again forgotten the rudiments of proper, pre-Keynesian
economics.
Solon’s New
Deal Athens
Back in 6th
century BC Lydia, Cyrus’ first impulse was to have his captured enemy,
Croesus, burnt at the stake. However, soon after the faggots were lit, his
royal victim could be heard plaintively uttering the name of Solon. Piqued by
this, the Persian ordered the flames to be doused and inquired of his
erstwhile foe what he had meant, only to be told that the famous Athenian
law-giver had once warned Croesus that fortune was so fickle that it was
impossible to say which man was truly fortunate until his life had finally
ended and a full account of it rendered.
Recognising true
wisdom when he heard it, Cyrus immediately ordered Croesus to be spared and,
indeed, went so far in his reconciliation as to make him a senior member of
his council – a far-sighted piece of clemency well beyond the ken of
the present era’s serial regime changers.
As for Solon, well
he, too, would have been fully at home today.
A well-known
establishment figure who was appointed to the archonship amid the severe
credit crisis which was mowing down broad swathes of woefully over-mortgaged
smallholders, he first absolved the sad, deluded "condo flippers"
of his day of all responsibility for the unpayable debts imposed upon them by
oligarchic "predatory lenders." Next, he attempted to counteract
the deflationary affects of this officially sanctioned mass default by means
of a 37% devaluation of the drachma – moves which laid him open to
charges that he had allowed certain of his acquaintances (later branded the
Repudiators) into the secret ahead of time, so enabling them to profit
inordinately from the eventual rescue plan.
Plus ça change, for today we see
Treasury Secretary Henry Paulson scrambling to prevent the contemporary
mortgage crisis from worsening, while the Fed has cut rates in the face of a
dollar declining at an annualized pace not that far removed from
Solon’s one-off parity change.
With almost
preternatural resonance, Chairman Bernanke has also been reviled for
naïvely sounding out the opinions of the good and great immediately
before he started cutting rates, while Paulson, for his part, has been
accused of tipping off the members of his notorious Working Group early
enough for them to take a lucrative advantage of the imminent policy easing. Neither
charge, however unfounded it might be, has done much to restore confidence in
either the credit system or the ailing dollar.
Scarcity v Abundance
So, where for a gold
price which has already had a spectacular – if, so far, brief –
run to well beyond what (unsurprisingly) proved the largely illusory
"barrier" of $800/oz?
Well, in the short
run, caution must be exercised as the speculative throng on the main COMEX
exchange have built up an unprecedented long position of up to 240,000
contracts. To put that into perspective, the size of the bet works out at about
745 tonnes equivalent, roughly equivalent to a four months’ mined
supply of metal. With so much hot money having been brought to the party in
so short a time, it is little wonder that the recent price action has been so
savage.
Looking beyond this,
however, consider that, over the past two years alone, broad money in the US,
the UK, the Eurozone, and the BRIC quartet (of Brazil, Russia, India, and
China) has risen a combined $11.5 trillion – equivalent to around
$70,000 for every ounce of newly mined gold wrested from anything down to
4½ kilometres deep in the Earth’s crust in that same period.
Bear in mind also
that the outstanding notional stock of derivatives has soared to more than
$1/2 quadrillion over this horizon, representing an extra $1.7
million haystack in which to search for the poisoned needle of
mathematically-abstruse, systemic risk for each and every, readily-valued,
new ounce of metal brought laboriously up from the Stygian gloom and into the
broad light of day.
Such are the risks
and so great is the disproportion entailed in this orgy of overtrading and
speculation that a clamour has arisen on both sides of the Atlantic for the
central banks to undertake yet more inflation in order to stave off a
potentially damaging aftermath.
You see, no matter
how big the inflationary bubble, an offsetting deflation is merely a policy
choice to be avoided in its wake. No cold turkey will be endured here
– no emetic will be taken to purge the poison – only a stiff hair
of the dog administered to spare the drunk the worst of his pain.
In light of this
– and with gold still some 60–65% off its CPI-adjusted peaks in
dollars, deutschemarks, and in terms of US average wages – we
can confidently argue that while the metal may have undergone an impressive
degree of reassessment already in this young century, it has hardly exhausted
all its strength in this latest round of its multi-millennium struggle
against the endemic evil of inflation – an inference that is likely to
hold even if a misguided American electorate fails to give Ron Paul the
chance to restore both the long-lost Jeffersonian Republic and the
sound money, based on a true gold standard, so essential to its future
maintenance .
Sean Corrigan
Sean Corrigan is Chief
Investment Strategist at Diapason Commodities Management (Lausanne and
London)
Copyright © 2006 -
Copyright © Diapason Commodities Management - Sean Corrigan
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