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Two things happen to cash savers (meaning pretty
much everyone) when real interest rates get stuck below zero...
HOW HAS GOLD reached and breached new all-time highs in the absence of strong
1970s-style inflation?
The Buttonwood column in last weekend's Economist
is only the latest analysis to miss the point, and despite tripping right
over it, too.
"Owning gold is traditionally seen as offering protection against
inflation. And inflation is very bad news for owners of government bonds.
"But the ten-year Treasury bond yields just 3.3%, a level that is
towards the low end of the historical range...You would expect the
performance of gold and Treasury bonds to be inversely correlated. When gold
was at its real all-time high in 1980, the ten-year Treasury-bond yield was
10.8%. Fixed-income investors had suffered years of negative real returns in
the 1970s."
But there's the rub, as we never tire of telling people here at
BullionVault. They tire so quickly of hearing it, however, that even The Economist can't square the circle
of rising gold, falling bond yields. Because it never was inflation alone in
the '70s that drove people to buy or sell a lump of rare, indestructible
metal. It was rather the rate of return offered by cash and bonds –
those better competitors as a store of wealth, all things being equal – over and above (or below)
inflation.
That's why gold made a terrible inflation hedge in the
1980s and '90s, most especially for Dollar investors. Because no-one needed
an inflation hedge! Not when 10-year Treasuries paid 4.3% on average over and
above CPI inflation. Not when the real Fed Funds rate averaged
3%-plus...leaving gold to drop three-quarters of its real Dollar value inside
20 years...as the real value of cash-on-deposit doubled.
Now compare and contrast with the last eight-and-a-half years. CPI
inflation has averaged barely half its previous two-decade average, yet the
real returns paid to bonds and cash have collapsed. Adjusted for inflation,
in fact, the real Fed Funds rate has now been below zero for 54 of the last
101 months. That matches the 54 months of sub-zero real rates which the Fed
delivered in the 1970s...
...but things are worse yet, of course. First because that
decade's 54 months of negative real rates were spread across 10 full years
from Jan. 1970. So second, the overall effect on the average real rate since
2002 has been to drive it lower again.
Short of a revolution in Fed thinking (no sign of that today), the
decade starting Jan. 2002 looks set to deliver yet more negative real rates
before 2012, if not beyond. Which will continue to mean that:
- Holding cash-on-deposit guarantees a loss of
real value, something that even the most passive, cautious savers will
only put up with for so long;
- The opportunity cost of holding gold or silver
– the foregone interest you'd otherwise receive on cash –
remains absent.
The monetary metals may not have been official money for many decades today. But the
Fed's interest-rate policy is actively leading the remonetization of gold and
silver as popular stores of value.
Because when "risk free" cash keeps paying a guaranteed
loss, then a growing number of people will, in due course, start seeking
shelter elsewhere. At the same time, holding gold and/or silver has ceased
being a burden (bullion storage rates need not be onerous), inviting fresh
flows of retained capital, tired of earning nothing or less.
Real returns to cash have now been low-to-negative for almost a
decade, and so it might not be too long before a far broader, and thus
larger, volume of savings turns from cash to the obvious and historic
alternatives. Either that or the Fed will hike rates so high, you get 4% and
more above inflation.
Adrian Ash
Head of
Research
Bullionvault.com
You can also Receive your first gram of Gold free by opening an account
with Bullion Vault : Click here.
City correspondent for The Daily Reckoning in London, Adrian Ash is
head of research at BullionVault.com – giving you direct access to investment
gold, vaulted in Zurich, on $3 spreads and 0.8% dealing fees.
Please Note: This article is
to inform your thinking, not lead it. Only you can decide the best place for
your money, and any decision you make will put your money at risk.
Information or data included here may have already been overtaken by events
– and must be verified elsewhere – should you choose to act on
it.
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