Financial markets are becoming aware that the US economy is stalling, so
investors increasingly take the view that with demand likely to stagnate or
even fall, prices for goods and services will soften. This is already
threatening to be the situation in a number of other advanced nations, with
negative interest rates to combat it becoming commonplace. For this reason,
gold and silver priced in dollars are expected by many traders to drift
lower.
Putting the prices of precious metals to one side for a moment, there are
some serious issues with this analysis. Let us assume for a moment that the
US economy does stall; the text-books tell us supply and demand for goods and
services will rebalance at lower prices. This was what effectively happened
in the wake of the Lehman Crisis, when energy, metals and precious metal
prices all fell sharply and large discounts for manufactured capital goods
became available. This does not mean that second time round (and a sliding US
economy could create the sort of financial strains that make Lehman look like
a walk in the park), the same thing will happen again. Indeed, for next time
the central banks already have a plan to contain the situation based on their
experience in the Lehman Crisis. It involves the rapid expansion of money,
which to the Federal Reserve System ("Fed") at least has been
proven on recent experience to have little or no inflationary consequences
whatever.
We therefore know something we did not know in the wake of August 2008,
when the imminent collapse of the global banking system drove everyone to
increase their cash balances. This time we know that last time's guarantees
of $13 trillion, or whatever sum you care to think of, will yet again be
provided by the Fed, backed by hard cash on demand. Forget bail-ins; they are
for dealing with one-off bank insolvencies, not a wider systemic crisis.
Of course it's tempting to think that a new financial and economic crisis
will drive us towards selling anything we can for cash. However, this has not
necessarily been the experience of previous monetary inflations: after
printing money fails to raise the animal spirits, the consensus often expects
a fall in prices, only for the opposite to happen. This was certainly the
case in Germany and Austria after the First World War, when economic burdens
from the combined destruction of infrastructure and wealth, the loss of
productive lives, the end of military spending and the burden of reparations
were all expected to overwhelm their respective economies. The result was people
briefly preferred to hold onto their savings rather than spend. How wrong
they were.
The political situation then was very different from that of today, but
there was an important economic similarity. The rapid acceleration of growth
in money supply failed to stimulate the Germanic economies in the preceding
seven years. It's the same today. The mistake is the one identified by
Frederik Bastiat nearly 200 years ago with his fallacy of the broken window.
We see the dynamics of a failing economy and draw our conclusions from that
observation alone. We disregard the previous monetary inflation, and we have
yet to see the more rapid expansion of money and credit to come. This is why
we do not anticipate the growing certainty that the purchasing power of money
will fall and not increase, embarking on the same value-path as the German
mark and Austrian crown in 1920-23.
If a financial crisis is to be averted, the best we can hope for is an
economy moving sideways rather than expanding. But there are dangers to this
hope, partly from markets that are dangerously over-valued, and partly from
the limitations on further private sector debt creation. In short, we are
living with a situation that is highly vulnerable to an exogenous shock.
Meanwhile, the prices of gold and silver reflect the deflationary view to
the exclusion of the likely outcome. There is no doubt that many dealers
believe that gold and silver are merely commodities, otherwise they would be
chasing their prices upwards in a dash for cash. Future historians should be
puzzled. Perhaps someone will write a history with a snappy title, such as
"Extraordinary Popular Delusions and the Madness of Crowds." 1
1 Already written by Charles Mackay and published in 1851.
Updates will doubtless be required.
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