This story was on Yahoo Finance the other day. It’s like something out of a movie. If you’ve found this thread interesting, you’ll probably really enjoy it: http://finance.yahoo.com/family-home/article/113398/double-eagle-gold-coins-mystery-businessweek
Thought I’d link this since we’ve discussed GLD ad nauseum. It’s a remarkably level-headed article from Casey Research via Zero Hedge on how GLD works. Doesn’t get into any tinfoil hat theories. Just a summary of what you get when you buy GLD. It’s a good read. http://www.zerohedge.com/news/guest-post-tracking-gold
Fascinating article. Amazing what people will invest in and how wealthy you can get by financializing something investors would want to speculate on.
Really interesting article from Barry Ritholtz’s group. I interviewed with him once, and am still really bummed that it didn’t go anywhere. http://www.ritholtz.com/blog/2011/09/your-gold-teeth/ Among other things, it suggest that paper gold includes an embedded (short) call option if faith in fiat currencies collapses completely (i.e. US goes through Weimar Germany type inflation).
bchadwick Wrote: ------------------------------------------------------- > Really interesting article from Barry Ritholtz’s > group. I interviewed with him once, and am still > really bummed that it didn’t go anywhere. > > http://www.ritholtz.com/blog/2011/09/your-gold-tee > th/ > > Among other things, it suggest that paper gold > includes an embedded (short) call option if faith > in fiat currencies collapses completely (i.e. US > goes through Weimar Germany type inflation). From the article: “We view discussions about record nominal gold prices or CPI-adjusted gold prices unworthy of serious thought.” Sounds familiar… “Consistent with those who claim that financial statement information is of very limited use in the valuation of internet firms, we are unable to detect a significant positive association between bottom-line net income and our sample firms’ stock prices.” -Academic study by Haas, published in January 2000 http://www.auroy.com/memoire/++++%20The%20Eyeballs%20Have%20It%20-%20Searching%20for%20the%20Value%20in%20Internet%20Stocks.pdf Or in other words: “it’s different this time”.
bchadwick Wrote: ------------------------------------------------------- > Really interesting article from Barry Ritholtz’s > group. I interviewed with him once, and am still > really bummed that it didn’t go anywhere. > > http://www.ritholtz.com/blog/2011/09/your-gold-tee > th/ > > Among other things, it suggest that paper gold > includes an embedded (short) call option if faith > in fiat currencies collapses completely (i.e. US > goes through Weimar Germany type inflation). If that is the case then people are absolutely insane. The Weimar Republic’s inflation wasn’t generated through exogenous commodity inflation through financial instruments, nor was it generated by expanded monetary base supportive of domestic production (goods and services). It was solely for the purpose of paying external creditors for no productive or manufactured product gains. This is why any comparison to the WR is silly, same with Zimbabwe. That’s not even to mention that neither had the largest economy, military, land (and huge resources), IP portfolio…etc. Hell, the WR was even missing massive portions of its manufacturing sector b/c the allies had carved out portions, including the Saarland and Ruhr. That’s not even touching the deflationary issues the US currently faces, including housing, credit contraction, manufacturing slack…etc. This whole thing is being driven by a feedback loop caused by marginal players entering the “gold” market through highly leveraged paper gold. Effectively, those who cannot afford to hold large quantities of physical are utilizing low-down, no-doc, option arms to bet on gold. Sounds familiar.
spierce Wrote: ------------------------------------------------------- > This is why any comparison to the WR is silly, > same with Zimbabwe. That’s not even to mention > that neither had the largest economy, military, > land (and huge resources), IP portfolio…etc. > Hell, the WR was even missing massive portions of > its manufacturing sector b/c the allies had carved > out portions, including the Saarland and Ruhr. Agreed. Weimar was a story of crushing foreign debt obligations and destruction of economic capacity. It is not an effective comparison to today’s deflationary environment. Similarly, Zimbabwe was also a supply side phenomenon. Mugabe instituted a huge land redistribution scheme in 2000 taking land from 4,000 white farmers and giving it to political allies. Not surprisingly, the gov’t beurocrats knew nothing about running farms, and as a result something like 70% of the productive capacity of the economy was destroyed in a short period of time. Government spending remained roughly constant (reached 67% of GDP in 2007), and Zimbabwe started importing food and tobacco instead of exporting, necessitating large borrowing from other countries. So you had a situation where demand remained pretty much the same, while the ability to meet that demand was dramatically reduced. Too much money chasing too many goods led to hyperinflation. “Printed” money (is there any other kind?) that sits in bank reserves not chasing goods creates no additional inflation pressure, which is in contrast to what bchadwick’s article argues. People/banks can literally hold on to as many printed dollars as they want - there is no theoretical limit - it’s the act of spending when there is a shortage that drives up prices. The opposite is the case in modern day US where we have substantial idle real resources and substantial “hoarding” of financial resources. The savings make sense on an individual level (paying down debt, etc) but aggregated they are self-defeating, since spending is income for someone else. The bottom line is I’ll take the bet against hyperinflation in the US any day and sleep soundly on it.
Just to be clear, I am not expecting a Weimar Republic type hyperinflation, although I don’t dismiss the possibility entirely. I just brought it up because I have been trying to get a better grip on what people are concerned about when they do the physical-vs-paper gold discussion, and so one financial way to think about it is that paper gold has a kind of embedded call option (short call option) in it, although you can’t really see the strike price. I only brought up Weimar because that is the kind of condition under which that call option would become meaningful, not because I necessarily expect a Weimar type outcome, but because that is one of the situations you’d have to see before you start to worry seriously about that call option. Historically hyperinflation seems to happen when a country cannot pay debts in hard currency and therefore has to choose who gets the limited hard currency/asset and who gets paid in paper, and then prints up increasing paper to pay those who are unable to demand hard currency (often this is to pay foreigners in hard currency, and the army and the civil service with printed money; these members benefit somewhat from being paid first and therefore are the first to be able to convert newly printed currency to harder assets)… For the US, we do have a printing press to back our debt without a gold standard (that was in place during Weimar times), and the people who have invested in our Treasurys just don’t have that many alternatives to switch to, which is why CHF has gone wacky, so it doesn’t look like the pieces are in place for Wiemar or Zimbabwe type situations. It is possible that at some point in the future, foreign or even domestic creditors to the US will no longer accept US debt denominated in dollars, and that would change things to make hyperinflation a more distinct possibility. Most likely this would start by the US beginning to issue some debt in other currencies, and then that debt becoming preferred over time to UST debt. TIPS might be the beginning of this, although the US can still manipulate the numbers on which TIPS are based. Hyperinflation aside, we did have inflation rates of about 10% a year in the US in the 1970s, which - although they weren’t hyperinflation - were enough to hurt, primarily because the economy was also in recession. If people are employed, mild-but-not-hyper-inflation may be more “annoying” than catastrophic… however, stagflation has the outcome of draining the unemployed’s savings so fast that destitution quickly follows. So our danger is less about hyperinflation, and more about stagflation - that inflation will tick up long before unemployment ticks down.
bchadwick Wrote: ------------------------------------------------------- > It is possible that at some point in the future, > foreign or even domestic creditors to the US will > no longer accept US debt denominated in dollars, > and that would change things to make > hyperinflation a more distinct possibility. Most > likely this would start by the US beginning to > issue some debt in other currencies, and then that > debt becoming preferred over time to UST debt. > TIPS might be the beginning of this, although the > US can still manipulate the numbers on which TIPS > are based. Here’s the problem with this analysis: the US does not need to borrow from other countries so there is no reason to believe it would start issuing debt in other currencies. Other countries desire to hold US assets (dollars/treasuries) as their savings. You have the correlation/causality backwards. If other countries decide to diversify away from the dollar that is a GOOD thing for the US because less of our internal demand is pulled overseas by manipulated trade structures, improving US production and employment. In the meantime, the world’s insatiable desire for a risk free asset (US dollars) can be satisfied to whatever extent necessary, there will just be no significant growth to support decent returns/interest rates on that risk free asset since there is no free lunch. Geithner does not call up Chinese premier Wen Jiabao each month and ask for a loan to float us through a bit longer and then ask him how much interest he will charge to do so. What happens is the US government effectively spends whatever it wants to buy anything sold in dollars. Then federal reserve policy is involved secondarily through buying and selling bonds on the open market to manage liquidity needs in the economy and target whatever interest rates it wants anywhere along the curve. There are no theoretical constraints imposed on this model by creditors, either foreign or domestic. TIPS pay roughly 0% after inflation and have paid negative rates as recently as last october. There is not a solvency risk to a country that pays TIPS in US dollars anyway, let alone when the interest rate is 0%. Sure if war debts were imposed on the US at some point or for some reason or we had a massive supply shock to the system there could be hyperinflation. However the current conditions are in no way supportive of significant inflation or higher interest rates, and deflation is a far more likely possibility.
I agree with you that this is not an imminent problem. But societies and economies evolve, empires rise and fall, and it’s important to consider some of the ways that they evolve over time. Punctuated equilibria is a useful framework for understanding things. I generally think in terms of scenarios, and the scenario I described and you commented on is a scenario that I consider unlikely, but not inconceivable. It’s important to conceive of these scenarios if you can because it forces you to think of what has to happen and what has to be in place for them to happen. As events unfold, we move closer or further away and you can plan your investments accordingly. The other thing that this exercise does is that if a low-likelihood scenario actually does take place, then the time invested in considering it (or even a similar scenario) gives you an advantage in responding to it, while everyone else is simply panicking. Thats a key point that allows you to *respond* to market events, rather than simply *react* to them.
Dwight… I’m not sure what this sentence really means. Can you elaborate? "If other countries decide to diversify away from the dollar that is a GOOD thing for the US because less of our internal demand is pulled overseas by manipulated trade structures, improving US production and employment. " The part that confuses me is “less of our internal demand is pulled overseas by manipulated trade structures.”
I agree but there is a difference between something being a low-likelihood scenario and something that just isn’t going to happen given the state of the world today. Like if I said to you “real estate prices will not always go up by 10% annually” you could counter that “probably they won’t but that there is a small likelihood that they could”. I would argue that the same holds true in the hyperinflation scenario. It is based on a misunderstanding of monetary and fiscal policy rather than an effective model of the real world supported by history and math.
bchadwick Wrote: ------------------------------------------------------- > Dwight… I’m not sure what this sentence really > means. Can you elaborate? > > "If other countries decide to diversify away from > the dollar that is a GOOD thing for the US because > less of our internal demand is pulled overseas by > manipulated trade structures, improving US > production and employment. " > > > The part that confuses me is “less of our internal > demand is pulled overseas by manipulated trade > structures.” Right so when China exports goods to the US they get dollars in return. They can just hold onto those dollars, in which case the value of the Yuan would rise, or they can spend those dollars on dollar denominated assets (effectively treasuries is the only large enough market) depressing the value of the dollar to remain competitive. The point is that the balance of payments offsets the trade surplus, such that rising debt (public or private) in the US is offset by rising savings in China. The net effect is that China is borrowing demand from the US so that it can save.
OK, so manipulated trade structures means, basically, keeping currency low. The low currency “borrows/steals demand from other countries, such as the US.” The rising yuan is therefore good because it allows more US demand to come back to the US (and makes US labor more competitive). I’m with you there. Borrowing demand from the US in order to finance savings… Yes, that’s an interpretation I haven’t used in a while, and is a useful way to think about it.
bchadwick Wrote: ------------------------------------------------------- > Punctuated equilibria is a useful framework > for understanding things. I had to Wikipedia this one… awesome reference 
Dwight Wrote: -------------------------- > Right so when China exports goods to the US they > get dollars in return. They can just hold onto > those dollars, in which case the value of the Yuan > would rise, or they can spend those dollars on > dollar denominated assets (effectively treasuries > is the only large enough market) depressing the > value of the dollar to remain competitive. I guess you meant “depressing the value of the yuan to remain competitive”…?
newsuper Wrote: ------------------------------------------------------- > I guess you meant “depressing the value of the > yuan to remain competitive”…? My bad thanks for the catch. That’s exactly what I meant.
bchadwick Wrote: ------------------------------------------------------- > OK, so manipulated trade structures means, > basically, keeping currency low. > > The low currency “borrows/steals demand from other > countries, such as the US.” > > The rising yuan is therefore good because it > allows more US demand to come back to the US (and > makes US labor more competitive). > > I’m with you there. > > Borrowing demand from the US in order to finance > savings… Yes, that’s an interpretation I haven’t > used in a while, and is a useful way to think > about it. This is the correct way to look at it. No matter what, if we buy China’s stuff, we buy it with dollars. They have to do something with the dollars, either buy non-USD denominated assets from somebody else using dollars who wants those dollars, buy USD assets with USDs or simply hold USDs (through treasuries). 1. If you buy non-USD assets using USDs, then you’re effectively dumping the USDs on somebody else’s plate. They can, in turn, either well the USDs, depressing the USD price, or they can use the USDs to buy other stuff they want. Unless they want to accumulate USD’s similar to the option the first trading partner has, the end result is the same. 2. You can buy USD assets, such as US companies, US real estate, US baseball teams…etc, but then you run into. A little problem, what happens if the value of those assets decline? What happens if the USD weakens? Buying real assets through trade surplus USDs hasn’t worked out well for many countries, including Japan. 3. Since you can’t dump the USD’s, otherwise you weaken the USD, making domestic goods more attractive and you can’t buy real assets, otherwise you can be trapped in ill-liquid instruments, you buy highly liquid financial instruments, UST’s, keeping the USDs off the market. Now, furthe compounding the issue is the fact that China has manipulated the Yuan for 20 years to suppress the currency and make their domestic goods more competitive internationally. The primary target has been the US, thus the peg to the basket of currency. This causes an additional problem, as the USD weakens, so does the Yuan (effectively) in order to keep the peg in place. To keep the Yuan weak, they must print more Yuan. As that happens, since there is no large international demand for Yuan and you have huge amounts of FDI into your “hot” economy, you get inflation. Wage inflation destroys your competitive advantage and pisses of the peasants, both of which are working against your peg. The only way to maintain the peg is to keep buying USTs while managing internal inflation, hence the change in the reserve ratio while allowing the Yuan to float up (marginally). The problem there is that for every incremental increase in Yuan, the less competitive Chinese goods become, the less US consumers will buy them, the more manufacturing slack there is, the more pissed off people get. You see, the entire reason for the peg was to legitimize the Yuan. However, as the government became punch drunk with economic growth through the peg, they decided to keep the peg for that reason only. This has locked the US into China’s goods while locking China into USTs. The thought is that China was bootstrapping their economy into the 21st century off the backs of the US, waiting for the consumerist economy to take over internally. However, you can’t just do that to that many people that quickly and they are losing the race to keep things balanced while keeping double-digit growth while maintaining low inflation. If people think the US has huge problems with our debt, China has larger problems with our debt. If I owe you $100 I have a problem, if I owe you $1,000,000,000,000, you have a problem. This is one reason why I think QE has been enacted, to force the Chinese to unpeg the Yuan.
Great analysis, spierce, thanks a lot. You added some extra detail that was very helpful to me. Nial Ferguson calls this interlocking “Chimerica” (and it makes me think a bit of the “Firefly” science fiction series, too).
Let’s see - gold is supposed to be doing well in such a fearful environment right? @$1680 this morning… anyone buying now?