Hyperinflation

It must be pointed out that gold is certainly no longer the bargain it was at the lows over a decade ago (at which time Warren Buffett undoubtedly hated it just as much as today). This is by no means akin to saying that there is no longer a bull market in force though. What seems however extremely unlikely to us is that the long term bull market is anywhere near to being over. After all, the people in charge of  fiscal and monetary policy all over the globe are applying their 'tried and true' recipe to the perceived economic ills of the world in ever bigger gobs of 'more of the same'. Until that changes – and we feel pretty sure that the only thing that can usher in profound change on that score is a crisis of such proportions that the ability of said authorities to keep things under control by employing this recipe is simply overwhelmed – there is no reason not to hold gold in order to insure oneself against their depredations.

A week ago, Mark Carney was announced as the BoE’s next Governor amid much fanfare. This week, Japan’s election could herald a new more aggressive approach from the BoJ. 2013 will then see speculation mount about Bernanke’s successor and also likely see the operation of the ECB landmark OMT program. It will also mark the 100 years of the Fed and probably much reflection on their impact on the US/Global financial system. So, as Deutsche's Jim Reid notes, central banks will remain in the spotlight for 2013. However whilst their actions to date have certainly minimized the tail-risk post-GFC, they have yet to lift real GDP above their 2007/2008 peak in most countries and virtually every developed economy is operating well below what is perceived to be trend growth. QE would have been seen as highly unorthodox four years ago - and unique for most central banks stretching back through their history. However fast forward to today, that old unorthodoxy has become the new orthodoxy. But what have the world’s central banks got left to offer a world that at some point might be hungry for more?  as the world economy peers into the future and sees a growing threat of a recurring recessions and below target inflation, radical monetary policy may become increasingly appealing as elected politicians stuck in gridlock turn to (relatively) politically unconstrained central bankers to save them from their failings and get their economies racing again. For better or for worse.

"They say this is not massive money printing, but first they are wrong; and second, monetary authorities in the United States did not see the crash coming and the unsoundness of the financial system. In fact, right up until the crash they were saying that nothing like what happened could ever happen... This monetary policy, $3 trillion of bond buying in the United States, $3 trillion in Europe and another $2.5 trillion to $3 trillion in Japan, is unprecedented. ... If and when people lose confidence in paper money because of repeated bouts of quantitative easing and zero-percent interest rates—it could happen suddenly and in a ferocious manner in the commodity markets, in gold, possibly in real estate—interest rates could go up at the long end by hundreds of basis points in a very short time. I’m quite concerned as a money manager that we have to manage money, not just for the boundaries of what’s in front of our faces—maybe we’ll have a little tax increase or not, the fiscal cliff, or the stock market might go up or down 10% or 15%—but for a basic shift. The thing that scares me most is significant inflation, which could destroy our society."

One thing that has undergone hyperinflation in recent years is the length of financial regulations. Big, messy legislation leaves legal loopholes that clever and highly-paid lawyers and (non-) compliance officers can cut through. Bigger and more extensive regulation can make a system less well-regulated. We propose that this is what the big banks will use Dodd-Frank to accomplish. We predict that the regulatory hyperinflation will make the financial industry and the wider economy much more fragile.

Well, my fellow Slope-a-Dopes, although this will undoubtedly be a dreadful decidedly devastating disappointment to many of you, I have chosen to put away my almighty artistically asinine alliteration pen for this Sunday's super significant spectacularly special EP.  Instead of dazzling you with my proficient pathetically putrid pitiful prose, I will focus my alertly astute attention on a stupefyingly serious subject.

As in any other Ponzi scheme, when the weakest link breaks, the chain breaks. The risk of such a break-up, applied to economics, is known as systemic risk or “correlation going to 1”. As the weakest link (i.e. the Euro zone) was coupled to the chain of the Fed, global systemic risk (or correlation) dropped. Apparently, those managing a correlation trade in IG9 (i.e. investment grade credit index series 9) for a well-known global bank did not understand this. But it would be misguided to conclude that the concept has now been understood, because there are too many analysts and fund managers who still interpret this coupling as a success at eliminating or decreasing tail risk. No such thing could be farther from the truth. What they call tail risk, namely the break-up of the Euro zone is not a “tail” risk. It is the logical consequence of the institutional structure of the European Monetary Union, which lacks fiscal union and a common balance sheet.... And to think that because corporations and banks in the Euro zone now have access to cheap US dollar funding, the recession will not bring defaults, will be a very costly mistake. Those potential defaults are not a tail risk either: If you tax a nation to death, destroy its capital markets, nourish its unemployment, condemn it to an expensive currency and give its corporations liquidity at stupidly low costs you can only expect one outcome: Defaults. The fact that they shall be addressed with even more US dollars coming from the Fed in no way justifies complacency.

We face one of the deepest crises in history. A prognosis for the economic future requires a deepening of the concepts of inflation and deflation. Inflation is a political phenomenon because monetary aggregates are not determined by market forces but are planned by central banks in agreement with governments. Inflation is a tax affecting all real incomes. Inflation is a precondition of extreme deflation: depression. Should in fact the overall debt collapse, there would be an extreme deflation or depression because the money aggregate would contract dramatically. In fact the money equivalent to the defaulted debt would literally vanish. It is for this reason that central banks monetize new debt at a lower interest rates, raising its value. All the financial bubbles and the mass of derivatives are just the consequence of debt monetization. How will this all end? In history, debt monetization has always produced hyperinflation. In Western countries, despite the exponential debt a runaway inflation has not yet occurred. Monetary policy has only inflated the financial sector, starving the private one, which is showing a bias towards a deflationary depression. Unfortunately governments and banks will go for more inflation. As history teaches, besides money the freedom of citizens can also be the victim.

Isaac Newton, the father of classical mechanics and progenitor of nearly every technology we use today, was easily one of the top 10 most influential minds in all of human history... Yet as accomplished as he was, Newton credited the brilliant scientists and philosophers who came before him, acknowledging that his insights would not have been remotely possible without the foundations laid by great thinkers– Archimedes, da Vinci, Descartes, etc. No doubt, all great ideas flourish by expanding upon the works of others. Unfortunately, so do terrible ones. And one of the worst ideas in history that continues to play out today is the grand experiment of fiat money. The idea is simple. Rather than allowing money to be scarce and have intrinsic value, our fiat system grants power to a tiny elite to conjure money out of thin air. Presumably, if the ones in control are smart, honest guys, then everything should be fine. Fiat was a total failure right from the beginning... and yet the economic engines deep below are steered by people who worship at the cult of bad ideas.

The conflict between labor and capital is a long and illustrious one, and one in which ideology and politics have played a far greater role than simple economics and math. And while labor enjoyed a brief period of growth in the the past 100 years first due to the anti-trust and anti-monopoly, and pro-union laws and regulations taking place in the early 20th century US, and subsequently due to the era of "Great Moderation"-driven "trickling down" abnormal growth in the developed world, it is precisely the unwind of this latest period of prosperity, loosely known as "The New Normal", and in which economic growth will persist at well sub-optimal (<2%) rates for the foreseeable future, that is pushing the precarious balance between labor and capital costs - in their purest economic sense, and stripped of all ethics and ideology - to a point in which labor will likely find itself at a persistent disadvantage, leading to the same social upheaval that ushered in pure Marxist ideology in the late 19th century. Only this time there will be a peculiar twist, because while in relative terms labor costs as a percentage of all operating expenses are declining around the world, when accounting for benefits, and entitlement funding, labor costs are rising in absolute terms if at uneven rates and are now at record highs. Which sets the stage for what may probably be the biggest push-pull tension of the 21st century for the simple worker: declining relative wages, which however are increasing in absolute terms when factoring in the self-funded components paid into an insolvent welfare system. But the rub comes when one considers the biggest disequilibrium creator of all: central bank predicated cost of capital "planning", whereby Fed policies may be the most insidious and stealth destroyer of all of labor's hard won gains over the past century. 

Rising inequality might “jeopardize social cohesion”

Have you ever wondered what the typical Chinese gold investor thinks about our Western ideas of gold? We read month after month about demand hitting record after record in their country – how do they view our buying habits? Since 2007, China's demand for gold has risen 27% per year. Its share of global demand doubled in the same time frame, from 10% to 21%. And this occurred while prices were rising. Americans are buying precious metals, no doubt. But let's put the differences into perspective.

Hedge funds, allegations, and arm-twisting. But it beats the alternative....

About a month ago, in the third-quarter report of a Canadian global macro fund, its strategist made the interesting observation that “…Four ideas in particular have caught the fancy of economic policy makers and have been successfully sold to the public…” One of these ideas “…that has taken root, at least among the political and intellectual classes, is that one need not fear fiscal deficits and debt provided one has monetary sovereignty…”. This idea is currently growing, particularly after Obama’s re-election. But it was only after writing our last letter, on the revival of the Chicago Plan (as proposed in an IMF’ working paper), that we realized that the idea is morphing into another one among Keynesians: That because there cannot be a gold-to-US dollar arbitrage like in 1933, governments do indeed have the monetary sovereignty. It is not; and in the process of explaining why, we will also describe the endgame for the current crisis... "…We cannot arbitrage fiat money, but we can repudiate the sovereign debt that backs it! And that repudiation will be the defining moment of this crisis…"

Something odd popped up while going through the weekly H.6 update...

After 40 years of boozing on easy money and feasting on fantastical asset price inflations, the global monetary system is approaching catharsis, its arteries clogged and instant cardiac arrest a persistent threat. ‘Muddling through’ is the name of the game today but in the end authorities will have two choices: stop printing money and allow the market to cleanse the system of its dislocations. This would involve defaults (including those of sovereigns) and some pretty nasty asset price corrections. Or, keep printing money and risk complete currency collapse. We think they should go for option one but we fear they will go for option two. In this environment, how can people protect themselves and their property? Our three favourite assets are, in no particular order, gold, gold and gold. After that, there may be silver. We are, in our assessment, in the endgame of this, mankind’s latest and so far most ambitious, experiment with unconstrained fiat money. The present crisis is a paper money crisis. Whenever paper money dies, eternal money – gold and silver – stage a comeback. Remember, paper money is always a political tool, gold is market money and apolitical.