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Through the years I have
read a multitude of articles and books with one extreme point of view or
another regarding impending economic doom. Everything from impending
goldilocks prosperity to imminent 1930s depression is floating around in
bookstores these days.
The deflationists argue
that when debt is issued at increasing levels, there comes a point when we
cannot service the debt, and eventually resort to selling everything we have
– bonds, stocks, houses, cars – to raise dollars to pay debt. In
this scenario, deflation occurs as money aggregates shrink by debt
repayments, people hold off purchases knowing goods will get cheaper, and
workers will be laid off as there is no demand.
Five years ago when the
Dow was 8,000, I talked to Mr. Ian Gordon, who based his 1,000 Dow target on
this deflation premise. Buy gold, he says, because it’s the ultimate
money during times of world depression and deflation.
Well, he was wrong on the Dow.
But he was right on gold, for the wrong reason. Gold rises in tandem with
rising fear of price inflation, not fear of deflation. Gold and deflation
simply do not go together. Why would you buy gold when your dollar is
appreciating in value?
Deflationists and Depressionists are often the same bunch. They eagerly
anticipate some specific back-breaking straw, an event that triggers the debt
implosion, with the world blown back to stone ages and streets filled with
riots and violence. I like to bring up two contrarian points to this
view:
The worst possible event
that could trigger debt implosion has already occurred, with demand for the
multi-trillion US mortgage debt market suddenly and completely dried up. Yet
the world has gone on with business as usual.
In the last four weeks, we
have witnessed the worst financial event in the US over the last 50 years. The subprime mess shook the US
financial system to the core, as it directly affected the marketability of
the $30 trillion+ US
debt market.
Would you touch beef (US
debts) again knowing there is a significant quantity of mad cow disease (subprime) going around?
The significance of this
dwarfs the recent events of 9/11, LTCM, the dot.com bubble burst or the more
distant events of the 1987 crash and the 1970s oil embargos.
To avoid the default of 10
million households and the systemic collapse of major banks such as
Countrywide, The Fed and US
government had no choice but to bail out.
For lenders and investors,
central banks are lending unlimited amount of money to troubled outfits on
renewable terms with faulty mortgages as collateral. Fannie May and Freddie
Mac are buying increase mortgage purchase to troubled outfits.
For borrowers, Mr. Bush is
working with banks and set to “forgive” certain amount of
mortgages. The Fed is lowering interest rates to lessen the burden despite
oil and commodities prices reaching all time high.
Investors see such
inevitable and destructive path for the dollar and it should be no surprise
that gold has broken through $730 and oil has reached a new high at $83.
2. Debt is a man-made virtual feature with
limited, localized effect.
Can you honestly see
Safeway running out of food or corporate America such as McDonalds or 3M
stop growing? The world is forever going forwards, not backwards. Remember
debts are man-made features, existing in a virtual world, serving to
facilitate the transfer of ownership of real assets. While debt implosion may
cause localized social instability, the disruption does not affect technological
or intellectual capacities, or the existence of hard assets. All the houses,
cars, planes, and technologies are still here regardless of the fate of the
dollar.
What I am saying is, people outside of US hardly noticed any difference with
the US
debt implosion taking place in full view. I was in Thailand for a three day break
and the immigration lines at the airport where full of mainland Chinese. What
subprime problem so they say.
In my view, the dollar
losing its reigning status would affect the global economy mildly and
swiftly, as the loss of purchasing power by the dollar merely facilitate
transfer of wealth of dollar holders to other fiat currency holders, and the
owner of hard assets. If the party has to end for the dollar, it just means
that the party is starting somewhere else.
Co-existence of Prosperity
and Gold’s rising popularity?
The topic linking gold to
prosperity deserves a long discussion on its own. Here let me point out that
Gold has risen from $250/oz to $720/oz in six years while the global economy
has grown the fastest since WWII according to The Financial Times, this goes
to show that a Gold bull and prosperity can happily co-exist without a doom
and gloom outcome. With an increasing global middle class and ever-expanding
fiat money aggregate, I don’t see the rising gold and economic trends
reversing anytime soon.
By :
John Lee, CFA
www.goldmau.com
John Lee is a
portfolio manager at Mau Capital Management. He is a CFA charter holder
and has degrees in Economics and Engineering from Rice University.
He previously studied under Mr. James Turk, a renowned authority on the gold
market, and is specialized in investing in junior gold and resource
companies. Mr. Lee's articles are frequently cited at major resource websites
and a esteemed speaker at several major resource
conferences.
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