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Gold,
taken in correct dosages to cure the ills which plague the economy and future
financial security may be just what the doctor ordered. But this remedy
administered without following proper protocols may increase the incidence of
unwanted side effects such as nausea, vomiting and loose stool. Taken to
excess, addiction may follow, and the antidote may prove to be a gateway to
harder substances. Many a parent has lost hope when a son or daughter has
moved on from gold to silver and fallen prey to more exotic rare earths or
the influences of Ron Paul, or the musings of Friedman, Hayek or von Mises.
Children are our future, you know.
It
has been over six months from my completion of the Herculean assignment to
grade 219 research papers critiquing the Financial Crisis by mid-career
bankers at the Pacific Coast Banking School in Seattle, Washington. The most
pedestrian explanation for the crisis, falling to the level of Oliver
Stone’s awakening in Wall Street, was greed. While greed
undeniably was ubiquitous during the crisis, so too were earth, wind and
fire; all unacceptably simplistic scapegoats for what should have been very
serious analyses. Another frightening undercurrent was a disturbing lack of
faith in the Law of Supply and Demand, with the desperate hope that the next
time government might get it right and make life fair. As sure as the law of
gravity, the Law of Supply and Demand cannot be amended, appealed, or
overturned. Karma would have been preferred to greed.
The
Role of Moral Hazard in the Financial Crisis
The
papers which intrigued me the most are those which recognized the
debilitating effects of a culture that has nurtured Moral Hazard and rooted
the Great Depression. Moral Hazard is like the middle child, who
redirects blame to the eldest child (greed in this case) and avoiding
judgment and responsibility. Moral Hazard sprouted in the U.S., undeniably
the world’s most free society and stable economy, during the sixties
with the societal awakening of social relativity. This is a particularly
strong franchise among the baby boomer generation. Not to justify or
make rationalizations for their behavior, but one could say that they never
had a chance with academics pushing loose monetary policy and a leadership
vacuum at the highest levels including a string of four of the most
financially flawed U.S. Presidents: Johnson, Nixon, Ford and Carter. These
brought us the Great Society and Vietnam, the end of Bretton Woods, Wage and
Price Controls, the EPA, Whip-Inflation-Now, and the Misery Index. Who wouldn’t
choose sex, drugs and rock’n roll?
The
harm done by Moral Hazard and embracing absolute relativity is that
individuals make the excuse that their actions, in the big picture, have no
consequences. Politicians can and do make careers out of these little
white lies, but as a society it is the end of social order and placing
civilization at risk. Let’s examine the presence of Moral Hazard in the
current crisis. Borrowers made promises to pay without the ability or
willingness (or collateral) to repay. Lenders, independent mortgage bankers
to major banks, willingly made loans on the condition that for a fee they
could sell the loan and pass all the risk down the line. Financial
intermediaries packaged, securitized, rated and willingly recommended these
“assets” to their most “valued” institutional
clients. These institutions gladly accepted higher returns without due
diligence, while assuring their clients that the risk was diversified
away.
Moral
Hazard Metastasized in Systematic Risk
How
correct their assumptions were, since the ultimate owners of these assets
were the compilation of all the world’s investors. The
“assets” became ubiquitous, and diversification as a concept was
replaced by systematic risk as a reality. The Karma of “what goes
around comes around” was realized as we took our gains and passed on
risk, and risk made it all the way around to the source. In October of
2008, the circle was closed and we truly became one world with the
near-meltdown of world credit markets.
Most
of the world’s advanced economies responded in similar
fashion. Liquidity was uniformly made available by central banks and
each instituted reforms in their best interests. Countries with large
resource based economies (hard assets) such as Australia or Canada, as global
participants, were affected but had the financial flexibility. Since the
height of the crisis, countries returning to classic liberal ideals of low
taxes, smaller government and free trade have enjoyed greater progress to
normalcy. In fact, countries in Asia, including Brazil and the Middle East
are making good progress in advancing developing economies and bypassing the
west with free trade agreements as they accelerate the creation of wealth and
modern consumer economies.
The
U.S. and the west have pursued national policies to preserve systematic risk,
concentrating it at the national level. In the U.S. this would extend to the
largest corporations and financial institutions. This would include GM, AIG,
any financial institution identified as “Too Big To Fail”, as
well as Fannie Mae and Freddie Mac. In the world’s greatest
financial experiment, the success of these institutions is now underwritten
by the full faith and credit of the U.S. government.
The
Advanced State of Moral Uncertainty of Success
A
strong dollar seems to offer support to the notion that the experiment in the
U.S. is working. In the big picture, the U.S. Dollar continues to hold
in with the Euro, giving back as much as it has taken since the depths of the
crisis. Interestingly, the U.S. Dollar on a gold exchange basis has not fared
as well. Simply put, gold prices on a dollar basis have increased and
stabilized. Gold may simply be a barometer of the uncertainty for the
eventual success for the U.S. growing an economy with a decade of $600
billion plus deficits, and the increasing likelihood of monetizing a mountain
of national debt.
Current
U.S. national policy may not be able to extinguish the Hydra of Uncertainty
threatening the greatest experiment in national fiscal policy since the Great
Depression. The three heads are higher taxes, increasing regulations, and
declining levels of confidence in the U.S. Dollar as a long-term store of
value. The Bush tax cuts are set to expire at the end of 2010, and it is not
clear that this will lead to sustained tax revenues to the federal government
without retarding economic growth. Likewise, the U.S. Administration has
installed dozens of czars, expanding the reach of the government to an extent
unknown even to themselves.
Investors
and consumers are not sure what the future holds. This is made apparent by
the confusion over inflation-deflation. With record bank reserves, bank
credit and credit demand is suspect, and the velocity of money declines amid
growing chronic unemployment. The U.S. Congressional mid-term elections
may provide some redirection toward certain ground, but this is optimistic at
best, with good prospects for the continuation of six more years of the
current administration. The prospects for cutting off all three heads of the
Hydra of Uncertainty, in order to compete against developing countries while
dealing with looming demographic issues, appears uncertain and problematic at
best.
Moral
Courage is Now at a Premium
It is
interesting that the challenges of the present day do not appear to exceed
levels experienced in the past. Unemployment reached upwards of 25% during
the Great Depression, even without the confidence of an underlying social
safety net beyond family, church and community. Many in government or
government sympathizers advertise that the crisis has been averted and are
sounding “all is clear” to get back to business. These seem to be
concentrated among recipients of stimulus funds, or with too much influence
in government to fail. The other small businesses, community banks or the
millions of unemployed (or underemployed) individuals who lack a lobby,
special caucus and voice in major media to be interesting, may not be so
confident.
It is
interesting that gold is considered to be a relative measure of confidence,
and a low gold price implies a relatively high level of confidence. This
would suggest that the pre-9/11 Bush/Clinton years were a veritable age of
stability. The question U.S. residents are asking is if they are better today
than they were six years ago. More importantly, if they are going to be
better off six years in the future. While moral courage is a
pre-requisite for economic survival, the supply and nature of gold on the
earth is a constant.
Gold
in Proper Doses May be an Appropriate Antidote.
Many
have recognized and made physical gold, gold ETFs and gold equities part of
their investment portfolio. Should this be acted upon, the limited supply of
gold and gold equities may present an option for mitigating growing
uncertainty in the near-term for the systematic risk posed by government
solutions. As more nations around the globe liberalize their economies, the
U.S. and western nations may come under increasing competitive pressure, and
for residents in these economies gold may be an even more important antidote
for what ails their wealth.
Many
gold analysts and experts are becoming more emboldened to predict gold
reaching several thousand dollars per ounce in the near to mid-term. My
earlier estimated range of $900 to $1,200 per ounce in 2010, with the
potential of reaching $1,500 at year end still appears reasonable. The
likelihood of staying within the range seems reasonable given the
deflationary pressures of unemployment and credit supply/demand. Despite the
record monetary base, banks appear interested in leveraging the arbitrage of
investing in Treasuries, not supporting risk-taking commercial endeavors.
Should a shock to the market’s confidence in the U.S. Dollar erode the
moral courage of the market, gold could move beyond our year-end estimate.
In any event, the U.S. government’s absorption, concentration and
underwriting of systematic risk presents significant uncertainty for U.S.
investors, and is a call for appropriate respect for gold.
The Gold Report
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