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What G20 will not discuss this weekend (but probably should)



June 22, 2010 – Comments (2)

Here is another very intersting article by Jim Rickards on King World News. A common theme through Rickards' work is the inevitability for returning to a gold standard. This is not necessarily my opinion. Not because I don't think it is a good idea, I am just skeptical of it happening within any kind a predictable timeframe. So (unlike most gold bashers who think this is the main reason why 'gold bugs' hold gold) I do *not* hold gold because I think it will return as an official currency or because the US or any major economy is returning to a gold standard (although this is certainly a "possibility", I am just not commenting on its "probability"). But I do hold gold because it continues to be, and never has stopped ceasing to be money. Gold, in my opinion, is and will continue to be the premier safe haven investment for the next several years and is the one asset I am most bullish on. Here is my thesis for why I hold gold (Why I hold Gold: Why I am a Long Term Optimist and consider holding gold and Optimistic Endeavor, and Why I think the Stagflationary Scenario is more likely Macroeconomically in the Intermediate term (next several years) - and no where do I list as a reason is for a return to the gold standard.

Talking about a gold standard for a moment: As outoffocus and I were discussing here:

outoffocus wrote:

Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.

I think the part that Keynes failed to take into account and inform his followers of, is when times are good, that is the time use the good times to save for the bad.  While times were "good" in the last decade, governments on all levels were running massive deficits, leaving no room to run up deficits during the bad times. 

Its a situation many Americans find themselves in now.  I actually read a Business Week article in 2008 that used the Bible story in the Old Testament of, I think it was Joseph, who had the dream of the 7 fat cows and the 7 skinny cows.  He was warning the king of 7 year famine.  They key was to store up food during the good years so that the kingdom could survive the bad years.  We as Americans did the exact opposite. Instead of paying off our debts during the "good years" we ran up more debt.  Now that we are going through the "famine", we have no more credit to use and are forced to pay our debts with less money.

This is why the Keynesian policies are failing.  Deficits wouldn't matter if we had run surpluses in the good times.  In all things economic there must be a balance. Yea we avoided one tragedy but we set ourselves up for another by simply being foolish.  And no good can come from solving foolishness with more foolishness.

binve replied:

>>While times were "good" in the last decade, governments on all  levels were running massive deficits, leaving no room  to run up deficits during the bad times. 

Exactly. And while I am not advocating for a gold standard per se, I am very interested in the Austrian economic and monetary policy and think it is far more of a sustainable proposal (i.e. preserves the value of the currency while maintaining economic stablity). Because everything I read about it shows that it is built on sound principles (or at the very least, much more sound than the system that we have now). This is why I find the arguments against the gold standard to be the most perplexing. The detractors always point out that we had booms and busts on the gold standard too. But they are missing the point that the failure is not of monetary policy, but it was economic policy. You can run up defecits on a gold standard (you get credit from outside the country), but you are not allowed to monetize it. So if congress and the Treasury are profligate, you will have booms and busts. Moreover, no system will ever prevent speculation. There needs a much more focused economic policy at the top levels of government. But since that goes against the intrest of powerful lobbies, that will never happen.

But getting back to my point, a fiat monetary system allows you defecit spend *and* monetize the debt, which hides problems during good years, and exascerbates them during bad years. And since we have reached Debt Saturation (as I have discussed in the past), we will have a lot of bad years ahead of us.


What G20 will not discuss this weekend (but probably should)
By James G. Rickards

There's a growing sense that the current global economic "Plan A", i.e. substitute public debt for private debt and use fiscal stimulus to keep economies afloat until private demand kicks in, has failed. Not surprising to many of us; it was destined to fail, but now the reality of that is becoming undeniable so leaders are scrambling for Plan B.  For the U.S., Plan B is to double-down on Plan A. Others are not so sure.  One problem is timing.  There are several Plan B's, but they all take 5-7 years to implement, e.g. yuan as reserve asset, SDR's as a new liquidity source, etc.  The two-tier Euro plan is just another Plan B although it might possibly be implemented in 2-3 years rather than 5-7.

None of these plans is totally ridiculous, but they all suffer from the same weakness which is that they depend on continued faith in paper money in a world where that faith is rapidly eroding.  So the meta-political question becomes: can one or more of these plans be implemented faster than the paper currencies collapse? My spot estimate is "no".  The avalanche has already started; there is no way to push the snow back uphill; it's just a matter of time before the paper money village below gets buried.  Plan A and the the system it represents will collapse before there's time for Plan B.

This brings us to Plan C of which there are several: (x) chaos, autarky, neomercantilism and heavy-duty protectionism; i.e. playing to win a negative sum game, (y) draconian policy responses including seizure, delegitimization and/or taxation of private gold and forced use of paper money, or (z) gold and commodity backed currencies and a gradual return to stability (albeit with a depression between here and there).  Options (x) and (y) more or less speak for themselves.  Option (z) is the most interesting because it involves a host of policy choices and political considerations such as: what is the non-deflationary price at which the gold standard should be reestablished (probably $5,000/oz or higher); and who gets to participate and at what levels, (and this is where the true weakness of players like China, India and Brazil comes into sharp relief).  Russia is the most interesting case because although it has a relatively small GDP (less than 3% of world GDP) it is a natural resource powerhouse which could play with the big boys in a world of commodity backed currencies.  Italy is another interesting case because it is a true gold power (over 2,400 tonnes) although it is frequently lumped in with the Club Med miscreants.

Given the dynamics and cross currents, a likely scenario consists of elements of all of the above.  The U.S. and China will continue to lead the world to a new regime of dollars and yuan as reserve currencies and SDR's plus IMF leverage as the key instrument for increasing world liquidity and settling international payments imbalances.  As the system breaks down anyway (because of private demand for gold due to lack of faith in official solutions) one political response will be protectionism (to appease local populations) and efforts at confiscation (to put the gold genie back in the bottle). At that point, and amid the chaos, one or more countries will "go for gold" on their own to preserve wealth and the purchasing power of export income; the most likely axis here is Germany-Russia with Austria, the Netherlands, France and possibly Italy joining in.  The German-Russian axis is the most natural in the world because each has what the other needs; technology and manufacturing in the case of Germany and energy and other natural resources in the case of Russia.  At that point, the U.S. may have to give up its alternative paper plans and join the gold rush leaving China heavily exposed to collapse because of its shortage of gold relative to GDP.  It seems likely that China sees the same scenario which explains its own rush to gold, albeit mostly from captive domestic production in the short run.

The end result is a chaotic, ad hoc, but nevertheless eventual return to a global gold standard.  It would be far better for G20 to set up the processes, study groups and other mechanisms to make this an organized and efficient transition.  That is the one thing I do not expect to happen this weekend.

2 Comments – Post Your Own

#1) On June 22, 2010 at 7:27 PM, amassafortune (29.24) wrote:

For a Keynesian, any store of value is a private virtue and a public vice. Gold is no different. Your bible reference indicates that the savings / stable store of value struggle has been as constant in human history as market bubbles. You'd have better luck trying to get routinely-flooded areas to build upon a rock for a change. Human nature drives these phenomenon which is why they never change. 

In a few years, you may be giving parental support to a large, annual, national cookie sale. After a few years of pushing hundreds of boxes of cookies to relatives, co-workers, and friends, you may think, "Hey, if we just save 10% of the profits each year, this organization's need for fundraisers would pretty much be eliminated in ten years. At the very least, we can start taking the annual goal down each year instead of raising it every year." This is the gold standard in micro-view - a store of value that gives nearly-constant support to an organization's core needs.

Enter the Type-A, driver-driver - the (guy, usually) who tends to rise to the top of any organization, public or private. Now, it doesn't matter if it's 1938 and an inconvenient time to back all your debt with gold, or 2008 and some buddies need like $700 billion to save their banks that they over-leveraged. The type-A's will get their way and won't stop talking about it until you agree that it was the right thing to do. How often do you publicly agree with a driver type that is moving ahead with a less-than-ideal solution? 

The most any analytical can hope for is a private virtue solution, because if you succeed in a public solution, at some point a driver-type will convince the organization to eat the seed corn. 

Native Americans must have found a way to suppress the Type-A's, because year after year, the food kept wandering by, clean water flowed automatically, and no one even conceived of owning more shelters than they needed. History books tell of the importation of "know-how", but I think this may just be an euphemism for Type-A behavior, because today we have to drive to get food from corporate entities. Water is processed miles away and piped to my spigot just after the billing meter records the volume. And as for shelter, well, we've all heard enough about shelter recently. 

An organization with strong, new leadership can take a self-sustaining organizaton back to shirtsleeves in just a couple years. Their "vision" of growth can waste an endowment and send its members back to fundraising before you can say precious metal. We already see this in states that are selling 100%-owned buildings and roads to hedge funds and leasing them back. How can actions like these not become regrets?

I like your idea, but no store of value in the public sector is safe from strong leadership. 

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#2) On June 22, 2010 at 8:57 PM, binve (< 20) wrote:

amassafortune ,

Hey amass!

>>For a Keynesian, any store of value is a private virtue and a public vice. Gold is no different. Your bible reference indicates that the savings / stable store of value struggle has been as constant in human history as market bubbles. You'd have better luck trying to get routinely-flooded areas to build upon a rock for a change. Human nature drives these phenomenon which is why they never change. 

Oh, I totally agree, you will get no dispute from me. Gold standard or no, there will always be bubbles, there will always be mania, there will always be panics, and they will always run in cycles. There are very long cycles at work and humans in general are very bad at seeing cylcles that last longer than 1 year ( and on top of that, we want to extrapolate trends linearly even though there are very few truly linear realtionships in nature and in the systems that humans create (

>>The most any analytical can hope for is a private virtue solution, because if you succeed in a public solution, at some point a driver-type will convince the organization to eat the seed corn.

I agree. But there were booms and busts that didn't end the economy from the late 1800's to 1920. Yes we had panic and a few of them were quite severe, but they were relatively short lived and the market and the economy got back to normal. It wasn't until massive leverage was introduced in the 1920s to combat the last panic that gave rise to a massive bubble that jeopardized the economic for a couple of decades (the leverage created the bubble and governement mismanagement of the crisis prolonged the crisis). Eventually the market cleans up the mistakes and no matter how bone-headed the "A-type" is that is in charge, there will be some period of calm and growth because that is what the market wants to do.

And that is how I see gold's role: to preserve wealth during the next phase of the crisis, and when everybody is talking about the end of the market / economy / civilization / etc (which will *not* happen), that is when the start extrapolating the downward trajectory linarly when we are at the peak of the cycle, then I dump my gold for equities. Because then the market, regardless of who is in charge, will be ready to start healing. Smart investors who keep cool heads will make massive capital investments (and I hope I will be one of those), entrepreneurs will pick up good deals on under-utilitzed capacity and labor (again, I hope I will be one of those). Things will look dark at the moment because nobody will be perceiving the cycle.

My $0.02 at any rate. Thanks for the great conversation my man!!..

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