Wednesday, 24 October 2012

What Gold Is Telling Us

I've been watching the price of Gold for more than ten years. For Marxist economists, Gold holds a special place. It is real money, as opposed to the paper tokens and credit that circulate in its name. Yet, in modern economies it is the latter, which appear as money, whereas Gold has been reduced to the role merely of a commodity used for jewellery production, or hoarded by investors as a hedge against risk. Even the role Gold formerly played as money in settling international debts has largely been replaced by the dollar as global reserve currency. A while ago, when asked, in that regard, why Central Banks continued to hold Gold in their reserves, Federal Reserve Chairman, Ben Bernanke, said it was largely for historical reasons.

But, using Gold prices is difficult for these reasons. The prices of any commodity, including Gold, differ from the Exchange Value of these commodities. That is for two reasons. Firstly, under Capitalism, because Capital moves to where the Rate of Profit is highest, Supply increases in these areas, and falls where its lowest, so that equilibrium prices necessarily differ from Exchange Values. This is what Marx describes in the so called Transformation Problem. The resultant prices, he calls Prices of Production, which are Cost prices plus the average rate of profit. But, secondly, as Marx describes there and elsewhere in Capital, there is no automatic mechanism, which means that demand and supply will be in equilibrium. On the contrary, it will more often not be in equilibrium. As a result whenever Supply is greater than the Demand for any commodity, at its Price of Production, the current market price will fall below it, and vice versa. In, the former case, the lower profits should cause Capital to be withdrawn reducing Supply, and thereby raising prices and profits accordingly. But, in practice, there are many reasons why this may not happen, so Supply does not fall. By the same token, more Supply may be withdrawn than needed, causing an imbalance in the other direction.

With Gold, because all of it that has ever been produced still exists, this can cause even greater fluctuations. Compare it with say shirts. If too many shirts are produced, then a reduction in Supply of shirts will quickly restore that situation. Every day, some old shirts are thrown away, meaning new ones are needed to replace them. That is not the case with Gold. If too much is produced, and its price falls that has no effect on the Gold that still sits in bank vaults etc. or in the form of jewellery. It still sits there weighing on the market as excess supply. In fact, if people think that a fall in its price might continue, many people who own Gold, might even try to sell it, increasing the Supply of Gold for sale, pushing its price down lower. For the same reason, if the price of gold is rising sharply, owners of gold might be more inclined to hold on to it, and others might join them. Because very little new gold is produced each year compared to what already exists, Supply cannot increase fast enough to satisfy the new demand, so the market price rises above the price of production. I described this in my post Gold Price Of Production Argument last year.

I began watching Gold, just after the turn of the century, because its movement is indicative of the progress of the Long Wave Boom. Like most other primary products, the price of Gold reached its low point in 1999, which also marked the end of the previous Long Wave downturn, and beginning of the current Long Wave Boom. It had fallen to just $250 an ounce, compared with its price today of around $1700 an ounce. The increase in price reflects two factors. Firstly, the Long Wave Boom has massively increased demand for primary products. The prices of these during the Long Wave downturn, were below their actual Prices of Production. The increase in demand has corrected that. Secondly, there has been a huge amount of money printing. That means that paper currency has been devalued relative to Gold, and other commodities.

A couple of years ago, I wrote that my gauge of when it was time to sell Gold was when all of the Gold for cash shops began to close down, and people began to want to buy gold rather than exchange it for bits of paper. That was the equivalent of what people said in relation to the Tech Bubble of 2000, when they said that when the cab driver started giving tips on the next Tech share it was sign to sell. In fact, not long after I wrote the article in July 2011, my landlord told me that her son had been advised by his Financial Advisor to buy some gold, and I said to he that that was probably a sign that it was getting close to the time to sell! A month later, having reached $1923 an ounce Gold crashed, falling to around $1500 an ounce. In the year since, it has not moved much, until the announcement by the ECB to start printing money via the OMT, and the decision of the Federal Reserve to give an open ended commitment to keep printing money until unemployment in the US falls significantly. But, having done so, and despite all that money printing, the price of Gold is falling again. Having almost got back up to $1800, it has sunk back to $1700, and looks set to continue falling.

I think this tells us a lot. What it immediately tells us, I think, is that the policy of money printing by Central banks has now decisively hit the buffers. That is also the message from Bank of England Governor Mervyn King. Money printing works by both making the cost of borrowing cheaper, and by providing banks with money that they can lend. This increased borrowing then puts the additional money into circulation, buying goods and services. The intention is that this additional demand for goods results in increased supply, and increased employment. But, if the increased money printing causes demand to rise faster than supply can expand to cover it, prices rise. There is inflation.

Part of the reason for the increasing price of Gold has been a belief that excessive money printing over the last 20 years or so, would cause inflation, or would cause a devaluation of the value of currencies. But, although there has been inflation during that period, and there are signs in Britain of inflation rising once again, as fuel and food prices climb significantly, inflation has not been excessive over that period compared to the past. As I've previously described, the main reason for that has been the impact of large volumes of very cheap commodities imported from China. But, although consumer price inflation has not been excessive, all of the money printing has caused large amounts of inflation. It has caused large-scale asset price inflation. In fact, most of the damage from that was caused in the 1980's and 90's, according to some of the analysis I have been doing recently.

It was during that period when money printing and financial deregulation caused massive increases in share prices, and in property prices, and in Bond Markets. Even though the bubbles that blew up in these markets have corrected at various points – the 1987 Stock Market Crash, the 1990 property Market Crash, the 2000 Tech Wreck, the 2008 Stock Market Crash – these corrections have usually been rapidly reversed as a result of even more money printing. The 1987 Stock Market Crash saw the biggest one day drop in share prices, exceeding that of the 1929 Wall Street Crash. Yet, Stock Markets rose more than enough over the next year to recover it. House prices collapsed by 40% in 1990, and they did not recover until 1996, but from 1997 until 2008 they multiplied there existing astronomical levels by even more unsustainable amounts. Although, they fell in 2008 by around 20%, the slashing of interest rates, meant they more or less recovered that fall in 2009/10, before beginning to fall again. Stock Markets have also more than recovered their astronomical levels from the falls of 2008. The S&P 500 has risen by around 40% in just the last year!

But, what the inability of Gold to rise above its 2011 high, despite all of the increased money printing, seems to be saying is that this process has finally come to an end. In the last year Stock Markets have risen on the back of the promise of more money printing, but when the Federal Reserve actually delivered on QEIII, markets responded with a shrug of the shoulders, as I set out in QE etc. Spells Desperation. Now Stock Markets have begun to sell off, though we have not yet seen the kind of October Crash that could easily mark such a conjuncture. As set out in that blog, the real question markets are now asking is, what next? That question has been emphasised by the fact that the Eurozone economy has gone into technical recession, the UK is in a double-dip, and although tomorrow's data might show some growth, that might only be a prelude to a triple dip, when then next set of figures are released in January! US economic growth is anaemic, and the big increases in profits that US firms have been making in the last couple of years, appear to be petering out. China continues to grow at around 7.5%, but even its economy has slowed during the current cyclical slowdown. The problem is that although, it appears as a cyclical slowdown for China and other newer economies, for the Eurozone, UK, and US, it looks more structural.

In order to change that the huge bubble in asset markets needs to burst. All bubbles continue to inflate so long as there are more people prepared to pump more money into them – what investors call the “bigger fools”. It is the way any Ponzi Scheme works. Although, no real increase in value occurs, prices continue to rise, because the earlier investors get paid out in income or capital gains made possible by the money paid in by those who come after them. But, eventually, there are no bigger fools to perpetuate the scam. Then prices fall. And they fall fast. All of the uncertainty of the last couple of years has caused firms to slow down their investment, unsure as to whether there would be a market for increased output. Profits have gone into deposit accounts, or into supposed safe havens such as the Bonds of countries like the US, UK and Japan, who can always print money to cover their debts. But, that has caused a massive Bond Bubble. It seems unlikely the prices of these Bonds can rise much more. Big investors work on the basis of probabilities. Bill Gross, who manages the biggest Bond Fund in the world, is a former Poker World Champion. When the price of anything has risen beyond certain limits, the probability is greater that it will fall rather than rise. That is what causes people to decide to sell under those conditions, before they get trampled by the herd. 

The price of Gold is falling, despite more money printing, for the same reason that Stock Markets can no longer make headway, for the same reason, that Bond Markets appear to have reached their limits, and for the same reason that property prices are falling. It is the same reason that all of the money printing is not causing massive inflation, nor prompting increased economic activity. That is that the money being printed is not being converted into currency. In order to stimulate economic activity, just as in order to act to depreciate the currency, or cause inflation, the money printed has to be demanded by someone, it has to be borrowed, and spent. All of the Government's measures to try to get the banks to lend are failing because no one wants to borrow, other than those who need to borrow to stay afloat, and to whom the Banks, therefore, do not want to lend. That is why despite official interest rates, those who need to borrow to stay afloat are having to resort to pay day loans, or other forms of expensive credit.

No one in their right mind, even if they could raise the required deposit, would want to borrow large amounts of money to buy a house under current conditions, when its clear that the only way house prices can go is down. Increasingly, investors will see even “safe” Bonds, as not being safe, and seek to put their money into cash itself. With economic activity declining, and Stock Markets at the highs they reached at the peak of the Boom, there is equally no reason to put money into shares, including into things like Pension Schemes that invest in Bonds and Shares. But, with the likelihood then that money will be taken out of circulation, the case for investing in Gold also collapses. Only if there is a co-ordinated strategy of fiscal expansion at an international level, that directly pumps some of the money printing into the economy, would that change.

A look at the situation in the US is indicative of this. There house prices have fallen by between 66% and 75%. You can now buy a six bedroom, luxury house in Florida for around £70,000! But, the effect of this collapse of prices down to more realistic levels is that the demand for houses has begun to increase. On the back of that, business for some house builders has also begun to turn round, which also means business for shops supplying furnishings etc. increases too. Some big US investors like Wilbur Ross, have begun to buy houses, and rent them out. On the back of similar falls in house prices in Ireland, Ross has also begun buying houses in Ireland on a similar basis. He says that he will look at buying Spanish Banks when the collapse of Spanish property prices occurs. A report on CNBC yesterday, said that Spanish house prices need to fall by around 50% from current levels, whereas land in Spain needs to fall by around 85%. This is much more than is currently accounted for in the stress tests on Spanish Banks, which is why Ross is waiting for that collapse before he invests in Spanish Banks.

But, this kind of collapse in Stock Market, Bond market, and Property Market prices is a precondition for beginning to quickly deal with the situation in the real economy. Then there will be an incentive to invest in real productive capacity, rather than the insane belief in money for nothing created by these asset markets. Mervyn King seems to have come to a similar conclusion.

Robert Peston writes,

Here is his stark and gloomy warning: 'I am not sure that advanced economies in general will find it easy to get out of their current predicament without creditors acknowledging further likely losses, a significant writing down of asset values and recapitalisation of their financial systems.'

He continues: 'Only then will it be possible to return to a more normal provision of vital banking services so crucial to an economic recovery'.”

In that context, King argues the policy of the banks in forbearing the loans of those who cannot repay could end up being a mistake similar to that of the 1930's. The banks are allowing people to continue in arrears on their mortgages and loans, not out of any sense of social conscience, but because they want, as long as possible to avoid a collapse in property prices, which would bankrupt them. They hope that something might turn up that allows people to repay those debts. Instead, things are getting worse. One in three people now run out of money before the end of the month. Pay Day Lending is increasing, and real wages are falling as pay rises fail to keep up with price increases. When that collapses it will be even worse for the banks than if they simply cut their losses now.

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