Under the Gold Standard, or any other metallic standard, the value of money is not really derived from gold. The fact is, that the necessity of redeeming the money they issue in gold, places upon the issuers a discipline which forces them to control the quantity of money in an appropriate manner; I think it is quite as legitimate to say that under a gold standard it is the demand of gold for monetary purposes which determines that value of gold, as the common belief that the value which gold has in other uses determines the value of money. The gold standard is the only method we have yet found to place a discipline on government, and government will behave reasonably only if it is forced to do so--Friedrich A. Hayek
The Historic Gold and Bond Bull-Market Tango
Remember my outlook on Gold last February?
What you are about to see is a defining monumental process in financial history!
Lo and Behold, Gold’s phenomenal rise against central banking’s Fiat Money standard!
Aside from all other (fiat) currencies, gold prices broke to record highs this week against the last holdover, the USD.
From the US perspective, record USD gold prices have been attained as USTs hit record low yields amidst a flattening curve. Furthermore, gold prices have surged along with a resurgent buildup of global negative-yielding bonds, even as personal savings rate hit record highs.
There are those who want to excoriate Nobel Laureate Milton Friedman for saying that inflation was everywhere and always a monetary phenomenon. But he also proposed the Permanent Income Hypothesis. The Permanent Income Hypothesis, according to the Wikipedia, supposes that a person's consumption at a point in time is determined not just by their current income but also by their expected income in future years—their "permanent income". In its simplest form, the hypothesis states that changes in permanent income, rather than changes in temporary income, are what drive the changes in a consumer's consumption patterns. Its predictions of consumption smoothing, where people spread out transitory changes in income over time, depart from the traditional Keynesian emphasis on the marginal propensity to consume. It has had a profound effect on the study of consumer behavior, and provides an explanation for some of the failures of Keynesian demand management techniques.
Though the monetary mechanism is necessary for inflation to occur, it is insufficient. Other real factors are material to its existence.
The surge in personal savings appears to reinforce Friedman’s PIH theory.
The deflationary impact of a recession must be remedied by an increase in savings.
Wrote the dean of the Austrian school Murray N. Rothbard*,
Furthermore, deflation will hasten adjustment in yet another way: for the accounting error of inflation is here reversed, and businessmen will think their losses are more, and profits less, than they really are. Hence, they will save more than they would have with correct accounting, and the increased saving will speed adjustment by supplying some of the needed deficiency of savings.
Even in the Philippines, the same process is in motion. This excerpt showcases how businesses are likely to react to the disruptions caused by work stoppage policies to contain the virus.
From Philstar (August 2): Enterprises hit by the pandemic may have to pause operations temporarily once their cash flow turns negative and consider other opportunities in agriculture and digital space, Presidential Adviser on Entrepreneurship and Go Negosyo founder Joey Concepcion said. “My advice to many of our MSMEs (micro, small and medium enterprises) and I always share this with them: You have to have a plan. You have to remain cash flow positive and if you turn cash flow negative, at a certain point in time, don’t wait until it depletes your entire working capital or even your family’s savings.” “Close the business for the time being because it’s not going to be worth wasting all your family’s savings and it will create more problems for you. That’s my advice to many of our entrepreneurs,” he said in an interview on the The Chiefs aired on One News.” This counsel goes against the mainstream ivory tower based ludicrous prescription that one should take advantage of low rates and borrow to spend.
Furthermore, based on the analysis of sectoral balances, fiscal deficit equates to net private saving or private sector surplus. So the financing of the US record deficit would translate to massive increases in domestic and or foreign private savings.
That buildup of savings appears to be consistent with the recent spike in deficits.
However, the US isn’t the only nation experiencing unprecedented deficits. Most of the world have ramped up public spending such that McKinsey and the IMF expect the global deficit to reach a historic $11 trillion in 2020! That’s about 12% of the $90 trillion global GDP.
So if sopping up of savings wouldn’t be sufficient, global central banks are likely to be filling in the vacuum through debt monetization. Global debt hit a record of $258 trillion or 331% of the Global GDP in the 1Q. But debt issuance picked up speed in the 2Q, according to the Reuters, "Overall gross debt issuance hit an “eye-watering” record of $12.5 trillion in the second quarter, compared with a quarterly average of $5.5 trillion in 2019, the IIF said. It noted that 60% of those issues came from governments".
Nevertheless, the current amount of money printing may be inadequate to offset structural deflationary forces embedded in the system, such as excessive debt, overcapacity in several significant sectors, and zombie financing, as well as, recent policies used to constrict the spread of the pandemic.
For instance, even after the $2.2 trillion bailout package called the Cares Act and the $3 trillion expansion of the Federal Reserve’s assets, the US GDP suffered a 9.5% YoY (32.9% quarter annualized)! But their stock markets rocketed instead.
For a broader purview of the economic damage caused by recent policies to contain Covid-19: Singapore suffered a 41.2% contraction quarter on quarter and 12.6% year on year. Hong Kong shrank by 9% YoY. The Euro-zone area declined by 12.1% YoY while the US suffered a 9.5% YoY (32.9% quarter annualized) even after the $2.2 trillion Cares Act and the $3 trillion expansion of the Federal Reserve’s assets. China escaped a recession by posting a positive 3.2%.
As an aside, the Philippines will be reporting its 2Q GDP on August 6th. Based on the PSA’s data on Gross Regional Domestic Product, the NCR and CALABARZON area contributes about 52% of the total statistical economy (2018). Along with the rest of Luzon, during the ECQ or MECQ period, economic activities were mostly suspended within these areas. And strict quarantine policies were also implemented in parts of Visaya and the Mindanao region. If only 30% of the capacity of the CALABARZON and NCR had been in operations in 2Q, not counting other parts of the nation, how much loss of output will these translate to?
Lastly, inflation is not set on the stone by Federal Reserve asset purchases or QE as exhibited by the immediate post World War II era. Though monetary actions matter, again, many other factors will determine inflation’s appearance.
As the Eurodollar wiz Alhambra Partner’s Jeffrey Snider wrote of the Fed’s inflationary panic episodes post-World War II:
Like the 1947-48 bond buying episode (the Fed’s inflation panic), we’re supposed to believe that the central bank played the pivotal role in keeping the financial situation orderly, trading off that priority by risking an inflationary breakout. Bullshit. That’s the myth that has been conjured, hardly in keeping with the reality of the situation.
Sure, the Fed monetized the bills during WWII, but so what? The depressionary conditions rampant throughout the markets and economy led the private system to easily monetize everything else, the vast majority. Even the Fed’s inflation panic in bond buying was a tiny drop in the bucket.
Yields said so.
Furthermore, record money supply’s transmission into street inflation represents a time-consuming complex process that will have to confront opposing forces that may offset its impact. And there will be action-reaction feedback loops that contribute to the process. For instance, if money creation adds to the money supply, debt defaults subtract to it.
That is, should global central banks succeed in the re-combusting of inflation, this would only happen when inflationary monetary forces overwhelm deflationary structures, which would take time.
As I concluded last February,
Whether street inflation surges or not, in reaction to the massive supply-side disruptions from a crucible of real adverse forces in the face of central bank actions, the escalating uncharted experiments on monetary inflation have pointed to the magnification of uncertainty on a global scale.
The bottom line: Gold's uprising against central banking fiat currencies warn that the world is in the transition of entering the eye of the financial-economic hurricane!
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