James Grant on Faith based Paper Money and the Gold Standard

Wall Street Journal’s Holman W Jenkins Jr. interviews James Grant (hat tip Laird Smith) [bold emphasis mine]

The gold standard, he says, citing the "late, great" libertarian economist Murray Rothbard, was the "people's system. If you didn't like the currency, you could exchange your paper for gold and that sent a message."

More from Mr. Jenkins interview of James Grant

The "fiat" dollar, he adds ruefully, "is one of the world's astounding monetary creations. That a currency of no intrinsic value is accepted as money the world over is an achievement that no monetary economist up until not so many decades ago could have imagined. It'll be 40 years next month that the dollar has been purely faith-based. I don't believe for a moment it's destined to go on much longer. I think the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

How exactly the transition to a new gold standard might take place is a puzzle, but Mr. Grant says he's seen many "impossible" things come to pass in his career. A certain "social spontaneity" might take a hand. He points to GLD—the ticker symbol for an exchange-traded fund whose gold holdings now make it equivalent to the world's 10th largest central bank. "At the margin," he says, "people are registering dissent from the judgment of our central bankers by bidding up the price of gold."

Read the rest here

Chart from Sharelynx/goldchartrus.com

Anyone who thinks that today’s economic climate poses little risk for dramatic transitions in today’s monetary architecture should look at my post below on Dead Currencies.

They are likely to be overestimating the strength of today’s system which have increasingly been based on serial bailout policies, especially in developed economies.

Once the tipping point from the accretion of political mistakes have been reached, we are likely to see a hastening of the implosion of today’s money system.

And as a popular Wall Street maxim goes:

Past performance does not guarantee future results.

As for the return of the gold standard, that’s something unclear for now. But as history has shown, economic forces could compel us to drastically embrace this option once the motion of monetary collapse becomes entrenched and accelerates.

Gold and the precious metal group, based on the price trends relative to the incumbent 'faith based' currencies of major economies, seem to be showing their revitalized role as man's default currency or the public's dissent over the judgment of central bankers as Mr. Grant rightly observes.

Ultimately, the fate of our currency system depends on the direction of monetary politics which constitutes a substantial tail risk that the mainstream continues to ignore.

Philippines Secures Funding Requirements; Return Of The Bond Vigilantes?

At the onset of 2009, so far there have been a few signs of troubles evident in the global bond markets.

If there is anything paramount, I should salute or commend the Philippine Central Bank, the Bangko Sentral ng Pilipinas (BSP), for their intrepid and swift actions as the “first mover” in tapping of the debt markets in the region, amidst a jittery backdrop.

You probably have read how the Philippines secured $1.5 billion in what was to be a remarkable FOUR times oversubscribed issuance (Businessworld) under a highly apprehensive atmosphere.

This comes even as the government’s budget deficit has reportedly increased to Php 102 billion from Php 75 billion which incorporates the Php 300 billion stimulus package (AFP). While a foreign institution have made a call to sell the Peso based on perils of “exploding” fiscal position, our view is that currency valuations are always relative, if paired with the conventional US dollar, fiscal cost of the latter will likely balloon more than the Philippines.

Anyway, the Philippines haven’t reportedly overpaid, in terms of high interest rates, in enticing investors though.

Besides, analyzing the buying composition of the deal gives us some clues of the potential flow of funds or source of future investments for Philippine assets.

According to the Finance Asia (bold emphasis mine),

``The 10-year bonds were priced at 99.158, which gives investors a yield of 8.5% – equivalent to a spread of 599.9bp over US Treasuries and 20bp over the implied 10-year curve. Investors paid a very tight new-issue concession of just 23-24bp, which compares very favourably with similarly sized 10-year offers by Brazil and Colombia on Tuesday, and a $2 billion 10-year offer by Mexico in December, all of which paid premiums of between 40bp and 50bp.

``This is partly explained by the strong Asian sponsorship of Philippine deals – 41% of the issue was picked up by regional investors, with 38% going to the US and 21% to Europe – because many of the region's investors are not heavily influenced by the premiums paid in international markets…

``In total, the lead banks – Credit Suisse, Deutsche Bank and HSBC – took $5.8 billion of orders from 281 investors. Funds dominated demand for the bonds, accounting for 58% of the orders, followed by: banks (20%); pension funds, insurers and government institutions (16%); and retail and corporates (6%).”

As you can see aside from the remarkable huge bid-to-cover spreads albeit slower than last year (Finance Asia), Asian buyers which may have comprised of regional financial institutions had been the primary buyers, although a significant chunk of the regional demand could have also been rooted from local institutions.

The point is Philippine bond deal may have reflected some improvement in investor’s sentiment, as we have seen positive uptake of emerging market issuance in Turkey for $1 billion, Brazil for $1 billion and Colombia for $1 billion (Financial Times) or even in France and Spain for a combined € 11.4 billion (guardian) or Austria € 3 billion and Ireland € 6 billion (Financial Times), this despite the seeming outlier or the poorly supported German bond auction which initially targeted € 6 billion but received only 87% bid for an issuance of € 5.24 billion (Financial Times). Incidentally, the dismal result of the German bond offering came almost a day ahead of the Philippine tender, which has shown little influence to the deal’s outcome.

Besides, despite the highly anxious global financial market conditions, the success of the Philippine bond deal could have indicated of the improving liquidity conditions in the region or locally, aside from the surprisingly strong appetite for its securities from the financially and economically besieged Anglo Saxon economies.

As for the demand from Western markets, perhaps the closing of year end related tax portfolio rebalancing (see Phisix: The Fantasy Of The 2008 "Window Dressing" Year End Rally) could have likewise enhanced the reception of Philippine bonds.

Additional interesting insights from the recent offerings:

One, the yields were significantly higher than the previous, for the Philippines 6.5% in January 2008 while 8.5% for last week. Austria and Ireland were likewise “forced to pay higher yields than existing bonds to issue debt”. This gives credence to our belief that funding cost will climb over time, especially as governments actualize their purported programs.

Finally, while the drab results of the German bond auction could be construed as a market anomaly, on the obverse side, it could likewise signal an incipient crack in the bond auction markets as ‘bond vigilantes’ stage a reawakening.

Bond vigilantes, by the way, are fixed income investors who, according to the illustrious Forbes analyst James Grant, “took a pledge: Never again would they be the dupes of a central bank. They would henceforth sell at the first sign of inflation.”

Thus, the latest offering secures the Philippines and the other early birds, who availed of the seemingly improved market sentiment and conditions, the trouble of a probable “buyers strike” or the return of the bond vigilantes possibly anytime within the year.