Let us start by looking at the economy from 10,000 feet above: After
40 years of boozing on easy money and feasting on fantastical asset
price inflations, the global monetary system is approaching catharsis,
its arteries clogged and instant cardiac arrest a persistent threat.
Most financial assets are expensive, and many appear to be little more
than securitized promises with low probability of ever delivering
payment in full. Around the globe, from Japan to the US, a policy of
never-ending monetary stimulus consisting of zero interest rates and
recurring rounds of ‘quantitative easing’ has been established aimed at
numbing the market’s growing urge to liquidate. Via the printing press,
the central banks, the lenders-of last resort, prop up banks and
financial assets and simultaneously fatten the state, the borrower of
last resort, which, despite excited editorials against the savage policy
of ‘austerity,’ keeps going further into debt almost everywhere.
‘Muddling through’ is the name of the game today but in the end authorities will have two choices:
stop printing money and allow the market to cleanse the system of its
dislocations. This would involve defaults (including those of
sovereigns) and some pretty nasty asset price corrections. Or, keep
printing money and risk complete currency collapse. I think they should
go for option one but I fear they will go for option two.
In this environment, how can people protect themselves and their property?
Disclaimer
Before I start sharing some of my
own personal thoughts on this topic with you I should repeat my usual
disclaimer: I provide economic analysis and opinion, food for thought.
But I do not intend to give investment advice and certainly not any
specific trade ideas. I provide a worldview, and an unconventional one
at that. You alone remain responsible for your actions, and whatever you
do, you do it at your own risk.
My three favourite assets
My three favourite assets are, in no particular order, gold, gold and gold.
After that, there may be silver, and after a long gap of nothing there
could be – if one really stretches the imagination – certain equities or
commercial real estate.
Why gold?
We are, in my assessment, in the
endgame of this, mankind’s latest and so far most ambitious, experiment
with unconstrained fiat money. The present crisis is a paper
money crisis. The gigantic imbalances that threaten to unravel the
system momentarily are the direct consequences of years and decades of
artificially cheap credit and easy money, and are simply unfathomable in
a hard money system. Take away fiat money and central banks and our
current problems would be inexplicable. (If you are still under the
widespread but erroneous impression that the gold standard caused the
Great Depression you may want to consider that the strictures of hard
money were systematically disabled and the disciplinary power of a true
gold standard increasingly weakened with the establishment of the
Federal Reserve in 1913, and the introduction and spreading of
lender-of-last resort central banking in the US financial system. In any
case, we are now in the Greater Depression, and this one is entirely
the responsibility of central banking and unlimited fiat money.)
Whenever paper money dies, eternal money – gold and silver – stage a comeback.
We have already seen a major re-monetisation of gold over the past
decade, as the metal again becomes the store of value of choice for many
investors. This will continue in my view, and even accelerate.
Gold is money
A frequent allegation against gold
is that its non-monetary applications are minor and do not justify the
present price, and that gold doesn’t pay interest or dividends, quite
the opposite, storing and insuring it incurs running expenses. Gold is
an instrument with a negative cash yield.
None of these objections stand up to scrutiny. They are either wrong or irrelevant.
It is investment goods that are supposed to offer cash yields – interest income or dividends. But gold is not an investment good, it is a form of money.
Gold is the oldest form of money still considered a monetary asset
today, and the only truly global form of money (besides silver but
silver is today still more of an industrial commodity than a financial
one). Gold is – importantly – inelastic money. It cannot be created nor
be destroyed by politicians and central bankers. It can, of course, be
taxed and confiscated, and I come to that later.
The main alternative to gold is therefore not bonds, equities and commercial real estate but cash, i.e. state paper money.
The person who ‘invests’ in gold is holding money. The cash in your
wallet or under your mattress does not give you a cash return either.
Neither does gold.
Sometimes I get asked, what if people suddenly stopped considering gold to be a monetary asset and a store of value?
Would its price not drop steeply? – That is a fair point. But this
applies to your paper money, too. In fact, it applies to paper money
more so.
Every monetary asset – whether gold,
paper tickets from the state, or electronic book-entries at your bank –
receives its value (exchange value or purchasing power) from the trading
public, and from nobody and nothing else, not from the state, nor from
any non-monetary uses of the monetary asset, if it has any at all. If
the public stops treating the item in question as money, or uses it less
as money or only at a discount, it looses its monetary value. That is
also always the case with state paper money. It is a sign of our
hopelessly statist zeitgeist that many people believe that the state
‘assigns’ value to its paper money and somehow supports this value.
This is not the case. The truth is that the paper tickets in your
wallet have purchasing power (and thus have value beyond their paper
content) for one reason and one reason only: the public accepts them as a
medium of exchange, the public accepts them in exchange for goods and
services.
The public also determines what the exact purchasing power of
those banknotes is at any moment in time and at any given place. The
state does not even back its paper money with anything. If you take your
paper tickets to the central bank, what do you get in return? – Change.
Paper monies come and go.
In fact, throughout history every experiment with paper money has ended
in failure, with over-issuance the predominant cause of death. Pound
and dollar are the two oldest currencies around today but through most
of their history they were linked to gold or silver, which restricted
their issuance. Our system of hundreds of entirely unrestricted local
fiat money monopolies dates back only to 1971, at least in its present
form. In the 20th century alone, almost 30 hyperinflations of paper monies were recorded.
By contrast, gold has been money for
2,500 years at least. Should you be more concerned about the public not
taking your gold any longer, or your paper money?
Gold is hard, apolitical, and global money, supported by an unparalleled history and tradition.
That is the asset I want to own when our assorted finance PhDs in the
central banks, the bureaucrats in the Treasuries and Ministries of
Finance, and our sociopathic welfare politicians have manoeuvred the
system to the edge of the abyss. Which is now.
Remember, paper money is always a political tool, gold is market money and apolitical. Paper monies come and go, gold is ‘eternal’ (as far as we can tell presently).
You have to be clear in your mind why you buy gold.
At every moment in time, all your possessions – all your wealth – can be split into three categories: consumption goods, investment goods, and money.
For most of your possessions the category is pretty clear: The clothes
you wear and the car you drive are consumption goods; your investment
funds or your equity portfolios are investments; the banknotes in your
drawer are money. For some things it is not so clear: An expensive
painting might be an investment but if you hang it in your living room
and enjoy looking at it, it is also a long-lasting consumption good. The
house you live in could be both but in most cases it is more of a
long-lasting consumption good than an investment: you use it up over
time, albeit slowly, and you cannot easily liquidate it. You have to
live somewhere.
The wealth you are not consuming
in the here and now but want to maintain for the future can thus be
held in the form of money or investment goods. Money gives you
(usually) no return but has other advantages, namely that it allows you
to maintain your purchasing power, at least if it is proper, hard money,
and simultaneously retain complete flexibility. You are not committing
yourself today to any investment good (or consumption good); you remain
on the sidelines to wait how things turn out. But as you hold a monetary
asset – a store of value and medium of exchange of (almost) universal
acceptance – you can re-enter the markets quickly and easily. Somebody
will always buy the gold from you in the future (which is far from
certain in the case of most of your consumption and investment goods,
and also in the case of that other form of money, state paper money).
Why gold now?
It seems that this is an opportune time to be on the sidelines,
to be not engaged in the markets for equities, bonds and real estate,
or to at least keep one’s exposure to these markets very low, since
years and decades of unprecedented money growth have inflated and
gravely corrupted the prices of standard investment goods. Sadly, these
prices now rely increasingly on the kindness and efforts of manipulating bureaucrats to simply sit still and avoid a painful descent.
Central bankers state – openly and unashamedly – that they now consider it part of their mandate, if not the chief part of it, to keep asset prices at elevated levels
and, if possible, even boost them further.
Naturally, this will require
ever more aggressive money printing and eternally super-low interest
rates, and certainly argues against holding much paper money. Those who
like to bet on the bureaucrats may claim that it makes sense to hold the
very financial assets the prices of which central bankers are
manipulating. As long as the central bankers are not ashamed of running
the printing presses ever faster, they will simply get their way. Well,
even under the rosiest of assumptions, this argument does not support
investment in bonds. It could, in principle, be an argument for equities
and real estate as ‘real assets’ of a sort but even in respect to these
assets I consider it unsound, as I will explain later. Be that as it
may, the beauty of gold is precisely that it allows you to remain on the
sidelines and keep your powder dry. By holding gold you remove
your wealth to a considerable degree from the rigged game of
artificially inflated and openly manipulated financial markets.
You commit internal capital flight from the fiat money system, and you
simultaneously bet on the further debasement of paper money. The bet is
this: The central bankers are trapped. The state, the banks, the pension
funds, the insurance companies, the investment funds – they all would
be in a right mess – or an even deeper mess than they already are –
without cheap money from the central bank. Ergo, the policy of
super-cheap money will have to continue until the bitter end.
There are a few more things to say about gold but before I do this let us talk about the worst asset.
Bonds – the worst asset class in my view
Bonds are ideal assets for you if you suffer from a financial death wish. Let me put it like this: After 40 years of almost relentless and of late accelerating money production we have too much debt.
When you buy bonds you buy debt, and there is a lot of it to go around.
And it is not even cheap. In most cases, it is ridiculously expensive,
in particular when considering that most of it will never get repaid.
This is especially true of the sovereign bonds of major governments,
which are probably among the worst ‘assets’ on the planet, yet are
bizarrely still considered ‘safe haven’ assets, a ridiculous concept to
begin with. What are the prospects in the long run for government bonds?
Remember that most sovereign states are now credit-addicts, desperately
relying on low rates and cheap credit to fund their incurable spending
habits, and increasingly leaning on their central banks to provide the
daily fixes. If the central banks stop printing money and thus stop
funding the governments, they go broke. If the central banks keep funding the governments they will have to keep printing money, and this will certainly lead to higher inflation at some point, and that point may even be soon.
As an investor you will ultimately lose money through default or through inflation,
and if it is a hyperinflation there will be default at the end of the
hyperinflation. For the bond investor the choice is between death by
hanging and death by drowning.
If that sounds overly dramatic then ask yourself in what scenario you win or even get your money back.
Only if the present policies lead to a slow and steady return to
self-sustaining growth that is inflation-free and allows the central
banks to slowly and painlessly remove accommodation and deflate their
overgrown balance sheets, and if the political class then grows up and
gets sensible, departs from its free-spending ways, gets the fiscal
house in order, and starts paring back the debt.
Yeah, and pigs might fly!
That this scenario is evidently
the basis of much strategizing by professional money managers does not
say much about its soundness or even remote probability. It is
simply the scenario in which the financial industry comes out unscathed,
with its size, reputation and income-stream intact. It is also the one
scenario in which you need little money – neither paper money nor gold –
but can stay fully invested in equities, bonds and real estate, as the
rosy outlook of seamless crisis resolution and onwards growth forever
will ultimately justify today’s lofty valuations. This is the scenario
the financial industry favours and has an overwhelming desire to believe
in – as do all politicians, central bankers and assorted Keynesians and
other interventionists. Good luck to all of them! I fear this is wishful thinking rationalized with poor economics.
Every day that the markets are open the
US government borrows an additional $4billion, roughly. For 5 years
running the country’s budget deficits were considerably in excess of $1
trillion. Britain is among the world’s most highly indebted societies if
you combine private and public debt, and despite all the blather in the press about ‘austerity’, the public sector keeps going more into debt. Japan has long been a bug in search of a windshield.
Bond investors may counter that it is
all about the timing. Until death arrives, you collect coupons. – Well,
hardly. With yields for the bonds of major bankrupt nations now in the 1
to 2 percent range, if that much, there is, in my view, little point in
sitting on a gigantic powder keg and hoping the fuse is long enough. When this one blows, the fallout will be substantial.
Why are bonds not selling off?
As David Stockman has pointed out, much of the US Treasury market is not owned but rented.
The big primary dealers and many hedge funds hold government bonds as
trading positions funded with cheap money from the Fed. That is the true
reason for the Fed’s new communications policy. Ben Bernanke now goes
so far as to promise to keep rates and therefore the trading community’s
funding costs near zero, not only for the near-term, but even beyond
the tenure of his own chairmanship at the Fed. The goal is to make sure that these leveraged renters of Treasury debt stay engaged and help funding the state.
Then there are the big bureaucratic
asset management entities that have historically always provided a
reliable home for government bonds: insurance companies, pension funds,
sovereign wealth funds, foreign central banks. Built-in risk-aversion
and intellectual inertia are here working in support of over-valued bond
markets. Here, the big investment decisions are made by
committees of professional fund managers who are often in charge of
obscenely large amounts of money. To beat the market and
achieve superior returns is an objective located somewhere between the
hugely improbable and the completely impossible. They are destined to fail,
and in this position of nerve-shredding uncertainty they all cling to
the same straws: 1) do what everybody else does; 2) stick to what has
worked in the past; 3) stick to the industry’s assumed wisdom, such as
‘never fight the Fed’; ‘government bonds are safe assets because the
government can always pay’, and so forth. The last point has no basis in theory and history, and looks increasingly like a heroic assumption today, but that is the fund manager’s line and he is sticking with it.
That government bonds are a safe
investment can, of course, not be left a matter of simple opinion but
has to be enshrined in the laws of the land, and the state’s rapidly
expanding finance constabulary is already working on it. Via legislation and regulation, the state is busily building itself a captive investor base for its own debt.
The state regulates the banks and has
long been telling them that if they want to lend their money securely
they should give it to the state. Everywhere, state-imposed capital requirements for banks can best be met by buying government bonds.
The advantages are obvious: Spanish banks heavily increased their
exposure to ‘safe’ Spanish government bonds over the past year, from
about 13 percent of their balance sheets to 31 percent. And what is safe
for the banks is certainly safe for insurance companies, pension funds
and other ‘socially important’ pools of saving. ‘Capital controls’ is such a nasty term. Much nicer to call it ‘regulation’,
and the masses have now been sufficiently indoctrinated with the idea
that the financial crisis was caused by lack of ‘regulation’ so that the
state can now safely and calmly tighten the screws.
I fear that to a large degree this is even welcome by the asset management industry. In an unstable and increasingly uncertain world, being told what to buy lifts a great responsibility of one’s shoulders.
Although individually many money managers complain about stifling
restrictions and regulations, it is usually the case that any outsized
boom industry, when faced with the end of its boom, happily embraces
state involvement to avoid getting trimmed back by market forces too
harshly. Rather than seeing the return of the ‘bond vigilantes’ who
instilled fear and loathing in debtors in the 1970s and 1980s but who
roamed the financial landscape of a different age, one in which
grown-ups were still allowed to smoke in public, we will most likely be
treated to the sad spectacle of timid money mangers being herded into
officially sanctioned asset classes by the cocksure financial market
police.
All of the above may help explain why expensive assets may keep getting more expensive but these are, in the end, mitigating factors only that will, at the most, postpone the endgame but not change it.
One popular way to rationalize
investments in bonds is that they are deflation hedges. Whenever the
forces of liquidation and cleansing get the upper hand, bonds do well.
This may be the case in the short term but any extended period of deflationary correction must be poison for sovereign bonds
in particular: tax receipts will drop, non-discretionary state spending
will balloon, and credit risk will rise. The bond market’s pendulum of
doom will simply swing from the risk of higher inflation to the risk of
default.
Gold versus other ‘real assets’ (equities and real estate)
It is often argued that equities and real estate are also good inflation hedges, and I know many people who prefer them to gold. I see the rationale but disagree with the conclusion. Gold may no longer be cheap because
what I explain here has been a powerful force behind gold for a decade.
But I would argue that equities and real estate are in general much
more overvalued as the current financial infrastructure is designed to
channel new money into financial assets and real estate but not into
gold, and our financial infrastructure has been operating on these
principles for decades. How many people do you know who not only own
gold but bought it on loan from their bank? Now ask yourself the same
question with respect to real estate. – Gold is the great ‘under-owned’ asset. Its share in global portfolios is miniscule. It plays hardly any role in institutional asset management.
It is true that during deflationary
phases when the inflationary impetus from central banks slackens a bit
and the urge of the markets to liquidate comes to the fore again, gold
often sells off in sympathy with equities. But I believe that
any risk of a more extended period of deflationary correction poses a
much bigger problem for equities, and by extension real estate, than for
gold.
Additionally, ask yourself how equities
and real estate will fare in an inflationary crisis or a currency
catastrophe. Which companies will make money, pay dividends or even
survive? Which tenants, whether residential or commercial, will keep
paying the rent? I am not saying that all these equities and all the
real estate will become worthless – far from me to forecast a ‘Mad
Max’-style end of civilisation. It is indeed to be expected that certain
equities and select pieces of real estate will turn out to be decent
instruments for carrying wealth through the valley of tears, and for
coming out at the other end with one’s prosperity intact. But which
ones? It strikes me that the variance of outcomes is much
greater in these hugely heterogeneous, highly inflated and widely held
sectors than anything that can come from holding the eternal money and
homogenous commodity gold. If you consider any major economic
crisis, whether inflationary or deflationary, gold beats equities and
real estate in my book. (Equities and real estate are superior to bonds
and paper money, however, and this is why I listed them above as
potential holdings.)
Additionally, there is one aspect of
real estate investing that is, in my opinion, frequently overlooked or
underappreciated, and that is this one: Your property is like a marriage agreement with the local taxman, as my friend Tristan Geschex keeps reminding me. The War On Wealth is intensifying,
as are the fiscal problems of most states. Both go hand in hand. Real
estate is low-hanging fruit for the state, and taxation on it will most
certainly increase. What market value and rent-income your property will
manage to sustain through the vagaries of the crisis will most probably
be subjected to confiscatory taxation from a bankrupt state. The ownership of gold could potentially also be restricted or heavily taxed. This is certainly a risk.
But as I said, gold is still the under-owned asset, and there is still a
chance that you can find arrangements for your gold holdings that
lessen the tax implications. When the winds of change alter the
political landscape in your country of residence and bring the War On
Wealth to a cinema near you, you may still – if you are quick and lucky –
pack your things, take your gold and move somewhere else (as long as
they let you), maybe even obtain a different citizenship (as long as
they let you), but owning property means having nailed your wealth to the ground and having signed up for whatever the local purveyors of snake-oil (politicians) manage to sell your fellow voters.
Paper money versus gold
Under what scenario would paper money beat gold, i.e. would the paper-money-price of gold drop sharply? – The answer is clear, in my view: If
the central banks stopped the printing press and stopped depressing
interest rates artificially and fully accepted the consequences for
other asset classes and the economy. If the central banks
decided to defend the value of their paper money and credibly assigned a
greater importance to this objective than to the now dominant ones,
which are sustaining a mirage of solvency of banks and states, funding
the governments, propping up asset prices, and creating short-term
growth spurts.
The big gold bull market of the 1970s ended harshly in 1980, when then Fed-chairman Paul Volcker stopped the printing press,
let interest rates shoot up, and looked on as the economy slipped into
recession. The paper dollar enjoyed a revival and the gold price tanked.
My view is that this is exceedingly unlikely to happen today.
The global financial system is considerably more leveraged than it was
32 years ago, and presently much more dependent on never-ending cheap
money from the central bank. In 1980, the total debt of the US
government was less than $1 trillion, today the annual budget deficits
are bigger than that. The fallout from an end to free money would be huge, and most politicians would deem the consequences inacceptable.
Today, there are also no other strategies available that could cushion
the impact. In the early 1980s, then-president Reagan countered hard
money with an easy fiscal policy, and simply let the budget deficit
balloon throughout his tenure. Today, the bond market would be quickly
in trouble without support from the central bank, and the government
would soon face its very own Greece-moment.
But even if this were indeed to
happen, I think that gold would still do better than equities and real
estate, and certainly bonds, which would suffer hugely from
rapidly rising default risk. The deflationary correction is also a huge
threat to the over-stretched banking system, which means you may not
want to hold your paper money in form of bank deposits. Again, gold
seems to be a decent self-defence asset, even in this scenario.
How to own gold
Personally, I believe one should hold gold in physical form (bars and coins), not through ETFs, derivatives or gold accounts.
If one wants to have it held within the banking system (not ideal but
there could be reasons for it), one should insist on having it in
allocated form, that is, clearly allocated to one’s name and identified
by serial numbers. Or, have the gold delivered and keep it in a safety deposit at a bank.
Alternatively, there are now a number of specialised asset managers or
gold dealers around that offer storage facilities as well.
I think the risk of gold confiscation is small in most countries at present but things may change.
The risk of taxation on gold or restrictions on gold ownership is
somewhat higher. The safest places to hold gold are probably Switzerland
(still) and Singapore at present but if you live in the wrong place or
have the wrong passport, having your gold there may not protect you from
the long arm of your government when it begins to show interest in your
gold. It is no surprise that people who really care about their wealth,
which are often people who are very wealthy, now consider changing
residency and even changing citizenship as an important component of
their estate planning. The last time the US government
confiscated private gold, in April 1933, it only grabbed what was held
within the territory of the United States, and many people probably kept
their gold by simply burying it in the backyard. Believe me, the next time private property will be confiscated, the process will not be handled so amateurishly.
In any case, these are just my opinions. As I said, food for thought….
In the meantime, the debasement of paper money continues.