August 12, 2011

Tim Price Nails It Again

If you are not reading Tim Price's stuff, please start now:

Conventional thinking has it that the financial crisis began in September 2008 with the failure of Lehman Brothers. We believe that conventional thinking is missing the point. As economist Tim Lee of pi Economics indicated several years ago, subprime, for example, was never THE problem, it was merely the first and worst part of the debt edifice to collapse. The reality, we would suggest, is that the world is drowning in debt of dubious provenance which will never be paid back in full. Instead of addressing the debt burden, the politicians of the western economies (where most of this debt is sitting) have repeatedly tried to kick the can down the road, because they are more in thrall to the electoral calendar than to a day of reckoning they are trying to hospital-pass down to the next generation. At the same time, since 1971 the world’s central banks have operated to a purely fiat money system, in which currency is backed not by precious metal but by faith in government and nothing more. We believe that this experiment in unbacked currency may be moving to some form of ultimate resolution or recalibration. Having the US dollar as the global reserve currency is incompatible with having US Treasury bonds representing the de facto riskfree rate, given that the accumulated debt burden of the US is bigger than that of any other sovereign power, and is still expanding when it should be contracting. Meanwhile the euro zone for the last decade has attempted its own science project, of trying to operate a common currency bloc without full political or fiscal union. This is unworkable.

In supposedly ‘rescuing’ the banks by gifting their bad debts to the taxpayer, western governments merely converted a private sector solvency problem into a public sector solvency problem. Whereas banks were too big to fail, governments and their finances are now probably too big to save. The problem of debt service would have been problematic even if western economies were growing at something close to their pre-crisis rate, but with austerity having become the new black, it is now closer to being an existential problem eroding public confidence in both markets and money, because at near zero GDP growth, governments will soon struggle just to service their historic debts, let alone take out new ones or undertake new bail-outs, which we should perhaps call fail-outs, in that they are now predestined to fail.

It has taken just a few reported instances of sub-par growth in the western economies for the marginal investor to grasp the situation. It is not a subprime debt crisis or a euro zone debt crisis or a US debt crisis. It is a global sovereign debt crisis and since government bonds are the largest asset class in the world, there will inevitably be fall-out in other markets when a sufficient number of investors starts to appreciate that the emperor is wearing no clothes. Equity markets have been pumped up by otherwise ineffective money printing, given the spurious quasi-scientific gloss of quantitative easing, which has done precisely nothing to improve the economy on the ground. Investors have been conditioned to call for more, even as the process has been revealed to be an exercise in magical thinking, whereby temporarily boosted financial assets somehow mysteriously trickle down wealth into the real economy. Quantitative easing has one specific side-effect, which is to savage the currencies of whichever administration practises this dark art. Choose your poison. Global investors have a fairly limited choice: they can hold US dollars (with a reserve currency status that the Fed is doing its damnedest to destroy), or they can hold euros (a currency that may break apart if euro zone politicians continue to avoid taking hard choices, and with other people’s money). Rational investors have been voting in favour of harder currencies, in the form of gold, for roughly the last decade and the logic for that currency preference is as indisputable now as it ever has been. Gold is the premier stateless currency and is guaranteed to see its supply rise at a slower rate than that of any paper currency, which is what the trend of the last decade really represents. Other than gold and silver, investors have so far correctly identified the superior currencies of the world as stores of value on a relative basis, a club that includes the Japanese yen and the Swiss franc.

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