Gold’s day will come, but mar­kets are wrong to bet on wild in­fla­tion

A fresh bout of eco­nomic fear will trig­ger a spike in real yields and set off an ex­o­dus of cash from gold

The Daily Telegraph - Business - - Business Comment - AM­BROSE EVANSPRITC­HARD

Gold was “wrong” a decade ago. Prices surged to an all-time high on breath­less talk that dol­lar de­base­ment and pro­mis­cu­ous print­ing by the US Fed­eral Re­serve would ig­nite roar­ing in­fla­tion.

I still have a cur­rency note for 1,000,000,000 Zim­babwe dol­lars kindly sent to me by a reader at the height of the gold bug fever in 2011.

But the great in­fla­tion­ary blow-off never hap­pened. Those who held on to their gold bars with sa­cred con­vic­tion watched gold prices drop 40pc over the next three years, even as equities marched higher in the Ber­nankeDragh­i-Car­ney bull mar­ket.

The US dol­lar did not col­lapse. The Fed’s broad dol­lar in­dex touched bot­tom in May 2011 and then em­barked on a ver­tig­i­nous climb to a 30-year high. It was the Chi­nese yuan that in­stead ran into trou­ble, forc­ing the Peo­ple’s Bank to burn through

$1 tril­lion of for­eign re­serves to de­fend the cur­rency.

So, is it dif­fer­ent this time as gold closes in on $2,000 an ounce? Gold­man Sachs seems to think so, warn­ing clients that “real con­cerns around the longevity of the US dol­lar as a re­serve cur­rency have started to emerge”.

The ar­gu­ment is a mind-twist­ing para­dox. “Iron­i­cally, the greater the de­fla­tion­ary con­cerns that pol­i­cy­mak­ers must fight to­day, the greater the debt build-up and the higher the in­fla­tion­ary risks in the fu­ture,” it said. The bank fore­casts the gold price to hit $2,300 over the next 12 months. Are the hy­poth­e­sis, tim­ing, and se­quence cor­rect? Yes and no.

One can ar­gue that the global dol­lar sys­tem of the last half a cen­tury is in its death throes. There are echoes of the early Sev­en­ties when a com­pli­ant Fed ac­com­mo­dated the fis­cal over­reach of the Viet­nam War and the Great So­ci­ety, cul­mi­nat­ing in the in­fla­tion­ary col­lapse of the Bret­ton Woods sys­tem.

One can ar­gue too that the mis­han­dling of Covid-19 by the US (and Europe) has ac­cel­er­ated the shift in eco­nomic power to Asia, bring­ing for­ward a Chi­nese eco­nomic sor­passo by a decade. But be care­ful of in­stant im­pres­sions. It was said in 2008 that the Lehman cri­sis had taken the US down a few geostrate­gic pegs, ex­pos­ing the Achilles’ heel of the Amer­i­can model. China’s polit­buro cer­tainly reached that con­clu­sion and this tempted them into er­ror. They dou­bled-down on Lenin­ist cap­i­tal­ism, flat­tered by in­dis­crim­i­nate credit bub­bles. We now know that China suf­fered the greater struc­tural dam­age from the Lehman cri­sis, and the greater fall in pro­duc­tiv­ity growth.

The trig­ger for the lat­est jump in gold has been the spec­tac­u­lar fall in real 10-year US bond yields to mi­nus 0.92pc. In­fla­tion ex­pec­ta­tions are shoot­ing up, but at the same time the Fed is hold­ing down nom­i­nal rates by fi­nan­cial re­pres­sion.

“That is what has prompted the spec­u­la­tive moves over the last two weeks,” says Adrian Ash from Bul­lion Vault. “There is a sense of in­cip­i­ent in­fla­tion, and hedge funds are pil­ing in. You have also got pri­vate Swiss banks rec­om­mend­ing a 10pc al­lo­ca­tion in gold.”

Be­hind this move lies a pow­er­ful slower-mov­ing force. Cen­tral banks are no longer sell­ing gold. Gor­don Brown’s give-away sales of Bri­tish bul­lion seem ex­tra­or­di­nary now.

Rus­sia, China, In­dia and Turkey have been ac­cu­mu­lat­ing, but so have Poland, Hun­gary, Bul­garia and the Czechs. Cen­tral banks bought a net 656 tons in 2018 and another 650 in 2019, the high­est lev­els in 50 years. “It has been phe­nom­e­nal, but right now gold has got ahead of it­self and needs to catch its breath,” says Ross Nor­man from Met­als Daily.

Need­less to say, the Fed de­nies that it is de­bauch­ing the dol­lar, in­sist­ing that the Covid shock has left ram­pant over-ca­pac­ity and will be

“dis­in­fla­tion­ary” for years to come. Former Fed chair­man Ben Ber­nanke says mar­kets were wrong to bet on in­fla­tion when QE was first launched, and they are wrong now.

He has a point. Real rates col­lapsed in much the same way in 2012. It proved to be a false alarm. Equities did in­flate but con­sumer prices did not. In­fla­tion fell for the next three years. So the ques­tion is whether some­thing has changed in mon­e­tary dy­nam­ics since then.

Pro­fes­sor Tim Cong­don, from In­ter­na­tional Mon­e­tary Re­search, says QE did not catch fire last time be­cause the Western bank­ing sys­tem was bro­ken, and Basel reg­u­la­tion made mat­ters worse by forc­ing lenders to raise cap­i­tal buf­fers. Cen­tral banks had to ramp up QE to off­set the en­su­ing de­struc­tion of broad M3 money.

Lenders are now in bet­ter shape and the Fed’s $3 tril­lion (£2.3 tril­lion) blast of QE since March has led to a 27pc rise in M3 year on year, the fastest rise in the US money sup­ply since 1943. The money sits in bank ac­counts wait­ing for in­fla­tion­ary ig­ni­tion once life re­turns to nor­mal. The Fed could hoover up the liq­uid­ity be­fore this hap­pens but clearly has no in­ten­tion of do­ing so.

The Pow­ell Fed is openly aim­ing to “run the econ­omy hot” as an in­surance pol­icy. It faces pres­sure from Joe Bi­den and the Democrats to fight inequal­ity, de­ploy­ing stim­u­lus to close the wealth gap rather than driv­ing up as­set prices. The fis­cal pic­ture is in­fin­itely worse to­day than a decade ago. The In­ter­na­tional Mon­e­tary Fund fore­casts a fed­eral deficit of 24pc of GDP this year, lift­ing the debt ra­tio to 141pc. That es­ti­mate was be­fore the Covid-19 sec­ond wave caused the re­cov­ery to stall.

Fis­cal dom­i­nance now hov­ers like Ban­quo’s ghost in the Fed’s Board Room. There must be a pow­er­ful temp­ta­tion to dab­ble in Mod­ern Mon­e­tary The­ory and to start in­ject­ing QE stim­u­lus di­rectly into the veins of the US econ­omy. In­deed, I am sure this will even­tu­ally hap­pen.

What I doubt is that Re­ichs­bank mon­e­tary fi­nanc­ing of the US gov­ern­ment is im­mi­nent. Nor is it that easy to re­flate. The process can short-cir­cuit quickly if bond vig­i­lantes awaken from their slum­ber and take fright, pre­cip­i­tat­ing a credit crunch.

My pre­sump­tion is that the re­cov­ery will be slower and more painful than mar­kets ex­pect. The lat­est re­lief pack­ages on both sides of the At­lantic are too small and poorly de­signed to avert a creep­ing in­sol­vency cri­sis in the au­tumn. State and lo­cal gov­ern­ments in the US are be­ing forced into aus­ter­ity cuts.

If so, a fresh bout of eco­nomic fear will cause in­fla­tion ex­pec­ta­tions to fall again, trig­ger­ing a spike in real yields and set­ting off an in­stant ex­o­dus of hot money from gold.

So, yes, Gold­man Sachs is right in a sense. We have to re­visit the de­fla­tion­ary quag­mire one last time be­fore the Fed and fel­low cen­tral banks turn on the print­ing press as the lesser of pol­icy evils. Gold will have its day of glory but don’t jump the gun.

Gold­man Sachs fore­casts the gold price to hit $2,300 over the next 12 months

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