Wednesday, December 9, 2009

The Gold Bug decease

There is a lot of garbage on the internets about gold these days. Head over to ZeroHedge and, on a daily basis, the site has at least one post on the price of gold - and each post will generate well over a hundred responses from a dedicated army of gold bugs. Bloomberg has opinion pieces on the subject - generally more balanced, but with both perspectives on the subject. Financial analysts, hedgies and CNBC garbage cans all talk about the falling dollar and in the next breath will inevitably allude to gold one way or another. So I thought I'd jump on the bandwagon and offer a few words of wisdom: gold bugs are idiots.

1.  Gold as inflation hedge. As an empirical matter, gold used to offer passable protection from inflation, but really got messed up in the later part of the 20th century as the gold standard went by the way of the dodo. Here is a chart, shamelessly stolen, from here.

 Obviously, if gold were a perfect hedge, real price would be flat. It's not. Gold bugs will inevitably argue that there is a problem with CPI data sice it excludes the volatile energy and food prices (and the beginning of the 1977-1981 run-up in gold price correlates highly with the oil crisis back then, as does the run-up of late 2000s). That's all well and good of course, but as a consumer I don't live to buy oil - I only consume it in a form of gas, and it's not really all that much when you compare it to items like the rent or the cost of a car itself. Surely, from a consumer's perspective, no oil bubble justifies a runup in price of an "inflation hedge" so steep - and subsequent corrections bear that out.

2. Gold as an investment asset. Well, it's really an odd one. Empirically again, it's performance is not bad - but you really have to time it right to not get completely screwed over. And of course, there is no dividend stream or any income as such at all to compare gold to something like bonds or stocks. So it's hard to find a fundamental justification for the price of gold in this sense.

3. Gold as currency. This is a good one. Last time I checked, gold coins are not an accepted form of payment in supermarkets, gas stations, restaurants or event bordellos. Dollars - paper ones, or electronic ones - are. There are other currencies too, but none of them are gold, or are even convertible into gold.

 Gold bugs say that fiat currencies will collapse (because there is no check on the governments ability to print) and since gold can't be printed and its supply is rather steady, it's the only real currency out there, to which when the proverbial shit hits the fan, everyone will inevitably revert.  This ties into a theory of gold being a good financial armageddon protection (given that there has been few such events during modernity, this is a claim that is hard to confirm empirically). Let's examine this one a bit more closely.

There is no argument that gold used to be a currency. This has been true for much longer than any of the modern fiat currencies have been in existence, and, in fact, has been true during the bulk of western civilization's existence. But ultimately any currency is valuable only if many people believe that it's valuable. In other words, for a currency to function, people must believe in the system. Gold bugs expessly reject such belief in the current system, because... well, you know, the government is bad, helicopter Ben can print money at a push of a button and Timmy G and BO are in the pocket of Wallstreet.

But what eludes them is that if the current monetary system indeed collapses, there is absolutely no guarantee that the one that immediately preceded it will step up to take its place. Put another way, if the financial and economic armageddon does take place, why would one think that gold will suddenly be accepted as payment for bread? More fundamentally, what makes anyone think that there will be any bread to buy? There is actually recent empirical evidence to the contrary: in none of the countries that have undergone through massive currency devaluation and hyperinflation, e.g., the former Soviet bloc in the early 1990s, nobody even tried (or thought of trying) using precious metals as legal tender. And oh yes, there really was very little bread to actually buy. It sucked -- and gold reserves were of absolutely no help. What helped was having USD, which began to circulate in large quantities and in which anything that was of any importance was priced and measured. If dollars were unavailable, people would probably resort straight to barter. Thus, when shit hits the fan, that gold bar might buy you shelter for life, a loaf of bread for a day or anything in between, above or below - it'll take a while, if ever, before the bread/gold exchange rate settles down in the absense of actual currency.

5. Simple math/conclusion.  There is little to no fundamental demand for gold, as stated above. At present, it's price is therefore a factor of (1) the growth in money supply relative to the growth in the supply of gold and (2) how many people belive that gold has any value whatsoever. Factor (2) is what fuels speculative bubbles in gold. A belief that the price of gold will always increase requires a belief that either the government will keep printing money like crazy forever (demonstrably false) or that the number of people who believe that gold has value will increase.  The influence of factor (2) is not to be underestimated - and this really makes gold worse than anything else out there: if no one has faith in gold, it will become completely worthless. It's true that people could decide that the dollars aren't worth the paper they are printed on anymore. But, objectively, how much more likely is that to happen than the people deciding that gold is of no use or value to anybody - which is true, by the way - and you can't even wipe your ass with it?

If people are looking to invest in something that has constrained supply and therefore not subject to Fed's manipulations and something you can "store", they could look to precious metals with industrial uses, such as platinum or palladium, or, better yet, land/real estate. The latter, by the way, has a pretty fundamental value: so long as there are people, they will need a place to live. And if there are no people... well, who cares about capital preservation at that point? Of course, just as is the case with gold, real estate has proven to be succeptible to the problem of belief: when too many people start thinking that it will incraese in value, bubbles form, and one might get screwed. Still, one won't get screwed nearly as much as if one bought gold at $800+ per ounce in 1980. That was one horrible "store of value."

Tuesday, December 1, 2009

BoJ to provide emergency loans to banks

From Bloomberg:

The Bank of Japan said it will provide short-term loans to commercial banks amid pressure from Prime Minister Yukio Hatoyama’s administration to address falling prices and the yen’s surge to a 14-year high.
Thus, BoJ's key overnight rate just became also the 3-month rate.  At first blush, it's not totally apparent whether this will take the yen down a few notches as the Japanese exporters desperately need it to. The most direct way to achieve the desired result would be for BoJ to boost its QE program, as many others have observed. Today's move may give some boost to the Yen carry trade, but, at least as of today, not so much against the dollar: at quick check, 3-months T-bills are still yielding barely above zero at only 4 bps. To make the essentially riskless trade, an institution could borrow from BoJ at the advertised 0.1% and use the proceeds to buy the equivalent duration T-bills. At today's prices, however, such a trade is a still a losing one (to make any money at all, the 3-months treasury yields would need to be above 0.1%). 

The participant banks can be happy though - here is another way to make a lot of money through very little effort with such cheap 3-months financing. All you need is to find a higher yielding asset that qualifies as collateral for BoJ and bingo! There are still many, many sovereign nations whose 3-months debt yields more than that. Traders would need to try really, really hard to loose any money these days....

When is the madness going to stop? Why to ALL efforts to boost the economy are so focused on monetary stimilus these days - which first and foremost result in banks making more money.